##### 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, 2006

OR



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

For the Transition Period from              to

Commission File Number: 000-50391



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SIGMATEL, INC.

(Exact name of registrant as specified in its charter)



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

1601 S. MoPac Expressway

Suite 100

Austin, Texas 78746

(512) 381-3700

(Address
and telephone number of principal executive offices)



---

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2
of the Exchange Act. (Check one):

Large accelerated filer ̈Accelerated filer  x    Non-accelerated filer ̈

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

The number of shares outstanding of the Issuers Common Stock, $0.0001 par value, was 35,205,412 as of July 31,
2006.



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##### Table of Contents

SIGMATEL, INC.

FORM 10-Q

TABLE OF CONTENTS



|          |  |                                                                                                                    |  |         
|--------- |  | ------------------------------------------------------------------------------------------------------------------ |  | --------
|          |  |                                                                                                                    |  | Page No.
|PART I:   |  | FINANCIAL INFORMATION                                                                                              |  |         
|          |  |                                                                                                                   
|Item 1.   |  | Financial Statements                                                                                               |  |         
|          |  |                                                                                                                   
|          |  | Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005                                    |  | 3       
|          |  |                                                                                                                   
|          |  | Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2006 and June 30, 2005 |  | 4       
|          |  |                                                                                                                   
|          |  | Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and June 30, 2005           |  | 5       
|          |  |                                                                                                                   
|          |  | Notes to Condensed Consolidated Financial Statements                                                               |  | 6       
|          |  |                                                                                                                   
|Item 2.   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                              |  | 18      
|          |  |                                                                                                                   
|Item 3.   |  | Quantitative and Qualitative Disclosures about Market Risk                                                         |  | 31      
|          |  |                                                                                                                   
|Item 4.   |  | Controls and Procedures                                                                                            |  | 31      
|          |  |                                                                                                                   
|PART II:  |  | OTHER INFORMATION                                                                                                  |  |         
|          |  |                                                                                                                   
|Item 1.   |  | Legal Proceedings                                                                                                  |  | 32      
|          |  |                                                                                                                   
|Item 1A.  |  | Risk Factors                                                                                                       |  | 32      
|          |  |                                                                                                                   
|Item 2.   |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                        |  | 47      
|          |  |                                                                                                                   
|Item 3.   |  | Defaults upon Senior Securities                                                                                    |  | 47      
|          |  |                                                                                                                   
|Item 4.   |  | Submission of Matters to a Vote of Security Holders                                                                |  | 47      
|          |  |                                                                                                                   
|Item 5.   |  | Other Information                                                                                                  |  | 47      
|          |  |                                                                                                                   
|Item 6.   |  | Exhibits                                                                                                           |  | 47      
|          | 
|Signature |  | 48                                                                                                                



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 30,2006 |         |   | December 31,2005 |  
|ASSETS                                                                                                                                                           |  |              |         |   |                  |   |         |  
|Current assets:                                                                                                                                                  |  |              |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                        |  | $            | 19,483  |   |                  | $ | 65,712  |  
|Short-term investments                                                                                                                                           |  |              | 21,017  |   |                  |   | 53,172  |  
|Accounts receivable, net                                                                                                                                         |  |              | 25,588  |   |                  |   | 48,633  |  
|Inventories, net                                                                                                                                                 |  |              | 37,245  |   |                  |   | 21,036  |  
|Income tax receivable                                                                                                                                            |  |              | 609     |   |                  |   | 5,446   |  
|Deferred tax asset, net                                                                                                                                          |  |              | 7,743   |   |                  |   | 1,401   |  
|Prepaid expenses and other assets                                                                                                                                |  |              | 7,523   |   |                  |   | 6,963   |  
|Assets held for sale                                                                                                                                             |  |              | 5,351   |   |                  |   | 2,903   |  
|                                                                                                                                                                 |  |              |         |   |                  |   |         |  
|Total current assets                                                                                                                                             |  |              | 124,559 |   |                  |   | 205,266 |  
|Property, equipment and software, net                                                                                                                            |  |              | 13,659  |   |                  |   | 13,164  |  
|Intangible assets, net                                                                                                                                           |  |              | 35,986  |   |                  |   | 37,478  |  
|Goodwill                                                                                                                                                         |  |              | 62,859  |   |                  |   | 63,203  |  
|Deferred tax asset, net                                                                                                                                          |  |              | 7,510   |   |                  |   |        |  
|Assets held for sale                                                                                                                                             |  |              | 22,389  |   |                  |   | 22,236  |  
|Other assets                                                                                                                                                     |  |              | 3,485   |   |                  |   | 2,095   |  
|                                                                                                                                                                 |  |              |         |   |                  |   |         |  
|Total assets                                                                                                                                                     |  | $            | 270,447 |   |                  | $ | 343,442 |  
|                                                                                                                                                                 |  |              |         |   |                  |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                             |  |              |         |   |                  |   |         |  
|Current liabilities:                                                                                                                                             |  |              |         |   |                  |   |         |  
|Accounts payable                                                                                                                                                 |  | $            | 25,286  |   |                  | $ | 48,093  |  
|Accrued compensation                                                                                                                                             |  |              | 8,449   |   |                  |   | 7,020   |  
|Other accrued expenses                                                                                                                                           |  |              | 4,975   |   |                  |   | 6,442   |  
|Deferred revenue                                                                                                                                                 |  |              | 5,889   |   |                  |   | 10,093  |  
|Current portion of long-term obligations                                                                                                                         |  |              | 392     |   |                  |   | 528     |  
|Liabilities to be assumed in sale                                                                                                                                |  |              | 3,823   |   |                  |   | 2,053   |  
|                                                                                                                                                                 |  |              |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                        |  |              | 48,814  |   |                  |   | 74,229  |  
|Non-current income taxes payable                                                                                                                                 |  |              | 6,474   |   |                  |   | 7,906   |  
|Other liabilities                                                                                                                                                |  |              | 979     |   |                  |   | 2,113   |  
|                                                                                                                                                                 |  |              |         |   |                  |   |         |  
|Total liabilities                                                                                                                                                |  |              | 56,267  |   |                  |   | 84,248  |  
|                                                                                                                                                                 |  |              |         |   |                  |   |         |  
|Stockholders equity:                                                                                                                                            |  |              |         |   |                  |   |         |  
|Common stock, $0.0001 par value; 170,000 shares authorized; shares issued and outstanding: 35,263 and 35,173 at 2006 and 37,507 and 37,417 at
2005, respectively |  |              | 4       |   |                  |   | 4       |  
|Additional paid-in capital                                                                                                                                       |  |              | 191,233 |   |                  |   | 218,492 |  
|Notes receivable from stockholders                                                                                                                               |  |              | (5      | ) |                  |   | (5      | )
|Deferred stock-based compensation                                                                                                                                |  |              |        |   |                  |   | (3,874  | )
|Treasury stock, 90 common shares at cost                                                                                                                         |  |              | (741    | ) |                  |   | (741    | )
|Accumulated surplus                                                                                                                                              |  |              | 23,538  |   |                  |   | 45,337  |  
|Accumulated other comprehensive income (loss)                                                                                                                    |  |              | 151     |   |                  |   | (19     | )
|                                                                                                                                                                 |  |              |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                       |  |              | 214,180 |   |                  |   | 259,194 |  
|                                                                                                                                                                 |  |              |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                                                       |  | $            | 270,447 |   |                  | $ | 343,442 |  
|                                                                                                                                                                 |  |              |         |   |                  |   |         |  

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 OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|---------------------------------------- |  | -------------------------- | ------- | - | ------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                         |  | Three Months EndedJune 30, |         |   | Six Months EndedJune 30, |  
|                                         |  | 2006                       |         |   | 2005                     |   |        | 2006 |  |   | 2005    |  
|Revenues, net                            |  | $                          | 43,812  |   |                          | $ | 69,572 |      |  | $ | 76,833  |   |  | $ | 168,910 |  
|Cost of goods sold                       |  |                            | 24,890  |   |                          |   | 30,999 |      |  |   | 43,182  |   |  |   | 73,293  |  
|                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Gross profit                             |  |                            | 18,922  |   |                          |   | 38,573 |      |  |   | 33,651  |   |  |   | 95,617  |  
|                                         |  |                            |         |  
|Operating expenses:                      |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Research and development                 |  |                            | 23,061  |   |                          |   | 13,024 |      |  |   | 45,253  |   |  |   | 25,025  |  
|Selling, general and administrative      |  |                            | 12,639  |   |                          |   | 9,430  |      |  |   | 26,632  |   |  |   | 16,593  |  
|                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses                 |  |                            | 35,700  |   |                          |   | 22,454 |      |  |   | 71,885  |   |  |   | 41,618  |  
|                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Operating income (loss)                  |  |                            | (16,778 | ) |                          |   | 16,119 |      |  |   | (38,234 | ) |  |   | 53,999  |  
|                                         |  |                            |         |  
|Interest income, net                     |  |                            | 422     |   |                          |   | 1,245  |      |  |   | 1,205   |   |  |   | 2,067   |  
|Foreign exchange loss                    |  |                            | (52     | ) |                          |   | (43    | )    |  |   | (104    | ) |  |   | (43     | )
|                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Total other income                       |  |                            | 370     |   |                          |   | 1,202  |      |  |   | 1,101   |   |  |   | 2,024   |  
|                                         |  |                            |         |  
|Income (loss) before income taxes        |  |                            | (16,408 | ) |                          |   | 17,321 |      |  |   | (37,133 | ) |  |   | 56,023  |  
|                                         |  |                            |         |  
|Income tax expense (benefit)             |  |                            | (19,335 | ) |                          |   | 6,425  |      |  |   | (15,334 | ) |  |   | 19,597  |  
|                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net income (loss)                        |  | $                          | 2,927   |   |                          | $ | 10,896 |      |  | $ | (21,799 | ) |  | $ | 36,426  |  
|                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|BASIC NET INCOME (LOSS) PER SHARE        |  | $                          | 0.08    |   |                          | $ | 0.31   |      |  | $ | (0.62   | ) |  | $ | 1.02    |  
|                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|DILUTED NET INCOME (LOSS) PER SHARE      |  | $                          | 0.08    |   |                          | $ | 0.29   |      |  | $ | (0.62   | ) |  | $ | 0.97    |  
|                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|WEIGHTED AVERAGE SHARES USED TO COMPUTE: |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Basic net income (loss) per share        |  |                            | 34,881  |   |                          |   | 35,704 |      |  |   | 35,343  |   |  |   | 35,552  |  
|Diluted net income (loss) per share      |  |                            | 35,695  |   |                          |   | 37,351 |      |  |   | 35,343  |   |  |   | 37,584  |  

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



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SIGMATEL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                                   |  |                          |         |   |      |   |         |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                                   |  | Six Months EndedJune 30, |        
|                                                                                                   |  | 2006                     |         |   | 2005 |  
|Cash flows from operating activities:                                                              |  |                          |         |   |      |   |         |  
|Net income (loss)                                                                                  |  | $                        | (21,799 | ) |      | $ | 36,426  |  
|Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: |  |                          |         |   |      |   |         |  
|Depreciation and amortization                                                                      |  |                          | 7,295   |   |      |   | 3,026   |  
|Stock-based compensation expense                                                                   |  |                          | 5,064   |   |      |   | 418     |  
|Deferred income taxes                                                                              |  |                          | (15,240 | ) |      |   | 7,452   |  
|Lease abandonment adjustments                                                                      |  |                          |        |   |      |   | (385    | )
|Tax benefit related to exercise of employee stock options                                          |  |                          |        |   |      |   | 6,358   |  
|Excess tax benefit from employee stock plans                                                       |  |                          | (299    | ) |      |   |        |  
|Other non-cash expense (benefit)                                                                   |  |                          | 120     |   |      |   | (112    | )
|Changes in assets and liabilities:                                                                 |  |                          |         |   |      |   |         |  
|Accounts receivable, net                                                                           |  |                          | 22,536  |   |      |   | (6,068  | )
|Inventories, net                                                                                   |  |                          | (18,449 | ) |      |   | (7,509  | )
|Prepaid expenses and other assets                                                                  |  |                          | (1,949  | ) |      |   | (1,145  | )
|Accounts payable                                                                                   |  |                          | (21,037 | ) |      |   | (1,186  | )
|Accrued expenses                                                                                   |  |                          | 766     |   |      |   | 146     |  
|Income taxes payable                                                                               |  |                          | 3,373   |   |      |   | 2,707   |  
|Deferred revenue and other liabilities                                                             |  |                          | (4,312  | ) |      |   | 1,228   |  
|                                                                                                   |  |                          |         |   |      |   |         |  
|Net cash (used in) provided by operating activities                                                |  |                          | (43,931 | ) |      |   | 41,356  |  
|                                                                                                   |  |                          |         |   |      |   |         |  
|Cash flows from investing activities:                                                              |  |                          |         |   |      |   |         |  
|Proceeds from maturities of short-term investments                                                 |  |                          | 32,157  |   |      |   | 73,056  |  
|Purchases of short-term investments                                                                |  |                          |        |   |      |   | (63,451 | )
|Purchases of property, equipment, software and intangible assets                                   |  |                          | (6,057  | ) |      |   | (7,273  | )
|                                                                                                   |  |                          |         |   |      |   |         |  
|Net cash provided by investing activities                                                          |  |                          | 26,100  |   |      |   | 2,332   |  
|                                                                                                   |  |                          |         |   |      |   |         |  
|Cash flows from financing activities:                                                              |  |                          |         |   |      |   |         |  
|Payments on capital lease obligations                                                              |  |                          | (7      | ) |      |   | (32     | )
|Common stock repurchases                                                                           |  |                          | (29,999 | ) |      |   |        |  
|Proceeds from notes receivable from stockholders                                                   |  |                          |        |   |      |   | 2       |  
|Excess tax benefit from employee stock plans                                                       |  |                          | 299     |   |      |   |        |  
|Proceeds from issuance of common stock, net of issuance costs                                      |  |                          | 1,251   |   |      |   | 3,048   |  
|                                                                                                   |  |                          |         |   |      |   |         |  
|Net cash (used in) provided by financing activities                                                |  |                          | (28,456 | ) |      |   | 3,018   |  
|                                                                                                   |  |                          |         |   |      |   |         |  
|Effect of exchange rate changes on cash and cash equivalents                                       |  |                          | 58      |   |      |   | (58     | )
|Net (decrease) increase in cash and cash equivalents                                               |  |                          | (46,229 | ) |      |   | 46,648  |  
|Cash and cash equivalents, beginning of period                                                     |  |                          | 65,712  |   |      |   | 27,246  |  
|                                                                                                   |  |                          |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                                           |  | $                        | 19,483  |   |      | $ | 73,894  |  
|                                                                                                   |  |                          |         |   |      |   |         |  

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



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of SigmaTel, Inc. and its wholly owned subsidiaries (the
Company). All material intercompany balances and transactions have been eliminated. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by
accounting principles generally accepted by the United States of America. 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. The Company has reclassified certain assets as assets held for sale and certain liabilities have been
reclassified as liabilities to be assumed in sale (see Note 10). Previously, the Company recorded amortization of stock compensation as a separate line item in the condensed consolidated statements of operations. In March 2005, the
Securities and Exchange Commission (SEC) released Staff Accounting Bulletin No. 107 (SAB 107), which states that companies should present the expense related to share-based payment arrangements in the same line or lines
as cash compensation paid to the same employees. Accordingly, the Company has reclassified share-based payments previously recorded as Amortization of deferred stock-based compensation to the appropriate functional categories. The
reclassifications had no impact on the Companys financial position, operating income, or net income. The following table summarizes stock-based compensation expense that is now recorded within functional categories in the condensed
consolidated statements of operations (in thousands):



|                                    |  |                            |       |                          |   |      |  |      |       |  |   |    
|----------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ---- |  | ---- | ----- |  | - | ---
|                                    |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|                                    |  | 2006                       |       | 2005                     |   | 2006 |  | 2005
|Research and development            |  | $                          | 1,709 |                          | $ | 134  |  | $    | 3,371 |  | $ | 265
|Selling, general and administrative |  |                            | 863   |                          |   | 104  |  |      | 1,693 |  |   | 153
|                                    |  |                            |       |                          |   |      |  |      |       |  |   |    
|                                    |  | $                          | 2,572 |                          | $ | 238  |  | $    | 5,064 |  | $ | 418
|                                    |  |                            |       |                          |   |      |  |      |       |  |   |    

In the opinion of management, all adjustments and reclassifications considered necessary for a
fair and comparable statement of the Companys financial position, results of operations and cash flows for the periods presented have been included and are of a normal recurring nature. Operating results for the three and six months ended
June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

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 filed with the SEC. Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
Share-Based Payment (see Note 4). There have been no other changes in our critical accounting policies since December 31, 2005.

Net
Income (Loss) per Share

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



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



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



|                                                                                              |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |        |  
|--------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                                                              |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                                              |  | 2006                       |        |   | 2005                     |   |        | 2006 |  |   | 2005    |  
|Numerator:                                                                                    |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Net income (loss)                                                                             |  | $                          | 2,927  |   |                          | $ | 10,896 |      |  | $ | (21,799 | ) |  | $ | 36,426 |  
|                                                                                              |  |                            |        |  
|Denominator:                                                                                  |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Weighted-average common stock outstanding                                                     |  |                            | 35,157 |   |                          |   | 35,729 |      |  |   | 35,611  |   |  |   | 35,576 |  
|Less: weighted-average shares subject to repurchase                                           |  |                            | (36    | ) |                          |   | (25    | )    |  |   | (28     | ) |  |   | (24    | )
|Less: shares held in escrow                                                                   |  |                            | (240   | ) |                          |   |       |      |  |   | (240    | ) |  |   |       |  
|                                                                                              |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Weighted-average shares used in computing basic net income (loss) per share                   |  |                            | 34,881 |   |                          |   | 35,704 |      |  |   | 35,343  |   |  |   | 35,552 |  
|Dilutive potential common shares used in computing diluted net income (loss) per share        |  |                            | 814    |   |                          |   | 1,647  |      |  |   |        |   |  |   | 2,032  |  
|                                                                                              |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Total weighted-average number of shares used in computing diluted net income (loss) per share |  |                            | 35,695 |   |                          |   | 37,351 |      |  |   | 35,343  |   |  |   | 37,584 |  
|                                                                                              |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |        |  

The following outstanding options and restricted stock units were excluded from the computation of
diluted net income (loss) per share as they had an anti-dilutive effect:



|                                 |  |                            |  |                          |  |       |  |      
|-------------------------------- |  | -------------------------- |  | ------------------------ |  | ----- |  | -----
|                                 |  | Three Months EndedJune 30, |  | Six Months EndedJune 30,
|                                 |  | 2006                       |  | 2005                     |  | 2006  |  | 2005 
|Options to purchase common stock |  | 4,919                      |  | 1,600                    |  | 5,894 |  | 1,100
|Restricted stock units           |  | 205                        |  |                         |  | 216   |  |     
|                                 |  |                            |  |                          |  |       |  |      
|                                 |  | 5,124                      |  | 1,600                    |  | 6,110 |  | 1,100
|                                 |  |                            |  |                          |  |       |  |      

3. Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Income Tax Uncertainties (FIN 48). FIN 48 defines the
threshold for recognizing the benefits of tax return positions in the financial statements as more-likely-than-not to be sustained by the taxing authority. The recently issued literature also provides guidance on the de-recognition,
measurement and classification of income tax uncertainties, along with any related interest and penalties. FIN 48 also includes guidance concerning accounting for income tax uncertainties in interim periods and increases the level of disclosures
associated with any recorded income tax uncertainties.

FIN 48 is effective for fiscal years beginning after December 15, 2006. The
differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of
retained earnings. The Company is still evaluating the impact, if any, of adopting the provisions of FIN 48 on its financial position, results of operations and liquidity.

4. Stock-based Compensation

Prior to January 1, 2006, employee stock awards under the
Companys compensation plans were accounted for in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting Standards Board (FASB)
Interpretation No. 44, Emerging Issues Task Force (EITF) Issue No. 00-23, and related interpretations. The Company accounted 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. For employee stock awards, we have historically adhered to the
disclosure-only provisions of these applicable accounting principles.



7



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



Prior to January 1, 2006, compensation costs related to stock options granted to employees at
fair value under the Companys compensation plans were not recognized in the condensed consolidated statements of operations. Compensation costs related to options, restricted stock units (RSUs), stock options granted to employees
below fair value, and stock options granted to non employees were recognized in the condensed consolidated statements of operations.

In
December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, (SFAS 123R). Under the new standard, companies are no longer able to account for share-based compensation transactions using the intrinsic value
method in accordance with APB Opinion No. 25. Instead, companies are required to account for such transactions using a grant date fair value method and recognize the expense over the employees requisite service period in the condensed
consolidated statements of operations.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS
123R using the modified prospective transition method. Under that transition method, compensation cost recognized in 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1,
2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair
value estimated in accordance with the provisions of SFAS 123R. Results of prior periods have not been revised.

On December 31, 2005,
the Company accelerated the vesting of approximately 1.8 million unvested stock options outstanding under the Companys stock plan with exercise prices per share of $20.00 or higher. The options had a range of exercise prices between
$20.03 and $55.86 and a weighted average exercise price of $31.10. The closing price of the Companys common stock on December 16, 2005, the day the Companys Board of Directors approved the acceleration, was $13.34. In
accordance with SFAS No. 123, the Company expensed the remaining unrecognized compensation cost associated with the options with accelerated vesting in the pro forma disclosure. These actions were taken in order to avoid expense recognition in
future financial statements upon adoption of SFAS 123R. The aggregate pre-tax expense associated with the accelerated options that would have been reflected in the Companys consolidated financial statements in future fiscal years was
approximately $25.9 million, which was included in the pro forma disclosure of stock-based employee compensation expense for the year ended December 31, 2005.

As a result of adopting SFAS 123R on January 1, 2006, the Companys loss before income taxes for the three and six months ended June 30, 2006 was $2.6 million and $5.1 million higher, respectively, than
if it had continued to account for share-based compensation under APB Opinion No. 25. After applying the provisions of SFAS 109, Accounting for Income Taxes, on an annual basis, the adoption of SFAS 123R had a negative $2.2 million
impact on net income, or $0.06 per basic and diluted earnings per share, for the three months ended June 30, 2006, and a negative $4.2 million impact on net loss, or $0.12 per basic and diluted net loss per share, for the six months ended
June 30, 2006.

Prior to adopting SFAS 123R, the Company presented all tax benefits of deductions resulting from the exercise of stock
options as operating cash flows in the condensed consolidated statements of cash flows. SFAS 123R requires the cash flows resulting from the tax benefits from tax deductions in excess of recognized compensation cost (excess tax benefits) to be
classified as financing cash flows. This requirement reduced net operating cash flows and increased net financing cash flows for the three and six months ending June 30, 2006 by approximately $34,000 and $299,000, respectively.

1995 Stock Option/Stock Issuance Plan

As of
June 30, 2006, options to purchase 1,248,488 shares of the Companys common stock were outstanding under the Companys 1995 Stock Option/Stock Issuance Plan (the 1995 Plan). Under the 1995 Plan, incentive stock options may
be granted to employees and non-statutory stock options may be granted to non-employees, directors or consultants at prices not lower than 100% of the fair market value of the Companys common stock at the date of grant as determined by the
Board of Directors. Any 10% shareholder must be granted



8



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



options to purchase the Companys common stock at an exercise price no lower than 110% of the fair market value
of the Companys common stock at the date of grant as determined by the Board of Directors. Generally, options vest either (i) at the rate of 20% per year over five years, or (ii) over a four year period (25% at end of the first
year from date of grant, and 1/36 of remaining shares per month over next 36 months) and are exercisable for a period of ten years from the date of grant. In February 2003, the Board of Directors approved an increase of 1,641,667 shares available
for issuance under the 1995 Plan. Effective upon completion of the Companys initial public offering, no more options were issued under the 1995 Plan.

2003 Equity Incentive Plan

In July 2003, the Companys Board of Directors and stockholders approved the 2003 Equity
Incentive Plan (the 2003 Plan) that became effective upon completion of the initial public offering. The 2003 Plan provides for the grant of incentive stock options and nonqualified stock options, stock awards, stock purchase rights and
RSUs for the purchase of up to 6,866,747 shares of the Companys common stock by officers, employees, consultants and directors of the Company. However, this share reserve shall be reduced by the exercise of stock options outstanding under the
Companys 1995 Stock Option/Stock Issuance Plan. In April 2005, the Board of Directors approved an increase of 2,500,000 shares available for issuance under the 2003 Plan. As of June 30, 2006, options to purchase 4,645,068 shares and RSUs
to purchase 215,694 shares of the Companys common stock were outstanding under the 2003 Plan.

The compensation committee of the
Board of Directors is responsible for administration of the 2003 Plan. The compensation committee determines the term of each option, the option exercise price, the number of shares for which each option is granted and the rate at which each option
is exercisable. Incentive stock options may be granted to any officer or employee at an exercise price per share of not less than the fair value per common share on the date of the grant (not less than 110% of fair value in the case of holders of
more than 10% of the Companys voting stock) and with a term generally seven to ten years from the date of the grant (five years for incentive stock options granted to holders of more than 10% of the Companys voting stock). Generally,
options vest either (i) at the rate of 20% per year over five years, or (ii) over a four year period (25% at end of the first year from date of grant, and 1/36 of remaining shares per month over next 36 months). Nonqualified stock
options may be granted to any officer, employee, consultant or director at an exercise price per share of not less than the market value per share.

Employee Stock Purchase Plan

In July 2003, the Companys Board of Directors and stockholders approved an
Employee Stock Purchase Plan (ESPP) that became effective upon completion of the Companys initial public offering. Employees who own less than 5% of the Company, work more than 20 hours a week and are generally employed for greater
than 5 months per year are eligible and may designate up to 15% of their compensation for the purchase of common stock semi-annually at the lower of 85% of the fair market value of the stock at the beginning or end of the six-month payment period,
through accumulation of payroll deductions. Common stock reserved under the ESPP is 892,487 shares at June 30, 2006.

Accounting for Stock
Compensation

Stock-based compensation costs are based on the fair value calculated with the Black-Scholes option-pricing model on the
date of grant for stock options and on the date of enrollment for the ESPP. RSU fair values equal their intrinsic value on the date of grant.

The fair values of stock awards are amortized as compensation expense on a straight-line basis over their requisite service period. Compensation expense recognized is shown in the operating activities section of the condensed consolidated
statements of cash flows.

The Company used the following assumptions in the Black-Scholes model for calculating fair value of stock-based
compensation costs: expected volatility is a combination of the Companys historical and implied volatility; expected term is calculated using the simplified method prescribed in Staff Accounting Bulletin No. 107,
Share-Based Payment; the risk free rate is based on the U.S. Treasury yield curve in effect at the time of grant; a dividend yield is not used since the Company has never paid cash dividends and does not currently intend to pay cash
dividends. The Company periodically reviews the assumptions and modifies the assumptions accordingly.



9



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



The fair value of common stock options granted during the three and six months ended June 30,
2006 and 2005 were estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:



|                    |  |                             |   |  |                           |   |  |           |   |  |                  |  
|------------------- |  | --------------------------- | - |  | ------------------------- | - |  | --------- | - |  | ---------------- | -
|                    |  | Three Months Ended June 30, |   |  | Six Months Ended June 30, |  
|                    |  | 2006                        |   |  | 2005                      |   |  | 2006      |   |  | 2005             |  
|Dividend yield      |  |                            |   |  |                          |   |  |          |   |  |                 |  
|Expected life       |  | 4.5 years                   |   |  | 3.25  3.5 years          |   |  | 4.5 years |   |  | 3.25  3.5 years |  
|Expected volatility |  | 65                          | % |  | 75                        | % |  | 60  65   | % |  | 75               | %
|Risk-free rate      |  | 5.0                         | % |  | 3.8  4.0                 | % |  | 4.6  5.0 | % |  | 3.2  4.0        | %

As part of the requirements of SFAS 123R, the Company is required to estimate potential
forfeitures of stock grants and adjust compensation cost recorded accordingly. The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such
estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods.

A summary of the Companys stock compensation activity with respect to the six months ended June 30, 2006 follows (share and intrinsic value
amounts in thousands):



|                                             |  |        |   |  |                                      |       |                                            |     |                          |   |      
|-------------------------------------------- |  | ------ | - |  | ------------------------------------ | ----- | ------------------------------------------ | --- | ------------------------ | - | -----
|Stock Options Under the 1995 and 2003 Plans  |  | Shares |   |  | WeightedAverageExercise Price        |       | Weighted Average RemainingContractual Term |     | AggregateIntrinsic Value
|Outstanding at December 31, 2005             |  | 5,496  |   |  | $                                    | 19.07 |                                            |     |                          |   |      
|Granted                                      |  | 1,005  |   |  |                                      | 8.47  |                                            |     |                          |   |      
|Exercised                                    |  | (258   | ) |  |                                      | 2.06  |                                            |     |                          |   |      
|Cancelled or expired                         |  | (349   | ) |  |                                      | 20.24 |                                            |     |                          |   |      
|                                             |  |        |   |  |                                      |       |                                            |     |                          |   |      
|Outstanding at June 30, 2006                 |  | 5,894  |   |  |                                      | 17.94 |                                            | 6.6 |                          | $ | 2,234
|                                             |  |        |   | 
|Vested at June 30, 2006 and expected to vest |  | 5,492  |   |  | $                                    | 18.13 |                                            | 6.6 |                          | $ | 2,160
|                                             |  |        |   | 
|Exercisable at June 30, 2006                 |  | 3,466  |   |  | $                                    | 21.04 |                                            | 6.6 |                          | $ | 1,433
|                                             |  |        |   | 
|Restricted Stock Units                       |  | Shares |   |  | Weighted Average GrantDate FairValue |       | Weighted AverageRemaining VestingTerm      |     | AggregateIntrinsic Value
|Nonvested at December 31, 2005               |  |       |   |  | $                                    |      |                                            |     |                          |   |      
|Granted                                      |  | 227    |   |  |                                      | 8.74  |                                            |     |                          |   |      
|Exercised                                    |  |       |   |  |                                      |      |                                            |     |                          |   |      
|Forfeited                                    |  | (11    | ) |  |                                      | 8.74  |                                            |     |                          |   |      
|                                             |  |        |   |  |                                      |       |                                            |     |                          |   |      
|Nonvested at June 30, 2006                   |  | 216    |   |  |                                      | 8.74  |                                            | 3.8 |                          | $ | 887  
|                                             |  |        |   | 
|Vested at June 30, 2006 and expected to vest |  | 184    |   |  | $                                    |      |                                            | 3.8 |                          | $ | 757  
|                                             |  |        |   | 
|Exercisable at June 30, 2006                 |  |       |   |  | $                                    |      |                                            |    |                          | $ |     

The weighted-average fair value of common stock options granted during the six months ended
June 30, 2006 and 2005 was $4.72 and $19.61, respectively. During the same periods, the total intrinsic value of stock options exercised was $2.2 million and $20.7 million, respectively, and the total fair value of stock options that vested was
$4.3 million and $3.5 million, respectively.

During the three and six months ended June 30, 2006, no RSUs vested. The Company had
$16.3 million of total unrecognized compensation costs related to stock options and RSUs at June 30, 2006 that are expected to be recognized over a weighted-average period of 3.0 years. There were no stock compensation costs capitalized into
assets as of June 30, 2006.



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



For the three months ended June 30, 2006 and June 30, 2005, approximately $0.1 million and
$0.3 million, respectively, was received for the exercise of stock options and the tax benefit realized from these stock option exercises was $34,000 and $1.0 million, respectively. For the six months ended June 30, 2006 and June 30, 2005,
approximately $0.6 million and $2.1 million, respectively, was received for the exercise of stock options, and the tax benefit realized from these stock option exercises was $0.3 million and $6.4 million, respectively. Cash was not used to settle
any equity instruments previously granted. The Company issues shares from the 1995 Plan and 2003 Plan reserves upon the exercise of stock options and vesting of RSUs. The Company does not currently expect to repurchase shares from any source to
satisfy such obligation under the 1995 Plan or 2003 Plan.

Other Stock Options

In March 2001, the Company executed an employment agreement with a key executive whereby it granted the executive an option, exercisable over five years,
to purchase up to approximately 0.5 million shares of Series I Preferred Stock at an exercise price of $2.57 per share. One half of these option shares vested immediately. The remaining option shares vested upon the closing of a firm commitment
underwritten public offering, resulting in a $0.9 million expense. Due to the automatic conversion of all of the Companys then outstanding preferred stock into common stock, in conjunction with the Companys initial public offering, the
option was exercisable for approximately 0.2 million shares of common stock at an exercise price of $6.24 per share. This option expired on April 11, 2006.

The grant date fair value of the employees purchase rights under the ESPP were calculated using the Black-Scholes model with the following assumptions:



|                    |  |                             |   |  |                           |   |  |           |   |  |           |  
|------------------- |  | --------------------------- | - |  | ------------------------- | - |  | --------- | - |  | --------- | -
|                    |  | Three Months Ended June 30, |   |  | Six Months Ended June 30, |  
|                    |  | 2006                        |   |  | 2005                      |   |  | 2006      |   |  | 2005      |  
|Dividend yield      |  |                            |   |  |                          |   |  |          |   |  |          |  
|Expected life       |  | 6 months                    |   |  | 6 months                  |   |  | 6 months  |   |  | 6 months  |  
|Expected volatility |  | 60                          | % |  | 75                        | % |  | 60  67   | % |  | 75        | %
|Risk-free rate      |  | 5.0                         | % |  | 3.8                       | % |  | 4.4  5.0 | % |  | 3.2  3.8 | %

Weighted average, grant date fair value of purchase rights granted under the ESPP are as
follows:



|                            |  |                            |  |                          |  |        |  |       
|--------------------------- |  | -------------------------- |  | ------------------------ |  | ------ |  | ------
|                            |  | Three Months EndedJune 30, |  | Six Months EndedJune 30,
|                            |  | 2006                       |  | 2005                     |  | 2006   |  | 2005  
|Number of shares            |  |                           |  |                         |  | 96,812 |  | 45,733
|Weighted average fair value |  |                           |  |                         |  | 6.89   |  | 8.50  

As discussed above, results for prior periods have not been revised to reflect the effects of
implementing SFAS 123R. The following table illustrates the effect on net income and earnings per share for the three and six months ended June 30, 2005 as if the Company had applied the fair value recognition provisions of SFAS No. 123
(in thousands, except per share data):



|                                                                                                                                                          |  |                                  |        |   |                                |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------ | - | ------ | -
|                                                                                                                                                          |  | Three Months Ended June 30, 2005 |        |   | Six Months Ended June 30, 2005 |  
|Net income, as reported                                                                                                                                   |  | $                                | 10,896 |   |                                | $ | 36,426 |  
|Add: Stock-based employee compensation expense recognized in net income, net of related income tax effects                                                |  |                                  | 155    |   |                                |   | 272    |  
|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 | ) |                                |   | (5,536 | )
|                                                                                                                                                          |  |                                  |        |   |                                |   |        |  
|Pro forma net income                                                                                                                                      |  |                                  | 8,032  |   |                                |   | 31,162 |  
|                                                                                                                                                          |  |                                 
|Pro forma basic net income per share, as adjusted                                                                                                         |  | $                                | 0.22   |   |                                | $ | 0.88   |  
|Pro forma diluted net income per share, as adjusted                                                                                                       |  | $                                | 0.22   |   |                                | $ | 0.84   |  



11



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



5. Comprehensive Income (Loss)

The components of comprehensive income (loss) are comprised of net income (loss), foreign currency translation adjustments and unrealized gains and losses on securities. Comprehensive income (loss) is as follows (in
thousands):



|                                                     |  |                            |       |      |                          |        |      |  |   |         |   |  |   |        |  
|---------------------------------------------------- |  | -------------------------- | ----- | ---- | ------------------------ | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                     |  | Three Months EndedJune 30, |       |      | Six Months EndedJune 30, |       
|                                                     |  | 2006                       |       | 2005 |                          |        | 2006 |  |   | 2005    |  
|Net income (loss)                                    |  | $                          | 2,927 |      | $                        | 10,896 |      |  | $ | (21,799 | ) |  | $ | 36,426 |  
|Foreign currency translation adjustments, net of tax |  |                            | 62    |      |                          | (11    | )    |  |   | 151     |   |  |   | (11    | )
|Unrealized gain on securities                        |  |                            | 4     |      |                          |       |      |  |   | 19      |   |  |   |       |  
|                                                     |  |                            |       |      |                          |        |      |  |   |         |   |  |   |        |  
|Total comprehensive income (loss)                    |  | $                          | 2,993 |      | $                        | 10,885 |      |  | $ | (21,629 | ) |  | $ | 36,415 |  
|                                                     |  |                            |       |      |                          |        |      |  |   |         |   |  |   |        |  

6. Short-term Investments

Short-term investments at June 30, 2006 and December 31, 2005, consisting of corporate, state and municipal securities, were acquired at an aggregate cost of $21.0 million and $53.2 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.

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



|                               |  |              |        |                  |   |        |  
|------------------------------ |  | ------------ | ------ | ---------------- | - | ------ | -
|                               |  | June 30,2006 |        | December 31,2005 |  
|Available-for-sale securities: |  |              |        |                  |   |        |  
|Auction rate preferred notes   |  | $            | 21,017 |                  | $ | 47,225 |  
|U.S. agencies                  |  |              |       |                  |   | 2,498  |  
|Corporate notes                |  |              |       |                  |   | 3,468  |  
|                               |  |              |        |                  |   |        |  
|Total investments              |  |              | 21,017 |                  |   | 53,191 |  
|Unrealized loss on securities  |  |              |       |                  |   | (19    | )
|Total short-term investments   |  | $            | 21,017 |                  | $ | 53,172 |  

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 fair value. As of June 30, 2006, $21.0 million of investments mature beyond five years, but have interest rate maturities of less than
thirty-five days.

7. Inventories

Inventories, net of reserves, consist of the following (in thousands):



|                       |  |              |        |                  |   |       
|---------------------- |  | ------------ | ------ | ---------------- | - | ------
|                       |  | June 30,2006 |        | December 31,2005
|Work in process        |  | $            | 18,729 |                  | $ | 12,880
|Finished goods         |  |              | 18,516 |                  |   | 8,156 
|                       |  |              |        |                  |   |       
|Total inventories, net |  | $            | 37,245 |                  | $ | 21,036
|                       |  |              |        |                  |   |       

At June 30, 2006 and December 31, 2005, the Companys reserve for slow-moving and
obsolete inventory was approximately $2.1 million and $1.3 million, respectively.

8. Goodwill and Other Intangible Assets

As of June 30, 2006, SigmaTel had goodwill in the amount of $62.9 million associated with the acquisitions of Oasis Semiconductor, Inc.
(Oasis), Protocom Corporation (Protocom), and certain assets and intellectual property of D&M Holdings, Inc (Rio), and Apogee Technology, Inc. (Apogee) and certain assets of Mooji Corporation
Limited (Mooji) of which, approximately $13.8 million is deductible for income tax purposes. These acquisitions were accounted for using the purchase method of accounting. In accordance with SFAS No. 142



12



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



Goodwill and Other Intangible Assets(SFAS 142), the Company assesses the impairment of goodwill
annually in the fourth quarter, or more frequently if other indicators of potential impairment arise. The amounts listed below are shown net of the $21.0 million of goodwill and $0.2 million of patents, respectively that are classified as held for
sale in connection with the sale of our PC Audio product line to IDT (Notes 1 and 10).

Goodwill and other intangibles consist of the
following (in thousands):



|                                                 |  |                     |         |                         |   |        |     |  |                     |        |                         |   |         |     |   |        |   |  |   |        
|------------------------------------------------ |  | ------------------- | ------- | ----------------------- | - | ------ | --- |  | ------------------- | ------ | ----------------------- | - | ------- | --- | - | ------ | - |  | - | -------
|                                                 |  | June 30, 2006       |         | December 31, 2005      
|                                                 |  | GrossCarryingAmount |         | AccumulatedAmortization |   |        | Net |  | GrossCarryingAmount |        | AccumulatedAmortization |   |         | Net
|Goodwill                                         |  | $                   | 62,859  |                         | $ |       |     |  | $                   | 62,859 |                         | $ | 63,203  |     | $ |       |   |  | $ | 63,203 
|Other intangible assets subject to amortization: |  |                     |         |                         |   |        |     |  |                     |        |                         |   |         |     |   |        |   |  |   |        
|Developed product technology                     |  |                     | 15,060  |                         |   | (2,246 | )   |  |                     | 12,814 |                         |   | 15,060  |     |   | (904   | ) |  |   | 14,156 
|Customer relationships                           |  |                     | 13,242  |                         |   | (1,247 | )   |  |                     | 11,995 |                         |   | 13,232  |     |   | (502   | ) |  |   | 12,730 
|Trademarks and trade names                       |  |                     | 2,200   |                         |   | (277   | )   |  |                     | 1,923  |                         |   | 2,200   |     |   | (106   | ) |  |   | 2,094  
|Patents                                          |  |                     | 4,388   |                         |   | (556   | )   |  |                     | 3,832  |                         |   | 3,127   |     |   | (237   | ) |  |   | 2,890  
|Licenses to manufacture and other                |  |                     | 9,139   |                         |   | (3,717 | )   |  |                     | 5,422  |                         |   | 8,226   |     |   | (2,618 | ) |  |   | 5,608  
|                                                 |  |                     |         |                         |   |        |     |  |                     |        |                         |   |         |     |   |        |   |  |   |        
|                                                 |  | $                   | 106,888 |                         | $ | (8,043 | )   |  | $                   | 98,845 |                         | $ | 105,048 |     | $ | (4,367 | ) |  | $ | 100,681
|                                                 |  |                     |         |                         |   |        |     |  |                     |        |                         |   |         |     |   |        |   |  |   |        

Intangible asset amortization expense for the three months ended June 30, 2006 and 2005 was
$1.9 million and $0.3 million, respectively, and $3.7 million and $0.6 million for the six months ended June 30, 2006 and 2005, respectively. Estimated aggregate intangible asset amortization expense is expected to be $7.4 million for 2006 and
is estimated to be $7.2 million in 2007, $6.5 million in 2008, $5.8 million in 2009, and $5.1 million in 2010. The Company is amortizing intangible assets on a straight-line basis over their estimated useful lives. The weighted average useful life
is generally 6 years for developed product technology, 9 years for customer relationships, 7 years for trademarks and trade names, 7 years for patents, and 5 years for licenses to manufacture.

The Company records intangible assets in accordance with Statement of Financial Accounting Standards No. 141 Business Combinations (SFAS
141) and SFAS 142. The developed product technologies the Company acquired from the above acquisitions were as follows: the Oasis acquisition consisted of three integrated circuit products (and the intellectual property contained therein)
(referred to hereafter as chips), used to control the operation of devices which can scan, fax and print documents; the Protocom acquisition consisted of chips that are used in camcorders and other video capture equipment and implement
different video compression and decompression algorithms; the Rio acquisition consisted of computer programs, intellectual property and other proprietary know-how related to the hard-drive MP3 player business and the Apogee acquisition consisted of
chips, which perform digital audio amplification functions and can be used in a variety of different consumer audio applications. The developed product technologies above were feasible at the date of acquisition as they were being actively marketed
and sold by the acquired companies at the respective dates of acquisition. The developed product technologies were recognized as intangible assets separate from goodwill as they were capable of being separated or divided from the acquired entities
and sold or licensed. The estimated useful lives were primarily based on the weighted average time to cash flows for each respective developed product technology.

9. Acquisitions

The acquisitions of Oasis, Protocom, and certain assets and intellectual property of Rio and Apogee
and certain assets of Mooji were accounted for using the purchase method of accounting. The purchase price of each of the acquisitions was paid during the year ended December 31, 2005. The purchase price recorded for the acquisitions did not
include any amount for contingent considerations. Actual amounts of future consideration related to contingencies, if any, will be recognized as an adjustment to the purchase price in the period in which the contingency is resolved. In the six
months ended June 30, 2006, there were no adjustments to the purchase prices of the acquisitions.



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Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



The following unaudited pro forma financial information presents the results of operations for the
three and six months ended June 30, 2005 as if the acquisitions had occurred at the beginning of the earliest period presented.

The
pro forma financial information for the combined entities has been prepared for comparative purposes only and is not indicative of what actual results would have been if the acquisitions had taken place at the beginning of the period presented, or
of future results (in thousands, except per share data):



|                                |  |                                  |        |                                |   |        
|------------------------------- |  | -------------------------------- | ------ | ------------------------------ | - | -------
|                                |  | Three Months Ended June 30, 2005 |        | Six Months Ended June 30, 2005
|Pro forma net revenues          |  | $                                | 86,001 |                                | $ | 192,073
|Pro forma net income            |  |                                  | 10,523 |                                |   | 34,191 
|Pro forma net income per share: |  |                                  |        |                                |   |        
|Basic                           |  | $                                | 0.29   |                                | $ | 0.93   
|Diluted                         |  | $                                | 0.27   |                                | $ | 0.87   

10. Assets and Liabilities Held for Sale

On July 31, 2006, we sold certain assets and liabilities, intellectual property and engineering resources relating to our PC Audio product line to
Integrated Device Technology Inc. (IDT) for approximately $80 million, subject to certain post-closing adjustments, which consists of $72.0 million in cash, accounts receivable of the PC Audio product line which were retained by us, and
accounts payable of the PC Audio product line being assumed by IDT. $7.2 million of the purchase price was deposited into an escrow account upon closing for purposes of settling indemnification claims for the one-year period following the closing.
In connection with the sale, the Company and IDT entered into several ancillary agreements, including a transition services agreement designed to ensure a smooth transition of the PC Audio product line to IDT, and an intellectual property license
agreement pursuant to which IDT received rights to certain intellectual property being retained by SigmaTel related to the PC Audio product line.

The Company has reclassified certain assets as assets held for sale and certain liabilities have been reclassified as liabilities to be assumed in sale. The retained assets and liabilities remain classified as
assets of other ongoing operations. The Company reviewed Statement of Financial Accounting Standards No. 144 Accounting for the Disposal of Long-Lived Assets(SFAS 144) and has determined that the sale does not meet the
criteria to be recognized as a discontinued operation, as we will have significant continuing involvement and the sale involved a subcomponent of the entity.

The carrying amounts of the major classes of assets and liabilities that have been included in assets held for sale and liabilities to be assumed in sale, are as follows (in thousands):



|                                           |  |              |        |                  |   |       
|------------------------------------------ |  | ------------ | ------ | ---------------- | - | ------
|                                           |  | June 30,2006 |        | December 31,2005
|Current assets held for sale:              |  |              |        |                  |   |       
|Accounts receivable, net                   |  | $            | 509    |                  | $ |      
|Inventories, net                           |  |              | 4,738  |                  |   | 2,498 
|Other                                      |  |              | 104    |                  |   | 405   
|                                           |  |              |        |                  |   |       
|Total current assets                       |  | $            | 5,351  |                  | $ | 2,903 
|Non-current assets held for sale:          |  |              |        |                  |   |       
|Property, equipment and software, net      |  |              | 1,189  |                  |   | 1,036 
|Intangible assets, net                     |  |              | 200    |                  |   | 200   
|Goodwill                                   |  |              | 21,000 |                  |   | 21,000
|                                           |  |              |        |                  |   |       
|Total assets                               |  | $            | 27,740 |                  | $ | 25,139
|                                           |  |              |        |                  |   |       
|Current liabilities to be assumed in sale: |  |              |        |                  |   |       
|Accounts payable                           |  | $            | 3,823  |                  | $ | 2,053 
|                                           |  |              |        |                  |   |       



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



11. Common Stock

On January 25, 2006, the Companys Board of Directors authorized a share repurchase plan for up to $30.0 million of its common stock. During the first quarter of 2006, 2.6 million shares were
repurchased for $30.0 million and were retired. There were no share repurchases during the three months ended June 30, 2006.

12. Income Taxes

The Companys effective tax rate was 118% and 37% for the three months ended June 30, 2006 and 2005, respectively, and 41%
and 35% for the six months ended June 30, 2006 and 2005, respectively. The provision for income taxes has been calculated based on the Companys estimate of its effective tax rate for the full fiscal year. At June 30, 2006, the
Companys effective tax rate estimate for the year ended December 31, 2006 was 32%. This estimate differed from the statutory rate primarily due to the effect of different tax rates in foreign jurisdictions, non-deductible charges related
to stock based compensation and one time benefits related to a change in the Companys international tax strategy.

During the three
months ended June 30, 2006, the Company changed its international tax strategy (intellectual property or IP Migration strategy). As a result, the Company made a voluntary tax election that changed the tax status of the
Companys Cayman subsidiary by causing a deemed liquidation of the subsidiary for US federal income tax purposes. This resulted in a one-time benefit of $9.3 million that was reported as a discrete period tax benefit in accordance with the
provisions of SFAS No. 109, Accounting for Income Taxes. The change in the Companys tax strategy caused a significant change in the Companys estimate of its effective tax rate for the year ended December 31, 2006. As a
result, the tax benefit for the three months ended June 30, 2006 includes amounts to apply the current effective tax rate estimate to the loss before income taxes for the six months ended June 30, 2006.

The Company recognized certain tax benefits related to stock option plans in the amount of zero and $1.0 million during the three months ended
June 30, 2006 and 2005, respectively and $0.3 million and $6.4 million during the six months ended June 30, 2006 and 2005, 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 significant income tax benefits or expenses being recognized in a
future period.

13. Commitments and Contingencies

In connection with a technology license agreement with Metanoia Technologies, Inc. (Metanoia), the Company has indemnified Metanoia with respect to the infringement of third party proprietary rights. The
indemnification is limited to $2.5 million. No claims or assertions have been made against the Company in connection with this indemnification.

In connection with the acquisition of certain assets, intellectual property and engineering resources of the Direct Digital Amplification (DDX®) product line of Apogee Technology, Inc., we agreed to make a payment of up to $4.5 million
in cash pursuant to the terms of an earn-out provision based on the achievement by the DDX® business of certain revenues during the one-year period following the closing. Also, in connection with the acquisition of Oasis Semiconductor, Inc., a
privately held provider of ICs for the multi-function peripheral market, we agreed to make a payment of up to $25.0 million in cash pursuant to the terms of an earn-out provision based on the achievement by the Oasis business of certain calendar
year 2006 revenues.

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.



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



Litigation

On January 4, 2005, the Company 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. The Company asserts 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 the
Companys portable multimedia SoCs. The Company is seeking damages and requesting a permanent injunction prohibiting Actions Semiconductor from designing, manufacturing or selling the infringing MP3 integrated circuits in the United States. The
Company is also requesting a permanent injunction prohibiting further shipment of products into the United States that use Actions Semiconductor ICs. In May, 2005, this United States District Court case was formally stayed, by mutual agreement of
the parties, during the pendency of the U.S. International Trade Commission (the ITC) investigation described below.

On
March 14, 2005, the Company filed a complaint requesting that the ITC initiate an investigation of Actions Semiconductor, for violation of Section 337 of the Tariff Act of 1930, in the importation, sale for importation and sale in the
United States (U.S.) after importation of certain audio processing ICs and other products containing these audio processing ICs. In the Companys complaint, as amended, the Company asked the ITC to investigate whether certain
Actions Semiconductor products infringe one or more of the claims of U.S. Patent Nos. 6,137,279 and 6,366,522. On April 18, 2005, the ITC instituted an investigation into Actions Semiconductors actions based on the Companys
allegations. The Company is 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. During the course of the ITC investigation, the Company dropped its infringement assertion of the 279 patent and asserted an additional patent - Patent No. 6,633,187. The ITC conducted a hearing on the merits in late
November 2005. In March 2006, the ITC administrative law judge, (ALJ), determined that Actions Semiconductor infringed the two patents asserted by the Company and recommended that an exclusion order be issued which prevents the
importation of infringing Actions chips and certain MP3 players which contain these chips. The ALJs initial decision was reviewed by the full ITC, which, in June 2006, issued a decision that altered the ALJs construction of one of
the patents at issue and asked the ALJ to make some further determinations. On August 4, 2006, the ALJ concluded that in light of the ITCs revised claim construction, certain Actions Semiconductor chips, when operating under the control
of a particular firmware version, do not infringe the Companys 522 patent. The ITC expects to issue a final decision regarding an exclusion order in September 2006.

On April 4, 2006, the Company filed a lawsuit against Telechips Inc., based in Seoul, South Korea (Telechips), in the United States
District Court for the Eastern District of Texas, Marshall Division. The Company asserts that certain Telechips ICs that are incorporated as components in MP3 players being shipped into the United States infringe multiple SigmaTel patents. In July,
2006, the Company dismissed this lawsuit, without prejudice.

14. Related Party Transactions

Revenues from an affiliated customer, who as of October 2005 no longer held more than 5% of our stock, was approximately $8.0 million and $2.9 million for
the three months ended June 30, 2006 and 2005, respectively, and $12.2 million and $22.9 million for the six months ended June 30, 2006 and 2005, respectively. Accounts receivable from sales to this affiliated customer was approximately
$6.9 million and $7.8 million as of June 30, 2006 and December 31, 2005, respectively.

15. 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.



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##### Table of Contents

Sigmatel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

(unaudited)



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



|                |  |                              |   |  |                           |   |  |       |   |  |       |  
|--------------- |  | ---------------------------- | - |  | ------------------------- | - |  | ----- | - |  | ----- | -
|                |  | Three Months Ending June 30, |   |  | Six Months Ended June 30, |  
|                |  | 2006                         |   |  | 2005                      |   |  | 2006  |   |  | 2005  |  
|Taiwan          |  | 43.1                         | % |  | 34.0                      | % |  | 47.2  | % |  | 44.7  | %
|China/Hong Kong |  | 28.8                         |   |  | 46.4                      |   |  | 24.7  |   |  | 33.0  |  
|Singapore       |  | 18.5                         |   |  | 4.6                       |   |  | 16.7  |   |  | 13.7  |  
|United States   |  | 0.9                          |   |  | 5.7                       |   |  | 0.6   |   |  | 2.4   |  
|Other           |  | 8.7                          |   |  | 9.3                       |   |  | 10.8  |   |  | 6.2   |  
|                |  |                              |   |  |                           |   |  |       |   |  |       |  
|Total sales     |  | 100.0                        | % |  | 100.0                     | % |  | 100.0 | % |  | 100.0 | %
|                |  |                              |   |  |                           |   |  |       |   |  |       |  

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



|              |  |              |   |  |                  |  
|------------- |  | ------------ | - |  | ---------------- | -
|              |  | June 30,2006 |   |  | December 31,2005 |  
|United States |  | 84.7         | % |  | 85.5             | %
|Hong Kong     |  | 5.6          |   |  | 4.4              |  
|Taiwan        |  | 3.2          |   |  | 4.0              |  
|Other         |  | 6.5          |   |  | 6.1              |  
|              |  |              |   |  |                  |  
|              |  | 100.0        | % |  | 100.0            | %
|              |  |              |   |  |                  |  

16. Subsequent Event

On July 31, 2006, we sold certain assets and liabilities, intellectual property and engineering resources relating to our PC Audio product line to IDT for $80 million, subject to certain post-closing adjustments,
which consists of $72.0 million in cash, accounts receivable of the PC Audio product line which were retained by us, and accounts payable of the PC Audio product line being assumed by IDT. $7.2 million of the purchase price was deposited into an
escrow account upon closing for purposes of settling indemnification claims for the one-year period following the closing. In connection with the sale, the Company and IDT entered into several ancillary agreements, including a transition services
agreement designed to ensure a smooth transition of the PC Audio product line to IDT, and an intellectual property license agreement pursuant to which IDT received rights to certain intellectual property being retained by SigmaTel related to the PC
Audio product line.



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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 Factors 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.

Overview

General. We are a fabless semiconductor company that designs, develops, and markets
proprietary, analog-intensive, mixed-signal integrated circuits, or ICs. We currently offer products that serve several markets: portable multimedia players, consumer audio, multi-function peripherals, digital video cameras and USB peripherals. We
made our first commercial shipments of portable multimedia systems on a chip, or SoCs, for the portable multimedia player market in 2001. We made our first commercial shipments of PC audio codecs during 1997. 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. We made our first commercial shipments of both multi-function peripheral ICs and digital video camera ICs in the third quarter of 2005 as a result
of the Oasis Semiconductor, Inc. (Oasis) and Protocom Corporation (Protocom) acquisitions, respectively. Through acquisitions and internal development efforts, we continue to diversify our product offerings. We plan to
continue to diversify our product offerings by introducing new versions of existing products with additional functionality, and by introducing ICs for markets we do not currently serve, thereby expanding our total available market opportunity.

Net Loss.We incurred a net loss of $21.8 million for the six months ended June 30, 2006 and we will likely incur net losses
in the future. We have faced a number of challenges that have affected our operating results during the past year and a half, including extreme competition in the portable multimedia SoCs market, continuing erosion of average selling prices of our
portable multimedia SoCs, delays in delivering new product features to existing and new customers, and price volatility and shortages of other components used to build our customers devices. Although we are taking steps to address these
challenges and to improve our results of operations, we cannot provide assurance that we will return to profitability on a quarterly or annual basis.

New Product Introduction and Acceptance. In March 2006, we announced the SGTV58XX family, our first family of high fidelity TV audio processors that was created as a cost effective audio solution for analog,
digital, and hybrid TVs offering high-end value added features. In October of 2005, we introduced our STMP 36XX family of portable multimedia SoCs, our newest SoC for flash-based and hard disk-based digital multimedia players. In November 2005, we
introduced our STFM 1000 FM tuner companion processor to our STMP 35XX and 36XX families of portable multimedia SoCs that provides the added capability of receiving signals from FM radio stations. Our historical revenue growth has been primarily
from sales of our STMP 35XX family of portable multimedia SoCs, which accounted for 89.3% of our revenue in the year ended December 31, 2005 and 56.2% of our revenue for the six months ended June 30, 2006. We introduced the STMP 35XX
family of portable multimedia SoCs in the fourth quarter of 2003 and, despite continued sales of the STMP 35XX SoCs, as those products have matured, their average selling prices have declined, which is typical for the semiconductor industry. Our
future success depends on our ability to market and sell the STMP 36XX SoC, the STMP 35XX SoC, the STFM 1000 FM Tuner, and to develop other new products, like the SGTV58XX products, in a timely and cost-effective manner. We cannot assure you that we
will be able to develop and introduce, or that potential customers will be able to implement, new or enhanced products in a timely and cost-effective manner or that our new products will generate significant revenues.



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##### Table of Contents

Competition; Average Selling Prices. We face competition from a relatively large number of
competitors in each of our target markets. The consumer electronics market, which is a principal end market for our ICs, has historically been subject to intense price competition. As a result of this competition, we continue to experience
substantial period-to-period fluctuations in operating results due to the erosion of our average selling prices, particularly for portable multimedia SoCs. In the past, we have reduced the average selling price of our products in anticipation of or
in response to competitive pricing pressures and new product introductions by us or our competitors. We believe that, as our product lines continue to mature and competitive markets evolve, we are likely to experience further decline in the average
selling prices of our products, although we cannot predict the timing and amount of such future changes with any certainty. If we are unable to offset any such reductions in our average selling prices by timely introducing new products and product
enhancements, increasing our sales volumes and reducing costs, our gross profits and revenues will suffer.

Historical Growth; Recent
Pressures. Our business has grown rapidly since our inception as a result of acquisitions, the opening of international locations and through hiring, both domestically and internationally, as reflected by our employee headcount, which increased
to 627 as of June 30, 2006, from 135 employees as of December 31, 2003. As a result of our focused development efforts towards portable multimedia SoCs and audio codecs in early 2001, our annual revenues grew substantially from $30.9
million in 2002 to $324.5 million in 2005 due primarily to increased sales of our portable multimedia SoCs. Our operating results improved from an operating loss of $5.6 million in 2002 to operating income of $56.4 million in 2005. However, our
revenue for the six months ended June 30, 2006 of $76.8 million represents a 54.5% decrease from our revenue of $168.9 million for the six months ended June 30, 2005, and we recognized an operating loss of $38.2 million for the six months
ended June 30, 2006 compared to operating income of $54.0 million for the six months ended June 30, 2005. We do not expect revenue growth or market share gains for future periods that are comparable with those quarterly or annual gains
from 2001 to 2005. Further, we will likely continue to incur operating losses in the near future and may incur operating losses in more distant future periods. Our historical expansion of our business and operations, which includes the acquisitions
of Oasis and Protocom, has placed, and any future expansion will continue to place, a significant strain on our management, personnel, systems and resources, and has significantly increased our operating expenses. 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, regain profitability or respond to
competitive pressures. Accordingly, you should not rely on the results of any prior quarterly or annual periods as an indication of our future operating performance.

Sales Channels. 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 distributors result in lower gross margins. However, this decrease in gross margins from sales through distributors is partially offset by lower selling expenses than are associated with direct sales to end customers.
In recent periods, we have begun engaging in more direct sales to customers, which generally results in higher gross margins than indirect sales, but also involves increased selling expenses. As our sales practices continue to evolve towards
increased direct sales to end customers, there will be continued fluctuations in our gross margins and operating margins.

Significant
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 Ending June 30, |   |  | Six Months Ended June 30, |  
|                                    |  | 2006                         |   |  | 2005                      |   |  | 2006 |   |  | 2005 |  
|Creative Technology(1)              |  | 18.2                         | % |  | *                         |   |  | 15.9 | % |  | 13.6 | %
|ASUSTEK Computer, Inc               |  | 12.7                         | % |  | *                         |   |  | 12.5 | % |  | 19.9 | %
|Holystone Enterprise                |  | *                            |   |  | *                         |   |  | 10.6 | % |  | *    |  
|G.M.I. Technology                   |  | *                            |   |  | 21.1                      | % |  | *    |   |  | 16.8 | %
|King Horn Enterprises, Limited      |  | *                            |   |  | 11.1                      | % |  | *    |   |  | *    |  
|Samsung Electronics Company Limited |  | *                            |   |  | 10.9                      | % |  | *    |   |  | *    |  

---

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

|(1) | Creative Technology held more than 5% of our outstanding stock until October 2005.
|--- | ----------------------------------------------------------------------------------



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##### Table of Contents

We expect that our largest customers will continue to account for a substantial portion of our sales for
the foreseeable future. The identities of our largest customers and their respective contributions to our net revenues have varied and will likely continue to vary from period to period.

Overseas Revenues. The percentage of our revenues from customers located outside the U.S. was 99.1% and 94.3% for the three months ended
June 30, 2006 and 2005, respectively, and 99.4% and 97.6% for the six months ended June 30, 2006 and 2005, 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 United States. All of our revenues to date have been denominated in United States dollars.

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



|                |  |                              |   |  |                           |   |  |       |   |  |       |  
|--------------- |  | ---------------------------- | - |  | ------------------------- | - |  | ----- | - |  | ----- | -
|                |  | Three Months Ending June 30, |   |  | Six Months Ended June 30, |  
|                |  | 2006                         |   |  | 2005                      |   |  | 2006  |   |  | 2005  |  
|Taiwan          |  | 43.1                         | % |  | 34.0                      | % |  | 47.2  | % |  | 44.7  | %
|China/Hong Kong |  | 28.8                         |   |  | 46.4                      |   |  | 24.7  |   |  | 33.0  |  
|Singapore       |  | 18.5                         |   |  | 4.6                       |   |  | 16.7  |   |  | 13.7  |  
|United States   |  | 0.9                          |   |  | 5.7                       |   |  | 0.6   |   |  | 2.4   |  
|Other           |  | 8.7                          |   |  | 9.3                       |   |  | 10.8  |   |  | 6.2   |  
|                |  |                              |   |  |                           |   |  |       |   |  |       |  
|Total sales     |  | 100.0                        | % |  | 100.0                     | % |  | 100.0 | % |  | 100.0 | %
|                |  |                              |   |  |                           |   |  |       |   |  |       |  

Sales Cycles. The length of our sales cycle varies depending on the end application for our
products, but our sales cycles are generally lengthy. The cycle can be as short as several months for some portable SoCs and as long as 18 months for our multi-function peripheral system controller solutions. 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, but 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, adversely affecting our results of operations.

Seasonality. Because many of our ICs are designed for use in
consumer electronic products, such as portable multimedia players, multi-function printers, video cameras, 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 historic rapid revenue growth and recent revenue declines make it difficult for us to assess the impact of
seasonal factors on our business. For example, strong sales of our portable multimedia SoCs resulted in increased revenues during the first quarter of 2005 compared to the fourth quarter of 2004, offsetting seasonal demand factors. In addition to
the negative impacts of seasonal demand factors, our revenues for the first quarter of 2006 were negatively impacted by price volatility and shortages of other components, namely NAND Flash memory, used to build our customers devices, as well
as high inventory levels of our products at specific customers at the end of the first quarter of 2006.

International Expansion. In
the third quarter of 2004, we established an international subsidiary and opened an office in Hong Kong. During 2005, we opened branch offices in Taipei, Taiwan and Shenzhen, China, and established international subsidiaries and opened offices in
Singapore, Seoul, South Korea, Tokyo, Japan, and Cambridge, England. During the second quarter of 2006, we converted our Shenzhen, China office to a subsidiary. As we pursue advantages of overseas product development and expand the support of our
customers in Asia, we anticipate that we will continue to increase our employee headcount in our Asian offices as our Asian operations mature.

Recent Disposition and Acquisitions. On July 31, 2006, we sold certain assets, liabilities, intellectual property and engineering resources relating to our PC Audio product line to Integrated Device Technology, Inc.
(IDT) for approximately $80 million, subject to certain post-closing adjustments, which consists of $72.0 million in cash, accounts receivable of the PC Audio product line which were retained by us, and accounts payable of the PC Audio
product line being assumed by IDT. $7.2 million of the purchase price was deposited into an escrow account upon closing for purposes of settling indemnification claims for the one-year period following the closing.



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Pursuant to the terms of the sale, approximately 60 employees and associated contractors were
transitioned to IDT. In connection with the sale, we entered into several ancillary agreements with IDT, including a transition services agreement designed to ensure a smooth transition of the PC Audio product line to IDT, and an intellectual
property license agreement pursuant to which IDT received rights to certain intellectual property being retained by us related to the PC Audio product line. As part of the sale, we agreed not to engage in the business associated with the PC Audio
product line for a period of two years following the closing.

On October 5, 2005, we acquired certain assets, intellectual property
and engineering resources of the Direct Digital Amplification (DDX®) product line from Apogee for $9.4 million in cash. We also agreed to make an additional payment of up to $4.5 million in cash pursuant to the terms of an earn-out provision
based on the achievement by the DDX® business of certain revenues during the one-year period following the closing. The acquisition has been accounted for under the purchase method of accounting.

On September 6, 2005, we acquired Oasis, a privately held provider of ICs for the multi-function peripheral market, for $57.0 million in cash. We
also agreed to make an additional payment of up to $25.0 million in cash pursuant to the terms of an earn-out provision based on the achievement by the Oasis business of certain calendar year 2006 revenues. The acquisition has been accounted for
under the purchase method of accounting.

On August 24, 2005, we completed our acquisition of Protocom, a privately held provider of
ICs to the digital video camera market, for $18.8 million in cash and $28.2 million in the form of 1,437,304 shares of our common stock. The acquisition has been accounted for under the purchase method of accounting.

On July 26, 2005, we acquired certain assets, intellectual property and engineering resources associated with the Rio® portable audio product line from D&M Holdings, Inc. for $10.2 million in
cash. The acquisition has been accounted for under the purchase method of accounting.

Statement of Operations Overview

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 or later if required by shipping terms. We defer revenues on sales through distributors which have rights of return or price protection until products are resold by such distributors to their customers. We also defer
revenue from nonrecurring engineering fees (NRE) until the obligations under the NRE agreements have been met and the related products are shipping in production quantities. The main factors that impact our revenues are unit volumes
shipped and average selling prices. Overall, we expect average selling prices for our products to decline over time as products mature. Our ability to increase revenues in the future is dependent on increased demand for our established products and
our ability to develop or acquire new products and subsequently achieve customer acceptance of newly introduced products.

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. Cost of goods sold also consists of amortization of developed product technology and an intellectual property license agreement purchased through our acquisitions, which are amortized over not more than six
years. 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 salaries and related costs of employees engaged in ongoing research, design and development activities, including stock compensation, contractor fees,
expenses for development testing and evaluation, mask costs, occupancy costs and depreciation of research and development equipment. All research and development costs are expensed as incurred. We believe that continued investment in research and
development is critical to meeting the changing requirements of our customers and to our overall long-term success. We expect that research and development expenses could increase in absolute



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dollars as we employ additional research and development personnel, particularly in Asia, and continue to invest in
research and development activities to develop new products to be competitive in the future, although such expenses as a percentage of revenues may fluctuate.

Selling, General and Administrative. Selling, general and administrative expense consists primarily of salaries and related costs, including stock compensation, occupancy costs, sales commissions to independent
sales representatives, amortization of acquired intangible assets and related overhead costs for sales, marketing and administrative personnel, legal and accounting services, as well as marketing activities. We expect that selling, general and
administrative expenses could increase in absolute dollars as we expand our business to support our future operations. We also expect to continue to incur significant litigation expenses in the future as we protect and defend our intellectual
property and technology.

Other Income (Expense). Other income consists of interest income and foreign exchange losses. Interest
income reflects interest earned on cash equivalents and short-term investment balances. Foreign exchange loss reflects realized losses on foreign currency transactions.

Income Tax Expense (Benefit). We accrue federal, state, and foreign income taxes at the applicable statutory rates adjusted for certain items including non-deductible expenses, tax credits, interest income from
tax advantaged investments, as well as changes in our deferred tax asset valuation allowance. The provision for income taxes also includes amounts intended to satisfy unfavorable adjustments by tax authorities in any future examination of our income
tax returns. Refer to Note 12 of the notes to the condensed consolidated financial statements.

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 EndingJune 30, |   |  | Six Months EndedJune 30, |  
|                                    |  | 2006                        |   |  | 2005                     |   |  | 2006  |    |  | 2005  |  
|Revenues, net                       |  | 100.0                       | % |  | 100.0                    | % |  | 100.0 | %  |  | 100.0 | %
|Cost of goods sold                  |  | 56.8                        |   |  | 44.6                     |   |  | 56.2  |    |  | 43.4  |  
|                                    |  |                             |   |  |                          |   |  |       |    |  |       |  
|Gross Profit                        |  | 43.2                        |   |  | 55.4                     |   |  | 43.8  |    |  | 56.6  |  
|                                    |  |                             |   | 
|Operating expenses:                 |  |                             |   |  |                          |   |  |       |    |  |       |  
|Research and development            |  | 52.6                        |   |  | 18.7                     |   |  | 58.9  |    |  | 14.8  |  
|Selling, general and administrative |  | 28.9                        |   |  | 13.5                     |   |  | 34.7  |    |  | 9.8   |  
|                                    |  |                             |   |  |                          |   |  |       |    |  |       |  
|Total operating expenses            |  | 81.5                        |   |  | 32.2                     |   |  | 93.6  |    |  | 24.6  |  
|                                    |  |                             |   |  |                          |   |  |       |    |  |       |  
|Operating income (loss)             |  | (38.3                       | ) |  | 23.2                     |   |  | (49.8 | )  |  | 32.0  |  
|                                    |  |                             |   | 
|Other income (expense):             |  |                             |   |  |                          |   |  |       |    |  |       |  
|Interest income, net                |  | 1.0                         |   |  | 1.8                      |   |  | 1.5   |    |  | 1.2   |  
|Foreign exchange loss               |  | (0.1                        | ) |  | (0.1                     | ) |  | (0.1  | )  |  |      |  
|                                    |  |                             |   |  |                          |   |  |       |    |  |       |  
|Total other income                  |  | 0.8                         |   |  | 1.7                      |   |  | 1.4   |    |  | 1.2   |  
|                                    |  |                             |   |  |                          |   |  |       |    |  |       |  
|Income (loss) before income taxes   |  | (37.5                       | ) |  | 24.9                     |   |  | (48.4 | )  |  | 33.2  |  
|Income tax expense (benefit)        |  | (44.1                       | ) |  | 9.2                      |   |  | (20.0 | )  |  | 11.6  |  
|                                    |  |                             |   |  |                          |   |  |       |    |  |       |  
|Net income (loss)                   |  | 6.7                         | % |  | 15.7                     | % |  | (28.4 | )% |  | 21.6  | %
|                                    |  |                             |   |  |                          |   |  |       |    |  |       |  

Comparison of Three Months Ended June 30, 2006 to Three Months Ended June 30, 2005

Revenues. Revenues for the three months ended June 30, 2006 were $43.8 million compared to $69.6 million for the three
months ended June 30, 2005, a decrease of 37.1%. This decrease was due to a 53.1% decrease in revenues from the sale of our portable multimedia SoCs, which was offset by a 84.1% increase in the sale of our audio codecs. Revenues from the sale
of our portable multimedia SoCs and of our audio codecs were 69.0% and 19.6%, respectively, of total revenues for the three months ending June 30, 2006.

Portable Multimedia SoCs. The decrease in revenues from the sale of our portable multimedia SoCs was primarily due to a decline in market share, decreased average selling prices and our failure to deliver the
STMP 36xx family of portable multimedia SoC and supporting software as early as we had targeted. We expect the trend of



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declining average selling prices for existing portable multimedia SoCs products to continue as these products mature
further and as the market becomes more competitive, which may have a negative impact on our future revenues if we cannot sell newer products with enhanced features at relatively higher prices.

Audio Codecs and Other Products. The increase in revenues from the sale of our audio codecs was due to increased unit shipments to support new
design wins at certain customers in the personal computing market. Revenues from Oasis and Protocom products totaled $4.8 million for the three months ended June 30, 2006. We expect revenue from the sales of audio codecs to decrease from the
second quarter of 2006 as a result of the sale of our PC Audio product line.

Revenues from Significant Customers. Sales to Creative
Technology, an affiliate until October 2005, increased to 18.2% of total revenues during the three months ended June 30, 2006 from less than 10% during the three months ended June 30, 2005 due to increased sales of our SoCs that are used
in their portable digital audio players. Creative Technology purchases our standard products at prices and on terms similar to other customers who buy similar products and volumes. Sales to ASUSTEK Computer Inc. increased to 12.7% of total revenues
during the three months ended June 30, 2006 from less than 10% during the three months ended June 30, 2005 due to increased sales of our SoCs and audio codecs that are used in products they manufacture. Sales to Samsung, a direct customer
in Taiwan and South Korea, decreased to less than 10% of revenues for the three months ended June 30, 2006 compared to 10.9% for the three months ended June 30, 2005 due to decreased sales of our SoCs that are used in their portable
digital audio players. Revenues from G.M.I. Technology, a distributor located in Hong Kong and Taiwan, decreased from 21.1% to less than 10% of total revenues during the three months ended June 30, 2005 and 2006, respectively, due to decreased
sales of our SoCs that are used in portable digital audio players that their customers manufacture, as well as increased sales to direct customers.

Gross Profit. Gross profit as a percentage of revenues, or gross margin, was 43.2% for the three months ended June 30, 2006 compared with 55.4% for the three months ended June 30, 2005. The decrease in gross margin was
primarily due to an aggressive pricing program on our portable multimedia SoCs that target the value segment of the overall portable multimedia player market, and a higher percentage of our revenue coming from our lower margin audio codecs. The
lower gross margins were also due to $0.8 million of amortization of developed technology from acquired companies during the three months ended June 30, 2006. We expect our gross margins for the third quarter of 2006 to be comparable to those
achieved during the second quarter of 2006. We also expect the trend of declining average selling prices for existing portable multimedia SoCs products to continue, which may have a negative impact on our future gross margins if we cannot reduce our
associated costs accordingly and sell newer products with enhanced features at relatively higher prices.

Research and Development.
Research and development expenses increased to $23.1 million, or 52.6% of revenues, for the three months ended June 30, 2006 from $13.0 million, or 18.7% of revenues, for the three months ended June 30, 2005. This dollar increase of $10.1
million was primarily due to increases in our engineering headcount, which increased salary and salary related expense, costs associated with the acquisitions of Rio, Protocom, Oasis and Apogee during the second half of 2005, and increases in the
costs of design tools and mask sets, as well as $1.7 million in stock compensation expense resulting from our adoption of SFAS 123R in the first quarter of fiscal year 2006. The headcount increases were primarily to support hardware and software
development on our latest portable multimedia SoCs, the STMP 36XX, STMP 37XX and the SGTV58XX family 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 Class D amplifier products for consumer applications. The increase in research and development spending has resulted in substantial progress on our completion of the
design of our products and the creation of several patentable inventions, enabling us to identify additional U.S. patent applications we will file covering inventions made during the STMP 36XX, STMP 37XX and digital FM tuner design processes. We
expect that research and development expenses will remain relatively consistent in future periods as the research and development costs will decrease due to the sale of our PC Audio product line on July 31, 2006. The reduction of costs could be
offset by an increase in expense as we continue 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 $12.6 million, or 28.9% of revenues, for the three
months ended June 30, 2006, from $9.4 million or 13.5% of revenues,



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for the three months ended June 30, 2005. This dollar increase of $3.2 million was primarily due to increases in
headcount of sales, marketing, and administrative personnel including a substantial increase in personnel located in the Asia-Pacific region, and approximately $0.9 million of stock compensation expense resulting from our adoption of SFAS 123R in
the first fiscal quarter of 2006. The increase was also due to increased lease expenses related to additional leased office space both domestically and internationally, as well as increases in legal expenses related to setting up and maintaining our
international subsidiaries. We expect selling, general and administrative expenses will remain relatively consistent in future periods due to the reduction in expense associated with the PC Audio disposal, which could be offset by increases to our
staffing and customer support and associated costs.

Other Income (Expense). Interest income decreased to $422,000 for the three
months ended June 30, 2006 from $1.2 million for the three months ended June 30, 2005. This was due to a decrease in our cash balances and investments in short-term marketable securities from $118.9 million at December 31, 2005 to
$40.5 million at June 30, 2006.

Income Tax Expense (Benefit). Our income tax benefit of $19.3 million for the three months
ended June 30, 2006 represents a decrease in income tax expense from the $6.4 million of income tax expense for the three months ended June 30, 2005. This decrease was primarily due to decreased income before taxes, as well as a change in
the estimate of our effective tax rate. At June 30, 2006, our effective tax rate estimate for the year ended December 31, 2006 was 32%. This estimate differed from the statutory rate primarily due to the effect of different tax rates in
foreign jurisdictions, and non-deductible charges related to stock-based compensation, and one time benefits related to unwinding the Companys intellectual property (IP) or IP migration strategy. At June 30, 2005, our
effective tax rate estimate for the year ended December 31, 2005 was 35.0%.

During the three months ended June 30, 2006, the
Company changed its international tax strategy. As a result, the Company made a voluntary tax election that changed the tax status of the Companys Cayman subsidiary by causing a deemed liquidation of the subsidiary for US federal income tax
purposes. This resulted in a one-time benefit of $9.3 million that was recognized in the three months ending June 30, 2006.

Comparison of Six
Months Ended June 30, 2006 to Six Months Ended June 30, 2005

Revenues. Revenues for the six months ended
June 30, 2006 were $76.8 million compared to $168.9 million for the six months ended June 30, 2005, a decrease of 55%. This decrease was due to a 67.8% decrease in revenues from the sale of our portable multimedia SoCs for the six months
ended June 30, 2006, this was partially offset by a 79.1% increase in the sale of our audio codecs for the six months ended June 30, 2006. Revenues from the sale of our portable multimedia SoCs and of our audio codecs were 66.7% and 19.9%,
respectively, of total revenues for the six months ended June 30, 2006 and 94.3% and 5.0% for the six months ended June 30, 2005, respectively.

Portable Multimedia SoCs. The decrease in revenues from the sale of our portable multimedia SoCs was primarily due to increased levels of our customers inventory of our products during the first quarter,
as well as the rapid decline of NAND flash memory prices during the first quarter that caused our customers to delay their purchases of that component and purchases of our products as a result. The revenue decline was also due to a decline in market
share, decreased average selling prices and our failure to deliver the STMP 36xx family of portable multimedia SoC and supporting software as early as we had targeted. We expect the trend of declining average selling prices for existing portable
multimedia SoCs products to continue as these products mature further and as the market becomes more competitive, which may have a negative impact on our future revenues if we cannot sell newer products with enhanced features at relatively higher
prices.

Audio Codecs and Other Products. The increase in revenues from the sale of our audio codecs was due to increased unit
shipments to support new design wins at certain customers in the personal computing market. Revenues from Oasis and Protocom products totaled $9.6 million for the six months ended June 30, 2006. We expect revenue from the sales of audio codecs
to decrease from the second quarter of 2006 as a result of the sale of our PC Audio product line.



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Revenues from Significant Customers. Sales to Creative Technology, an affiliate until October
2005, increased to 15.9% of total revenues during the six months ended June 30, 2006 from 13.6% during the six months ended June 30, 2005 due to increased sales of our SoCs that are used in their portable digital audio players. Creative
Technology purchases our standard products at prices and on terms similar to other customers who buy similar products and volumes. Sales to ASUSTEK Computer Inc. decreased to 12.5% of total revenues during the six months ended June 30, 2006
from 19.9% during the six months ended June 30, 2005 primarily due to a decrease in demand for their products compared to 2005 when one of their large customers launched its new portable audio player. Revenues from G.M.I. Technology, a
distributor located in Hong Kong and Taiwan, decreased from 16.8% to less than 10% of total revenues during the six months ended June 30, 2005 and 2006, respectively, due to decreased sales of our SoCs that are used in portable digital audio
players their customers manufacture, as well as increased sales to direct customers. Revenues from Holystone, also a distributor, increased to 10.6% during the six months ended June 30, 2006 from less than 10% during the six months ended
June 30, 2005, due to increased sales of our PC Audio codecs that are used in PCs that their customers manufacture.

Gross
Profit. Gross profit as a percentage of revenues, or gross margin, was 43.8% for the six months ended June 30, 2006 compared with 56.6% for the six months ended June 30, 2005. The decrease in gross margin was primarily due to an
aggressive pricing program on our portable multimedia SoCs that target the value segment of the overall portable multimedia player market, and a higher percentage of our revenue coming from our lower margin audio codecs. The lower gross margins were
also due to $1.6 million of amortization of developed technology from acquired companies during the six months ended June 30, 2006. We expect our gross margins for the third quarter of 2006 to be comparable to those achieved during the first
two quarters of 2006. We also expect the trend of declining average selling prices for existing portable multimedia SoCs products to continue, which may have a negative impact on our future margins if we cannot reduce our associated costs
accordingly and sell newer products with enhanced features at relatively higher prices.

Research and Development. Research and
development expenses increased to $45.3 million, or 58.9% of revenues, for the six months ended June 30, 2006 from $25.0 million, or 14.8% of revenues, for the six months ended June 30, 2005. This dollar increase of $20.3 million was
primarily due to increases in our engineering headcount, which increased salary and salary related expense, costs associated with the acquisitions of Rio, Protocom, Oasis and Apogee during the second half of 2005, and increases in the costs of
design tools and mask sets, as well as an increase of $3.4 million in stock compensation expense resulting from our adoption of SFAS 123R in the first quarter of fiscal year 2006. The headcount increases were primarily to support hardware and
software development on our latest portable multimedia SoCs, the STMP 36XX, STMP 37XX and the SGTV58XX family 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 Class D amplifier products for consumer applications. The increase in research and development spending has resulted in substantial progress on our completion of
the design of our products and the creation of several patentable inventions, enabling us to identify additional U.S. patent applications we will file covering inventions made during the STMP 36XX, STMP 37XX and digital FM tuner design processes. We
expect that research and development expenses will remain relatively consistent in future periods as the research and development costs will decrease due to the sale of our PC Audio product line on July 31, 2006. The reduction of costs could be
offset by an increase in expense as we continue 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 $26.6 million, or 34.7% of revenues, for the six
months ended June 30, 2006, from $16.6 million or 9.8% of revenues, for the six months ended June 30, 2005. This dollar increase of $10.0 million was primarily due to increases in headcount of sales, marketing, and administrative personnel
including a substantial increase in personnel located in the Asia-Pacific region, and an increase of approximately $1.7 million of stock compensation expense resulting from our adoption of SFAS 123R in the first fiscal quarter of 2006. The increase
was also due to increased lease expenses related to additional leased office space both domestically and internationally, as well as increases in legal expenses related to setting up and maintaining our international subsidiaries. We expect selling,
general and administrative expenses will remain relatively consistent in future periods due to the reduction in expense associated with the PC Audio disposal, which could be offset by increases to our staffing and customer support and associated
costs.



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Other Income (Expense). Interest income decreased to $1.2 million for the six months ended
June 30, 2006 from $2.1 million for the six months ended June 30, 2005. This was due to a decrease in our cash balances and investments in short-term marketable securities, as a result of the $43.9 million of cash used in financing our
ongoing operations, and the $30.0 million repurchase of shares of our common stock in February 2006.

Income Tax Expense. Our income
tax benefit of $15.3 million for the six months ended June 30, 2006 represents a decrease in income tax expense from our income tax expense of $19.6 million for the six months ended June 30, 2005. This decrease was primarily due to
decreased income before taxes, as well as a change in the estimate of our effective tax rate. At June 30, 2006, our effective tax rate estimate for the year ended December 31, 2006 was 32%. This estimate differed from the statutory rate
primarily due to the effect of different tax rates in foreign jurisdictions, and non-deductible charges related to stock-based compensation, and one time benefits related to unwinding the Companys IP migration strategy. At June 30, 2005,
our effective tax rate estimate for the year ended December 31, 2005 was 35.0%.

During the six months ended June 30, 2006, the
Company changed its IP Migration strategy. As a result, the Company made a voluntary tax election that changed the tax status of the Companys Cayman subsidiary by causing a deemed liquidation of the subsidiary for US federal income tax
purposes. This resulted in a one-time benefit of $9.3 million that was recognized in the six months ending June 30, 2006.

Liquidity and Capital
Resources

Working Capital, Cash and Cash Equivalents and Short-term Investments. The following table presents working capital,
cash and cash equivalents and short-term investments (in thousands):



|                             |  |              |        |              |   |                    |  |   |          |  
|---------------------------- |  | ------------ | ------ | ------------ | - | ------------------ |  | - | -------- | -
|                             |  | June 30,2006 |        | June 30,2005 |   | Increase(Decrease) | 
|Working capital              |  | $            | 75,745 |              | $ | 216,315            |  | $ | (140,570 | )
|Cash and cash equivalents(1) |  |              | 19,483 |              |   | 73,894             |  |   | (54,411  | )
|Short-term investments(1)    |  |              | 21,017 |              |   | 104,726            |  |   | (83,709  | )

---

|(1) | Included in working capital.
|--- | ----------------------------

Our working capital as of June 30, 2006 represents a decrease from our working capital as of June 30, 2005 primarily due to $92.8 million in
cash used in acquisitions of businesses, net of cash acquired in 2005 and $30.0 million in cash used in repurchasing our common stock in February 2006, as well as the $21.8 million net loss incurred during the six months ended June 30, 2006.
This decrease was further negatively impacted by a decrease in cash provided by operating activities and a decrease in cash proceeds for issuances of common stock in connection with the exercise of employee stock options and pursuant to our employee
stock purchase plan.

We have historically financed our operations primarily through cash from our financing activities and our operating
activities. Our principal source of liquidity as of June 30, 2006 consisted of $40.5 million in cash, cash equivalents and short-term investments. Our short-term investments consist primarily of corporate, state and municipal securities. On
July 31, 2006, in connection with the sale of our PC Audio product line, we received approximately $80 million, subject to certain post-closing adjustments, which consists of $72.0 million in cash, accounts receivable of the PC Audio product
line which are being retained by SigmaTel, and accounts payable of the PC Audio product line being assumed by IDT. $7.2 million was deposited into an escrow account at closing for purposes of settling indemnification claims for the one-year period
following the closing. Refer to Note 10 of the Condensed Consolidated Financial Statements for additional information on this disposition.

Operating Activities. Net cash used in operating activities was $43.9 million during the six months ended June 30, 2006, compared to net cash provided of $41.4 million for the six months ended June 30, 2005. Operating cash
flows during the six months ended June 30, 2006 reflect our net loss of $21.8 million, adjustments primarily for depreciation, amortization, and stock-based compensation expense of $12.4 million, deferred income taxes of $15.2 million, and a
net decrease from the changes in assets and liabilities of $19.1 million. Our accounts receivable decreased $22.5 million during the six months ended June 30, 2006 due to decreases in revenues and the timing of customer payments, compared to an
increase of $6.1 million, during the six months ended June 30, 2005 due to



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increases in revenue. Our accounts payable decreased $21.0 million during the six months ended June 30, 2006,
primarily due to payments related to inventory purchases, compared to a decrease of $1.2 million, during the six months ended June 30, 2005, related to the increased purchases of inventory to support the higher revenue levels in the 2005
period. Our inventories increased $18.4 million and $7.5 million, during the six months ended June 30, 2006 and 2005, respectively, due to decreases in demand for our products during the beginning of 2006 that led to lower than expected
revenues. In 2005, the increase in inventory was driven by the higher levels of demand for our products at that time, primarily from Creative and ASUSTEK Computer, Inc. Our reserve for slow-moving and obsolete inventory as a percentage of total
inventory was 5.5% and 8.3% as of June 30, 2006 and June 30, 2005, respectively. We monitor and analyze our inventory for obsolescence and adjust this reserve accordingly. The reserve increased by $106,000 and $243,000 during the six
months ended June 30, 2006 and June 30, 2005, respectively.

The decrease in deferred revenue and other liabilities of $4.3
million during the six months ended June 30, 2006 is net of a $4.2 million decrease in deferred revenue and $181,000 increase in deferred rent. The decrease in deferred revenue is primarily due to improved management of distributor inventory
levels. Our deferred revenue and other liabilities increased by $1.2 million during the six months ended June 30, 2005 due to changes in the amount of our products held at distributors to enable them to meet customer demand of our products at
that time. Income taxes payable decreased by $3.4 million for the six months ended June 30, 2006 and increased by $2.7 million for the six months ended June 30, 2005. Research and development resources are required to develop and expand
our core technologies and proprietary product offerings. Our research and development expenses were $45.3 million and $25.0 million during the six months ended June 30, 2006 and 2005, 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. Included in research and development for the six months ended June 30, 2006 was $3.4 million for the SFAS 123R stock based compensation charge.

Investing Activities. Our investing activities provided cash of $26.1 million and $2.3 million during the six months ended June 30, 2006 and
2005, respectively. Investing activities during the six months ended June 30, 2006 primarily represented proceeds from maturities of short-term investments.

The fair value of our investments in marketable securities at June 30, 2006 was $21.0 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.

Capital expenditures were $6.1 million and $7.3 million during the six months ended June 30, 2006 and 2005, respectively. These expenditures during the six months ended June 30, 2006 were incurred primarily
for the purchase of engineering tools, computer equipment, and software.

Financing Activities. Our financing activities used $28.5
million and provided $3.0 million of cash during the six months ended June 30, 2006 and 2005, respectively. On January 24, 2006, our Board of Directors authorized a share repurchase plan for up to $30.0 million of our common stock. During
the six months ended June 30, 2006, we purchased approximately 2.6 million shares for $30.0 million. We received $0.6 million and $2.1 million in proceeds from the exercise of employee stock options during the six months ended
June 30, 2006 and 2005, respectively. We also received $0.7 million and $0.9 million from the purchase of stock under our Employee Stock Purchase Plan during the six months ended June 30, 2006 and 2005, respectively.

Capital Requirements. We could continue to experience growth in our operating expenses, including our research and development, sales and
marketing and general and administrative expenses in the foreseeable future in order to execute our business strategy. Additionally, as part of our growth and diversification strategy, we may evaluate opportunities to invest in or acquire other
businesses, intellectual property or technologies that would compliment or expand our current offerings, expand the breadth of our markets or enhance our technical capabilities.



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We intend to fund these activities with cash generated from operations and existing cash balances. An
increase in operating expenses may not result in an increase in our revenue and our anticipated revenue may not be sufficient to support these increased expenditures. We anticipate that operating expenses, working capital as well as planned capital
expenditures will constitute a material use of our cash resources.

There can be no assurances that we can reduce our net losses and
negative cash flow in the foreseeable future, excluding the third quarter of 2006 when we expect to record a substantial gain on the sale of our PC Audio product line to IDT. Also, there can be no assurances that we can raise capital as needed to
fund our operations on an ongoing basis. However, based on current business conditions and our current operating and financial plans, but subject to the discussion in Item 1A Risk Factors below, we believe our existing cash balances
and short-term investments, together with cash generated from operating activities, and the sale of our PC Audio product line, will be sufficient to meet our anticipated cash needs for at least the next 12 months. The amount of cash used in the six
months ending June 30, 2006 included $21.0 million in reductions in accounts payable and an $18.4 million increase in the level of our inventory. We do not expect accounts payable or inventory fluctuations to be as significant in the near
future. 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, the continuing market acceptance of our products and the realization of contingent payouts resulting from our acquisitions. 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. If we are unable to obtain additional financing if needed, we may be required to
reduce the scope of our planned product development and sales and marketing efforts, which could harm our business, financial conditions, and operating results. We may enter into 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 is 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. These criteria are usually met at
the time of product shipment. However, we do not recognize revenue until all customer acceptance requirements have been met, when applicable. Revenues from product sales to customers other than distributors are generally recognized upon shipment and
reserves are provided for estimated allowances. We defer revenue recognition of nonrecurring engineering fees until contractual obligations are met and the related products are shipped. A portion of our sales are made through distributors under
agreements allowing for price protection and/or rights of return. Product revenue on sales made through these distributors is not recognized until the distributors sell the product to their customers. Customer purchase orders and/or contracts are
generally used to determine the existence of an arrangement. Shipping documents and the completion of any customer acceptance requirements, when applicable, are used to verify product delivery. Management assesses whether a price is fixed or
determinable based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. Management assesses the collectibility of our accounts receivable based primarily upon the



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creditworthiness of the customer as determined by credit checks and analysis, as well as the customers payment
history. 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.

Inventory Valuation. We value our inventory at the lower of the actual costs of our inventory or its current estimated market value. We establish
inventory reserves at least quarterly for estimated obsolescence or unmarketable inventories in an amount equal to the difference between the cost of the inventory and its estimated realizable value based upon assumptions about future demand and
market conditions. If actual demand and market conditions are less favorable than those projected, additional inventory reserves may be required that could adversely affect our operating results.

Stock-Based Compensation. Prior to January 1, 2006, employee stock awards under our compensation plans were accounted for in accordance with
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting Standards Board (FASB) Interpretation No. 44, Emerging Issues Task Force (EITF)
Issue No. 00-23, and related interpretations. We accounted 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. For employee stock awards, we have historically adhered to the disclosure-only provisions of these applicable accounting principles.

Prior to January 1, 2006, compensation costs related to stock options granted to employees at fair value under our compensation plans were not
recognized in the condensed consolidated statements of operations. Compensation costs related to options, restricted stock units (RSUs), stock options granted to employees below fair value, and stock options granted to non employees were
recognized in the condensed consolidated statements of operations.

In December 2004, the FASB issued SFAS No. 123 (revised 2004),
Share-Based Payment, (SFAS 123R). Under the new standard, companies are no longer able to account for share-based compensation transactions using the intrinsic value method in accordance with APB Opinion No. 25. Instead,
companies are required to account for such transactions using a grant date fair value method and recognize the expense over the employees requisite service period in the condensed consolidated statements of operations.

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R using the modified prospective transition method. Under
that transition method, compensation cost recognized in 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in
accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of
SFAS 123R. Results of prior periods have not been revised.

On December 31, 2005, we accelerated the vesting of approximately
1.8 million unvested stock options outstanding under our stock plans with exercise prices per share of $20.00 or higher. The options had a range of exercise prices between $20.03 and $55.86 and a weighted average exercise price of
$31.10. The closing price of our common stock on December 16, 2005, the day the Companys Board of Directors approved the acceleration, was $13.34. In accordance with SFAS No. 123, we expensed the remaining unrecognized
compensation cost associated with the options with accelerated vesting in the pro forma disclosure. These actions were taken in order to avoid expense recognition in future financial statements upon adoption of SFAS 123R. The aggregate pre-tax
expense associated with the accelerated options that would have been reflected in our consolidated financial statements in future fiscal years was approximately $25.9 million, which was included in the pro forma disclosure of stock-based employee
compensation expense for the year ended December 31, 2005.

As a result of adopting SFAS 123R on January 1, 2006, our loss before
income taxes for the six months ended June 30, 2006 was $5.1 million higher than if it had continued to account for share-based compensation under APB Opinion No. 25. Applying the provisions of SFAS 109, Accounting for Income Taxes,
on an annual basis, the adoption of SFAS 123R had a negative $0.8 million impact on the net loss for the six months ended June 30, 2006. Also, basic and diluted loss per share for the same period were $0.12 higher due to our adopting SFAS 123R.



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Prior to adopting SFAS 123R, we presented all tax benefits of deductions resulting from the exercise of
stock options as operating cash flows in the condensed consolidated statements of cash flows. SFAS 123R requires the cash flows resulting from the tax benefits from tax deductions in excess of recognized compensation cost (excess tax benefits) to be
classified as financing cash flows. This requirement reduced net operating cash flows and increased net financing cash flows for the six months ending June 30, 2006 by approximately $0.3 million.

The fair value of our stock-based awards is estimated at the date of grant using the Black-Scholes option pricing model. The Black-Scholes valuation
calculation requires us to estimate key assumptions such as future stock price volatility, expected terms, risk-free rates and dividend yield. If our actual experience differs significantly from the assumptions used to compute our stock-based
compensation cost, or if different assumptions had been used, we may have recorded too much or too little stock-based compensation cost. In addition, we are required to estimate the expected forfeiture rate of our stock grants and only recognize the
expense for those shares expected to vest. If the actual forfeiture rate is materially different from our estimate, our stock-based compensation expense could be materially different. We periodically evaluate the assumptions used in the
Black-Scholes model, and calculate expected volatility based on a combination of our historical and implied volatility. The Company calculates the expected term using the simplified method prescribed in Staff Accounting Bulletin
No. 107, Share-Based Payment.

We continue to base the estimate of risk-free rate on the U.S. Treasury yield curve in effect at
the time of grant. We have never paid cash dividends and do not currently intend to pay cash dividends, thus we assume a 0% dividend yield.

As part of the requirements of SFAS 123R, we are required to estimate potential forfeitures of stock grants and adjust compensation cost recorded accordingly. The estimate of forfeitures will be adjusted over the requisite service period to
the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of stock
compensation expense to be recognized in future periods.

During the six months ended June 30, 2006, no RSUs vested. We had $16.3
million of total unrecognized compensation costs related to stock options and RSUs at June 30, 2006 that are expected to be recognized over a weighted-average period of 3.0 years.

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.

Goodwill. Goodwill is tested for impairment on an annual basis in the fourth quarter of each
year, and in the interim if events and circumstances indicate that goodwill may be impaired. Impairment of goodwill is evaluated using a two-step process. The first step involves a comparison of the fair value of a reporting unit with its carrying
value. If the carrying amount of the reporting unit exceeds its fair value, the second step of the process involves a comparison of the fair value and carrying value of the goodwill of that reporting unit. If the carrying value of the goodwill of a
reporting unit exceeds the fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess.

Accounting
for Income Taxes. We account for income taxes under SFAS No. 109, Accounting for Income Taxes. Under this method, we estimate the current tax liability and the tax effect of temporary difference between the financial and tax
accounting recognition of income and expenses. We record deferred tax assets and liabilities for these temporary difference. We then assess the likelihood that the deferred tax asset will be recovered from future taxable income and feasible tax
planning strategies and, to the extent we believe that recovery is not likely, we establish a valuation allowance against the deferred tax asset.



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Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation 48, Accounting for Income Tax Uncertainties (FIN 48). FIN 48 defines the threshold for recognizing the benefits of tax return positions in the
financial statements as more-likely-than-not to be sustained by the taxing authority. The recently issued literature also provides guidance on the de-recognition, measurement and classification of income tax uncertainties, along with any
related interest and penalties. FIN 48 also includes guidance concerning accounting for income tax uncertainties in interim periods and increases the level of disclosures associated with any recorded income tax uncertainties.

FIN 48 is effective for fiscal years beginning after December 15, 2006. The differences between the amounts recognized in the statements of
financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are still evaluating the impact, if any, of
adopting the provisions of FIN 48 on our financial position, results of operations and liquidity.

Item 3: Quantitative and Qualitative Disclosures about Market Risk

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 the market value of our investments. As of June 30, 2006, all of our investments were in money
market accounts or investment grade securities.

Foreign Currency Risks

We are exposed to foreign currency fluctuations. Sales and inventory purchases made by us and our 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.

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, 2006 to ensure that information required to be disclosed by us in the
reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, that such information is accumulated and communicated to our management,
including our CEO and our CFO, as appropriate, to allow timely decisions regarding required disclosures. During our last fiscal quarter, there were no changes in our internal controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial reporting.



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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Many participants in the semiconductor industry have a significant number of
patents and have frequently demonstrated a willingness to commence litigation based on allegations of patent and other intellectual property infringement. From time to time, we have received, and expect to continue to receive, notices of claims of
infringement, misappropriation or misuse of other parties proprietary rights. In the past, some of these claims have led to litigation. We cannot assure you that 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, 2006, we were party to the following legal proceedings:

Actions Semiconductor.

On
January 4, 2005, the Company 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. The Company asserts 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 the Companys portable multimedia SoCs.
The Company is seeking damages and requesting a permanent injunction prohibiting Actions Semiconductor from designing, manufacturing or selling the infringing MP3 integrated circuits in the United States. The Company is also requesting a permanent
injunction prohibiting further shipment of products into the United States that use Actions Semiconductor ICs. In May, 2005, this United States District Court case was formally stayed, by mutual agreement of the parties, during the pendency of the
U.S. International Trade Commission (the ITC) investigation described below.

On March 14, 2005, the Company filed a
complaint requesting that the ITC initiate an investigation of Actions Semiconductor, for violation of Section 337 of the Tariff Act of 1930, in the importation, sale for importation and sale in the United States (U.S.) after
importation of certain audio processing ICs and other products containing these audio processing ICs. In the Companys complaint, as amended, the Company asked the ITC to investigate whether certain Actions Semiconductor products infringe one
or more of the claims of U.S. Patent Nos. 6,137,279 and 6,366,522. On April 18, 2005, the ITC instituted an investigation into Actions Semiconductors actions based on the Companys allegations. The Company is 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. During the course of the ITC
investigation, the Company dropped its infringement assertion of the 279 patent and asserted an additional patent - Patent No. 6,633,187. The ITC conducted a hearing on the merits in late November 2005. In March 2006, the ITC
administrative law judge, (ALJ), determined that Actions Semiconductor infringed the two patents asserted by the Company and recommended that an exclusion order be issued which prevents the importation of infringing Actions chips
and certain MP3 players which contain these chips. The ALJs initial decision was reviewed by the full ITC, which, in June 2006, issued a decision that altered the ALJs construction of one of the patents at issue and asked the ALJ to make
some further determinations. On August 4, 2006, the ALJ concluded that in light of the ITCs revised claim construction, certain Actions Semiconductor chips, when operating under the control of a particular firmware version, do not
infringe the Companys 522 patent. The ITC expects to issue a final decision regarding an exclusion order in September 2006.

Telechips Inc.

On April 4, 2006, the Company filed a lawsuit against Telechips Inc., based in Seoul, South Korea
(Telechips), in the United States District Court for the Eastern District of Texas, Marshall Division. The Company asserts that certain Telechips ICs that are incorporated as components in MP3 players being shipped into the United States
infringe multiple SigmaTel patents. In July, 2006, the Company dismissed this lawsuit, without prejudice.

Item 1A. Risk Factors

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



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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, 2006 and for the three and six month periods then ended
contained elsewhere in this Form 10-Q.

You should carefully consider these risk factors and the information contained in this quarterly
report on Form 10-Q in evaluating SigmaTel and our business. The risks and uncertainties described in these risk factors 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 events discussed in these risk factors 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.

We incurred a net loss for the six months ended
June 30, 2006, have incurred net losses in prior periods, and we will likely incur losses in the future, and if we cannot return to sustained profitability, our liquidity and ability to operate our business effectively could be adversely
affected.

We incurred a net loss of approximately $21.8 million for the six months ended June 30, 2006 and have incurred net
losses in the past and we will likely continue to incur net losses in the future. Our operating expenses could continue to increase as we pursue our strategic objectives. Our results of operations for the three and six months ended June 30,
2006 include a non-cash charge of approximately $2.6 million and $5.1 million, respectively, related to stock-based compensation, and our results of operations for the year ended December 31, 2005 include a non-cash charge of approximately $1.3
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 stock options or restricted stock unit grants. Further, due to our recent adoption of Financial
Accounting Standard Board Statement No. 123R, we are now required to apply certain expense recognition provisions to share-based payments to employees using the fair value method, which expense recognition will further negatively impact our
profitability and could cause us to have difficulty becoming profitable again in future quarterly or annual periods. Our ability to become profitable again and 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 in the past, we may not be able to become profitable again or
sustain or increase profitability on a quarterly or an annual basis. If we continue to experience negative cash flow from operations over a prolonged period of time or if we suffer unexpected cash outflows, our liquidity and ability to operate our
business effectively could be adversely affected.

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

We began shipping our latest product, the STMP 36XX family of portable audio SOCs, in the fourth quarter of 2005. Sales of the STMP
35XX and STMP 36XX families of products are highly dependent upon continued acceptance of portable multimedia players by consumers. Since we cannot accurately monitor sell-through of our ultimate end customers portable multimedia players which
contain our portable multimedia 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 multimedia 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 have recently expanded our staffing and increased 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 return our historic growth rate in the future.

Due primarily to increased sales of our portable multimedia SoCs, in the past we experienced significant revenue growth and gained significant market
share in a relatively short period of time. Specifically, our annual revenues increased from approximately $30.9 million in 2002, to $100.2 million in 2003, to $194.8 million in 2004, and to $324.5 million in 2005. However, revenues decreased from
$168.9 million for the six months ended June 30, 2005 to $76.8 million for the six months ended June 30, 2006 and we do not expect similar revenue growth or market share gains in future periods. We have faced a number of challenges that
have affected our operating results during the past year and a half, including extreme competition in the portable multimedia SoCs market, continuing erosion of average selling prices of our portable multimedia SoCs, delays in delivering new product
features to existing and new customers, and price volatility and shortages of other components used to build our customers devices. Although we are taking steps to address these challenges and to improve our results of operations, we cannot
provide assurance that we will return to profitability on a quarterly or annual basis. Accordingly, you should not rely on the results of any prior quarterly or annual periods as an indication of our future operating performance.

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 have historically accounted 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 and 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. We currently account for equity awards issued to non-employees in accordance with the provisions of SFAS No. 123 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. For employee stock awards, we have historically adhered to the disclosure-only provisions of these
applicable accounting principles. In December 2004, the FASB issued a revision to SFAS No. 123 (SFAS No. 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. As a result of our adoption of SFAS No. 123R, we recognized approximately $2.6 million
in stock-based compensation expense during the three months ended June 30, 2006.

SFAS No. 123R also requires the benefits of tax
deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as previously required. This requirement reduced net operating cash flows and increased net financing cash flows on
the condensed consolidated statements of cash flows.

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, 2006 and 2005, sales to our top five customers accounted for approximately 54.9% and 67.1%, respectively, of our revenues. Our operating results in the foreseeable future will likely continue to depend on sales to a relatively small
number of customers, as well as the ability of these customers to sell products that use our ICs. Our revenues would likely decline if one or more of these customers were to significantly reduce, delay or cancel their orders for any reason. In
addition, any difficulty in collecting outstanding amounts due from our customers, particularly customers who place large orders, would harm our financial performance. Because our sales are made by means of customer 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 38.2% and 47.4% of our revenues for the six months ended June 30, 2006 and 2005,
respectively. Our sales to Holystone, a distributor in Taiwan and China, accounted for 10.6% and less than 10% of



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our revenues in the six months ended June 30, 2006 and 2005, respectively. Our sales to G.M.I. Technology, a
distributor, accounted for less than 10% and 16.8% of our revenues for the six months ended June 30, 2006 and 2005, respectively. Despite the decreases as a percentage of total revenues, the dollar amount of our products sold through
distributors is significant. If Holystone, G.M.I. Technology, 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, and could impact the effectiveness of our internal controls.

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 of flash memory 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 given 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 multimedia players, the sales of our products that are also included in such devices would be adversely affected. Certain of our customers have indicated in recent periods that they
have had difficulty in obtaining flash memory which is a key component of their portable multimedia players which also incorporate our portable multimedia SoCs. Certain of our customers have also recently indicated that they have postponed
purchasing additional portable multimedia SoCs and other components for portable multimedia players due to volatility in the price of NAND flash. We believe that any such flash memory supply constraints and price volatility could cause our customers
to purchase fewer portable multimedia SoCs than they might otherwise purchase, thus negatively affecting our business and revenue. 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 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.

Because many of our ICs are designed for use in consumer electronic products, such as portable multimedia players,
PCs, and DVD players, we expect our business to be subject to seasonality, with increased revenue in the



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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 historic 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 multimedia 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.

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 18 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 original equipment manufacturers, or OEMs, and original design manufacturers, or 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.

We derive a substantial portion of our revenues from our portable multimedia SoCs, the selling prices of which 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 multimedia SoCs, which accounted for 90.6% of our revenues in the year ended December 31, 2005 and 66.7% of our revenues in the six months ended June 30, 2006. 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;
| | - |  | ------------------------------------------------------



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| |  |  | 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 prices of our products tend to decline significantly over the life of the products. 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 silicon
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



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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 or subcontractors 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 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.

The recent changes in our organization, including recent acquisitions and dispositions, have 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 these changes or any organization changes.

Our organization has changed rapidly, and further organizational changes may be required, particularly in Asia, to address our strategic objectives and potential growth in our customer base. We have changed our
organization through acquisitions and dispositions, opening international locations and through increasing headcount, both domestically and internationally. These changes have placed, and any future organizational changes will continue to place a
significant strain on our management, personnel, systems and resources. If we are unable to manage our organizational changes 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 organization, 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;
| | - |  | -----------------------------------------



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



| |  |  | manage the recent transition of our PC Audio product line to IDT.
| | - |  | -----------------------------------------------------------------

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;
| | - |  | --------------------------------------------------------



| |  |  | discontinuation of the use of our products by customers or distributors;
| | - |  | ------------------------------------------------------------------------



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



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



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| |  |  | technological innovations or new products by our competitors, customers or us;
| | - |  | ------------------------------------------------------------------------------



| |  |  | the dispositions of product lines;
| | - |  | ----------------------------------



| |  |  | 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 multimedia 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 and dilution from the issuance of our stock in connection 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.
| | - |  | ------------------------------------

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. Other factors that could cause our stock to be highly volatile are: announcements of changes to senior management and changes in earnings estimates or investment recommendations by analysts.

The average selling prices of our products could continue to 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 multimedia SoCs. We have in the past and expect in the future to reduce 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.



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

The semiconductor industry is highly cyclical. The industry has experienced significant downturns, often in connection with, or in anticipation of,
maturing product cycles (of both semiconductor companies and their customers products) and declines in general economic conditions. These downturns have been characterized by production overcapacity, high inventory levels and accelerated
erosion of average selling prices. Any future downturns could significantly harm our sales, reduce our profitability or prevent us from regaining 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 consumer audio markets, we compete primarily with Micronas, Cirrus Logic, and Wolfson. In the portable multimedia player market, our principal competitors include Actions Semiconductor, ALi, Austria Microsystems,
Freescale Semiconductor, Philips Semiconductor, PortalPlayer, Samsung, Sunplus, Telechips, and Texas Instruments. Within the digital video camera market we compete primarily with Texas Instruments and Ambarella. Within the USB peripherals market, we
compete primarily with MosChip Semiconductor and Prolific Technology, and other companies providing various multi-chip solutions. Within the MFP market, we compete primarily with Zoran Corporation and in-house captive suppliers. 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, broader product offerings, technical and other resources than us. As a result, they may be able to respond more quickly to
changing customer demands or to devote greater resources to the development, promotion and sales of their products than we can. Our current and potential competitors may develop and introduce new products that will be priced lower, provide superior
performance or achieve greater market acceptance than our products. In addition, in the event of a manufacturing capacity shortage, these competitors may be able to obtain capacity when we are unable to do so. Furthermore, our current or potential
competitors have established, or may establish, financial and strategic relationships among themselves or with existing or potential customers or other third parties to increase the ability of their products to address the needs of our prospective
customers. Accordingly, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share, which would harm our business.

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

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



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

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

We may experience difficulties in transitioning to smaller
geometry process technologies or in achieving higher levels of design integration, which may result in reduced manufacturing yields, delays in product deliveries and increased expenses.

To remain competitive, we expect to continue to transition our semiconductor products to increasingly smaller line width geometries. This transition
requires us to modify the manufacturing processes for our products and to redesign some products as well as standard cells and other IC designs that we may use in multiple products. We periodically evaluate the benefits, on a product-by-product
basis, of migrating to smaller geometry process technologies to reduce our costs. Currently most of our products are manufactured in 0.35 micron, 0.18 micron, 0.16 micron and 0.13 micron geometry processes. In the future, we are planning to migrate
some of our products to 90-nanometer process technologies. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies and new manufacturing processes, which resulted in reduced manufacturing yields,
delays in product deliveries and increased expenses. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes. We are dependent on our relationships with our foundry subcontractors
to transition to smaller geometry processes successfully. We cannot assure you that the foundries that we use will be able to effectively manage the transition or that we will be able to maintain our existing foundry relationships or develop new
ones. If any of our foundry subcontractors or we experience significant delays in this transition or fail to efficiently implement this transition, we could experience reduced manufacturing yields, delays in product deliveries and increased
expenses, all of which could harm our relationships with our customers and adversely impact our operations. As smaller geometry processes become more prevalent, we expect to continue to integrate more functionality, as well as third party
intellectual property, into our products. However, we may not be able to achieve higher levels of design integration or deliver new integrated products on a timely basis, if at all. Moreover, even if we are able to achieve higher levels of design
integration, such integration may have a short-term adverse impact on our operating results, as we may reduce our revenue by integrating the functionality of multiple chips into a single chip.

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 2005, we opened branch
offices in Taiwan, China and established international subsidiaries in Singapore, Japan and 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 an office in Cambridge, England. The percentage of our revenues, from customers located outside of the U.S., was 99.4% for the six months ended June 30, 2006 and 97.6% for the six months ended June 30, 2005. 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;
| | - |  | ---------------------------------------------------------------------



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



| |  |  | public health concerns, such as the SARS outbreak in 2003 and the current bird flu outbreak, and natural disasters, such as the earthquakes and 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.
| | - |  | ----------------------------------------------------------------------------------------------------------

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 currently hold relatively few 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. In January 2005, we filed a lawsuit against Actions Semiconductor and requested the United States International Trade Commission to initiate an investigation against Actions
Semiconductors products, seeking to halt Actions infringement of our intellectual property rights. Most recently, we filed a lawsuit against Telechips Inc., seeking to halt Telechips 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



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such allegations could subject us to significant liability for damages and invalidate our proprietary rights. These
lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation also could force us to do one or more of the following:



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



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



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



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

Our intellectual property indemnification practices may adversely impact our business.

We have
historically indemnified our customers for certain costs and damages of patent infringement in circumstances where our product is the factor creating the customers infringement exposure. This practice may subject us to significant
indemnification claims by our customers, and one of our key customers has requested indemnification from us relating to a patent infringement allegation received from a third party. In some instances, our products are designed for use in devices
manufactured by our customers that comply with international standards, such as the MP3 standard. These international standards are often covered by patent rights held by third parties, which may include our competitors. The combined costs of
identifying and obtaining licenses from all holders of patent rights essential to such international standards could be high and could reduce our profitability or increase our losses. The cost of not obtaining such licenses could also be high if a
holder of such patent rights brings a claim for patent infringement. We are aware that certain of our customers have received a notice from a third party seeking to grant a royalty bearing patent license to those customers and claiming that those
customers manufacture and sale of products capable of decoding MP3 files violates patents which the third party has the right to enforce. 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.

Acquisitions we have made or may make in the future could disrupt our ongoing business and may harm
our financial condition or present risks not contemplated at the time of the transaction.

We cannot be certain that we will realize the
anticipated benefits of the acquisitions of Oasis, Protocom and certain assets and intellectual property of Apogee and Rio. The demand for our combined product offerings may fluctuate and we may face increased competition in the markets for our
products. Any of these factors may have a material adverse effect on our business, operating results or financial condition. 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 acquisitions we have completed 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;
| | - |  | ------------------------------------------------------------------------------------------------------



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| |  |  | 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 or business; 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.

We may be required to record a significant charge to earnings if our goodwill or amortizable intangible assets become impaired.

Under generally accepted accounting principles, we are required to review our amortizable intangible assets for impairment when events or
changes in circumstances indicate the carrying value may not be recoverable. We are required to test goodwill for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying
value of our amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization, deterioration of our performance, and slower growth rates in our industry. We may be required to record a
significant charge to earnings in our financial statements during the period in which we determine that our goodwill or amortizable intangible assets have been impaired. Any such charge would adversely impact our results of
operations. As of June 30, 2006, our goodwill and amortizable intangible assets totaled approximately $98.8 million.

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 portable
multimedia 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 expense.

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
then download and play on their personal media player. Microsoft has launched digital rights management software which provides personal media players access to music content on a subscription basis in which consumers can pay a subscription fee to
rent, rather than own, the song file. The technology adds 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 better able to interface 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 adversely impacted.



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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, we adopted FASB Statement No. 123R, effective January 1, 2006, and we are now required to apply certain expense recognition provisions to share-based payments to employees using the fair value
method. This new accounting policy will have a material adverse effect on our financial position, results of operation and cash flow, 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.

If our internal control over financial reporting does not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely
affected.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over
financial reporting as of the end of each year, and to include a management report assessing the effectiveness of our internal control over financial reporting in our annual reports. Section 404 also requires our independent registered public
accounting firm to attest to, and report on, managements assessment of our internal control over financial reporting.



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Our management, including our CEO and CFO, does not expect that our internal control over financial
reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems objectives will be met. Further, the design of
a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. There exist inherent limitations in all control systems, so no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any, involving SigmaTel have been, or will be, detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can
occur because of simple human error. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by an override of those controls. The design of any system of controls is based in part on certain
assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Controls may become inadequate over time because of changes in conditions
or deterioration in the compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Although our management has determined, and our independent registered public accounting firm has attested, that our internal control over financial
reporting was effective as of December 31, 2005, we cannot assure you that we or our independent registered public accounting firm will not identify a material weakness in our internal controls in the future. A material weakness in our internal
control over financial reporting would require management and our independent registered public accounting firm to evaluate our internal control over financial reporting as ineffective. If our internal control over financial reporting is considered
ineffective, we may experience a loss of public confidence, which could have an adverse effect on our business and our stock price.

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

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

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

On April 26, 2006, we held our Annual
Meeting of Stockholders. The matters voted upon at the meeting and the results of those votes were as follows:

Election of Class III
Directors.



|                  |  |                              |  |                                       
|----------------- |  | ---------------------------- |  | --------------------------------------
|                  |  | Total Vote for Each Director |  | Total Vote Withheld From Each Director
|John A. Hime      |  | 29,355,303                   |  | 986,582                               
|Kenneth P. Lawler |  | 30,079,641                   |  | 262,244                               

In addition to the above Class III directors, the following directors terms of office as director
extended beyond the date of the meeting: Class I directors (Ronald P. Edgerton and William P. Osborne), and Class II directors (Alexander M. Davern and Robert T. Derby), who will serve until the annual meetings of stockholders to be held in 2007 and
2008, respectively. Kenneth P. Lawler resigned from SigmaTels board of directors effective July 25, 2006.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

See Exhibit Index.



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SIGMATEL, INC.

SIGNATURE

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



|                      |  |                |  |                                                      
|--------------------- |  | -------------- |  | -----------------------------------------------------
|                      |  | SIGMATEL, INC.
|                      |  |               
|Dated: August 9, 2006 |  | 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.                                                                                                                                 
|              | 
|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.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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