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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended March 31, 2005



OR



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



For the Transition Period from  to



Commission File Number: 000-50391



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SIGMATEL, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 74-2691412                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



1601 S. MoPac
Expressway

Suite 100

Austin, Texas 78746

(512) 381-3700

(Address and telephone number of principal executive offices)



---



Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.    Yes  x    No ̈



Indicate by check mark whether the registrant is an accelerated
filer (as defined in Exchange Act Rule 12b-2).    Yes  x    No ̈



The number of shares outstanding of the
Registrants Common Stock, $0.0001 par value, was 35,692,760 as of April 8, 2005.



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##### Table of Contents

SIGMATEL, INC.

FORM 10-Q



TABLE OF CONTENTS



|                                          |  |                                                                                                              |  |         
|----------------------------------------- |  | ------------------------------------------------------------------------------------------------------------ |  | --------
|                                          |  |                                                                                                              |  | Page No.
|PART I:    
INTERIM FINANCIAL INFORMATION |  |                                                                                                             
|                                          |  |                                                                                                             
|Item 1.                                   |  | Financial Statements                                                                                         |  |         
|                                          |  |                                                                                                             
|                                          |  | Consolidated Condensed Balance Sheets as of March 31, 2005 and December 31, 2004                             |  | 3       
|                                          |  |                                                                                                             
|                                          |  | Consolidated Condensed Statements of Operations for the Three months ended March 31, 2005 and March 31, 2004 |  | 4       
|                                          |  |                                                                                                             
|                                          |  | Consolidated Condensed Statements of Cash Flows for the Three months ended March 31, 2005 and March 31, 2004 |  | 5       
|                                          |  |                                                                                                             
|                                          |  | Notes to Consolidated Condensed 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                                                   |  | 22      
|                                          |  |                                                                                                             
|Item 4.                                   |  | Controls and Procedures                                                                                      |  | 33      
|                                          | 
|PART II:    
OTHER INFORMATION            |  |                                                                                                             
|                                          |  |                                                                                                             
|Item 1.                                   |  | Legal Proceedings                                                                                            |  | 34      
|                                          |  |                                                                                                             
|Item 2.                                   |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                  |  | 34      
|                                          |  |                                                                                                             
|Item 3.                                   |  | Defaults upon Senior Securities                                                                              |  | 35      
|                                          |  |                                                                                                             
|Item 4.                                   |  | Submission of Matters to a Vote of Security Holders                                                          |  | 35      
|                                          |  |                                                                                                             
|Item 5.                                   |  | Other Information                                                                                            |  | 35      
|                                          |  |                                                                                                             
|Item 6.                                   |  | Exhibits                                                                                                     |  | 35      
|                                          | 
|Signature                                 |  | 36                                                                                                          



2



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##### Table of Contents

PART I: FINANCIAL INFORMATION



Item 1. Financial Statements



SIGMATEL, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands)

(unaudited)



|                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                 |  | March 31,2005 |         |   | December 31,2004 |  
|ASSETS                                                                                                                                                           |  |               |         |   |                  |   |         |  
|Current assets:                                                                                                                                                  |  |               |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                        |  | $             | 30,221  |   |                  | $ | 27,246  |  
|Short-term investments                                                                                                                                           |  |               | 120,527 |   |                  |   | 114,451 |  
|Accounts receivable, net                                                                                                                                         |  |               | 62,090  |   |                  |   | 34,195  |  
|Inventories, net                                                                                                                                                 |  |               | 37,106  |   |                  |   | 19,411  |  
|Deferred tax asset, net                                                                                                                                          |  |               | 8,375   |   |                  |   | 7,613   |  
|Prepaid expenses and other assets                                                                                                                                |  |               | 4,689   |   |                  |   | 4,241   |  
|                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total current assets                                                                                                                                             |  |               | 263,008 |   |                  |   | 207,157 |  
|                                                                                                                                                                 |  |              
|Property, equipment and software, net                                                                                                                            |  |               | 8,638   |   |                  |   | 7,116   |  
|Intangible assets, net                                                                                                                                           |  |               | 4,729   |   |                  |   | 4,357   |  
|Other assets                                                                                                                                                     |  |               | 1,139   |   |                  |   | 1,285   |  
|                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total assets                                                                                                                                                     |  | $             | 277,514 |   |                  | $ | 219,915 |  
|                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                             |  |               |         |   |                  |   |         |  
|Current liabilities:                                                                                                                                             |  |               |         |   |                  |   |         |  
|Accounts payable                                                                                                                                                 |  | $             | 35,134  |   |                  | $ | 23,016  |  
|Accrued compensation                                                                                                                                             |  |               | 2,350   |   |                  |   | 3,884   |  
|Other accrued expenses                                                                                                                                           |  |               | 2,292   |   |                  |   | 2,459   |  
|Income taxes payable                                                                                                                                             |  |               | 1,587   |   |                  |   | 239     |  
|Deferred revenue                                                                                                                                                 |  |               | 13,604  |   |                  |   | 7,286   |  
|Current portion of long-term obligations                                                                                                                         |  |               | 903     |   |                  |   | 1,223   |  
|                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                        |  |               | 55,870  |   |                  |   | 38,107  |  
|                                                                                                                                                                 |  |              
|Non-current income taxes payable                                                                                                                                 |  |               | 6,646   |   |                  |   |        |  
|Other liabilities                                                                                                                                                |  |               | 491     |   |                  |   | 892     |  
|                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total liabilities                                                                                                                                                |  |               | 63,007  |   |                  |   | 38,999  |  
|                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Stockholders equity:                                                                                                                                            |  |               |         |   |                  |   |         |  
|Common stock, $0.0001 par value; 170,000 shares authorized; shares issued and outstanding: 35,735 and 35,645 at 2005 and 35,205 and 35,115 at
2004, respectively |  |               | 4       |   |                  |   | 4       |  
|Additional paid-in capital                                                                                                                                       |  |               | 181,470 |   |                  |   | 173,480 |  
|Notes receivable from stockholders                                                                                                                               |  |               | (7      | ) |                  |   | (7      | )
|Deferred stock-based compensation                                                                                                                                |  |               | (1,207  | ) |                  |   | (1,278  | )
|Treasury stock, 90 common shares at cost                                                                                                                         |  |               | (741    | ) |                  |   | (741    | )
|Accumulated surplus                                                                                                                                              |  |               | 34,988  |   |                  |   | 9,458   |  
|                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                       |  |               | 214,507 |   |                  |   | 180,916 |  
|                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                                                       |  | $             | 277,514 |   |                  | $ | 219,915 |  
|                                                                                                                                                                 |  |               |         |   |                  |   |         |  



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



3



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##### Table of Contents

SIGMATEL, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                  |  |                             |        |      |   |       
|------------------------------------------------- |  | --------------------------- | ------ | ---- | - | ------
|                                                  |  | Three Months EndedMarch 31,
|                                                  |  | 2005                        |        | 2004
|Revenues, net                                     |  | $                           | 99,338 |      | $ | 31,500
|Cost of goods sold(1)                             |  |                             | 42,294 |      |   | 14,784
|                                                  |  |                             |        |      |   |       
|Gross Profit                                      |  |                             | 57,044 |      |   | 16,716
|Operating Expenses:                               |  |                             |        |      |   |       
|Research and development(1)                       |  |                             | 11,870 |      |   | 6,083 
|Selling, general and administrative(1)            |  |                             | 7,114  |      |   | 2,899 
|Amortization of deferred stock-based compensation |  |                             | 180    |      |   | 995   
|                                                  |  |                             |        |      |   |       
|Total operating expenses                          |  |                             | 19,164 |      |   | 9,977 
|                                                  |  |                             |        |      |   |       
|Operating income                                  |  |                             | 37,880 |      |   | 6,739 
|Interest income, net                              |  |                             | 822    |      |   | 333   
|                                                  |  |                             |        |      |   |       
|Income before income taxes                        |  |                             | 38,702 |      |   | 7,072 
|Income tax expense                                |  |                             | 13,172 |      |   | 141   
|                                                  |  |                             |        |      |   |       
|Net income                                        |  | $                           | 25,530 |      | $ | 6,931 
|                                                  |  |                             |        |      |   |       
|BASIC NET INCOME PER SHARE                        |  | $                           | 0.72   |      | $ | 0.20  
|                                                  |  |                             |        |      |   |       
|DILUTED NET INCOME PER SHARE                      |  | $                           | 0.68   |      | $ | 0.18  
|                                                  |  |                             |        |      |   |       
|WEIGHTED AVERAGE SHARES USED TO COMPUTE:          |  |                             |        |      |   |       
|Basic net income per share                        |  |                             | 35,398 |      |   | 34,487
|Diluted net income per share                      |  |                             | 37,756 |      |   | 38,446

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|(1) | Amounts exclude amortization of deferred stock-based compensation as follows:
|--- | -----------------------------------------------------------------------------



|                                  |  |                             |     |      |   |    
|--------------------------------- |  | --------------------------- | --- | ---- | - | ---
|                                  |  | Three Months EndedMarch 31,
|                                  |  | 2005                        |     | 2004
|Cost of goods sold                |  | $                           | 6   |      | $ | 50 
|Research and development          |  |                             | 125 |      |   | 606
|Selling, general & administrative |  |                             | 49  |      |   | 339
|                                  |  |                             |     |      |   |    
|Total                             |  | $                           | 180 |      | $ | 995
|                                  |  |                             |     |      |   |    



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



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SIGMATEL, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                  |  |                             |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Three Months EndedMarch 31, |        
|                                                                                  |  | 2005                        |         |   | 2004 |  
|Cash flows from operating activities:                                             |  |                             |         |   |      |   |         |  
|Net income                                                                        |  | $                           | 25,530  |   |      | $ | 6,931   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                             |         |   |      |   |         |  
|Depreciation and amortization                                                     |  |                             | 1,413   |   |      |   | 1,005   |  
|Amortization of deferred stock-based compensation                                 |  |                             | 180     |   |      |   | 995     |  
|Amortization of premium and accretion of discount on securities                   |  |                             | 80      |   |      |   | 94      |  
|Deferred income tax benefit                                                       |  |                             | (569    | ) |      |   |        |  
|Lease abandonment adjustments                                                     |  |                             | (385    | ) |      |   |        |  
|Tax benefit related to exercise of employee stock options                         |  |                             | 5,355   |   |      |   |        |  
|Other non-cash (benefit) expense                                                  |  |                             | (188    | ) |      |   | 50      |  
|Changes in assets and liabilities:                                                |  |                             |         |   |      |   |         |  
|Accounts receivable, net                                                          |  |                             | (27,895 | ) |      |   | (428    | )
|Inventories, net                                                                  |  |                             | (17,695 | ) |      |   | (624    | )
|Prepaid expenses and other assets                                                 |  |                             | (495    | ) |      |   | (1,084  | )
|Accounts payable                                                                  |  |                             | 12,118  |   |      |   | (2,386  | )
|Accrued expenses                                                                  |  |                             | (1,681  | ) |      |   | (338    | )
|Income taxes payable                                                              |  |                             | 7,994   |   |      |   | (59     | )
|Deferred revenue and other liabilities                                            |  |                             | 5,975   |   |      |   | 902     |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Net cash provided by operating activities                                         |  |                             | 9,737   |   |      |   | 5,058   |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Cash flows from investing activities:                                             |  |                             |         |   |      |   |         |  
|Proceeds from maturities of short-term investments                                |  |                             | 29,275  |   |      |   |        |  
|Purchases of short-term investments                                               |  |                             | (35,431 | ) |      |   | (42,410 | )
|Purchases of property, equipment, software and intangible assets                  |  |                             | (3,307  | ) |      |   | (2,878  | )
|                                                                                  |  |                             |         |   |      |   |         |  
|Net cash used in investing activities                                             |  |                             | (9,463  | ) |      |   | (45,288 | )
|                                                                                  |  |                             |         |   |      |   |         |  
|Cash flows from financing activities:                                             |  |                             |         |   |      |   |         |  
|Payments on capital lease obligations                                             |  |                             | (13     | ) |      |   | (11     | )
|Proceeds from notes receivable from stockholders                                  |  |                             |        |   |      |   | 104     |  
|Proceeds from issuance of common stock, net of issuance costs                     |  |                             | 2,714   |   |      |   | 8,113   |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Net cash provided by financing activities                                         |  |                             | 2,701   |   |      |   | 8,206   |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |                             | 2,975   |   |      |   | (32,024 | )
|Cash and cash equivalents, beginning of period                                    |  |                             | 27,246  |   |      |   | 61,841  |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                          |  | $                           | 30,221  |   |      | $ | 29,817  |  
|                                                                                  |  |                             |         |   |      |   |         |  



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



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SigmaTel, Inc.

Notes to Consolidated Condensed Financial Statements



1. Basis of Presentation



The accompanying unaudited consolidated condensed financial statements
include the accounts of SigmaTel, Inc. and its wholly owned subsidiaries (the Company). All material intercompany accounts and transactions have been eliminated in consolidation. The statements have been prepared in accordance with
accounting principles generally accepted in the United States of America applicable to interim financial statements. Accordingly, they do not include all of the information and notes required for complete financial statements. Certain
reclassifications have been made to all periods presented in the consolidated condensed financial statements to conform to the current year presentation. These reclassifications had no effect on the results of operations or stockholders
equity. In the opinion of management, all adjustments and reclassifications considered necessary for a fair and comparable presentation have been included and are of a normal recurring nature. Operating results for the three month period ended March
31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.



SigmaTel, Inc. was incorporated on December 28, 1993 and is a fabless designer of analog-intensive mixed-signal integrated circuits headquartered in
Austin, Texas. SigmaTel Hong Kong, Limited was established and incorporated in Hong Kong in July 2004 and became a wholly owned subsidiary of SigmaTel, Inc. in August of 2004 for the purpose of providing engineering support to customers in Asia for
their product development activities. In March 2005, the Company effected a name change of the Hong Kong subsidiary to SigmaTel Asia, Limited.



In March 2005, SigmaTel Caymans was established and incorporated in the Cayman Islands as a wholly owned subsidiary of SigmaTel, Inc. for the purpose of
holding the stock of future international subsidiaries and to license the economic rights to certain intellectual property from SigmaTel, Inc. and to further license those rights to other subsidiaries of the Company in the future.



2. Equity Offerings



On September 18, 2003, the Securities and Exchange Commission declared effective the Companys first registration
statement, which the Company filed on Form S-1 (Registration No. 333-106796) under the Securities Act of 1933 in connection with the initial public offering of its common stock. Under this registration statement, the Company registered 11,500,000
shares of its common stock, including 1,500,000 shares subject to the underwriters overallotment option (which was exercised in full), with a public offering price of $15.00 per share and aggregate proceeds of approximately $172,500,000. The
Company registered 7,383,917 of these shares on its behalf and 4,116,083 shares on behalf of certain stockholders of the Company. The underwriting syndicate was managed by Merrill Lynch & Co., JPMorgan, CIBC World Markets and Needham &
Company, Inc. This offering terminated after the sale of all of the shares of the Companys common stock that it registered under its registration statement on Form S-1. The sale of shares of common stock by the Company, including the sale of
383,917 shares pursuant to the exercise of the over-allotment option by the underwriters, resulted in aggregate gross proceeds of approximately $110.8 million, approximately $7.8 million of which the Company applied to underwriting discounts and
commissions and approximately $1.6 million of which the Company applied to related costs. As a result, the Company received approximately $101.4 million of the offering proceeds. The sale of shares of common stock by the selling stockholders
resulted in aggregate gross proceeds of $61.7 million, $4.3 million of which the selling stockholders applied to underwriting discounts and commissions. As a result, the selling stockholders received $57.4 million of the offering proceeds. Upon
completion of the initial public offering, 22,022,367 outstanding shares of the Companys redeemable convertible preferred stock were converted into 19,177,818 shares of common stock.



On February 18, 2004, the Securities and Exchange Commission declared
effective the Companys registration statement, which the Company filed on Form S-1 under the Securities Act of 1933 in connection with a follow-on offering of its common stock. Under this registration statement, the Company registered
9,830,422 shares of its common stock, including 1,282,229 shares subject to the underwriters overallotment option (of which 212,229 shares were exercised), with a public offering price of $25.01 per share. The Company registered 250,000 of
these shares on its behalf and 9,580,422 on behalf of certain stockholders of the Company. The Company received $5.3 million in proceeds after deducting the underwriters fees and transaction costs.



In July of 2004, the Companys Board of Directors authorized a share
repurchase plan for up to $30 million of common stock. Under this plan, the Company used $21.0 million of cash during July and August of 2004 to purchase 1,381,991 shares of common stock. All shares purchased during the three months ended September
30, 2004 were retired during the period.



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##### Table of Contents

SigmaTel, Inc.

Notes to Consolidated Condensed Financial Statements Continued



3. Significant Accounting Policies



For a description of what the Company believes to be the critical accounting policies that affect our more significant judgments and estimates used in the preparation of our financial statements, refer to our Form
10-K filed with the Securities and Exchange Commission. There have been no changes in our critical accounting policies since December 31, 2004.



Accounting for Stock-Based Compensation



Employee stock awards under the Companys compensation plans are accounted for in accordance with Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting Standards Board Interpretation No. 44, Emerging Issues Task Force (EITF) Issue No. 00-23, and related interpretations. The Company accounts for equity
awards issued to non-employees in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation, Transition and Disclosure, and EITF Issue No. 96-18, Accounting for Equity Instruments that are Issued to other than Employees for Acquiring, or in Conjunction with Selling Goods or Services and related interpretations. The
following table illustrates the effect on net income as if the Company had applied the fair value recognition provisions of SFAS No. 123 (in thousands, except per share data):



|                                                                                                                                                          |  |                             |        |   |      |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                                                                          |  | Three Months EndedMarch 31, |       
|                                                                                                                                                          |  | 2005                        |        |   | 2004 |  
|Net income, as reported                                                                                                                                   |  | $                           | 25,530 |   |      | $ | 6,931  |  
|Add: Stock-based employee compensation expense recognized in net income, net of related income tax effects                                                |  |                             | 117    |   |      |   | 995    |  
|Deduct: Stock-based employee compensation expense determined under the fair value based method for all employee awards, net of related income
tax effects |  |                             | (2,516 | ) |      |   | (1,421 | )
|                                                                                                                                                          |  |                             |        |   |      |   |        |  
|Pro forma net income                                                                                                                                      |  | $                           | 23,131 |   |      | $ | 6,505  |  
|                                                                                                                                                          |  |                             |        |   |      |   |        |  
|Pro forma basic net income per share, as adjusted                                                                                                         |  | $                           | 0.65   |   |      | $ | 0.19   |  
|                                                                                                                                                          |  |                             |        |   |      |   |        |  
|Pro forma diluted net income per share, as adjusted                                                                                                       |  | $                           | 0.63   |   |      | $ | 0.17   |  
|                                                                                                                                                          |  |                             |        |   |      |   |        |  



Comprehensive Income



Comprehensive income includes all changes in
stockholders equity during a period from non-owner sources. For the three months ended March 31, 2005 and 2004, there were no differences between the Companys net income and its comprehensive income.



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##### Table of Contents

SigmaTel, Inc.

Notes to Consolidated Condensed Financial Statements Continued



Net Income per Share



Basic net income per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding for the period. Diluted net income per share is computed giving effect to all potential dilutive common
stock, including options, warrants, and common stock subject to repurchase.



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



|                                                                                       |  |                             |        |   |      |   |        |  
|-------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                       |  | Three Months EndedMarch 31, |       
|                                                                                       |  | 2005                        |        |   | 2004 |  
|Numerator:                                                                             |  |                             |        |   |      |   |        |  
|Net income                                                                             |  | $                           | 25,530 |   |      | $ | 6,931  |  
|                                                                                       |  |                             |        |   |      |   |        |  
|Denominator:                                                                           |  |                             |        |   |      |   |        |  
|Weighted-average common stock outstanding                                              |  |                             | 35,421 |   |      |   | 34,553 |  
|Less: weighted-average shares subject to repurchase                                    |  |                             | (23    | ) |      |   | (67    | )
|                                                                                       |  |                             |        |   |      |   |        |  
|Weighted-average shares used in computing basic net income per share                   |  |                             | 35,398 |   |      |   | 34,486 |  
|Dilutive potential common shares used in computing diluted net income per share        |  |                             | 2,358  |   |      |   | 3,960  |  
|                                                                                       |  |                             |        |   |      |   |        |  
|Total weighted-average number of shares used in computing diluted net income per share |  |                             | 37,756 |   |      |   | 38,446 |  
|                                                                                       |  |                             |        |   |      |   |        |  



Approximately 430,000
and 171,000 weighted-average dilutive potential shares have been excluded for the three months ended March 31, 2005 and 2004, respectively, as the exercise price of the underlying stock options exceeded the average market price of the stock during
the respective periods. The Company issued approximately 530,000 shares of common stock during the three months ended March 31, 2005.



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##### Table of Contents

SigmaTel, Inc.

Notes to Consolidated Condensed Financial Statements Continued



4. Short-term Investments



Short-term investments at March 31, 2005 and December 31, 2004, consisting of corporate, state and municipal securities, were acquired at an aggregate cost of $121.0 million and $114.8 million, respectively. The fair values of these
instruments are based on market interest rates and other market information available to management as of each balance sheet date presented and was not materially different than the aggregate cost.



Short-term investments consist of the following (in thousands):



|                               |  |               |         |   |                  |   |         |  
|------------------------------ |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                               |  | March 31,2005 |         |   | December 31,2004 |  
|Available-for-sale securities: |  |               |         |   |                  |   |         |  
|Commercial paper               |  | $             | 6,887   |   |                  | $ | 7,628   |  
|U.S. agencies                  |  |               | 9,110   |   |                  |   | 14,985  |  
|Auction rate preferreds        |  |               | 97,625  |   |                  |   | 92,300  |  
|Corporate notes                |  |               | 9,853   |   |                  |   | 9,972   |  
|                               |  |               |         |   |                  |   |         |  
|Total investments              |  |               | 123,475 |   |                  |   | 124,885 |  
|Less: cash equivalents         |  |               | (2,948  | ) |                  |   | (10,434 | )
|                               |  |               |         |   |                  |   |         |  
|                               |  | $             | 120,527 |   |                  | $ | 114,451 |  
|                               |  |               |         |   |                  |   |         |  



Management
classifies investments in marketable securities at the time of purchase and reevaluates such classification at each balance sheet date. Securities classified as available-for-sale are stated at amortized cost, which is not materially different than
market value as of March 31, 2005. $13.0 million of total liquid investments mature within three months, $11.7 million mature beyond three months but within one year, $1.2 million of investments mature beyond one year and within five years and $97.6
million of investments mature beyond five years, but have interest rate maturities of less than thirty-five days.



5. Inventories



Inventories consist of the following (in thousands):



|                |  |               |        |                  |   |       
|--------------- |  | ------------- | ------ | ---------------- | - | ------
|                |  | March 31,2005 |        | December 31,2004
|Work in process |  | $             | 21,471 |                  | $ | 9,433 
|Finished goods  |  |               | 15,635 |                  |   | 9,978 
|                |  |               |        |                  |   |       
|                |  | $             | 37,106 |                  | $ | 19,411
|                |  |               |        |                  |   |       



At March 31, 2005 and
December 31, 2004, the Companys reserve for slow-moving and obsolete inventory was approximately $2.7 million and $2.2 million, respectively. This increase resulted from additional reserve of $0.8 million for obsolescence offset by scrap and
sales of items which had previously been reserved of $0.3 million.



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##### Table of Contents

SigmaTel, Inc.

Notes to Consolidated Condensed Financial Statements Continued



6. Intangible Assets



Intangible assets subject to amortization expense relate to licenses to use intellectual property in manufacturing and patents. Intangible assets consist of the following (in thousands):



|                                           |  |               |        |   |                  |   |        |  
|------------------------------------------ |  | ------------- | ------ | - | ---------------- | - | ------ | -
|                                           |  | March 31,2005 |        |   | December 31,2004 |  
|Intangible assets subject to amortization: |  |               |        |   |                  |   |        |  
|Gross carrying amount                      |  | $             | 6,283  |   |                  | $ | 5,605  |  
|Accumulated amortization                   |  |               | (1,554 | ) |                  |   | (1,248 | )
|                                           |  |               |        |   |                  |   |        |  
|Intangible assets, net                     |  | $             | 4,729  |   |                  | $ | 4,357  |  
|                                           |  |               |        |   |                  |   |        |  



Intangible asset
amortization expense for the three months ended March 31, 2005 and 2004 was $0.3 million and $0.2 million, respectively. Estimated aggregate intangible asset amortization expense is expected to be $1.2 million for each of the fiscal years 2005
through 2007, $1.0 million in 2008 and $0.2 million in 2009. The weighted average amortization period for intangible assets is five years.



7. Income Taxes



The provision for income taxes has been calculated based on the Companys estimate of its effective tax rate for the full fiscal year. At March 31,
2005, the Companys estimate of the effective tax rate for the year ended December 31, 2005 was 34.0%. This estimate differed from the statutory rate primarily due to research and development tax credits. At March 31, 2004, the Companys
estimate of the effective tax rate for the year ended December 31, 2004 was 2.0%. This estimate differed from the statutory rate primarily due to the Companys anticipated reduction in its deferred tax asset valuation allowance attributable to
the utilization of loss carryforwards.



During the three months
ended March 31, 2005 and 2004, the Company recognized certain tax benefits related to stock option plans in the amount of $5.4 million and zero, respectively. These benefits were recorded as a reduction of income taxes payable and an increase in
additional paid-in capital.



The determination of the provision
for income taxes requires the Company to take positions on certain issues where there is uncertainty in the application of the tax law. The provision for income taxes includes amounts intended to satisfy unfavorable adjustments by the Internal
Revenue Service and other tax authorities in an examination of the Companys income tax returns. The ultimate resolution of these uncertainties may result in an assessment that is materially different from the current estimate of the liability
and, if favorable, may result in income tax benefits being recognized in a future period.



8. Commitments and Contingencies



In December 2004, the Company abandoned a lease of office space in order to move its Austin, Texas operations to a larger location that would accommodate the Companys rapidly growing staff of engineers as well
as support staff. The total amount incurred in connection with the lease abandonment was approximately $2.0 million, which was expensed entirely in 2004. During the three months ended March 31, 2005, the Company adjusted the lease abandonment charge
by approximately $385,000 due to additional subleases that were executed in the abandoned space during the period. The adjustment is reflected in the selling, general and administrative operating expense in the consolidated condensed statement of
operations. At March 31, 2005, the liability is allocated between a current liability of approximately $850,000 and a non-current liability of approximately $350,000. The Company does not expect any future charges related to this abandonment.



In the normal course of its business, the Company enters into
contracts that contain a variety of representations and warranties and which provide general indemnifications. The Companys exposure under these arrangements is unknown as this would involve future claims that might be made against the Company
that have not yet occurred. However, based on experience, the Company expects the risk of any loss to be remote.



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SigmaTel, Inc.

Notes to Consolidated Condensed Financial Statements Continued



9. Related Party Transactions



Revenues from a significant stockholder were approximately $20.0 million and $3.2 million for the three months ended March 31, 2005 and 2004, respectively.



Accounts receivable from sales to an affiliated customer were approximately $15.9 million and $7.0 million as of March 31,
2005 and December 31, 2004, respectively.



10. Operating Segments and
Geographic Information



The Company operates as a single
segment. The Companys chief operating decision maker is considered to be the Chief Executive Officer. The chief operating decision maker allocates resources and assesses performance of the business at the entity-wide level to manage the
business.



The following table summarizes the percentages of
revenues by geographic region:



|                |  |                             |   |  |       |  
|--------------- |  | --------------------------- | - |  | ----- | -
|                |  | Three Months EndedMarch 31, |  
|                |  | 2005                        |   |  | 2004  |  
|Taiwan          |  | 52.2                        | % |  | 52.3  | %
|China/Hong Kong |  | 23.6                        |   |  | 27.8  |  
|Singapore       |  | 20.1                        |   |  | 10.3  |  
|South Korea     |  | 3.0                         |   |  | 7.0   |  
|Japan           |  | 0.8                         |   |  | 2.1   |  
|Malaysia        |  | 0.1                         |   |  |      |  
|United States   |  | 0.1                         |   |  | 0.1   |  
|Other           |  | 0.1                         |   |  | 0.4   |  
|                |  |                             |   |  |       |  
|Total sales     |  | 100.0                       | % |  | 100.0 | %
|                |  |                             |   |  |       |  



The table below
summarizes the percentage of long-lived assets by geographic region:



|              |  |               |   |  |                  |  
|------------- |  | ------------- | - |  | ---------------- | -
|              |  | March 31,2005 |   |  | December 31,2004 |  
|United States |  | 88            | % |  | 88               | %
|Taiwan        |  | 4             |   |  | 1                |  
|Other         |  | 8             |   |  | 11               |  
|              |  |               |   |  |                  |  
|              |  | 100           | % |  | 100              | %
|              |  |               |   |  |                  |  



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SigmaTel, Inc.

Notes to Consolidated Condensed Financial Statements Continued



11. Recent Accounting Pronouncements



In November 2004, the FASB issued SFAS 151,Inventory Costs, an amendment of ARB No. 43, Chapter 4. The standard requires that abnormal amounts of idle capacity and spoilage costs should be excluded from the
cost of inventory and expensed when incurred. The provision is effective for fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of
operations or cash flows.



In December 2004, the FASB issued
SFAS 153,Exchanges of Nonmonetary Assets,an amendment of APB No. 29, Accounting for Nonmonetary Transactions. SFAS 153 requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis,
unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance. SFAS 153 is effective for nonmonetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.



In December 2004, the FASB released its final revised standard, SFAS No.
123R,Share-Based Payment. SFAS 123R requires that a public entity measure the cost of equity based service awards based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is
required to provide service in exchange for the award or the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. A public entity will initially measure the cost of
liability based service awards based on its current fair value; the fair value of that award will be remeasured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be
recognized as compensation cost over that period. Adoption of SFAS 123R is required for annual periods beginning after June 15, 2005. The Company is evaluating SFAS 123R and believes it will have a material effect on the Companys financial
position, results of operations and cash flows.



In March 2005,
the FASB issued FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations(FIN 47). FIN 47 clarifies that an entity must record a liability for a conditional asset retirement obligation if the fair value
of the obligation can be reasonably estimated. The provision is effective for no later than the end of fiscal year ending December 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial
position, results of operations or cash flows.



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##### Table of Contents

Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations



Forward-looking Statements



This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking
statements. For example, the words believes, anticipates, plans, expects, intends and similar expressions are intended to identify forward-looking statements. Our actual results and the
timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in Overview, Results of
Operations, Liquidity and Capital Resources and Risks That May Affect Future Results below. All forward-looking statements in this document are based on information available to us as of the date hereof and we assume no
obligation to update any such forward-looking statements. The following discussion should be read in conjunction with our consolidated condensed financial statements and the accompanying notes contained in this quarterly report. Unless expressly
stated or the context otherwise requires, the terms we, our, us and SigmaTel refer to SigmaTel, Inc.



Overview



We are a fabless semiconductor company that designs, develops, and markets proprietary, analog-intensive, mixed-signal integrated circuits, or ICs. We
were founded in 1993 with an initial focus on providing semiconductor design services on a contract basis. We began to develop our first IC product, an AC97 audio codec for PC sound cards, in 1995 and began shipping this product in 1997. From 1997
to 2000, our annual revenues grew rapidly from $1.2 million to $47.4 million. During that time, we began to develop an asymmetric digital subscriber line, or ADSL system on a chip, or SoC and a portable audio SoC. Neither of these products generated
revenues, which led to significant operating losses in 2000 and 2001. During 2000 and 2001, the PC audio market transitioned from sound cards to host audio solutions, which are integrated on desktop PC motherboards and in notebook PCs. As sound
cards began to lose market share, we experienced a significant loss in market share and a revenue decline from 2000 to 2001.



In early 2001, we hired our current Chief Executive Officer, Ronald Edgerton, and established a new management team. This new management team stopped
development of our ADSL SoC, reduced headcount, and redirected our development efforts towards host audio codecs and portable audio SoCs. Due primarily to increased sales of our portable audio SoCs, our revenues increased from $30.9 million for the
year ended December 31, 2002 to $100.2 million for the year ended December 31, 2003 to $194.8 million for the year ended December 31, 2004. Our operating results improved from an operating loss of $5.6 million for the year ended December 31, 2002 to
operating income of $11.3 million for the year ended December 31, 2003 and $53.1 million for the year ended December 31, 2004. Our operating results improved from an operating income of $6.7 million for the three months ended March 31, 2004 to $37.9
million for the three months ended March 31, 2005.



We
currently offer products that serve four markets: portable compressed audio players, notebook and desktop PC audio, consumer audio, and USB peripherals. We made our first commercial shipments of PC audio codecs during 1997. We made our first
commercial shipments of USB peripheral ICs in 2000, primarily targeting USB-to-Infrared wireless connectivity applications. We made our first commercial shipments of portable audio SoCs in 2001. The primary market for these products is the portable
compressed audio player market. During 2001, we also began to sell our audio codecs into the consumer electronics market for products such as DVD players and set top boxes.



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As a fabless semiconductor company, our business model is less capital intensive because we rely on third
parties to manufacture, assemble, and test our ICs. We rely on distributors to market our products. Our sales through distributors result in lower gross margins, but also lower selling expenses than are associated with direct sales to end customers.
A few customers account for a substantial portion of our sales. The following table sets forth our customers that represented 10% or more of our revenues for the periods indicated:



|                       |  |                             |   |  |      |  
|---------------------- |  | --------------------------- | - |  | ---- | -
|                       |  | Three Months EndedMarch 31, |  
|                       |  | 2005                        |   |  | 2004 |  
|ASUSTEK Computer Inc.  |  | 27.1                        | % |  | *    |  
|Creative Technology(1) |  | 20.1                        | % |  | 10.2 | %
|G.M.I. Technology      |  | 13.8                        | % |  | 18.1 | %
|Holystone Enterprise   |  | *                           |   |  | 25.5 | %

---

|* | Less than 10%
|- | -------------

|(1) | Creative Technology holds more than 10% of our outstanding stock and had a representative on our Board of Directors until his resignation on June 10, 2004.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------



The percentage of our revenues from customers
located outside the U.S. was 99.9% for each of the three months ended March 31, 2005 and 2004. Most of the products that use our ICs are manufactured outside of the U.S. As a result, we believe that a substantial majority of our revenues will
continue to come from customers located outside of the U.S. All of our revenues to date have been denominated in U.S. dollars.



The percentages of our revenues by country are set forth in the following table:



|                |  |                             |   |  |       |  
|--------------- |  | --------------------------- | - |  | ----- | -
|                |  | Three Months EndedMarch 31, |  
|                |  | 2005                        |   |  | 2004  |  
|Taiwan          |  | 52.2                        | % |  | 52.3  | %
|China/Hong Kong |  | 23.6                        |   |  | 27.8  |  
|Singapore       |  | 20.1                        |   |  | 10.3  |  
|South Korea     |  | 3.0                         |   |  | 7.0   |  
|Japan           |  | 0.8                         |   |  | 2.1   |  
|Malaysia        |  | 0.1                         |   |  |      |  
|United States   |  | 0.1                         |   |  | 0.1   |  
|Other           |  | 0.1                         |   |  | 0.4   |  
|                |  |                             |   |  |       |  
|Total           |  | 100.0                       | % |  | 100.0 | %
|                |  |                             |   |  |       |  



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Our sales cycles can take up to 12 months to complete and volume production of products that use our ICs
can take an additional 3 to 6 months to be achieved, if at all. The lengthy sales cycles of our products make forecasting the volume and timing of orders difficult. In addition, the delays inherent in lengthy sales cycles increase the risk that
customers may seek to cancel or modify their orders. Our sales are made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, and order lead times can vary period to period, backlog
is not a good indicator of our future sales. Cancellations of customer orders or changes in product specifications could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses.



Because many of our ICs are designed for use in consumer
electronic products, such as portable compressed audio players, PCs, and DVD players, we expect our business to be subject to seasonality, with increased revenues in the third and fourth quarters of each year, when customers place orders to meet
year-end holiday demand, and lower revenues in the first and second quarters of each year. However, our recent rapid revenue growth makes it difficult for us to assess the impact of seasonal factors on our business. In particular, strong sales of
our portable audio SoCs resulted in increased revenues during the first quarter of 2005 compared to the fourth quarter of 2004, offsetting seasonal demand factors.



SigmaTel, Inc. was incorporated on December 28, 1993 and is a fabless designer of analog-intensive mixed-signal ICs
headquartered in Austin, Texas. SigmaTel Hong Kong, Limited was established and incorporated in Hong Kong in July 2004 and became a wholly owned subsidiary of SigmaTel, Inc. in August of 2004 for the purpose of providing engineering support to
customers in Asia for their product development activities. In March 2005, the Company effected a name change of the Hong Kong subsidiary to SigmaTel Asia, Limited. The accompanying consolidated financial statements include the accounts of both
SigmaTel, Inc. and SigmaTel Asia, Limited, and all material intercompany accounts and transactions have been eliminated in consolidation.



In March 2005, SigmaTel Caymans was established and incorporated in the Cayman Islands as a wholly owned subsidiary of SigmaTel, Inc. for the purpose of
holding the stock of future international subsidiaries and to license the economic rights to certain intellectual property from SigmaTel, Inc. and to further license those rights to other subsidiaries of the Company in the future.



The following describes certain line items in our consolidated condensed
statements of operations:



Revenues. Revenues consist
primarily of sales of our ICs, net of sales discounts or incentives. We recognize revenues on direct sales at the time of shipment to our customers. We defer revenues on sales through distributors with rights of return or price protection until
products are resold by such distributors to their customers.



Cost of Goods Sold. Cost of goods sold consists primarily of the costs of purchasing silicon wafers, and also includes costs associated with assembly, test and shipping of our ICs, costs of personnel and equipment associated with
manufacturing support and quality assurance, and occupancy costs. Because we do not have long-term, fixed-price supply contracts, our wafer costs are subject to the cyclical demand for semiconductors.



Research and Development. Research and development expense consists
primarily of employee, contractor, and related costs, expenses for development testing, evaluation, masking costs, occupancy costs, and depreciation on research and development equipment. All research and development costs are expensed as incurred.
We plan to continue to invest a significant amount in research and development activities to develop new products. We expect research and development expenses to increase in absolute dollars.



Selling, General and Administrative. Selling, general and
administrative expense consists primarily of employee, contractor, and related costs, occupancy costs, sales commissions to independent sales representatives, professional services, and promotional and marketing expenses. We expect selling expenses
will fluctuate with changes in revenues, and we expect that general and administrative expenses will increase to support our future operations as well as the additional costs of operating as a publicly traded company.



Amortization of Deferred Stock-Based Compensation. In connection with
grants of stock options and the issuance of warrants as a private company between 2000 and 2003, we recorded an aggregate of $7.5 million in



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##### Table of Contents

deferred stock-based compensation. These options and warrants are considered compensatory because the fair value of our
stock determined for financial reporting purposes was greater than the fair value determined by our board of directors on the date of grant or issuance. We have also recorded deferred stock-based compensation due to the conversion of certain
contractors to employees. As of March 31, 2005, we had an aggregate of $1.2 million of deferred stock-based compensation remaining to be amortized. We are amortizing deferred stock-based compensation over the vesting period of the related options
and warrants, which is generally four or five years. This deferred stock-based compensation balance is expected to be amortized as follows: $0.7 million during 2005 and $0.5 million during 2006 and beyond.



Provision for Income Taxes. We accrue federal and state income taxes
at the applicable statutory rates adjusted for certain items including non-deductible expenses, research and development tax credits, interest income from tax advantaged investments, as well as changes in our deferred tax asset valuation allowance.



Results of Operations



The following table sets forth our consolidated condensed statements of
operations as a percentage of revenues for the periods indicated:



|                                                  |  |                             |   |  |       |  
|------------------------------------------------- |  | --------------------------- | - |  | ----- | -
|                                                  |  | Three Months EndedMarch 31, |  
|                                                  |  | 2005                        |   |  | 2004  |  
|Revenues, net                                     |  | 100.0                       | % |  | 100.0 | %
|Cost of goods sold                                |  | 42.6                        |   |  | 46.9  |  
|                                                  |  |                             |   |  |       |  
|Gross profit                                      |  | 57.4                        |   |  | 53.1  |  
|Operating expenses:                               |  |                             |   |  |       |  
|Research and development                          |  | 11.9                        |   |  | 19.3  |  
|Selling, general and administrative               |  | 7.2                         |   |  | 9.2   |  
|Amortization of deferred stock-based compensation |  | 0.2                         |   |  | 3.2   |  
|                                                  |  |                             |   |  |       |  
|Total operating expenses                          |  | 19.3                        |   |  | 31.7  |  
|                                                  |  |                             |   |  |       |  
|Operating income                                  |  | 38.1                        |   |  | 21.4  |  
|Interest income, net                              |  | 0.9                         |   |  | 1.1   |  
|                                                  |  |                             |   |  |       |  
|Income before income taxes                        |  | 39.0                        |   |  | 22.5  |  
|Income tax expense                                |  | 13.3                        |   |  | 0.5   |  
|                                                  |  |                             |   |  |       |  
|Net income                                        |  | 25.7                        | % |  | 22.0  | %
|                                                  |  |                             |   |  |       |  



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##### Table of Contents

Comparison of Three Months Ended March 31, 2005 to Three Months Ended March 31, 2004



Revenues. Revenues for the three months ended March 31, 2005 were
$99.3 million compared to $31.5 million for the three months ended March 31, 2004, an increase of 215.4%. This increase was due to an increase in revenues from portable audio SoCs of 273.4%, offset by a 0.9% decrease in revenues from our audio
codecs and a 75.6% decrease in revenues from our USB peripheral ICs. The increase in revenues from our portable audio SoCs was due to the continued growth of the emerging portable compressed audio player market and our favorable competitive position
within that market as well as increased unit shipments to support new design wins at certain customers. Revenues from our portable audio SoCs were 95.6% of total revenues for the three months ended March 31, 2005. Our favorable competitive position
in this market is primarily due to our integration of analog and digital components onto a single IC, and the resulting small form factor, low power consumption, and overall low cost to our customers. The decrease in revenues from our USB peripheral
ICs was primarily due to competitive pressures at the low end of the market.



Revenues from ASUSTEK Computer Inc., an original design manufacturer, or ODM, based in Taiwan, which manufactures products for Apple and other companies, increased to 27.1% of total revenues during the three months
ended March 31, 2005 from less than 10% of total revenues during the three months ended March 31, 2004 due primarily to increased purchases of our portable audio SoCs. Sales to Creative Technology, an affiliate, increased to 20.1% of total revenues
during the three months ended March 31, 2005 from 10.2% during the three months ended March 31, 2004 due to stronger demand for our portable audio SoCs. Creative Technology purchases our standard products at prices and on terms similar to other
customers who buy similar products and volumes. Revenues from G.M.I., a distributor located in Hong Kong, decreased to 13.8% of total revenues during the three months ended March 31, 2005 from 18.1% of total revenues during the three months ended
March 31, 2004 primarily due to stronger demand for our portable audio SoCs from direct customers ASUSTEK Computer Inc. and Creative Technology. Revenues from Holystone, a distributor located in Taiwan, decreased to less than 10% of total revenues
during the three months ended March 31, 2005 from 25.5% during the three months ended March 31, 2004, primarily due to increases in sales to our direct customers as well as customers who use our portable audio SoCs being served by other distributors
in geographic regions such as China and South Korea.



Gross
Profit. Gross profit as a percentage of revenues, or gross margin, was 57.4% for the three months ended March 31, 2005 compared with 53.1% for the three months ended March 31, 2004. The increase in gross margin was primarily due to a favorable
product mix, a shift to direct customers, and a reduction in manufacturing costs, which included both lower wafer costs, lower test costs and improved manufacturing yields. The favorable product mix resulted from increased revenues from sales of our
portable audio SoCs into the mainstream segment of the portable compressed audio market as a percentage of total revenues, as the gross margin from these products is generally higher than from the value segment of the market. We expect our gross
margins for the second quarter of 2005 to be consistent with those achieved during the previous two quarters. However, increased competition could adversely impact our pricing, particularly in the portable compressed audio player market, which could
adversely impact our gross margins.



Research and
Development. Research and development expenses increased to $11.9 million, or 11.9% of revenues, for the three months ended March 31, 2005 from $6.1 million, or 19.3% of revenues, for the three months ended March 31, 2004. This dollar increase
of 95.1% was primarily due to increases in our engineering headcount, including independent contractors, as well as increases in the costs of design tools and mask sets. Such increases were primarily to support hardware and software development on
our latest portable audio SoCs, the yet to be released STMP 36XX families of products, audio codecs targeted for applications in the PC market, including the Intel High Definition Audio standard, also known as Azalia, and various USB peripheral ICs,
as well as development efforts on new products yet to be announced. This increased research and development spending has resulted in substantial progress on or completion of the design of these products and the creation of several patentable
inventions, enabling us to identify additional U.S. patent applications covering inventions made during the STMP 36XX design processes. We expect that research and development expenses will increase in absolute dollars in future periods as we
continue to increase our staffing and associated costs to pursue additional new product development opportunities, but such expenses will fluctuate as a percentage of revenue due to changes in revenue.



Selling, General and Administrative. Selling, general and
administrative expenses increased to $7.1 million, or 7.2% of revenues, for the three months ended March 31, 2005 from $2.9 million, or 9.2% of



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revenues, for the three months ended March 31, 2004. This dollar increase of 145.4% was due to increases in sales,
marketing, and administrative personnel including a substantial increase in personnel located in the Asia-Pacific region. The increase was also due to increased lease expense relating to office space both domestically and internationally, as well as
increases in commissions paid to independent sales representatives due to our revenue growth. We expect that selling, general and administrative expenses will increase in absolute dollars in future periods as we continue to increase our staffing and
customer support and associated costs, but such expenses will fluctuate as a percentage of revenues due to changes in revenues.



Amortization of Deferred Stock-Based Compensation. We record deferred stock-based compensation for the difference between the exercise price of
option grants and the fair value of our common stock at the time of such grants which resulted in amortization expense of $0.2 million and $1.0 million for the three months ended March 31, 2005, and 2004, respectively.



Interest Income. Interest income increased to $0.8 million for the
three months ended March 31, 2005 from $0.3 million for the three months ended March 31, 2004. This was due to increased income earned on our cash balances and investments in short-term marketable securities.



Income Taxes. Our income tax expense increased to $13.2 million for
the three months ended March 31, 2005 from $141,000 for the three months ended March 31, 2004. This was primarily due to increased income before taxes, as well as an increase in the estimate of our effective tax rate. At March 31, 2005, the estimate
of the effective tax rate for the year ended December 31, 2005 was 34.0%. This estimate differed from the statutory rate primarily due to research and development tax credits. At March 31, 2004, the estimate of the effective tax rate for the year
ended December 31, 2004 was 2.0%. This estimate differed from the statutory rate primarily due to our anticipated reduction in our deferred tax asset valuation allowance attributable to the utilization of loss carryforwards.



Liquidity and Capital Resources



As of March 31, 2005, we had $150.7 million in cash, cash equivalents and
short-term investments. On September 19, 2003, we completed an initial public offering of approximately 7.4 million shares of our common stock resulting in net proceeds to us of approximately $101.4 million. On February 18, 2004, we completed a
follow-on public offering of 250,000 shares of our common stock resulting in net proceeds to us of approximately $5.3 million.



Net cash provided by operating activities was $9.7 million and $5.1 million for the three months ended March 31, 2005 and 2004, respectively. The
improvement in our operating cash flows is primarily the result of increased revenues, gross margins and net income. Our accounts receivable increased $27.9 million and $0.4 million during the three months ended March 31, 2005 and 2004,
respectively. These changes are due to fluctuations in revenues, the timing of customer payments, and a shift in our revenue base from sales primarily to distributors in the 2004 period to sales primarily to direct customers in the 2005 period. More
of our business has shifted to direct customers, and our direct customers generally require longer payment terms. Our inventories increased $17.7 million and $0.6 million during the three months ended March 31, 2005 and March 31, 2004, respectively.
This increase in inventories is required to support the increase in demand for our products during the first and second quarters of 2005. Our reserve for slow-moving and obsolete inventory as a percentage of total inventory was 6.7% and 10.1% as of
March 31, 2005 and December 31, 2004, respectively. We monitor and analyze our inventory for obsolescence and adjust this reserve accordingly. Although the reserve decreased as a percentage of total inventory, it increased by $0.5 million and $0.7
million at March 31, 2005 and March 31, 2004 respectively. This change in the 2005 period was due to additional reserve for obsolescence offset by scrap and sales of items which had previously been reserved. Our accounts payable increased $12.1
million and decreased $2.4 million during the three months ended March 31, 2005 and 2004, respectively. These changes generally relate to increases in our inventories and the timing of payments. Our deferred revenue increased $6.3 million and $0.9
million during the three months ended March 31, 2005 and March 31, 2004, respectively, due to increases in our products held at distributors to enable them to meet increased customer demand for our products.



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Our investing activities used cash of $9.5 million and $45.3 million during the three month periods ended
March 31, 2005 and March 31, 2004, respectively. Investing activities primarily represented purchases of capital equipment and short-term investments.



Capital expenditures were $3.3 million and $2.9 million during the three months ended March 31, 2005 and 2004, respectively. These expenditures were
incurred primarily for the purchase of engineering tools, computer equipment, software, office equipment, and leasehold improvements related to our office relocation in Austin, Texas and our new office openings internationally. Research and
development resources are required to develop and expand our core technologies and proprietary product offerings. Our research and development expenses were $11.9 million and $6.1 million during the three months ended March 31, 2005 and 2004,
respectively. These expenditures resulted in the enhancement of our product offerings, technological know how and inventions that have yielded several U.S. patents and pending U.S. patents. We expect to continue to incur significant research and
development expenses and will fund these expenses with operating cash flow and existing cash balances.



Our financing activities provided cash of $2.7 and $8.2 million during the three months ended March 31, 2005 and 2004, respectively. On February 18, 2004,
we completed a follow-on equity offering and received $5.3 million of net offering proceeds. We also received $1.8 million in proceeds from the exercise of employee stock options during each of the three months ended March 31, 2005 and 2004 and $0.9
million from the purchase of stock under our Employee Stock Purchase Plan during each of the three months ended March 31, 2005 and 2004. These proceeds were invested in short-term, investment grade, interest bearing instruments, pending their use to
fund working capital and capital expenditures as required.



The
fair value of our investments in marketable securities at March 31, 2005 was $120.5 million. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities
represent the investment of cash that is available for current operations. Our investment policy is to manage our investment portfolio to preserve principal and liquidity while maximizing the return on the investment portfolio through the full
investment of available funds. We diversify the marketable securities portfolio by investing in multiple types of investment-grade securities. Our investment portfolio is primarily invested in short-term securities with at least an investment grade
rating to minimize interest rate and credit risk as well as to provide for an immediate source of funds.



We believe our existing cash balances and short-term investments, together with cash expected to be generated from operating activities, will be
sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support product development efforts,
the expansion of sales and marketing activities, the timing of introductions of new products, the costs to ensure access to adequate manufacturing capacity, and the continuing market acceptance of our products. We could be required, or could elect,
to seek additional funding through public or private equity or debt financing and additional funds may not be available on terms acceptable to us or at all.



Critical Accounting Policies and Estimates



Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to uncollectible accounts receivable, inventories, investments, intangible assets, income taxes, financing operations, warranty
obligations and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments
about the carrying values of assets and liabilities that are not readily apparent from other sources. Because this can vary in each situation, actual results may differ from the estimates under different assumptions and conditions.



We believe the following critical accounting policies affect our more
significant judgments used in the preparation of our financial statements.



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Revenue Recognition. We recognize revenues in accordance with Securities and Exchange Commission
Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by SAB 101A and 101B (SAB 101) and SAB 104, Revenue Recognition. SAB 101 requires that four basic criteria must be met before
revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3)
and (4) are based on managements judgment regarding the fixed nature of the fee charged for products delivered and the collectibility of those fees. Should changes in conditions cause management to determine these criteria are not met for
certain future transactions, revenues recognized for any reporting period could be adversely impacted.



Revenues from product sales to customers other than distributors are recognized upon shipment and reserves are provided for estimated allowances. We defer
recognition of revenues on sales to distributors with rights of return or price protection until our product has been sold by the distributor to their customers.



Short-term Investments.Short-term investments consist of corporate, state and municipal securities with readily
determinable fair market values and original maturities in excess of three months. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the
investment of cash that is available for current operations. Our investments are classified as available-for-sale and accordingly are reported at fair value, with unrealized gains and losses, if material, reported as a component of
stockholders equity. Unrealized losses are charged against income when a decline in the fair market value of an individual security is determined to be other than temporary. Realized gains and losses on investments are included in interest
income.



Inventory Valuation. We value our inventory at
the lower of the actual costs of our inventory or its current estimated market value. We record inventory provisions for estimated obsolescence or unmarketable inventories based upon assumptions about future demand and market conditions. If actual
market conditions are less favorable than those projected by management, additional inventory provisions may be required.



Accounting for Stock-Based Compensation. We account for our stock-based employee compensation plans under the recognition and measurement
principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock issued toEmployees, and related interpretations. We amortize stock-based compensation over the vesting periods of the related options,
which are generally either four or five years, in accordance with FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, an interpretation of APB Opinions No. 15 and 25.



We have recorded deferred stock-based compensation
representing the difference between the deemed fair value of our common stock for accounting purposes and the option exercise price. We determined the deemed fair value of our common stock based upon several factors, including trends in the broad
market for technology stocks and the expected valuation we would obtain in an initial public offering. Had different assumptions or criteria been used to determine the deemed fair value of our common stock, materially different amounts of
stock-based compensation could have been reported.



Pro forma
information regarding net income and net income per share is required in order to show our net income as if we had accounted for employee stock options under the fair value method of Statement of Financial Accounting Standards (SFAS) No.
123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure. This information is contained in Note 3 to our financial statements. The fair value of
options and shares issued pursuant to our option plan at the grant date were estimated using the Black-Scholes option-pricing model.



Impairment of Long-lived Assets. We evaluate long-lived assets held and used by us for impairment whenever events or changes in circumstances
indicate that their net book value may not be recoverable. When such factors and circumstances exist, we compare the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives
against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period
in which the determination is made.



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Accounting for Income Taxes. We account for income taxes under SFAS No. 109,Accounting for
Income Taxes. Under this method, we determine deferred tax assets and liabilities based upon the difference between the financial and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the
differences will affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.



Because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities,
equity, revenue, expenses, gains and losses, differences arise between the amount of taxable income and pretax financial income for a year and between the tax bases of assets or liabilities and their reported amounts in the financial statements.
Where it is assumed that the reported amounts will be recovered and settled, and that a difference between the tax basis of an asset or liability and its reported amount in the balance sheet will result in a taxable or deductible amount in some
future year, a deferred tax asset or liability is established. We assess the likelihood that our deferred tax assets will be recovered from future taxable income and feasible tax planning strategies, and to the extent we believe it is not likely, we
establish a valuation allowance.



The determination of the
provision for income taxes requires the Company to take positions on certain issues where there is uncertainty in the application of the tax law. The provision for income taxes includes amounts intended to satisfy unfavorable adjustments by the
Internal Revenue Service and other tax authorities in an examination of the Companys income tax returns. The ultimate resolution of these uncertainties may result in an assessment that is materially different from the current estimate of the
liability and, if favorable, may result in income tax benefits being recognized in a future period.



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Item 3: Quantitative and Qualitative Disclosures About Market Risk



We operate in a dynamic and rapidly changing environment that involves numerous risks and uncertainties. The following section describes some, but not
all, of these risks and uncertainties that we believe may adversely affect our business, financial condition or results of operations. This section should be read in conjunction with the Unaudited Consolidated Condensed Financial Statements and
Notes thereto, and Managements Discussion and Analysis of Financial Condition and Results of Operations as of March 31, 2005 and for the three month period then ended contained elsewhere in this Form 10-Q.



Interest Rate Risk



The primary objective of our investment activities is to preserve principal while maximizing the income without
significantly increasing risk. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk in the
future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and certificates of deposit. The
risk associated with fluctuating interest rates is limited to our investment portfolio and we do not believe that a 10% change in interest rates would have a significant impact on our interest income. As of March 31, 2005, all of our investments
were in money market accounts or investment grade securities.



Risks That
May Affect Future Results



You should carefully consider
the risks described below and all of the other information contained in this quarterly report on Form 10-Q in evaluating SigmaTel and our business. The risks and uncertainties described below are not the only risks and uncertainties we face.
Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition and results of operations
would suffer. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment in our common stock.



Our limited history of sales of our key products makes it difficult to evaluate our prospects.



Most of our key products have only been sold in significant quantities for a short time. For example, our STMP 3410 portable
audio SoC was introduced in the fourth quarter of 2001 but did not begin shipping in significant quantities until the second quarter of 2002, and production volumes of our STMP 35XX family of portable audio SoC products began shipping in the fourth
quarter of 2003. Sales of both the STMP 3410 and the STMP 35XX family of products are highly dependent upon continued acceptance of portable MP3 music players by consumers. Since we cannot accurately monitor sell-through of our ultimate end
customers MP3 players which contain our portable audio SoCs, it is possible that some of these products may not be selling through. As a result, our customers could experience inventory growth that could cause them to purchase fewer products
from us or seek to return products to us in the future. There can be no assurance that our customers have not or will not place orders in excess of their requirements in response to actual or perceived shortages in the supply of our ICs. In such
event, it will be more difficult for us to forecast our future revenues and budget our operating expenses, and our operating results would be adversely affected to the extent such excess orders are cancelled or rescheduled. We have limited
historical financial data from which to predict our future sales and operating results for our portable audio SoCs and other key products that we have recently introduced. Our limited operating experience with these products, combined with the
rapidly evolving nature of the markets in which we sell our products, and other factors which are beyond our control, limit our ability to accurately forecast quarterly or annual sales. Because most of our expenses are fixed in the short term or
incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any shortfall in sales. We are currently expanding our staffing and increasing our expenditures to support future growth. If our
growth does not materialize, our operating results would be adversely impacted.



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We do not expect to sustain our recent growth rate.



Due primarily to increased sales of our portable audio SoCs, we have experienced significant revenue growth and have gained
significant market share in a relatively short period of time. Specifically, our annual revenues increased from $30.9 million in 2002 to $100.2 million in 2003 and to $194.8 million in 2004. Revenues increased from $31.5 million for the three months
ended March 31, 2004 to $99.3 million for the three months ended March 31, 2005. However, we do not expect similar revenue growth or market share gains in future periods. Accordingly, you should not rely on the results of any prior quarterly or
annual periods as an indication of our future operating performance.



We
have incurred losses in prior periods and may incur losses in the future.



Although we had net income of $25.5 million for the three months ended March 31, 2005 and $52.6 million and $10.0 million for the years ended December 31, 2004 and 2003, respectively, we incurred net losses of
approximately $8.3 million and $18.4 million for the years ended December 31, 2002, and 2001, respectively. Despite realizing net income in the three months ended March 31, 2005 and in the years ended December 31, 2004 and 2003, we may incur losses
in the future. We expect our operating expenses to increase as we pursue our strategic objectives. Our results of operations for the three months ended March 31, 2005 include a non-cash charge of approximately $180,000 related to stock based
compensation, and our results of operations for the year ended December 31, 2004 include a non-cash charge of $2.2 million related to stock based compensation. We will continue to incur stock-based compensation in the future as a result of past
option grants. Further, under the recently issued Financial Accounting Standard Board Statement No. 123R, we will be required to apply certain expense recognition provisions for annual periods beginning after June 15, 2005 to share-based payments to
employees using the fair value method, which expense recognition will reduce our profitability and could cause us to again incur net losses on a quarterly or annual basis. Our ability to maintain profitability depends on the rate of growth of our
target markets, the continued market acceptance of our customers products, the competitive position of our products, and our ability to develop new products. Even though we have achieved profitability, we may not be able to sustain or increase
profitability on a quarterly or an annual basis.



Stock-based compensation
plans.



We currently have three active stock-based
compensation plans, namely the SigmaTel 1995 Stock Option/Stock Issuance Plan, the SigmaTel 2003 Equity Incentive Plan, and the SigmaTel Employee Stock Purchase Plan. We currently account for employee stock awards under our stock-based compensation
plans in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting Standards Board Interpretation No. 44, Emerging Issues Task Force (EITF) Issue
No. 00-23, and related interpretations. We currently account for equity awards issued to non-employees in accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and EITF Issue No. 96-18, Accounting for
Equity Instruments that are Issued to other than Employees for Acquiring, or in Conjunction with Selling Goods or Services and related interpretations. We currently adhere to the disclosure-only provisions of these applicable accounting
principles. In December 2004, the FASB issued a revision to SFAS No. 123 (SFAS 123R) that eliminates the alternative to use the disclosure-only provisions of SFAS No. 123, thereby requiring entities to recognize the cost of employee services
received in exchange for awards of equity instruments based on the grant-date fair value of those awards. We will be required to recognize the cost of these equity awards granted beginning in the first quarter of 2006. While we are currently
reviewing the implementation alternatives allowed under SFAS 123R, we expect the impact of the adoption of SFAS 123R in our first quarter of 2006 to have a material adverse effect on our results of operations in future periods.



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We depend on a few key customers for a substantial majority of our sales and the loss of, or a significant reduction
in orders from, any of them would likely significantly reduce our revenues.



For the three months ended March 31, 2005 and 2004, sales to our top five customers accounted for approximately 78.1% and 72.3%, respectively, of our revenues. Our operating results in the foreseeable future will
likely continue to depend on sales to a relatively small number of customers, as well as the ability of these customers to sell products that use our ICs. Our revenues would likely decline if one or more of these customers were to significantly
reduce, delay or cancel their orders for any reason. In addition, any difficulty in collecting outstanding amounts due from our customers, particularly customers who place large orders, would harm our financial performance. Because our sales are
made by means of standard purchase orders rather than long term contracts, we cannot assure you that our customers will continue to purchase our products at current levels, or at all.



We rely on a small number of distributors to market and distribute our products, and if we fail to maintain or expand these sales
channels, our revenues would likely decline.



Sales to a
small number of distributors generate a significant amount of our revenues. Our sales through distributors accounted for 47.7% and 75.5% of our revenues for the three months ended March 31, 2005 and 2004, respectively. Our sales to G.M.I., a
distributor, accounted for 13.8% and 18.1% of our revenues in the three months ended March 31, 2005 and 2004, respectively, and our sales to Holystone, also a distributor, accounted for less than 10% and 25.5% of our revenues in the three months
ended March 31, 2005 and 2004, respectively. Despite the decreases as a percentage of total revenues, the dollar amount of our products sold through distributors is significant. If G.M.I., Holystone or our other distributors were to materially
reduce their purchases from us, our business, financial condition and results of operations would suffer.



Our business will depend on our ability to maintain and expand our relationships with distributors, develop additional channels for the distribution and
sale of our products and effectively manage these relationships. Our distributors decide whether to include our products among those that they sell and may carry and sell product lines that are competitive with ours. Because our distributors are not
required to make a specified minimum level of purchases from us, we cannot be sure that they will prioritize selling our products. As we continue to expand our indirect sales capabilities, we will need to manage the potential conflicts that may
arise within our indirect sales force. We also rely on our distributors to accurately and timely report to us their sales of our products and to provide certain engineering support services to customers. Our inability to obtain accurate and timely
reports and to successfully manage these relationships would adversely affect our business and financial results.



Our business is highly dependent on the consumer electronics market, which is characterized by short product life cycles, fluctuations in demand and seasonality, and
subject to risks related to product transitions and supply of other components.



We derive a substantial portion of our revenues from a limited number of products that are used in consumer electronic devices. The consumer electronics market is characterized by intense competition, rapidly evolving
technology, and ever-changing consumer preferences. These factors result in the frequent introduction of new products, short product life cycles and significant price competition. The dynamic nature of this market limits our, as well as our
customers, ability to accurately forecast quarterly and annual sales. If we, or our customers, are unable to manage product transitions, our business and results of operations could be negatively affected. For example, if our customers
transition from one type of flash memory to another type and our product is not compatible with the new type of flash memory, sales of our ICs would be adversely affected if we were unable to update our product in a timely manner. In addition, we
are subject to the risk of supply problems with other components of the end products of our customers. For example, if our customers could not obtain sufficient supplies of flash memory or hard disk drives, key components in many portable compressed
audio players, the sales of our products that are also included in such devices would be adversely affected. Furthermore, continuing technological advancement in consumer electronic devices, which is a significant driver of customer demand, is
largely beyond our control.



The expansion of the consumer
electronics market in general, and the demand for MP3 products in particular, may be adversely impacted by the enforcement of limits on file sharing and downloadable music. The major record labels have complained about consumers downloading music
off of the Internet without paying any fees or royalties to the owners of that music. In particular, the Recording Industry Association of America, a recording industry trade group, has sued numerous individuals who illegally distribute copyrighted
songs over the Internet. If the record labels, other music producers, or other parties are successful in limiting the ability of consumers to obtain free music on the Internet, the demand for consumer electronic devices such as MP3 players that use
our ICs may



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decline. Any decline in consumer spending, whether relating to general economic conditions, future terrorist attacks or
disease outbreaks, such as Severe Acute Respiratory Syndrome, or SARS, could also limit the expansion of the consumer electronics market, thus adversely affecting our business.



Because many of our ICs are designed for use in consumer electronic products, such as portable compressed audio players,
PCs, and DVD players, we expect our business to be subject to seasonality, with increased revenue in the third and fourth quarters of each year, when customers place orders to meet year-end holiday demand, and lower revenue in the first and second
quarters of each year. However, our recent rapid growth in revenues makes it difficult for us to assess the impact of seasonal factors on our business. In particular, strong sales of our portable audio SoCs resulted in increased revenues during the
first quarter of 2005 compared to the fourth quarter of 2004, offsetting seasonal demand factors. If we or our customers are unable to ramp up production of new or existing products to meet any increases in demand due to seasonality or other
factors, our revenues from such products would be adversely affected.



China
and South Korea, where we have significant sales, could be experiencing a slowing in economic growth, which may reduce our expected revenues if the slowing continues.



A significant portion of our sales to manufacturers of compressed digital audio players occur in China and South Korea, two
countries that could be experiencing a slowdown in economic growth. During the three months ended March 31, 2005, 23.6% of our sales occurred in China and 3.0% of our sales occurred in South Korea. While we cannot precisely determine the percentage
of worldwide end user purchases of compressed digital audio players that occur in China and South Korea, some of our customers have indicated that the growth in their sales to end customers in China and South Korea will be slower than originally
anticipated due to the overall slowdown in economic growth in those countries. Thus, our ability to increase revenues and grow our profits in the short term could be negatively impacted as a result of a slowdown in economic growth in China and South
Korea.



Because of the lengthy sales cycles for our products and the fixed
nature of a significant portion of our expenses, we may incur substantial expenses before we earn associated revenues and may not ultimately achieve our forecasted sales for our products.



Our sales cycles can take up to 12 months to complete and volume production
of products that use our ICs can take an additional 3 to 6 months to be achieved, if at all. Sales cycles for our products are lengthy for a number of reasons:



| |  |  | our customers usually complete an in-depth technical evaluation of our products before they place a purchase order;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | the commercial adoption of our products by OEMs and ODMs, is typically limited during the initial release of their product to evaluate product performance and consumer demand;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | new product introductions often center around key trade shows and failure to deliver a product prior to such an event can seriously delay introduction of a product; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the development and commercial introduction of products incorporating new technology frequently are delayed.
| | - |  | ------------------------------------------------------------------------------------------------------------



As a result of our lengthy sales cycles, we may incur substantial expenses
before we earn associated revenues because a significant portion of our operating expenses is relatively fixed and based on expected revenues. The lengthy sales cycles of our products make forecasting the volume and timing of orders difficult. In
addition, the delays inherent in lengthy sales cycles raise additional risks that customers may cancel or change their orders. Our sales are made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on
relatively short notice, backlog is not always a good indicator of our future sales. If customer cancellations or product changes occur, this could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory
and operating expenses.



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We derive a substantial portion of our revenues from our portable audio SoCs, the selling prices of our products tend
to decline over time, and if we are unable to develop successful new products in a timely manner, our operating results and competitive position could be harmed.



Our recent revenue growth has been primarily from sales of our portable audio SoCs, which accounted for 89.3% of our
revenues in the year ended December 31, 2004 and 95.6% of our revenues in the three months ended March 31, 2005. Our future success depends on our ability to develop successful new products in a timely and cost-effective manner. We are required to
continually evaluate expenditures for planned product developments and choose among alternatives based upon our expectations of future market trends. We cannot assure you that we will be able to develop and introduce new or enhanced products in a
timely and cost-effective manner or that our products will generate significant revenues. The development of our ICs is highly complex, and successful product development and market acceptance of our products depend on a number of factors,
including:



| |  |  | our accurate prediction of the changing requirements of our customers;
| | - |  | ----------------------------------------------------------------------



| |  |  | our timely completion and introduction of new designs;
| | - |  | ------------------------------------------------------



| |  |  | the availability of third-party manufacturing, assembly, and test capacity;
| | - |  | ---------------------------------------------------------------------------



| |  |  | the ability of our foundries to achieve high manufacturing yields for our products;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | our ability to transition to smaller manufacturing process geometries;
| | - |  | ----------------------------------------------------------------------



| |  |  | the quality, price, performance, power efficiency and size of our products and those of our competitors;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | our management of our indirect sales channels;
| | - |  | ----------------------------------------------



| |  |  | our customer service capabilities and responsiveness;
| | - |  | -----------------------------------------------------



| |  |  | the success of our relationships with existing and potential customers; and
| | - |  | ---------------------------------------------------------------------------



| |  |  | changes in industry standards.
| | - |  | ------------------------------



As is typical in the semiconductor industry, the selling price of a product tends to decline significantly over the life of the product. If we are unable
to offset any reductions in the selling prices of our products by introducing new products at higher prices or by reducing our costs, our revenues, gross margins and operating results would be adversely affected.



We rely on third-party contractors to manufacture, assemble and test our products and our
failure to successfully manage our relationships with these contractors could damage our relationships with our customers, decrease our sales, and limit our growth.



We rely on third-party contractors to manufacture, assemble, and test our ICs. We currently do not have long-term supply
contracts with any of our third-party vendors. None of our third-party vendors are obligated to perform services or supply products to us for any specific period, or in any specific quantities, except as may be provided in a particular purchase
order. There are significant risks associated with our reliance on these third-party contractors, including:



| |  |  | potential price increases;
| | - |  | --------------------------



| |  |  | capacity shortages;
| | - |  | -------------------



| |  |  | their inability to increase production and achieve acceptable yields on a timely basis;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | reduced control over delivery schedules and product quality;
| | - |  | ------------------------------------------------------------



| |  |  | increased exposure to potential misappropriation of our intellectual property;
| | - |  | ------------------------------------------------------------------------------



| |  |  | limited warranties on wafers or products supplied to us;
| | - |  | --------------------------------------------------------



| |  |  | shortages of materials that foundries use to manufacture our products;
| | - |  | ----------------------------------------------------------------------



| |  |  | failure to qualify a selected supplier;
| | - |  | ---------------------------------------



| |  |  | labor shortages or labor strikes; and
| | - |  | -------------------------------------

| |  |  | actions taken by our third-party contractors that breach our agreements.
| | - |  | ------------------------------------------------------------------------



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Because future foundry capacity may be limited and because we do not have long-term agreements with our foundries, we
may not be able to secure adequate manufacturing capacity to satisfy the demand for our products.



Our products are designed to be foundry-portable. In general, each of our products is primarily manufactured at a single foundry. We provide these
foundries with monthly rolling forecasts of our production requirements; however, the ability of each foundry to provide wafers to us is limited by the foundrys available capacity. Moreover, the price of our wafers will fluctuate based on
changes in available industry capacity. We do not have long term supply contracts with any of our foundries. Therefore, our foundry suppliers could choose to prioritize capacity for other customers, particularly larger customers, reduce or eliminate
deliveries to us on short notice or increase the prices they charge us. Accordingly, we cannot be certain that our foundries will allocate sufficient capacity to satisfy our requirements. If we are not able to obtain foundry capacity as required,
our relationships with our existing customers would be harmed and our sales would likely decline.



If our foundries do not achieve satisfactory yields or quality, our sales could decrease, and our relationships with our customers and our reputation may be harmed.



Minor deviations in the IC manufacturing process can cause substantial
decreases in yields, and in some cases, cause production to be suspended. For example, a design error by one of our third-party foundries during 2001 caused very low yields for several months, which negatively impacted our business. Our foundries
are responsible for yield losses due to their errors, but these yield losses could cause us to delay shipments to our customers. Our parts are qualified with our foundries, at which time a minimum acceptable yield is established. If actual yield is
below the minimum, the foundry incurs the cost of the wafers. If actual yield is above the minimum, we incur the cost of the wafers. The manufacturing yields for our new products tend to be lower initially and increase as we achieve full production.
Our product pricing is based on the assumption that an increase in manufacturing yields will continue, even with the increasing complexity of our ICs. Shorter product life cycles require us to develop new products faster and to manufacture these
products for shorter periods of time. In many cases, these shorter manufacturing periods will not reach the longer, high volume manufacturing periods conducive to higher manufacturing yields and declining costs. As a result, if our foundries fail to
deliver fabricated silicon wafers of satisfactory quality in the volume and at the price required, we will be unable to meet our customers demand for our products or to sell those products at an acceptable profit margin, which would adversely
affect our sales and margins and damage our customer relationships.



We
often build our products based on forecasts provided by customers before receiving purchase orders for the products and may therefore incur product shortages or excess product inventory.



In order to ensure availability of our products for some of our largest
customers, we begin the manufacturing of our products in advance of receiving purchase orders based on forecasts provided by these customers and our distributors. These forecasts, however, do not represent binding purchase commitments and we do not
recognize sales for these products until they are shipped to the customer. As a result, we incur inventory and manufacturing costs in advance of anticipated sales. Because demand for our products may not materialize, manufacturing based on forecasts
subjects us to increased risks of high inventory carrying costs and increased obsolescence and may increase our operating costs. These inventory risks are exacerbated when our customers purchase indirectly through contract manufacturers because this
causes us to have less visibility regarding the accumulated levels of inventory for such customers. A resulting write-off of unusable or excess inventories would adversely affect our operating results.



Our third-party foundries, other subcontractors and many of our customers and end
customers are located in the Pacific Rim, an area subject to significant earthquake risk and adverse consequences related to the outbreak of bird flu, SARS, and other public health concerns.



All of the principal foundries that manufacture our products and all of the
principal subcontractors that assemble, package, and test our products are located in either South Korea, Singapore, Hong Kong, or Taiwan. Many of our customers are also located in these areas. The risk of an earthquake in these Pacific Rim
locations is significant. The occurrence of an earthquake or other natural disaster near these foundries or subcontractors could result in damage, power outages and other disruptions that impair their production and assembly capacity. Any disruption
resulting from such events could cause significant delays in the production or shipment of our products until we are able to shift our manufacturing, assembling, packaging or production testing from the affected contractor to another third-party
vendor. While we have some foundry capacity in the United States, we may not be able to increase our foundry capacity in the United States, or obtain other alternate foundry capacity on favorable terms, if at



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all. The 2003 outbreak of SARS curtailed travel to and from certain countries (primarily in the Asia-Pacific region) and
limited travel and shopping within those countries and any future outbreaks of SARS, bird flu, or other public health concerns could have similar consequences. In addition, outbreaks of disease or other disasters could limit consumer demand for our
ICs or the products that use our ICs.



Our recent expansion has placed a
significant strain on our management, personnel, systems and resources, and the continued success of our business depends on our ability to successfully manage any future expansion.



Our business has expanded rapidly, and we expect that further expansion will be required to address the potential growth in
our customer base. This expansion has placed, and any future expansion will continue to place, a significant strain on our management, personnel, systems and resources. If we are unable to manage our growth effectively, we may not be able to take
advantage of market opportunities, develop new products, enhance our technological capabilities, satisfy customer requirements, execute on our business plan or respond to competitive pressures. To successfully manage our growth, we believe we must
effectively:



| |  |  | hire, 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;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | expand and upgrade our core technologies; and
| | - |  | ---------------------------------------------



| |  |  | manage multiple relationships with our distributors, suppliers, and other third parties.
| | - |  | ----------------------------------------------------------------------------------------



We may experience significant period-to-period quarterly and annual fluctuations in our revenues and operating results, which may result
in volatility in our stock price.



We have in the past and
may in the future experience significant period-to-period fluctuations in our revenues and operating results due to a number of factors, including:



| |  |  | the timing and volume of purchase orders and cancellations from our customers;
| | - |  | ------------------------------------------------------------------------------



| |  |  | the rate of acceptance of our products by our customers;
| | - |  | --------------------------------------------------------



| |  |  | the rate of growth of the market for analog-intensive, mixed-signal ICs;
| | - |  | ------------------------------------------------------------------------



| |  |  | fluctuation and seasonality in demand for our products;
| | - |  | -------------------------------------------------------



| |  |  | increases in prices charged by our foundries and other third-party subcontractors;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | the availability of third-party foundry capacity;
| | - |  | -------------------------------------------------



| |  |  | the availability of components used in our customers products, such as flash memory or hard disk drives, which are key components in many portable compressed audio players;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | fluctuations in manufacturing yields;
| | - |  | -------------------------------------



| |  |  | the difficulty of forecasting and managing our inventory and production levels;
| | - |  | -------------------------------------------------------------------------------



| |  |  | the rate at which new markets emerge for products we are currently developing or our ability to develop new products;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | our involvement in litigation;
| | - |  | ------------------------------



| |  |  | natural disasters, particularly earthquakes, or disease outbreaks, such as the recent outbreak of SARS, affecting countries in which we conduct our business or in which our products
are manufactured, assembled, or tested;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in our product mix; and
| | - |  | -------------------------------



| |  |  | the evolution of industry standards.
| | - |  | ------------------------------------



Any variations in our quarter-to-quarter performance may cause our stock price to fluctuate. It is likely that in some future period our operating results
will be below the expectations of public market analysts or investors. If this occurs, our stock price may drop, perhaps significantly.



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We are subject to the highly cyclical nature of the semiconductor industry.



The semiconductor industry is highly cyclical. The industry has experienced
significant downturns, often in connection with, or in anticipation of, maturing product cycles (of both semiconductor companies and their customers products) and declines in general economic conditions. These downturns have been
characterized by production overcapacity, high inventory levels and accelerated erosion of average selling prices. Any future downturns could significantly harm our sales or reduce our profitability for a prolonged period of time. From time to time,
the semiconductor industry also has experienced periods of increased demand and production capacity constraints. We may experience substantial changes in future operating results due to general semiconductor industry conditions, general economic
conditions and other factors.



Because the markets in which we compete are
highly competitive and many of our competitors have greater resources than us, we cannot be certain that our products will compete favorably in the marketplace.



We face competition from a relatively large number of competitors in each of our targeted markets. In the PC and consumer
audio markets, we compete primarily with AKM, Analog Devices, C-Media, Cirrus Logic, and Realtek. In the portable compressed audio market, our principal competitors include Actions Semiconductor, Austria Microsystems, Philips Semiconductor,
PortalPlayer, Samsung, Sunplus, Telechips, and Texas Instruments. Within the USB peripherals market, we compete primarily with MosChip Semiconductor and Prolific Technology, and other companies providing various multi-chip solutions. We expect to
face increased competition in the future from our current and emerging competitors. In addition, some of our customers have developed and other customers could develop their own internal ICs that could replace their need for our products or
otherwise reduce demand for our products.



The consumer
electronics market, which is a principal end market for our ICs, has historically been subject to intense price competition. In many cases, low cost, high volume producers have entered markets and driven down profit margins. If a low cost, high
volume producer should develop products that are competitive with our products, our sales and profit margins would suffer.



Many of our current and potential competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly
greater financial, sales and marketing, manufacturing, distribution, technical and other resources than us. As a result, they may be able to respond more quickly to changing customer demands or to devote greater resources to the development,
promotion and sales of their products than we can. Our current and potential competitors may develop and introduce new products that will be priced lower, provide superior performance or achieve greater market acceptance than our products. In
addition, in the event of a manufacturing capacity shortage, these competitors may be able to obtain capacity when we are unable to do so. Furthermore, our current or potential competitors have established or may establish, financial and strategic
relationships among themselves or with existing or potential customers or other third parties to increase the ability of their products to address the needs of our prospective customers. Accordingly, it is possible that new competitors or alliances
among competitors could emerge and rapidly acquire significant market share, which would harm our business.



We depend on our key personnel to manage our business effectively, and if we are unable to retain our current personnel and hire additional personnel, our ability to develop and successfully market our products
could be harmed.



We rely heavily on the services of our
key employees, including Ronald Edgerton, our Chief Executive Officer. In addition, our analog designers and other key technical personnel represent a significant asset and serve as the source of our technological and product innovations. We believe
our future success will depend upon our ability to retain these key employees and our ability to attract and retain other skilled managerial, engineering and sales and marketing personnel. Any of our current employees may terminate their employment
with us at any time. The competition for such personnel is intense in our industry. We may not be successful in attracting and retaining sufficient numbers of technical personnel to support our anticipated growth. The loss of any of our key
employees or our inability to attract or retain qualified personnel, including engineers, could delay the development and introduction of, and negatively impact our ability to sell, our products.



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Our products are complex and may require modifications to resolve undetected errors or failures in our hardware and
software, which could lead to an increase in our costs, a loss of customers or a delay in market acceptance of our products.



Our ICs are complex and may contain undetected hardware and software errors or failures when first introduced or as new versions are released. These
errors could cause us to incur significant re-engineering costs, divert the attention of our engineering personnel from product development efforts and cause significant customer relations and business reputation problems. If we deliver products
with errors, defects or bugs, our credibility and the market acceptance and sales of our products could be harmed. Defects could also lead to liability for defective products as a result of lawsuits against us or against our customers. We have
agreed to indemnify our customers in some circumstances against liability from defects in our products. A successful product liability claim could require us to make significant damage payments.



We have substantial international activities, which expose us to additional business risks
including increased logistical complexity and political instability.



We recently established an international subsidiary and opened an office in Hong Kong, and have recently opened branch or liaison offices of the Hong Kong subsidiary in Singapore and Taiwan to increase our
international activities in Asia. The percentage of our revenues from customers located outside of the U.S. were 99.9% for each of the three months ended March 31, 2005 and 2004. We plan to expand our international sales and operations activities,
but may not be able to maintain or increase international market demand for our products. Our international sales and operations are subject to a number of risks, including:



| |  |  | increased complexity and costs of managing international sales and operations;
| | - |  | ------------------------------------------------------------------------------



| |  |  | protectionist laws and business practices that favor local competition in some countries;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | multiple, conflicting and changing laws, regulations and tax schemes;
| | - |  | ---------------------------------------------------------------------



| |  |  | longer sales cycles;
| | - |  | --------------------



| |  |  | public health concerns, such as the SARS outbreak in 2003 and the bird flu outbreak in 2004 and 2005, and natural disasters, such as the tsunamis in 2004;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | greater difficulty in accounts receivable collection and longer collection periods;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | political and economic instability; and
| | - |  | ---------------------------------------



| |  |  | greater difficulty in hiring qualified employees.
| | - |  | -------------------------------------------------



To date, all of our sales to international customers and purchases of components from international suppliers have been denominated in U.S. dollars. As a
result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive for our international customers, thus potentially leading to a reduction in sales and profitability. Furthermore, many of our
competitors are foreign companies that could benefit from such a currency fluctuation making it more difficult for us to compete with those companies.



We may be unable to effectively protect our intellectual property, which would negatively affect our ability to compete.



We believe that the protection of our intellectual property rights will
continue to be important to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or
license agreements with our employees, consultants and business partners, and control access to and distribution of our documentation and other proprietary information. Despite these efforts, unauthorized parties may attempt to copy or otherwise
obtain and use our proprietary technology. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as do the laws of the U.S. Many U.S. companies have encountered substantial infringement problems in foreign countries, including countries in which we sell products. We do not currently hold any
non-U.S. patents. We cannot be certain that patents will be issued as a result of our pending applications nor can we be certain that any issued patents would protect or benefit us or give us adequate protection from competing products. For example,
issued patents may be circumvented or challenged and declared invalid or unenforceable. We also cannot be certain that others will not develop our unpatented proprietary technology or effective competing technologies on their own.



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Significant litigation over intellectual property in our industry may cause us to become involved in costly and
lengthy litigation, which could subject us to liability, require us to stop selling our products or force us to redesign our products.



In recent years, there has been significant litigation in the U.S. involving patents and other intellectual property rights in the semiconductor industry.
In the past, we have found it necessary to engage in litigation to enforce and defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of proprietary rights of others. For example, in 2000 we
settled a patent infringement and trade secret claim filed by Cirrus Logic related to our audio codec products. Most recently, we filed a lawsuit against Actions Semiconductor and requested the United States International Trade Commission to
initiate an investigation against Actions Semiconductors products, in both instances seeking to halt Actions infringement of our intellectual property rights. We believe future litigation involving intellectual property could occur.



From time to time, we receive letters from various industry
participants alleging infringement of patents or trade secrets. We typically respond when appropriate and as advised by legal counsel. Any lawsuits resulting from such allegations could subject us to significant liability for damages and invalidate
our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation also could force us to do one
or more of the following:



| |  |  | stop selling products or using technology that contain the allegedly infringing intellectual property;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | pay damages to the party claiming infringement;
| | - |  | -----------------------------------------------



| |  |  | attempt to obtain a license to the relevant intellectual property, which may not be available on reasonable terms or at all; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | attempt to redesign those products that contain the allegedly infringing intellectual property.
| | - |  | -----------------------------------------------------------------------------------------------



Our intellectual property indemnification practices may adversely impact our business.



We have historically indemnified our customers for certain costs and damages
of patent infringement in circumstances where our product is the factor creating the customers infringement exposure. This practice may subject us to significant indemnification claims by our customers, and one of our key customers has
requested indemnification from us relating to a patent infringement allegation received from a third party. In some instances, our products are designed for use in devices manufactured by our customers that comply with international standards, such
as the MP3 standard. These international standards are often covered by patent rights held by third parties, which may include our competitors. The combined costs of identifying and obtaining licenses from all holders of patent rights essential to
such international standards could be high and could reduce our profitability or increase our losses. The cost of not obtaining such licenses could also be high if a holder of such patent rights brings a claim for patent infringement. We are aware
that certain of our customers have received a notice from a third party seeking to grant a royalty bearing patent license to those customers and claiming that those customers manufacture and sale of products capable of decoding MP3 files
violates patents which the third party has the right to enforce. We have not received any such notice, and we are not aware of any claimed violations on our part. In the contracts under which we distribute MP3 decoding products, we generally have
not agreed to indemnify our customers with respect to patent claims related to MP3 decoding technology. However, we cannot assure you that claims for indemnification will not be made or that if made, such claims would not have a material adverse
effect on our business, operating results or financial condition.



Any
acquisition activity could disrupt our ongoing business and may present risks not contemplated at the time of the transaction.



We may acquire companies that have products, services, personnel and technologies that complement our strategic direction and product roadmap. These
acquisitions may involve significant risks and uncertainties, including difficulties in incorporating the acquired companies operations and technologies; distraction of managements attention away from normal business operations;
insufficient revenue generation to offset liabilities assumed and expenses associated with acquisition; and unidentified issues not discovered in our due diligence process, including product quality issues and legal contingencies. Acquisitions are
inherently risky, and no assurance can be given that any acquisitions will be successful and will not materially adversely affect business, operating results or financial condition. Should we issue our common stock or other equity related purchase
rights as consideration in an acquisition, current stockholders percentage ownership and earnings per share may become diluted.



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The industry standards supported by our products are continually evolving, and our success depends on our ability to
adapt our products to meet these changing industry standards.



Our ability to compete in the future will depend on our ability to ensure that our products are compliant with evolving industry standards, such as the introduction of new compression algorithms for compressed audio players. The
emergence of new industry standards could render our products incompatible with products developed by other suppliers. As a result, we could be required to invest significant time and effort and to incur significant expense to redesign our products
to ensure compliance with relevant standards. If our products are not in compliance with prevailing industry standards for a significant period of time, we could miss opportunities to achieve crucial design wins. We may not be successful in
developing or using new technologies or in developing new products or product enhancements that achieve market acceptance and such efforts may require substantial time and expenses.



If securities or industry analysts do not continue to publish research or reports about our business, our stock price and trading volume
could decline.



The trading market for our common stock
will depend on the research and reports that industry or securities analysts publish about us or our business. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our stock, our stock price would
likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.



Our products may be found to be defective, product liability claims may be
asserted against us and we may not have sufficient liability insurance.



One or more of our products may be found to be defective after shipment, requiring a product replacement, recall or a software solution that would cure the defect but impede performance of the product. We may also be
subject to product returns which could impose substantial costs and harm our business. In addition, product liability claims may be asserted with respect to our technology or products. Our products are typically sold at prices that are significantly
lower than the cost of the end-products into which they are incorporated. A defect or failure in our product could give rise to failures in our customers end-product, so we may face claims for damages that are disproportionately higher than
the revenues and profits we receive from the products involved, especially if our customer seeks to recover for damage claims made against it by its own customers. While we maintain insurance, there can be no assurance that we have obtained a
sufficient amount of insurance coverage, that asserted claims will be within the scope of coverage of the insurance, or that we will have sufficient resources to satisfy any asserted claims.



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



We prepare our
financial statements to conform with generally accepted accounting principles, or GAAP, in the United States. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, or FASB, the Securities and Exchange
Commission and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is
announced. Changes to those rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, under the recently issued FASB Statement No. 123R, we will be required to
apply certain expense recognition provisions for annual periods beginning after June 15, 2005 to share-based payments to employees using the fair value method. This new accounting policy and any other changes in accounting policies in the future may
result in significant accounting charges.



Being a public company increases
our administrative costs.



As a public company, we incur
significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission and new listing
requirements subsequently adopted by Nasdaq in response



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to Sarbanes-Oxley, have required changes in corporate governance practices of public companies. These new rules,
regulations, and listing requirements have increased our legal and financial compliance costs, and made some activities more time consuming and costly. For example, as a result of becoming a public company, we have added additional independent
directors, created several board committees, adopted additional internal controls and disclosure controls and procedures, retained a transfer agent and a financial printer, adopted an insider trading policy, and have all of the internal and external
costs of preparing and distributing periodic public reports in compliance with our obligations under the securities laws. These new rules and regulations have made it more difficult and more expensive for us to obtain director and officer liability
insurance. These new rules and regulations could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee, and qualified executive officers.



The emergence of alternative models for downloading digital music content may impact our
business in ways we cannot anticipate.



Currently, most
purchased music content is available through a pay-per-download model in which consumers purchase and own the song file which they can download and play on their personal media player. Microsoft is in the process of launching digital rights
management software which is expected to provide personal media players access to music content on a subscription basis in which consumers can pay a subscription fee to rent, rather than own, the song file. The technology seeks to add a security
feature to Microsofts digital rights management technology to allow a personal media player to determine when a specific file has expired. If this technology is successful and our customers are unable to integrate with such technology, it
could compete with existing pay-per-download music services. We cannot predict the impact on our business should this or other similar technology or other content distribution models become widely adopted. In addition, to the extent other providers
of digital content or providers of platforms or components for personal media players take market share away from our customers products and services, our business and results of operations could be materially harmed.



Item 4: Controls and Procedures



We have performed an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and
procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act). Based on that evaluation, our management, including our CEO and CFO, concluded that our disclosure controls and procedures were effective as of
March 31, 2005 to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and
forms. During our last fiscal quarter, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



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PART II. OTHER INFORMATION



Item 1. Legal Proceedings



Many
participants in the semiconductor industry have a significant number of patents and have frequently demonstrated a willingness to commence litigation based on allegations of patent and other intellectual property infringement. From time to time, we
have received, and expect to continue to receive, notices of claims of infringement, misappropriation or misuse of other parties proprietary rights. Some of these claims have led to litigation. We cannot assure you that we will prevail in
these actions, or that other actions alleging infringement by us of third-party patents, misappropriation or misuse by us of third-party trade secrets, or invalidity of our patents will not be asserted or prosecuted against us, or that any
assertions of infringement, misappropriation or misuse or prosecutions seeking to establish the invalidity of our patents will not materially and adversely affect our business, financial condition and results of operations. As of March 31, 2005, we
were party to the following legal proceeding:



Actions
Semiconductor



On January 4, 2005, we filed a lawsuit
against Actions Semiconductor Company, Ltd., based in Zhuhai, Guangdong, China (Actions Semiconductor), in the United States District Court for the Western District of Texas, Austin Division. We assert that certain Actions Semiconductor
ICs that are incorporated as components in MP3 players being shipped into the United States infringe multiple SigmaTel patents related to our portable audio SoCs. We are seeking damages and requesting a permanent injunction prohibiting Actions
Semiconductor from designing, manufacturing or selling the infringing MP3 integrated circuits in the United States. We are also requesting a permanent injunction prohibiting further shipment of products into the United States that use Actions
Semiconductor integrated circuits.



In addition, on March 14,
2005, we filed a complaint requesting that the U.S. International Trade Commission (the ITC) initiate an investigation of Actions Semiconductor Company, Ltd., for violation of Section 337 of the Tariff Act of 1930, in the importation,
sale for importation and sale in the U.S. after importation of certain audio processing integrated circuits and other products containing these audio processing ICs. In our complaint, we asked the ITC to investigate whether certain Actions
Semiconductor products infringe on one or more of the claims of U.S. Patent Nos. 6,137,279 and 6,633,187. On April 18, 2005, the ITC instituted an investigation into Actions Semiconductors actions based on our allegations. With respect to both
patents, we are seeking a permanent exclusion order banning the importation into the U.S. of the allegedly infringing products and a cease-and-desist order halting the sale of these infringing products, as well as other relief the ITC deems
appropriate.



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds



(a) Not applicable.



(b) The Securities and
Exchange Commission declared our first registration statement, which we filed on Form S-1 (Registration No. 333-106796) under the Securities Act of 1933 in connection with the initial public offering of our common stock, effective on September 18,
2003. Under this registration statement, we registered 11,500,000 shares of our common stock, including 1,500,000 shares subject to the underwriters over-allotment option, with an aggregate public offering price of $172.5 million. We
registered 7,383,917 of these shares on our behalf and 4,116,083 of these shares on behalf of certain or our stockholders.



Our initial public offering commenced on September 19, 2003 and all of the shares of our common stock that we registered on our behalf and on behalf of
the selling stockholders were sold for the aggregate public offering price of $172.5 million through an underwriting syndicate managed by Merrill Lynch & Co., JPMorgan, CIBC World Markets and Needham & Company, Inc. The underwriters
exercised the over-allotment option effective as of September 22, 2003, and the offering terminated as of that date with the sale of all securities registered.



The sale of 7,383,917 shares of common stock by us, including the sale of 383,917 shares pursuant to the exercise of the over-allotment option by the
underwriters, resulted in aggregate gross proceeds to us of approximately $110.8 million, approximately $7.8 million of which we applied to underwriting discounts and commissions and approximately $1.6 million of which we applied to related costs.
None of these expenses were direct or indirect payments to directors, officers or holders of 10% or more of any class of our equity. As a result, we received approximately $101.4 million in aggregate net proceeds from the offering.



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As of March 31, 2005, we used the net proceeds of the offering as follows:



| |  |  | $4.5 million to satisfy an outstanding obligation to Cirrus Logic related to the settlement of an intellectual property dispute in 2000, which we recorded as a litigation settlement
expense upon completion of the offering;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | $4.2 million to repay existing debt under our Loan and Security Agreement with Silicon Valley Bank;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | $1.6 million to repay accrued interest on convertible promissory notes ($1.4 million of which was paid to our affiliates as described below), the principal amount of which notes
were converted into 1,022,102 shares of our common stock in connection with our initial public offering;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | $21 million to repurchase 1,381,991 shares of our common stock in open-market transactions pursuant to a share repurchase program announced on July 27, 2004; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the remaining net proceeds were invested in short-term, investment-grade, interest bearing instruments, pending their use to fund working capital and other general corporate
purposes, including capital expenditures and research and development.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The affiliates who received the $1.4 million of proceeds in payment of accrued interest on their convertible promissory notes were as follows: funds affiliated with Invesco Private Capital$0.1 million; funds
affiliated with Creative Technology Ltd.$0.9 million; funds affiliated with Battery Ventures$0.4 million; and Mr. C. Hock Leow$3,000.



(c) Not applicable.



Item 3. Defaults Upon Senior Securities



Not applicable.



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



Not applicable.



Item 5. Other Information



(a) Not applicable



(b) Not applicable



Item 6. Exhibits



(a) See Exhibit Index.





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SIGMATEL, INC.



SIGNATURE



Pursuant to the requirements of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                      |  |                |  |                                                      
|--------------------- |  | -------------- |  | -----------------------------------------------------
|                      |  | SIGMATEL, INC.
|                      |  |               
|Dated: April 19, 2005 |  | By:            |  | /s/ Ross A. Goolsby                                  
|                      |  |                |  | Ross A. Goolsby                                      
|                      |  |                |  | Vice President of Finance and Chief Financial Officer
|                      |  |                |  | (Principal Financial and Accounting Officer)         



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EXHIBIT INDEX



|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              | 
|3.1(1)        |  | Second Restated Certificate of Incorporation of SigmaTel, Inc.                                                                                                                                                                                                                                                                                                                                                                  
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|3.2(2)        |  | Amended and Restated Bylaws of SigmaTel, Inc.                                                                                                                                                                                                                                                                                                                                                                                   
|              | 
|4.1(2)        |  | Specimen certificate for shares of common stock                                                                                                                                                                                                                                                                                                                                                                                 
|              | 
|10.1(3)       |  | Incentive Bonus Plan                                                                                                                                                                                                                                                                                                                                                                                                            
|              | 
|10.2(4)       |  | Statement of performance based cash bonuses approved and paid for fiscal year and fourth quarter 2004 to SigmaTels named executive officers listed in SigmaTels proxy statement
filed with the Securities and Exchange Commission on March 24, 2004                                                                                                                                                                           
|              | 
|10.3(5)       |  | Summary of base salaries and performance based bonus opportunities for the period beginning April 1, 2005 and ending March 31, 2006 for SigmaTels named executive officers listed in
SigmaTels proxy statement filed with the Securities and Exchange Commission on March 4, 2005                                                                                                                                             
|              | 
|31.01         |  | Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.                                                                                                                                                                                                                                               
|              | 
|31.02         |  | Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.                                                                                                                                                                                                                                               
|              | 
|32.01*        |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                  
|             
|              | 
|*             |  | This exhibit shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be
deemed incorporated by reference in any filings 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 in any
filings.
|              | 
|(1)           |  | Incorporated by reference to Exhibit 3.3 of the Registrants Form S-1 Registration Statement (Registration No. 333-106796), declared effective by the Securities and Exchange Commission
on September 18, 2003.                                                                                                                                                                                                                 
|              | 
|(2)           |  | Incorporated by reference to the exhibit of the same number to the Registrants Form S-1 Registration Statement (Registration No. 333-106796), declared effective by the Securities and
Exchange Commission on September 18, 2003.                                                                                                                                                                                              
|              | 
|(3)           |  | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 2, 2005.                                                                                                                                                                                                                                                                
|              | 
|(4)           |  | Incorporated by reference to the Registrants Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 25, 2005.                                                                                                                                                                                                                                                                               
|              | 
|(5)           |  | Incorporated by reference to the Registrants Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 21, 2005.