##### Table of Contents

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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 June 30, 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 |  | (I.R.S. Employer   
|incorporation or organization)  |  | Identification No.)



1601 S. MoPac
Expressway

Suite 100

Austin, Texas 78746

(512) 381-3700

(Address and telephone number of principal executive offices)

|
|



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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 Rule 12b-2 of the Exchange
Act).    Yes  x    No ̈



The number of shares outstanding of the Registrants Common Stock, $0.0001 par value,
was 35,799,237 as of July 26, 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                                                                                              |  |         
|                                              |  |                                                                                                                  
|                                              |  | Condensed Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004                                   |  | 3       
|                                              |  |                                                                                                                  
|                                              |  | Condensed Consolidated Statements of Operations for the Three and Six Months EndedJune 30, 2005 and June 30, 2004 |  | 4       
|                                              |  |                                                                                                                  
|                                              |  | Condensed Consolidated Statements of Cash Flows for the Six Months EndedJune 30, 2005 and June 30, 2004           |  | 5       
|                                              |  |                                                                                                                  
|                                              |  | Notes to Condensed Consolidated Financial Statements                                                              |  | 6       
|                                              |  |                                                                                                                  
|Item 2.                                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                             |  | 15      
|                                              |  |                                                                                                                  
|Item 3.                                       |  | Quantitative and Qualitative Disclosures about Market Risk                                                        |  | 26      
|                                              |  |                                                                                                                  
|Item 4.                                       |  | Controls and Procedures                                                                                           |  | 39      
|                                              | 
|PART II:         
OTHER INFORMATION           |  |                                                                                                                  
|                                              |  |                                                                                                                  
|Item 1.                                       |  | Legal Proceedings                                                                                                 |  | 40      
|                                              |  |                                                                                                                  
|Item 2.                                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                       |  | 40      
|                                              |  |                                                                                                                  
|Item 3.                                       |  | Defaults upon Senior Securities                                                                                   |  | 41      
|                                              |  |                                                                                                                  
|Item 4.                                       |  | Submission of Matters to a Vote of Security Holders                                                               |  | 41      
|                                              |  |                                                                                                                  
|Item 5.                                       |  | Other Information                                                                                                 |  | 42      
|                                              |  |                                                                                                                  
|Item 6.                                       |  | Exhibits                                                                                                          |  | 42      
|                                              | 
|Signature                                     |  | 43                                                                                                               



2



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##### Table of Contents

PART I: FINANCIAL INFORMATION



Item 1. Financial Statements



SIGMATEL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)



|                                                                                                                                                                 |  |              |          |   |                   |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                 |  | June 30,2005 |          |   | December 31, 2004 |  
|ASSETS                                                                                                                                                           |  |              |          |   |                   |   |         |  
|Current assets:                                                                                                                                                  |  |              |          |   |                   |   |         |  
|Cash and cash equivalents                                                                                                                                        |  | $            | 73,894   |   |                   | $ | 27,246  |  
|Short-term investments                                                                                                                                           |  |              | 104,726  |   |                   |   | 114,451 |  
|Accounts receivable, net                                                                                                                                         |  |              | 40,263   |   |                   |   | 34,195  |  
|Inventories, net                                                                                                                                                 |  |              | 26,920   |   |                   |   | 19,411  |  
|Income tax receivable                                                                                                                                            |  |              | 3,861    |   |                   |   |        |  
|Deferred tax asset, net                                                                                                                                          |  |              | 364      |   |                   |   | 7,613   |  
|Prepaid expenses and other assets                                                                                                                                |  |              | 4,474    |   |                   |   | 4,241   |  
|                                                                                                                                                                 |  |              |          |   |                   |   |         |  
|Total current assets                                                                                                                                             |  |              | 254,502  |   |                   |   | 207,157 |  
|                                                                                                                                                                 |  |             
|Property, equipment and software, net                                                                                                                            |  |              | 10,984   |   |                   |   | 7,116   |  
|Intangible assets, net                                                                                                                                           |  |              | 4,736    |   |                   |   | 4,357   |  
|Other assets                                                                                                                                                     |  |              | 1,992    |   |                   |   | 1,285   |  
|                                                                                                                                                                 |  |              |          |   |                   |   |         |  
|Total assets                                                                                                                                                     |  | $            | 272,214  |   |                   | $ | 219,915 |  
|                                                                                                                                                                 |  |              |          |   |                   |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                             |  |              |          |   |                   |   |         |  
|Current liabilities:                                                                                                                                             |  |              |          |   |                   |   |         |  
|Accounts payable                                                                                                                                                 |  | $            | 21,830   |   |                   | $ | 23,016  |  
|Accrued compensation                                                                                                                                             |  |              | 3,592    |   |                   |   | 3,884   |  
|Other accrued expenses                                                                                                                                           |  |              | 2,956    |   |                   |   | 2,698   |  
|Deferred revenue                                                                                                                                                 |  |              | 9,094    |   |                   |   | 7,286   |  
|Current portion of long-term obligations                                                                                                                         |  |              | 715      |   |                   |   | 1,223   |  
|                                                                                                                                                                 |  |              |          |   |                   |   |         |  
|Total current liabilities                                                                                                                                        |  |              | 38,187   |   |                   |   | 38,107  |  
|                                                                                                                                                                 |  |             
|Non-current income taxes payable Other liabilities                                                                                                               |  |              | 6,807340 |   |                   |   | 892    |  
|                                                                                                                                                                 |  |              |          |   |                   |   |         |  
|Total liabilities                                                                                                                                                |  |              | 45,334   |   |                   |   | 38,999  |  
|                                                                                                                                                                 |  |              |          |   |                   |   |         |  
|Stockholders equity:                                                                                                                                            |  |              |          |   |                   |   |         |  
|Common stock, $0.0001 par value; 170,000 shares authorized; shares issued and outstanding: 35,867 and 35,777 at 2005 and 35,205 and 35,115 at
2004, respectively |  |              | 4        |   |                   |   | 4       |  
|Additional paid-in capital                                                                                                                                       |  |              | 182,618  |   |                   |   | 173,480 |  
|Notes receivable from stockholders                                                                                                                               |  |              | (5       | ) |                   |   | (7      | )
|Deferred stock-based compensation                                                                                                                                |  |              | (869     | ) |                   |   | (1,278  | )
|Treasury stock, 90 common shares at cost                                                                                                                         |  |              | (741     | ) |                   |   | (741    | )
|Accumulated surplus                                                                                                                                              |  |              | 45,884   |   |                   |   | 9,458   |  
|Accumulated other comprehensive loss                                                                                                                             |  |              | (11      | ) |                   |   |        |  
|Total stockholders equity                                                                                                                                       |  |              | 226,880  |   |                   |   | 180,916 |  
|                                                                                                                                                                 |  |              |          |   |                   |   |         |  
|Total liabilities and stockholders equity                                                                                                                       |  | $            | 272,214  |   |                   | $ | 219,915 |  
|                                                                                                                                                                 |  |              |          |   |                   |   |         |  



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



3



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SIGMATEL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|------------------------------------------------- |  | -------------------------- | ------ | ------------------------ | ---- | - | ------ |  | - | ------- | - |  | - | ------
|                                                  |  | Three Months EndedJune 30, |        | Six Months EndedJune 30,
|                                                  |  | 2005                       |        |                          | 2004 |   | 2005   |  |   | 2004   
|Revenues, net                                     |  | $                          | 69,572 |                          |      | $ | 36,608 |  | $ | 168,910 |   |  | $ | 68,108
|Cost of goods sold(1)                             |  |                            | 30,999 |                          |      |   | 16,778 |  |   | 73,293  |   |  |   | 31,562
|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|Gross Profit                                      |  |                            | 38,573 |                          |      |   | 19,830 |  |   | 95,617  |   |  |   | 36,546
|                                                  |  |                            |        |                         
|Operating Expenses:                               |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|Research and development(1)                       |  |                            | 12,890 |                          |      |   | 7,170  |  |   | 24,760  |   |  |   | 13,253
|Selling, general and administrative(1)            |  |                            | 9,326  |                          |      |   | 3,603  |  |   | 16,440  |   |  |   | 6,502 
|Amortization of deferred stock-based compensation |  |                            | 238    |                          |      |   | 402    |  |   | 418     |   |  |   | 1,397 
|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|Total operating expenses                          |  |                            | 22,454 |                          |      |   | 11,175 |  |   | 41,618  |   |  |   | 21,152
|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|Operating income                                  |  |                            | 16,119 |                          |      |   | 8,655  |  |   | 53,999  |   |  |   | 15,394
|                                                  |  |                            |        |                         
|Other income (expense):                           |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|Interest income, net                              |  |                            | 1,245  |                          |      |   | 345    |  |   | 2,067   |   |  |   | 678   
|Foreign exchange loss                             |  |                            | (43    | )                        |      |   |       |  |   | (43     | ) |  |   |      
|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|Total other income                                |  |                            | 1,202  |                          |      |   | 345    |  |   | 2,024   |   |  |   | 678   
|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|Income before income taxes                        |  |                            | 17,321 |                          |      |   | 9,000  |  |   | 56,023  |   |  |   | 16,072
|                                                  |  |                            |        |                         
|Income taxes                                      |  |                            | 6,425  |                          |      |   | 179    |  |   | 19,597  |   |  |   | 320   
|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|Net income                                        |  | $                          | 10,896 |                          |      | $ | 8,821  |  | $ | 36,426  |   |  | $ | 15,752
|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|BASIC NET INCOME PER SHARE                        |  | $                          | 0.31   |                          |      | $ | 0.25   |  | $ | 1.02    |   |  | $ | 0.45  
|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|DILUTED NET INCOME PER SHARE                      |  | $                          | 0.29   |                          |      | $ | 0.23   |  | $ | 0.97    |   |  | $ | 0.41  
|                                                  |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|WEIGHTED AVERAGE SHARES USED TO COMPUTE:          |  |                            |        |                          |      |   |        |  |   |         |   |  |   |       
|Basic net income per share                        |  |                            | 35,704 |                          |      |   | 35,147 |  |   | 35,552  |   |  |   | 34,820
|Diluted net income per share                      |  |                            | 37,351 |                          |      |   | 38,768 |  |   | 37,584  |   |  |   | 38,607

---

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



|                                  |  |                             |     |                           |   |      |  |      |     |  |   |      
|--------------------------------- |  | --------------------------- | --- | ------------------------- | - | ---- |  | ---- | --- |  | - | -----
|                                  |  | Three Months Ended June 30, |     | Six Months Ended June 30,
|                                  |  | 2005                        |     | 2004                      |   | 2005 |  | 2004
|Cost of goods sold                |  | $                           | 10  |                           | $ | 17   |  | $    | 16  |  | $ | 67   
|Research and development          |  |                             | 124 |                           |   | 281  |  |      | 249 |  |   | 887  
|Selling, general & administrative |  |                             | 104 |                           |   | 104  |  |      | 153 |  |   | 443  
|                                  |  |                             |     |                           |   |      |  |      |     |  |   |      
|Total                             |  | $                           | 238 |                           | $ | 402  |  | $    | 418 |  | $ | 1,397
|                                  |  |                             |     |                           |   |      |  |      |     |  |   |      



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



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##### Table of Contents

SIGMATEL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                  |  |                           |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Six Months Ended June 30, |        
|                                                                                  |  | 2005                      |         |   | 2004 |  
|Cash flows from operating activities:                                             |  |                           |         |   |      |   |         |  
|Net income                                                                        |  | $                         | 36,426  |   |      | $ | 15,752  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                           |         |   |      |   |         |  
|Depreciation and amortization                                                     |  |                           | 3,026   |   |      |   | 2,098   |  
|Amortization of deferred stock-based compensation                                 |  |                           | 418     |   |      |   | 1,397   |  
|Amortization of premium and accretion of discount on securities                   |  |                           | 120     |   |      |   | 97      |  
|Deferred income tax expense                                                       |  |                           | 7,452   |   |      |   |        |  
|Lease abandonment adjustments                                                     |  |                           | (385    | ) |      |   |        |  
|Tax benefit related to exercise of employee stock options                         |  |                           | 6,358   |   |      |   |        |  
|Other non-cash (benefit) expense                                                  |  |                           | (232    | ) |      |   | 409     |  
|Changes in assets and liabilities:                                                |  |                           |         |   |      |   |         |  
|Accounts receivable, net                                                          |  |                           | (6,068  | ) |      |   | (3,182  | )
|Inventories, net                                                                  |  |                           | (7,509  | ) |      |   | (6,613  | )
|Prepaid expenses and other assets                                                 |  |                           | (1,145  | ) |      |   | (1,021  | )
|Accounts payable                                                                  |  |                           | (1,186  | ) |      |   | 3,141   |  
|Accrued expenses                                                                  |  |                           | 146     |   |      |   | 1,151   |  
|Income taxes payable                                                              |  |                           | 2,707   |   |      |   |        |  
|Deferred revenue and other liabilities                                            |  |                           | 1,228   |   |      |   | 2,863   |  
|                                                                                  |  |                           |         |   |      |   |         |  
|Net cash provided by operating activities                                         |  |                           | 41,356  |   |      |   | 16,092  |  
|                                                                                  |  |                           |         |   |      |   |         |  
|Cash flows from investing activities:                                             |  |                           |         |   |      |   |         |  
|Proceeds from maturities of short-term investments                                |  |                           | 73,056  |   |      |   | 48,250  |  
|Purchases of short-term investments                                               |  |                           | (63,451 | ) |      |   | (89,929 | )
|Purchases of property, equipment, software and intangible assets                  |  |                           | (7,273  | ) |      |   | (6,649  | )
|                                                                                  |  |                           |         |   |      |   |         |  
|Net cash provided by (used in) investing activities                               |  |                           | 2,332   |   |      |   | (48,328 | )
|                                                                                  |  |                           |         |   |      |   |         |  
|Cash flows from financing activities:                                             |  |                           |         |   |      |   |         |  
|Payments on capital lease obligations                                             |  |                           | (32     | ) |      |   | (23     | )
|Proceeds from notes receivable from stockholders                                  |  |                           | 2       |   |      |   | 108     |  
|Proceeds from issuance of common stock, net of issuance costs                     |  |                           | 3,048   |   |      |   | 8,312   |  
|                                                                                  |  |                           |         |   |      |   |         |  
|Net cash provided by financing activities                                         |  |                           | 3,018   |   |      |   | 8,397   |  
|                                                                                  |  |                           |         |   |      |   |         |  
|Effect of exchange rate changes on cash                                           |  |                           | (58     | ) |      |   |        |  
|                                                                                  |  |                           |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |                           | 46,648  |   |      |   | (23,839 | )
|Cash and cash equivalents, beginning of period                                    |  |                           | 27,246  |   |      |   | 61,841  |  
|                                                                                  |  |                           |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                          |  | $                         | 73,894  |   |      | $ | 38,002  |  
|                                                                                  |  |                           |         |   |      |   |         |  



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



5



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##### Table of Contents

SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements



1. Basis of Presentation



The accompanying unaudited condensed consolidated financial statements
include the accounts of SigmaTel, Inc. and its wholly owned subsidiaries (the Company). 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 condensed consolidated 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 and six month periods ended June 30, 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 June 2005, SigmaTel Asia, Limited expanded its scope to include operational and other financial activities.



2. 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 most
recently filed Form 10-K with the Securities and Exchange Commission.



Consolidation and Foreign Currency Translation



The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated. The reporting currency of the
Companys foreign subsidiaries is the U.S. dollar. Assets and liabilities are translated at exchange rates in effect at the balance sheet date. Income and expense accounts are translated at the average monthly exchange rates for the periods.
Resulting translation adjustments are recorded as a separate component of accumulated other comprehensive loss.



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 EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                                                                                                          |  | 2005                       |        |   | 2004                     |   |        | 2005 |  |   | 2004   |  
|Net income, as reported                                                                                                                                   |  | $                          | 10,896 |   |                          | $ | 8,821  |      |  | $ | 36,426 |   |  | $ | 15,752 |  
|Add: Stock-based employee compensation expense recognized in net income, net of related income tax effects                                                |  |                            | 155    |   |                          |   | 402    |      |  |   | 272    |   |  |   | 1,397  |  
|Deduct: Stock-based employee compensation expense determined under the fair value based method for all employee awards, net of related income
tax effects |  |                            | (3,019 | ) |                          |   | (1,540 | )    |  |   | (5,536 | ) |  |   | (2,942 | )
|                                                                                                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Pro forma net income                                                                                                                                      |  | $                          | 8,032  |   |                          | $ | 7,683  |      |  | $ | 31,162 |   |  | $ | 14,207 |  
|                                                                                                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Pro forma basic net income per share, as adjusted                                                                                                         |  | $                          | 0.22   |   |                          | $ | 0.22   |      |  | $ | 0.88   |   |  | $ | 0.41   |  
|                                                                                                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Pro forma diluted net income per share, as adjusted                                                                                                       |  | $                          | 0.22   |   |                          | $ | 0.20   |      |  | $ | 0.84   |   |  | $ | 0.37   |  
|                                                                                                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  





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##### Table of Contents

SigmaTel, Inc.

Notes to Condensed Consolidated 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 EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                                       |  | 2005                       |        |   | 2004                     |   |        | 2005 |  |   | 2004   |  
|Numerator:                                                                             |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net income                                                                             |  | $                          | 10,896 |   |                          | $ | 8,821  |      |  | $ | 36,426 |   |  | $ | 15,752 |  
|                                                                                       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Denominator:                                                                           |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Weighted-average common stock outstanding                                              |  |                            | 35,729 |   |                          |   | 35,191 |      |  |   | 35,576 |   |  |   | 34,876 |  
|Less: weighted-average shares subject to repurchase                                    |  |                            | (25    | ) |                          |   | (44    | )    |  |   | (24    | ) |  |   | (56    | )
|                                                                                       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Weighted-average shares used in computing basic net income per share                   |  |                            | 35,704 |   |                          |   | 35,147 |      |  |   | 35,552 |   |  |   | 34,820 |  
|Dilutive potential common shares used in computing diluted net income per share        |  |                            | 1,647  |   |                          |   | 3,621  |      |  |   | 2,032  |   |  |   | 3,787  |  
|                                                                                       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total weighted-average number of shares used in computing diluted net income per share |  |                            | 37,351 |   |                          |   | 38,768 |      |  |   | 37,584 |   |  |   | 38,607 |  
|                                                                                       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  



Weighted-average
anti-dilutive potential shares have been excluded, as the exercise price of the underlying stock options exceeded the average market price of the stock during the respective periods. These excluded shares were approximately 1.6 million and 278,000
for the three months ended June 30, 2005 and 2004, respectively, and 1.1 million and 278,000 for the six months ended June 30, 2005 and 2004, respectively. The Company issued approximately 133,000 and 663,000 shares of common stock during the three
and six months ended June 30, 2005, respectively.



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##### Table of Contents

SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued



3. Comprehensive Income



The components of comprehensive income are comprised of net income and foreign currency translation adjustments. Comprehensive income for the three and six months ended June 30, 2005 and 2004 was as follows (in thousands):



|                                         |  |                             |        |                          |      |   |       |  |   |        |   |  |   |       
|---------------------------------------- |  | --------------------------- | ------ | ------------------------ | ---- | - | ----- |  | - | ------ | - |  | - | ------
|                                         |  | Three Months Ended June 30, |        | Six Months EndedJune 30,
|                                         |  | 2005                        |        |                          | 2004 |   | 2005  |  |   | 2004  
|Comprehensive Income:                    |  |                             |        |                          |      |   |       |  |   |        |   |  |   |       
|Net income                               |  | $                           | 10,896 |                          |      | $ | 8,821 |  | $ | 36,426 |   |  | $ | 15,752
|Foreign currency translation adjustments |  |                             | (11    | )                        |      |   |      |  |   | (11    | ) |  |   |      
|                                         |  |                             |        |                          |      |   |       |  |   |        |   |  |   |       
|Total comprehensive income               |  | $                           | 10,885 |                          |      | $ | 8,821 |  | $ | 36,415 |   |  | $ | 15,752
|                                         |  |                             |        |                          |      |   |       |  |   |        |   |  |   |       



4. Short-term Investments



Short-term investments at June 30, 2005 and
December 31, 2004, consisting of corporate, state and municipal securities, were acquired at an aggregate cost of $117.1 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 were not materially different than the aggregate cost.



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



|                               |  |              |         |   |                   |   |         |  
|------------------------------ |  | ------------ | ------- | - | ----------------- | - | ------- | -
|                               |  | June 30,2005 |         |   | December 31, 2004 |  
|Available-for-sale securities: |  |              |         |   |                   |   |         |  
|Commercial paper               |  | $            | 9,627   |   |                   | $ | 7,628   |  
|U.S. agencies                  |  |              | 8,242   |   |                   |   | 14,985  |  
|Auction rate preferreds        |  |              | 94,900  |   |                   |   | 92,300  |  
|Corporate notes                |  |              | 4,223   |   |                   |   | 9,972   |  
|                               |  |              |         |   |                   |   |         |  
|Total investments              |  |              | 116,992 |   |                   |   | 124,885 |  
|Less: cash equivalents         |  |              | (12,266 | ) |                   |   | (10,434 | )
|                               |  |              |         |   |                   |   |         |  
|                               |  | $            | 104,726 |   |                   | $ | 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 June 30, 2005. $12.3 million of total liquid investments mature within three months, $9.8 million mature beyond three months but within one year and $94.9 million of investments have stated maturities beyond five years, but have
interest rate maturities of less than thirty-five days.



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##### Table of Contents

SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued



5. Inventories



Inventories consist of the following (in thousands):



|                |  |              |        |                   |   |       
|--------------- |  | ------------ | ------ | ----------------- | - | ------
|                |  | June 30,2005 |        | December 31, 2004
|Work in process |  | $            | 14,605 |                   | $ | 9,433 
|Finished goods  |  |              | 12,315 |                   |   | 9,978 
|                |  |              |        |                   |   |       
|                |  | $            | 26,920 |                   | $ | 19,411
|                |  |              |        |                   |   |       



At June 30, 2005 and
December 31, 2004, the Companys reserve for slow-moving and obsolete inventory was approximately $2.4 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 $0.6 million.



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##### Table of Contents

SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued



6. Intangible Assets



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



|                                           |  |              |        |   |                   |   |        |  
|------------------------------------------ |  | ------------ | ------ | - | ----------------- | - | ------ | -
|                                           |  | June 30,2005 |        |   | December 31, 2004 |  
|Intangible assets subject to amortization: |  |              |        |   |                   |   |        |  
|Gross carrying amount                      |  | $            | 6,608  |   |                   | $ | 5,605  |  
|Accumulated amortization                   |  |              | (1,872 | ) |                   |   | (1,248 | )
|                                           |  |              |        |   |                   |   |        |  
|Intangible assets, net                     |  | $            | 4,736  |   |                   | $ | 4,357  |  
|                                           |  |              |        |   |                   |   |        |  



Intangible asset
amortization expense was $0.3 and $0.2 million for the three months ended June 30, 2005 and 2004, respectively, and was $0.6 and $0.5 million for the six months ended June 30, 2005 and 2004, respectively. Estimated aggregate intangible asset
amortization expense is expected to be $1.3 million for each of the fiscal years 2005 through 2007, $1.1 million in 2008 and $0.3 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. The Companys effective tax rate was 37% and 2% for the three months ended June 30, 2005 and 2004, respectively, and 35% and 2% for the six months ended June 30, 2005 and 2004, respectively. The Companys estimate of the
effective tax rate for 2004 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.



The Company recognized certain tax benefits related to stock option plans in
the amount of $1.0 million and $0 during the three months ended June 30, 2005 and 2004, respectively and $6.4 and $0 during the six months ended June 30, 2005 and 2004, 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 may result in income tax benefits or expenses 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 and six months
ended June 30, 2005, the Company adjusted the lease abandonment charge by $0 and $0.4 million 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 condensed consolidated statement of operations. At June 30, 2005, the liability is allocated between a current liability of approximately $0.7 million and a non-current liability of approximately $0.2 million.
The Company does not expect any future charges related to this abandonment.



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##### Table of Contents

SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued



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.



9. Related Party Transactions



Revenues from a significant stockholder were approximately $2.9 million and
$5.9 million for the three months ended June 30, 2005 and 2004, respectively, and $22.9 million and $9.1 million for the six months ended June 30, 2005 and 2004, respectively.



Accounts receivable from sales to a significant stockholder were approximately $3.5 million and $7.0 million as of June 30,
2005 and December 31, 2004, respectively.



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##### Table of Contents

SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued



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 Ended June 30, |   |  | Six Months Ended June 30, |  
|                |  | 2005                        |   |  | 2004                      |   |  | 2005  |   |  | 2004  |  
|China/Hong Kong |  | 46.4                        | % |  | 29.5                      | % |  | 33.0  | % |  | 28.7  | %
|Taiwan          |  | 34.0                        |   |  | 43.8                      |   |  | 44.7  |   |  | 47.7  |  
|South Korea     |  | 6.0                         |   |  | 5.9                       |   |  | 4.3   |   |  | 6.4   |  
|United States   |  | 5.7                         |   |  | 0.2                       |   |  | 2.4   |   |  | 0.2   |  
|Singapore       |  | 4.6                         |   |  | 18.0                      |   |  | 13.7  |   |  | 14.5  |  
|Other           |  | 3.3                         |   |  | 2.6                       |   |  | 1.9   |   |  | 2.5   |  
|                |  |                             |   |  |                           |   |  |       |   |  |       |  
|Total sales     |  | 100.0                       | % |  | 100.0                     | % |  | 100.0 | % |  | 100.0 | %
|                |  |                             |   |  |                           |   |  |       |   |  |       |  



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



|              |  |              |   |  |                   |  
|------------- |  | ------------ | - |  | ----------------- | -
|              |  | June 30,2005 |   |  | December 31, 2004 |  
|United States |  | 88           | % |  | 88                | %
|Hong Kong     |  | 4            |   |  | 5                 |  
|Taiwan        |  | 3            |   |  | 1                 |  
|Other         |  | 5            |   |  | 6                 |  
|              |  |              |   |  |                   |  
|              |  | 100          | % |  | 100               | %
|              |  |              |   |  |                   |  



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##### Table of Contents

SigmaTel, Inc.

Notes to Condensed Consolidated 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 adverse effect on its 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.



In May 2005, the FASB
issued SFAS 154, Accounting Changes and Error Corrections  A Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. This
statement requires retrospective application to prior periods financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This
statement redefines restatements as the revising of previously issued financial statements to reflect the correction of an error. SFAS 154 requires that retrospective application of a change in accounting principle be limited to the direct effects
of the change. This statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS
154 is effective for accounting changes and corrections of errors made in fiscal years beginning after 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.



12. Subsequent Events



In July 2005, the Company announced that it had signed a definitive
agreement to acquire Protocom Corporation, a provider of semiconductors to the multi-function imaging market. In connection with the acquisition, the Company expects to pay $28.2 million in the form of approximately 1,437,000 shares of its common
stock issued or reserved for future issuance and make a cash payment of $18.8 million, in exchange for all outstanding shares of capital stock of Protocom. A portion of the consideration payable to the shareholders will be placed into escrow
pursuant to the terms of the acquisition agreement. The Company will also assume all unvested employee stock options of Protocom, which will entitle the holders to receive up to approximately 185,000 shares of the Companys common stock upon
exercise and vesting. The Company may record a one-time charge for purchased in-process research and development expenses related to the acquisition in its third fiscal quarter. The amount of that charge, if any, has not yet been determined.



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##### Table of Contents

SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued



Also, in July 2005, the Company closed its acquisition of the software, patents and engineering resources associated with the Rio® portable audio product line from D&M Holdings, Inc.
In connection with the acquisition, the Company made a cash payment of $9.5 million, and $0.5 million will be held in escrow pursuant to the terms of the acquisition agreement. The Company may record a one-time charge for purchased in-process
research and development expenses related to the acquisition in its third fiscal quarter. The amount of that charge, if any, has not yet been determined.



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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 condensed consolidated 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. and its consolidated subsidiaries.



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. From 2002 to 2004, our annual revenues grew substantially from $30.9 million to $194.8 million due primarily to
increased sales of our portable audio SoCs. Our operating results improved from an operating loss of $5.6 million to operating income of $53.1 million from 2002 to 2004. Revenues and operating results continue to improve during 2005. Revenue
increased from $68.1 million to $168.9 million for the six months ended June 30, 2004 and 2005, respectively. Our operating results improved from an operating income of $15.4 million to $54.0 million for the six months ended June 30, 2004 and 2005,
respectively.



In the third quarter of 2004, we established an
international subsidiary and opened an office in Hong Kong. In March and June of 2005, we opened branch or liaison offices of our Hong Kong subsidiary in Taipei, Taiwan and Shenzhen, China, respectively. We also recently established international
subsidiaries and opened offices in Singapore and Seoul, South Korea.



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.



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 also utilize distributors to sell our products. Our sales through



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##### Table of Contents

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 Ended June 30, |   |  | Six Months Ended June 30, |  
|                                    |  | 2005                        |   |  | 2004                      |   |  | 2005 |   |  | 2004 |  
|G.M.I. Technology                   |  | 21.1                        | % |  | 19.5                      | % |  | 16.8 | % |  | 18.8 | %
|King Horn Enterprises, Limited      |  | 11.1                        | % |  | *                         |   |  | *    |   |  | *    |  
|Samsung Electronics Company Limited |  | 10.9                        | % |  | 14.8                      | % |  | *    |   |  | 12.5 | %
|Holystone Enterprise                |  | *                           |   |  | 18.4                      | % |  | *    |   |  | 21.7 | %
|Creative Technology(1)              |  | *                           |   |  | 16.1                      | % |  | 13.6 | % |  | 13.3 | %
|ASUSTEK Computer Inc.               |  | *                           |   |  | *                         |   |  | 19.9 | % |  | *    |  

---

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

|(1) | Creative Technology holds more than 5% 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 94.3% and 99.8% for the three months ended June 30, 2005 and 2004, respectively, and 97.6% and 99.8% for the six months ended June 30, 2005 and 2004, respectively. 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.



16



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##### Table of Contents

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



|                |  |                             |   |  |                           |   |  |       |   |  |       |  
|--------------- |  | --------------------------- | - |  | ------------------------- | - |  | ----- | - |  | ----- | -
|                |  | Three Months Ended June 30, |   |  | Six Months Ended June 30, |  
|                |  | 2005                        |   |  | 2004                      |   |  | 2005  |   |  | 2004  |  
|China/Hong Kong |  | 46.4                        | % |  | 29.5                      | % |  | 33.0  | % |  | 28.7  | %
|Taiwan          |  | 34.0                        |   |  | 43.8                      |   |  | 44.7  |   |  | 47.7  |  
|South Korea     |  | 6.0                         |   |  | 5.9                       |   |  | 4.3   |   |  | 6.4   |  
|United States   |  | 5.7                         |   |  | 0.2                       |   |  | 2.4   |   |  | 0.2   |  
|Singapore       |  | 4.6                         |   |  | 18.0                      |   |  | 13.7  |   |  | 14.5  |  
|Other           |  | 3.3                         |   |  | 2.6                       |   |  | 1.9   |   |  | 2.5   |  
|                |  |                             |   |  |                           |   |  |       |   |  |       |  
|Total           |  | 100.0                       | % |  | 100.0                     | % |  | 100.0 | % |  | 100.0 | %
|                |  |                             |   |  |                           |   |  |       |   |  |       |  



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. Seasonal demand factors normalized in the second quarter; however, specific demand for our products was affected by the price volatility in other components used to build our customers devices, specifically NAND Flash, as well as high
inventory levels of our products at specific customers at the end of the first quarter.



17



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##### Table of Contents

The following describes certain line items in our condensed consolidated 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.



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 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 June 30, 2005, we had an aggregate of $0.9 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: $0.4 million
during 2005 and $0.5 million during 2006 and beyond.



Provision for Income Taxes. We accrue federal, state, and foreign 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 condensed consolidated statements of operations as a percentage of revenues for the periods indicated:



|                                                  |  |                             |   |  |                           |   |  |       |   |  |       |  
|------------------------------------------------- |  | --------------------------- | - |  | ------------------------- | - |  | ----- | - |  | ----- | -
|                                                  |  | Three Months Ended June 30, |   |  | Six Months Ended June 30, |  
|                                                  |  | 2005                        |   |  | 2004                      |   |  | 2005  |   |  | 2004  |  
|Revenues, net                                     |  | 100.0                       | % |  | 100.0                     | % |  | 100.0 | % |  | 100.0 | %
|Cost of goods sold                                |  | 44.6                        |   |  | 45.8                      |   |  | 43.4  |   |  | 46.3  |  
|                                                  |  |                             |   |  |                           |   |  |       |   |  |       |  
|Gross profit                                      |  | 55.4                        |   |  | 54.2                      |   |  | 56.6  |   |  | 53.7  |  
|Operating expenses:                               |  |                             |   |  |                           |   |  |       |   |  |       |  
|Research and development                          |  | 18.5                        |   |  | 19.6                      |   |  | 14.7  |   |  | 19.5  |  
|Selling, general and administrative               |  | 13.4                        |   |  | 9.9                       |   |  | 9.7   |   |  | 9.5   |  
|Amortization of deferred stock-based compensation |  | 0.3                         |   |  | 1.1                       |   |  | 0.2   |   |  | 2.1   |  
|Total operating expenses                          |  | 32.2                        |   |  | 30.6                      |   |  | 24.6  |   |  | 31.1  |  
|                                                  |  |                             |   |  |                           |   |  |       |   |  |       |  
|Operating income                                  |  | 23.2                        |   |  | 23.6                      |   |  | 32.0  |   |  | 22.6  |  
|                                                  |  |                             |   |  |                           |   |  |       |   |  |       |  
|Other income (expense):                           |  |                             |   |  |                           |   |  |       |   |  |       |  
|Interest income, net                              |  | 1.8                         |   |  | 1.0                       |   |  | 1.2   |   |  | 1.0   |  
|Foreign exchange loss                             |  | (0.1                        | ) |  |                          |   |  |      |   |  |      |  
|                                                  |  |                             |   |  |                           |   |  |       |   |  |       |  
|Total other income                                |  | 1.7                         |   |  | 1.0                       |   |  | 1.2   |   |  | 1.0   |  
|                                                  |  |                             |   |  |                           |   |  |       |   |  |       |  
|Income before income taxes                        |  | 24.9                        |   |  | 24.6                      |   |  | 33.2  |   |  | 23.6  |  
|Income taxes                                      |  | 9.2                         |   |  | 0.5                       |   |  | 11.6  |   |  | 0.5   |  
|                                                  |  |                             |   |  |                           |   |  |       |   |  |       |  
|Net income                                        |  | 15.7                        | % |  | 24.1                      | % |  | 21.6  | % |  | 23.1  | %
|                                                  |  |                             |   |  |                           |   |  |       |   |  |       |  





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Comparison of Three Months Ended June 30, 2005 to Three Months Ended June 30, 2004



Revenues. Revenues for the three months ended June 30, 2005 were
$69.6 million compared to $36.6 million for the three months ended June 30, 2004, an increase of 90%. This increase was due to an increase in revenues from portable audio SoCs of 106.1% and from our audio codecs of 6.5%. 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 92.6% of total revenues for the three months ended June 30, 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.



Sales to Creative Technology, an affiliate, decreased to less than 10% of total revenues during the three months ended June 30, 2005 from 16.1% during the
three months ended June 30, 2004 due to stronger demand for our portable audio SoCs from other customers as well as Creative Technology experiencing softer than expected overall market demand for their portable audio digital players in the period.
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. Technology, a distributor located in Hong Kong and Taiwan, increased from 19.5% to 21.1%
of total revenues during the three months ended June 30, 2004 and 2005, respectively. This increase was primarily due to G.M.I. Technology growing their business in China. Revenues from Holystone Enterprise, a distributor located in Taiwan,
decreased to less than 10% of total revenues during the three months ended June 30, 2005 from 18.4% during the three months ended June 30, 2004, primarily due to increases in our direct sales to 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 55.4% for the three months ended June 30, 2005 compared with 54.2% for
the three months ended June 30, 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 third quarter of 2005 to be slightly lower than 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 to a greater extent.



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Research and Development. Research and development expenses increased to $12.9 million, or 18.5%
of revenues, for the three months ended June 30, 2005 from $7.2 million, or 19.6% of revenues, for the three months ended June 30, 2004. This dollar increase of 79.8% 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 headcount increases were primarily to support hardware and software development on our latest portable audio SoCs, the STMP 36XX families of products, audio codecs
targeted for applications in the PC market, including the Intel High Definition Audio standard, a new digital FM tuner product, and various USB peripheral ICs, as well as development efforts on new audio products for PC and consumer applications.
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 and digital FM tuner 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 $9.3 million, or 13.4% of revenues, for the three
months ended June 30, 2005 from $3.6 million, or 9.9% of revenues, for the three months ended June 30, 2004. This dollar increase of 158.8% 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 expenses relating to office space both domestically and internationally, as well as increases in legal expenses related to setting up our international
subsidiaries and defending our patents. 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 $0.4 million for the three months ended June 30, 2005, and 2004, respectively.



Interest Income. Interest income increased to $1.2 million for the three months ended June 30, 2005 from $0.3 million for the three months ended
June 30, 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 $6.4 million for the three months ended June 30, 2005 from $0.2 million for the three months
ended June 30, 2004. This was primarily due to increased income before taxes, as well as an increase in our effective tax rate. Our effective tax rate for the three months ended June 30, 2005 was 37%. This estimate differed from the statutory rate
primarily due to an adjustment to increase our estimate of the effective tax rate for the full year ended December 31, 2005 to 35%. Our effective tax rate for the three months ended June 30, 2004 was 2%. 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.



Comparison of Six Months Ended June 30, 2005 to Six Months Ended June 30, 2004



Revenues. Revenues for the six months ended June 30, 2005 were $168.9 million compared to $68.1 million for the six
months ended June 30, 2004, an increase of 148%. This increase was due to an increase in revenues from all of our product linesportable audio SoCs, audio codecs and 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. Revenues from our portable audio SoCs were 94.3% of total revenues for the six months ended June 30, 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 increase
in revenues from audio codecs was due to increased sales to PC manufacturers and their ODMs partially offset by decreased sales to sound card manufacturers.



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Revenues from G.M.I. Technology, our largest distributor, located in Hong Kong and Taiwan, increased by
$15.6 million from $12.8 million in the six months ended June 30, 2004, and decreased to 16.8% of total revenues during the six months ended June 30, 2005 from 18.8% of revenues during the six months ended June 30, 2004. This increase from year to
year was due to G.M.I. Technology growing its business in China.



Direct revenues from ASUSTEK Computer, Inc., an original design manufacturer, or ODM, based in Taiwan, which manufactures products for Apple and other companies, increased to 19.9% of total revenues during the six months ended June 30, 2005
from less than 10% of total revenues during the six months ended June 30, 2004 due primarily to increased purchases of our portable audio SoCs.



Revenues from Holystone Enterprise, one of our distributors located in Taiwan, decreased by $0.2 million from $14.8 million in the six months ended June
30, 2004, and decreased to 8.6% of total revenues during the six months ended June 30, 2005 from 21.7% during the six months ended June 30, 2004 due to stronger demand for our portable audio SoCs in geographic regions such as China and South Korea.
Sales to Creative Technology, an affiliate, increased to 13.6% of total revenues during the six months ended June 30, 2005 from 13.3% during the six months ended June 30, 2004 due to an increase in their purchases of 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.



Gross Profit. Gross profit as a percentage of revenues, or gross margin, was 56.6% for the six months ended June 30, 2005 compared with 53.7% for
the six months ended June 30, 2004. The increase in gross margin was primarily due to a favorable product mix 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 our portable audio SoCs and USB peripheral ICs, as a percentage of total revenues, as the gross margin from these products is generally higher than from our audio codecs. Also, the increase
in revenues of our STMP 35XX family of products caused higher overall margins for our portable audio SoCs. We expect our gross margins for the third quarter of 2005 to be slightly lower than those achieved during the first half of 2005.
However, increased competition could adversely impact our pricing, particularly in the portable compressed audio player and USB peripherals markets, which could adversely impact our gross margins.



Research and Development. Research and development expenses increased
to $24.8 million, or 14.7% of revenues, for the six months ended June 30, 2005 from $13.3 million, or 19.5% of revenues, for the six months ended June 30, 2004. This dollar increase of 86.8% was primarily due to increases in our engineering
headcount, including independent contractors, as well as increases in the costs of design tools and mask revisions. Such increases were primarily to support hardware and software development on our latest portable audio SoCs, the STMP 35XX and STMP
36XX families of products, and audio codecs targeted for applications in the PC market, including the Intel High Definition Audio standard. 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 35XX and STBD 2010 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 $16.4 million, or 9.7% of revenues, for the six months ended June 30, 2005 from $6.5 million, or 9.5% of revenues, for the six months ended June 30, 2004. This dollar
increase of 152.8% was due to increases in sales, marketing, and administrative personnel, as well as increases in legal expenses related to setting up our international subsidiaries and protecting our intellectual property and 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 $0.4 million and $1.4 million for the six months ended June 30, 2005, and 2004, respectively.





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Interest Income. Interest income increased to $2.1 million for the six months ended June 30, 2005
from $0.7 million for the six months ended June 30, 2004. This was due to increased income earned on our cash balances and investments in short-term marketable securities since the completion of our initial public offering in September 2004.



Income Taxes. Income tax expense increased to $19.6
million for the six months ended June 30, 2005 from $0.3 million for the six months ended June 30, 2004. This was due to an increase in income before income taxes to $56 million for the six months ended June 30, 2005 compared to $16.1 million for
the six months ended June 30, 2004. Our effective tax rate was 35% and 2% for the six month periods ended June 30, 2005 and 2004, respectively. Our effective tax rate for the period ended June 30, 2004 is less than the statutory rate on taxable
income due to the a reduction in the Companys deferred tax asset valuation allowance attributable to the utilization of loss carryforwards.



Liquidity and Capital Resources



As of June 30, 2005, we had $178.6 million in cash, cash equivalents and short-term investments. Our short-term investments consist primarily of
corporate, state and municipal securities.



Net cash provided
by operating activities was $41.4 million and $16.1 million for the six months ended June 30, 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 $6.1 million and $3.2 million during the six months ended June 30, 2005 and 2004, respectively. These changes are due to increases 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
$7.5 million and $6.6 million during the six months ended June 30, 2005 and June 30, 2004, respectively. This increase in inventories is required to support the increase in demand for our products during the second and third quarters of 2005. Our
reserve for slow-moving and obsolete inventory as a percentage of total inventory was 8.3% and 9.5% as of June 30, 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 $0.2 million and $0.3 million for the six month period ended June 30, 2005 and June 30, 2004, respectively. This change in the 2005 period was due to additional
reserve of $0.8 million for obsolescence offset by scrap and sales of items which had previously been reserved of $0.6 million. Our accounts payable decreased $1.2 million and increased $3.1 million during the six months ended June 30, 2005 and
2004, respectively. These changes generally relate to increases in our inventories and the timing of payments to our vendors. Our deferred revenue increased $1.2 million and $2.9 million during the six months ended June 30, 2005 and June 30, 2004,
respectively, due to increases in our products held at distributors to enable them to meet increased customer demand for our products.



Our investing activities provided cash of $2.3 million and used cash of $48.3 million during the six month periods ended June 30, 2005 and June 30, 2004,
respectively. Investing activities primarily represented purchases of capital equipment and purchases and proceeds from maturities of short-term investments.



Capital expenditures were $7.3 million and $6.6 million during the six months ended June 30, 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 $24.8 million and $13.3 million during the six months ended June 30, 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.



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Our financing activities provided cash of $3 and $8.4 million during the six months ended June 30, 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 $2.1 million in proceeds from the exercise of employee stock options during each of the six
months ended June 30, 2005 and 2004 and $0.9 million from the purchase of stock under our Employee Stock Purchase Plan during each of the six months ended June 30, 2005 and 2004. These proceeds were invested in short-term, investment grade, interest
bearing instruments, pending their use to fund working capital, acquisitions, and capital expenditures as required.



The fair value of our investments in marketable securities at June 30, 2005 was $117 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. We may enter into
acquisitions or strategic arrangements in the future which also could require us to seek additional equity or debt financing.



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.



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.



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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.



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





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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 may result in income tax benefits or expenses being recognized in a future period.



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 adverse 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.



In
May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections  A Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting
principle. This statement requires retrospective application to prior periods financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the
change. This statement redefines restatements as the revising of previously issued financial statements to reflect the correction of an error. SFAS 154 requires that retrospective application of a change in accounting principle be limited to the
direct effects of the change. This statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting
principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after 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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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 Condensed Consolidated Financial Statements and
Notes thereto, and Managements Discussion and Analysis of Financial Condition and Results of Operations as of June 30, 2005 and for the three and six month periods 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 June 30, 2005, all of our investments were
in money market accounts or investment grade securities.



Foreign Currency
Risks



The Company is exposed to foreign currency
fluctuations. Sales and inventory purchases made by the Company and its subsidiaries are denominated in U.S. dollars. A small percentage of our international purchase transactions are in currencies other than the U.S. dollar. Any currency risks
related to these transactions are deemed to be immaterial to us as a whole.



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, including decreases in the overall average selling prices of 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 $68.1 million for the six months
ended June 30, 2004 to $168.9 million for the six months ended June 30, 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 $36.4 million for the six months ended June 30, 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 six months ended June 30, 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 six months ended June 30, 2005 include a non-cash charge of approximately $418,000 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 and potentially
future 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.



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 six months ended June 30, 2005 and 2004, sales to our top five customers accounted for approximately 67.1% and 74.4%, respectively, of our
revenues. Our operating results in the foreseeable future will



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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 47.4% and 70.0% of our revenues for the six months ended June 30, 2005 and 2004, respectively. Our sales to G.M.I. Technology, a distributor, accounted for 16.8% and 18.8% of our revenues in the six months ended June 30, 2005 and 2004,
respectively, and our sales to Holystone Enterprise, also a distributor, accounted for 8.6% and 21.7% of our revenues in the six months ended June 30, 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. Technology, Holystone Enterprise 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 were to 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. Further, our customers may choose to replace our products with products of our competitors if we fail to implement our new products within the time constraints. In
addition, we are subject to the risk of price volatility and 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 decline. Any decline in consumer spending, whether relating to general economic conditions, future terrorist attacks or disease outbreaks, such as bird flu and Severe Acute Respiratory
Syndrome, or SARS, could also limit the expansion of the consumer electronics market, thus adversely affecting our business.



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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 six months ended June 30, 2005, 33.0% of our sales occurred in China and 4.3% 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 94.3% of our revenues in the six months ended June 30, 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 ability to transition customers from one generation of our products to the next;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | 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, other public health concerns and other factors that could negatively impact our third-party
foundries or customers.



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 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 earthquakes; other natural disasters or other events that would disrupt or impair our foundries production and assembly capacity 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



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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 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, including recent acquisitions, 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. We have expanded our business through acquisitions, opening international locations and through increasing headcount, both domestically and internationally. 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;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | decreases in the overall average selling prices of our products;
| | - |  | ----------------------------------------------------------------



| |  |  | 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;
| | - |  | ------------------------------



| |  |  | cost associated with acquisitions;
| | - |  | ----------------------------------



| |  |  | natural disasters, particularly earthquakes, or disease outbreaks, such as the recent outbreaks of bird flu and 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.
| | - |  | ------------------------------------



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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.



The average selling prices of our products could decrease rapidly which may negatively impact our revenues and gross profits.



We may experience substantial period-to-period
fluctuations in future operating results due to the erosion of our average selling prices, particularly for portable audio SoCs. We have reduced the average unit price of our products in anticipation of or in response to competitive pricing
pressures, new product introductions by us or our competitors and other factors. If we are unable to offset any such reductions in our average selling prices by increasing our sales volumes and reducing production costs, our gross profits and
revenues will suffer. To maintain our gross profit percentage, we will need to develop and introduce new products and product enhancements on a timely basis and continually reduce our costs. Our failure to do so would cause our revenues and gross
profit percentage to decline.



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.



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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 our products, which may also negatively impact our ability to sell them.



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.



In the third quarter of 2004, we established an international subsidiary and opened an office in Hong Kong. In March and June of 2005, we opened branch or
liaison offices of our Hong Kong subsidiary in Taipei, Taiwan and Shenzhen, China, respectively. We also recently established international subsidiaries and opened offices in Singapore and Seoul, South Korea. In connection with our acquisition of
certain assets from D&M Holdings, Inc. in July 2005, we also established an international subsidiary and opened on office in Cambridge, England. The percentage of our revenues, from customers located outside of the U.S., were 97.6% for the six
months ended June 30, 2005 and 99.8% for the six months ended June 30, 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;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | foreign currency exchange rate fluctuations
| | - |  | -------------------------------------------



| |  |  | difficulties with financial reporting in foreign countries
| | - |  | ----------------------------------------------------------



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



| |  |  | difficulties and costs in staffing and managing international operations, as well as cultural differences.
| | - |  | ----------------------------------------------------------------------------------------------------------



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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.



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



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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. 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 acquisitions we make could disrupt our ongoing business and may harm our financial condition or present risks not contemplated at the time of the transaction.



As part of our growth and product diversification strategy, we continue to evaluate opportunities to acquire other
businesses, intellectual property or technologies that would complement our current offerings, expand the breadth of our markets or enhance our technical capabilities. The acquisition of certain assets from D&M Holdings, Inc., the contemplated
Protocom acquisition and other acquisitions that we may potentially make in the future entail a number of risks that could materially and adversely affect our business and operating results, including:



| |  |  | problems integrating the acquired operations, technologies or products with our existing business and products;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | diversion of managements time and attention from our core business;
| | - |  | --------------------------------------------------------------------



| |  |  | need for financial resources above our planned investment levels;
| | - |  | -----------------------------------------------------------------



| |  |  | difficulties in retaining business relationships with suppliers and customers of the acquired company;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | risks associated with entering markets in which we lack prior experience;
| | - |  | -------------------------------------------------------------------------



| |  |  | risks associated with the transfer of licenses of intellectual property;
| | - |  | ------------------------------------------------------------------------



| |  |  | acquisition-related disputes, including disputes over earn-outs and escrows;
| | - |  | ----------------------------------------------------------------------------



| |  |  | potential loss of key employees of the acquired company; and
| | - |  | ------------------------------------------------------------



| |  |  | potential impairment of related goodwill and intangible assets.
| | - |  | ---------------------------------------------------------------



Future acquisitions also could cause us to incur debt or contingent liabilities or cause us to issue equity securities that could negatively impact the ownership
percentages of existing stockholders.



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.



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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 to 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 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,



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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.



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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
June 30, 2005 to provide reasonable assurance 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.



Management, with the participation
of the CEO and CFO of our Company, has evaluated any changes in our Companys internal control over financial reporting that occurred during the most recent fiscal quarter. Based on that evaluation, management, including the CEO and CFO of our
Company, have concluded that there has been no change in our Companys internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our
Companys internal control 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 June 30, 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, as amended, 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, 6,633,187, and 6,366,522. On April 18, 2005, the ITC instituted an investigation into Actions Semiconductors actions based on our allegations.
With respect to all of the 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



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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.



As of June 30, 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



On April 21, 2005, we held our Annual Meeting of Stockholders. The matters voted upon at the meeting and the results of those votes were as follows:



1. Election of Class II Directors



|                    |  |                              |  |                                       
|------------------- |  | ---------------------------- |  | --------------------------------------
|                    |  | Total Vote For Each Director |  | Total Vote Withheld From Each Director
|Alexander M. Davern |  | 28,286,925                   |  | 1,656,879                             
|                    |  |                             
|Robert T. Derby     |  | 29,265,210                   |  | 678,594                               



The terms of our Class
I directors, Ronald P. Edgerton and William P. Osborne, and our Class III directors, John A. Hime and Kenneth P. Lawler, continued after the meeting.



2. Approval of amendments to the SigmaTel, Inc. 2003 Equity Incentive Plan (the Plan) to (i) increase by 2,500,000 the maximum number of
shares of common stock that may be issued under the Plan, (ii) reduce to 500,000 (from 1,000,000 as originally approved by stockholders) the number of shares which may be issued pursuant to any stock purchase right, stock bonus, restricted stock
unit, performance share or performance unit, and (iii) approve certain provisions of the Plan solely for the purpose of preserving our ability to deduct in full for federal income tax



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purposes the compensation recognized by our executive officers in connection with certain awards that may be granted in
the future under the Plan



|           |  |              |  |                 |  |                 
|---------- |  | ------------ |  | --------------- |  | ----------------
|Votes For  |  | VotesAgainst |  | VotesAbstaining |  | Broker Non-Votes
|20,363,176 |  | 4,550,915    |  | 111,785         |  | 4,917,928       



Item 5. Other Information



|(a) | Not applicable
|--- | --------------



|(b) | Not applicable
|--- | --------------



Item 6. Exhibits



See Exhibit
Index



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##### Table of Contents

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: August 9, 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.                                                                                                                   
|              | 
|3.2(2)        |  | Amended and Restated Bylaws of SigmaTel, Inc.                                                                                                                                    
|              | 
|4.1(2)        |  | Specimen certificate for shares of common stock                                                                                                                                  
|              | 
|10.1(3)       |  | SigmaTel, Inc. 2003 Equity Incentive Plan (including forms of standard option agreements for employees and directors)                                                            
|              | 
|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 April 25, 2005.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------



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