**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 thequarterly period ended March 31, 2008**

** **

**OR**

** **

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

** **

**For thetransition period from             to**

 

***Commission file number 000-52014***

 

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**Techwell, Inc.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address of principal executive office andzip code)

 

**(408)435-3888**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to filing requirements for the past90 days.     YES  x   NO  o

 

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

 

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

 

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

Yes o No x

 

As of April 30, 2008, 21,049,698 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  March 31, 2008 and December 31, 2007                 | 3        |
|                |                                                                                                     |     |
|                | Condensed Consolidated Statements of Operations for  the three months ended March 31, 2008 and 2007 | 4        |
|                |                                                                                                     |     |
|                | Condensed Consolidated Statements of Cash Flows for  the three months ended March 31, 2008 and 2007 | 5        |
|                |                                                                                                     |     |
|                | Notes to Condensed Consolidated Financial Statements                                                     | 6        |
|                |                                                                                                     |     |
| Item 2.             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations              | 13       |
|                |                                                                                                     |     |
| Item 3.             | Quantitative  and Qualitative Disclosures About Market Risk                                              | 23       |
|                |                                                                                                     |     |
| Item 4.             | Controls and  Procedures                                                                                 | 24       |
|                |                                                                                                     |     |
| PART II — | OTHER INFORMATION                                                                                        | 24       |
|                |                                                                                                     |     |
| Item 1.             | Legal Proceedings                                                                                        | 24       |
|                |                                                                                                     |     |
| Item  1A.           | Risk  Factors                                                                                            | 25       |
|                |                                                                                                     |     |
| Item 2.             | Unregistered  Sales of Equity Securities and Use of Proceeds                                             | 36       |
|                |                                                                                                     |     |
| Item 3.             | Defaults Upon  Senior Securities                                                                         | 36       |
|                |                                                                                                     |     |
| Item 4.             | Submission of  Matters to a Vote of Security Holders                                                     | 36       |
|                |                                                                                                     |     |
| Item 5.             | Other Information                                                                                        | 36       |
|                |                                                                                                     |     |
| Item  6.            | Exhibits                                                                                                 | 36       |
|                |                                                                                                     |     |
|                | Signatures                                                                                               | 37       |

 

 

2

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**PART I—FINANCIAL INFORMATION**

 

**Item 1.           ****Financial****Statements**

 

**TECHWELL, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(Unaudited)(In thousands, except share and per share amounts)**

** **

| ** **                                                                                                                                                                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                      | ** ** | **2008**           | ** ** | **2007**              | ** ** |
|                                                                                                                                                                                            |       |               |       |                  |       |
| **ASSETS**                                                                                                                                                                                      | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                                 |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                       |       | $                  | 35,902     |                  | $          | 27,177 |   |
| Short-term investments                                                                                                                                                                          |       | 21,248             |       | 33,384                |       |
| Total cash, cash equivalents and short-term investments                                                                                                                                         |       | 57,150             |       | 60,561                |       |
| Accounts receivable                                                                                                                                                                             |       | 2,161              |       | 2,095                 |       |
| Inventory                                                                                                                                                                                       |       | 5,309              |       | 4,753                 |       |
| Deferred income tax assets                                                                                                                                                                      |       | 1,823              |       | 2,016                 |       |
| Prepaid expenses and other current assets                                                                                                                                                       |       | 1,684              |       | 1,456                 |       |
| Total current assets                                                                                                                                                                            |       | 68,127             |       | 70,881                |       |
| Property and equipment, net                                                                                                                                                                     |       | 1,396              |       | 1,471                 |       |
| Long-term investments                                                                                                                                                                           |       | 14,028             |       | 7,839                 |       |
| Deferred income tax assets                                                                                                                                                                      |       | 3,671              |       | 3,419                 |       |
| Other assets                                                                                                                                                                                    |       | 141                |       | 127                   |       |
| Total assets                                                                                                                                                                                    |       | $                  | 87,363     |                  | $          | 83,737 |   |
|                                                                                                                                                                                            |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                   | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                                            |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                |       | $                  | 2,413      |                  | $          | 2,973 |   |
| Accrued liabilities                                                                                                                                                                             |       | 3,508              |       | 2,534                 |       |
| Total current liabilities                                                                                                                                                                       |       | 5,921              |       | 5,507                 |       |
| Deferred rent                                                                                                                                                                                   |       | 154                |       | 165                   |       |
| Total liabilities                                                                                                                                                                               |       | 6,075              |       | 5,672                 |       |
|                                                                                                                                                                                            |       |               |       |                  |       |
| 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;  21,001,356 shares and 20,889,349 shares issued and outstanding at  March 31, 2008 and December 31, 2007, respectively |       | 21                 |       | 21                    |       |
| Additional paid-in capital                                                                                                                                                                      |       | 74,960             |       | 73,454                |       |
| Deferred stock-based compensation                                                                                                                                                               |       | (101               | )          | (160                  | )          |
| Accumulated other comprehensive gain (loss)                                                                                                                                                     |       | (169               | )          | 44                    |       |
| Retained earnings                                                                                                                                                                               |       | 6,577              |       | 4,706                 |       |
| Total stockholders’ equity                                                                                                                                                                 |       | 81,288             |       | 78,065                |       |
| Total liabilities and stockholders’ equity                                                                                                                                                 |       | $                  | 87,363     |                  | $          | 83,737 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

 

3

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**TECHWELL, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)****(In thousands, except per share amounts)**

 

| ** **                                                       | ** ** | **Three  Months Ended** | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                       | ** ** | **March 31,**      | ** ** |
| ** **                                                       | ** ** | **2008**                | ** ** | **2007** | ** ** |
|                                                             |       |                    |       |   |   |
| Revenues                                                         |       | $                       | 15,607     |   | $ | 13,517 |   |
| Cost of revenues                                                 |       | 6,061                   |       | 5,791 |   |
| Gross profit                                                     |       | 9,546                   |       | 7,726 |   |
|                                                             |       |                    |       |   |   |
| Operating expenses:                                              |       |                    |       |   |   |
| Research and development                                         |       | 3,549                   |       | 2,215 |   |
| Selling, general and administrative                              |       | 3,692                   |       | 2,758 |   |
| Total operating expenses                                         |       | 7,241                   |       | 4,973 |   |
|                                                             |       |                    |       |   |   |
| Income from operations                                           |       | 2,305                   |       | 2,753 |   |
| Interest income                                                  |       | 755                     |       | 679 |   |
|                                                             |       |                    |       |   |   |
| Income before income taxes                                       |       | 3,060                   |       | 3,432 |   |
| Income tax provision                                             |       | 1,189                   |       | 968 |   |
| Net income                                                       |       | $                       | 1,871      |   | $ | 2,464 |   |
|                                                             |       |                    |       |   |   |
| Basic net income per share                                       |       | $                       | 0.09       |   | $ | 0.12 |   |
|                                                             |       |                    |       |   |   |
| Diluted net income per  share                                    |       | $                       | 0.09       |   | $ | 0.11 |   |
|                                                             |       |                    |       |   |   |
| Weighted average shares  used in computing net income per share: |       |                    |       |   |   |
| Basic                                                            |       | 20,926                  |       | 20,637 |   |
| Diluted                                                          |       | 21,821                  |       | 21,827 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

 

4

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**TECHWELL, INC.****CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)(In thousands)**

 

| ** **                                                                         | ** ** | **Three  Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                         | ** ** | **March 31,**      | ** ** |
| ** **                                                                         | ** ** | **2008**                | ** ** | **2007** | ** ** |
|                                                                               |       |                    |       |   |   |
| **Cash flows from operating  activities:**                                         | ** ** | ** **              | ** ** |   |   |
| Net income                                                                         |       | $                       | 1,871      |   | $ | 2,464 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                    |       |   |   |
| Depreciation and amortization                                                      |       | 180                     |       | 83 |   |
| Stock-based compensation                                                           |       | 1,457                   |       | 749 |   |
| Tax benefit from employee equity incentive plan                                    |       | 6                       |       | 655 |   |
| Deferred income tax                                                                |       | (59                     | )          | — |   |
| Changes in assets and liabilities:                                                 |       |                    |       |   |   |
| Accounts receivable                                                                |       | (66                     | )          | (105 | ) |
| Inventory                                                                          |       | (556                    | )          | 785 |   |
| Prepaid expenses and other current assets                                          |       | (228                    | )          | 177 |   |
| Other assets                                                                       |       | (14                     | )          | (64 | ) |
| Accounts payable                                                                   |       | (495                    | )          | (923 | ) |
| Accrued liabilities                                                                |       | (161                    | )          | (1,668 | ) |
| Accrued taxes                                                                      |       | 1,133                   |       | 113 |   |
| Deferred rent                                                                      |       | (11                     | )          | — |   |
| Net cash provided by operating activities                                          |       | 3,057                   |       | 2,266 |   |
| **Cash flows from investing  activities:**                                         | ** ** | ** **              | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                |       | (168                    | )          | (121 | ) |
| Purchases of investments                                                           |       | (14,363                 | )          | (20,291 | ) |
| Proceeds from maturities of investments                                            |       | 20,097                  |       | 19,331 |   |
| Net cash provided by (used in) investing activities                                |       | 5,566                   |       | (1,081 | ) |
| **Cash flows from financing  activities:**                                         | ** ** | ** **              | ** ** | ** ** | ** ** |
| Proceeds from exercise of stock options                                            |       | 102                     |       | 290 |   |
| Net cash provided by financing activities                                          |       | 102                     |       | 290 |   |
| Net increase in cash and  cash equivalents                                         |       | 8,725                   |       | 1,475 |   |
| Cash and cash equivalents  at beginning of period                                  |       | 27,177                  |       | 13,201 |   |
| Cash and cash equivalents  at end of period                                        |       | $                       | 35,902     |   | $ | 14,676 |   |
|                                                                               |       |                    |       |   |   |
| **Supplemental cash flow  information — income tax paid**                     |       | $                       | —     |   | $ | — |   |
|                                                                               |       |                    |       |   |   |
| **Supplemental disclosure of  non-cash investing and financing activities:**       |       |                    |       |   |   |
| Accrued equipment purchase costs                                                   |       | $                       | (62        | ) | $ | 8 |   |
| Reversal of deferred stock-based compensation for cancellation of  stock options   |       | $                       | 49         |   | $ | 30 |   |
| Increase (decrease) in other comprehensive income                                  |       | $                       | (213       | ) | $ | 6 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

 

5

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**TECHWELL, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

 

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

 

***The Company***

 

Techwell, Inc.(“Techwell” or the “Company”) was incorporated in California on March 7,1997 and reincorporated in Delaware on March 30, 2006. The Company is afabless semiconductor company that designs, markets and sells mixed signalintegrated circuits for multiple video applications in the securitysurveillance, automotive, consumer and PC markets.

 

TheCompany’s international offices include branch offices in South Korea andTaiwan and subsidiaries in China and Japan. These offices provide marketingsupport to customers. The South Korea and Japan offices are also involved inproduct development.

 

***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 consolidatedbalance sheet at December 31, 2007 has been derived from the auditedconsolidated financial statements as of and for the year then ended. Certaininformation and disclosures normally included in financial statements preparedin accordance with accounting principles generally accepted in the UnitedStates of America have been condensed or omitted in accordance with these rules andregulations. The information in this report should be read in conjunction withthe Company’s consolidated financial statements and notes thereto included inits Annual Report on Form 10-K for the year ended December 31, 2007.

 

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 months ended March 31,2008 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2008 or for any other future period.

 

***Principlesof Consolidation and Year End***

*** ***

The condensed consolidated financial statementsinclude the accounts of the Company and its subsidiaries. All significantintercompany transactions and balances 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 condensed consolidated financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom these estimates.

 

***CertainSignificant Risks and Uncertainties***

*** ***

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

 

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***Fair Value of Financial Instruments***

 

Ourfinancial instruments consist principally of cash equivalents, short-term andlong-term marketable securities. Marketable securities are comprised ofavailable-for-sale securities that are reported at fair value with the relatedunrealized gains and losses included in accumulated other comprehensive income(loss), a component of shareholders’ equity, net of tax. Pursuant to SFAS No. 157,*Fair Value Measurement*, orSFAS No. 157, the Company adopted the provisions of SFAS No. 157effective January 1, 2008, which defines fair value, establishes aframework for measuring fair value and expands disclosures about fair valuemeasurements required under other accounting pronouncements. SFAS No. 157clarifies that fair value is an exit price, representing the amount that wouldbe received to sell an asset or paid to transfer a liability in an orderlytransaction between market participants. SFAS No. 157 also requiresthat a fair value measurement reflect the assumptions market participants woulduse in pricing an asset or liability based on the best information available.Assumptions include the risks inherent in a particular valuation technique(such as a pricing model) and/or the risks inherent in the inputs to the model.

 

***Accumulated Other Comprehensive Loss***

 

Accumulated other comprehensive loss consists of netunrealized losses on available-for-sale investments. The change in unrealizedlosses on investments, net of tax, was an increase of $0.2 million in the threemonths ended March 31, 2008 and a reduction of $6,000 in the three monthsended March 31, 2007.

 

**Note 2.****Stock-BasedCompensation**

 

TheCompany has equity incentive plans (“Plans”) under which it may grant stockoptions, restricted stock awards, stock units and stock appreciation rights toemployees, consultants and directors. At March 31, 2008, the total numberof shares available for issuance under the Plans is 1,830,729. Stock optionsand awards granted under the Plans may have a contractual term up to ten years,generally vest over four years at the rate of 25 percent on the one-yearanniversary of the vesting commencement date and ratably each month thereafterand are exercisable under conditions determined by the Board as permissibleunder the terms of the Plans. At March 31, 2008, 18,334 shares exercisedprior to vesting are subject to repurchase by the Company.

 

Effective January 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(revised 2004), *Share-Based Payment*,(“SFAS No. 123(R)”) which requires the measurement and recognition ofcompensation expense for all share-based payment awards made to employees anddirectors, including employee stock options, based on estimated fair valuesrecognized over the requisite service period. Prior to the adoption of SFAS No. 123(R),the Company accounted for stock-based compensation awards issued to itsemployees using the intrinsic value measurement provisions of AccountingPrinciples Board Opinion No. 25 (“APB Opinion No. 25”), *Accounting for Stock Issued to Employees*.

 

The Company adopted SFAS No. 123(R) usingthe prospective transition method. Under this method, SFAS No. 123(R) isapplied to new awards and to awards modified, repurchased or cancelled afterthe adoption date of January 1, 2006. Compensation cost previouslyrecorded under APB Opinion No. 25 for awards outstanding at the adoptiondate, such as unvested options, continues to be recognized as the options vest.Accordingly, for the three months ended March 31, 2008 and 2007,stock-based compensation expense includes compensation cost related toestimated fair values of awards granted after the date of adoption of SFAS No. 123(R) andcompensation costs related to unvested awards at the date of adoption based onthe intrinsic values as previously recorded under APB Opinion No. 25.

 

The following table summarizes the distribution of stock-basedcompensation expense (in thousands):

 
| ** **                             | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **March 31,**               | ** ** |
| ** **                             | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Cost of revenues                       |       | $                                | 113        |   | $ | 45 |   |
| Research and development               |       | 693                              |       | 318 |   |
| Selling, general and administrative    |       | 871                              |       | 386 |   |
| Related tax effect                     |       | (598                             | )          | (158 | ) |
| Total stock-based compensation expense |       | $                                | 1,079      |   | $ | 591 |   |

 

 

7

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Totalcompensation cost attributable to activities capitalized into inventory was notsignificant in all periods presented. Stock-based compensation expense in thethree months ended March 31, 2008 and 2007 includes $5,000 and $0,respectively, for immediately vested options granted to consultants.

 

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

 

**Note 3.****NetIncome per Share**

 

TheCompany calculates net income per share in accordance with SFAS No. 128, *Earnings Per Share.* Under SFAS No. 128,basic net income per share is calculated by dividing net income by the weightedaverage number of common stock shares outstanding during the period excludingshares subject to repurchase. Diluted net income per share reflects the effectsof potentially dilutive securities, which consist of common stock options,restricted stock awards and common stock subject to repurchase.

 

A reconciliation of shares used in the calculationof basic and diluted net income per share is as follows (in thousands):

 
| ** **                                            | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|
| ** **                                            | ** ** | **March 31,**     | ** ** |
| ** **                                            | ** ** | **2008**               | ** ** | **2007** | ** ** |
|                                                  |       |                   |       |   |   |
| Weighted average common shares outstanding            |       | 20,949                 |       | 20,690 |   |
| Weighted average shares subject to repurchase         |       | (23                    | )          | (53 | ) |
| Shares used to calculate basic net income per share   |       | 20,926                 |       | 20,637 |   |
| Effective of dilutive securities                      |       |                   |       |   |   |
| Restricted stock awards                               |       | 24                     |       | 2 |   |
| Common stock options                                  |       | 871                    |       | 1,  188 |   |
| Diluted potential common stock                        |       | 895                    |       | 1,190 |   |
| Shares used to calculate diluted net income per share |       | 21,821                 |       | 21,827 |   |

 

# **Note 4. Income Taxes**

# ** **

TheCompany accounts 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 taxexpense together with assessing temporary differences resulting from differingtreatments of items for tax and accounting purposes. These differences resultin deferred tax assets and liabilities. Significant management judgment is requiredto assess the likelihood that its deferred tax assets will be recovered fromfuture taxable income. As of March 31, 2008, the Company’s total deferredtax assets were principally comprised of net operating loss carryforwards,research and othercredit carryforwards, stock-based compensation, and other accruals.

 

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 other foreign jurisdictions.

 

The Company’s effective tax rate is based on theestimated annual effective tax rate in accordance with SFAS No. 109. Inthe three months ended March 31, 2008 and 2007, the effective tax ratediffered from the statutory federal income tax rate primarily because of theimpact of state income taxes.

 

**Note 5.Financial Instruments**

 

TheCompany’s investments are considered available-for-sale and primarily consistof corporate bonds, US government agency securities, commercial paper andauction rate securities, or ARS. These securities other than ARS are carried atfair market value based on market quotes. The ARS investments are intended toprovide liquidity via an auction process that resets the applicable interest rateat predetermined calendar intervals, allowing investors to either roll overtheir holdings or gain immediate liquidity by selling such interests at par.The recent uncertainties in the credit markets have affected all of the Company’sholdings in ARS investments and auctions for the Company’s investments in thesesecurities have failed to settle on their respective settlement dates.Consequently, the investments are not currently liquid and the Company will notbe able to access these funds until a future auction

 

8

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ofthese investments is successful or a buyer is found outside of the auctionprocess. All of the ARS investments were investment grade quality and were incompliance with the Company’s investment policy at the time of acquisition. TheCompany currently has the ability and intent to hold these ARS investmentsuntil a recovery of the auction process or until maturity. As of March 31,2008, the Company reclassified the entire ARS investment balance fromshort-term investments to long-term investment on its condensed consolidatedbalance sheet because of the Company’s inability to determine when itsinvestments in ARS would settle.

 

EffectiveJanuary 1, 2008, the Company adopted the provisions of Statement ofFinancial Accounting Standards No. 157 (SFAS No. 157) “Fair ValueMeasurements”, which defines fair value, establishes a framework for measuringfair value and expands disclosures about fair value measurements required underother accounting pronouncements. SFAS No. 157 clarifies that fair value isan exit price, representing the amount that would be received to sell an assetor paid to transfer a liability in an orderly transaction between marketparticipants. SFAS No. 157 also requires that a fair valuemeasurement reflect the assumptions market participants would use in pricing anasset or liability based on the best information available. Assumptions includethe risks inherent in a particular valuation technique (such as a pricingmodel) and/or the risks inherent in the inputs to the model. The adoption ofSFAS No. 157 on our assets and liabilities did not have a significantimpact on our financial statements.

 

SFAS No. 157establishes a fair value hierarchy that prioritizes the inputs to valuationtechniques used to measure fair value. The hierarchy gives the highest priorityto unadjusted quoted prices in active markets for identical assets orliabilities (Level 1 measurements) and the lowest priority to unobservableinputs (Level 3 measurements). The three levels of the fair valuehierarchy under SFAS No. 157 are described below:

 

Level1: Quoted prices (unadjusted) in active markets that are accessible at themeasurement date for assets or liabilities. The fair value hierarchy gives thehighest priority to Level 1 inputs.

 

Level2: Observable prices that are based on inputs not quoted on active markets, butcorroborated by market data.

 

Level3: Unobservable inputs are used when little or no market data is available. Thefair value hierarchy gives the lowest priority to Level 3 inputs.

 

Afinancial instrument’s level within the fair value hierarchy is based on thelowest level of any input that is significant to the fair value measurement.

 

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

 

As of March 31,2008, the Company had $6.8 million of auction rate securities, the fair valueof which has been measured using Level 3 inputs. These ARS are collateralizedmostly with Student Loan Auction Rate Certificates. The monthly auctions havehistorically provided a liquid market for these securities. The ARS in theCompany’s portfolio had successful auctions until January 2008 and assuch, their fair value would have been measured using Level 1 inputs at January 1,2008. However, since February 2008, there has not been a successfulauction in that there were insufficient buyers for these ARS, therefore theCompany transferred them from Level 1 to Level 3 category as of March 31,2008.

 

The Company has used adiscounted cash flow model to determine the estimated fair value of itsinvestment in ARS as of March 31, 2008. The assumptions used in preparingthe discounted cash flow model include estimates for interest rates, estimatesfor discount rates using yields of comparable traded instruments adjusted forilliquidity and other risk factors, amount of cash flows and expected holdingperiods of the ARS. These inputs reflect the Company’s own assumptions aboutthe assumptions market participants would use in pricing the ARS, includingassumptions about risk, developed based on the best information available inthe circumstances. Based on this assessment of fair value, as of March 31,2008, the Company determined there was a decline in the fair value of its ARSinvestments of approximately $0.3 million, which was deemed temporary as the Company currentlyhas the ability and intent to hold these ARS investments until a recovery ofthe auction process or until maturity. As of March 31, 2008, the Companyreclassified the entire ARS investment balance from short-term investments tolong-term investments on its condensed consolidated balance sheet because ofthe Company’s belief that it will take longer than one year for its investmentsin ARS to settle.

 

9

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The fair value decline inARS of approximately $0.3 million was recorded as anunrealized loss reported in a separate component of stockholders’ equity andincluded in accumulated other comprehensive loss as of March 31, 2008.Realized gains and losses are recorded based on the specific identificationmethod and are not significant in any period presented. The change inunrealized losses on investments, net of tax, in the three months ended March 31,2008 and 2007, was an increase of $0.2 million and a reduction of $6,000,respectively.

 

Fairvalue measurements of financial assets carried at fair value as of March 31,2008 are classified in the table below in one of the three categories describedabove (in thousands):

 
| ** **                | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|---------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds        |       | $           | 32,834     |        | $          | —      |       | $         | —     |   | $ | 32,834 |   |
| Corporate bonds           |       | 17,282      |       | —      |       | —      |       | 17,282    |       |
| Municipal bonds           |       | 1,000       |       | —      |       | —      |       | 1,000     |       |
| Commercial paper          |       | 10,199      |       | —      |       | —      |       | 10,199    |       |
| Auction rate securities   |       | —      |       | —      |       | 6,795       |       | 6,795     |       |
| Total                     |       | $           | 61,315     |        | $          | —      |       | $         | 6,795      |   | $ | 68,110 |   |
| Amount included in:       |       |        |       |        |       |        |       |      |       |
| Cash and cash equivalents |       | $           | 32,834     |        | $          | —      |       | $         | —     |   | $ | 32,834 |   |
| Short-term investments    |       | 21,248      |       | —      |       | —      |       | 21,248    |       |
| Long-term investments     |       | 7,233       |       | —      |       | 6,795       |       | 14,028    |       |
| Total                     |       | $           | 61,315     |        | $          | —      |       | $         | 6,795      |   | $ | 68,110 |   |

 

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

 
| ** **                                                   | ** ** | **Total** | ** ** |
|--------------------------------------------------------------|------------|-----------|------------|
| Beginning balances as of  January 1, 2008               |       | $         | —     |   |
| Total unrealized gains  (loss) included in accumulated other |       |      |       |
| comprehensive gain (loss)                                    |       | (305      | )          |
| Transfer in and/or out of  Level 3                           |       | 7,100     |       |
| Ending balances as of  March 31, 2008                   |       | $         | 6,795      |   |

 

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

 

**Inventory**(in thousands):

 
| ** **      | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------|------------|-------------------------|------------|---------------------------------|------------|
| Finished goods  |       | $                       | 3,134      |                            | $          | 3,194 |   |
| Work in process |       | 2,175                   |       | 1,559                           |       |
|            |       |                    |       |                            |       |
|            |       | $                       | 5,309      |                            | $          | 4,753 |   |

 

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

 
| ** **                                      | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Equipment                                       |       | $                       | 1,768      |                       | $          | 1,727 |   |
| Software                                        |       | 587                     |       | 546                        |       |
| Furniture and fixtures                          |       | 284                     |       | 279                        |       |
| Leasehold improvements                          |       | 432                     |       | 414                        |       |
|                                            |       |                    |       |                       |       |
|                                            |       | 3,071                   |       | 2,966                      |       |
| Less accumulated  depreciation and amortization |       | (1,675                  | )          | (1,495                     | )          |
|                                            |       |                    |       |                       |       |
|                                            |       | $                       | 1,396      |                       | $          | 1,471 |   |

 

 

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**Accruedliabilities**(in thousands):

 
| ** **                           | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Accrued compensation                 |       | $                       | 830        |                       | $          | 1,008 |   |
| Accrued inventory purchases          |       | 357                     |       | 461                        |       |
| Customer advances                    |       | 442                     |       | 280                        |       |
| Taxes payable                        |       | 1,337                   |       | 204                        |       |
| Accrued tape out expenses            |       | 41                      |       | 158                        |       |
| Legal and professional services fees |       | 108                     |       | 116                        |       |
| Exercise of unvested stock options   |       | 50                      |       | 62                         |       |
| Other                                |       | 343                     |       | 245                        |       |
|                                 |       |                    |       |                       |       |
|                                 |       | $                       | 3,508      |                       | $          | 2,534 |   |

 

**Note 7. Segment Information**

 

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

 

The percentage of total revenues by geographiclocation are as follows:

 
| ** **    | ** ** | **Three Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|
| ** **    | ** ** | **March 31,**               | ** ** |
| ** **    | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Taiwan        |       | 34                               | %          | 44 | % |
| South Korea   |       | 30                               |       | 33 |   |
| China         |       | 28                               |       | 19 |   |
| Japan         |       | 6                                |       | 2 |   |
| United States |       | 1                                |       | 1 |   |
| Other         |       | 1                                |       | 1 |   |
| Total         |       | 100                              | %          | 100 | % |

 

Revenuesby product line are as follows (in thousands):

 
| ** **               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|
| ** **               | ** ** | **2008**                              | ** ** | **2007** | ** ** |
| Security Surveillance(1) |       | $                                     | 11,609     |   | $ | 8,908 |   |
| Video Decoders(2)        |       | 2,112                                 |       | 2,639 |   |
| LCD Display(3)           |       | 1,697                                 |       | 1,607 |   |
| Other(4)                 |       | 189                                   |       | 363 |   |
| Total                    |       | $                                     | 15,607     |   | $ | 13,517 |   |

----

| (1)    | Consists of application  specific products designed for use in security surveillance systems.                                                                                                                                                                                                                                                     |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                              |
| (2)    | Consists of video  decoders designed for use in the security surveillance, automotive and  consumer markets. Revenues from video decoders used in security surveillance  systems and liquid crystal display, or LCD displays, are reported under the  video decoder product line and not the security surveillance or LCD display  product lines. |
|   |                                                                                                                                                                                                                                                                                                                                              |
| (3)    | Consists of application  specific products designed for use in LCD displays.                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                              |
| (4)    | Consists of contract  development projects, early generation mixed signal semiconductors for  digital video applications and a PCI video decoder product.                                                                                                                                                                                         |

 

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

 
| **Country**   | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|---------------|------------|-------------------------|------------|---------------------------------|------------|
| United States |       | $                       | 1,136      |                            | $          | 1,187 |   |
| Taiwan        |       | 62                      |       | 67                              |       |
| South Korea   |       | 26                      |       | 39                              |       |
| China         |       | 39                      |       | 45                              |       |
| Japan         |       | 133                     |       | 133                             |       |
|          |       |                    |       |                            |       |
| Total         |       | $                       | 1,396      |                            | $          | 1,471 |   |

 

The revenues and accounts receivable from customersrepresenting 10% or more of total revenues and accounts receivable are asfollows:

 
| ** **   | ** ** | **Accounts Receivable at** | ** ** | **Revenues**          | ** ** |
|--------------|------------|---------------------------------|------------|-----------------------|------------|
| ** **   | ** ** | ** **                      | ** ** | ** **            | ** ** | **Three Months Ended** | ** ** |
| ** **   | ** ** | **March 31,**              | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
| **Customer** | ** ** | **2008**                        | ** ** | **2007**              | ** ** | **2008** | ** ** | **2007** | ** ** |
| A            |       | 14                              | %          | 14                    | %          | 27 | % | 16 | % |
| B            |       | *                               |       | 28                    |       | * |   | 13 |   |
| C            |       | 13                              |       | 19                    |       | * |   | * |   |
| D            |       | 11                              |       | *                     |       | 13 |   | * |   |
| E            |       | 11                              |       | *                     |       | * |   | * |   |
| F            |       | 10                              |       | *                     |       | * |   | * |   |
| G            |       | 10                              |       | *                     |       | * |   | * |   |
| H            |       | *                               |       | *                     |       | * |   | 10 |   |

----

* less than 10%

 

# **Note 8. RelatedParty Transactions**

# ** **

Oneof the Company’s Board members is a partner in a law firm that provides legalservices to the Company. The Company incurred fees of $9,000 and $6,000 fromthis law firm for legal services in the three months ended March 31, 2008and 2007, respectively. The amount payable to this law firm was $4,000 at March 31,2008 and December 31, 2007. This Board member also receives compensationin accordance with the Company’s compensation program for non-employeedirectors.

 

**Note 9. Recent AccountingPronouncements**

 

In September 2006,the FASB issued SFAS No. 157,*FairValue Measurements*, which defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. This statement appliesto other accounting pronouncements that require or permit fair valuemeasurements, the FASB having previously concluded in those accountingpronouncements that fair value is the relevant measurement attribute.Accordingly, this Statement does not require any new fair value measurements.SFAS No. 157 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007. However, on February 12, 2008, theFASB issued SFAS No. 157-2 which delays the effective date of SFAS No. 157for all nonfinancial assets and nonfinancial liabilities, except those that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). SFAS No. 157-2 partially defers theeffective date of SFAS No. 157 to fiscal years beginning after November 15,2008, and interim periods within those fiscal years for items within the scopeof this FASB Staff Position. Effective January 1, 2008, the Companyadopted SFAS No. 157 for financial assets and liabilities recognizedat fair value on a recurring basis except as it applies to those nonfinancialassets and nonfinancial liabilities as noted in SFAS No. 157-2. Thepartial adoption of SFAS No. 157 did not have a material impact on theconsolidated financial positions, results of operations or cash flows.

 

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*, to permit all entities to choose to elect,at specified election dates, to measure eligible financial instruments at fairvalue, to report unrealized gains and

 

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losses on items for whichthe fair value option has been elected in earnings at each subsequent reportingdate, and recognize upfront costs and fees related to those items in earningsas incurred and not deferred. An entity is prohibited from retrospectivelyapplying SFAS No. 159, unless it chooses early adoption. SFAS No. 159is effective as of the beginning of the first fiscal year that begins after November 15,2007. Effective January 1, 2008, the Company adopted SFAS No. 159.The adoption of SFAS No. 159 did not have a material impact on theconsolidated financial positions, results of operations or cash flows.

 

In June 2007, theEITF reached a consensus on Issue No. 07-3, *Accounting for Nonrefundable Advance Payments for Goods or ServicesReceived to Be Used in Future Research and Development Activities*.Nonrefundable advance payments for goods or services that will be used orrendered for future research and development activities should be deferred andcapitalized. Such amounts should be recognized as an expense as the relatedgoods are delivered or the services are performed, or when the goods orservices are no longer expected to be provided. This Issue is effective forfiscal years beginning after December 15, 2007, and earlier application isnot permitted. Effective January 1, 2008, the Company adopted EITF No. 07-3.The adoption of EITF No. 07-03 did not have a material impact on theconsolidated financial positions, results of operations or cash flows.

 

**ITEM 2.          Management’s Discussion and Analysis of Financial Conditionand 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 March 31,2008 and our audited consolidated financial statements for the year ended December 31,2007 included in our Annual Report on Form 10-K.*

 

*This Report contains forward-looking statements thatinvolve risks and uncertainties. These statements relate to future periods,future events or our future operating or financial plans or performance. Thesestatements can often be identified by the use of forward-looking terminologysuch as “expects,” “believes,” “intends,” “anticipates,” “estimates,” “plans,” “may,”or “will,” or the negative of these terms, and other similar expressions. Theseforward-looking statements include statements as to the source of our revenues,our ability to generate revenues, our ability to sustain our growth rate andprofitability, our expectation regarding the increase in certain expenses, ourcash needs, our capital requirements, our market risk sensitivity, our businessand product strategies, our anticipated tax rate, our intention to addintegrated audio functionality to our video decoders, industry trends and ouranticipation that developments in our technologies and new products willincrease our target market share.*

 

*These forward-looking statements reflect our currentviews with respect to future events are based on assumptions and are subject torisks and uncertainties. These risks and uncertainties could cause actualresults to differ materially from those projected and include, but are notlimited to, fluctuations in our revenue and operating results, the demand fordigital video applications for the security surveillance, automotive andconsumer markets, our ability to compete, our dependence on key and highlyskilled personnel, the ability to develop new products and to enhance ourexisting products, the continued seasonality of our business due to our targetmarkets and location of our customers, our ability to integrate businesses thatwe may acquire, our ability to estimate and predict customer demand, economicvolatility in either domestic or foreign markets, the impact of any change inUnited States federal income tax laws and the loss of any beneficial taxtreatment that we currently enjoy, our reliance on independent foundries andsubcontractors for the manufacture, assembly and testing of our products, thelength of our sales cycle and reliance on distributors, our ability to protectour intellectual property, the cyclical nature of the semiconductor industry,our ability to raise capital, the potential volatility of our stock, theoutcome of future litigation and the risks set forth under PART II — OTHERINFORMATION, Item 1A. “Risk Factors.” Given these risks and uncertainties, youshould not place undue reliance on these forward-looking statements. Except asrequired by federal securities laws, we undertake no obligation to update anyforward-looking statements for any reason, even if new information becomesavailable or other events occur in the future.*

 

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

 

*Techwell is our registeredtrademark. We also refer to trademarks of other corporations and organizationsin 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 security surveillance,automotive, consumer and PC markets. We target video applications based on digitaltechnologies that receive and process analog video signals. These videoapplications include security surveillance systems, in-car LCD displays,advanced TVs, multifunction LCD monitors, camcorders, DVD recorders and TVtuner cards. These applications receive analog video signals commonly generatedby surveillance cameras, by consumer electronics devices such as set-top boxes,DVD recorders, VCRs and camcorders, and to a lesser extent by over-the-air TVbroadcasts. We design application specific products that enable the conversionof analog video sources to digital form and perform advanced digital videoprocessing to facilitate the display, storage and transport of video content.We believe this product strategy allows us to better address varying customerrequirements, fully leverage our technology capabilities and achieve greatershare within our target markets. Our semiconductors are based on ourproprietary architecture and mixed signal technologies that we believe providehigh video quality under a wide range of signal conditions, enable high levelsof integration and are cost effective.

 

Wecommenced operations in 1997. From 1997 to 1999, we were primarily involved indeveloping our technology. We shipped our first generation video decoder in1999. Since 1999, our business has experienced significant growth primarily asa result of our ability to develop new products, obtain design wins and convertthese design wins into revenues. We generated revenues from the sale of over 25different products in the quarter ended March 31, 2008.

 

We design, market andsell mixed signal semiconductor products that enable the conversion of analogvideo signals to digital form and perform advanced digital video processing tofacilitate the display, storage and transport of video content. Historically,we classified our initial products as general purpose products in that theyserviced multiple markets. In the process of supplying products to thesemarkets we developed specific knowledge regarding the requirements for eachmarket. We then determined that we would concentrate our development efforts onvideo applications in the security surveillance, automotive, consumer and PCmarkets. Today, our application specific products include products specificallydesigned for security surveillance systems, LCD displays primarily for theautomotive market and video decoders used in consumer products. We intend tocontinue to develop new generations of products for each of these applicationspecific product lines.

 

Oursecurity surveillance products integrate important functions required todisplay, store and transport analog video signals from security surveillancecameras. For example, we integrate multiple video decoders into a singlesemiconductor.  As a result, thissemiconductor is able to receive and decode analog video signal from multiplecameras into a standard digital format. In addition, we integrate a multiplexer, a key technology required tocombine multiple video signals into a single video signal. In 2007, we introduced our mostintegrated security surveillance product, which includes four video decodersand a system controller and a multiplexer on a single semiconductor. We alsohave developed a motion JPEG, or MJPEG, encoder/decoder, or CODEC, thatfacilitates the storage and playback of video from a hard disk drive andtransport of video over the Internet. We currently sell oursecurity surveillance products to customers for the followingapplications:  embedded digital videorecorders, or DVRs, PC-based DVRs, network video recorders, or NVRs andmultiplexers.

 

OurLCD display products integrate important functions required to display popularanalog video, high definition video and PC graphics signals on an LCD display.These key functions include a video decoder, deinterlacer and scaler.  In addition, our newer generation LCD displayproducts integrate a timing controller to interface directly with certain typesof LCD display and image enhancement functionality to improve overall videoquality.  In January 2008, we announcedthe introduction of five new LCD display processors designed for the automotivemarkets. These new products are designed to provide advanced image processing,an integrated programmable timing controller and multiple analog and digitalvideo inputs.

 

Ourvideo decoder products are high-performance mixed signal semiconductors thatdecode analog TV broadcast signals, including National Television SystemsCommittee, or NTSC, phase alternation line, or PAL, and sequential color withmemory, or SECAM, and popular analog video signals, including composite,S-Video, component and Syndicate of Radio and Television Manufacturers, orSCART, into a standard digital format. Our video decoder products integrate proprietary syncprocessing, color demodulating and digital 2D and 3D comb filtering, which arethe key technologies required for high performance video decoding. We offer abroad range of video decoder products at various price points and with varyingfeatures. We currently sell our video decoder products to customers across thefollowing digital video applications: advanced TV, multifunction LCD monitor,DVD recorder, camcorder, security surveillance systems and in-car LCD display.

 

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Althoughour revenues 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 security surveillance, automotive andconsumer 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.

 

Weundertake significant product development efforts well in advance of a product’srelease, and in advance of receiving purchase orders from our customers. Ourproduct development efforts, which are focused on developing new designs withbroad demand and potential for future derivative products, typically take fromsix months 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 24 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.

 

Asa fabless semiconductor company, we outsource all of our manufacturing,assembly and test functions to third-party vendors primarily located in Taiwan.This business model enables us to reduce our capital expenditures and fixedcosts, while focusing our engineering and design resources on our corestrength, the design of mixed signal semiconductors for digital videoapplications.

 

Wesell our products to a limited number of distributors that fulfill third-partyorders for our products. We also sell directly, using independent salesrepresentatives, to original equipment manufacturers, or OEMs, such as Samsungand LG Electronics, which have historically been some of our largest customers,and to original design manufacturers, or ODMs.  In 2007, we derivedapproximately 77% of our revenues from products sold to distributors and 23%from products sold to OEMs or ODMs. In the three months ended March 31,2008, we derived approximately 73% of our revenues from products sold to distributorsand 27% 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 79% and 78% of our revenues from our ten largestcustomers in the three months ended March 31, 2008 and 2007,respectively.  In the three months ended March 31,2008, two of our customers accounted for 27% and 13% of our revenues, thelarger of which was a distributor. In the three months ended March 31,2007, three of our customers, all of which are distributors, accounted for 16%,13% and 10% of our revenues, respectively.

 

Wederive substantially all of our revenues from sales to foreign customers,particularly in Asia, which sales accounted for approximately 98% of ourrevenues in both the three months ended March 31, 2008 and 2007. The tablebelow indicates the percentage of total revenue by geographic location for theperiods indicated:

 
| ** **  | ** ** | **Three Months Ended** | ** ** |
|-------------|------------|----------------------------------|------------|
| ** **  | ** ** | **March 31,**               | ** ** |
| ** **  | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Taiwan      |       | 34                               | %          | 44 | % |
| South Korea |       | 30                               |       | 33 |   |
| China       |       | 28                               |       | 19 |   |
| Japan       |       | 6                                |       | 2 |   |
| Other       |       | 2                                |       | 2 |   |
| Total       |       | 100                              | %          | 100 | % |

 

 

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Webelieve that a substantial majority of our revenues will continue to come fromcustomers located in Asia, where most of the electronic devices that use oursemiconductors are manufactured. As a result of this regional customer concentration,we may be subject to economic, cultural and political events and otherdevelopments that impact our customers in Asia. All of our sales currently aredenominated in U.S. dollars. Therefore, an increase in the value of the U.S.dollar relative to foreign currencies could make our products less competitivein international markets. Substantially all of our cost of revenues and amajority of our operating expenses are also denominated in U.S. dollars. As aconsequence, we believe that our overall exposure to foreign exchange risk islow.

 

Wehave international branches in South Korea and Taiwan and we have subsidiariesin China and Japan. At March 31, 2008, 59 of our 147 employees werelocated in our international offices. These offices provide marketing supportto our customers. Our South Korea and Japan offices also perform productdevelopment activities.

 

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

 

Generally,the average selling price of our products will decline over the life of theproduct. Our experience to date is that the decline has not had a materialeffect on our gross margins, as price reductions have been mitigated by lowerper unit costs associated with both high unit volume and the transition of ourproducts to smaller process geometries. 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. Inaddition, a significant number of our semiconductors are sold to customerslocated in Asia, primarily to customers located in regions who observe theLunar New Year holiday. Typically, our customers are closed for a week or moreduring the extended holiday period, which negatively impacts our business. As aresult of seasonality associated with the consumer market and our customerconcentration in Asia, we expect our revenues to lower in the first calendarquarter of each year.

 

Ourrevenues increased by 15% for the three months ended March 31, 2008compared to the three months ended March 31, 2007 and our net incomedecreased to $1.9 million for the three months ended March 31, 2008 from$2.5 million for the three months ended March 31, 2007 primarily due toincreased stock compensation and income tax expenses. Our revenues increased by11% for the year ended December 31, 2007 compared to the year ended December 31,2006 and our net income before income taxes decreased to $14.2 million for theyear ended December 31, 2007 from $14.5 million for the year ended December 31,2006 primarily due to increased compensation related expenses, tape-outexpenses, and expenses associated with the expansion of our foreign offices. Wemay not be able to maintain our recent growth and profitability and our limitedoperating history makes the prediction of future operating results verydifficult. We believe that period-to-period comparisons of operating resultsshould not be relied upon as predictive of future performance.

 

***Critical Accounting Policies***

 

Ourdiscussion and analysis of our financial condition and results of operationsare based upon our condensed consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amount of assets,liabilities, revenues and expenses and related disclosure of contingent assetsand liabilities. We evaluate our estimates on an on-going basis, includingthose related to inventory valuations, income taxes, warranty obligations,stock-based compensation and valuation of investments of which some of theseinvestments such as auction rate securities do not have observable marketquotes. We base our estimates on historical experience and on various otherassumptions 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.

 

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Webelieve the following critical accounting policies affect our more significantjudgments used in the preparation of our condensed consolidated financialstatements.

 

*Revenue Recognition.  * Revenues fromproduct sales are recognized upon shipment, provided that title and risk ofloss has passed to the customer, persuasive evidence of an arrangement exists,the price is fixed or determinable and collectibility is probable. We do notallow for price protection or stock rotation rights with any of our distributors.If we change our practice and allow stock rotation or price protection in thefuture, we would 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 replacementwarranty against any defective product. We accrue for estimated returns ofdefective products at the time revenue is recognized, based on the rate ofreturn from our historical experience. As a consequence of standardizedmanufacturing processes and product testing procedures, returns of defectiveproduct are infrequent and the quantities have not been significant.Accordingly, historical warranty costs have not been significant in the fiscalperiods presented. If our future experience with warranty costs differssignificantly from our historical experience, we would need to exerciseincreased judgment in determining the appropriate warranty accrual.

 

*FairValue Measurements.*  Effective January 1,2008, the Company adopted the provisions of Statement of Financial AccountingStandards No. 157 (SFAS No. 157) “Fair Value Measurements”, whichdefines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements required under otheraccounting pronouncements.  SFAS No. 157clarifies that fair value is an exit price, representing the amount that wouldbe received to sell an asset or paid to transfer a liability in an orderlytransaction between market participants. SFAS No. 157 also requiresthat a fair value measurement reflect the assumptions market participants woulduse in pricing an asset or liability based on the best information available.Assumptions include the risks inherent in a particular valuation technique(such as a pricing model) and/or the risks inherent in the inputs to the model.The adoption of SFAS No. 157 on our assets and liabilities did not have asignificant impact on our financial statements.

 

*Inventory Valuation.  * Inventory isvalued at the lower of cost or market, computed on a first-in, first-out basis.We evaluate inventory for excess and obsolescence and write-off units that areunlikely to be sold based upon a six months’ demand forecast. This evaluationmay take into account matters including expected demand, anticipated salesprice, product obsolescence and other factors. If actual future demand for ourproducts is less than currently forecasted, additional inventory adjustmentsmay be required. Once a reserve is established, it is maintained until theproduct to which it relates is sold or scrapped. If a unit that has beenwritten down or off is subsequently sold, the cost associated with the revenuefrom this unit is reduced to the extent of the write-off, resulting in anincrease in gross profit.

 

*Accounting for Income Taxes.  * We account forincome taxes under the provisions of Statement of Financial Standards, or SFAS No. 109,*  Accountingfor Income Taxes*. In applying SFAS No. 109, we are required toestimate our current tax expense together with assessing temporary differencesresulting from differing treatments of items for tax and accounting purposes.These differences result in deferred tax assets and liabilities. We must assessthe likelihood that our deferred tax assets will be recovered from futuretaxable income and to the extent we believe that recovery is not likely, wemust establish a valuation allowance. Significant management judgment isrequired to assess the likelihood that our deferred tax assets will berecovered from future taxable income. At March 31, 2008, our totaldeferred tax assets were principally comprised of net operating losscarryforwards, research and other credit carryforwards, stock-basedcompensation expenses and expense accruals.

 

Asrequired under the provisions of SFAS No. 109, we assess therecoverability of our deferred tax assets.     To assess the likelihood that the deferred tax assets will be recoveredfrom taxable income, we applied the guidance provided in SFAS No. 109 andconsidered both positive evidence that indicates a valuation allowance is notneeded and negative evidence that indicates a valuation allowance is needed. Asof March 31, 2008, we believe that our continued and predictable strongearnings provides ample evidence that no valuation allowance is required atthis 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 theprovisions of Financial Accounting Standards Board Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes,* or FIN No. 48.  FIN No. 48clarifies the accounting for uncertainty 

 

17

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inincome taxes recognized in an enterprise’s financial statements in accordancewith SFAS No. 109*.*  As a result of the implementation of FIN No. 48, we recognized nomaterial adjustment to the January 1, 2007 balance of retainedearnings.  As of March 31, 2008, theCompany has unrecognized tax benefits of approximately $0.6 million but doesnot expect its unrecognized tax benefits to change significantly over the next12 months. We recognize interest related to unrecognized tax benefits inour income tax expense and penalties related to unrecognized tax benefits inour operating expenses. For the three months ended March 31, 2008, we didnot recognize any interest or penalties related to unrecognized tax benefits.

 

*Stock-Based Compensation.  * Effective January 1,2006, we adopted SFAS No. 123 (revised 2004),*Share-Based Payment*, or SFAS No. 123(R), whichrequires that we measure compensation expense for all share-based payment awardsmade to employees and directors, including employee stock options, based onestimated fair values and recognize that expense over the required serviceperiod. Prior to our adoption of SFAS No. 123(R), we accounted forstock-based compensation awards issued to our employees using the intrinsicvalue measurement provisions of Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,or Opinion No. 25.

 

Weadopted SFAS No. 123(R) using the prospective transition method.Under this method, SFAS No. 123(R) is applied to new awards and toawards modified, repurchased or cancelled after January 1, 2006.Compensation cost previously recorded under Opinion No. 25 for unvestedoptions will continue to be recognized as the required services are rendered.Accordingly, for the three months ended March 31, 2008 and 2007, stockbased compensation expense includes compensation costs related to estimatedfair values of awards granted after the date of adoption of SFAS No. 123(R) andcompensation costs related to unvested awards at the date of adoption based onthe intrinsic values as previously recorded under Opinion No. 25.

 

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

 

Thefair value of options granted after January 1, 2006 is estimated on thegrant date using the Black-Scholes option valuation model. Since our stock hasbeen actively traded for only a short period of time for the periods through2007, we used the simplified calculation of expected term described in StaffAccounting Bulletin No. 107 and volatility was based on an average of thehistorical volatilities of the common stock of several entities withcharacteristics similar to us. For the quarter ended March 31, 2008, weperformed a review of our assumptions using additional historical dataavailable to us. In the expected term assumption calculation, we started withour additional historical data as suggested by Staff Accounting Bulletin No. 107and adjusted the historical data for any changes in future expectations. Sincewe do not have any publicly traded options, we rely exclusively on historicalvolatility in the expected volatility assumption calculation. The risk-freerate is based on the U.S. Treasury yield curve in effect at the time of grantfor periods corresponding with the expected term of the option. The estimatedforfeiture rate is based on our historical forfeiture experience and isestimated at 10% for all periods presented.

 

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

 
| ** **              | ** ** | **Three Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **March 31,**               | ** ** |
| ** **              | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Expected term in years  |       | 4.28                             |       | 6.08 |   |
| Risk-free interest rate |       | 2.57                             | %          | 4.60 | % |
| Expected volatility     |       | 64.0                             | %          | 70.6 | % |
| Dividend yield          |       | 0                                | %          | 0 | % |

 

Compensation expense for restricted stock awards is determined usingthe fair value of Techwell’s stock on the date of the grant and is recognizedon a straight-line basis 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 in future periods primarily as a result of ouradoption of SFAS No. 123(R).

 

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***Resultsof Operations***

 

                The following table is derivedfrom our selected financial data and sets forth our historical operatingresults as a percentage of revenues for the periods indicated:

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                         | ** ** | **March 31,**               | ** ** |
| **Consolidated Statement of Operations Data:** | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Revenues                                                           |       | 100.0                            | %          | 100.0 | % |
| Cost of revenues*                                                  |       | 38.8                             |       | 42.8 |   |
| Gross margin                                                       |       | 61.2                             |       | 57.2 |   |
|                                                               |       |                             |       |   |   |
| Operating expenses:                                                |       |                             |       |   |   |
| Research and development*                                          |       | 22.7                             |       | 16.4 |   |
| Selling, general and administrative*                               |       | 23.7                             |       | 20.4 |   |
|                                                               |       |                             |       |   |   |
| Total operating expenses                                           |       | 46.4                             |       | 36.8 |   |
|                                                               |       |                             |       |   |   |
| Income from operations                                             |       | 14.8                             |       | 20.4 |   |
| Interest income                                                    |       | 4.8                              |       | 5.0 |   |
|                                                               |       |                             |       |   |   |
| Income before income taxes                                         |       | 19.6                             |       | 25.4 |   |
| Income taxes provision                                             |       | 7.6                              |       | 7.2 |   |
| Net income                                                         |       | 12.0                             | %          | 18.2 | % |

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| (*) | Percentages  include stock-based compensation. |
|-----|------------------------------------------------|

 

Thetable below indicates the percentage of stock-based compensation attributed toeach item as a percentage of revenues for the periods indicated:

 
| ** **                           | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **March 31,**               | ** ** |
| ** **                           | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                                 |       |                             |       |   |   |
| Cost of revenues                     |       | 0.7                              | %          | 0.3 | % |
| Research and development             |       | 4.4                              |       | 2.4 |   |
| Selling, general and  administrative |       | 5.6                              |       | 2.9 |   |

 

***Revenues by product lineare as follows (in thousands):***

 
| ** **               | ** ** | **Three Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|
| ** **               | ** ** | **March 31,**               | ** ** |
| ** **               | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Security Surveillance(1) |       | $                                | 11,609     |   | $ | 8,908 |   |
| Video Decoders(2)        |       | 2,112                            |       | 2,639 |   |
| LCD Display(3)           |       | 1,697                            |       | 1,607 |   |
| Other(4)                 |       | 189                              |       | 363 |   |
| Total                    |       | $                                | 15,607     |   | $ | 13,517 |   |

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| (1)    | Consists of application  specific products designed for use in security surveillance systems.                                                                                                                                                                                                                            |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                     |
| (2)    | Consists of our video  decoders designed for use in the security surveillance, automotive and  consumer markets. Revenues from video decoders used in security surveillance  systems and LCD displays are reported under the video decoder product line  and not the security surveillance or LCD display product lines. |
|   |                                                                                                                                                                                                                                                                                                                     |
| (3)    | Consists of application  specific products designed for use in LCD displays.                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                     |
| (4)    | Consists of early  generation mixed signal semiconductors for digital video applications and PCI  video decoder products.                                                                                                                                                                                                |

 

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**Comparisons of the Three Months Ended March 31,2008 and 2007**

 

*Revenues.*    Ourrevenues consist of sales of our mixed signal integrated circuits for digitalvideo applications. We have three principal product lines: securitysurveillance, LCD display and video decoder. All of our sales are denominatedin U.S. dollars.

 

Revenueswere $15.6 million for the three months ended March 31, 2008 and $13.5million for the three months ended March 31, 2007, an increase of 15%.Revenues from our security surveillance products increased approximately $2.7million or 30% in the three months ended March 31, 2008 compared to the three months ended March 31, 2007, primarily as aresult of the increase in sales of our integrated four-in-one-video decoderproducts. Revenues from of our LCD display products increased slightlyby approximately $0.1 million or 6% in the three months ended March 31,2008 compared to the three months ended March 31,2007, primarilyas a result of continuing demands in the automotive market of vehiclesinstalled with in-car LCD displays that utilize our product. Revenuesfrom video decoder products decreased approximately $0.5 million or 20% in thethree months ended March 31, 2008 compared to thethree months ended March 31, 2008, primarilyas a result of a general decrease in demand from our target markets forproducts utilizing video decoders such as multi-function monitors and DVDrecorders. Other revenues decreased $0.2 million or 48% in the threemonths ended March 31, 2008 compared with thethree months ended March 31, 2007, primarily as a result of decreasedsales of our PCI video decoder products.

 

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

 

Gross profit was $9.6 million for the three months ended March 31,2008 and $7.7 million for the three months ended March 31, 2007, anincrease of 24%. Gross margin was 61% forthe three months ended March 31, 2008 increasing from 57% for the threemonths ended March 31, 2007.The increase in gross profit was primarily due to an increase in revenue of$2.1 million or 15%. The increase in gross margin was primarily a result of reduced materialcosts partially attributable to increased volume purchases and the transition of our products to lower process geometries in thefirst quarter of 2008 compared to the first quarter of 2007.

 

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 March 31,2008 and 2007, respectively.

 

*Research and Development.*    Researchand development expenses consist primarily of compensation and associated costsof employees 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 attributable to new product development may causeour research and development expenses to fluctuate because they are notincurred uniformly every quarter. We expect our research and developmentcosts to increase in absolute dollars in 2008 as we increase our investment indeveloping new products.

 

Researchand development expenses were $3.5 million, or 23% of revenues, for the threemonths ended March 31, 2008 and $2.2 million or 16% of revenues for thethree months ended March 31, 2007, an increase of 60%.  This increase was primarily due to increasedcompensation related expenses of approximately $1.2 million in salary andbenefits associated with new hires in the U.S. and the opening of our Japanoffice in mid-2007 to support product development efforts, and an increase of$0.4 million of stock-based compensation expense. Tape-out expenses for thethree months ended March 31, 2008 decreased by $0.2 million compared tothe three months ended March 31, 2007 primarily from an increase of $0.6million expenses to support increased development effort, and offset by a $0.4million credit received from one of our vendors that recalculated our maskcosts that resulted in a cost reduction for goods and services we previouslypaid.

 

Weincurred stock-based compensation expense associated with research anddevelopment personnel of $0.7 million and $0.3 million in the three monthsended March 31, 2008 and 2007, respectively.

 

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*Selling,General and Administrative.*    Selling, general and administrative expenses consistprimarily of compensation and associated costs for marketing, selling andadministrative personnel, sales commissions to independent salesrepresentatives, contractor compensation, public relations, promotional andother marketing expenses, insurance and fees paid for professional services,travel, depreciation expenses and occupancy costs. Costs associated with auditand tax services, corporate governance and compliance and financial reportingare also included in selling, general and administrative expenses.

 

Selling, general and administrative expenses were $3.7million, or 24% of revenues, for the three months ended March 31, 2008 and$2.8 million, or 20% of revenues, for the three months ended March 31,2007, an increase in absolute dollars of 34%.The increase in expensewas primarily dueto increasedsalary-related expenses of approximately $0.3 million associated with new hiresto support the expansion of our subsidiary in China and the opening of ourJapan office in mid-2007, and $0.5 million in stock-basedcompensation expenses. We expect selling, general and administrative expensesto continue to increase in the future in support of our anticipated growth as we hireadditional personnel, expand our sales and marketing efforts and pay increasedsales commissions based on a projected increase in sales volume. Administrativeexpenses will also increase to cover additional costs associated withoperating as a public company, such as growth in our informationtechnology infrastructure.

 

Weincurred stock-based compensation expense associated with selling, general andadministrative personnel of $0.9 million and $0.4 million in the threemonths ended March 31, 2008 and 2007, respectively.

 

*Interest Income.*    Interestincome was $0.8 million for the three months ended March 31, 2008 and $0.7million for the three months ended March 31, 2007, an increase of 11%. Theincrease was primarily due to higher cash, cash equivalent and investmentbalances primarily as a result of our income from operations. This was offsetby a decrease in our short-term investments resulting from the sale ofapproximately $6.0 million in these investments in order to reduce our holdingsin auction rate securities, as well as lower interest rates earned on ourshort-term investments in the three months ended March 31, 2008.

 

*IncomeTaxes.*    Ourprovision for income taxes was $1.2 million for the three months ended March 31,2008 and $1.0 million for the three months ended March 31, 2007. The effectivetax rate for both periods differed from the statutory federal income tax rateprimarily because we utilized prior net operating losses to offset profits in2007 and in 2008 due to the impact of state income taxes. 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 totake advantage of the available tax planning strategies and the availability oftax credits. As a result of these factors, our effective tax rate increased toapproximately 39% in the three months ended March 31, 2008 fromapproximately 28% in the three months ended March 31, 2007.

 

***Liquidityand Capital Resources***

*** ***

Since our inception, wehave financed our growth primarily with proceeds from the issuance of preferredstock and common stock and our cash flows from operations.  Our cash, cash equivalents and short-terminvestments were $57.2 million as of March 31, 2008.

 

Net cash provided byoperating activities was $3.1 million in the three months ended March 31,2008. The net cash provided by our operating activities in the three monthsended March 31, 2008 was primarily due to our net income of$1.9 million and an increase of accrued liabilities of $1.0 millionprimarily attributable to income taxes payable, as well as non-cash chargesfrom stock-based compensation expenses of $1.5 million.  These were partially offset by increases ininventory of $0.6 million and prepaid expenses of $0.2 million and a decreasein accounts payable of $0.5 million due to the timing of payments to vendors.

 

Net cash provided byoperating activities was $2.3 million in the three months ended March 31,2007. The net cash provided by our operating activities in the three monthsended March 31, 2007 was primarily due to our net income of $2.5 million,a reduction in inventory of $0.8 million associated with increased sales ofexisting products and a decrease in prepaid expenses and other current assetsof $0.2 million related to excess tax benefits from stock-basedcompensation. The net cash provided by our operating activities was offset by adecrease in accounts payable and accrued liabilities of $2.5 millionprimarily related to a reduction in accrued compensation, an increase inaccounts receivable of $0.1 million attributable to the timing of customercollections and an increase in other assets of $0.1 million attributable to newdeposits. We incurred non-cash expenses of $0.7 million for stockcompensation 

 

21

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expenses and$0.1 million in depreciation expense in the three months ended March 31,2007. We also recognized a tax benefit of $0.7 million attributable to ourequity incentive plans.

 

Net cash provided by ourinvesting activities was $5.6 million in the three months ended March 31,2008 due to the maturities of our investments of $20.1 million offset bypurchases of short and long-term investments of $14.4 million and capitalexpenditures of $0.2 million.

 

Net cash used in ourinvesting activities was $1.1 million in the three months ended March 31,2007 reflecting purchases of short and long-term investments of $20.3 millionand purchases of capital equipment of $0.1 million offset by maturities ofshort and long-term investments of $19.3 million.

 

Net cash provided byfinancing activities of $0.1 million in the three months ended March 31,2008 and $0.3 million in the three months ended March 31, 2007 primarilyconsisted of proceeds from the exercise of stock options.

 

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

 

At March 31, 2008,we held approximately $6.8 million of investments, classified as long-termassets, with an auction reset feature, which are referred to as “auction ratesecurities”, whose underlying assets are generally student loans which aresubstantially backed by the federal government. The carrying value of ourinvestment in these auction rate securities has been valued lower than theirpar value of $7.1 million as of March 31, 2008.  The loss was recorded as anunrealized loss reported in a separate component of stockholders’ equity andincluded in accumulated other comprehensive loss. Our holdings of auction rate securities decreased from$11.6 million at December 31, 2007 due to successful sales of severalauction rate securities at the carrying value in the first quarter of 2008. In February andMarch of 2008, auctions failed for our auction rate securities, and thereis no assurance that currently successful auctions on the other auction ratesecurities in our investment portfolio will continue to succeed. Our ability toliquidate our investment and fully recover the carrying value of our investmentin the near term may be limited or not exist and as a result we have classifiedthese investments as long-term. An auction failure means that the partieswishing to sell securities could not. All of our auction rate securities,including those subject to the failure, were rated AAA at the time of purchase,the highest rating, by a rating agency. If the issuers of these securities areunable to successfully close future auctions and their credit ratingsdeteriorate, we may in the future be required to record an impairment charge onthese investments. We believe that theunderlying credit quality of the assets backing our auction rate securitieshave not been impacted by the reduced liquidity of these investments. We arecontinuing to evaluate the credit quality, classification and valuation of ourauction rate securities; however, we are not yet able to quantify the amount ofimpairment, if any, or change in classification in these investments at thistime. Based on our expected operating cash flows, and our other sourcesof cash, we do not anticipate the potential lack of liquidity on theseinvestments will affect our ability to execute our current business plan.

 

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

 

***Off-Balance Sheet Arrangements***

 

As of March 31,2008, we have no off-balance sheet arrangements as defined in Item 303(a)(4) ofthe Securities and Exchange Commission’s Regulation S-K.

 

** *Contractual Obligations***

 

The following table identifies our commitments tosettle contractual obligations as of March 31, 2008:

 
| ** **                | ** ** | **Payment Due by Period** | ** ** |
|---------------------------|------------|---------------------------|------------|
| ** **                | ** ** | ** **                | ** ** | **Less than 1** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                | ** ** | **Total**                 | ** ** | **year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** |
|                      |       |                      |       |   |   |   |   |   |   |
| Minimum lease commitments |       | $                         | 1,490      |   | $ | 475 |   | $ | 731 |   | $ | 284 |   |
| Purchase commitments      |       | 2,713                     |       | 2,713 |   | — |   | — |   |
| Total commitments         |       | $                         | 4,203      |   | $ | 3,188 |   | $ | 731 |   | $ | 284 |   |

 

 

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***RecentAccounting Pronouncements***

 

In September 2006,the FASB issued SFAS No. 157,*FairValue Measurements*, which defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. This statement appliesto other accounting pronouncements that require or permit fair valuemeasurements, the FASB having previously concluded in those accountingpronouncements that fair value is the relevant measurement attribute.Accordingly, this Statement does not require any new fair value measurements.SFAS No. 157 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007. However, on February 12, 2008, theFASB issued SFAS No. 157-2 which delays the effective date of SFAS No. 157for all nonfinancial assets and nonfinancial liabilities, except those that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). SFAS No. 157-2 partially defers theeffective date of SFAS No. 157 to fiscal years beginning after November 15,2008, and interim periods within those fiscal years for items within the scopeof this FASB Staff Position. Effective January 1, 2008, the Companyadopted SFAS No. 157 for financial assets and liabilities recognizedat fair value on a recurring basis except as it applies to those nonfinancialassets and nonfinancial liabilities as noted in SFAS No. 157-2. Thepartial adoption of SFAS No. 157 did not have a material impact on theconsolidated financial positions, results of operations or cash flows.

 

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*, to permit all entities to choose to elect,at specified election dates, to measure eligible financial instruments at fairvalue, to report unrealized gains and losses on items for which the fair valueoption has been elected in earnings at each subsequent reporting date, andrecognize upfront costs and fees related to those items in earnings as incurredand not deferred. An entity is prohibited from retrospectively applying SFAS No. 159,unless it chooses early adoption. SFAS No. 159 is effective as of the beginningof the first fiscal year that begins after November 15, 2007. Effective January 1,2008, the Company adopted SFAS No. 159. The adoption of SFAS No. 159did not have a material impact on the consolidated financial positions, resultsof operations or cash flows.

 

In June 2007, theEITF reached a consensus on Issue No. 07-3, *Accounting for Nonrefundable Advance Payments for Goods or ServicesReceived to Be Used in Future Research and Development Activities*.Nonrefundable advance payments for goods or services that will be used orrendered for future research and development activities should be deferred andcapitalized. Such amounts should be recognized as an expense as the relatedgoods are delivered or the services are performed, or when the goods or servicesare no longer expected to be provided. This Issue is effective for fiscal yearsbeginning after December 15, 2007, and earlier application is notpermitted. Effective January 1, 2008, the Company adopted EITF No. 07-3.The adoption of EITF No. 07-03 did not have a material impact on theconsolidated financial positions, results of operations or cash flows.

 

**ITEM 3.****          Qualitative and QuantitativeDisclosure about Market Risk**

 

Theprimary objectives 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.

 

At March 31, 2008,we held approximately $6.8 million of investments, classified as long-termassets, with an auction reset feature, which are referred to as “auction ratesecurities”, whose underlying assets are generally student loans which aresubstantially backed by the federal government. The carrying value of ourinvestment in these auction rate securities has been valued lower than theirpar value of $7.1 million as of March 31, 2008.  The loss was recorded as an unrealizedloss reported in a separate component of stockholders’ equity and included inaccumulated other comprehensive loss. Our holdings of auction rate securities decreased from$11.6 million at December 31, 2007 due to successful sales of several auctionrate securities at the carrying value in the first quarter of 2008. In February andMarch of 2008, auctions failed for our auction rate securities, and thereis no assurance that 

 

23

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currently successfulauctions on the other auction rate securities in our investment portfolio willcontinue to succeed. Our ability to liquidate our investment and fully recoverthe carrying value of our investment in the near term may be limited or notexist and as a result we have classified these investments as long-term. Anauction failure means that the parties wishing to sell securities could not.All of our auction rate securities, including those subject to the failure,were rated AAA at the time of purchase, the highest rating, by a rating agency.If the issuers of these securities are unable to successfully close futureauctions and their credit ratings deteriorate, we may in the future be requiredto record an impairment charge on these investments. We believe that the underlying credit quality of the assets backing ourauction rate securities have not been impacted by the reduced liquidity ofthese investments. We are continuing to evaluate the credit quality,classification and valuation of our auction rate securities; however, we arenot yet able to quantify the amount of impairment, if any, or change inclassification in these investments at this time. Based on our expectedoperating cash flows, and our other sources of cash, we do not anticipate thepotential lack of liquidity on these investments will affect our ability toexecute our current business plan. We believe our existing cash balances, aswell as cash expected to be generated from operating activities, will besufficient to meet our anticipated cash needs for at least the next12 months.

 

Todate, our international customer agreements have been denominated solely inU.S. dollars, and accordingly, we have not been exposed to foreign currencyexchange rate fluctuations from customer agreements, and do not currentlyengage in foreign currency hedging transactions. However, the functionalcurrency of our operations in Taiwan, South Korea, Japan and China is the U.S.dollar and our local accounts are maintained in the local currency in Taiwan,South Korea, Japan and China, respectively, and thus we are subject to foreigncurrency exchange rate fluctuations associated with remeasurement to U.S.dollars. Such fluctuations have not been significant historically and webelieve that a 10% change in exchange rates would not have a significant impacton our operating expenses.

 

**ITEM 4.          Controls and Procedures**

 

(a) ***  Evaluation of disclosurecontrols and procedures.***   We maintain “disclosurecontrols and procedures,” as such term is defined in Rule 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”),that are designed to ensure that information required to be disclosed by us inreports that we file or submit under the Exchange Act is recorded, processed,summarized, and reported within the time periods specified in Securities andExchange Commission rules and forms, and that such information isaccumulated and communicated to our management, including our chief executiveofficer and chief financial officer, as appropriate, to allow timely decisionsregarding required disclosure. In designing and evaluating our disclosurecontrols and procedures, management recognized that disclosure controls andprocedures, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the disclosurecontrols and procedures are met. Our disclosure controls and procedures havebeen designed to meet the reasonable assurance standards. Additionally, indesigning disclosure controls and procedures, our management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible disclosure controls and procedures. The design of any disclosurecontrols and procedures also is based in part upon certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions.

 

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

 

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

 

**PART II—OTHER INFORMATION**

 

**ITEM 1.****          LegalProceedings**

 

We arecurrently not a party to any other material legal proceedings. We may from timeto time become involved in litigation relating to claims arising from ourordinary course of business. These claims, even if not meritorious, couldresult in the expenditure of significant financial and managerial resources.

 

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**ITEM 1A.****       RiskFactors**

 

Ifany of the following risks actually occur, our business, results of operationsand financial condition could suffer significantly.

 

**Risks Related to Our Business**

 

***Fluctuations in our revenue and operatingresults on a quarterly basis could cause the market price of our common stockto decline.***

 

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

 

| · | unpredictable  volume and timing of customer orders, which are not fixed by contract but  vary on a purchase order basis;            |
|--------|--------------------------------------------------------------------------------------------------------------------------------------|
| · | uncertain  demand in the consumer market for LCD display products;                                                                   |
| · | the  loss of one or more of our customers, causing a significant reduction or  postponement of orders from these customers;          |
| · | decreases  in the overall average selling prices of our products;                                                                    |
| · | changes  in the relative sales mix of our products;                                                                                  |
| · | changes  in our cost of finished goods;                                                                                              |
| · | the  availability, pricing and timeliness of delivery of other components used in  our customers’ products;                     |
| · | our  customers’ sales outlook, purchasing patterns and inventory adjustments based  on demands and general economic conditions; |
| · | product  obsolescence and our ability to manage product transitions;                                                                 |
| · | our  ability to successfully develop, introduce and sell new or enhanced products  in a timely manner;                               |
| · | the  timing of new product announcements or introductions by us or by our  competitors; and                                          |
| · | fluctuations  in our effective tax rate.                                                                                             |

 

Webase our planned operating expenses in part on our expectations of futurerevenue, and a significant portion of our expenses is relatively fixed in theshort term. We have limited historical financial data from which to predictfuture sales for our products. As a result, it is difficult for us to forecastour future revenue and budget our operating expenses accordingly. If revenuefor a particular quarter is lower than we expect, we likely will be unable toproportionately reduce our operating expenses for that quarter, which wouldharm our operating results for that quarter.

 

***We have only been profitable since 2005 andmay not sustain or increase profitability in the future which may cause themarket price of our common stock to decline.***

 

Wefirst became profitable in the second quarter of 2005. We incurred significantnet losses prior to that quarter. To sustain or increase profitability, we willneed to generate and sustain substantially higher revenue while maintainingreasonable cost and expense levels. We currently expect to increase expenselevels in each of the next several quarters to support increased research anddevelopment and sales and marketing efforts. These expenditures may not resultin increased revenue or customer growth. Because many of our expenses are fixedin the short term, or are incurred in advance of anticipated sales, we may notbe able to decrease our expenses in a timely manner to offset any shortfall ofsales. We also believe our effective tax rate will increase in the future,which will harm our financial results and negatively impact our profitability.We may not be able to sustain or increase profitability on a quarterly or anannual basis. This may, in turn, cause the price of our common stock todecline.

 

***If the growth of demand for digital videoapplications for the security surveillance, automotive and consumer and PC  markets does not continue, our ability toincrease our revenue could suffer.***

 

Ourability to increase our revenue will depend on increased demand for digitalvideo applications in the security surveillance, automotive and consumermarkets. If our target markets do not grow as rapidly or to the extent 

 

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weanticipate, our business could suffer. The growth of our target markets isuncertain and will depend in particular upon:

 

| · | consumer  confidence and the continued increase of consumer spending levels;                            |
|--------|---------------------------------------------------------------------------------------------------------|
| · | the  pace at which new digital video applications are adopted;                                          |
| · | a  continued reduction in the costs of products in these markets; and                                   |
| · | the  availability, at a reasonable price, of components required by such products,  such as LCD panels. |

 

***Our success depends on the development and introduction ofnew products, which we may not be able to do in a timely manner, as productdevelopment in smaller wafer fabrication geometries becomes more complex andcostly.***

 

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

 

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

 

***The average selling prices of oursemiconductor products may be subject to rapid price declines which could harmour revenue and gross profits.***

 

Thesemiconductor products we develop and sell may be subject to rapid declines inaverage selling 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 beable to compete effectively, which could reduce our market share and decreaseour net revenue and profitability.***

 

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

 

***We depend on key and highly skilledpersonnel to operate our business, and if we are unable to retain our currentpersonnel and hire additional personnel, our ability to develop and market ourproducts could be harmed.***

 

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

 

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***If we fail to develop new products andenhance our existing products in order to react to rapid technological changeand market demands, our business will suffer.***

 

Wemust develop new products and enhance our existing products with improvedtechnologies to meet rapidly evolving customer requirements. We need to designproducts for customers who continually require higher performance and functionalityat lower costs. We must, therefore, continue to cost-effectively add featuresthat enhance performance and functionality to our products. The developmentprocess for these advancements is lengthy and requires us to accuratelyanticipate market trends. Our failure to accurately anticipate market trends ina timely manner will harm the market acceptance of our products and the salesof our products. Forexample, we were excluded from certain customer qualification processes in thepast due to the lack of integrated audio functionality in our general purposedecoders. As part of our continued investment in new technologies, we intend to add integrated audiofunctionality to our general purpose decoders in the near term to address themarket requirements of our customers.

 

Developingand enhancing 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 winsfor our products, we may lose the opportunity for sales for a significantperiod of time to customers and be unable to recoup our investments in ourproducts.***

 

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

 

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

 

Oursemiconductors are principally designed to decode analog broadcast TV signalsinto digital images. InFebruary 2009, transmission of broadcast TV signals will no longer bepermitted in analog and all signals must be in a digital format.We are in theprocess of developing mixed signal and digital technology to decode digitalsignals. However, transmission of digital video involves a combination ofemerging technologies. The complexities of these technologies and the variabilityin implementations between manufacturers may cause our development ofsemiconductors to be costly and time-consuming. We may never obtain thebenefits of our investment in developing this technology. The complexities ofdigital broadcast 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.

 

***A significant portion of our products are sold into the consumerand security surveillance markets, and if sales of our semiconductors intothese markets decline or do not increase, or if we do not increase our salesinto the automotive market, our business and financial results could suffer.***

 

We sell semiconductorstargeted for the security surveillance, automotive, consumer and PC markets.For the year ended December 31, 2007 more than 85% of our sales werederived from the sale of our products designed for the consumer and securitysurveillance markets. If sales of semiconductors into these markets decline ordo not increase, or if demand slows in these markets generally, our operatingresults would suffer. In addition, we have increased our focus on theautomotive market and devoted substantial resources to the development ofsemiconductors for digital video applications that address this market. If weare not successful in selling our 

 

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semiconductors into thismarket, we may not recover the costs associated with our efforts in this areaand our operating results could suffer.

 

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

 

Ourbusiness is subject to seasonality as a result of our target markets and thelocation of our customers. We sell a significant number of our semiconductorsinto the consumer market. Our customers who manufacture products for theconsumer market experience seasonality in the sales of their products, which inturn may affect the timing and volume of orders for our semiconductors. Becausethe consumer market for digital video applications is characterized by thisseasonality, our operating results may vary significantly from quarter toquarter. For example, we generally experience lower sales in the first calendarquarter with our video decoder and LCD display products as a result of theseasonality associated with the consumer markets. In addition, a significantnumber of our semiconductors are sold to customers located in Asia, primarilyto customers located in regions who observe the Lunar New Year holiday, alsoreferred to as Chinese New Year. Typically, our foreign offices and those ofour customers are closed for a week or more during the extended holiday period.For the three months ended March 31, 2008, approximately 92% of ourrevenues were attributable to customers located in regions that observe theLunar New Year holiday. As a result, we typically experience fluctuations inour first calendar quarter due in part to a slowing of business activity aroundthe period of the Lunar New Year holiday. These sales fluctuations are expectedto continue.

 

***We manufacture our products based on ourestimates of customer demand, and if our estimates are incorrect our financialresults could be negatively impacted.***

 

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

 

***We do not expect to sustain the growth rateof our recent revenues.***

 

Ourrevenues increased approximately 109% in 2005 from 2004, approximately 49% in2006 from 2005. We do not expect to achieve similar growth rates in futureperiods. For example, our revenues increased approximately 11% in 2007 from2006. You should not rely on the results of any prior quarterly or annualperiods as an indication of our future operating performance. If we are unableto maintain adequate revenue growth, our stock price may decline and we may nothave adequate financial resources to execute our business objectives.

 

***We may pursue acquisitions or investmentsin complementary technologies and businesses, which could harm our operatingresults and may disrupt our business.***

 

Inthe future, we may pursue acquisitions of, or investments in, complementarytechnologies and businesses. Acquisitions present a number of potential risksand challenges that could, if not met, disrupt our business operations,increase our operating costs and reduce the value to us of the acquiredcompany. Even if we are successful, we may not be able to integrate theacquired businesses, products or technologies into our existing business andproducts. Furthermore, potential acquisitions and investments, whether or notconsummated, may divert our management’s attention and require considerablecash outlays at the expense of our existing operations. In addition, tocomplete future acquisitions, we may issue equity securities, incur debt,assume contingent liabilities or have amortization expenses and write-downs ofacquired assets, which could adversely affect our profitability.

 

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

 

Ourfuture effective tax rates will be favorably or unfavorably affected by theabsolute amount and future geographic distribution of our pre-tax income, ourability to take advantage of the available tax planning strategies and theavailability of tax credits. Prior to September 30, 2007, we determinedthat it was not more likely than not that our deferred tax assets would berecovered from future taxable income. Therefore we provided a valuationallowance for our deferred tax assets. At September 30, 2007, we assessedthe recoverability of our deferred tax assets. As a result of this assessment,we released the valuation allowance recorded against our deferred tax assets of

 

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approximately$5.5 million. Our effective tax rate for the years ended December 31, 2007and 2006 was approximately (4)% and 9%, respectively. The negative effectivetax rate in 2007 was a result of the release of the valuation allowance on ourdeferred tax assets. However, we expect our effective tax rate to increasesignificantly in 2008 and to range between 35% and 40%. In addition, we aresubject to the examination of our income tax returns by the Internal RevenueService and other tax authorities. The outcomes of these examinations, if theyoccur, could harm our net income and financial condition.

 

***We may not be able to manage our futuregrowth effectively, and we may need to incur significant expenditures toaddress the additional operational and control requirements of our growth.***

 

Weare experiencing a period of significant growth and expansion, which hasplaced, and any future expansion will continue to place, a significant strainon our management, personnel, systems and financial resources. We have hiredadditional employees to support an increase in research and development as wellas increase our sales and marketing efforts, which resulted in increasing ourheadcount from 96 employees at the end of 2006 to 142 employees at the end of2007. To manage our growth successfully, we believe we must effectively:

 

| · | train,  integrate and manage additional qualified engineers for research and  development activities, sales and marketing personnel and financial and  information technology personnel; |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | continue  to enhance our customer resource management and manufacturing management  systems;                                                                                             |
| · | implement  additional and improve existing administrative, financial and operations  systems, procedures and controls, including the requirements of the  Sarbanes-Oxley Act of 2002;    |
| · | expand  and upgrade our technological capabilities; and                                                                                                                                  |
| · | manage  multiple relationships with our customers, distributors, suppliers and other  third parties.                                                                                     |

 

Ourefforts may require substantial managerial and financial resources and mayincrease our operating costs even though these efforts may not be successful.If we are unable to manage our growth effectively, we may not be able to takeadvantage of market opportunities, develop new products, satisfy customerrequirements, execute our business plan or respond to competitive pressures.

 

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

 

Weoccasionally have experienced delays in completing the development andintroduction of new products and product enhancements, and we could experiencedelays in the future that may render our new or enhanced products, whenintroduced, obsolete and unmarketable. In addition, it is often difficult for semiconductorfoundries to achieve satisfactory product yields. Product yields depend on bothour product design and the manufacturing process technology unique to thesemiconductor foundry. Since low yields may result from either design orprocess difficulties, 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 ourcosts, cause customer claims and delay our product shipments.***

 

Althoughwe test our products, they are complex and may contain defects and errors. Inthe past, we have encountered defects and errors in our products. For example,in 2003 we were unable to sell certain products to a customer for whom theseproducts were specifically designed as a result of our failure to produce aproduct that met this customer’s specifications. We believe this customersecured the product from another vendor. Delivery of products with defects orreliability, quality or compatibility problems may damage our reputation andour ability to retain existing customers and attract new customers. Inaddition, product defects and errors could result in additional developmentcosts, diversion of technical resources, delayed product shipments, increasedproduct returns and product liability claims against us, which may not be fullycovered by insurance. Any of these could harm our business.

 

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***We rely on a limited number of independentsubcontractors for the manufacture, assembly and testing of our semiconductors,and the failure of any of these third-party vendors to deliver products orotherwise perform as requested could damage our relationships with ourcustomers, decrease our sales and limit our growth.***

 

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

 

| · | reduced  control over product cost, delivery schedules and product quality;                                                                                |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | potential  price increases;                                                                                                                                |
| · | inability  to achieve required production or test capacity and achieve acceptable yields  on a timely basis;                                               |
| · | longer  delivery times;                                                                                                                                    |
| · | increased  exposure to potential misappropriation of our intellectual property;                                                                            |
| · | shortages  of materials that foundries use to manufacture products;                                                                                        |
| · | labor  shortages or labor strikes; and                                                                                                                     |
| · | quarantines  or closures of manufacturing facilities due to the outbreak of viruses, such  as SARS, the avian flu or any similar future outbreaks in Asia. |

 

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

 

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

 

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

 

***Our business depends on internationalcustomers, suppliers and operations in Asia, and as a result we are subject toregulatory, operational, financial and political risks, which could adverselyaffect our financial results.***

 

Thepercentage of our revenues attributable to sales to customers in Asia wasapproximately 98% for both the three months ended March 31, 2008 and 2007.We expect that revenues from customers in Asia will continue to account forsubstantially all of our revenues. All our sales currently are denominated inU.S. dollars. As a result, an increase in the value of the U.S. dollar relativeto foreign currencies could make our products less competitive in internationalmarkets.

 

Currently,we maintain international sales offices in Asia, and we rely on a network ofthird-party sales representatives to sell our products internationally. We havealso established offices in China, Japan, Taiwan and South Korea, which servevarious aspects of our business. Moreover, we have in the past relied on, andexpect to continue to rely on, suppliers, manufacturers and subcontractorsprimarily located in Taiwan. Accordingly, we are subject to several risks andchallenges, any of which could harm our business and financial results. Theserisks and challenges include:

 

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| · | difficulties  and costs of staffing and managing international operations across different  geographic areas and cultures;                                                                                                                                                   |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | compliance  with a wide variety of domestic and foreign laws and regulations, including  those relating to the import or export of semiconductor products;                                                                                                                   |
| · | legal  uncertainties regarding taxes, tariffs, quotas, export controls, export  licenses and other trade barriers;                                                                                                                                                           |
| · | foreign  currency exchange fluctuations relating to our international operating  activities;                                                                                                                                                                                 |
| · | our  ability to receive timely payment and collect our accounts receivable;                                                                                                                                                                                                  |
| · | political,  legal and economic instability, foreign conflicts and the impact of regional  and global infectious illnesses, such as the SARS outbreak or avian flu in  the countries in which we and our customers, suppliers, manufacturers and  subcontractors are located; |
| · | legal  uncertainties regarding protection for intellectual property rights in some  countries; and                                                                                                                                                                           |
| · | fluctuations  in freight rates and transportation disruptions.                                                                                                                                                                                                               |

 

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

 

Becauseour products are based on constantly evolving technologies, we have experienceda lengthy sales cycle for some of our semiconductors, particularly thosedesigned for digital video applications in the automotive market. Our salescycle typically ranges from six to 24 months. We may experience a delay betweenthe time we increase expenditures for research and development, sales andmarketing efforts and inventory and the time we generate revenue, if any, fromthese expenditures. In addition, because we do not have long-term commitmentsfrom our customers, we must repeat our sales process on a continual basis evenfor current customers looking to purchase a new product. As a result, ourbusiness could be harmed if a customer reduces or delays its orders, choosesnot to release products incorporating our semiconductors or elects not to purchasea new product or product enhancements from us.

 

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

 

Wemarket and distribute our products primarily through a limited number of******distributors,most of which are located in Asia. This distribution channel has beencharacterized by rapid change and consolidations. Distributors have accountedfor a significant portion of our revenues in the past. Sales to ourdistributors represented approximately 77% of our revenues in 2007 and 73% ofour revenues in the three months ended March 31, 2008.

 

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

 

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

 

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

 

| · | the  laws of other countries in which we market our semiconductors, such as some  countries in the Asia/Pacific region, may offer little or no protection for  our proprietary technologies; |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | people  may not be deterred from misappropriating our technologies despite the  existence of laws or contracts prohibiting these actions; and                                                |
| · | policing  unauthorized use of our intellectual property may be difficult, expensive and  time-consuming, and we may be unable to determine the extent of any  unauthorized 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 

 

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forus to take remedial measures since it is located in Taiwan, which does not havethe same protection for intellectual property as is provided in the UnitedStates. Any inability to adequately protect our proprietary rights could harmour ability to compete, generate revenue and grow our business.

 

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

 

Althoughwe rely primarily on trade secret laws and contractual restrictions to protectthe technology in the semiconductors we currently manufacture and market, oursuccess and ability to compete in the future may also depend to a significantdegree upon obtaining patent protection for our proprietary technology. As of December 31,2007, we had three issued patents in the United States and five patentapplications pending in the United States and three applications pending inforeign jurisdictions. These patents and patent applications cover aspects ofthe technology in the semiconductors we currently manufacture and market,including a patent for our video decoding architecture. Patents that wecurrently own do not cover all of the semiconductors that we presentlymanufacture and market. Our patent applications may not result in issuedpatents, and even if they result in issued patents, the patents may not haveclaims of the scope we seek. In addition, any issued patents may be challenged,invalidated or declared unenforceable. The term of any issued patents would be20 years from its filing date and if our applications are pending for a long timeperiod, 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 our intellectualproperty from misuse or infringement by anyone in these countries. Ourinability 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 iscommon in our industry, could be costly, harm our reputation, limit our abilityto sell our products and divert the attention of management and technicalpersonnel.***

 

Ourindustry is characterized by frequent litigation regarding patent and otherintellectual property rights. For example, we were a party to an administrativeproceeding in front of the intellectual property tribunal in South Korea inwhich another party unsuccessfully sought a determination that our TW2824 andTW2834 products infringed a South Korean patent allegedly held by that party.We have certain indemnification obligations to customers under our contractdevelopment projects with respect to any infringement of third-party patentsand intellectual property rights by our products. If a lawsuit were to be filedagainst us in connection with claims of infringement, our business would beharmed.

 

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

 

***Our headquarters are located in the Stateof California and our third-party manufacturing, assembly and testing vendorshave facilities in the State of Washington and in Asia, areas subject tosignificant earthquake risks. Any disruption to our or their operationsresulting from earthquakes or other natural disasters could cause significantdelays in the production or shipment of our products.***

 

TSMC,which manufactures our semiconductors, has facilities in the State of Washingtonand in Taiwan. Our assembly and testing vendors’ facilities are primarilylocated in Taiwan. In addition, our headquarters are located in NorthernCalifornia. The risk of an earthquake or extreme weather in the Pacific Rimregion or an earthquake in Northern California or Washington State issignificant due to the proximity of major earthquake fault 

 

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lines.In September 1999, a major earthquake in Taiwan affected the facilities ofTSMC and ASE, our primary assembly vendor, as well as other providers offoundry, packaging and test services. As a result of these natural disasters,these contractors suffered power outages and disruptions that impaired theirproduction capacity. In March 2002 and June 2003, additionalearthquakes occurred in Taiwan. In 2005, several typhoons also disrupted theoperations of TSMC and ASE. As a result of these natural disasters, these contractors sufferedpower outages and disruptions that impaired their production capacity. The occurrenceof earthquakes or other natural disasters could result in the disruption of ourfoundry or assembly and test capacity. We may not be able to obtain alternatecapacity on favorable terms, if at all, which could harm our operating results.

 

***Changes to financial accounting standardsmay affect our results of operations and cause us to change our businesspractices.***

 

Weprepare our financial statements to conform to accounting principles generallyaccepted in the United States of America, or GAAP. These accounting principlesare subject to interpretation by the Financial Accounting Standards Board, orFASB, the Securities and Exchange Commission, or SEC, and various bodies formedto interpret 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, including rules relatingto employee stock option grants, have recently been revised. The FASB and otheragencies have made changes to GAAP that required us, starting in our firstquarter of fiscal 2006, to record a charge to earnings for the estimated fairvalue of employee stock option grants and other equity incentives, whereasunder prior accounting rules charges were required only for the intrinsicvalue, if any, of such awards to employees. We may have significant and ongoingaccounting charges under the new rules resulting from option grant andother equity incentive expensing, which could reduce our overall net income. Inaddition, since we historically have used equity-related compensation as acomponent of our total employee compensation program, the accounting changecould make the use of equity-related compensation less attractive to us orrequire us to pay more cash compensation and therefore make it more difficultfor us to attract and retain employees.

 

***Management may apply our cash, cashequivalents, short-term and long-term investments to uses that do not increaseour market value or improve our operating results.***

 

Weintend to use our cash, cash equivalents, short-term and long-term investmentsfor general corporate purposes, including working capital and capitalexpenditures. We may also use a portion of our cash, cash equivalents,short-term and long-term investments to acquire or invest in complementarytechnologies, businesses or other assets. We have not reserved or allocated ourcash, cash equivalents, short-term and long-term investments for any specificpurpose, and we cannot state with certainty how our management will use ourcash, cash equivalents, short-term and long-term investments. Accordingly, ourmanagement has considerable discretion in applying our cash, cash equivalents,short-term and long-term investments and may use our cash, cash equivalents,short-term and long-term investments for purposes that do not result in anyincrease in our results of operations or market value. Until the cash, cashequivalents, short-term and long-term investments are used, they may be placedin investments that do not produce income or that lose value.

 

**Risks Related to Our Industry**

 

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

 

Thesemiconductor industry is highly cyclical and subject to rapid change andevolving industry standards and, from time to time, has experienced significantdownturns. These downturns are characterized by decreases in product demand,excess customer inventories and accelerated erosion of prices. These factorshave caused and could cause substantial fluctuations in our net revenue and inour operating results. Any downturns in the semiconductor industry may besevere and prolonged, and any failure of this industry to fully recover fromdownturns could 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.

 

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***The demand for semiconductors is affectedby general economic conditions, which could impact our business.***

 

TheUnited States and international economies have recently experienced a period ofslow economic growth. A sustained economic recovery is uncertain. In addition,terrorist acts and similar events, turmoil in the Middle East or war ingeneral, could contribute to a slowdown of the market demand for our products.If the economic recovery slows down as a result of the recent economic,political and social turmoil, or if there are further terrorist attacks in theUnited States or elsewhere, we may experience decreases in the demand for ourproducts, which may harm our operating results. Our business has been adverselyaffected by previous economic downturns. For example, during the globaleconomic downturn in 2002 to 2003, demand for many semiconductor and consumerelectronics products suffered as consumers delayed purchasing decisions orchanged or reduced their discretionary spending. As a result, demand for ourproducts suffered and we had to implement restructuring initiatives to alignour corporate spending with a slower than anticipated revenue growth duringthat timeframe.

 

**Risks Related to Our Common Stock**

 

***Our stock price has been volatile and youmay not be able to resell shares of our common stock at or above the price youpaid, or at all.***

 

Thetrading price of our common stock has experienced wide fluctuations due to thefactors discussed in this risk factors section and elsewhere in this QuarterlyReport on Form 10-Q. For example, in the three months ended March 31,2008, the closing price of our stock ranged from a low of $9.11 on February 15,2008 to a high of $10.85 on February 1, 2008. In addition, the stockmarket in general has, and The NASDAQ Global Market and technology companies inparticular have, experienced extreme price and volume fluctuations. Thesetrading prices and valuations may not be sustainable. These broad market andindustry factors may decrease the market price of our common stock, regardlessof our actual operating performance. In addition, in the past, followingperiods of volatility in the overall market and the market price of a company’ssecurities, securities class action litigation has often been institutedagainst companies that experienced such volatility. This litigation, 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 notpublish research or reports about our business, or if they change theirrecommendations regarding our stock adversely, our stock price and tradingvolume could decline.***

 

Thetrading market for our common stock is influenced by the research and reportsthat industry or securities analysts publish about us or our business. If oneor more of the analysts who cover us downgrade our stock, our stock price wouldlikely decline. If one or more of these analysts cease coverage of our companyor fail to regularly publish reports on us, we could lose visibility in thefinancial markets, which in turn could cause our stock price or trading volumeto decline.

 

***Our ability to raise capital in the futuremay be limited and our failure to raise capital when needed could prevent usfrom executing our growth strategy.***

 

Webelieve that our existing cash and cash equivalents and our investments will besufficient to meet our anticipated cash needs for at least the next 12 months.The timing and amount of our working capital and capital expenditurerequirements may vary significantly depending on numerous factors, including:

 

| · | market  acceptance of our products;                                                                  |
|--------|------------------------------------------------------------------------------------------------------|
| · | the  need to adapt to changing technologies and technical requirements;                              |
| · | the  existence of opportunities for expansion; and                                                   |
| · | access  to and availability of sufficient management, technical, marketing and  financial personnel. |

 

Ifour capital resources are insufficient to satisfy our liquidity requirements,we may seek to sell additional equity securities or debt securities or obtaindebt financing. 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 obtain additionalfinancing and there is no assurance that financing, if required, will beavailable in amounts or on terms acceptable to us, if at all.

 

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

 

Additionalsales of our common stock in the public market, or the perception that thesesales could occur, could cause the market price of our common stock to decline.At March 31, 2008, we had 21,001,356 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 these shares,other than shares purchased by our affiliates, becoming freely tradable withoutrestriction under the Securities Act immediately upon the effectiveness of theregistration.

 

Someof our officers and directors have entered into 10b5-1 trading plans, whichgenerally provide for pre-determined sales of stock by these officers. Thesales of stock by our officers and directors, even if made pursuant to these10b5-1 trading plans may cause our stock price to fall.

 

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

 

Ourdirectors, executive officers and their affiliated entities beneficially own asignificant percentage of our outstanding common stock. These stockholders, ifthey acted together, could exert substantial control over matters requiringapproval by our stockholders, including electing directors and approvingmergers or other business combination transactions. This concentration ofownership may also discourage, delay or prevent a change in control of ourcompany, which could deprive our stockholders of an opportunity to receive apremium for their stock as part of a sale of our company and might reduce ourstock price. These actions may be taken even if they are opposed by our otherstockholders.

 

***Delaware law and our corporate charter andbylaws contain anti-takeover provisions that could delay or discourage takeoverattempts that stockholders may consider favorable.***

 

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

 

| · | the  right of the board of directors to elect a director to fill a vacancy created  by the expansion of the board of directors;                                                                                                                                                                                                            |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | the  prohibition of cumulative voting in the election of directors, which would  otherwise allow less than a majority of stockholders to elect director  candidates;                                                                                                                                                                       |
| · | the  requirement for advance notice for nominations for election to the board of  directors or for proposing matters that can be acted upon at a stockholders’  meeting;                                                                                                                                                              |
| · | the  ability of the board of directors to alter our bylaws without obtaining  stockholder approval;                                                                                                                                                                                                                                        |
| · | the  ability of the board of directors to issue, without stockholder approval, up  to 10,000,000 shares of preferred stock with terms set by the board of  directors, which rights could be senior to those of common stock;                                                                                                               |
| · | the  required approval of holders of at least two-thirds of the shares entitled to  vote at an election of directors to adopt, amend or repeal our bylaws or  amend or repeal the provisions of our certificate of incorporation regarding  the indemnification of directors and officers and the ability of stockholders  to take action; |
| · | the  required approval of holders of at least a majority of the shares entitled to  vote at an election of directors to remove directors for cause; and                                                                                                                                                                                    |
| · | the  elimination of the right of stockholders to call a special meeting of  stockholders and to take action by written consent.                                                                                                                                                                                                            |

 

Inaddition, because we are incorporated in Delaware, we are governed by theprovisions of Section 203 of the Delaware General Corporation Law. Theseprovisions may prohibit or restrict large stockholders, in particular thoseowning 15% or more of our outstanding voting stock, from merging or combiningwith us. These provisions in our certificate of incorporation and bylaws andunder Delaware law could discourage potential takeover attempts and couldreduce the price that investors might be willing to pay for shares of ourcommon stock in the future and result in our market price being lower than itwould without these provisions.

 

***We have incurred and will continue to incurincreased costs as a result of being a public company.***

 

Asa public company, we have incurred and will continue to incur significantlegal, accounting and other expenses that we did not incur as a privatecompany. In addition, the Sarbanes-Oxley Act of 2002, as well as new 

 

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rules subsequentlyimplemented by the SEC and NASDAQ, have required changes in corporategovernance practices of public companies. We expect these new rules andregulations to increase our legal and financial compliance costs and to makesome activities more time-consuming and costly. For example, as a result ofbecoming a public company, we have added an independent director, createdadditional board committees and adopted policies regarding internal controlsand disclosure controls and procedures. In addition, we have incurred and willcontinue to incur additional costs associated with our public company reportingrequirements. We continue to evaluate and monitor developments with respect tothese new rules, and we cannot predict or estimate the amount of additionalcosts we may incur or the timing of such costs.

 

**ITEM 2.****          Unregistered Sales of EquitySecurities and Use of Proceeds**

 

Not applicable.

 

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

 

Not applicable.

 

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

 

Not applicable.

 

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

 

Not applicable.

 

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

 

(a)            Exhibits

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

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| (1) | The  material 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: May 8, 2008 |   |                                                                                 |
|-------------------------|--------|--------------------------------------------------------------------------------------|
|                    |   |                                                                                 |   |   |   |   |
|                    |   |                                                                                 |   | /s/ Fumihiro Kozato |   |
|                    |   | Fumihiro Kozato                                                                      |
|                    |   | President and Chief Executive Officer                                                |
|                    |   |                                                                                 |
| Dated: May 8, 2008 |   |                                                                                 |
|                    |   |                                                                                 |   |   |   |   |
|                    |   |                                                                                 |   | /s/ Mark Voll |   |
|                    |   | Mark Voll  Vice President of Finance and Administration  and Chief Financial Officer |

 

 

 

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