UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
                                    FORM 20-F
(Mark One)

[ ]   Registration statement pursuant to Section 12(b) or 12(g) of the
      Securities Exchange Act of 1934 or

[x]   Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
      Act of 1934 For the fiscal year ended December 31, 2006 or

[ ]   Transition report pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934 For the transition period from ____ to_____. or

[ ]   Shell company report pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934 Date of event requiring this shell company report


Commission file number: 0-30910

                          O2MICRO INTERNATIONAL LIMITED
             (Exact Name of Registrant as Specified in Its Charter)
                               The Cayman Islands
                 (Jurisdiction of Incorporation or Organization)
                 Grand Pavilion Commercial Centre, West Bay Road
                         P.O. Box 32331 SMB, George Town
                          Grand Cayman, Cayman Islands
                    (Address of Principal Executive Offices)

         Securities registered or to be registered pursuant to Section 12(b) of
the Act:
<TABLE>
<CAPTION>

             Title of Each Class                              Name of Each Exchange On Which Registered
             -------------------                              -----------------------------------------
<S>                                                          <C>
          American Depositary Shares                                 Nasdaq Global Select Market
Ordinary Shares, par value $0.00002 per share                  The Stock Exchange of Hong Kong Limited
                                                                    Cayman Islands Stock Exchange
</TABLE>

      Securities registered or to be registered pursuant to Section 12(g) of the
Act:

                                      None
                                (Title of Class)

      Securities for which there is a reporting obligation pursuant to Section
15(d) of the Act:

                                      None
                                (Title of Class)

      Indicate the number of outstanding shares of each of the issuer's classes
      of capital or common stock as of the close of the period covered by the
      annual report.

      As of December 31, 2006, there were 1,906,969,950 ordinary shares, par
      value US$0.00002 per share, outstanding.

      Indicate by check mark if the registrant is a well-known seasoned issuer,
      as defined in Rule 405 of the Securities Act.

                  Yes      [ ]              No       [x]

      If this report is an annual or transition report, indicate by check mark
      if the registrant is not required to file reports pursuant to Section 13
      or 15(d) of the Securities Exchange Act of 1934.

                  Yes      [ ]              No       [x]

      Note - Checking the box above will not relieve any registrant required to
      file reports pursuant to Section 13 or 15(d) of the Securities Exchange
      Act of 1934 from their obligations under those Sections.

<PAGE>

      Indicate by check mark whether the 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 which financial statement item the registrant has
      elected to follow:

                  Item 17  [ ]             Item 18  [x]

         If this is an annual report, indicate by check mark whether the
         registrant is a shell company (as defined in Rule 12b-2 of the Exchange
         Act).

                  Yes      [ ]              No      [x]

                                       2
<PAGE>

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<CAPTION>

                                            TABLE OF CONTENTS

                                                  PART I
<S>   <C>                                                                                           <C>
 Item 1.      Identity of Directors, Senior Management and Advisors..................................6

 Item 2.      Offer Statistics and Expected Timetable................................................6

 Item 3.      Key Information........................................................................6

 Item 4.      Information on the Company............................................................20

 Item 4A.     Unresolved Staff Comments.............................................................28

 Item 5.      Operating and Financial Review and Prospects..........................................28

 Item 6.      Directors, Senior Management and Employees............................................38

 Item 7.      Major Shareholders and Related Party Transactions.....................................45

 Item 8.      Financial Information.................................................................47

 Item 9.      The Offer and Listing.................................................................47

 Item 10.     Additional Information................................................................49

 Item 11.     Quantitative and Qualitative Disclosures About Market Risk............................59

 Item 12.     Description of Securities Other Than Equity Securities................................61

                                                    PART II

 Item 13.     Defaults, Dividend Arrearages and Delinquencies.......................................61

 Item 14.     Material Modifications to the Rights of Security Holders and Use of Proceeds..........61

                                                   PART III

 Item 15T.    Controls and Procedures...............................................................61

 Item 16.     Reserved..............................................................................62

 Item 16A     Audit Committee Financial Expert......................................................62

 Item 16B     Code of Ethics........................................................................62

 Item 16C     Principal Accountant Fees and Services ...............................................62

 Item 16D     Exemption from the Listing Standards for Audit Committee..............................63

 Item 16E     Purchases of Equity Securities by the Issuer and Affiliated Purchasers................64
</TABLE>

                                       3
<PAGE>
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                                                    PART IV

<S>   <C>                                                                                          <C>
 Item 17.     Financial Statements..................................................................65

 Item 18.     Financial Statements..................................................................65

 Item 19.     Exhibits..............................................................................65

 Index to Consolidated Financial Statements........................................................F-1

 Signatures
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                                       4

<PAGE>


                       Certain Definitions and Conventions

         In this annual report on Form 20-F (this "Annual Report"), references
to "$" and "dollars" are to United States dollars. Percentages and certain
amounts contained herein have been rounded for ease of presentation. Any
discrepancies in any table between totals and the sums of amounts listed are due
to rounding.


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

         This Annual Report contains statements of a forward-looking nature.
These statements are made under the "safe harbor" provisions of the U.S. Private
Securities Litigation Reform Act of 1995. You can identify these forward-looking
statements by terminology such as "may," "will," "expects," "should," "could,"
"plans," "intends," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of these terms and other comparable
terminology. These forward-looking statements include, without limitation,
statements regarding our expectation to increase expenses for personnel, new
product development, to protect our technology and to expand our product
offerings, our anticipation that sales to a relatively small number of customers
will continue to account for significant portion of net sales, our expectation
that non-U.S. operations and sales will continue to grow and account for a
substantial percentage of our net sales, our statements regarding the growing
popularity of thinner displays, mobile computing and portable devices, and the
emergence and continued development of the Internet and wireless communications
networks, our belief that we participate in large and growing markets, our
belief that potential future growth in the LCD television market, especially
units with larger-size panels, represents an attractive growth opportunity for
us, our belief that manufacturers are turning to innovative new semiconductor
technologies to manage the available power source capacity more efficiently, our
belief that there is an increasing need for higher levels of system integration,
our belief in the need for mixed-signal and analog integrated circuits
specifically designed to optimize the power system usage in devices, our belief
in the need to use advanced design methodologies to allow manufacturers to
achieve rapid time-to-market with their new products, our expectation that our
markets will be dominated by a small number of major brand name companies, our
expectation that we will experience the highest sales volume in the third and
fourth quarter of each year, our ability to develop and introduce products in a
timely manner to meet customer demands, our expectation that analog and
mixed-signal circuits have substantially longer life-cycles than digital
integrated circuits, our ability to take advantage of cost-efficiencies
associated with the "fabless" semiconductor business model, our future gross
profit, our expectation that gross margin on products we sell will typically
decline over the life of the products, our expectation that gross profit as a
percentage of net sales will continue to fluctuate, our expectation that
research and development expenses as a percentage of net sales will continue to
fluctuate, our expectation to continue development of innovative technologies
and processes, and continued expansion and investment of our engineering,
research and development resources, our expectation to continue to invest
significant resources into research and development in the future, our
expectation that selling, general and administrative expenses will continue to
increase in absolute dollars, our expectation that patent litigation expenses
will continue to fluctuate in absolute dollars and will remain significant
leading up to and during our trials scheduled for July 2007 and February 2008,
our expectations regarding the outcome of litigation matters, our belief that
cash balances will be sufficient to meet our capital requirements for at least
the next 12 months, our belief that our research and development staffing will
increase in the next 12 months primarily due to expansion of existing design
centers and the opening of additional design centers, our intention to continue
expanding research and development operations, our intention to expand the scope
of our international operations, our expectation that semiconductor companies
will increasingly be subject to infringement claims as the number of products
and competitors in the semiconductor industry grows, our belief that we operate
in compliance with all applicable transfer pricing laws in all of the
jurisdictions in which we operate, our belief regarding our efforts to remediate
concerns relating to our internal controls, our anticipation that we will not
declare any dividend in the foreseeable future,

                                       5
<PAGE>

our belief that our system-level expertise and extensive experience with power
management systems allow us to develop proprietary solutions and foster
long-term relationships with our customers, our intention to continue to
evaluate additional investment opportunities in our supply chain, our belief
that our current facilities are adequate for our needs for the foreseeable
future, and that any additional space required will be available to us on
commercially reasonable terms, our expectation that our results of operations or
cash flows will not be affected to any significant degree by a sudden short-term
change in market interest rates, and our statements regarding the effect of
adoption of certain accounting policies. These forward-looking statements are
based on our current assumptions and beliefs in light of the information
currently available to us. Actual results, levels of activity, performance or
achievements may differ materially from those expressed or implied in these
forward-looking statements for a variety of reasons, including: changes in
demand for devices that use our products; market conditions in the semiconductor
industry and the economy as a whole; the stages of our products in their life
cycles, variations, expansions or reductions in the mix of our product
offerings, the timing of our product introductions, specific product
manufacturing costs, increased competition, introduction of new competing
technologies and the increase of unexpected expenses, and such other factors
discussed under "Key Information - Risk Factors", "Operating and Financial
Review and Prospects" and elsewhere in this Annual Report. We assume no
obligation to update or revise any forward-looking information, whether as a
result of new information, future events or otherwise. You are cautioned not to
place undue reliance on these forward-looking statements which apply only as of
the date of this Annual Report.

                                     PART I

ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

         Not applicable.

ITEM 2.  OFFER STATISTICS AND EXPECTED TIMETABLE

         Not applicable.

ITEM 3.  KEY INFORMATION

SELECTED CONSOLIDATED FINANCIAL DATA

         The selected consolidated financial data for the years ended December
31, 2004, 2005 and 2006, and the selected consolidated financial data as of
December 31, 2005 and 2006, set forth below, are derived from our audited
consolidated financial statements included herein, and should be read in
conjunction with, and are qualified in their entirety by reference to, these
consolidated financial statements, including the notes to these consolidated
financial statements and "Item 5. Operating and Financial Review and Prospects"
included elsewhere in this Annual Report on Form 20-F. The selected consolidated
financial data for the years ended December 31, 2002 and 2003 and the selected
consolidated financial data as of December 31, 2002, 2003 and 2004, set forth
below, are derived from our audited consolidated financial statements and
related notes which do not appear in this Annual Report on Form 20-F. Our
consolidated financial statements are prepared and presented in accordance with
generally accepted accounting principles in the United States of America.

                                       6
<PAGE>
<TABLE>
<CAPTION>
                                                        Year Ended December 31,
                                   -------------------------------------------------------------------
                                      2002          2003          2004           2005         2006
                                   -----------   -----------   -----------   -----------   -----------
                                                 (in thousands, except per share data)
Consolidated Statement of
 Operations Data:
<S>                                <C>           <C>           <C>           <C>           <C>
Net sales ......................   $    70,187   $    88,599   $    92,196   $   105,552   $   124,915

Cost of sales ..................        28,143        38,314        37,403        40,741        56,772
                                   -----------   -----------   -----------   -----------   -----------
Gross profit ...................        42,044        50,285        54,793        64,811        68,143
Operating expenses:
   Research and development ....        18,965        19,219        20,260        25,421        31,751
   Selling, general and
     administrative ............        11,804        13,522        16,348        20,279        29,209
   Patent related litigation ...           535         3,954         5,334        10,174        10,962
   Stock Exchange of Hong Kong
     listing expenses ..........          --            --            --           2,460           786
                                   -----------   -----------   -----------   -----------   -----------
     Total operating expenses ..        31,304        36,695        41,942        58,334        72,708
                                   -----------   -----------   -----------   -----------   -----------
Income (loss) from operations ..        10,740        13,590        12,851         6,477        (4,565)
Non-operating income - net .....         1,662         1,437         2,705         2,704         2,858
                                   -----------   -----------   -----------   -----------   -----------
Income (loss) before income tax         12,402        15,027        15,556         9,181        (1,707)
Income tax expense (benefit)  ..         1,673         1,826         1,472         1,034        (2,450)
                                   -----------   -----------   -----------   -----------   -----------
Net income .....................        10,729        13,201        14,084         8,147           743
                                   ===========   ===========   ===========   ===========   ===========
Earnings per share(1):
       Basic ...................        0.0056        0.0069        0.0072        0.0042        0.0004
       Diluted .................        0.0054        0.0066        0.0070        0.0041        0.0004
Shares used to compute basic
    earnings per share(1): .....     1,915,000     1,918,700     1,957,800     1,961,168     1,932,575
                                   ===========   ===========   ===========   ===========   ===========
Shares used to compute diluted
    earnings per share(1): .....     1,979,550     1,986,800     2,005,100     1,997,459     1,946,896
                                   ===========   ===========   ===========   ===========   ===========
Earnings per ADS(2):
       Basic ...................          0.28          0.34          0.36          0.21          0.02
       Diluted .................          0.27          0.33          0.35          0.20          0.02
ADS equivalents used to compute
    basic earnings per ADS(2): .        38,300        38,374        39,156        39,223        38,652
                                   ===========   ===========   ===========   ===========   ===========
ADS equivalents used to compute
    diluted earnings per ADS(2):        39,591        39,736        40,102        39,949        38,938
                                   ===========   ===========   ===========   ===========   ===========
</TABLE>

<TABLE>
<CAPTION>
                                                               December 31,
                                           ----------------------------------------------------
                                             2002        2003      2004       2005      2006
                                           --------   --------   --------   --------   --------
                                                              (in thousands)
Consolidated Balance Sheet Data:
<S>                                        <C>        <C>        <C>        <C>        <C>
Cash and cash equivalents ..............   $ 69,334   $ 66,489   $ 56,320   $ 46,375   $ 45,438
Short-term investments .................     42,675     53,923     63,768     55,653     19,697
Working capital ........................    120,793    130,510    132,713    117,942     90,865
Total assets ...........................    145,836    169,293    185,196    199,655    197,020
Long-term liabilities, excluding current
   portion .............................       --         --         --         --          455
Net assets .............................    135,148    154,727    170,781    175,896    173,511
Ordinary shares and additional paid-in
   capital .............................    126,232    137,115    139,620    138,275    140,262
</TABLE>


   (1) All share information has been adjusted retroactively to reflect the
      50-for-1 share split effected on November 25, 2005.

   (2) Fifty ordinary shares equal one American Depositary Share ("ADS").

CAPITALIZATION AND INDEBTEDNESS

Not applicable.

REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable.

                                       7
<PAGE>

RISK FACTORS

         We wish to caution readers that the following important factors, and
those important factors described in other reports submitted to, or filed with,
the Securities and Exchange Commission, among other factors, could affect our
actual results and could cause our actual results to differ materially from
those expressed in any forward-looking statements made by us or on our behalf
and that such factors may adversely affect our business and financial status and
therefore the value of your investment:

If the markets for consumer electronics, computers, industrial or communications
products do not grow substantially or even decrease, our net sales may be
harmed.

         Our business focuses on designing, developing and marketing high
performance integrated circuits for manufacturers of products for the consumer
electronics, computer, industrial and communications markets. As many of the
leading sellers of these products have an intermediary manufacture their
products or those portions of their products containing our components, we
currently derive substantially all of our product revenues from sales to these
intermediaries or their suppliers. We also have targeted and are designing
products for applications such as LCD monitors, LCD televisions, notebook
computers, Internet security, mobile phones, GPS and portable media players,
such as portable DVD players. We believe that the important factors driving
growth in these markets have been the growing popularity of thinner displays,
mobile computing and portable devices, and the emergence and continued
development of the Internet and wireless communications networks. If demand for
products using LCDs or other devices using our products declines, or does not
grow as quickly as we anticipate, our customers may experience lower demand for
their products that use our products, which may cause our net sales to suffer.
We cannot be certain that the markets for these products will continue to grow
as rapidly as they have in the past or that a significant slowdown in these
markets will not occur.

Fluctuations in our quarterly operating results due to factors such as changes
in the demand for electronic devices that utilize our products could adversely
affect the trading price of our ordinary shares and/or our ADSs.

         We believe that quarter-to-quarter comparisons of our financial results
are not necessarily meaningful indicators of our future results of operations,
and they should not be relied upon as an indication of our future performance.
If our quarterly operating results fail to meet the expectations of securities
analysts, the trading price of our ordinary shares and/or our ADSs could be
adversely affected. Our quarterly operating results have varied substantially in
the past and may vary substantially in the future depending upon a number of
factors described below and elsewhere in this Risk Factors section, including
many factors that are beyond our control. These factors include changes in
demand for devices that use our products; market conditions in the semiconductor
industry and the economy as a whole; the timing and cancellation of customer
orders; the level of orders received that can be shipped in a quarter; the
availability of third party semiconductor foundry, assembly and test capacities;
fluctuations in manufacturing yields; delays in the introduction of new
products; changes in the mix of sales of higher margin products and lower margin
products; seasonal changes in demand during the year-end holiday season for
devices that use our products; and the amount of legal and other expenses
incurred in a particular quarter.

         In addition, the trading price of our ordinary shares and/or our ADSs
may be affected by factors such as: significant price and volume fluctuations in
our ordinary shares and/or our ADSs and financial markets in the U.S. and other
countries, as well as relatively thin trading volume of our ordinary shares
and/or our ADSs on Nasdaq and the HKSE, respectively. Further, the trading
markets for our ordinary shares and/or our ADSs are affected by the research
reports that securities or industry analysts publish about us or our business.
We do not have control over such coverage. If one or more analysts were to
downgrade our ordinary shares and/or our ADSs, the price of our ordinary shares
and/or our ADSs may decline. If one or more analysts cease coverage of our
company or does not regularly publish reports on us, we may lose visibility in
the financial markets, which could cause the price of our ordinary shares and/or
our ADSs or trading volume to decline.

                                       8
<PAGE>

If orders for our products are cancelled or deferred, our net sales, operating
margins and net income could be substantially reduced.

         Orders for our products can be cancelled or deferred with little notice
from and without significant penalty to our customers. A significant portion of
our net sales in any financial reporting period depends on orders booked and
shipped in that period. If a large amount of orders placed is cancelled or
deferred, our net sales in that period could be substantially reduced. Since we
do not have significant non-cancellable backlog, we typically plan our
production and inventory expenses based on internal forecasts of customer
demand, which are highly unpredictable and can fluctuate substantially. In
particular, in response to anticipated lengthy lead times, which in the past
have been as much as ten weeks or more, to obtain inventory and materials from
our suppliers, we place orders with these suppliers in advance of anticipated
customer demand, which can result in excess inventory if the expected orders
fail to materialize. We also expect to increase our expenses for personnel and
new product development. It is difficult for us to reduce our production,
inventory, personnel and new product development expenses quickly in response to
any shortfalls in net sales resulting from cancelled or deferred orders. As a
result, any cancellation or deferral of orders would not only harm our net
sales, it would also likely have a disproportionately adverse effect on our
operating margins and net income.

We depend on third parties to manufacture, assemble and test our products and,
if they are unable to do so, our ability to ship products and our business and
results of operations will be harmed.

         We do not own or operate the integrated circuit fabrication facilities
that manufacture the products we design. Three foundries, SMIC, TSMC and X-FAB,
manufactured most of the integrated circuit products that we sold in 2006. These
foundries manufacture integrated circuit products for us according to purchase
orders. We do not have a guaranteed level of production capacity at any of these
foundries, and any one or more could raise prices without notice. Although we
provide the foundries with rolling forecasts of our production requirements, the
ability of each foundry to provide wafers to us is limited by the foundry's
available capacity. The term "wafers" refers to slices of silicon used to
manufacture integrated circuits, and it is one of the principal raw materials in
our products. These foundries 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 these foundries will allocate sufficient capacity, if any, to
satisfy our requirements particularly during any industry-wide capacity
shortages. In addition, if any of these foundries were unable to continue
manufacturing our products in the required volumes at acceptable quality, yields
and costs or in a timely manner, our business and results of operations would be
seriously harmed.

         There are other significant risks associated with our reliance on these
foundries, including the disruption in our ability to ship products caused by
the length of time, as much as 12-to-18 months, required for us to find
alternative foundries for existing or new products; the reduction or elimination
of deliveries to us by these outside foundries caused by a sudden increase in
demand for semiconductor devices or a sudden reduction or elimination of
manufacturing capacity by any existing manufacturers of semiconductor devices;
the unavailability of, or delays in obtaining access to, key process
technologies used by these foundries; and the susceptibility of our outside
foundries to production interruptions resulting from natural disasters, such as
the interruptions experienced in Taiwan in the past due to earthquake activity.
Any of these events could cause these foundries to reduce or eliminate
deliveries to us and cause disruption in our ability to ship products to our
customers which could negatively affect our business and results of operations.

         We also rely on independent subcontractors to assemble and test most of
our integrated circuit products. We do not have long-term agreements with any of
these subcontractors but obtain services from them primarily on a purchase order
basis. Our reliance on these subcontractors involves risks such as reduced
control over delivery schedules, quality assurance and costs. These risks could
result in product shortages or

                                       9
<PAGE>

increase our costs of manufacturing, assembling or testing our products. If
these subcontractors were unable or unwilling to continue to provide assembly
and test services and deliver products at acceptable quality, yields and costs
or in a timely manner, our business would be seriously harmed. We would also
have to identify and qualify substitute subcontractors, which would be time
consuming and costly and could result in unforeseen operational difficulties.

If we cannot compete effectively against new and existing competitors, our net
sales and gross margins could be harmed.

         Our ability to compete successfully in the market for integrated
circuit products depends on factors both within and outside our control,
including: our success in designing and subcontracting the manufacture of new
products that implement new technologies and satisfy our customers' needs; the
performance of our products across a variety of parameters such as reliability
and cost efficiency; the price of our products and those of our competitors; our
ability to control production costs; and the features of our competitors'
products.

         We believe our principal competitors include Intersil Corporation,
Linear Technology Corporation, Maxim Integrated Products, Inc., Microsemi
Corporation, Monolithic Power Systems, Inc., Ricoh Company, Ltd., Rohm Co., Ltd
and Texas Instruments Incorporated. There is also competition from the internal
integrated circuit design and manufacturing capabilities of some of our existing
and potential customers, such as Toshiba and Fujitsu. In addition to these
competitors, other integrated circuit companies may decide to enter the market
with mixed-signal integrated circuit products that compete with our products or
incorporate functions similar to those provided by our products.

         Some of our competitors, such as Texas Instruments, have greater name
recognition, their own manufacturing capabilities, significantly greater
financial and technical resources, and the sales, marketing and distribution
strengths that are normally associated with large multinational companies. These
competitors may also have pre-existing relationships with our customers or
potential customers. These competitors may be able to introduce new technologies
more quickly, address customer requirements more rapidly and devote greater
resources to the promotion and sale of their products than we do. Further, in
the event of a manufacturing capacity shortage, these competitors may be able to
manufacture products themselves or obtain third-party manufacturing capability
when we are unable to do so.

If we do not develop and introduce new products in a timely manner, our net
sales and gross margins could be harmed.

      Our success depends upon our ability to develop and introduce new products
selected for design into products for the consumer electronics, computer,
industrial and communications markets. If we are unable to develop new products
in a timely manner, our net sales will suffer. In addition, because our gross
margins typically decline over the life cycle of our products as a result of
competitive pressures and voluntary pricing arrangements, any failure to develop
new products in a timely manner will likely cause our gross margins to decline.
The development of our new products is highly complex, and from time to time we
have experienced delays in the introduction of new products of as much as
eight-to-twelve weeks or more. Successful product development and introduction
of new products depend on a number of factors, including accurate new product
definition; timely completion of new product designs; achievement of
manufacturing yields; timely and cost-effective production of new products; and
timely delivery of new third-party supplied products used as key components in
devices that incorporate our products. We often incur significant expenditures
in the development of a new product without any assurance that it will be
selected for design into our customers' products. If we incur such expenditures
but fail to be selected, our results of operations will be adversely affected
and may fluctuate significantly from period to period. Furthermore, even if our
products were selected for design into our customers' products, we cannot be
certain that these products will be commercially successful or that we will
benefit from any associated sales.

                                       10

<PAGE>

It is difficult to evaluate our future prospects, and we cannot assure you that
we will not incur future losses.

         Our past results cannot be relied upon to predict our future
performance. We incurred net losses in each year prior to the year ended
December 31, 1999. We then experienced significant quarter-to-quarter sales
growth in each of the years ended December 31, 2001, 2002 and 2003. However,
since the first quarter ended March 31, 2004, we have experienced fluctuations
in net sales compared to the previous quarter. Our net sales are subject to
fluctuation from quarter to quarter, our previous overall growth may not
continue, and we may not be able to sustain or increase profitability in the
future. We anticipate that our expenses will increase substantially in the
foreseeable future as we continue to develop our technology, protect our
technology, expand our product offerings and expand our capabilities. These
efforts may prove more expensive than we currently anticipate, and we may not
succeed in increasing our net sales sufficiently to offset our increased
expenses. If we fail to increase our net sales to keep pace with our increased
expenses, we may again experience net losses in future periods, which could
cause the trading price of our ordinary shares and/or our ADSs to decline.

If we fail to protect our intellectual property rights, competitors may be able
to use our technology or trademarks, and this could weaken our competitive
position, increase our costs, reduce our margins and reduce our net sales.

         Our success is heavily dependent upon our proprietary technology. We
rely primarily on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary technology and prevent competitors from using our technology in
their products. These laws and procedures provide only limited protection. Our
patents may not provide sufficiently broad protection or they may not prove to
be enforceable in actions against alleged infringement.

         Our ability to sell our products and prevent competitors from
misappropriating our proprietary technology and trade names is dependent upon
protecting our intellectual property. Despite the precautions we take,
unauthorized third parties may copy aspects of our current or future products or
obtain and use information that we regard as proprietary. Additionally, our
competitors may independently develop similar or superior technology. Policing
unauthorized use of software, circuit design or semiconductor design is
difficult and some countries' laws do not protect our proprietary rights to the
same extent as the laws of the United States, Hong Kong and other developed
countries. We have in the past and currently have initiated litigation to
protect our intellectual property rights. Litigation may be necessary in the
future to enforce our intellectual property rights, to protect our trade secrets
or to determine the validity and scope of the proprietary rights of others.
Litigation could result in substantial costs and diversion of resources, and
could also result in a decision that our intellectual property is invalid or
unenforceable and, could adversely affect our business, future results of
operations and financial condition. See the section headed "Business
Overview--Intellectual Property".

If we cannot adapt our product offerings to respond to rapid technological
changes, our net sales will be harmed.

         The markets for consumer electronics, computer, industrial and
communications products, and the components used in these products, are
characterized by rapidly changing technology and very frequent new product
introductions by our direct customers and our competitors. For example, the
microprocessor, display and battery technologies with which our products
inter-operate change very rapidly. Although our products integrate analog and
mixed-signal circuits and therefore have substantially longer life-cycles than
digital integrated circuits, we must still update our products or introduce new
ones on a regular basis. If we do not respond in a timely manner to
technological changes and new product introductions by our direct customers and
competitors, we will be unable to maintain and grow our product sales. In
addition, the emergence of significantly more efficient or cost-effective
microprocessor, display and battery technologies could lessen the need for the
power management functionality of our products, which would harm our net sales.

                                       11
<PAGE>

Defects in our products could result in significant costs and could impair our
ability to sell our products.

         Detection of any significant defects in our products may result in,
among other things, loss of or delay in market acceptance and sales of our
products, diversion of development resources, injury to our reputation and
increased service and warranty costs. Because our products are complex, they may
contain defects that can be detected at any point in a product's life cycle.
These defects could harm our reputation, which could result in significant costs
to us and could impair our ability to sell our products. The costs we may incur
in correcting any product defects may be substantial and could materially
adversely affect our results of operations. While we continually test our
products for defects and work with customers through our customer support
services to identify and correct problems, defects in our products may be found
in the future. Testing for defects is complicated in part because it is
difficult to simulate the highly complex environments in which our customers may
use our products. In the past, we have discovered defects in our products and
have experienced delays in the shipment of our products. These delays have
principally related to new product update releases. To date, none of these
delays has materially affected our business. However, product defects or delays
in the future could be material, and could adversely affect our reputation and
our ability to sell our products.

We have substantial operations outside of the United States that expose us to
risks specific to our international operations that could harm our net sales and
net income.

         As of December 31, 2006, a substantial portion of our operations, most
of our employees, and most of the third parties we use to manufacture, assemble
and test our products were located in Japan, Korea, China, Singapore and Taiwan.
In addition, sales outside the United States as a percentage of net sales were
almost 100% in the years ended December 31, 2002, 2003, 2004, 2005 and 2006. We
expect our non-U.S. operations to grow and non-U.S. sales to continue to account
for a substantial percentage of our net sales.

         We are subject to risks specific to our international business
operations, including: the risk of supply disruption, production disruption or
other disruption arising from the outbreak of any severe communicable disease or
other widespread health problems; the risk of potential conflict and further
instability in the relationship between Taiwan and China; risks related to
international political instability and to the recent global economic turbulence
and adverse economic circumstances in Asia, such as in Japan and Korea;
unpredictable consequences on the economic conditions in the U.S. and the rest
of the world arising from terrorist attacks, such as the attacks of September
11, 2001 in the U.S. and other military or security operations, particularly
with regard to the conflicts in the Middle East involving Iraq; unexpected
changes in regulatory requirements or legal uncertainties regarding tax regimes,
such as the change to the tax code of Taiwan in 2001 that resulted in a higher
income tax rate on our retained earnings; tariffs and other trade barriers,
including current and future import and export restrictions; difficulties in
staffing and managing international operations; adverse effects of changes in
foreign currency exchange rates on our results of operations; limited ability to
enforce agreements and other rights in foreign countries; changes in labor
conditions; longer payment cycles and greater difficulty in collecting accounts
receivables; burdens and costs of compliance with a variety of foreign laws;
expropriation of private enterprises; and reversal of the current policies
(including favorable tax and lending policies) encouraging foreign investment or
foreign trade by our host countries. In addition, the geographical distances
between Asia, the U.S., the Cayman Islands and Europe also create a number of
logistical and communication challenges. Although we have not experienced any
serious harm in connection with our international operations, we cannot assure
you that such problems will not arise in the future.

         In addition, our reporting currency is the U.S. dollar. However, a
significant portion of our operating expenses is denominated in currencies other
than the U.S. dollar, primarily the New Taiwan dollar and the Chinese Renminbi.
As a result, appreciation or depreciation of other currencies in relation to the
U.S. dollar could result in material transaction or translation gains or losses
that could adversely affect, or cause fluctuations in, our results of
operations. We do not currently engage in currency hedging activities.

                                       12
<PAGE>

We will need to recruit and retain qualified personnel to grow our business
successfully.

         Our future success will depend on our ability to attract and retain
experienced sales, research and development, marketing, customer support and
management personnel. If we do not attract and retain these personnel, our
ability to grow our business, sell our products, enter new markets and increase
our share of existing markets could be harmed. There can be no assurance that we
will be successful in hiring for these positions in the near future. Our sales
strategy requires that we hire additional direct sales persons and independent
sales representatives in our major markets. Moreover, our independent sales
representatives and direct sales personnel must market our products effectively
and be qualified to provide timely and cost-effective customer support and
service. If they are unable to do so or if we are unable to expand these
organizations, this could harm our ability to increase our net sales and limit
our ability to sell our products or expand our market share. Competition for
qualified personnel in digital, analog and mixed-signal integrated circuit
design is intense. In the past, we have experienced difficulty in recruiting
qualified personnel, especially technical and sales personnel. As we intend to
expand the scope of our international operations, this will require us to
attract experienced management, research and development, marketing, sales and
customer support personnel for our international offices. We expect competition
for qualified personnel to remain intense, and we may not succeed in attracting
or retaining such personnel. In addition, new employees generally require
substantial training in our design methodology, design flow and technology,
which in turn requires significant resources and management attention. There is
a risk that, even if we invest significant resources in attempting to attract,
train and retain qualified personnel, we will not be successful in our efforts.
In that event, our costs of doing business would increase without a
corresponding increase in net sales.

         Our success will depend to a significant extent on the continued
service of our executive officers, including Sterling Du, our chief executive
officer and chairman of our board, and other key employees, including key sales,
consulting, technical, marketing and legal personnel. If we lose the services of
one or more of our executives or key employees, our business and ability to
implement our business objectives successfully could be harmed, particularly if
one or more of our executives or key employees decide to join a competitor or
otherwise compete directly or indirectly with us.

A substantial portion of our net sales is generated by a small number of
customers. If any of these customers delays or reduces its orders, our net sales
and earnings may be harmed.

         Historically, a relatively small number of customers has accounted for
a significant portion of our net sales in any particular period. We have no
long-term volume purchase commitments from any of our significant customers. We
cannot be certain that our current customers will continue to place orders with
us, that orders by existing customers will continue at the levels of previous
periods or that we will be able to obtain orders from new customers. In
addition, some of our customers, acting as intermediary manufacturers, supply
products to end-market purchasers, and any of these end-market purchasers could
choose to reduce or eliminate orders for our customers' products. This would in
turn lower our customers' orders for our products.

         In 2006, no customer accounted for 10% or more of net sales. In 2005,
no customer accounted for 10% or more of net sales. In 2004, one customer
accounted for 17.5% of our net sales. The variations in sales to these customers
as a percentage of our total net sales have been caused by a number of factors,
some of which were outside our control. We anticipate that sales of our products
to a relatively small number of customers will continue to account for a
significant portion of our net sales. The reduction, delay or cancellation of
orders from one or more of our significant customers would have a
disproportionately negative impact on our results of operations.

Our ability to manage growth will affect our ability to achieve and maintain
profitability.

         Our ability to maintain profitability will depend in part on our
ability to implement and expand operational, customer support and financial
control systems and to train and manage our employees. We may

                                       13
<PAGE>

not be able to augment or improve existing systems and controls or implement new
systems and controls in response to future growth, if any. In addition, we will
need to expand our facilities to accommodate the growth in our personnel. Any
failure to manage growth could divert management attention from executing our
business plan and adversely affect our ability to expand our business
successfully. Our historical growth has placed, and any further growth is likely
to continue to place, a significant strain on our resources. In order to grow
successfully, we will need to maintain close coordination among our executive,
engineering, accounting, finance, marketing, sales, operations and customer
support organizations, particularly in light of the internationally dispersed
nature of our operations.

Third parties have asserted, and in the future could assert, that our products
infringe their intellectual property rights. These claims could harm our ability
to sell our products and expose us to litigation.

         As is typical in the semiconductor industry, we have from time to time
received communications from third parties asserting patents that cover certain
of our technologies or products and alleging infringement of certain of their
intellectual property rights. We may receive similar communications in the
future. In the event any third party were to make a valid claim against us or
our customers, we could be enjoined from selling selected products such as our
inverter or power products or could be required to pay royalties to third
parties. Third-party infringement claims, with or without merit, have been and
could continue to be time consuming, result in substantial diversion of our
resources and potentially significant litigation costs, including costs related
to any damages we may owe, cause product shipment delays or require us to enter
into license agreements. Such license agreements may not be available on
acceptable terms, or at all. Any such event could seriously harm our business
and our results of operations. We expect that semiconductor companies will
increasingly be subject to infringement claims as the number of products and
competitors in the semiconductor industry grows. See the section headed
"Business Overview--Intellectual Property."

         From time to time, in the normal course of business, we agree to
indemnify third parties with whom we enter into contractual relationships,
including customers and parties to other transactions with us, with respect to
certain matters. We have agreed, under certain conditions, to hold these third
parties harmless against specified losses, such as those arising from a breach
of representations or covenants, other third-party claims that our products when
used for their intended purposes infringe the intellectual property rights of
such other third parties or other claims made against certain parties. It is not
possible to determine the maximum potential amount of liability under these
indemnification obligations due to our limited history of prior indemnification
claims and the unique facts and circumstances that are likely to be involved in
each particular claim. To date, we have not made any payments under these
obligations.

         Until all outstanding litigation is resolved, we will continue to incur
substantial legal expenses that vary with the level of activity in the legal
proceedings. This level of activity is not entirely within our control as we may
need to respond to legal actions. Consequently, we may find it difficult to
predict the legal expenses for any given period, which will impair our ability
to forecast our results of operations for that period. It is likely that these
expenses will remain significant leading up to and during our trials scheduled
for July 2007 and February 2008.

         Given the inherent uncertainties in litigation, there cannot be any
assurance that we will prevail in any particular litigation matter, and we
cannot predict the outcome of any such litigation. If any party were to prevail
in its claims against us, our rights to certain patents and results of
operations could be materially adversely affected. In any litigation arising
from claims that we infringe on the intellectual property rights of others, an
adverse result could involve an injunction to prevent the sales of a material
portion of our products, and a reduction or the elimination of the value of
related inventories, any of which could have a material adverse effect on our
net sales, results of operations and financial condition. See the section headed
"Business Overview--Intellectual Property."

                                       14

<PAGE>

We may be subject to lawsuits from third parties.

         We are a defendant or plaintiff in actions that arise in the normal
course of business as well as actions that arose as counterclaims in response to
our patent infringement actions, including actions for antitrust, unfair
competition and interference. While we currently believe the amount of ultimate
liability, if any, with respect to these actions will not materially affect our
financial position, overall trends in results of operations, or liquidity, the
ultimate outcome of any litigation or claim is uncertain, and the impact of an
unfavorable outcome could be material to us.

Sales of our products could decline if our products fail to support evolving
industry standards.

         Our net sales are derived from sales of integrated circuit products
that are components of electronic devices built to industry standards and widely
accepted specifications. For example, the bus interconnect specifications of
most notebook computers for attaching integrated peripherals are currently
Peripheral Component Interconnect (PCI), Universal Serial Bus (USB) and Low Pin
Count (LPC) and the software used to control the power management functions of
many notebook computers conforms to the industry's Advanced Configuration Power
Interface specification. Our products must be designed to conform to these
standards and specifications in order to achieve market acceptance. Technology
standards and specifications continually evolve, and we may not be able to
successfully design and manufacture new products in a timely manner that conform
to these new standards or specifications. Additionally, new products we develop
to conform to new specifications may not be accepted in the market.

We have incurred, and continue to incur, significant costs with respect to
corporate governance and financial reporting compliance.

         The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as
new rules subsequently implemented by the Securities and Exchange Commission, or
the SEC, and adopted by the Nasdaq in response to the Sarbanes-Oxley Act, have
increased and will continue to increase the scope, complexity and costs of our
financial reporting, securities disclosure and corporate governance practices.
These new or revised rules, regulations, and listing requirements are subject to
varying interpretations in many cases and their application in practice may
evolve over time as new guidance is provided by regulatory and governing bodies.
As a result, we may incur further legal and financial compliance costs and be
required to make unanticipated changes to our reporting, disclosure and
governance practices. These rules may divert management time and resources, make
it more difficult for us to attract and retain qualified executive officers and
members of our board, and make it more costly to obtain liability insurance
coverage for our officers and directors which could prove disruptive to our
business. In particular, the Sarbanes-Oxley Act requires that, among other
things: our chief executive officer and chief financial officer personally
certify our annual report on Form 20-F which is filed with the SEC each year,
which certification includes statements as to the accuracy and fair presentation
of the report's disclosure, the establishment and maintenance of controls and
procedures related to our disclosure and issues regarding our internal
accounting controls; we refrain from making most types of loans to our officers
and directors after the adoption of the Sarbanes-Oxley Act or from making any
material modifications to loans that existed prior to the adoption of the
Sarbanes-Oxley Act; we furnish a report in certain SEC filings in the future
pursuant to Section 404 of the Sarbanes-Oxley Act, as discussed in the following
risk factor and our audit committee pre-approve all audit and non-audit services
provided by our independent registered public accounting firm except for de
minimis services; be directly responsible for the appointment, compensation and
oversight of the work of our independent registered public accounting firm;
establish procedures for the receipt and treatment of complaints received by us
regarding accounting, controls or auditing matters and any confidential
submissions by our employees regarding questionable accounting or auditing;
comprise independent directors, as defined under the Sarbanes-Oxley Act and
applicable Nasdaq rules. If we fail to comply with new or revised rules,
regulations, and listing requirements in a timely manner, we may be exposed to
liability and public perception of our financial reporting, securities
disclosure and corporate governance practices could be negatively affected. As a
result, the price of our ordinary shares and/or our ADSs could decline.

                                       15
<PAGE>

Our transfer pricing procedures may be challenged, which may subject us to
higher taxes and adversely affect our earnings.

         Transfer pricing refers to the prices that one member of a group of
affiliated corporations charges to another member of the group for goods,
services or the use of intellectual property. If two or more affiliated
corporations are located in different countries, the laws or regulations of each
country generally will require that transfer prices be the same as those charged
by unrelated corporations dealing with each other at arm's length. If one or
more of the countries in which our affiliated corporations are located believe
that transfer prices were manipulated by our affiliated corporations in a way
that distorts the true taxable income of the corporations, the laws of such
countries could require us to redetermine transfer prices and thereby reallocate
the income of our affiliate corporations in order to reflect such income
clearly. Any reallocation of income from one of our corporations in a lower tax
jurisdiction to an affiliated corporation in a higher tax jurisdiction would
result in a higher overall tax liability to us. Moreover, if the country from
which the income is being reallocated does not agree to the reallocation, the
same income could be subject to taxation by both countries.

         We have adopted transfer pricing agreements with our subsidiaries
located in the United States, China, Taiwan, Japan and Singapore to regulate
inter-company transfers. A transfer pricing agreement is a contract for the
transfer of goods, services or intellectual property from one corporation to a
related corporation that sets forth the prices that the related parties believe
are those charged by unrelated corporations dealing with each other at arm's
length. We have entered into these types of agreements because a portion of our
assets, such as intellectual property developed in our U.S. and foreign
subsidiaries, is transferred among our affiliated corporations. In such
agreements, we have determined transfer prices that we believe are the same as
the prices that would be charged by unrelated parties dealing with each other at
arm's length. In this regard, we are subject to risks not faced by other
companies with international operations that do not create inter-company
transfers. If the taxing authorities of any jurisdiction, including Taiwan and
the United States, were to challenge these agreements successfully or require
changes in our transfer pricing practices, we could become subject to higher
taxes and our earnings would be adversely affected. We believe that we operate
in compliance with all applicable transfer pricing laws in all of the
jurisdictions in which we operate. However, there can be no assurance that we
will continue to be found to be operating in compliance with transfer pricing
laws, or that such laws will not be modified, which, as a result, may require
changes to our transfer pricing practices or operating procedures. Any
determination of income reallocation or modification of transfer pricing laws
could result in an income tax assessment of the portion of income deemed to be
derived from the taxing jurisdiction that so reallocates the income or modifies
its transfer pricing laws.

If we fail to maintain an effective system of internal controls, we may not be
able to report our financial results accurately. As a result, we may fail to
meet our reporting obligations and current and potential holders of ADSs and/or
ordinary shares could lose confidence in our financial reporting, which could
adversely affect the trading price of our ADS and/or ordinary shares.

         Effective internal controls are necessary for us to provide reliable
financial reports. If we cannot provide reliable financial reports or prevent
fraud, our results of operations could be misstated, our reputation may be
harmed and the trading price of our ADSs and/or ordinary shares could be
adversely affected. In connection with the audit of our financial statements for
the years ended December 31, 2002, 2003 and 2004, in May 2005 our independent
registered public accounting firm reported to our audit committee a matter that
was a "reportable condition" in our internal controls as defined in standards
established by the American Institute of Certified Public Accountants at that
time. In general, reportable conditions are significant deficiencies in a
company's internal controls that, in the auditor's judgment, could adversely
affect the ability to record, process and report financial data consistent with
the assertions of management in the financial statements. During 2005, we
devoted significant resources to remediate and improve our internal controls. We
believe that these efforts have remediated the concerns that gave rise to the
"reportable condition." However, we cannot be certain that our controls over our
financial processes and reporting will continue to be adequate in the future.
Any failure of our internal controls over financial reporting could result in a
material misstatement in financial statements.

                                       16
<PAGE>

      In addition, under Section 404 of the Sarbanes-Oxley Act, beginning with
our annual report on Form 20-F for the fiscal year ended December 31, 2006, we
are required to furnish a report by our management on our internal control over
financial reporting. Such a report will contain, among other matters, an
assessment of the effectiveness of our internal control over financial reporting
as of the end of our fiscal year, including a statement as to whether or not our
internal control over financial reporting is effective. This assessment must
include disclosure of any material weaknesses in our internal control over
financial reporting identified by management. Beginning with our annual report
on Form 20-F for the fiscal year ending December 31, 2007, the report by our
management on our internal control over financial reporting must also contain a
statement that our independent auditors have issued an attestation report on
management's assessment of such internal controls.

      During this process, if our management identifies one or more material
weaknesses in our internal control over financial reporting, we may be unable to
assert that such internal control is effective. If we were unable to assert that
our internal control over financial reporting is effective (or if our
independent auditors were unable to attest that our management's report is
fairly stated or they are unable to express an opinion on the effectiveness of
our internal controls), we could lose investor confidence in the accuracy and
completeness of our financial reports, which could have an adverse effect on the
price of our ordinary shares and/or our ADSs.


Changes in accounting standards for stock option plans may impact our results of
operations and our ability to use stock options to recruit, retain and motivate
employees.

         The Financial Accounting Standards Board published revisions to
Statement of Financial Accounting Standards No. 123, or SFAS 123R, that required
all public entities to treat the value of stock options granted to employees as
an expense. As a public entity subject to SFAS 123R, we were required to record,
as of the first annual reporting period beginning after June 15, 2005, in our
case, beginning January 1, 2006, a compensation expense equal to the value of
each stock option granted. This expense would be recognized over the vesting
period of the stock option. The requirement to expense stock option grants
reduced the attractiveness of granting stock options because the additional
expense associated with these grants may adversely affect our results of
operations. Accordingly, we may not be able to attract and retain key personnel
if any future adverse effects on our profitability resulting from the
application of SFAS 123R compel us to reduce the scope of our employee stock
option plans. In addition, as a result of the requirement to adopt SFAS 123R to
expense stock option grants beginning with the first fiscal year after June 15,
2005, our future profitability may be reduced.

We have never declared or paid dividends on our ordinary shares or other
securities and do not anticipate paying dividends in the foreseeable future.

         We have not declared or paid dividends on our ordinary shares or other
securities since our incorporation of the company. We do not anticipate
declaring any dividend in the foreseeable future. Future dividends, if any, will
be at the discretion of our board and will depend upon our future results of
operations, capital requirements, general financial condition, legal and
contractual restrictions and other factors our board may deem relevant.

                                       17
<PAGE>

Provisions in our Memorandum and Articles of Association may discourage
potential acquisition bids for us and prevent changes in our management that our
shareholders may favor.

         Provisions in our Memorandum and Articles of Association could
discourage potential acquisition proposals and could delay or prevent a change
in control transaction that our shareholders favor. These provisions could have
the effect of discouraging others from making offers for our ordinary shares. As
a result, these provisions may prevent the market price of our ordinary shares
or ADSs from reflecting the effects of actual or rumored takeover attempts and
may prevent shareholders from reselling their ordinary shares or ADSs at or
above the price at which they purchased their ordinary shares or ADSs. These
provisions may also prevent changes in our management that our shareholders may
favor. Our Memorandum and Articles do not permit shareholders to act by written
consent, do not permit shareholders to call a general meeting and provide for a
classified board of directors, which means shareholders can only elect a limited
number of our directors in any given year. Furthermore, our board has the
authority to issue up to 250,000,000 preference shares in one or more series.
Our board can fix the price, rights, preferences, privileges and restrictions of
such preference shares without any further vote or action by our shareholders
but subject to any direction that may be given by the shareholders in a general
meeting. The issuance of preference shares may delay or prevent a change in
control transaction without further action by our shareholders or make removal
of management more difficult.

As we are a Cayman Islands company, it could be difficult for investors to
effect service of process on and recover against us or our directors and
officers and our shareholders may face difficulties in protecting their
interest.

         We are a Cayman Islands company, and many of our officers and directors
are residents of various jurisdictions outside the United States. A substantial
portion of our assets and the assets of our officers and directors, at any one
time, are and may be located in jurisdictions outside the United States.
Although we have irrevocably agreed that we may be served with process in Santa
Clara, California with respect to actions arising out of or in connection with
United States federal securities laws relating to offers and sales of our
ordinary shares and/or our ADSs, it could be difficult for investors to effect
service of process within the United States on our directors and officers who
reside outside the United States or to recover against us or our directors and
officers on judgments of the United States courts predicated upon the civil
liability provisions of the United States federal securities laws.

         Our corporate affairs are governed by our charter documents, consisting
of our Memorandum and Articles of Association, and by the companies law and
common law of the Cayman Islands. The rights of our shareholders and the
fiduciary responsibilities of our directors are governed by Cayman Islands law,
which are not as clearly established as under statutes or judicial precedent in
jurisdictions such as the United States. While there is some case law in the
Cayman Islands on these matters, it is not as developed as, for example, in the
United States. In addition, the laws of the Cayman Islands relating to the
protection of the interests of minority shareholders differ in some respects
from those established under statutes or judicial precedent in existence in the
United States. Such differences may mean that our minority shareholders may have
less protection than they would have under the laws of the United States. Due to
the less protective nature of such laws in the Cayman Islands, our shareholders
may have more difficulty in protecting their interests in the face of actions by
our management or directors than would shareholders of a corporation
incorporated in some other jurisdictions.

We may become a passive foreign investment company, which could result in
adverse U.S. tax consequences to U.S. investors.

         We may be classified as a passive foreign investment company by the
U.S. Internal Revenue Service for U.S. federal income tax purposes. Such
characterization could result in adverse U.S. tax consequences to you if you are
a U.S. investor. For example, if we are a passive foreign investment company,
our U.S. investors will become subject to increased tax liabilities under U.S.
tax laws and regulations and will become

                                       18
<PAGE>

subject to burdensome reporting requirements. The determination of whether or
not we are a passive foreign investment company will be made on an annual basis
and will depend on the composition of our income and assets, including goodwill,
from time to time. Specifically, we will be classified as a passive foreign
investment company for U.S. tax purposes if, after the application of
look-through rules, either (a) 75% or more of our gross income in a taxable year
is passive income, or (b) the average percentage of our assets (by value) in a
taxable year that produce or are held for production of passive income is at
least 50%. Our judgment is not binding on the Internal Revenue Service. In the
future, the valuation of our intangible assets will be based in part on the then
market value of our ADSs and ordinary shares which is subject to change. We
cannot assure you that we will not be a passive foreign investment company for
the current or any future taxable year. See "Taxation--United States Federal
Income Taxation--Passive Foreign Investment Company."

Holders of ADSs may not be able to exercise their right to vote.

         Holders of our ADSs may instruct the depositary of our ADSs to vote the
ordinary shares underlying their ADSs but only if we ask the depositary to ask
for instructions. Otherwise, they will not be able to exercise their right to
vote unless they withdraw the ordinary shares underlying the ADSs they hold.
However, they may not know about the meeting sufficiently enough in advance to
withdraw those ordinary shares. If we ask for instructions, the depositary will
notify the holders of the upcoming vote and arrange to deliver our voting
materials to them. We cannot assure you that holders will receive the voting
materials in time to ensure that they can instruct the depositary to vote their
ordinary shares. In addition, the depositary and its agents are not responsible
for failing to carry out voting instructions or for the manner of carrying out
voting instructions. This means that holders may not be able to exercise their
right to vote, and there is no guarantee that the ordinary shares underlying
your ADSs would be voted as requested.

The depositary for our ADSs may give us a discretionary proxy to vote the
ordinary shares underlying your ADSs if holders of ADSs do not vote at
shareholders' meetings which could adversely affect their interests.

         Under the deposit agreement for the ADSs, the depositary will give us a
discretionary proxy to vote the ordinary shares underlying ADSs at shareholders'
meetings if the holder of the ADSs did not vote, unless we notify the depositary
that we do not wish to receive a discretionary proxy, we think there is
substantial shareholder opposition to the particular question, or we think the
particular question would have a material adverse impact on our shareholders.

         The effect of this discretionary proxy is that holders of ADSs cannot
prevent the ordinary shares underlying their ADSs from being voted, absent the
situation described above, and it may make it more difficult for shareholders to
influence the management of our company. Holders of our ordinary shares are not
subject to a discretionary proxy.

Holders of ADSs may not receive distributions on ordinary shares or any value
for them if it is illegal or impractical to make them available.

         The depositary of our ADSs has agreed to pay to ADS holders the cash
dividends or other distributions it or the custodian for our ADSs receives on
ordinary shares or other deposited securities after deducting its fees and
expenses. Holders of our ADSs will receive these distributions in proportion to
the number of ordinary shares the ADSs represent. However, the depositary is not
responsible if it decides that it is unlawful or impractical to make a
distribution available to any holders of ADSs. We have no obligation to take any
other action to permit the distribution of our ADSs, ordinary shares, rights or
anything else to holders of our ADSs. This means that ADS holders may not
receive the distributions we make on ordinary shares or any value for them if it
is illegal or impractical for us to make them available. These restrictions may
have a material adverse effect on the value of the ADSs.

                                       19
<PAGE>

Holders of ADSs may be subject to limitations on transfer of ADSs.

         ADSs represented by American Depositary Receipts, or ADRs, are
transferable on the books of the depositary. However, the depositary may close
its books at any time or from time to time when it deems expedient in connection
with the performance of its duties. The depositary may refuse to deliver,
transfer or register transfers of our ADSs generally when our books or the books
of the depositary are closed, or at any time if we or the depositary thinks it
is advisable to do so because of any requirement of law or any government or
governmental body, or under any provision of the deposit agreement, or for any
other reason.

ITEM 4.  INFORMATION ON THE COMPANY

HISTORY AND DEVELOPMENT OF THE COMPANY

         Our legal name is O2Micro International Limited. We are incorporated in
Cayman Islands. Our registered office is located at M&C Corporate Services
Limited, P.O. Box 309, Ugland House, South Church Street, George Town, Grand
Cayman, Cayman Islands. Our principal executive offices are located at Grand
Pavilion Commercial Centre, West Bay Road, P.O. Box 32331 SMB, George Town,
Grand Cayman, Cayman Islands. Our telephone number is (345) 945-1110. We have a
subsidiary, O2Micro, Inc., which was incorporated as a California corporation in
March 1995. In March 1997, O2Micro International Limited was incorporated as a
Cayman Islands company. In March 1997, we exchanged our ordinary shares and
preference shares for common stock and preferred stock of O2 Micro, Inc. After
the exchange, we held all of the outstanding capital stock of O2 Micro, Inc.,
our wholly owned subsidiary in the United States. On November 25, 2005, we
effected a 50-for-1 share split of our ordinary shares and created an ADS
program for our ADSs to be quoted on Nasdaq, with each ADS representing 50
ordinary shares. We delisted our ordinary shares from Nasdaq on November 25,
2005 and listed our ADSs on Nasdaq on November 28, 2005, the next trading day.
We subsequently listed our ordinary shares on the Main Board of the Stock
Exchange of Hong Kong (the "SEHK") Limited on March 2, 2006 by way of
introduction.

         Our agent for service of process in the U.S. for the purpose of our
securities filings is our chief executive officer, Sterling Du, c/o O2Micro,
Inc., 3118 Patrick Henry Drive, Santa Clara, CA 95054.

         Since January 1, 2004, our principal capital expenditures were
investments in various private companies of approximately $18.8 million in the
aggregate, $49.2 million in the purchase of land, property and equipment, and
$3.8 million deposited for Taiwan court bonds in connection with preliminary
injunction actions in Taiwan.

BUSINESS OVERVIEW

         We design, develop and market high performance integrated circuits for
power management and security applications, as well as systems security
solutions. We focus our product design efforts on integrated circuits for
consumer electronics, computer, industrial and communications products,
including LCD computer monitors, LCD televisions, notebook computers, Internet
security devices, GPS, mobile phones and portable DVD players. Our integrated
circuit products manage and provide power for lighting of LCDs, provide
connections between notebook computers and external plug-in cards, provide
Internet security, control and monitor battery charging and discharging, and
select and switch between power sources.

         We believe that our focus on these products provides us with an
opportunity to participate in large and growing markets. Potential future growth
in the LCD television market, especially units with larger-size panels,
represents an attractive growth opportunity for us because larger LCD panels
require more of our inverters for cold cathode fluorescent lamps, or CCFLs.

                                       20
<PAGE>

         Our integrated circuit products use analog, digital or mixed-signal
designs that combine analog and digital circuits on a single chip, reducing the
number of components needed and allowing our customers to reduce the size,
weight, power requirements or cost of their products. We offer a wide range of
proprietary application specific standard products as well as customized
products. We work closely with our customers to identify their product needs and
establish engineering priorities for new product designs and development. We
believe that our system-level expertise and extensive experience with power
management systems allow us to develop proprietary solutions and foster
long-term relationships with our customers.

         We sell our products to OEMs, ODMs and module makers. Our integrated
circuits have been incorporated into products sold by Acer, Apple Computer,
Dell, Fujitsu, Hewlett-Packard, Lenovo, LG Electronics, NEC, Samsung
Electronics, Sharp, Sony and Toshiba, among others. We sell our products through
our direct sales force, independent sales representatives and distributors in
China, Hong Kong, Japan, Korea, Singapore, Taiwan and the United States. We also
have design centers in many of our key markets to provide design and engineering
support to our customers. We outsource the fabrication of our products to
standard, high volume semiconductor foundries. This "fabless" approach allows us
to focus on product development, minimize fixed costs and capital expenditures,
and access diverse manufacturing technologies.

         Our net sales have grown from $92.2 million in 2004 to $105.6 million
in 2005 and $124.9 million in 2006. In the three months ended March 31, 2007,
our net sales were $35.0 million, an increase of 20.4% as compared with net
sales of $29.1 million in the same period in 2006.

Industry Background

         The markets for consumer electronics, mobile computing and
communications products, such as LCD monitors, LCD televisions, notebook
computers, mobile handsets and portable entertainment devices, are large and
growing as functionality increases and prices decrease. One of the most
significant challenges in these markets remains the efficient management of
power. As the number of applications and features available for these products
has increased, the number and variety of power loads, or individual subsystems
requiring voltage or current regulation, has also grown. Each additional
application or feature can require multiple functions and circuits that, in
turn, require more individually-regulated and managed power sources.
Increasingly, manufacturers are turning to innovative new semiconductor
technologies to manage the available power source capacity more efficiently.

         Power management integrated circuits deliver power and regulate
voltage, controlling the flow of electrical energy among the various power loads
and energy sources in a product or system. Power management requires a
combination of two distinct technological disciplines: digital integrated
circuit design and analog integrated circuit design. Digital circuits, such as
microprocessor and memory semiconductors, provide most of the functionality of
computer processing. However, digital circuits generally cannot handle
significant amounts of current or multiple voltage levels. In contrast, analog
circuits use and manipulate continuously varying voltage and current levels.
Battery power systems, which have relatively high and continuously varying power
levels, are inherently analog systems.

         Digital integrated circuit technology can be used to manage power
systems more intelligently and efficiently and help to prolong battery life in
mobile applications. However, since battery power systems are analog by nature,
mixed-signal integrated circuits, or circuits that incorporate both digital and
analog technologies, are necessary in order to harness the intelligence provided
by digital technology. Designing mixed-signal integrated circuits poses a number
of difficulties: analog circuits are more sensitive than digital circuits to the
physical layout and electrical characteristics of the circuit; analog circuit
designers must have a very high level of circuit design experience; and basic
differences in the technologies used in digital and analog circuit design make
combining the technologies problematic.

         In addition, mixed-signal integrated circuits comprise both digital and
analog components, and the trend toward more complex devices has increased the
number of components substantially. Integrating the

                                       21
<PAGE>

functions of those components on a single chip, known as a system-on-a-chip, can
enable manufacturers to make products smaller, lighter and more reliable. Thus,
as mobile computing and communications devices grow in complexity and
functionality, there is an increasing need for higher levels of systems
integration. In addition, variances in battery designs among manufacturers make
it more difficult to design intelligent systems that are optimized for
particular power systems.

         Most consumer electronics, mobile computing and communications product
manufacturers need mixed-signal and analog integrated circuits specifically
designed to optimize the power system usage in their devices to enable them to
offer new devices with richer functionality and longer battery lives. These
semiconductors should also be highly integrated and standards-based to help
manufacturers create products that are smaller, lighter, easier to use, more
reliable and more cost-efficient to design and produce. In addition, in mobile
device markets where product life cycles can be less than one year, these
solutions typically need to be developed using advanced design methodologies to
allow manufacturers to achieve rapid time-to-market with their new products.

         Several different process technologies are available for designing and
fabricating analog and digital integrated circuits. Of these, complementary
metal oxide semiconductor, or CMOS, is the most widely used process technology,
especially for purely digital integrated circuits. CMOS processes are described
in terms of feature size, or geometry, and are measured in microns. One micron
equals one millionth of a meter. Currently, the most advanced process
technologies achieve feature sizes of 0.13 micron, 0.09 micron, 0.065 micron and
smaller. However, small feature size circuits can become damaged when exposed to
high voltages and therefore power management integrated circuits are typically
fabricated using larger feature sizes. For this reason, older manufacturing
facilities, or fabs, having feature sizes of 0.25 micron and 0.80 micron or
greater, have traditionally been used in fabricating power management integrated
circuits, while the most advanced, and most expensive fabs are used for digital
and non-power management analog integrated circuits.

Products

         We market power management and cardbus controller components for the
Consumer, Computer, Industrial and Communications markets and also market system
security solutions. Our power management and cardbus controller products include
ICs to provide power for lighting of LCDs and LEDs, control and monitor battery
charging and discharging, DC / DC conversion, and provide connections between
notebook computers and external plug-in cards including product to select and
switch between power sources. Our system security solutions products include
VPNs and firewalls which provide security functions for communications between
computer systems and networks, including the transmission of data across the
Internet. We sell our products into the following four end-markets:

         o  Consumer electronics market, including desktop monitors, LCD
            televisions, digital cameras and camcorders and portable media
            players;

         o  Computer market, including notebook computers, desktop computers and
            desktop servers;

         o  Industrial market, including any product that is specified to
            operate over an extended temperature range, for instance, beyond the
            standard commercial operating temperature range of standard
            semiconductor products of zero degrees to 70 degrees centigrade.
            Products that operate over an extended temperature range include
            industrial tools, automobile GPS systems, and other automobile
            systems; and

         o  Communications market, including portable GPS systems, data
            communications security and networking systems, Internet and
            Internet related systems and mobile phone handsets.

                                       22
<PAGE>

         The majority of our revenue is derived from the sale of our products in
the consumer and computer markets. Additionally, we have increased our efforts
to expand our product portfolio addressing opportunities in the communications
and industrial markets.

Marketing, Sales, and Customer Support

         Our marketing strategy is focused on the sale of proprietary analog and
mixed-signal integrated circuits to customers in the consumer electronics,
computer, industrial and communications markets. These markets tend to be
dominated by a small number of major brand name companies. As a result, we focus
our resources on the major vendors in each market.

         We primarily sell proprietary application specific products to our
customers and work with them on new product development. We also design
customized products for our customers. We work directly with our customers to
create demand for our products by providing them with application specific
product information for their system design, engineering and procurement groups.
We actively participate in their design processes to introduce them to our
products and the target applications our products address. We endeavor to design
products that will meet increasingly complex and specific design requirements,
but which will also support widespread demand for these future products. We
typically undertake a four-to-eight month development process with our
customers. If successful, this process culminates in a customer deciding to use
our product in its system, which we refer to as a design win. Volume production
generally takes an additional three-to-six months after the initial design win
confirmation. Once our products are accepted and designed into an application,
the customer is likely to continue to use the same power architecture and
derivative products in a number of its models, which tends to extend our product
life cycles.

         We sell our products to OEMs, ODMs and module makers. We market and
sell these products through a combination of our direct sales force, independent
sales representatives and distributors in Asia, Europe and North America. We
sell most of our products through direct sales. We maintain direct sales offices
in most of our major markets which include Texas, California, China, Taiwan,
Korea and Japan. Additionally, we have sales representatives in China, Hong
Kong, Singapore, Taiwan and the United States, as well as two distributors in
Japan.

         We pay our direct sales force on a salary and performance bonus basis
only. Our independent sales representatives are paid on a commission basis,
based on a percentage of the actual sales referred by them. For sales through
sales representatives, we invoice and deliver our products directly to the
customers. We have entered into distributorship arrangements with distributors
on a non-exclusive basis for the sale of our products in Japan as a principal at
the request of certain of our major end-customers in Japan. For our other
customers in Japan, sales are made through our direct sales offices in Japan. In
Japan, it is customary practice for OEMs, ODMs and module makers to purchase
products like ours through distributors because of the ancillary services
provided by them such as inventory storage, payment terms and conditions and
just-in-time delivery. We may provide a discount on the prices of the products
we sell to our distributors (as compared to the prices we offer to end
customers), depending on the term and conditions of the individual purchases. We
defer recognition of such sales until the product is sold by the distributors to
its end customers. In addition, products held by the distributors are considered
part of our inventory and included in our inventory balance. Sales to the
distributors are recognized and inventory is adjusted upon shipment to its
end-customers as title to inventories generally transfers upon shipment. We
receive monthly inventory and sales reports from the distributors in Japan,
which we use as part of our overall inventory control. We evaluate our inventory
on a quarterly basis and full provision is made for inventory which is over six
months old and for which there is not end customer demand based on forecasted
product demand and market conditions.

         Our marketing efforts include market analysis, participation in
industry trade shows and technical conferences, sales training, publication of
technical articles, maintenance of our web site and advertising. In addition, we
maintain customer support staff in United States, Taiwan, China, Japan and Korea
for post order servicing and applications support.

         Seasonality

                                       23
<PAGE>

         The consumer electronics and computer markets are characterized by
seasonal volume increases in the latter part of the year primarily driven by
increased consumer spending during the holiday season. We normally experience
the highest sales volume to our customers in these markets in the third and
fourth quarter of each year, when such customers increase their inventories in
anticipation of increased seasonal demand. Our customers in the industrial and
communications markets are to a lesser extent subject to seasonal consumer
demand. As a result, our sales volume to those customers has been largely
consistent from quarter-to-quarter.

Customers

         We focus on the major OEMs (or brand owners) in the consumer
electronics, computer, industrial and communications markets. Many of these
major OEMs use third-party providers, such as ODMs, module makers or other
intermediaries, to produce their products or portions of their products
containing our components. Hence, the majority of our direct sales are to these
third-party providers. We have maintained long-term relationships with our major
customers for a number of years.

         We have no long-term volume purchase contracts with any of our major
customers. The majority of our sales to customers are conducted on the basis of
purchase orders, which set out the specific terms for a particular sale. We
price our products primarily with reference to the prevailing market conditions,
taking into consideration the complexity, technology and features of the
product, the order size and the relationship with the customer.

         The table below sets forth, for the periods indicated, the dollar
amount of our net sales derived from Asia, North America States and other
regions:

                                          Years Ended December 31
                                    -----------------------------------
                                              (In Thousands)
         Location of customers        2004         2005          2006
         ---------------------      ---------    ---------    ---------

         Asia                       $  92,105    $ 105,517    $ 124,761
         North America                     53           29           32
         Other regions                     38            6          122
                                    ---------    ---------    ---------

                                    $  92,196    $ 105,552    $ 124,915
                                    =========    =========    =========


         We generally extend to our customers credit terms varying from 45 to 55
days. We may adjust our usual credit terms according to each customer's credit
history as well as local market practice. Our customers generally pay us either
by direct wire transfer or under letter of credit arrangement. To date, we have
not experienced any material problems relating to customer payments or material
write-offs of accounts receivable due to uncollectibility.

Manufacturing

         We subcontract the manufacture of our products and most of the testing
for our products to semiconductor foundries, assembly and testing service
providers. This "fabless" approach allows us to focus on product development,
reduce fixed costs and capital expenditures, and access diverse manufacturing
technologies.

         We use established mainstream processes for the manufacture of our
products. This approach reduces our technical risks and minimizes the risks
related to production capacity constraints.

Wafer Manufacturing

         Wafer manufacturing is a capital intensive and complex operation which
takes place at dedicated facilities of semiconductor foundries. After we have
designed our integrated circuits, we place orders with a semiconductor foundry
to fabricate wafers with our integrated circuits embedded in them. The
semiconductor foundry purchases raw

                                       24
<PAGE>

unprocessed wafers, or silicon substrates, and processes them according to our
specifications to fabricate the wafers used in our products. Currently, the
majority of our wafers are fabricated using 0.25 to 0.80 micron CMOS
semiconductor processes, which are the standard semiconductor processes used by
semiconductor foundries. The wafer fabrication process generally takes six to 10
weeks. Fabricated wafers are then shipped by the semiconductor foundry,
according to our instructions, to either an assembly service provider for
electrical wafer sort and assembly or to an electrical wafer sort service
provider for electrical wafer sort only.

         Our major semiconductor foundry providers are SMIC, TSMC and X-FAB. We
do not enter into long-term contracts with our semiconductor foundry providers.
They manufacture our products on a purchase-order basis in accordance with our
specifications and requirements. In general, the cost charged to us for the
foundry services depends on prevailing wafer costs, which, in turn, depends on
industry capacity and the state of manufacturing process technologies as well as
on the complexity of our product designs, order size, cycle time and foundry
capacity utilization.

Assembly and Testing

         After the fabricated wafers have been electrically sorted, they are
ready for assembly and are either sent to an assembly service provider for
assembly or held at our warehouse facilities, or an "inventory hub," for
assembly at a later date. An inventory hub is a provider of warehousing
services. We often hold inventory of our semi-finished products in the form of
electrically sorted wafers because it is at this manufacturing stage that most
time has been invested, with the least costs, and we then have the flexibility
of choosing the type of packaging into which they are to be assembled. The wafer
sort and assembly process generally takes three to six weeks.

         Once our integrated circuits are assembled and packaged, they are ready
for final electrical testing. We instruct the assembly service provider to send
our packaged integrated circuits to either a testing service provider or our
testing facilities for final testing or our warehouse facilities (or an
inventory hub) for testing at a later date. The electrical testing process
generally takes a few days. Once our products have been tested, they are ready
for use by our customers.

         Finished products may be sent to our customers or their designees such
as third party service providers that manufacture their products or a portion of
their products containing our integrated circuits. Our customers may request for
our integrated circuits to be shipped in plastic tubes, several to a tube, or
use a form of packaging called "tape and reel" that more readily provides for
automated assembly of our integrated circuits into their products. If a customer
orders "tape and reel" packaging, this is done either at a testing service
provider or a "tape and reel" service provider prior to shipment of our products
to the customer.

         We utilize several assembly and testing service providers in Taiwan and
other parts of Asia on a purchase order basis. They assemble and test our
products based on our specifications and requirements. In general, the cost
charged to us for these assembly and testing services depends on prevailing
market rates for these services and our relationship with the service provider.
We operate a semiconductor testing facility to test a portion of our products
prior to shipment. Typically analog and mixed-signal products have a greater
portion of their product cost associated with product testing than digital
products.

         Our current credit terms with our foundry, assembly and testing service
providers vary from 30 to 45 days, depending on our relationships with each of
them. We generally pay our service providers by direct wire transfer.

         We also have made investments in certain of our current suppliers and
potential future suppliers, including software developers, foundries and testing
service providers. These investments enable us to enhance our business
relationships with these suppliers to ensure the adequacy of foundry capacity
allocation and quality of services provided to us. We plan to continue to
evaluate additional investment opportunities in our supply chain.

Competition

                                       25
<PAGE>

         We compete in the market for analog and mixed-signal integrated
circuits based on such factors as product performance, power efficiency, new
technologies, functional innovation, reliability, price and availability. We
believe our principal competitors include Intersil Corporation, Linear
Technology Corporation, Maxim Integrated Products, Inc., Microsemi Corporation,
Monolithic Power Systems, Inc., Ricoh Company, Ltd., Rohm Co., Ltd and Texas
Instruments Incorporated. There is also competition from internal integrated
circuit design and manufacturing capabilities of some of our existing and
potential customers, such as Toshiba and Fujitsu. In addition to these
competitors, other integrated circuit companies may decide to enter the market
with analog and mixed signal integrated products that compete with our products
or incorporate functions similar to those provided by our products.

Intellectual Property

         Our intellectual property is primarily developed in-house. We do, from
time to time, acquire intellectual property from third parties which we believe
is instrumental or complementary to our business. We also on occasion license
our intellectual property to third parties in exchange for royalties or other
consideration.

         Our success depends significantly upon our ability to protect our
intellectual property. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our products or obtain and
use information that we regard as proprietary. Competitors may recruit our
employees who have access to our proprietary technologies, processes and
operations.

         We rely in part on patents to protect our intellectual property. As of
December 31, 2006, we had approximately 103 patents issued in the United States
and approximately 170 patents issued in other countries. In addition, we had
approximately 184 patent applications pending in the United States Patent and
Trademark Office. We also had approximately 345 patent applications pending in
various countries other than the United States. These patents may never be
issued. Even if these patents are issued, taken together with our existing
patents, they may not be sufficiently broad to protect our proprietary rights,
or they may prove to be unenforceable. To protect our proprietary rights, we
also rely on a combination of copyrights, trademarks, trade secret laws,
contractual provisions, licenses and maskwork protection under the Federal
Semiconductor Chip Protection Act of 1984 and similar laws in other
jurisdictions. We also enter into confidentiality agreements with our employees,
consultants and customers and seek to control access to, and distribution of,
our proprietary information.

         We may from time to time grant rights to third parties for our patents
and other intellectual property. In March 2003, we granted a limited
non-exclusive license to Ricoh Company, Ltd. for our patents entitled
"Integrated PC Card Host Controller for the Detection and Operation of a
Plurality of Expansion Cards" (U.S. Patent No. 6,470,284 and Taiwan Patent No.
155891) and their foreign counterparts. In April 2007, we entered into a
Memorandum of Agreement with Samsung Electronics Co., Ltd. and its subsidiaries
pursuant to which we agreed to certain provisions regarding our intellectual
property portfolio including without limitation patents owned by us.

         The laws of some foreign countries do not protect our proprietary
rights to the same extent as do the laws of the United States, and many
companies have encountered substantial infringement problems in these countries,
including countries in which we have sold and continue to sell a significant
portion of our products. There is a risk that our means of protecting our
proprietary rights may not be adequate. For example, our competitors may
independently develop similar technology, duplicate our products or design
around our patents or our other intellectual property rights. If we fail to
protect our intellectual property adequately, it would make it easier for our
competitors to sell competing products.

         We are involved in a variety of litigation matters involving
intellectual property. For example, we have initiated and are pursuing certain
patent infringement actions in Taiwan. We have obtained preliminary injunctions
and provisional attachment orders against numerous competitors, their customers
and users. As of December 31, 2006, we have deposited an amount of New Taiwan
dollars equivalent to approximately $14.5 million

                                       26
<PAGE>

with the Taiwan courts for court bonds in connection with the preliminary
injunction actions and related provisional attachment actions. The court bonds
provide security for the enjoined party to claim damages incurred from the
preliminary injunctions, provisional attachments or the provision of a
countersecurity against us in the event we do not ultimately succeed in the
underlying infringement actions. However, these preliminary injunctions or
provisional attachments may be rescinded if the relevant court allows the
opposing party to make its own deposit or countersecurity with the court.

We are currently in litigation against Microsemi Corporation in the United
States District Court in the Northern District of California and the United
States District Court in the Eastern District of Texas. In April 2007, we filed
a complaint in the United States District Court in the Northern District of
California for declaratory judgment that U.S. Patent Numbers 5,615,093,
5,923,129, 5,930,121 and 6,198,234 held by Microsemi Corporation are not
infringed by us, invalid and unenforceable. In response, Microsemi Corporation
filed a cross claim in the United States District Court in the Eastern District
of Texas alleging that we infringe their U.S. Patent Numbers 5,930,121 and
6,198,234. They are seeking preliminary injunction, permanent injunction,
damages, trebling of damages, enhancement, attorneys' fees and costs. On June 4,
2007, the United States District Court in the Northern District of California
granted a motion to transfer our declaratory judgment case against Microsemi
Corporation to the United States District Court in the Eastern District of
Texas. In addition, in May 2007, a jury in the United States District Court in
the Northern District of California found Claims 1, 2, 9, 12, 14 and 18 of our
U.S. Patent Number 6,396,722 to be invalid. In February 2007, Monolithic Power
Systems, Inc. amended its complaint in the Intermediate People's Court in
Chengdu, China alleging that two of our customers infringe Chinese Patent Number
ZL03140709.9.

         We are also involved in several other patent litigation matters in the
United States. Given the inherent uncertainties in litigation, there cannot be
any assurance that we will prevail in any of the pending litigation, and we
cannot predict the outcome of any such litigation. Litigation is costly, time
consuming, and may distract management from other important tasks and, in patent
litigation where we are the plaintiff, there is a risk that our patents may be
held invalid or unenforceable. In addition, in any litigation arising from
claims that we infringe on the intellectual property rights of others, an
adverse result could involve an injunction to prevent the sales of a material
portion of our products, a reduction or the elimination of the value of related
inventories, and the assessment of a substantial monetary award for damages
related to past sales, any of which could have a material adverse effect on our
result of operations and financial condition.

ORGANIZATIONAL STRUCTURE

         We are incorporated under the laws of the Cayman Islands and we are the
parent company for the various subsidiaries that conduct our business on a
worldwide basis. Our significant subsidiaries, all of which are wholly-owned,
are:

<TABLE>
<CAPTION>
---------------------------------------- -------------------------------------- --------------------------------------
        Significant Subsidiary                 Country of Incorporation                 Date of Incorporation
---------------------------------------- -------------------------------------- --------------------------------------
<S>                                                    <C>                                 <C>
             O2Micro, Inc.
                                                        U.S.A.                               March 1995
---------------------------------------- -------------------------------------- --------------------------------------
       O2Micro Electronics, Inc.
                                                        Taiwan                               March 1999
---------------------------------------- -------------------------------------- --------------------------------------
  O2Micro International Japan Limited
                                                         Japan                               August 1999
---------------------------------------- -------------------------------------- --------------------------------------
     O2Micro PTE Limited-Singapore
                                                       Singapore                           September 1999
---------------------------------------- -------------------------------------- --------------------------------------
      Aotu Micro (Wuhan) Co., Ltd.
                                                         China                              January 2001
---------------------------------------- -------------------------------------- --------------------------------------
      O2Micro (Beijing) Co., Ltd.
                                                         China                              February 2001
---------------------------------------- -------------------------------------- --------------------------------------
       O2Micro (China) Co., Ltd.
                                                         China                               April 2001
---------------------------------------- -------------------------------------- --------------------------------------
      O2Micro (Chengdu) Co., Ltd.
                                                         China                                July 2004
---------------------------------------- -------------------------------------- --------------------------------------
OceanOne Semiconductor (Ningbo) Limited
                                                         China                               August 2005
---------------------------------------- -------------------------------------- --------------------------------------
</TABLE>

                                       27
<PAGE>

PROPERTY, PLANT AND EQUIPMENT

                  The table below describes our headquarters and the facilities
where the above subsidiaries are located as of December 31, 2006:

                                     Approx. Available
Location                                Square Feet      Lease Expiration
-------------------------------      -----------------   ----------------
California, USA................            37,180         not applicable
Taipei, Taiwan.................            33,707              2011
Hsin-Chu, Taiwan...............            23,630              2007
Singapore......................             7,104              2008
Shanghai, China................            30,448         not applicable
Beijing, China.................            16,070              2008
Wuhan, China...................            11,220              2009
Chengdu, China.................            13,552              2007
Grand Cayman, Cayman Islands...               600              2008
Tokyo, Japan...................             1,302              2008
Ningbo, China                               5,187              2007


         We maintain our Cayman Islands office to process invoices and receive
amounts payable. Research and development, marketing, applications and
administrative staff are located in California. We also have sales offices in
Pfluggerville, Texas and Houston, Texas. Marketing, sales, applications, design,
worldwide production support, final inspection and shipping, and general and
administrative staff are located in Taiwan. We have offices Japan, Singapore,
Korea and China for marketing, sales, design, warehousing and applications. We
believe our current facilities are adequate for our needs for the foreseeable
future, and that any additional space required will be available to us on
commercially reasonable terms.

         In May 2004, we purchased a 37,180 square foot building in Santa Clara,
California housing our California operations. The purchase price was
approximately $4.6 million. In October 2005, we purchased a 30,448 square foot
facility in Shanghai, China for approximately $7.1 million. In April 2006, we
purchased 29,935 square feet of land in Hsin-Chu, Taiwan for approximately $8.8
million.

ITEM 4A. UNRESOLVED STAFF COMMENTS

         None.

ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Overview

         We design, develop and market high performance integrated circuits for
power management and security applications, as well as systems security
solutions. We also license a limited portion of our proprietary intellectual
property from and to third parties. Our net sales have been derived primarily
from the sale of analog and mixed-signal integrated circuit products to
customers in the consumer electronics, computer, industrial and communications
markets.

                                       28
<PAGE>

         Our net sales have grown from $92.2 million in 2004 to $105.6 million
in 2005 and $124.9 million in 2006. This increase in net sales was due primarily
to higher unit shipments of our existing products, expansion of our customer
base and the introduction of new products. We have continued to diversify our
customer base and market focus by providing new products to the consumer
electronics, computer, industrial and communications markets. Our overall gross
margin has fluctuated in the past and is likely to fluctuate in the future due
to the stages of our products in their life cycles, variations in our product
mix, the timing of our product introductions and specific product manufacturing
costs. New products typically have higher gross margins than products that are
more mature. Gross margins on the products we sell will typically decline over
the life of these products due to competitive pressures and volume pricing
agreements.

         Operating expenses grew from $41.9 million in 2004 to $58.3 million in
2005 and $72.7 million in 2006. Our operating expenses increased primarily from
new product development efforts, hiring additional personnel and expanding our
operations and recognized stock-based compensation due to adoption of Statement
of Financial Accounting Standards ("SFAS") No. 123 (R), "Share-Based Payment."

         Our net income was $14.1 million in 2004, $8.1 million in 2005 and
$743,000 in 2006. We have been profitable in each quarter since the quarter
ended September 30, 1999 except for the quarter ended June 30, 2006. We believe
this profitability has been the result of our strategy to make investments to
develop new products and grow net sales, while maintaining a high level of
fiscal control, product quality and customer satisfaction. Our profitability
resulted in retained earnings of $33.9 million at December 31, 2006.

         We utilize a fabless semiconductor business model, which means we focus
on designing, developing and marketing products, while having these products
manufactured by large independent semiconductor foundries. As a fabless
semiconductor company, we do not need to invest significant capital to
manufacture semiconductor devices, and can take advantage of some of the
cost-efficiencies of third-party foundries. We place purchase orders for
specific quantities of packaged semiconductor devices or wafers at set prices.
We currently use third parties to test and assemble most of our products, which
reduces the capital we need to invest in these activities. We also use
independent assembly suppliers for the production of our systems security
solutions products.

         We sell our products through a combination of direct sales offices,
sales representatives and distributors. We have sales representatives in China,
Hong Kong, Singapore, Taiwan and the United States, as well as two distributors
in Japan.

         Revenue from product sales to customers, other than distributors, is
recognized at the time of shipment, including revenue that has been realized and
earned. Sales through distributors are recognized when the distributors make a
sale. Under certain conditions, customers may return defective products.
Allowances for sales returns are provided on the basis of past experience. These
provisions are deducted from sales.

Critical Accounting Policies--

Revenue Recognition and Accounts Receivable Allowances

         We recognize revenue on sales to direct customers in accordance with
SEC Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial
Statements" ("SAB 104"). SAB 104 requires that four basic criteria must be met
before revenue can be recognized: (1) persuasive evidence of an agreement
exists, (2) delivery has occurred or services have been rendered, (3) the fee is
fixed and determinable, and (4) collectibility is reasonably assured.
Determination of criteria (4) is based on the management's judgments regarding
the collectibility of those fees.

         For sales made through distributors, we defer recognition of such sales
until the product is sold by the distributors to their end customers. Since we
have limited control over these distributors' sales to third parties, we
recognize revenues on these sales only when the distributors sell the products.
In addition, products held by distributors are included in our inventory
balance. Accounts receivable from distributors are recognized and inventory is
relieved upon shipment to end customers as title to inventories generally
transfers upon shipment.

                                       29
<PAGE>

         We make allowances for future product returns in the current period
revenue. We analyze historical returns, changes in current demand and acceptance
of products when evaluating the adequacy of such allowances. Estimates may
differ from actual product returns and allowances and these differences may
materially affect our reported revenue and amounts ultimately collected on
accounts receivable. In addition, we monitor collectibility of accounts
receivable primarily through review of the accounts receivable aging. When facts
and circumstances indicate the collection of specific amounts or from specific
customers is at risk, we assess the impact on amounts recorded for bad debts
and, if necessary, will record a charge in the period such determination is
made. To date, we have not experienced material write-offs of accounts
receivable due to uncollectibility.

Inventories

         Our inventories are stated at the lower of standard cost or market
value. Cost is determined on a currently adjusted standard basis, which
approximates actual cost on a first-in first-out basis. Because of the
cyclicality of the market, inventory levels, obsolescence of technology and the
product life cycles, we write down inventories to net realizable value based on
backlog, forecasted product demand and historical sales levels. Backlog is
subject to revisions, cancellations and rescheduling. Actual demand and market
conditions may be lower than those projected by us. This difference could have a
material adverse effect on our gross margin should additional inventory write
downs become necessary.

Long-Lived Assets

         We evaluate the recoverability of property and equipment in accordance
with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." We perform periodic reviews to determine whether facts and
circumstances exist that would indicate that the carrying amounts of property
and equipment might not be fully recoverable. If facts and circumstances
indicate that the carrying amount of property and equipment might not be fully
recoverable, we compare projected undiscounted net cash flows associated with
the related assets over their estimated remaining useful life against their
respective carrying amounts. In the event that the projected undiscounted cash
flows are not sufficient to recover the carrying value of the assets, the assets
are written down to their estimated fair values based on the expected discounted
future cash flows attributable to the assets. Evaluation of impairment of
property and equipment requires estimates in the forecast of future operating
results that are used in the preparation of the expected future undiscounted
cash flows. Actual operating results and remaining economic lives of the
property and equipment could differ from the estimates used in assessing the
recoverability of these assets. These differences could result in additional
impairment charges, which could have a material adverse impact on the results of
operations.

Income Taxes

         Our income taxes are accounted in accordance with SFAS No. 109,
"Accounting for Income Taxes". The provision for income tax represents income
tax paid and payable for the current year plus the changes in the deferred
income tax assets and liabilities during the years. Deferred income tax assets
are primarily the tax effects of the operating loss carryforwards, research and
development credit carryforwards and temporary differences. On a periodic basis
we evaluate the deferred tax assets balance for realizability. To the extent we
believe it is more likely than not that some portion of deferred tax assets will
not be recognized, we will increase the valuation allowance against the deferred
tax assets. Realization of the deferred tax assets is dependent primarily upon
future taxable income, changes in tax laws and other factors. These changes, if
any, may require possible material adjustment to the deferred tax assets,
resulting in a reduction in net income in the period when such determinations
are made. In addition, we recognize liabilities for potential income tax
contingencies based on the estimate of whether, and the extent to which,
additional taxes may be due. If we determine that payment of these amounts is
unnecessary or if the recorded tax liability is less than its current
assessment, we may be required to recognize an income tax benefit or additional
income tax expense in our consolidated financial statements, accordingly.

                                       30
<PAGE>

Legal Contingencies

         We are currently involved in various claims and legal proceedings. We
periodically assess each matter in order to determine if a contingent liability
in accordance with SFAS No. 5, "Accounting for Contingencies," should be
recorded. In making the determination, we may, depending on the nature of the
matter, consult with external counsel and technical experts. Based on the
information obtained combined with our judgment regarding all the facts and
circumstances of each matter, we determine whether it is probable that a
contingent loss may be incurred and whether the amount of such loss can be
estimated. Should a loss be probable and estimable, we record a contingent loss
in accordance with SFAS No. 5. In determining the amount of a contingent loss,
we take into consideration advice received from experts in the specific matter,
current status of legal proceedings, prior case history and other factors.
Should the judgments and estimates be incorrect, we may need to record
additional contingent losses that could materially adversely impact our results
of operations.

Stock-based compensation

         We grant stock options and other awards to our employees and certain
non-employees. Prior to January 1, 2006, we elected to follow Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees" and complied with the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" for our employee stock options. Under
APB No. 25, compensation expense is measured based on the difference, if any, on
the date of the grant, between the fair value of our ordinary shares and the
exercise price of the stock option.

         Effective January 1, 2006, we adopted the fair value recognition
provisions of SFAS No. 123 (R), "Share-Based Payments," using the modified
prospective application method. Under this transition method, compensation cost
recognized for the year ended December 31, 2006, includes the applicable amounts
of: (a) compensation cost of all stock-based payments granted prior to, but not
yet vested as of, December 31, 2005 (based on the grant-date fair value
estimated in accordance with the original provisions of SFAS No. 123 and
previously presented in pro forma footnote disclosures), and (b) compensation
cost for all stock-based payments granted subsequent to January 1, 2006 (based
on the grant-date fair value estimated in accordance with the new provisions of
SFAS No. 123 (R)). Results for periods prior to January 1, 2006, have not been
restated.

         At the end of June 2005, our board approved the acceleration of the
vesting of options with exercise prices greater than $17.00 or $0.34 after
taking into account the 50-to-1 stock split on November 25, 2005. Our board
evaluated the minimal benefit to our employees of accelerating the remaining
vesting on these significantly underwater options against the value to
shareholders of not having earnings materially affected and the impact that this
may have on our market value. In addition, these options had exercise prices in
excess of the then current market values and were not fully achieving their
original objectives of incentive compensation and employee retention.
Accelerating the vesting of these options accelerated the recognition of any
remaining expense associated with these options which is zero under APB No. 25.

Treasury Stock

         We cancel all shares repurchased under our share repurchase plan.
Accordingly, the excess of the purchase price over par value will be allocated
between additional paid-in capital and retained earnings based on the average
issue price of the shares repurchased. Shares that are repurchased and cancelled
are not counted as part of our issued share capital.

Research and development costs

                                       31
<PAGE>

         Our research and development costs consist of expenditures incurred
during the course of planned research and investigation aimed at the discovery
of new knowledge that will be useful in developing new products or processes, or
at significantly enhancing existing products or production processes as well as
expenditures incurred for the design and testing of product alternatives or the
construction of prototypes. We charge all of our expenditures related to
research and development activities to operating expenses when incurred.

Long-term Investments

         Our long-term investments in private companies over which we do not
exercise significant influence are accounted for under the cost method of
accounting. We evaluate related information in addition to quoted market prices,
if any, in determining the fair value of these investments and whether an
other-than-temporary decline in value exists. Factors indicative of an
other-than- temporary decline include recurring operating losses, credit
defaults and subsequent rounds of financings at an amount below the cost basis
of the investment. The list is not all-inclusive and we periodically weigh all
quantitative and qualitative factors in determining if any impairment loss
exists.

         Our long-term investments in listed companies are classified as
available-for-sales securities and are recorded at market value. Unrealized
gains and losses on these investments are included in accumulated other
comprehensive income and loss as a separate component of shareholders' equity,
net of any related tax effect, unless unrealized losses are deemed
other-than-temporary. Unrealized losses are recorded as a charge to income when
deemed other-than-temporary.

Recent Accounting Pronouncements

         On February 15, 2007, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities". Under this statement, the Company may elect to report financial
instruments and certain other items at fair value on a contract-by-contract
basis with changes in value reported in earnings. This election is irrevocable.
SFAS No. 159 provides an opportunity to mitigate volatility in reported earnings
that is caused by measuring hedged assets and liabilities that were previously
required to use a different accounting method than the related hedging contracts
when the complex provisions of SFAS No. 133 hedge accounting are not met. There
is no impact to the Company as a result of the adoption of this statement.

         In September, 2006, FASB issued SFAS No. 158, "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans - an amendment of
FASB Statements No. 87, 88, 106, and 132(R)" (hereinafter "SFAS No. 158"). This
statement requires an employer to recognize the overfunded or underfunded status
of a defined benefit postretirement plan (other than a multiemployer plan) as an
asset or liability in its statement of financial position and to recognize
changes in that funded status in the year in which the changes occur through
comprehensive income of a business entity or changes in unrestricted net assets
of a not for profit organization. This statement also requires an employer to
measure the funded status of a plan as of the date of its year end statement of
financial position, with limited exceptions. The adoption of this statement had
no material effect on the Company's financial statements.

         In September 2006, FASB issued SFAS No. 157, "Fair Value Measurements,"
effective for financial statements issued for fiscal years beginning after
November 15, 2007, the beginning of the Company's 2008 fiscal year. This
statement defines fair value, establishes a framework for measuring fair value,
and expands disclosures about fair value measurements. This statement
establishes a fair value hierarchy that distinguishes between valuations
obtained from sources independent of the entity and those from the entity's own
unobservable inputs that are not corroborated by observable market data. SFAS

                                       32
<PAGE>

No. 157 expands disclosures about the use of fair value to measure assets and
liabilities in interim and annual periods subsequent to initial recognition. The
disclosures focus on the inputs used to measure fair value and for recurring
fair value measurements using significant unobservable inputs, the effect of the
measurements on earnings or changes in net assets for the period. The Company is
currently assessing the impact of this guidance on its financial statements.

         In June 2006, FASB issued FASB Interpretation ("FIN") No. 48,
"Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109." The interpretation contains a two step approach to
recognizing and measuring uncertain tax positions accounted for in accordance
with SFAS No.109. The first step is to evaluate the tax position for recognition
by determining if the weight of available evidence indicates it is more likely
than not that the position will be sustained on audit, including resolution of
related appeals or litigation processes, if any. The second step is to measure
the tax benefit as the largest amount which is more than 50% likely of being
realized upon ultimate settlement. The provisions are effective for the Company
beginning in the first quarter of 2007. The Company believes that the adoption
of FIN No.48 does not have a significant impact on the Company's financial
statements.

         In September 2006, the Securities and Exchange Commission ("SEC")
issued Staff Accounting Bulletin ("SAB") No. 108. This Bulletin provides the
SEC's views on the consideration of the effects of prior year misstatements in
quantifying current year misstatements for the purpose of a materiality
assessment. The guidance in SAB No. 108 is effective for financial statements on
fiscal years ending after November 15, 2006. The adoption of this Bulletin had
no material effect on the Company's financial statements.

Operating Results

         The following table summarizes historical results of operations as a
percentage of net sales for the periods shown.

                                                 Year Ended December 31,
                                                -------------------------
                                                 2004     2005      2006
                                                ------   ------    ------
Consolidated Statement of Operations Data:
Net sales ................................      100.0%   100.0%    100.0%
Cost of sales ............................       40.6     38.6      45.4
                                                ------   ------    ------
Gross margin .............................       59.4     61.4      54.6
Operating expenses:
     Research and development ............       22.0     24.1      25.4
     Selling, general and administrative .       17.7     19.2      23.4
     Patent related litigation ...........        5.8      9.6       8.8
     Stock Exchange of Hong Kong listing
     expenses ............................          -      2.3       0.6
                                                ------   ------    ------
         Total operating expenses ........       45.5     55.2      58.2
                                                ------   ------    ------
Income (loss) from operations ............       13.9      6.2      (3.6)
Non-operating income-net .................        2.9      2.5       2.2
Income tax expenses (benefit) ............        1.6      1.0      (2.0)
                                                ------   ------    ------
Net income ...............................       15.2%     7.7%      0.6%
                                                ======   ======    ======

                                       33
<PAGE>

Years Ended December 31, 2006 and 2005

         Net Sales. Net sales consisted of product revenues generated
principally by sales of our integrated circuit products. Net sales for the year
ended December 31, 2006 were $124.9 million, an increase of $19.4 million or
18.3% from $105.6 million for the year ended December 31, 2005. The increase in
net sales resulted primarily from increased unit shipments to our existing
customers, expansion of our customer base and the introduction of new products.

         Gross Profit. Gross profit represents net sales less cost of sales.
Cost of sales primarily consists of the cost of purchasing packaged integrated
circuit products manufactured and assembled for us by independent foundries and
packaging vendors and other costs associated with the procurement, storage and
shipment of these products. Gross profit for the year ended December 31, 2006
was $68.1 million, an increase of $3.3 million or 5.1% from $64.8 million for
the year ended December 31, 2005. This increase was primarily due to increased
sales of our integrated circuit products. Gross profit as a percentage of net
sales for the year ended December 31, 2006 decreased to 54.6% from 61.4% for the
year ended December 31, 2005 primarily due to increased sales of our lower
margin products. We expect that our gross profit as a percentage of net sales
will continue to fluctuate in the future as a result of the stages of our
products in their life cycles, variations in our product mix, the timing of our
product introductions and specific product manufacturing costs.

         Research and Development Expenses. Research and development expenses
consist primarily of salaries and related costs of employees engaged in
research, design and development activities and, to a lesser extent, expenses
for outside engineering consultants. Research and development expenses for the
year ended December 31, 2006 were $31.8 million, an increase of $6.3 million or
24.9% from $25.4 million for the year ended December 31, 2005. As a percentage
of net sales, research and development expenses were 25.4% for the year ended
December 31, 2006, an increase from 24.1% for the year ended December 31, 2005.
Research and development expenses as a percentage of net sales will fluctuate
from quarter to quarter depending on the amount of net sales and the success of
new product development efforts, which we view as critical to our future growth.
At any point in time, we have several research and development projects
underway, and we believe that none of these projects is material on an
individual basis. We expect to continue the development of innovative
technologies and processes for new products and we believe that a continued
commitment to research and development is essential in order to maintain the
competitiveness of our existing products and to provide innovative new product
offerings. Therefore, we expect to continue to invest significant resources into
research and development in the future.

         Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of employee-related expenses, sales
commissions to agents, professional fees, travel and other promotional expenses.
Selling, general and administrative expenses for the year ended December 31,
2006 were $29.2 million, an increase of $8.9 million or 44.0% from $20.3 million
for the year ended December 31, 2005. This increase was primarily due to
additional hiring of sales, operations and administrative personnel, increased
promotional expense, increased traveling expense and the stock-based
compensation expense recognized due to adoption of SFAS No. 123 (R). As a
percentage of net sales, selling, general and administrative expenses were 23.4%
for the year ended December 31, 2006, an increase from 19.2% for the year ended
December 31, 2005. We expect that selling, general and administrative expenses
will continue to increase in absolute dollar terms for the foreseeable future.

         Patent Related Litigation Expenses. Patent related litigation expenses
consist primarily of fees paid to outside counsel and consultants engaged by
outside counsel. Patent related litigation expenses for the year ended December
31, 2006 were $11.0 million, an increase of $788,000 or 7.7% from $10.2 million
for the year ended December 31, 2005. This increase was primarily due to
increased activity in various litigation matters. As a percentage of net sales,
patent related litigation expenses were 8.8% for the year ended December 31,
2006, a decrease from 9.6% for the year ended December 31, 2005. We expect that
patent related litigation expenses will continue to fluctuate for the
foreseeable future. (Please see also, "Business Overview - Intellectual
Property.")

                                       34
<PAGE>

         Stock Exchange of Hong Kong Listing Expenses. The SEHK listing expenses
consist primarily of expenses incurred in relation to our SEHK listing
activities commencing in 2005. SEHK listing expenses for the year ended December
31, 2006 was $786,000, a decrease of $1.7 million or 68.0% from $2.5 million for
the year ended December 31, 2005.

         Non-operating Income-net. Non-operating income-net reflects primarily
interest earned on cash and cash equivalents and short-term investments,
impairment loss on long-term investments and foreign exchange transaction
losses. Non-operating income-net was $2.9 million for the year ended December
31, 2006 increasing from $2.7 million for the year ended December 31, 2005,
reflecting increased interest earned on cash and cash equivalents, and short
term investments.

          Income Tax Expenses (benefit). Income tax benefit was approximately
$2.5 million for the year ended December 31, 2006, compared to an income tax
expense of $1.0 million for the year ended December 31, 2005. This difference
was primarily due to a reversal of an accrual of income tax payable upon the
completion of examination of our 2001 tax filing by the Taiwan Tax Authority.

Years Ended December 31, 2005 and 2004

         Net Sales. Net sales for the year ended December 31, 2005 were $105.6
million, an increase of $13.4 million or 14.5% from $92.2 million for the year
ended December 31, 2004. The increase in net sales resulted primarily from
increased unit shipments to our existing customers and expansion of our customer
base.

         Gross Profit. Gross profit for the year ended December 31, 2005 was
$64.8 million, an increase of $10.0 million or 18.3% from $54.8 million for the
year ended December 31, 2004. This increase was primarily due to increased
sales. Gross profit as a percentage of net sales for the year ended December 31,
2005 increased to 61.4% from 59.4% for the year ended December 31, 2004
primarily due to increased sales of our higher margin products.

         Research and Development Expenses. Research and development expenses
for the year ended December 31, 2005 were $25.4 million, an increase of $5.1
million or 25.5% from $20.3 million for the year ended December 31, 2004. This
increase reflected the increased hiring of design engineers resulting from our
increased operations and increased consultancy fees paid to outside consultants
in respect of certain research and development projects. As a percentage of net
sales, research and development expenses were 24.1% for the year ended December
31, 2005, an increase from 22.0% for the year ended December 31, 2004.

         Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the year ended December 31, 2005 were $20.3 million,
an increase of $4.0 million or 24.1% from $16.3 million for the year ended
December 31, 2004. This increase was primarily due to additional hiring of
sales, operations and administrative personnel, increased sales commissions
relating to higher sales and increased professional fees. As a percentage of net
sales, selling, general and administrative expenses were 19.2% for the year
ended December 31, 2005, an increase from 17.7% for the year ended December 31,
2004.

         Patent Related Litigation Expenses. Patent related litigation expenses
consist primarily of fees paid to outside counsel and consultants engaged by
outside counsel. Patent related litigation expenses for the year ended December
31, 2005 were $10.2 million, an increase of $4.9 million or 90.7% from $5.3
million for the year ended December 31, 2004. This increase in absolute dollars
was primarily due to the MPS trial commencing in June 2005, Taiwan Sumida trial
in November 2005, increased litigation activity in other litigation matters and
filing of additional litigation by us. As a percentage of net sales, patent
related litigation expenses were 9.6% for the year ended December 31, 2005, an
increase from 5.8% for the year ended December 31, 2004.

                                       35
<PAGE>

         Stock Exchange of Hong Kong Listing Expenses.. SEHK listing expenses
for the year ended December 31, 2005 was $2.5 million, an increase of $2.5
million or 100.0% from $0 for the year ended December 31, 2004.

         Non-operating Income-net. Non-operating income-net was $2.7 million for
the year ended December 31, 2005 almost unchanged from $2.7 million for the year
ended December 31, 2004, reflecting a foreign exchange loss of $443,000 offset
by increased interest earned on our cash and cash equivalents and short term
investments.

         Income Tax Expenses. Income tax expenses were approximately $1.0
million for the year ended December 31, 2005, compared to $1.5 million for the
year ended December 31, 2004. This decrease was primarily due to an accrual of
approximately $658,000 for Taiwan income tax due on imported products as of
December 31, 2004, which was reversed and applied as a credit on our income tax
due in the year ended December 31, 2005, and a decrease in our income before
income tax as a result of an accrual for Stock Exchange of Hong Kong listing
expenses of $2.5 million in December 2005. The accrual and reversal related to
our application on May 24, 2004 to the Taiwan Customs Authority for the
rectification of the value of the imported goods reported for the period from
March 2003 to March 2004. We had mistakenly reported a lower amount to the
Taiwan Customs Authority than the correct amount that was reported on our tax
return for the years ended December 31, 2003 and 2004. However, a rectification
of the Taiwan Customs Authority's records usually cannot be made after six
months have elapsed, in which case the understated cost of the imported goods
reported to the customs officials would have been deemed to be the actual cost,
and thus the taxable income for the years ended December 31, 2003 and 2004 would
have been higher. We therefore accrued the provision for income tax of $658,000
based on our estimate of the most probable impact on income tax as at December
31, 2004. As we have addressed the design flaw in the customized report that was
submitted to the Taiwan Customs Authority, we have confirmed that there was no
need to make a similar accrual for Taiwan income tax in 2005. Adding back the
Stock Exchange listing expenses of $2.5 million to our income before income tax
and excluding the impact of the reversal of approximately $658,000 on our income
tax expenses, our effective income tax rate for 2005 would have been 14.5%. Our
effective tax rate was 11.3% for the year ended December 31, 2005, compared to
9.5% for the year ended December 31, 2004.

Liquidity and Capital Resources

         Since our inception, we have financed our operations primarily through
private sales of securities and through our initial public offering in August
2000 and our public offering in November 2001 as well as cash provided by
operating activities in recent years. Cash, cash equivalents and short-term
investments were $65.1 million at December 31, 2006 as compared to $102.0
million at December 31, 2005. Our operating activities provided cash in the
amount of $3.3 million in the year ended December 31, 2006, $11.0 million in the
year ended December 31, 2005, and $14.1 million in the year ended December 31,
2004.

         Non-cash charges primarily consist of depreciation of property and
equipment, impairment loss of long-term investment, changes of deferred income
tax assets and amortization of stock-based compensation from stock options. The
working capital components that have a significant impact on our cash flows are
accounts receivable, inventory, notes, accounts payable, prepaid expenses and
other current assets, income tax payable and accrued liabilities.

         Net cash inflows from operations resulted from net income adjusted by
changes in accounts receivable, inventory, notes and accounts payable, income
tax payable and accrued liabilities.

         In 2006, we had a net cash inflow from investing activities of $1.7
million as compared to a net cash outflow of $19.3 million in 2005. This
increase in net cash provided by investing activities between 2005 and 2006 was
principally due to an increase of $29.0 million in net sales of short-term
investments. This increase was partially offset by an increase of $8.5 million
in net acquisitions of property and equipment.

                                       36
<PAGE>

         In 2005, we had a net cash outflow from investing activities of $19.3
million as compared to a net cash outflow of $25.2 million in 2004. This
decrease in net cash used in investing activities between 2004 and 2005 was
principally due to a net sale of $6.6 million in short-term investments in 2005
as compared to a net purchase of $11.0 million in 2004 and a decrease of
$306,000 in restricted assets in 2005 as compared to an increase of $1.9 million
in 2004. This decrease was partially offset by an increase of $5.8 million in
the net purchase of long-term investments, an increase of $14.9 million in the
purchase of fixed assets and an increase of $5.5 million in restricted cash and
other assets in 2005. The increase in restricted cash and other assets was
mainly due to an increase in time deposits pledged to a bank for the issuance of
letters of credit to purchase certain testing equipment and an increase in the
amount of court bonds deposited with the Taiwan courts for preliminary
injunctions and provisional attachments.

         Net cash inflow from our financing activities in 2004 was $0.9 million,
primarily due to the exercise of stock options and issuance of shares under our
Employee Stock Purchase Plan, which was partially offset by the repurchase of
our shares under a share repurchase program. Net cash outflow from our financing
activities in 2005 was $2.1 million, primarily due to the repurchase of our
shares and ADSs under a share repurchase program, which was partially offset by
proceeds from the exercise of stock options and warrants and issuance of shares
under our Employee Stock Purchase Plan. Net cash outflow from our financing
activities in 2006 was $6.2 million, primarily due to the repurchase of $7.6
million of our Shares and American depositary shares under a share repurchase
program in 2006 which was partially offset by proceeds from the exercise of
stock options and issuance of shares under our existing Employee Stock Purchase
Plan for the year. The listing of our ordinary shares on the Main Board of the
SEHK may or may not enhance our ability to obtain additional financing in the
future.

         We believe our cash balances will be sufficient to meet our capital
requirements for at least the next 12 months. Our future capital requirements
will depend on many factors, including the inventory levels we maintain, the
level of investments we make in new technology and improvements to existing
technology, the levels of promotion and advertising required to launch new
products and attain a competitive position in the marketplace, and the market
acceptance of our products. Thereafter, we may need to raise additional funds
through public or private financing. No assurance can be given that additional
funds will be available or that we can obtain additional funds on terms
favorable to us.

Research and Development, Patents and Licenses, etc.

         We believe that the continued introduction of new products in our
target markets is essential to our growth. As of December 31, 2006, we had
approximately 613 full-time employees world-wide engaged in research and
development efforts. Our total expenditures for research and development were
$31.8 million for the year ended December 31, 2006, $25.4 million for the year
ended December 31, 2005, and $20.3 million for the year ended December 31, 2004.
We believe that our research and development staffing will increase in the next
12 months primarily due to the expansion of our existing design centers. We
intend to continue to expand our research and development operations, including
increasing the number of design engineers.

         We employ designers who are experienced in system architecture, analog,
digital, mixed signal and software design and development. We also utilize
independent contractors from time-to-time for specific research and development
projects. Our internal research and development personnel thoroughly review the
external development processes and the design of these products as part of our
quality assurance process. All development is carried out using ISO 9001
certified design processes, and our design tools are continuously enhanced to
improve design, fabrication and verification of our products.

         Our research and development activities are a constantly evolving
process which reflects the results of our ongoing projects, our expectations
regarding market developments and changes in customer demand and industry
specifications. We commence new projects or alter the scope or direction of
existing projects on a regular basis under the guidance of our management and
senior research personnel.

                                       37
<PAGE>

         We work with our customers to monitor the performance of our product
designs and to provide support at each stage of customer product development.
Due to the complexity of our products, we maintain a significant direct
applications support staff for customer technical support in our key markets
including in Japan, Taiwan, China, Korea and the United States. These direct
applications engineering personnel assist with supporting existing products at
key customers. Additionally, we work closely with our customers to develop
highly efficient power management products for specific applications.

Trend Information

         See "Risk Factors" and "Operating and Financial Review and Prospects"
above.

Off-Balance Sheet Arrangements

         There are no off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors.

Tabular Disclosure of Contractual Obligations

         The table below describes our contractual obligations as of December
31, 2006:


                                              Payments due by period
                                    -------------------------------------------
   Contractual Obligations          Total    Less      1-3      3-5       More
                                             than     years    years      than
                                            1 year                      5 years
                                    ------  -------   ------   ------   -------
                                                 (in thousands)

Operating Lease  Obligations ....   $3,189   $1,670   $1,088   $  431   $   --
Purchase Obligations ............      502      502       --       --       --
Licenses, Maintenance and Support      983      785      198       --       --
Pension .........................      455       --       --       --      455
Total ...........................    5,129    2,957    1,286      431      455


ITEM 6   DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

Directors and Senior Management

         Our executive officers and directors and their ages as of December 31,
2006, were as follows:

<TABLE>
<CAPTION>
Name                                 Age     Position
----                                 ---     --------
<S>                                 <C>      <C>
Sterling Du......................     47     Chief Executive Officer, Class I Director and Chairman of the
                                             Board
Chuan Chiung "Perry" Kuo.........     47     Chief Financial Officer, Joint Secretary and Class I Director
James Keim.......................     62     Class II Director and Head of Marketing and Sales
Michael Austin...................     71     Independent Non-executive Director, Class III Director and
                                             member of Compensation Committee
Geok Ling Goh....................     65     Independent Non-executive Director, Class I Director and member
                                             of Audit Committee
Lawrence Lin.....................     56     Independent Non-executive Director, Class II Director and member
                                             of Audit Committee and Compensation Committee
Keisuke Yawata...................     72     Independent Non-executive Director, Class III Director and
                                             Chairman of Audit Committee
Xiaolang Yan.....................     60     Independent Non-executive Director and Class III Director
Ivan Chang.......................     44     Vice-President, Finance
Johnny Chiang....................     49     Vice-President, Logistics and Backend
Jane Liang.......................     38     Qualified Accountant
</TABLE>

                                       38
<PAGE>

         Our Class I Directors have held office from the date of the annual
general meeting in 2005 for a three year term until 2008; our Class II Directors
have held office from the date of the annual general meeting in 2006 for a three
year term until 2009; and our Class III Directors are currently holding office
and have been nominated for re-election at the annual general meeting that will
be held in June 2007 and if re-elected will hold office for a three year term
until 2010.

         Executive Directors

         Sterling Du has served as our chief executive officer and chairman of
our board of directors since March 1997 and as a Class I Director since June
2001. He also served as our chief financial officer from March 1997 to March
1999. From May 1995 to March 1997, Mr. Du was president and chief executive
officer of O2Micro, Inc., our predecessor entity. From October 1993 to April
1995, Mr. Du was vice president of engineering at GreenLogic, Inc., a
semiconductor design company, which he co-founded. Mr. Du received a B.S. in
chemical engineering from National Taiwan University and an M.S. in electrical
engineering from the University of California, Santa Barbara.

         Chuan Chiung "Perry" Kuo has served as our general manager of Taiwan
operations since January 1997, as chief financial officer and a director since
March 1999, as secretary since October 1999 and as a Class I director since June
2001. From February 1992 to December 1996, he was executive vice president of
Pac Net Group, a holding company with investments in chemicals, electronics and
real estate. From July 1983 to February 1992, he held various positions at
Formosan Rubber Group, a rubber manufacturer, including product design engineer,
plant manager, research and development director, and vice president. Mr. Kuo
received a B.S. in chemical engineering from National Taiwan University and an
M.B.A. from the Rotterdam School of Management, Erasmus University in The
Netherlands.

         James Keim has served as a director since March 1999 and as Head of
Marketing and Sales since December 2001 and a Class II director since June 2001.
He also served as our chief operating officer from June 1998 to June 2001. From
March 1995 to June 1998, Mr. Keim was a principal in Global Marketing
Associates, an international consulting firm. Prior to March 1995, he had been
vice president of sales at Alliance Semiconductor Corporation, vice president of
marketing at Performance Semiconductor Corporation and worldwide linear
marketing manager at Fairchild Semiconductor Corporation. Mr. Keim received a
B.S. in engineering from Iowa State University, an M.S. in electrical
engineering and an M.B.A. from the University of Illinois.

         Independent Non-Executive Directors

         Michael Austin has served as a director since October 1997 and as a
Class III director since June 2001. He currently serves on the compensation
committee and nominating committee. Mr. Austin is a resident of the Cayman
Islands and is a Chartered Accountant. Mr. Austin was admitted as an Associate
of the Institute of Chartered Accountants in England and Wales in 1964 and as a
Fellow in 1974. Mr. Austin is also an Associate Member of The Chartered
Institute of Taxation, a Member of the Society of Trust and Estate
Practitioners, and a Notary Public of the Cayman Islands. Mr. Austin served as
the managing partner of the Cayman Islands office of KPMG Peat Marwick, an
international accounting firm, for 23 years. Since retiring in July 1992, Mr.
Austin has been a consultant and currently serves as a non-executive director on
several company boards, including those of a number of mutual funds, trust and
insurance companies. He serves as a director of Scottish Re,

                                       39
<PAGE>

a public company. Mr. Austin served as a director of the Cayman Islands Monetary
Authority from January 1997, and was appointed Chairman of the Board in January
2003, a position he held until his retirement on July 31, 2004. He has also
served on a variety of other government committees and government related
boards, including the Cayman Islands Agricultural and Industrial Development
Board, as Chairman; the Stock Exchange Committee; and the Government/Private
Sector Consultative Committee. In 1990 Mr. Austin was awarded an M.B.E. by Her
Majesty the Queen in recognition of services to the public and business
community.

         Geok Ling Goh has served as a director since January 2000, as a member
of the audit committee since August 2000 and as a Class I director since June
2001. From October 1998 to October 1999, he was the managing director of Micron
Semiconductor Asia Pte Ltd. From June 1970 to October 1998, he held various
positions at Texas Instruments Singapore Pte Ltd, including Vice-President of
Marketing and in 1993, the first local managing director of Texas Instruments
Singapore Pte Ltd. He serves as a director on the boards of Sembcorp Industries
Ltd., Venture Corporation Ltd., DBS Group Holdings Ltd. and DBS Bank Ltd. He is
also the chairman of Sembcorp Marine Ltd. and serves as a trustee of Nanyang
Technology University. He received a bachelor of engineering degree from Sydney
University.

         Lawrence Lin has served as a Class II Director and a member of the
audit committee since June 2003. He currently also serves as Chairman of the
Compensation Committee. He is a Certified Public Accountant in Taiwan. Since
1990, Mr. Lin has been a partner of L&C Company, Certified Public Accountants,
which is a member firm of Urbach Hacker Young International, and a director of
Urbach Hacker Young International from October 1994 to October 1998. Prior to
L&C Company, he was a partner at T N Soong & Co. Mr. Lin serves as an
independent non-executive director and chairman of the audit committee for Yageo
Corporation and corporate supervisor for Tex Year Industries Inc., both of which
are Taiwan public companies. He graduated from Taipei Vocational Commercial
School in 1969.

         Keisuke Yawata has served as a director since October 1999, as a member
of the audit committee since August 2000, as Chairman of the audit committee
since July 2001 and as a Class III director since June 2001. Mr. Yawata has been
a partner and director of Start-up101, a venture capital firm, since 1999 and is
the Chief Executive Officer of The Future International, a consulting firm he
founded in 1997. From 1995 to 1997, he was the president and chief executive
officer of Applied Materials Japan and a senior vice president of Applied
Materials, Inc. From 1985 to 1994, he was at LSI Logic KK, serving as president
and chief executive officer from 1985 to 1992, and as chairman of the board from
1993 to 1994. From 1958 to 1984, he was employed by NEC Corporation and its
subsidiaries where he held various positions, the last position being president
and chief executive officer of NEC Electronics, Inc. from 1981 to 1984. In
addition, Mr. Yawata was a vice president of the Semiconductor Industry
Association Japan Chapter from 1989 to 1994. Mr. Yawata serves as a director on
the boards of U10 Networks, DigiPub Japan, Sequence Design KK and NanoGeometry
Research. He received a B.S. in electrical engineering from Osaka University in
Osaka, Japan and an M.S. in electrical engineering from Syracuse University.

         Xiaolang Yan has served as a Class III Director since July 2005 and
currently serves on the nominating committee. Mr. Yan is a professor and Dean of
the Electrical Engineering College, Dean of the Information Science &
Engineering College and Director of Institute of VLSI Design at Zhejiang
University in China. He is also the Director of China's National Integrated
Circuit Talent Education Program and Vice President of China Semiconductor
Industry Association. From May 2002 to October 2006, he was the Director of the
Strategic Expert Committee for VLSI Design of the China State High Technology
Program (863 Program). From May 1994 to March 1999, he was Professor and Dean of
Hangzhou Institute of Electronic Engineering and Director of its ICCAD Research
Institute. From September 1993 to May 1994, he was a visiting scholar at
Stanford University. From March 1990 to September 1993, he was Executive
Vice-President and Chief Engineer at Beijing IC Design Center in Beijing, China.
Mr. Yan received his bachelor of science and master of science degrees in
electrical engineering from Zhejiang University in Hangzhou, China.

                                       40
<PAGE>

         Senior Management

         Ivan Chang has served as our Vice-President, Finance since February
2003. He also served as our Controller from July 1999 until February 2003. From
August 1996 to July 1999, he was Finance Manager at Siemens Limited in Taiwan.
Mr. Chang received a B.S. in Accounting from Soochow University and an M.S. in
Accounting Information from University of Maryland, College Park.

         Johnny Chiang has served as our Vice-President, Logistics and Backend
since February 2003. He also served as our Director of Operations from March
1999 to February 2003 and our Operations Manager from November 1997 to March
1999. Mr. Chiang received a B.S. in Industrial Engineering from Chung Yung
University.

         Jane Liang has served as our Qualified Accountant since November 2005.
She is a fellow of the Association of Chartered Certified Accountants and a
member of the Chinese Institute of Certified Public Accountants. From July 2000
to October 2003, she was senior finance manager at Bausch & Lomb (Shanghai)
Trading Co. From August 1999 to June 2000, she was an accounting supervisor at
Exxon Chemical (Shanghai) Trading Co. Ms. Liang received her bachelors and
masters degree in Philosophy from Fudan University.

         There are no family relationships among any of our directors or
executive officers. There are no arrangements or understandings with major
shareholders, customers, suppliers or others, pursuant to which any person
referred to above was selected as a director or member of senior management.

Compensation

         We paid an aggregate amount of compensation during 2006 to our
directors and members of our administrative, supervisory or management bodies as
a group equal to approximately $2,750,000. All of our officers and directors are
eligible to participate in our employee benefit plans except non-employee
directors are not eligible to participate in our ESPP plan.

Share Ownership of Directors and Senior Management

         As of December 31, 2006, the aggregate number of ordinary shares
beneficially owned by our directors and members of our administrative,
supervisory or management bodies was 247,097,750. This number includes options
to purchase an aggregate of 105,467,050 ordinary shares under our 1997 Stock
Plan, 1999 Stock Plan and 2005 Share Option Plan exerciseable within 60 days of
December 31, 2006.

Employee Benefit Plans

         1997 Stock Plan. Our 1997 stock plan was adopted by our board of
directors and approved by our shareholders in 1997. The 1997 stock plan provides
for the granting to our employees of incentive stock options within the meaning
of Section 422 of the United States Internal Revenue Code, and for the granting
to employees and independent contractors of nonstatutory stock options and stock
purchase rights. Our board of directors and our shareholders authorized a total
of 3,700,000 ordinary shares for issuance pursuant to the 1997 stock plan, as
amended or 185,000,000 ordinary shares after taking into account the 50-to-1
stock split on November 25, 2005. As of December 31, 2006, options outstanding
and exercisable under the 1997 stock plan were 17,520,850. No more grants have
been made under this plan after the consummation of our initial public offering
on August 23, 2000. Our 1997 stock plan was terminated effective on March 2,
2006, the date of the listing of our ordinary shares on the Hong Kong Stock
Exchange; provided that options granted under the plan remain outstanding in
accordance with their terms.

         1999 Stock Incentive Plan. Our 1999 stock plan was adopted by our board
of directors in October 1999 and was approved by our shareholders prior to the
consummation of our initial public offering in August 2000. The 1999 stock plan
provides for the granting to employees of incentive stock options within

                                       41
<PAGE>

the meaning of Section 422 of the Internal Revenue Code and the granting of
nonstatutory stock options, stock appreciation rights, dividend equivalent
rights, restricted stock, performance units, performance shares and other
equity-based rights to our employees, directors and consultants. Initially, we
have reserved 3,000,000 ordinary shares for issuance under the 1999 stock plan
or 150,000,000 ordinary shares after taking into account the 50-to-1 stock split
on November 25, 2005. Commencing January 1, 2001, the number of ordinary shares
of stock reserved for issuance under the 1999 stock plan will be increased
annually by a number equal to 4% of the fully-diluted number of ordinary shares
outstanding as of December 31 of the immediately preceding calendar year or a
lesser number determined by the administrator. However, the maximum number of
ordinary shares available for issuance as incentive stock options will be
increased by the least of 4% of the fully-diluted number of ordinary shares
outstanding on December 31 of the immediately preceding calendar year, 1,500,000
ordinary shares (or 75,000,000 ordinary shares after taking into account the
50-to-1 stock split on November 25, 2005) or a smaller number as determined by
the administrator. In the year ended December 31, 2006, the number of shares
reserved under the 1999 stock plan was not increased. Where an award agreement
permits the exercise or purchase of the award for a specified period of time
following the recipient's termination of service with us, or the recipient's
disability or death, the award will terminate to the extent not exercised or
purchased on the last day of the specified period or the last day of the
original term of the award, whichever occurs first. As of December 31, 2006,
options outstanding under the 1999 stock plan were 272,942,250, of which
221,683,400 were exercisable. Our 1999 stock plan was terminated effective on
March 2, 2006, the date of the listing of our ordinary shares on the Hong Kong
Stock Exchange; provided that options granted under the plan remain outstanding
in accordance with their terms.

         1999 Employee Stock Purchase Plan. Our 1999 purchase plan was approved
by our board of directors in October 1999, was approved by our shareholders
prior to the consummation of our initial public offering in August 2000 and is
intended to qualify as an "employee stock purchase plan" under Section 423 of
the Internal Revenue Code and to provide our employees with an opportunity to
purchase ordinary shares or ADSs through payroll deductions. In May 2005, our
board of directors adopted certain amendments to the 1999 purchase plan and in
October 2005 our board of directors adopted and approved an amendment and
restatement of 1999 purchase plan to amend various administrative terms in
anticipation of our listing on the Hong Kong Stock exchange. We have reserved
50,000,000 ordinary shares for issuance under our 1999 purchase plan, subject to
adjustment upon certain changes in our capitalization. The number of ordinary
shares which shall be made available for sale under the 1999 purchase plan, any
share options granted pursuant to our 2005 share option plan and any other plan
(but not including our 2005 share incentive plan) will not exceed 10% of the
number of ordinary shares to be issued and outstanding immediately following the
listing of our ordinary shares on the Hong Kong Stock Exchange. In no event may
an option be granted under our 1999 purchase plan if such grant would result in
the total aggregate number of ordinary shares subject to all then outstanding
purchase rights granted by us pursuant to our 1999 purchase plan, any share
option granted pursuant to our 2005 share option plan or any other plan (but not
including our 2005 share incentive plan) to exceed 30% of the issued and
outstanding ordinary shares from time to time. As of December 31, 2006,
34,148,050 shares had been issued under the 1999 purchase plan.

         Our board of directors or a committee designated by our board of
directors, referred to as the "plan administrator", administers our 1999
purchase plan. All of our employees who are regularly employed for more than
five months in any calendar year and work more than 20 hours per week are
eligible to participate in our 1999 purchase plan, subject to a 10 day waiting
period after hiring. Non-employee directors, consultants and employees subject
to the rules or laws of a non-U.S. jurisdiction that prohibit or make
impractical their participation in the plan will not be eligible to participate.
Our 1999 purchase plan designates offer periods, purchase periods and exercise
dates. Offer periods are periods of three months commencing in February, May,
August and November. Purchase periods will generally be three month periods.
Exercise dates are the last day of each purchase period. In the event of a
corporate transaction, the plan administrator may elect to shorten the offer
periods then in progress and set a new exercise date for the purchase of
ordinary shares or ADSs.

                                       42
<PAGE>

         On the first day of each offer period, a participating employee will be
granted a purchase right. A purchase right is a form of option to be
automatically exercised on the forthcoming exercise dates within the offer
period during which authorized deductions are to be made from the pay of
participants and credited to their accounts under our 1999 purchase plan. When
the purchase right is exercised, the participant's withheld salary is used to
purchase the ordinary shares or ADSs. The price per share at which the ordinary
shares or ADSs are to be purchased under our 1999 purchase plan during any
purchase period will be expressed as a percentage not less than the lower of (a)
90% of the fair market value of the ordinary shares or ADSs on the date of grant
of the purchase right (which is the commencement of the offer period) or (b) 90%
of the fair market value of the ordinary shares or ADSs on the date the purchase
right is exercised. Purchase rights may not be assigned, transferred, pledged or
otherwise disposed of in any way by the participant, other than by will or the
laws of descent and distribution.

         Payroll deductions may range from 1% to 10% in whole percentage
increments of a participant's regular base pay. The maximum number of ordinary
shares or ADSs that any employee may purchase under our 1999 purchase plan
during a purchase period is 100,000 ordinary shares or 2,000 ADSs. In addition,
Section 423 of the U.S. Internal Revenue Code imposes a US$25,000 limit on the
maximum amount of ordinary shares or ADSs that may be purchased under a
tax-qualified employee stock purchase plan during any calendar year. The
US$25,000 limit is determined at the fair market value of the ordinary shares or
ADSs at the time such option is granted for each calendar year in which such
option is outstanding.

         The plan administrator has the authority to amend or terminate our 1999
purchase plan. The plan administrator may terminate any offer period on any
exercise date if the plan administrator determines that the termination of the
offer period is in the best interests of our company and its shareholders.

         2005 Share Option Plan. Our 2005 share option plan was adopted by our
board of directors in August 2005, was approved by our shareholders in November
2005 and took effect on March 2, 2006. The 2005 share option plan provides for
the granting to employees of incentive stock options within the meaning of
Section 422 of the Internal Revenue Code and the granting of nonstatutory stock
options to our employees, directors and consultants. Initially, the maximum
aggregate number of shares reserved for issuance pursuant to all options
(including incentive stock options) under the 2005 share option plan is
100,000,000 ordinary shares after taking into account the 50-to-1 stock split on
November 25, 2005 and such number of shares shall not, when added to the
remaining number of ordinary shares available for the grant of options under any
other plan or employee share purchase plan, be greater than 10% of the number of
ordinary shares outstanding as of the date of adoption of the 2005 share option
plan. The maximum number of shares that may be issued upon exercise of all
outstanding (and unexercised) options under the 2005 share option plan and any
other plan of ours and any purchase rights granted by us pursuant to any
employee share repurchase plan must not, in aggregate, exceed 30% of the number
of ordinary shares outstanding from time to time. Where an award agreement
permits the exercise or purchase of the award for a specified period of time
following the recipient's termination of service with us, or the recipient's
disability or death, the award will terminate to the extent not exercised or
purchased on the last day of the specified period or the last day of the
original term of the award, whichever occurs first. As of December 31, 2006,
16,279,900 options were outstanding under the 2005 share option plan.

         2005 Share Incentive Plan. Our 2005 share incentive plan was adopted by
our board of directors in August 2005, was approved by our shareholders in
November 2005 and took effect on March 2, 2006. The 2005 share incentive plan
provides for the granting to our employees, directors and consultants of
restricted shares, cash dividend equivalent rights, restricted share units or
stock appreciation rights or similar right with a fixed or variable price
related to the fair market value of our ordinary shares and with an exercise or
conversion privilege related to the passage of time, the occurrence of one or
more events, or the satisfaction of performance criteria or other conditions.
Initially, the maximum aggregate number of shares which may be issued pursuant
the 2005 share incentive plan is 75,000,000 ordinary shares after taking into
account the

                                       43
<PAGE>

50-to-1 stock split on November 25, 2005. In addition, a right entitling a
grantee to compensation measured by dividends paid with respect to ordinary
shares shall be payable solely in cash and shall not be deemed to reduce the
maximum aggregate number of shares which may be issued under our 2005 share
incentive plan. Where an award agreement permits the exercise or purchase of the
award for a specified period of time following the recipient's termination of
service with us, or the recipient's disability or death, the award will
terminate to the extent not exercised or purchased on the last day of the
specified period or the last day of the original term of the award, whichever
occurs first. As of December 31, 2006, 7,914,750 shares were outstanding under
the 2005 share incentive plan.

Board Practices

Duties of Directors

         Under Cayman Islands law, our directors have a duty of loyalty to act
honestly in good faith with a view to promoting our best interests. Our
directors also have a duty of care to exercise the care, diligence and skills
that a reasonably prudent person would exercise in comparable circumstances. In
fulfilling their duty of care to us, our directors must ensure compliance with
our memorandum and articles of association and the class rights vested under our
memorandum and articles of association in the holders of the shares.

Terms of Directors and Officers

         Our articles of association provide for not less than five nor more
than nine directors although the holders of a majority of our shares may
increase or reduce such limits. Our articles of association provide for our
board of directors to be divided into three classes, designated Class I, Class
II and Class III, with each class consisting of an equal number of directors or
as nearly equal in number as the then total number of directors permits. The
directors of each class have been elected for terms of three years ending in
consecutive years. At each annual general meeting, successors to the class of
directors whose terms expire at that annual general meeting are elected for new
three year terms. If the number of directors is changed, any increase or
decrease is apportioned among the classes so as to maintain the number of
directors in each class as nearly equal as possible and any additional directors
of any class elected to fill a vacancy resulting from an increase in such class
shall hold office for a term that shall coincide with the remaining term of that
class, but in no case will a decrease in the number of directors shorten the
term of any incumbent directors. The term of executive officers is determined by
our board of directors. There are no provisions of Cayman Islands law which
require the term of executive officers to be for a particular period.

         Our board of directors has the power at any time and from time to time
to appoint any person to be a director, either to fill a casual vacancy or as an
additional to the existing directors provided that the appointment does not
cause the number of directors to exceed any number fixed by or in accordance
with the articles of association as a maximum number of directors. Any director
so appointed shall hold office only until one next annual general meeting and is
then eligible for re-election at that meeting.

         Our shareholders may by special resolution remove any directors before
the expiration of his period of office notwithstanding anything in the articles
of association or in any agreement we have entered into with such director (but
without prejudice to any claim for damages under any such agreement).

         There is no shareholding qualification for directors. Subject to any
retirement rules, statutes or provisions provided by applicable law, any
individual who reaches the age of seventy-five (75) years or older at the time
of election or re-election will not be eligible for recommendation for
nomination to our board. Subject to any retirement rules, statutes or provisions
provided by applicable law, upon reaching seventy-five (75) years of age, any
existing director will be allowed to complete his or her term in office but will
not be eligible for recommendation for nomination to our board for a subsequent
term.

                                       44
<PAGE>

Committees of the Board of Directors

         We have an audit committee, a compensation committee and a nominating
committee. Each of our audit committee members qualifies as an "independent"
director for purposes of the rules and regulations of Nasdaq. The audit
committee is established by the Board primarily for the purpose of overseeing
the accounting and financial reporting processes of the Company and audits of
the financial statements of the Company. The Committee's responsibilities
include (1) the appointment, retention, compensation and oversight of the work
of our independent auditors, and for review of its qualifications, and (2)
review of our system of internal controls. The Committee also maintains
procedures for the receipt, retention and treatment of complaints received by
the Company regarding accounting, internal controls, or auditing matters and for
the confidential, anonymous submission by employees of the company of concerns
regarding accounting or auditing matters. The audit committee meets at least
four times per year, and also meets separately with the representatives of
management at least annually. The audit committee held seven meetings in 2006.
Currently, Messrs. Yawata, Goh and Lin serve on the audit committee.

         The compensation committee establishes remuneration levels for our
officers, performs the functions that are provided under our employee benefit
programs and administers our long-term incentive, compensation and equity plans
including our 1999 stock incentive plan, our 1999 employee stock purchase plan,
our 2005 share incentive plan and 2005 share option plan. Currently, Messrs. Lin
and Austin serve on the compensation committee.

         The nominating committee assists our board of directors in selecting
nominees for election to our board of directors and makes recommendations to our
board of directors from time to time, or whenever it shall be called upon to do
so, regarding nominees for our board of directors. Currently, Messrs. Austin and
Yan serve on the nominating committee

Compensation Committee Interlocks and Insider Participation

         No member of our compensation committee serves as a member of the board
of directors or the compensation committee of any entity that has one or more
executive officers serving as a member of our board of directors or our
compensation committee.

Employees

         As of December 31, 2006, we had 1,001 full-time employees, 116 of which
were based in the United States, 850 in Asia, 32 in Europe and 3 in Cayman
Islands. Our employees are not represented by any collective bargaining
agreements, and we have never experienced a work stoppage. We believe our
employee relations are good.

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

MAJOR SHAREHOLDERS

         The following table sets forth information known to us with respect to
the beneficial ownership of our ordinary shares, as of March 31, 2007, by each
shareholder known by us to own beneficially more than 5% of our ordinary shares
based on SEC filings as of March 31, 2007.

                                       45
<PAGE>

                                                     Shares Beneficially Owned
                                                     -------------------------
          Name of Beneficial Owner                    Number           Percent
  -----------------------------------------------    -----------      --------
  Wasatch Advisors, Inc.                             356,712,650        18.73%
  Wellington Management Co. LLP                      187,601,500        9.85%
  Capital Research & Management Co.                  152,750,000        8.02%
  RS Investment Management Co                        116,456,350        6.11%
  Directors and members of our administrative,
      supervisory or management bodies               247,097,750        12.97%


None of the major shareholders listed above have differing voting rights with
respect to the ordinary shares of the Company. We do not know of any
arrangements the operation of which may at a subsequent date result in a change
in control of the Company. To our knowledge, we are not directly or indirectly
owned or controlled by another corporation, by a foreign government or any other
natural or legal person.

RELATED PARTY TRANSACTIONS

Loans

         In 2001, James Keim, one of our directors, accepted the assignment of
Head of Marketing and Sales in the Cayman Islands, and moved to the Cayman
Islands in December 2001. In connection with the move and to assist Mr. Keim to
purchase a residence in the Cayman Islands, we entered into a term loan
agreement with Mr. Keim in February 2002, under which we made an interest free,
unsecured loan in the amount of $400,000 to Mr. Keim. The loan is repayable in
February 2007 and was repaid in full in December 2006.

         In February 2000, we loaned $750,000 to 360(degree) Web Ltd
(360(degree) Web). The loan accrued interest at a rate of USD-LIBOR + 1% and was
to be paid semiannually until the loan was fully repaid or until the loan was
converted into up to 2,083,333 shares of Series B preference shares of
360(degree) Web. The conversion price was $0.36 per share, convertible at any
time before February 1, 2005 or before 360(degree) Web offers its shares in an
initial public offering. In February 2002, we made an additional loan of $1.0
million to 360(degree) Web on terms similar to the February 2000 loan. The
February 2002 loan was also convertible, into a maximum of 1,000,000 Series B2
preference shares of 360(degree) Web at a conversion price of $1.00 per share.
On January 3, 2003, we exercised our option to convert both the February 2000
and February 2002 loans (aggregate principal of $1,750,000) into 2,083,333
Series B preference shares at $0.36 per share and 1,000,000 Series B2 preference
shares at $1.00 per share. After the conversion, we owned a 35.18% interest in
360(degree) Web. We did not participate in 360(degree) Web's additional
financing rounds during 2003, and our ownership was diluted to 29.33% as of
December 31, 2003. In March 2004, we sold 1,000,000 shares of our stock in
360(degree) Web and recognized a gain of $340,000. In January 2005, we purchased
180,769 Series D preference shares of 360(degree) Web at $1.30 per share. As of
December 31, 2006, we held 19.52% ownership of 360(degree) Web. From time to
time, we may make additional loans to 360(degree) Web on similar terms.

Executive Severance and Change of Control Agreements

         In April 2007, we entered into an Executive Severance and Change of
Control Agreement with Sterling Du, our chief executive officer and chairman of
our board, pursuant to which Mr. Du would be entitled to, among other things,
two times his base salary and annual target bonus and immediate vesting of 50%
of his unvested equity awards if terminated under certain circumstances. In
addition, Mr. Du would be entitled to, among other things, three times his base
salary and annual target bonus and immediate vesting of 100% of his unvested
equity awards if terminated under certain circumstances within twenty-four
months of a change of control of our company.

         In April 2007, we entered into an Executive Severance and Change of
Control Agreement with Chuan Chiung "Perry" Kuo, our chief financial officer,
pursuant to which Mr. Kuo would be entitled to,

                                       46
<PAGE>

among other things, one times his base salary and annual target bonus and
immediate vesting of 50% of his unvested equity awards if terminated under
certain circumstances. In addition, Mr. Kuo would be entitled to, among other
things, one and a half times his base salary and annual target bonus and
immediate vesting of 50% of his unvested equity awards if terminated under
certain circumstances within twelve months of a change of control of our
company.

         In April 2007, we entered into an Executive Severance and Change of
Control Agreement with James Keim, our head of marketing and sales, pursuant to
which Mr. Keim would be entitled to, among other things, one times his base
salary and annual target bonus and immediate vesting of 50% of his unvested
equity awards if terminated under certain circumstances. In addition, Mr. Keim
would be entitled to, among other things, one and a half times his base salary
and annual target bonus and immediate vesting of 50% of his unvested equity
awards if terminated under certain circumstances within twelve months of a
change of control of our company.

ITEM 8   FINANCIAL INFORMATION

CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

Consolidated Financial Statements

         Our financial statements set forth in the accompanying index to
Consolidated Financial Statements included in this Annual Report following Part
IV beginning on page F-1 are hereby incorporated in this Annual Report. Our
Consolidated Financial Statements are filed as part of this Annual Report.


DIVIDEND POLICY

         We have never declared or paid any cash dividends on our ordinary
shares or other securities and do not anticipate paying cash dividends in the
foreseeable future.

ITEM 9   THE OFFER AND LISTING

ADS AND ORDINARY SHARE PRICES AND RELATED MATTERS

         Our ADSs are quoted and traded on the Nasdaq Global Select Market and
the Cayman Islands Stock Exchange. Our ordinary shares are listed on the SEHK
and the Cayman Islands Stock Exchange.

Ordinary Shares Prior to Close of Trading on November 25, 2005 and ADSs After
Commencement of Trading on November 28, 2005

The following table sets forth for the periods indicated the high and low last
reported sales prices per ordinary share prior to the close of trading on
November 25, 2005 and the high and low last reported sales prices per ADS after
the commencement of trading on November 28, 2005 as furnished by the Nasdaq
Global Select Market.

         (a)  Annual high and low market prices

                                                           High       Low
                                                           ----       ---

              January 1, 2002 through December 31, 2002   $25.28     $5.30
              January 1, 2003 through December 31, 2003   $25.29     $8.01
              January 1, 2004 through December 31, 2004   $24.98     $9.04
              January 1, 2005 through December 31, 2005   $17.72     $8.74
              January 1, 2006 through December 31, 2006   $13.55     $5.07

                                       47
<PAGE>

         (b)  Quarterly high and low market prices

              First Quarter 2005                          $10.95     $8.74
              Second Quarter 2005                         $14.72     $9.35
              Third Quarter 2005                          $17.72     $14.10
              Fourth Quarter 2005                         $15.83     $9.24
              First Quarter 2006                          $13.55     $9.95
              Second Quarter 2006                         $10.98     $7.20
              Third Quarter 2006                          $7.87      $5.07
              Fourth Quarter 2006                         $8.64      $6.40
              First Quarter 2007                          $8.65      $7.12


         (c)  Monthly high and low market prices

              December 2006                               $8.64      $7.49
              January 2007                                $8.43      $7.12
              February 2007                               $8.65      $7.68
              March 2007                                  $8.11      $7.33
              April 2007                                  $10.67     $7.80
              May 2007                                    $10.98     $9.72


         Ordinary Shares After Commencement of Trading On March 2, 2006
         --------------------------------------------------------------

The following table sets forth for the periods indicated the high and low last
reported sales prices per ordinary share in Hong Kong dollars (HK$) as furnished
by the Hong Kong Stock Exchange. Our ordinary shares commenced trading on the
Hong Kong Stock Exchange on March 2, 2006

         (a)  Quarterly high and low market prices

                                                           High        Low
                                                           ----        ---

              Second Quarter 2006                         HK$1.70    HK$1.11
              Third Quarter 2006                          HK$1.16    HK$0.84
              Fourth Quarter 2006                         HK$1.31    HK$0.94
              First Quarter 2007                          HK$1.32    HK$1.05

         (b)  Monthly high and low market prices

              December 2006                               HK$1.31    HK$1.00
              January 2007                                HK$1.28    HK$1.05
              February 2007                               HK$1.32    HK$1.14
              March 2007                                  HK$1.24    HK$1.16
              April 2007                                  HK$1.64    HK$1.16
              May 2007                                    HK$1.64    HK$1.51


                                       48

<PAGE>

ITEM 10  ADDITIONAL INFORMATION

         The following are summaries of material provisions of our memorandum
and articles of association and the Companies Law (2004 Revision). The summary
is qualified in its entirety by reference to our memorandum and articles of
association (see Item 19-Exhibit 1).

Registered Office

         The Company has been assigned registration number CR-72204 by the
registrar of companies in the Cayman Islands. The registered office is located
at the offices of M&C Corporate Services Limited, P.O. Box 309, Ugland House,
South Church Street, George Town, Grand Cayman, Cayman Islands. The telephone
number at that location is (345) 949-8066.

Objects and Purposes

         Paragraph 3 of the memorandum of association provides that the objects
and purposes of the Company are unlimited and the Company may perform all
corporate activities not prohibited by any law as provided by the Companies Law.

Directors

         Article 117 of the articles of association of the Company provides that
a director will not be disqualified by his office from contracting with the
Company notwithstanding such director's interest and that such an interested
director will not be liable to the Company for any profit realized through such
contract or arrangement, provided, the interested director declares such
interest at the earliest meeting of the board. Article 127 provides that
directors' compensation shall from time to time be determined by the Company in
general meeting or by the board in accordance with the articles of association.
Article 136 provides that the directors may exercise all the powers of the
Company to borrow money and to mortgage or charge its undertaking, property and
uncalled capital or any part thereof and to issue debentures, debenture stock
and other securities whether outright or as security for any debt, liability or
obligation of the Company or of any third party.

Ordinary Shares

         General. The Company's articles of association authorize the issuance
of 4,750,000,000 ordinary shares with a par value of US $0.00002. All the
outstanding ordinary shares are fully paid and nonassessable and accordingly no
further capital may be called for by the Company from any holder of the ordinary
shares outstanding. Certificates representing the ordinary shares are issued in
registered form. The ordinary shares are not entitled to any sinking fund or
pre-emptive or redemption rights. Under Cayman Islands Law, non-residents may
freely hold, vote and transfer ordinary shares in the same manner as Cayman
Islands residents, subject to the provisions of the Companies Law and the
articles of association. No Cayman Islands laws or regulations restrict the
export or import of capital or affect the payment of dividends to non-residents
holders of the ordinary shares.

         Dividends. The holders of our ordinary shares are entitled to receive
the dividends that are declared by the board of directors. Dividends may be paid
only out of profits, which include net earnings and retained earnings
undistributed in prior years, and out of share premium, a concept analogous to
paid-in-surplus in the United States, subject to a statutory solvency test.

         Voting Rights. Each ordinary share is entitled to one vote on all
matters upon which the ordinary shares are entitled to vote, including the
election of directors. Voting at any meeting of shareholders is by show of hands
unless a poll is demanded. A poll may be demanded by the chairman of the meeting
or any shareholder present in person or by proxy, before or on the declaration
of the result of the show of hands.

                                       49
<PAGE>

         A quorum required for a meeting of shareholders consists of at least a
number of shareholders present in person or by proxy and entitled to vote
representing the holders of not less than a majority of our issued voting share
capital. Shareholders' meetings are held annually and may be convened by the
board of directors on its own initiative. Advanced notice of at least twenty-one
days in the case of annual general meetings or any meeting at which the passing
of a special resolution is to be considered and fourteen days in all other cases
is required for the convening of shareholders' meetings.

         Any ordinary resolution to be made by the shareholders requires the
affirmative vote of a simple majority of the votes attaching to the ordinary
shares and preference shares, if any, cast in a general meeting, while a special
resolution requires the affirmative vote of two-thirds of the votes cast
attaching to the ordinary shares and preference shares, if any. Holders of
ordinary shares, which are currently the only shares, carrying the right to vote
at our general meetings, have the power, among other things, to elect directors,
appoint auditors and make changes in the amount of our authorized share capital.

         Material issues that require a special resolution of the shareholders
under the Companies Law include resolutions to alter the memorandum of
association with respect to any objects, powers or other matters specified
therein, any alteration of the articles of association, any reduction of
capital, any change of name, the appointment of an inspector for examining into
the affairs of the company, requiring the company to be wound up by a court, any
voluntary winding up, delegating to creditors the power of appointing
liquidators, making binding arrangements between the company and its creditors,
and sanctioning the transfer of the business or property of the company being
wound up to another company whether established in the Cayman Islands or in any
other jurisdiction.

         Liquidation. If we are to be liquidated, the liquidator may, with the
approval of the shareholders, divide among the shareholders in cash or in kind
the whole or any part of our assets, in a manner proportionate to their
shareholdings, and may vest the whole or any part of those assets in trustees of
those trusts for the benefit of the shareholders that the liquidator, with the
approval of the shareholders, thinks fit, provided that, in practice, a
shareholder may not be compelled to accept any shares or other assets that would
subject that shareholder to liability.

Preference Shares

         The articles of association authorizes the issuance of 250,000,000
preference shares with a par value of $0.00002 per share. Pursuant to our
articles of association, the board of directors has the authority, without
further action by the shareholders, to issue preference shares in one or more
series. It also has the authority to fix the designations, powers, preferences,
privileges and relative participating, optional or special rights and the
qualifications, limitations or restrictions of those shares, including dividend
rights, conversion rights, voting rights, terms of redemption and liquidation
preferences, any or all of which may be greater than the rights of the ordinary
shares. The board of directors, without shareholder approval, can issue
preference shares with voting, conversion or other rights that could harm the
voting power and other rights of the holders of ordinary shares. Subject to the
directors' duty of acting in our best interest, preference shares can be issued
quickly with terms calculated to delay or prevent a change in control or make
removal of management more difficult. Additionally, the issuance of preference
shares may have the effect of decreasing the market price of the ordinary
shares, and may harm the voting and other rights of the holders of ordinary
shares. We have confirmed that as long as our ordinary shares or preference
shares are listed on the SEHK, we will comply with the listing rules of the SEHK
and any preference shares issued or to be issued shall carry the same voting
rights as the ordinary shares.

Anti-takeover Effects of Provisions in Our Charter Documents

         Provisions in our charter documents could discourage potential
acquisition proposals and could delay or prevent a change in control transaction
that our shareholders favor. These provisions could have the effect

                                       50

<PAGE>

of discouraging others from making tender offers for our shares. As a result,
these provisions may prevent the market price of our ordinary shares from
reflecting the effects of actual or rumored takeover attempts and may prevent
shareholders from reselling their shares at or above the price at which they
purchased their shares. These provisions may also prevent changes in our
management that our shareholders may favor. Our charter documents do not permit
shareholders to act by written consent, do not permit shareholders to call a
general meeting and provide for a classified board of directors, which means
shareholders can only elect, or remove, a limited number of our directors in any
given year. Furthermore, as discussed above, our board of directors have the
authority to issue up to 250,000,000 preference shares in one or more series.
Our board of directors can fix the price, rights, preferences, privileges and
restrictions of such preference shares without any further vote or action by our
shareholders. The issuance of preference shares may delay or prevent a change in
control transaction without further action by our shareholders or make removal
of management more difficult.

Differences in Corporate Law

         The Companies Law of the Cayman Islands is modeled after that of
England but does not follow recent United Kingdom statutory enactments and
differs from laws applicable to United States corporations and their
shareholders. The following paragraphs are a summary of the significant
differences between the provisions of the Companies Law applicable to us and the
laws applicable to companies incorporated in the United States and to their
shareholders.

         Mergers and Similar Arrangements. Cayman Islands law does not provide
for mergers as that expression is understood under United States corporate law.
However, there are statutory provisions that facilitate the reconstruction and
amalgamation of companies, provided that the arrangement in question is approved
by a majority in number of each class of shareholders and creditors with whom
the arrangement is to be made, and who must in addition represent three-fourths
in value of each class of shareholders or creditors, as the case may be, that
are present and voting either in person or by proxy at a meeting or meetings
convened for that purpose. The convening of the meetings and subsequently the
arrangement must be sanctioned by the Grand Court of the Cayman Islands. While a
dissenting shareholder would have the right to express to the court the view
that the transaction ought not to be approved, the court can be expected to
approve the arrangement if it satisfies itself that:

         o  the parties have complied with the statutory provisions regarding
            majority vote;

         o  the shareholders have been fairly represented at the meeting in
            question;

         o  the arrangement is one that a businessman would reasonably approve;
            and

         o  the arrangement is not one that would more properly be sanctioned
            under some other provision of the Companies Law.

         When a take-over offer is made and accepted by holders of 90% of the
shares within four months, the offeror may, within a two-month period require
the holders of the remaining shares to transfer these shares on the terms of the
offer. An objection can be made to the Grand Court of the Cayman Islands but
this is unlikely to succeed unless there is evidence of fraud, bad faith or
collusion.

         If the arrangement and reconstruction is approved, the dissenting
shareholder would have no rights comparable to appraisal rights, which would
otherwise ordinarily be available to dissenting shareholders of United States
corporations, providing rights to receive payment in cash for the judicially
determined value of the shares.

         Shareholders' Suits. Maples and Calder has advised us that no
significant or major reported class action or derivative action has been brought
in a Cayman Islands court. In principle, we will normally be the proper
plaintiff and a derivative action may not be brought by a minority shareholder.
However, based on

                                       51
<PAGE>

English authorities, which would in all likelihood be of persuasive authority in
the Cayman Islands, exceptions to the foregoing principle apply in circumstances
in which:

         o  a company is acting or proposing to act illegally or outside of its
            powers;

         o  the act complained of, although not outside of its powers, could be
            effected only if authorized by more than a simple majority vote;

         o  the individual rights of the plaintiff shareholders have been
            infringed or are about to be infringed; or

         o  those who control the company are perpetrating a "fraud on the
            minority."

Indemnification

         Cayman Islands law does not limit the extent to which a company's
articles of association may provide for indemnification of officers and
directors, except to the extent that a provision may be held by the Cayman
Islands courts to be contrary to public policy, such as to provide
indemnification against civil fraud or the consequences of committing a crime.
Our articles of association provide for indemnification of officers and
directors for losses, damages, costs and expenses incurred in their capacities
as such, except if they acted in a willfully negligent manner or defaulted in
any action against them.

         Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to our directors, officers or persons controlling us
pursuant to these provisions, we have been informed that, in the opinion of the
Securities and Exchange Commission, this indemnification is against public
policy as expressed in the Securities Act and therefore is unenforceable.

Enforceability of Civil Liabilities

         We are a Cayman Islands company. We incorporated in the Cayman Islands
because of the following benefits associated with being a Cayman Islands
company:

         o    political and economic stability;

         o    an effective judicial system;

         o    unlike some jurisdictions which impose taxes on worldwide income,
              no taxation of companies based upon profits, income, gains or
              appreciation;

         o    the absence of exchange control or currency restrictions; and

         o    the availability of professional and support services.

         However, the Cayman Islands has a less developed body of securities
laws than the United States and provides less protection for investors. For
example, the remedies of shareholders and fiduciary responsibilities of our
directors are governed by Cayman Islands law and are not as clearly established
as under statutes or judicial precedent in existence in jurisdictions in the
United States. While there is some case law in the Cayman Islands on these
matters, it is not as developed as, for example, English law. However, we
believe that English case law, although not binding in the courts of the Cayman
Islands, would be regarded as persuasive. Based on English case law, we believe
under Cayman Islands law, our directors have a duty of loyalty to act honestly
in good faith with a view to promoting our best interests. Our directors also
have a duty of care to exercise the care, diligence and skills that a reasonably
prudent person would exercise in comparable circumstances. In fulfilling their
duty of care to us, our directors must ensure compliance with our memorandum and
articles of association and the class rights vested under our memorandum and
articles of association in the holders of the shares.

                                       52
<PAGE>

         A substantial majority of our assets are located outside the United
States. In addition, a majority of our directors and officers are nationals
and/or residents of countries other than the United States, and all or a
substantial portion of our assets and the assets of our directors and officers
are located outside the United States. As a result, it may be difficult to
effect service of process within the United States upon us or our directors and
officers or to enforce against us or against them judgments obtained in United
States courts, including judgments predicated upon the civil liability
provisions of the securities laws of the United States or any state thereof.

         Maples and Calder, our counsel as to Cayman Islands law, has advised us
that there is uncertainty regarding whether the courts of the Cayman Islands
would (1) recognize or enforce judgments of United States courts obtained
against us or our officers and directors predicated upon the civil liability
provisions of the securities laws of the United States or any state thereof or
(2) be competent to hear original actions brought in their jurisdiction against
us or our officers and directors predicated upon the securities laws of the
United States or any state thereof.

         There is no statutory enforcement in the Cayman Islands of judgments
obtained in the United States. Instead, such a judgment must be enforced by
action at common law. Maples and Calder have advised us that a final and
conclusive judgment in a federal or state court of the United States under which
a sum of money is payable, other than a sum payable in respect of taxes, fines,
penalties or similar charges, may be subject to enforcement proceedings as a
debt in the Courts of the Cayman Islands under the common law doctrine of
obligation.

Material Contracts

         Other than the contracts listed under Item 19--Exhibits and the
Executive Severance and Change of Control Agreements described in "Related Party
Transactions - Executive Severance and Change of Control Agreements", in the
past two years we have not entered into any material contracts other than
contracts entered into in the ordinary course of business.

Exchange Control

         Our articles of association authorizes us to issue an aggregate of
4,750,000,000 ordinary shares with a par value of $0.00002 per share. Of those
4,750,000,000 authorized ordinary shares, 1,906,969,950 shares were issued and
outstanding as of December 31, 2006, all of which are fully paid or credited as
fully paid. We may not call for any further capital from any holder of ordinary
shares outstanding. Under Cayman Islands law, non-residents of the Cayman
Islands may freely hold, vote and transfer ordinary shares in the same manner as
Cayman Islands residents, subject to the provisions of the Companies Law and our
articles of association. No Cayman Islands laws or regulations restrict the
export or import of capital, or affect the payment of dividends to non-resident
holders of ordinary shares.

TAXATION

Cayman Islands Taxation

         The Cayman Islands currently levy no taxes on individuals or
corporations based upon profits, income, gains or appreciation and there is no
taxation in the nature of inheritance tax or estate duty. There are no other
taxes likely to be material to us levied by the Government of the Cayman Islands
except for stamp duties that may be applicable on instruments executed in, or
after execution brought within, the jurisdiction of the Cayman Islands. The
Cayman Islands are not party to any double tax treaties. There are no exchange
control regulations or currency restrictions in the Cayman Islands.

                                       53
<PAGE>

         No stamp duties are payable on the issue or transfer of shares. An
agreement to transfer shares may be subject to stamp duty if the agreement is
executed in the Cayman Islands or, if executed outside the Cayman Islands,
subsequently brought into the Cayman Islands. The Stamp Duty Law (2005 Revision)
does not provide who is liable to pay stamp duty on any document but, in
practice, the person who seeks to rely on the document in any civil court
proceedings will be required to pay stamp duty in order to have the document
admitted in evidence.

United States Federal Income Taxation

         The following discussion addresses the material United States federal
income tax consequences of the ownership and disposition of ordinary shares or
ADSs held as a capital asset by a "U.S. Investor" (as defined below). This
summary does not provide a complete analysis of all potential tax consequences.
This summary is based on the Internal Revenue Code of 1986, as amended (the
"Code"), final, temporary and proposed Treasury Regulations thereunder, and
administrative and judicial interpretations thereof, all as in effect as of the
date hereof, and all of which are subject to change at any time (possibly on a
retroactive basis) by legislative, judicial or administrative action, and to
differing interpretations. There can be no assurance that the Internal Revenue
Service (the "IRS") will not take a contrary view. This summary does not discuss
state, local or foreign tax consequences of the ownership and disposition of
ordinary shares or ADSs.

         This summary is directed solely to U.S Investors that hold ordinary
shares or ADSs as capital assets within the meaning of Section 1221 of the Code,
which generally means as property held for investment. For purposes of this
discussion, a "U.S. Investor" means a beneficial owner of ordinary shares or
ADSs who is any of the following:

         o  a citizen or resident of the United States or someone treated as a
            U.S. citizen or resident for U.S. federal income tax purposes;

         o  a corporation or other entity taxable as a corporation for U.S.
            federal income tax purposes created or organized in or under the
            laws of the United States or any political subdivision thereof,
            including the District of Columbia;

         o  an estate the income of which is subject to U.S. federal income
            taxation regardless of its source;

         o  a trust that is subject to the primary supervision of a court within
            the United States and one or more U.S. persons have the authority to
            control all of its substantial decisions;

         o  a trust in existence on August 20, 1996 that has a valid election in
            effect under applicable U.S. Treasury regulations to be treated as a
            U.S. person; or

         o  a person that is otherwise subject to U.S. federal income taxation
            on its net income.

         If a partnership (including for this purpose any entity treated as a
partnership for U.S. federal income tax purposes) is a beneficial owner of
ordinary shares or ADSs, the U.S. federal income tax consequences to a partner
in the partnership will generally depend on the status of the partner and the
activities of the partnership. A holder of ordinary shares or ADSs that is a
partnership and partners in such partnership should consult their individual tax
advisors about the U.S. federal income tax consequences of holding or disposing
of the ordinary shares or ADSs.

                                       54
<PAGE>

         This summary does not address the United States federal income tax
treatment of investors having a special legal status, including without
limitation the following types of investors, who may be subject to tax rules
that differ significantly from those summarized below:

         o  life insurance companies;

         o  tax-exempt investors;

         o  banks and financial institutions;

         o  dealers in securities or foreign currencies;

         o  traders in securities that elect to use a mark-to-market method of
            accounting for their securities holdings;

         o  persons liable for alternative minimum tax;

         o  U.S. investors who or that actually or constructively hold 10% or
            more of our voting shares or ADSs;

         o  investors who hold our ordinary shares or ADSs as part of straddles,
            hedging or integrated or conversion transactions; or

         o  persons whose "functional currency" is not the U.S. dollar.

         This summary is not a comprehensive description of all of the tax
considerations that may be relevant with respect to your ownership of ordinary
shares or ADSs. You are advised to consult your own tax adviser with respect to
your particular circumstances and with respect to the effects of federal, state,
local or foreign tax laws to which you may be subject. The United States does
not have an income tax treaty with the Cayman Islands.

         As relates to the ADSs, this discussion is based in part upon the
representations of the depositary and the assumption that each obligation in the
deposit agreement and any related agreement will be performed in accordance to
its terms.

         Generally, a holder of ADSs will be treated as the owner of the
underlying ordinary shares represented by those ADSs for U.S. federal income tax
purposes. Accordingly, no gain or loss will be recognized if the holder
exchanges ADSs for the underlying ordinary shares represented by those ADSs. The
holder's adjusted tax basis in the ordinary shares will be the same as the
adjusted tax basis of the ADSs surrendered in exchange therefor, and the holding
period for the ordinary shares will include the holding period for the
surrendered ADSs.

         Dividends and Other Distribution on Ordinary Shares or ADSs. Subject to
the discussion in "Passive Foreign Investment Company Status" below, in the
event that a U.S. Investor receives a distribution on the ordinary shares or
ADSs, the U.S. Investor will be required to include the distribution in gross
income as a taxable dividend on the date of receipt by the depositary, in the
case of ADSs, or by the U.S. Investor, in the case of ordinary shares, but only
to the extent that a distribution is paid from our current or accumulated
earnings and profits as determined for United States federal income tax
principles. Dividends paid by us will not be eligible for the corporate
dividends received deduction. For taxable years beginning before January 1,
2011, "qualified dividend income" paid to a noncorporate U.S. Investor will be
subject to tax at the rates applicable to long-term capital gains (which are
currently taxed at the maximum rate of 15%) if (1) our ordinary shares or ADSs
are readily tradable on an established securities market in the United States,
(2) we are not a passive foreign investment company (as discussed below) for
either our taxable year in which the

                                       55
<PAGE>

dividend was paid or the preceding taxable year and (3) certain holding period
requirements must be met. It is expected that our ADSs will satisfy the "readily
tradable" requirement as a result of being traded on the Nasdaq Global Select
Market. However, any U.S. Investor that exchanges its ADSs for ordinary shares,
or that holds only ordinary shares, may not be eligible for the reduced rate of
taxation on dividends if the ordinary shares are not readily tradable on an
established securities market in the United States. In order for dividends to
constitute "qualified dividend income," a U.S. Investor generally must have held
the ADSs for more than 60 days during the 121-day period beginning 60 days
before the ex-dividend date; however, because the holding period rules are
intricate and because an owner's holding period is reduced for periods during
which the risk of loss is diminished, U.S. Investors should consult their own
advisors concerning the calculation of their holding periods. Moreover, a
dividend will not be treated as a qualified dividend income to the extent that
the taxpayer is under an obligation (whether pursuant to a short sale or
otherwise) to make related payments with respect to positions in substantially
similar or related property. U.S. Investors should consult their own tax
advisers regarding the availability of the lower rate for dividends paid with
respect to our ADSs or ordinary shares.

         The Company has the right to pay dividends in any currency. If
dividends are paid in a currency other than the U.S. dollar, the dividends will
be included in a U.S. Investor's income as a U.S. dollar amount based on the
exchange rate in effect on the date that the U.S. Investor receives the
dividend, regardless of whether the payment is in fact converted into U.S.
dollars. If the U.S. Investor does not receive U.S. dollars on the date the
dividend is distributed, the U.S. Investor will be required to include either
gain or loss in income when the U.S. Investor later exchanges the foreign
currency for U.S. dollars. The gain or loss will be equal to the difference
between the U.S. dollar value of the amount that the U.S. Investor includes in
income when the dividend is received and the amount that the US. Investor
receives on the exchange of the foreign currency for U.S. dollars. The gain or
loss generally will be ordinary income or loss from U.S. sources. If we
distribute as a dividend non-cash property, the U.S. Investor will generally
include in income an amount equal to the U.S. dollar equivalent of the fair
market value of the property on the date that it is distributed.

         Dividends will constitute foreign source income for foreign tax credit
limitation purposes. The limitation on foreign taxes eligible for credit is
calculated separately with respect to specific classes of income. Under current
law, for taxable years beginning after December 31, 2006, dividends distributed
by us with respect to ordinary shares or ADSs would generally constitute
"passive category income" but could, in the case of certain U.S. Investors,
constitute "general category income." Special rules apply to individuals whose
foreign source income during the taxable year consists entirely of "qualified
passive income" and whose creditable foreign taxes paid or accrued during the
taxable year do not exceed $300 ($600 in the case of a joint return). Further,
in particular circumstances, a U.S. Investor that (i) has held the ordinary
shares or ADSs for less than a specified minimum period during which it is not
protected from risk of loss, (ii) is obligated to make payments related to the
dividends, or (iii) holds the ordinary shares or ADSs in arrangements in which
the U.S. Investor's expected economic profit, after non-U.S. taxes, is
insubstantial, will not be allowed a foreign tax credit for foreign taxes
imposed on dividends paid on the ordinary shares or ADSs.

         The U.S. Treasury has expressed concerns that parties to whom ADSs are
pre-released may be taking actions that are inconsistent with the claiming of
foreign tax credits by U.S. Investors of ADSs. Such actions would also be
inconsistent with the claiming of the preferential tax rates applicable to
qualified dividend income, as defined above. Accordingly, the creditability of
foreign withholding taxes and the availability of such preferential tax rates
could be affected by future actions that may be taken by the U.S. Treasury or
parties to whom ADSs are pre-released.

         Distributions in excess of our current and accumulated earnings and
profits will be treated as a nontaxable return of capital to the extent of the
U.S. Investor's basis in the ordinary shares or ADSs and thereafter as gain from
the sale or exchange of a capital asset. We do not generally intend to calculate
our earnings and profits under U.S. federal income tax principles. Therefore a
U.S. Investor should expect that a distribution will generally be treated as a
dividend even if that distribution would otherwise be treated as a nontaxable
return of capital or as capital gain under the rules described above.

                                       56
<PAGE>

         Distributions to a U.S. Investor of new ordinary shares or ADSs or
rights to subscribe for new ordinary shares or ADSs that are received as part of
a pro rata distribution to all our shareholders will not be subject to U.S.
federal income tax. The adjusted tax basis of the new ordinary shares or ADSs or
rights so received will be determined by allocating the U.S. investor's adjusted
tax basis in the old ordinary shares or ADSs between the old ordinary shares or
ADSs and the new ordinary shares or ADSs or rights received, based on their
relative fair market values on the date of distribution. However, the adjusted
tax basis of the new ordinary shares or ADSs or rights will be zero if the fair
market value of the new rights is less than 15% of the fair market value of the
old ordinary shares or ADSs at the time of distribution and the U.S. Investor
does not make an election to determine the adjusted tax basis of the rights by
allocation as described above. A U.S. Investor's holding period in the new
ordinary shares or ADSs or rights will generally include the holding period of
the old ordinary shares or ADSs on which the distribution was made.

         Dispositions of ordinary shares or ADSs. Subject to the discussion in
"Passive Foreign Investment Company Status" below, gain or loss realized by a
U.S. Investor on the sale or other disposition of the ordinary shares or ADSs
will be subject to United States federal income tax as capital gain or loss in
an amount equal to the difference between the amount realized on the disposition
and that U.S. Investor's basis in the ordinary shares or ADSs. The capital gain
or loss will be long-term capital gain or loss if the U.S. Investor has held the
ordinary shares or ADSs for more than one year at the time of the sale or
exchange. A noncorporate U.S. investor will be eligible for reduced rates of
taxation (currently, at a maximum rate of 15% for sales occurring in taxable
years beginning before January 1, 2011) on long-term capital gain. The
deductibility of capital losses is subject to limitations. Any gain or loss
recognized by a U.S. Investor will generally be treated as U.S. source income or
loss for U.S. foreign tax credit purposes.

         U.S. Investors should consult their own tax advisor regarding the U.S.
federal income tax consequences if the U.S. Investor receives currency other
than U.S. dollars upon the disposition of ordinary shares or ADSs.

         Passive Foreign Investment Company Status. We believe that we are not a
passive foreign investment company and do not expect to become a passive foreign
investment company in the future. We will be classified as a passive foreign
investment company if for a taxable year, after the application of "look
through" rules, either (a) 75% or more of the gross income of the company in a
taxable year is passive income, or (b) the average percentage of assets by value
of the company in a taxable year that produce or are held for the production of
passive income (which includes cash) is at least 50%, the income or assets test.
Whether or not we are a passive foreign investment company will be determined
annually based upon the composition of our income and assets including goodwill,
from time to time. In determining that we are not a passive foreign investment
company, we are relying on the current valuation of our assets, including
goodwill. In calculating goodwill, we have valued our total assets based on our
total market value determined using the then market price of our ordinary shares
and ADSs and have made a number of assumptions regarding the amount of this
value allocable to goodwill. Because the determination of goodwill will be based
on the price of our ordinary shares and ADSs, it is subject to change. We
believe our valuation approach is reasonable. However, it is possible that the
Internal Revenue Service will challenge the valuation of our goodwill, which may
result in our being classified as a passive foreign investment company. In
addition, the composition of our income and assets will be affected by how we
spend the cash we have raised, which is a passive asset for purposes of the
passive foreign investment company asset test discussed above. We intend to use
the cash we have raised in the past and conduct our business activities in an
effort to reduce the risk of our classification as a passive foreign investment
company. Because the passive foreign investment company determination is made at
the end of each taxable year, we cannot determine in advance whether we will be
considered a passive foreign investment company for any future taxable year. If
we determine that we have become a passive foreign investment company, we will
notify the Bank of New York and all U.S. investors who have been record holders
of our ordinary shares or ADSs during any period in which we determine that we
are a passive foreign investment company, within 60 days of the end of our
taxable year for which we make such determination. If we are a passive foreign
investment company for any year during which a U.S. Investor holds ordinary
shares or ADSs, we generally will continue to be treated as a passive foreign
investment company for all succeeding years during which the U.S. Investor holds
ordinary shares or ADSs.

                                       57
<PAGE>

         Special U.S. tax rules apply to U.S. Investors of interests in a
passive foreign investment company. Subject to the discussion of the
market-to-market election and qualified electing fund election below, if we were
a passive foreign investment company for any taxable year during which a U.S.
Investor held ordinary shares or ADSs, the U.S. Investor would be subject to
special tax rules regardless of whether we meet the income or assets test for
any other year with respect to:

         o  any "excess distribution" by us to the U.S. Investor, which means
            any distributions received by the U.S. Investor on the ordinary
            shares or ADSs in a taxable year that are greater than 125% of the
            average annual distributions received by the U.S. Investor in the
            three preceding taxable years, or, if shorter, the U.S. Investor's
            holding period for the ordinary shares or ADSs; and

         o  any gain realized on the sale or other disposition, including a
            pledge, of ordinary shares or ADSs.

         Under these special tax rules:

         o  the excess distribution or gain would be allocated ratably over the
            U.S. Investor's holding period for the ordinary shares or ADSs;

         o  the amount allocated to the current taxable year and any taxable
            year prior to the first taxable year in which we are a passive
            foreign investment company would be treated as ordinary income;

         o  the amount allocated to each of the other years would be taxed as
            ordinary income at the highest tax rate in effect for that year;
            and

         o  the interest charge applicable to underpayments of tax would be
            imposed with respect to the resulting tax attributable to each
            prior year in which we were a passive foreign investment company
            to recover the deemed benefit from the deferred payment of the tax
            attributable to each prior year.

         In addition, dividends that a U.S. Investor receives from us will not
be eligible for the special tax rates applicable to "qualified dividend income"
(see "-- United States Federal Income Taxation --- Dividends") if we are a
passive foreign investment company either in the taxable year of the
distribution or the preceding taxable year, but will instead be taxable at rates
applicable to ordinary income.

         If we are a passive foreign investment company in any year, a U.S.
Investor would be required to file an annual return on Internal Revenue Service
Form 8621 regarding distributions received with respect to the ordinary shares
or ADSs and any gain realized on the disposition of the ordinary shares or ADSs.

         A U.S. Investor in a passive foreign investment company is allowed to
make a mark-to-market election with respect to the stock of the passive foreign
investment company, provided that the stock of the passive foreign investment
company is "marketable" within the meaning of the Code. The ordinary shares will
be "marketable" as long as they remain listed on the Nasdaq Global Select Market
and are "regularly traded." The ordinary shares or ADSs will be considered
"regularly traded" for any calendar year during which the ordinary shares or
ADSs are traded, other than in de minimis quantities, on at least fifteen days
during each calendar quarter. If the election is made, a U.S. Investor would be
required to mark the ordinary shares or ADSs to market each taxable year and
recognize ordinary income for any increase in market value for that taxable year
and would be allowed to recognize an ordinary loss for any decrease in that
market value to the extent that prior gains exceed prior losses. The adjusted
basis in the ordinary shares or ADSs would be adjusted to reflect that gain or
loss. The mark-to-market election will be effective for the taxable year for
which the election is made and all subsequent taxable years, unless the ordinary
shares cease to be marketable or the Internal Revenue Service consents to the
revocation of the election.

                                       58
<PAGE>

         Alternatively, for each year we meet the income or assets test, a U.S.
Investor can make an election to include in income annually its pro rata share
of our earnings and net capital gains. This election is referred to as a
qualified electing fund election. To make a qualified electing fund election, a
U.S. Investor will need to have an annual information statement from us
documenting the earnings and capital gain for the year. If we were to become a
passive foreign investment company, we would furnish the passive foreign
investment company annual information statement to any shareholder or former
shareholder who requested it. In general, a U.S. Investor must make a qualified
electing fund election on or before the due date for filing its income tax
return for the first year to which the qualified electing fund election will
apply. U.S. Investors are permitted to make retroactive elections in particular
circumstances, including if the U.S. Investor had a reasonable belief that the
foreign corporation was not a passive foreign investment company and filed a
protective election. As discussed above, we will notify investors if we
determine that we have become a passive foreign investment company. This notice
will provide U.S. Investors on a calendar tax year with sufficient time to make
the qualified electing fund election. U.S. Investors (in particular those with a
tax year other than the calendar year) should consult their own tax advisors as
to the consequences of making a protective qualified electing fund election or
other consequences of the qualified electing fund election.

         If we are a passive foreign investment company in any year, U.S.
Investors should consult with their tax advisers regarding whether to make a
mark-to-market or qualified electing fund election.

         Information Reporting and Backup Withholding. In general, information
reporting requirements will apply to dividends in respect of our ordinary shares
or ADSs or the proceeds received on the sale, exchange or redemption of our
ordinary shares or ADSs paid within the United States (and, in certain cases,
outside the United States) to U.S. Investors other than certain exempt
recipients, such as corporations, and a backup withholding tax (currently at a
rate of 28%) may apply to such amounts if the U.S. Investor fails to provide an
accurate taxpayer identification number or to report interest and dividends
required to be shown on its U.S. federal income tax returns. U.S. Investors who
are required to establish their exempt status generally must provide such
certification on IRS Form W-9.

         Backup withholding is not an additional tax. Amounts withheld as backup
withholding from a payment to a U.S. Investor may be allowed as a credit against
the U.S. Investor's U.S. federal income tax liability and the U.S. Investor may
obtain a refund of any excess amounts withheld by filing the appropriate claim
for refund with the IRS and furnishing any required information in a timely
manner.

DOCUMENTS ON DISPLAY

         We file annual reports on Form 20-F and furnish current reports on Form
6-K with the SEC. You may read and copy this information at the SEC's Public
Reference Room at Judiciary Plaza, 100 F Street N.E., Washington, D.C. 20549,
and at the regional offices of the SEC located at 233 Broadway, New York, New
York 10279 and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661. You can also request copies of the documents, upon payment of a
duplicating fee, by writing to the Public Reference Section of the SEC. Please
call the SEC at 1-800-SEC-0330 for further information on the operation of the
Public Reference Room. Certain of our SEC filings are also available to the
public from the SEC's website at http://www.sec.gov.

ITEM 11  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Market risk is the risk of loss related to adverse changes in market
prices, including interest rates and foreign exchange rates, of financial
instruments. In the normal course of business, our financial position is
routinely subject to a variety of risks, including market risk associated with
interest rate movements and currency rate movements on non-U.S. dollar
denominated assets and liabilities, as well as collectibility of accounts
receivable.

                                       59
<PAGE>

         We regularly assess these financial instruments and their ability to
address market risk and have established policies and business practices to
protect against the adverse effects of these and other potential exposures.

Interest Rate Risk

         Our major market risk exposure is changing interest rates. Our exposure
to market risk for changes in interest rates relates primarily to our
investments in government and corporate bonds.

         We maintain an investment portfolio consisting mainly of fixed income
securities, including time deposits and government bonds. These securities are
subject to interest rate risk and will fall in value if market interest rates
increase. If market rates were to increase immediately and uniformly by 10.0%
from the levels at December 31, 2006, the fair value of our investment portfolio
would decline by an immaterial amount. We presently intend to treat our fixed
income investments as available for sale, and therefore we do not expect our
results of operations or cash flows to be affected to any significant degree by
a sudden short-term change in market interest rates. We have not purchased and
do not currently hold any derivative financial instruments for hedging or
trading purposes.

         The table below provides information about our financial instruments
whose maturity dates are greater than three months as of December 31, 2006.

<TABLE>
<CAPTION>
                                2007      2008        2009       2010       2011      Thereafter     Total    Fair Value
                                ----      ----        ----       ----       ----      ----------     -----    ----------
Time Deposit:
<S>              <C>          <C>            <C>                                                      <C>        <C>
   Fixed rate (US$)....       $14,132        29          -           -           -          -         14,161     14,161
Government Bonds
   Fixed rate (US$)....         6,273         -      1,580           -           -          -          7,853      7,820
</TABLE>

Foreign currency risk

         Fluctuations in exchange rates may adversely affect our financial
results. The functional currency for each of our foreign subsidiaries is the
local currency. As a result, certain of our assets and liabilities, including
certain bank accounts, accounts receivable, restricted assets, short-term
investments and accounts payable, exist in non-US dollar-denominated currencies,
which are sensitive to foreign currency exchange rate fluctuations. If exchange
rates were to change immediately and uniformly from the levels at December 31,
2006, the fair value of such assets and liabilities would change by an
immaterial amount beyond the change reflected by the exchange rates. As of
December 31, 2006, we held approximately $23.3 million in government bonds,
certificates of deposits and bank demand accounts denominated in foreign
currencies.

         We have not engaged in hedging techniques to mitigate foreign currency
exposures and may experience economic losses as a result of foreign currency
exchange rate fluctuations. We will monitor currency exchange fluctuations
periodically. For the year ended December 31, 2006, we experienced a foreign
exchange loss of approximately $261,000 due to foreign currency exchange
fluctuations, which are reflected in our results of operations.

                                       60
<PAGE>

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

         Not applicable.

                                     PART II

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

         There are no defaults, dividend arrearages or delinquencies
that are required to be disclosed.

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE
         OF PROCEEDS.

RIGHTS OF SECURITY HOLDERS

         Effective March 2, 2006, upon the listing of our ordinary shares on the
Stock Exchange of Hong Kong, certain amendments to our Memorandum and Articles
of Association became effective. A summary of material provisions of our
Memorandum and Articles of Association is included in Item 10 above.

USE OF PROCEEDS

         As of December 31, 2006, the net proceeds from our initial public
offering in August 2000 and our public offering in November 2001 were primarily
used for general working capital and investment in interest income producing
financial instruments. None of the net proceeds from our initial public offering
were paid, directly or indirectly, to any of our directors, officers or general
partners or any of their associates, or to any person owning ten percent or more
of any class of our equity securities, or any of our affiliates.

                                    PART III

ITEM 15T. CONTROLS AND PROCEDURES

          We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports filed pursuant
to the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to the management,
including the Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives. In addition, the design of any control system is based in part upon
certain assumptions about the likelihood of future events. Our disclosure
controls and procedures are designed to provide reasonable assurance of
achieving their objectives.

          As of December 31, 2006, we carried out an evaluation, under the
supervision and with the participation of the management, including the Chief
Executive Officer and the Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on the
foregoing, the Chief Executive Officer and the Chief Financial Officer concluded
that the Company's disclosure controls and procedures were effective.

                                       61
<PAGE>

          Management is responsible for establishing and maintaining adequate
internal control over financial reporting for the company. Internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with accounting
principles generally accepted in the United States of America. Our company's
internal control over financial reporting includes those policies and procedures
that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of
our company; (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
accounting principles generally accepted in the United States of America, and
that receipts and expenditures of our company are being made only in accordance
with authorizations of management and directors of our company; and (iii)
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of our company's assets that could
have a material effect on the financial statements. Because of its inherent
limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate. Management conducted an evaluation of the
effectiveness of internal control over financial reporting based on the
framework in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Based on this
evaluation, management concluded that our company's internal control over
financial reporting was effective as of December 31, 2006. This Annual Report
does not include an attestation report of our registered public accounting firm
regarding internal control over financial reporting. Management's report was not
subject to attestation by our registered public accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit us to
provide only management's report in this Annual Report.

          There has been no change in our internal control over financial
reporting that occurred during our fiscal year 2006 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.

ITEM 16.  Not applicable.

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

         The Board of Directors has determined that Mr. Lawrence Lin is an
"audit committee financial expert" as defined in Item 16A of Form 20-F. We
believe Mr. Lin is "independent" as defined in Rule 4200(a)(15) of the
Marketplace Rules of the Nasdaq Stock Market.

ITEM 16B. CODE OF ETHICS

         We have adopted the O2Micro International Limited Code of Business
Conduct and Ethics ("Code of Conduct"), a code of business conduct and ethics
that applies to our employees, officers and non-employee directors, including
our principal executive officer, principal financial officer, principal
accounting officer or controller and persons performing similar functions. It is
publicly available on our website at www.o2micro.com. If we make any substantive
amendments or grant any waiver from a provision of the Code of Conduct to our
directors or executive officers, we will disclose the nature of such amendment
or waiver on that website or in a report on Form 6-K or in the next annual
report on Form 20-F.

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

         Deloitte & Touche has served as the Company's independent registered
public accounting firm for each of the fiscal years in the two-year period ended
December 31, 2006. The appointment of the independent registered public
accounting firm is subject to approval and ratification by the Company's
shareholders at the annual general meeting of shareholders. The following table
presents the aggregate fees for professional services and other services
rendered by Deloitte & Touche in each of the years ended December 31, 2005 and
2006.

                                       62

<PAGE>

                                        Year ended              Year ended
                                     December 31, 2006      December 31, 2005

           Audit Fees                    $436,200                $322,300
           Audit-related Fees              10,002                   9,599
           Tax Fees                        74,066                  85,761
           All Other Fees                 463,766                 475,695

           Total                         $984,034                $893,355


Audit Fees. This category includes the audit of our annual financial statements,
review of quarterly financial statements and services that are normally provided
by Deloitte & Touche in connection with statutory and regulatory filings or
engagements for those fiscal years.

Audit-related Fees. This category consists of assurance and related services by
Deloitte & Touche that are related to the performance of audit or review of our
financial statements and are reported above under "Audit Fees."

Tax Fees. This category consists of professional services rendered by Deloitte &
Touche for tax compliance and tax consultation. The services for fees disclosed
under this category include tax return preparation advice and technical tax
consultation.

All Other Fees: This category consists primarily of fees in connection with the
Stock Exchange of Hong Kong listing and Sarbanes-Oxley Act readiness
preparation.

The audit committee pre-approves all audit and permissible non-audit services
provided by the independent registered public accounting firm. These services
may include audit services, audit-related services, tax services and other
services. During the year ended December 31, 2006, the audit committee
pre-approved all audit and non-audit-fees of Deloitte & Touche.




ITEM 16D. EXEMPTION FROM THE LISTING STANDARDS FOR AUDIT COMMITTEE

          Not applicable.

                                       63
<PAGE>

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PERSONS

<TABLE>
<CAPTION>
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
Period                    Total Number of        Average Price Paid      Total Number of        Maximum Number of
                          Shares Purchased (2)   per Share (2)           Shares Purchased as    Shares that May Yet
                                                                         Part of Publicly       Be Purchased Under
                                                                         Announced Plans or     the Plans or
                                                                         Programs (1) (2) (3)   Programs (1) (2) (3)
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
<S>                       <C>                     <C>                    <C>                    <C>
January 4, 2006 to
January 12, 2006          595,000                0.2205                  595,000                83,065,000 (1)
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
April 18, 2006
                          1,000,000              0.2126                  1,000,000              197,049,435 (3)
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
May 11, 2006 to May 31,
2006                      4,000,000              0.1845                  4,000,000              193,049,435 (3)
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
June 2, 2006  to June
27, 2006                  3,445,000              0.1659                  3,445,000              189,604,435 (3) (4)
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
July 7, 2006 to July
31, 2006                  12,640,000             0.1303                  12,640,000             176,964,435  (4)
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
August 2, 2006 to
August 29, 2006           36,767,450             0.1146                  36,767,450             140,196,985 (4)
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
</TABLE>

(1) In May 2002, we announced a share repurchase program to repurchase up to
3,000,000 shares of our ordinary shares or 150,000,000 shares after taking into
account the 50-to-1 stock split on November 25, 2005. There is no expiration
date for the share repurchase program.

(2) All share and price per share numbers reflect the 50-for-1 stock split which
occurred on November 25, 2005

(3) On November 14, 2005, our shareholders adopted a general mandate (the
"Repurchase Mandate") to exercise all the powers of our company to repurchase
such number of Ordinary Shares not exceeding 10% of the total nominal amount of
the share capital of our company in issue and to be issued. The Repurchase
Mandate was to only become effective if and when our Ordinary Shares were listed
for trading on the SEHK, which occurred on March 2, 2006. On March 2, 2006, the
maximum number of shares that may yet be purchased was 198,049,435 shares.

(4) On June 15, 2006, our shareholders renewed the Repurchase Mandate to
exercise all the powers of the Company to repurchase such number of Ordinary
Shares not exceeding 10% of the total nominal amount of the share capital of the
Company in issue and to be issued. On June 15, 2006, the maximum number of
shares that may yet be purchased was 195,576,295 shares.

                                     PART IV

ITEM 17. FINANCIAL STATEMENTS

         The Company's Consolidated Financial Statements have been prepared in
accordance with Item 18 hereof.

                                       64
<PAGE>

ITEM 18. FINANCIAL STATEMENTS

         The Company's financial statements set forth in the accompanying Index
to Consolidated Financial Statements included in this Annual Report on Form 20-F
following Part IV beginning on page F-1 are hereby incorporated herein by this
reference. Such consolidated financial statements are filed as part of this
Annual Report on Form 20-F.

         Report of Independent Registered Public Accounting Firm

         Consolidated Balance Sheets as of December 31, 2005 and 2006

         Consolidated Statements of Operations and Comprehensive Income for the
         years ended December 31, 2004, 2005 and 2006

         Consolidated Statements of Shareholders' Equity for the years ended
         December 31, 2004, 2005 and 2006

         Consolidated Statements of Cash Flows for the years ended December 31,
         2004, 2005 and 2006

         Notes to Consolidated Financial Statements

ITEM 19. EXHIBITS

1.       Memorandum and Articles of Association, as amended, of the registrant.

4.1      Standard NNN Lease dated July 29, 1999 by and between Limir Realty
         Corp. #17 as landlord and O2Micro, Inc. as tenant (incorporated by
         reference from Exhibit 10.5 to the Registration Statement on Form F-1
         (File No.
         333-12386) filed by the registrant)

4.2      Lease dated October 16, 1997 by and between Hung Kuo Development Corp.
         as landlord and O2Micro, Inc. as tenant (incorporated by reference from
         Exhibit 10.6 to the Registration Statement on Form F-1 (File No.
         333-12386) filed by the registrant)

4.3      Agreement dated October 1, 1999 by and between PSA Corporation Limited
         as landlord and O2Micro, Inc. as tenant (incorporated by reference from
         Exhibit 10.8 to the Registration Statement on Form F-1 (File No.
         333-12386) filed by the registrant)

8.1      List of registrant's subsidiaries

12.1     Certification of Chief Executive Officer of the Company, pursuant to
         Section 302 of the Sarbanes-Oxley Act.

12.2     Certification of Chief Financial Officer of the Company, pursuant to
         Section 302 of the Sarbanes-Oxley Act.

13.      Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
         to Section 906 of the Sarbanes-Oxley Act.

15.1     Consent of Deloitte & Touche, independent registered public accounting
         firm.


                                       65

<PAGE>

                                   SIGNATURES

         Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant hereby certifies that it meets all of the
requirements for filing on Form 20-F and that it has duly caused and authorized
the undersigned to sign this Annual Report on its behalf.


                                          O2MICRO INTERNATIONAL LIMITED




Date:    June 18, 2007                    By:      /s/ STERLING DU
                                                   -----------------------------
                                          Name:    Sterling Du
                                          Title:   Chief Executive Officer

















                                       66

<PAGE>




                         O2 MICRO INTERNATIONAL LIMITED

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                      Page
                                                                      ----

Report of Independent Registered Public Accounting Firm...............F-1
Consolidated Balance Sheets...........................................F-2
Consolidated Statements of Operations and Comprehensive Income........F-3
Consolidated Statements of Shareholders' Equity.......................F-5
Consolidated Statements of Cash Flows.................................F-6
Notes to Consolidated Financial Statements............................F-8




<PAGE>

O2Micro International Limited and Subsidiaries

Consolidated Financial Statements as of
December 31, 2005 and 2006 and
Report of Independent Registered Public
Accounting Firm



<PAGE>

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


The Board of Directors and the Shareholders
O2Micro International Limited


We have audited the accompanying consolidated balance sheets of O2Micro
International Limited and subsidiaries (the "Company") as of December 31, 2005
and 2006 and the related consolidated statements of operations and comprehensive
income, shareholders' equity, and cash flows for each of the years ended
December 31, 2004, 2005 and 2006 (expressed in United States dollars). These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of O2Micro International Limited and
subsidiaries as of December 31, 2005 and 2006, and the results of their
operations and their cash flows for each of the years ended December 31, 2004,
2005 and 2006, in conformity with accounting principles generally accepted in
the United States of America.

As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for stock-based compensation in accordance with
Statement of Financial Accounting Standards No. 123(R), "Share-Based Payment."



April 16, 2007

                                      F-1

<PAGE>


O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In Thousand U.S. Dollars, Except Per Share Amounts)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                                                        December 31
                                                                                  ----------------------
ASSETS                                                                               2005          2006

CURRENT ASSETS
<S>                                                                               <C>          <C>
   Cash and cash equivalents                                                      $  46,375    $  45,438
   Restricted cash                                                                    5,605        8,342
   Short-term investments                                                            55,653       19,697
   Accounts receivable, net                                                          11,460       18,987
   Inventories                                                                       15,943       14,076
   Prepaid expenses and other current assets                                          6,665        7,379
                                                                                  ---------    ---------

         Total current assets                                                       141,701      113,919
                                                                                  ---------    ---------

LONG-TERM INVESTMENTS                                                                16,898       24,059
                                                                                  ---------    ---------

PROPERTY AND EQUIPMENT, NET                                                          23,319       41,427
                                                                                  ---------    ---------

RESTRICTED ASSETS                                                                    14,492       14,540
                                                                                  ---------    ---------

OTHER ASSETS                                                                          3,245        3,075
                                                                                  ---------    ---------

TOTAL                                                                             $ 199,655    $ 197,020
                                                                                  =========    =========

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES
   Notes and accounts payable                                                     $   5,760    $   9,851
   Income tax payable                                                                 3,907          991
   Accrued expenses and other current liabilities                                    14,092       12,212
                                                                                  ---------    ---------

         Total current liabilities                                                   23,759       23,054
                                                                                  ---------    ---------

ACCRUED RETIREMENT BENEFIT COSTS                                                        -            455
                                                                                  ---------    ---------

         Total liabilities                                                           23,759       23,509
                                                                                  ---------    ---------

COMMITMENTS AND CONTINGENCIES

SHAREHOLDERS' EQUITY
   Preference shares at $0.00002 par value per share
      Authorized - 250,000,000 shares                                                   -            -
   Ordinary shares at $0.00002 par value per share
      Authorized - 4,750,000,000 shares
      Issued - 1,967,824,350 shares and 1,906,969,950 shares as of December 31,
        2005 and 2006, respectively                                                      39           38
   Treasury stock - 15,030,000 shares and 0 nil as of December 31, 2005 and
     2006, respectively                                                              (3,296)         -
   Additional paid-in capital                                                       141,532      140,224
   Retained earnings                                                                 38,739       33,877
   Accumulated other comprehensive loss                                              (1,118)        (628)
                                                                                  ---------    ---------

         Total shareholders' equity                                                 175,896      173,511
                                                                                  ---------    ---------

TOTAL                                                                             $ 199,655    $ 197,020
                                                                                  =========    =========

       The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>

                                      F-2
<PAGE>


O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In Thousand U.S. Dollars, Except Per Share Amounts)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                            Years Ended December 31
                                                      -----------------------------------
                                                         2004         2005         2006
<S>                                                   <C>          <C>          <C>
NET SALES                                             $  92,196    $ 105,552    $ 124,915

COST OF SALES                                            37,403       40,741       56,772
                                                      ---------    ---------    ---------

GROSS PROFIT                                             54,793       64,811       68,143
                                                      ---------    ---------    ---------

OPERATING EXPENSES
   Research and development (a)                          20,260       25,421       31,751
   Selling, general and administrative (a)               16,348       20,279       29,209
   Patent related litigation                              5,334       10,174       10,962
   Stock Exchange of Hong Kong listing expenses             -          2,460          786
                                                      ---------    ---------    ---------

         Total operating expenses                        41,942       58,334       72,708
                                                      ---------    ---------    ---------

INCOME (LOSS) FROM OPERATIONS                            12,851        6,477       (4,565)
                                                      ---------    ---------    ---------

NON-OPERATING INCOME (EXPENSES)
   Interest income                                        1,455        2,824        3,627
   Impairment loss on long-term investments                 -            -           (756)
   Gain on sale of long-term investments                    340          -            -
   Foreign exchange gain (loss), net                        648         (443)        (261)
   Other, net                                               262          323          248
                                                      ---------    ---------    ---------

         Total non-operating income                       2,705        2,704        2,858
                                                      ---------    ---------    ---------

INCOME (LOSS) BEFORE INCOME TAX                          15,556        9,181       (1,707)

INCOME TAX EXPENSE (BENEFIT)                              1,472        1,034       (2,450)
                                                      ---------    ---------    ---------

NET INCOME                                               14,084        8,147          743
                                                      ---------    ---------    ---------

OTHER COMPREHENSIVE INCOME (LOSS)
   Foreign currency translation adjustments                 714         (238)         695
   Unrealized loss on available-for-sale securities        (303)        (770)        (205)
                                                      ---------    ---------    ---------

         Total other comprehensive income (loss)            411       (1,008)         490
                                                      ---------    ---------    ---------

COMPREHENSIVE INCOME                                  $  14,495    $   7,139    $   1,233
                                                      =========    =========    =========

EARNINGS PER SHARE:
   Basic                                              $  0.0072    $  0.0042    $  0.0004
                                                      =========    =========    =========
   Diluted                                            $  0.0070    $  0.0041    $  0.0004
                                                      =========    =========    =========
</TABLE>

                                                                     (Continued)

                                      F-3
<PAGE>


O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In Thousand U.S. Dollars, Except Per Share Amounts)
--------------------------------------------------------------------------------

                                                Years Ended December 31
                                         ------------------------------------
                                            2004         2005         2006

SHARES USED IN EARNINGS PER SHARE
  CALCULATION:
   Basic (in thousands)                   1,957,800    1,961,168    1,932,575
                                         ==========   ==========   ==========
   Diluted (in thousands)                 2,005,100    1,997,459    1,946,896
                                         ==========   ==========   ==========

INCLUDES STOCK-BASED COMPENSATION
  CHARGE AS FOLLOWS:
   Research and development              $      -     $      -     $    1,181
   Selling, general and administrative          -            -          1,408





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

                                                                     (Concluded)


                                      F-4
<PAGE>



O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In Thousand U.S. Dollars, Except Per Share Amounts)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                        Additional Paid-in Capital
                                                                                     ---------------------------------------
                                                         Ordinary Shares              Ordinary       Stock
                                                      ----------------------------
                                                           Shares          Amount      Shares       Options       Total

<S>                                                       <C>             <C>        <C>           <C>         <C>
BALANCE, JANUARY 1, 2004                                  1,951,630,800   $     39   $    136,077  $     999   $    137,076

   Issuance of:
      Shares issued for exercise of stock options             7,858,350          -          1,359        (77)         1,282
      Shares issued for 1999 Purchase Plan                    5,923,950          -          1,032          -          1,032
   Acquisition and retirement of treasury stock              (6,010,000)         -           (422)         -           (422)
   Options granted to nonemployees                                    -          -              -        613            613
   Net income for 2004                                                -          -              -          -              -
   Foreign currency translation adjustments                           -          -              -          -              -
   Unrealized loss on available-for-sale securities                   -          -              -          -              -
                                                      -----------------   --------   ------------  ---------   ------------

BALANCE, DECEMBER 31, 2004                                1,959,403,100         39        138,046      1,535        139,581

   Issuance of:
      Shares issued for exercise of stock options             7,422,050          -          1,203        (18)         1,185
      Shares issued for 1999 Purchase Plan                    6,389,200          -          1,110          -          1,110
   Acquisition of treasury stock - 20,420,000 shares                  -          -              -          -              -
   Retirement of treasury stock                              (5,390,000)         -           (380)         -           (380)
   Options granted to nonemployees                                    -          -              -         36             36
   Net income for 2005                                                -          -              -          -              -
   Foreign currency translation adjustments                           -          -              -          -              -
   Unrealized loss on available-for-sale securities                   -          -              -          -              -
                                                      -----------------   --------   ------------  ---------   ------------

BALANCE, DECEMBER 31, 2005                                1,967,824,350         39        139,979      1,553        141,532

   Issuance of:
      Shares issued for exercise of stock options             5,643,000          -            396        (42)           354
      Shares issued for 1999 Purchase Plan                    6,980,050          -            985          -            985
   Acquisition of treasury stock - 58,447,450 shares                  -          -              -          -              -
   Retirement of treasury stock                             (73,477,450)        (1)        (5,240)         -         (5,240)
   Options granted to nonemployees                                    -          -              -          4              4
   Stock-based compensation                                           -          -              -      2,589          2,589
   Net income for 2006                                                -          -              -          -              -
   Foreign currency translation adjustments                           -          -              -          -              -
   Unrealized loss on available-for-sale securities                   -          -              -          -              -
                                                      -----------------   --------   ------------  ---------   ------------

BALANCE, DECEMBER 31, 2006                                1,906,969,950   $     38   $    136,120  $   4,104   $    140,224
                                                      =================   ========   ============  =========   ============
</TABLE>

<TABLE>
<CAPTION>
                                                                             Accumulated Other
                                                                     Comprehensive Income (Loss)
                                                                   ---------------------------------------
                                                                   Unrealized     Cumulative
                                                       Treasury    Investment     Translation
                                                        Stock      Gain (Loss)    Adjustment      Total
<S>                                                   <C>           <C>             <C>          <C>
BALANCE, JANUARY 1, 2004                              $         -   $      149      $  (670)     $    (521)

   Issuance of:
      Shares issued for exercise of stock options               -            -            -              -
      Shares issued for 1999 Purchase Plan                      -            -            -              -
   Acquisition and retirement of treasury stock                 -            -            -              -
   Options granted to nonemployees                              -            -            -              -
   Net income for 2004                                          -            -            -              -
   Foreign currency translation adjustments                     -            -          714            714
   Unrealized loss on available-for-sale securities             -         (303)           -           (303)
                                                      -----------   ----------      -------      ---------

BALANCE, DECEMBER 31, 2004                                      -         (154)          44           (110)

   Issuance of:
      Shares issued for exercise of stock options               -            -            -              -
      Shares issued for 1999 Purchase Plan                      -            -            -              -
   Acquisition of treasury stock - 20,420,000 shares       (4,355)           -            -              -
   Retirement of treasury stock                             1,059            -            -              -
   Options granted to nonemployees                              -            -            -              -
   Net income for 2005                                          -            -            -              -
   Foreign currency translation adjustments                     -            -         (238)          (238)
   Unrealized loss on available-for-sale securities             -         (770)           -           (770)
                                                      -----------   ----------      -------      ---------

BALANCE, DECEMBER 31, 2005                                 (3,296)        (924)        (194)        (1,118)

   Issuance of:
      Shares issued for exercise of stock options               -            -            -              -
      Shares issued for 1999 Purchase Plan                      -            -            -              -
   Acquisition of treasury stock - 58,447,450 shares       (7,550)           -            -              -
   Retirement of treasury stock                            10,846            -            -              -
   Options granted to nonemployees                              -            -            -              -
   Stock-based compensation                                     -            -            -              -
   Net income for 2006                                          -            -            -              -
   Foreign currency translation adjustments                     -            -          695            695
   Unrealized loss on available-for-sale securities             -         (205)           -           (205)
                                                      -----------   ----------      -------      ---------

BALANCE, DECEMBER 31, 2006                            $         -   $   (1,129)     $   501      $    (628)
                                                      ===========   ==========      =======      =========
</TABLE>

<TABLE>
<CAPTION>
                                                                        Total
                                                       Retained      Shareholders'
                                                       Earnings         Equity
<S>                                                     <C>          <C>
BALANCE, JANUARY 1, 2004                                $  18,133    $    154,727

   Issuance of:
      Shares issued for exercise of stock options               -           1,282
      Shares issued for 1999 Purchase Plan                      -           1,032
   Acquisition and retirement of treasury stock              (946)         (1,368)
   Options granted to nonemployees                              -             613
   Net income for 2004                                     14,084          14,084
   Foreign currency translation adjustments                     -             714
   Unrealized loss on available-for-sale securities             -            (303)
                                                      -----------    ------------

BALANCE, DECEMBER 31, 2004                                 31,271         170,781

   Issuance of:
      Shares issued for exercise of stock options               -           1,185
      Shares issued for 1999 Purchase Plan                      -           1,110
   Acquisition of treasury stock - 20,420,000 shares            -          (4,355)
   Retirement of treasury stock                              (679)              -
   Options granted to nonemployees                              -              36
   Net income for 2005                                      8,147           8,147
   Foreign currency translation adjustments                     -            (238)
   Unrealized loss on available-for-sale securities             -            (770)
                                                      -----------    ------------

BALANCE, DECEMBER 31, 2005                                 38,739         175,896

   Issuance of:
      Shares issued for exercise of stock options               -             354
      Shares issued for 1999 Purchase Plan                      -             985
   Acquisition of treasury stock - 58,447,450 shares            -          (7,550)
   Retirement of treasury stock                            (5,605)              -
   Options granted to nonemployees                              -               4
   Stock-based compensation                                     -           2,589
   Net income for 2006                                        743             743
   Foreign currency translation adjustments                     -             695
   Unrealized loss on available-for-sale securities             -            (205)
                                                      -----------    ------------

BALANCE, DECEMBER 31, 2006                            $    33,877    $    173,511
                                                      ===========    ============
</TABLE>

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

                                      F-5

<PAGE>

O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousand U.S. Dollars)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                      Years Ended December 31
                                                                 -----------------------------------
                                                                    2004        2005         2006
OPERATING ACTIVITIES
<S>                                                              <C>          <C>          <C>
   Net income                                                    $  14,084    $   8,147    $     743
   Adjustments to reconcile net income to net cash provided by
     operating activities:
      Depreciation and amortization                                  2,692        3,684        4,947
      Amortization of stock options granted for services               386          264          239
      Stock-based compensation                                         -            -          2,589
      Gain on sale of long-term investments                           (340)         -            -
      Gain on sale of short-term investments                           -            (10)         (24)
      Deferred income taxes                                            (68)         527         (845)
      Impairment loss on long-term investments                         -            -            756
      Loss on sale/disposal of property and equipment                    3           18           76
      Reversal of income tax payable                                  (375)        (658)      (2,513)
      Changes in operating assets and liabilities:
         Accounts receivable, net                                      363       (2,029)      (7,527)
         Inventories                                                (1,618)      (4,712)       1,867
         Prepaid expenses and other current assets                  (1,278)      (2,721)        (819)
         Notes and accounts payable                                 (2,699)       2,125        4,091
         Income tax payable                                          1,274          814         (403)
         Accrued expenses and other current liabilities              1,705        5,570           11
         Accrued retirement benefit costs                              -            -             90
                                                                 ---------    ---------    ---------

         Net cash provided by operating activities                  14,129       11,019        3,278
                                                                 ---------    ---------    ---------

INVESTING ACTIVITIES
   Receivables from employees                                          116          -            402
   Acquisition of:
      Property and equipment                                        (8,354)     (14,870)     (23,367)
      Long-term investments                                         (4,861)      (5,819)      (8,073)
      Short-term investments                                      (166,045)    (151,562)     (98,755)
   (Increase) decrease in:
      Restricted assets                                             (1,945)         306          383
      Restricted cash                                                    5       (3,718)      (2,699)
      Other assets                                                    (187)      (1,750)        (496)
   Proceeds from:
      Sale of short-term investments                               155,021      158,132      134,297
      Sale of long-term investments                                  1,020          -            -
      Sale of property and equipment                                     2          -              4
                                                                 ---------    ---------    ---------

         Net cash provided by (used in) investing activities       (25,228)     (19,281)       1,696
                                                                 ---------    ---------    ---------
</TABLE>

                                                                     (Continued)

                                      F-6
<PAGE>

O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousand U.S. Dollars)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                    Years Ended December 31
                                                               --------------------------------
                                                                 2004         2005        2006
FINANCING ACTIVITIES
<S>                                                            <C>         <C>         <C>
   Acquisition of treasury stock                               $ (1,368)   $ (4,355)   $ (7,550)
   Proceeds from:
      Exercise of stock options                                   1,282       1,185         354
      Issuance of ordinary shares under 1999 Purchase Plan        1,032       1,110         985
                                                               --------    --------    --------

         Net cash provided by (used in) financing activities        946      (2,060)     (6,211)
                                                               --------    --------    --------

EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATE                         (16)        377         300
                                                               --------    --------    --------

NET DECREASE IN CASH AND CASH EQUIVALENTS                       (10,169)     (9,945)       (937)

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                   66,489      56,320      46,375
                                                               --------    --------    --------

CASH AND CASH EQUIVALENTS AT END OF YEAR                       $ 56,320    $ 46,375    $ 45,438
                                                               ========    ========    ========

SUPPLEMENTAL DISCLOSURES OF CASH FLOWS
   Cash paid for interest                                      $      -    $      -    $      -
   Cash paid for tax                                           $    641    $    292    $  1,311

NON-CASH INVESTING AND FINANCING ACTIVITIES
   Increase in payable for acquisition of equipment            $      -    $  1,183    $      -
   Short-term investments reclassified to restricted assets    $  1,144    $  1,430    $    307

</TABLE>



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

                                                                     (Concluded)


                                      F-7
<PAGE>

O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States Dollars Unless Otherwise Noted)
--------------------------------------------------------------------------------

 1.  GENERAL

     Business

     O2Micro, Inc. was incorporated in the state of California in the United
     States of America on March 29, 1995 to design, develop, and deliver
     semiconductor components primarily for mobile applications. In March 1997,
     O2Micro International Limited (the "Company") was formed in the Cayman
     Islands and all authorized and outstanding common stock, preferred stock
     and stock options of O2Micro, Inc. were exchanged for the Company's
     ordinary shares, preference shares and stock options with identical rights
     and preferences. O2Micro, Inc. became the Company's subsidiary after the
     share exchange.

     The Company has incorporated various wholly-owned subsidiaries, including
     (among others) O2Micro Electronics, Inc. ("O2Micro-Taiwan"), O2Micro
     International Japan Ltd. ("O2Micro-Japan"), O2Micro Pte Limited-Singapore
     ("O2Micro-Singapore") and O2Micro (China) Co., Ltd ("O2Micro-China").
     O2Micro-Taiwan is engaged in operations. O2Micro-Japan is engaged in
     trading. O2Micro-Singapore, O2Micro-China and other subsidiaries are mostly
     engaged in research and development. To assure the testing capacity and
     flexibility, the Company also established a subsidiary, OceanOne
     Semiconductor (Ningbo) Limited ("OceanOne") in NingBo of the People's
     Republic of China (the "PRC") in August 2005. OceanOne is engaged in
     semiconductor testing service and was still in its development stage as of
     December 31, 2006. The Company also established a Taiwanese branch office,
     O2Micro International Limited - Taiwan Branch ("O2Micro-Taiwan Branch") to
     engage in marketing and customer support related services. Due to the
     duplicated functions between O2Micro-Taiwan Branch and O2Micro-Taiwan, the
     Board of Directors ("Board") determined to dissolve O2Micro-Taiwan Branch
     on October 31, 2002. The dissolution process of O2Micro-Taiwan Branch was
     not completed as of December 31, 2006.

     At the extraordinary general meeting of shareholders of the Company held on
     November 14, 2005, the shareholders approved a public global offering of
     the Company's Ordinary Shares and the proposed listing of the Company's
     Ordinary Shares on the Main Board of The Stock Exchange of Hong Kong
     Limited ("SEHK") and various matters related to the proposed listing and
     offering, including the adoption of Amended and Restated Memorandum and
     Articles of Association, the 2005 Share Incentive Plan ("2005 SIP") and the
     2005 Share Option Plan ("2005 SOP"), general issue and repurchase mandates
     which would authorize the Company for a period of time to issue or purchase
     a limited number of shares in accordance with the Listing Rules of SEHK;
     and a 50-for-1 share split and the implementation of an American depositary
     share ("ADS") program with respect to the Company's Ordinary Shares quoted
     on The Nasdaq National Market ("Nasdaq"). Following approval of these
     matters, the Company effected the cessation of trading of its Ordinary
     Shares on Nasdaq and share split of Ordinary Shares on November 25, 2005,
     and the commencement of trading of ADSs on Nasdaq on November 28, 2005. All
     share and per share data have been retroactively restated in the
     accompanying consolidated financial statements and notes to the
     consolidated financial statements for all periods presented to reflect the
     share split.

                                      F-8
<PAGE>

     On December 30, 2005, the Board determined to file with SEHK for listing by
     way of introduction without issuing new shares instead of a global offering
     after taking market conditions and other factors into consideration.

     The adoption of the Amended and Restated Memorandum and Articles of
     Association, the 2005 SIP and the 2005 SOP, general issue and repurchase
     mandates have become effective upon the listing of the Ordinary Shares on
     SEHK on March 2, 2006.


 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Basis of Presentation

     The consolidated financial statements have been prepared in accordance with
     accounting principles generally accepted in the United States of America.
     The consolidated financial statements include the accounts of the Company
     and its wholly-owned subsidiaries. All intercompany accounts and
     transactions have been eliminated on consolidation.

     Use of Estimates

     The preparation of financial statements in conformity with accounting
     principles generally accepted in the United States of America requires
     management to make estimates and assumptions that affect certain reported
     amounts and disclosures. Accordingly, actual results could differ from
     those estimates.

     Concentration of Credit Risk

     Financial instruments that potentially subject the Company to a
     concentration of credit risk consist of cash, cash equivalents, short-term
     investments and accounts receivable. Cash is deposited with high credit
     quality financial institutions. For cash equivalents and short-term
     investments, the Company invests in debt securities with credit rating of A
     and better. For accounts receivable, the Company performs ongoing credit
     evaluations of its customers' financial condition and the Company maintains
     an allowance for doubtful accounts receivable based upon a review of the
     expected collectibility of individual accounts.

     Fair Value of Financial Instruments

     The Company's financial instruments, including cash and cash equivalents,
     restricted cash, accounts receivable, and notes and accounts payable are
     carried at cost, which approximates the fair value due to the short-term
     maturity of those instruments. Fair values of available-for-sale
     investments including short-term investments and long-term investments
     represent quoted market prices. Long-term investments in private company
     equity securities are accounted for under the cost method because the
     Company does not exercise significant influence over the entities. The
     Company evaluates related information including operating performance,
     subsequent rounds of financings, advanced product development and related
     business plan in determining the fair value of these investments and
     whether an other-than-temporary decline in value exists. Fair value of
     restricted assets, which are composed of Taiwan Government bonds,
     negotiable certificates of deposit and cash, is estimated based on the
     combination of fair value of each component.

                                      F-9

<PAGE>

     Cash and Cash Equivalents

     The Company considers all highly liquid investments with maturities of not
     more than three months when purchased to be cash equivalents. Time deposits
     with maturities of more than three months are classified as short-term
     investments.

     Restricted Assets

     The Company classifies deposits made for customs, collateral for obtaining
     foundry capacity, cash pledged to a bank for the issuance of letters of
     credit as restricted cash. The deposits are classified as current assets if
     refundable within a twelve-month period. Restricted assets consist of
     deposits made for Taiwan court cases in the form of Taiwan Government
     bonds, negotiable certificates of deposit and cash. Restricted assets can
     be released only upon the resolution of the related litigation.

     Short-term Investments

     The Company maintains its excess cash in U.S. treasury bills, government
     and corporate bonds issued with high ratings. The specific identification
     method is used to determine the cost of securities sold, with realized
     gains and losses reflected in non-operating income and expenses. As of
     December 31, 2006, all of the above-mentioned investments were classified
     as available-for-sale securities and were recorded at market value.
     Unrealized gains and losses on these investments are included in
     accumulated other comprehensive income and loss as a separate component of
     shareholders' equity, net of any related tax effect, unless unrealized
     losses are deemed other-than-temporary. Unrealized losses are recorded as a
     charge to income when deemed other-than-temporary.

     Inventories

     The Company outsources the wafer fabrication, assembly, and testing of its
     products. Inventories are stated at the lower of standard cost or market
     value. Cost is determined on a currently adjusted standard basis, which
     approximates actual cost on a first-in, first-out basis.

     Long-term Investments

     Long-term investments in private companies over which the Company does not
     exercise significant influence are accounted for under the cost method of
     accounting. Management evaluates related information in addition to quoted
     market prices, if any, in determining the fair value of these investments
     and whether an other-than-temporary decline in value exists. Factors
     indicative of an other-than- temporary decline include recurring operating
     losses, credit defaults and subsequent rounds of financings at an amount
     below the cost basis of the investment. The list is not all-inclusive and
     management periodically weighs all quantitative and qualitative factors in
     determining if any impairment loss exists.

     Long-term investments in listed companies are classified as
     available-for-sales securities and are recorded at market value. Unrealized
     gains and losses on these investments are included in accumulated other
     comprehensive income and loss as a separate component of shareholders'
     equity, net of any related tax effect, unless unrealized losses are deemed
     other-than-temporary. Unrealized losses are recorded as a charge to income
     when deemed other-than-temporary.


                                      F-10

<PAGE>

     Property and Equipment

     Property and equipment are stated at cost less accumulated depreciation.
     Major additions, renewals and betterments are capitalized, while
     maintenance and repairs are expensed as incurred.

     Depreciation is provided on the straight-line method over estimated service
     lives that range as follows: buildings - 35 to 49.7 years, equipment - 3 to
     10 years, furniture and fixtures - 3 to 15 years, leasehold improvements -
     the shorter of the estimated useful life or the lease term, which is 2 to 6
     years, and transportation equipment - 5 years.

     Long-lived Asset Impairment

     The Company evaluates the recoverability of long-lived assets whenever
     events or changes in circumstances indicate the carrying value may not be
     recoverable. The carrying value of a long-lived asset is considered
     impaired when the anticipated undiscounted cash flows from such asset is
     separately identifiable and is less than the carrying value. If impairment
     occurs, a loss based on the excess of carrying value over the fair market
     value of the long-lived asset is recognized. Fair market value is
     determined by reference to quoted market prices, if available, or
     discounted cash flows, as appropriate.

     Treasury Stock

     The Company retires ordinary shares repurchased under a share repurchase
     plan. Accordingly, upon retirement the excess of the purchase price over
     par value was allocated between additional paid-in capital and retained
     earnings based on the average issuance price of the shares repurchased. A
     repurchase of ADSs is recorded as treasury stock until the Company
     completes the withdrawal of the underlying ordinary shares from the ADS
     program.

     Revenue Recognition

     Revenue from product sales to customers, other than distributors, is
     recognized at the time of shipment and when title and right of ownership
     transfers to customers. The four criteria for revenue being realized and
     earned are the existence of evidence of sale, actual shipment, fixed or
     determinable selling price, and reasonable assurance of collectibility.

     Allowances for sales returns and discounts are provided at the time of the
     recognition of the related revenues on the basis of experience and these
     provisions are deducted from sales.

     In certain limited instances, the Company sells its products through
     distributors. The Company has limited control over these distributors'
     selling of products to third parties. Accordingly, the Company recognizes
     revenue on sales to distributors when the distributors sell the Company's
     products to third parties. Thus, products held by distributors are included
     in the Company's inventory balance.

     Research and Development

     Research and development costs consist of expenditure incurred during the
     course of planned research and investigation aimed at the discovery of new
     knowledge that will be useful in developing new products or processes, or
     at significantly enhancing existing products or production processes as
     well as expenditure incurred for the design and testing of product
     alternatives or construction of prototypes. All expenditures related to
     research and development activities of the Company are charged to operating
     expenses when incurred.

                                      F-11
<PAGE>

     Advertising Expenses

     The Company expenses all advertising and promotional costs as incurred.
     These costs were $1,108,000 in 2004, $1,447,000 in 2005 and $3,200,000 in
     2006, respectively. A portion of these costs was for advertising, which
     amounted to $367,000 in 2004, $453,000 in 2005 and $535,000 in 2006,
     respectively.

     Pension Costs

     For employees who participate in the defined benefit pension plan, their
     pension costs are recorded based on actuarial calculations.

     Income Tax

     The Company is not subject to income or other taxes in the Cayman Islands.
     However, subsidiaries are subject to taxes of the jurisdiction where they
     are located.

     Income taxes are accounted for in accordance with Statement of Financial
     Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes". The
     provision for income tax represents income tax paid and payable for the
     current year plus the changes in the deferred income tax assets and
     liabilities during the relevant years. Deferred income tax assets are
     recognized for operating loss carryforwards, research and development
     credits, and temporary differences. The Company believes that uncertainty
     exists regarding the realizability of certain deferred income tax assets
     and, accordingly, has established a valuation allowance for those net
     deferred income tax assets to the extent the realizability is not deemed to
     be more likely than not. In addition, The Company recognizes liabilities
     for potential income tax contingencies based on its estimate of whether,
     and the extent to which, additional taxes may be due. If the Company
     determines that payment of these amounts is unnecessary or if the recorded
     tax liability is less than its current assessment, the Company may be
     required to recognize an income tax benefit or additional income tax
     expense in its financial statements, accordingly.

     Stock-based Compensation

     The Company grants stock options to its employees and certain
     non-employees. Prior to January 1, 2006, the Company accounted for options
     granted under Accounting Principles Board Opinion ("APB") No. 25,
     "Accounting for Stock Issued to Employees" and complied with the disclosure
     provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" for
     its employee stock options. Under APB No. 25, compensation expense is
     measured based on the difference, if any, on the date of the option grant,
     between the fair value of the Company's stock and the exercise price of the
     option.

     Effective January 1, 2006, the Company adopted the fair value recognition
     provisions of SFAS No. 123(R), "Share-Based Payment" using the modified
     prospective application method. Under this transition method, compensation
     cost recognized for the year ended December 31, 2006, includes the
     applicable amounts of: (a) compensation cost of all stock-based payments
     granted prior to, but not yet vested as of, December 31, 2005 (based on the
     grant-date fair value estimated in accordance with the original provisions
     of SFAS No. 123 and previously presented in pro forma footnote
     disclosures), and (b) compensation cost for all stock-based payments
     granted subsequent to January 1, 2006 (based on the grant-date fair value
     estimated in accordance with the new provisions of SFAS No. 123(R)).
     Results for periods prior to January 1, 2006, have not been restated.

                                      F-12
<PAGE>

     As a result of adopting SFAS No. 123 (R) on January 1, 2006, the Company
     recorded stock-based compensation of $ 2,589,000 to income before income
     tax and net income for the year ended December 31, 2006, and a decrease of
     $0.0013 both to basic and diluted earnings per share. Total stock-based
     compensation includes the impacts of stock options, restricted stock units
     grants and the employee stock purchase plan. The Company's policy for
     attributing the value of graded vest share-based payments is a
     straight-line approach.

     At the end of June 2005, the Board approved the acceleration of vesting of
     certain options. The Board evaluated the minimal benefit to its employees
     of accelerating the remaining vesting on these significantly underwater
     options against the value to shareholders of not having earnings materially
     affected and the impact that this may have on the Company's market value.
     In addition, these options have exercise prices in excess of current market
     values and were not fully achieving their original objectives of incentive
     compensation and employee retention. Accelerating the vesting of these
     options accelerated the recognition of any remaining expense associated
     with these options which was zero under APB No. 25.

     The following pro forma information, as required by SFAS No. 148,
     "Accounting for Stock-Based Compensation - Transition and Disclosure, an
     amendment of FASB Statement No. 123," is presented for comparative purposes
     and illustrates the pro forma effect on net income and related earnings per
     share for the years ended December 31, 2004 and 2005, as if the Company had
     applied the fair value recognition provisions of SFAS No. 123 to
     stock-based compensation for that period.

<TABLE>
<CAPTION>
                                                                           Years Ended December 31
                                                                             2004            2005

<S>                                                                     <C>              <C>
     Net income as reported (in thousands)                              $       14,084   $        8,147
     Add:  Stock-based compensation expense included in net income,
       including tax expense of $0 for 2004 and 2005                                 -                -
     Deduct:  Stock-based compensation expense determined under
       SFAS No. 123, including tax expense of $0 for 2004 and 2005              (6,940)         (15,862)
                                                                        --------------   --------------

     Pro forma net income (loss)                                        $        7,144   $       (7,715)
                                                                        ==============   ==============

     Pro forma shares used in calculation - basic (in thousands)             1,957,800        1,961,168
                                                                        ==============   ==============
     Pro forma earnings (loss) per share - basic                        $       0.0036   $      (0.0039)
                                                                        ==============   ==============
     Earnings per share - basic as reported                             $       0.0072   $       0.0042
                                                                        ==============   ==============
     Pro forma shares used in calculation - diluted (in thousands)           2,005,100        1,997,459
                                                                        ==============   ==============
     Pro forma earnings per share - diluted                             $       0.0036   $           NA
                                                                        ==============   ==============
     Earnings per share - diluted as reported                           $       0.0070   $       0.0041
                                                                        ==============   ==============
</TABLE>

     Pro forma loss per share for the year ended December 31, 2005 was not
     disclosed because the results were antidilutive.

     This table includes a pro forma charge of $1,831,000 for the year ended
     December 31, 2005 related to the above accelerated vesting event.

     In September, November and December 2005, the Company granted 1,100,000,
     100,000 and 70,600,000 stock options to employees with the following
     features:

                                      F-13
<PAGE>

     a.  Employees will be granted fully vested, immediately exercisable stock
         options to purchase the Company's ordinary shares.

     b.  The Company has the right but is not required to repurchase exercised
         stock options upon termination of an employee's service with the
         Company at the closing market price on the date of repurchase. The
         shares subject to repurchase are those which qualify as mature shares
         at the date of such employee's termination. Mature shares are those
         that have been held by the employee for a period of more than six
         months.

     c.  Employees are restricted from selling shares which are issued upon the
         exercise of stock options for a total of four years with 25% of the
         restriction lapsing each year.

     d.  There is no requisite service period or other performance criteria
         required by the employee to earn the stock option.

     The total pro forma charge for the immediately vested options was
     $8,588,000 in 2005 and is included in the table above.

     Foreign Currency Transactions

     The functional currency is the local currency of the respective entities.
     Foreign currency transactions are recorded at the rate of exchange in
     effect when the transaction occurs. Gains or losses, resulting from the
     application of different foreign exchange rates when cash in foreign
     currency is converted into the entities' functional currency, or when
     foreign currency receivable and payable are settled, are credited or
     charged to income in the period of conversion or settlement. At year-end,
     the balances of foreign currency monetary assets and liabilities are
     restated based on prevailing exchange rates and any resulting gains or
     losses are credited or charged to income.

     Translation of Foreign Currency Financial Statements

     The reporting currency of the Company is the U.S. dollar. Accordingly, the
     financial statements of the foreign subsidiaries are translated into U.S.
     dollars at the following exchange rates: Assets and liabilities - current
     rate on balance sheet date; shareholders' equity - historical rate; income
     and expenses - weighted average rate during the year. The resulting
     translation adjustment is recorded as a separate component of shareholders'
     equity.

     Comprehensive Income (Loss)

     Comprehensive income represents net income plus the results of certain
     changes in shareholders' equity during a period from non-owner sources that
     are not reflected in the consolidated statement of operations.

     Legal Contingencies

     The Company is currently involved in various claims and legal proceedings.
     Periodically, the Company reviews the status of each significant matter and
     assesses the potential financial exposure. If the potential loss from any
     claim or legal proceeding is considered probable and the amount can be
     estimated, the Company accrues a liability for the estimated loss. In view
     of uncertainties related to these matters, accruals are based only on the
     best information available at the time. As additional information becomes
     available, the Company reassesses the potential liability related to the
     pending claims and litigation and revises these estimates as appropriate.
     Such revisions in the estimates of the potential liabilities could have a
     material impact on the results of operations and financial position.

                                      F-14
<PAGE>

     The Company indemnifies third parties with whom it enters into contractual
     relationships, including customers, however, it is not possible to
     determine the range of the amount of potential liability under these
     indemnification obligations due to the lack of prior indemnification
     claims. These indemnities typically hold these third parties harmless
     against specified losses, such as those arising from a breach of
     representation or covenant, or other third party claims that the Company's
     products when used for their intended purposes infringe the intellectual
     property rights of such other third parties. The indemnities are triggered
     by any claim of infringement of intellectual property rights brought out by
     a third party with respect to the Company's products. The terms of these
     indemnities may not be waived or amended except by written notice signed by
     the both parties and may only be terminated with respect to the Company's
     products.

     Recent Accounting Pronouncements

     In February, 2007, the Financial Accounting Standards Board ("FASB") issued
     SFAS No. 159, "The Fair Value Option for Financial Assets and Financial
     Liabilities". Under this statement, the Company may elect to report
     financial instruments and certain other items at fair value on a
     contract-by-contract basis with changes in value reported in earnings. This
     election is irrevocable. SFAS No. 159 provides an opportunity to mitigate
     volatility in reported earnings that is caused by measuring hedged assets
     and liabilities that were previously required to use a different accounting
     method than the related hedging contracts when the complex provisions of
     SFAS No. 133 hedge accounting are not met. There is no impact to the
     Company as a result of the adoption of this statement.

     In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
     Defined Benefit Pension and Other Postretirement Plans - an amendment of
     FASB Statements No. 87, 88, 106, and 132(R)" (hereinafter "SFAS No. 158").
     This statement requires an employer to recognize the overfunded or
     underfunded status of a defined benefit postretirement plan (other than a
     multiemployer plan) as an asset or liability in its statement of financial
     position and to recognize changes in that funded status in the year in
     which the changes occur through comprehensive income of a business entity
     or changes in unrestricted net assets of a not for profit organization.
     This statement also requires an employer to measure the funded status of a
     plan as of the date of its year end statement of financial position, with
     limited exceptions. The adoption of this statement had no material effect
     on the Company's financial statements.

     In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements",
     effective for financial statements issued for fiscal years beginning after
     November 15, 2007, the beginning of the Company's 2008 fiscal year. This
     statement defines fair value, establishes a framework for measuring fair
     value, and expands disclosures about fair value measurements. This
     statement establishes a fair value hierarchy that distinguishes between
     valuations obtained from sources independent of the entity and those from
     the entity's own unobservable inputs that are not corroborated by
     observable market data. SFAS No. 157 expands disclosures about the use of
     fair value to measure assets and liabilities in interim and annual periods
     subsequent to initial recognition. The disclosures focus on the inputs used
     to measure fair value and for recurring fair value measurements using
     significant unobservable inputs, the effect of the measurements on earnings
     or changes in net assets for the period. The Company is currently assessing
     the impact of this guidance on its financial statements.

                                      F-15
<PAGE>

     In June 2006, the FASB issued FASB Interpretation ("FIN") No. 48,
     "Accounting for Uncertainty in Income Taxes - an interpretation of FASB
     Statement No. 109." The interpretation contains a two step approach to
     recognizing and measuring uncertain tax positions accounted for in
     accordance with SFAS No.109. The first step is to evaluate the tax position
     for recognition by determining if the weight of available evidence
     indicates it is more likely than not that the position will be sustained on
     audit, including resolution of related appeals or litigation processes, if
     any. The second step is to measure the tax benefit as the largest amount
     which is more than 50% likely of being realized upon ultimate settlement.
     The provisions are effective for the Company beginning in the first quarter
     of 2007. The Company expects that the adoption of FIN No. 48 will not have
     a significant impact on the Company's financial statements.

     In September 2006, the Securities and Exchange Commission ("SEC") issued
     Staff Accounting Bulletin ("SAB") No. 108. This Bulletin provides the
     Staff's views on the consideration of the effects of prior year
     misstatements in quantifying current year misstatements for the purpose of
     a materiality assessment. The guidance in SAB No. 108 is effective for
     financial statements on fiscal years ending after November 15, 2006. The
     adoption of this Bulletin had no material effect on the Company's financial
     statements.

     Reclassifications

     Certain amounts reported in previous years have been reclassified to
     conform to the current year presentation.


 3.  CASH AND CASH EQUIVALENTS

                                                   (In Thousands)

                                                     December 31
                                               ------------------------
                                                  2005         2006

     Time deposits                             $    23,444  $    20,200
     Savings and checking accounts                  18,411       13,180
     US treasury bills and corporate bonds               -       12,041
     Petty cash                                         14           17
     Cash management account                         4,506            -
                                               -----------  -----------

                                               $    46,375  $    45,438
                                               ===========  ===========

     The Company's cash management account is administered by the Bank of China
     to receive a fixed-rate return and as of December 31, 2005, it held foreign
     currency which was equivalent to $4,506,000. The cash management account
     came due on January 16, 2006 and the Company received $4,528,000. It
     reinvested this amount at 3.9% of return which came due on February 21,
     2006.

                                      F-16

<PAGE>

 4.  SHORT-TERM INVESTMENTS

                                                   (In Thousands)

                                                     December 31
                                               ------------------------
                                                  2005         2006

     Time deposits                             $    15,993  $    19,697
                                               -----------  -----------
     Available-for-sale securities
        US treasury bills                           13,909            -
        Corporate bonds                             24,642            -
        Foreign government bonds                     1,075            -
        Others                                          34            -
                                               -----------  -----------
                                                    39,660            -
                                               -----------  -----------

                                               $    55,653  $    19,697
                                               ===========  ===========

     Short-term investments by contractual maturity are as follows:

                                                   (In Thousands)

                                                     December 31
                                               ------------------------
                                                  2005         2006

     Due within one year                       $    55,592  $    19,668
     Due after one year through two years                -           29
     Due after two years                                61            -
                                               -----------  -----------

                                               $    55,653  $    19,697
                                               ===========  ===========

     The Company's gross realized gains and losses on the sale of investments
     for the year ended December 31, 2004 were both $0, for the year ended
     December 31, 2005 were $12,000 and $2,000, respectively, and for the year
     ended December 31, 2006 were 26,000 and 2,000, respectively. Gross
     unrealized gains and losses at December 31, 2005 were $55,000 and $11,000,
     respectively, and at December 31, 2006 were $0 and $6,000, respectively.


                                      F-17
<PAGE>

     The following table shows the gross unrealized losses and fair value of the
     Company's investments with unrealized losses that were not deemed to be
     other-than-temporarily impaired, aggregated by investment category and
     length of time that individual securities have been in a continuous
     unrealized loss position, at December 31, 2005 and 2006.

                                                                  (In Thousands)
<TABLE>
<CAPTION>
                                                                    December 31
                 ------------------------------------------------------------------------------------------------------------------
                                              2005                                                                  2006
                 ------------------------------------------------------------------------------------     -------------------------
                    Less Than 12 Months         12 Months or Greater                  Total                  Less Than 12 Months
                 -------------------------    -------------------------      ------------------------     -------------------------
                                Unrealized                   Unrealized                    Unrealized                    Unrealized
                 Fair Value       Losses      Fair Value       Losses        Fair Value      Losses       Fair Value       Losses
<S>               <C>            <C>            <C>            <C>            <C>            <C>            <C>            <C>
Corporate bonds   $24,642        $    11        $     -        $     -        $24,642        $    11        $     -        $     -
Investment in
  CSMC (Note 8)       -              -            3,580            968          3,580            968          2,668          1,123
                  -------        -------        -------        -------        -------        -------        -------        -------

                  $24,642        $    11        $ 3,580        $   968        $28,222        $   979        $ 2,668        $ 1,123
                  =======        =======        =======        =======        =======        =======        =======        =======
</TABLE>

 5.  ACCOUNTS RECEIVABLE, NET

                                                        (In Thousands)

                                                         December 31
                                                   ------------------------
                                                      2005         2006

     Accounts receivable                           $    11,810  $    19,310
     Allowances for
        Doubtful accounts                                  (34)          (7)
        Sales returns and discounts                       (316)        (316)
                                                   -----------  -----------

                                                   $    11,460  $    18,987
                                                   ===========  ===========

     The changes in the allowances are summarized as follows:

<TABLE>
<CAPTION>
                                                                      (In Thousands)

                                                                  Years Ended December 31
                                                         ------------------------------------------
                                                             2004           2005           2006
     Allowances for doubtful receivables
<S>                                                      <C>            <C>            <C>
        Balance, beginning of the year                   $         86   $         90   $         34
        Additions                                                   4              -              -
        Reversal and Write-off                                      -            (56)           (27)
                                                         ------------   ------------   ------------

        Balance, end of the year                         $         90   $         34   $          7
                                                         ============   ============   ============

     Allowances for sales returns and discounts
        Balance, beginning of the year                   $        315   $        317   $        316
        Additions                                                 252            587            848
        Write-off                                                (250)          (588)          (848)
                                                         ------------   ------------   ------------

        Balance, end of the year                         $        317   $        316   $        316
                                                         ============   ============   ============
</TABLE>


                                      F-18


<PAGE>

6.  INVENTORIES

                                                       (In Thousands)

                                                         December 31
                                                   ------------------------
                                                      2005         2006

     Finished goods                                $     2,954  $     5,412
     Work-in-process                                     8,401        5,375
     Raw materials                                       4,588        3,289
                                                   -----------  -----------

                                                   $    15,943  $    14,076
                                                   ===========  ===========

7.  PREPAID EXPENSES AND OTHER CURRENT ASSETS

                                                       (In Thousands)

                                                         December 31
                                                   ------------------------
                                                      2005         2006

     Prepayment to foundry providers               $     3,000  $     2,940
     Interest receivable                                 1,656        2,203
     Prepaid expense                                       895        1,418
     Value-added-tax paid                                  309          174
     Other receivable                                      211           76
     Deferred tax assets                                    10           31
     Others                                                584          537
                                                   -----------  -----------

                                                   $     6,665  $     7,379
                                                   ===========  ===========


8.  LONG-TERM INVESTMENTS

                                                       (In Thousands)

                                                         December 31
                                                   ------------------------
                                                      2005         2006
     Cost method
        X-FAB Semiconductor Foundries AG ("X-FAB") $     4,968  $     4,968
        360 Degree Web Ltd. ("360 Degree Web")           1,305        1,305
        GEM Services, Inc. ("GEM")                         500          500
        Etrend Hightech Corporation ("Etrend")             960          960
        Asia SinoMOS Semiconductor Inc. ("Sinomos")      5,000       13,073
        Philip Ventures Enterprise Fund ("PVEF")           585          585
                                                   -----------  -----------
                                                        13,318       21,391
     Available for sale securities - noncurrent
        CSMC Technologies Corporation ("CSMC")           3,580        2,668
                                                   -----------  -----------

                                                   $    16,898  $    24,059
                                                   ===========  ===========

                                      F-19
<PAGE>

     The Company invested in X-FAB's ordinary shares in July 2002. X-FAB is a
     European-American foundry group that specialized in mixed signal
     application. As of December 31, 2006, the Company held 530,000 shares at
     the value of $4,968,000 (4,982,000 EURO), which represents a 1.60%
     ownership of X-FAB.

     The Company converted its convertible loans in 360 Degree Web to Series B
     and B2 preference shares of 360 Degree Web in January 2003. 360 Degree Web
     designs, develops and markets intelligent security software solutions that
     provide secure computing environment for personal computer mobile devices
     and the internet. In March 2004, the Company sold 1,000,000 shares of its
     stock in 360 Degree Web and recognized a gain of $340,000. In January 2005,
     the Company purchased additional 180,769 Series D preference shares of 360
     Degree Web at $1.3 per share. As of December 31, 2006, the Company held
     19.52% ownership of 360 Degree Web.

     The Company invested in GEM's preference shares in August 2002. GEM is a
     multinational semiconductor assembly and test company. As of December 31,
     2006, the Company held 333,334 shares at the value of $500,000, which
     represented a 0.96% ownership of GEM.

     The Company invested in Etrend's ordinary shares in December 2002, July
     2003 and March 2004. Etrend is a wafer probing, packing and testing
     company. As of December 31, 2006, the Company held 9.07% ownership of
     Etrend.

     In January 2005, the Company invested ordinary shares of Sinomos, a
     privately owned foundry company, at a total amount of $5,000,000. In May
     and December 2006, the Company further invested preferred shares of
     $3,288,000 and $4,785,000, respectively. As of December 31, 2006, the
     Company held 30,101,353 of ordinary and preference shares, representing an
     18.44% ownership of Sinomos.

     In November 2005, the Company invested in PVEF, a fund managed by a fund
     management company in Singapore, with investment amount of SG$1,000,000 for
     20 units in the placement at SG$50,000 per unit. The Company held 2.00% of
     the fund as of December 31, 2006.

     The Company invested in Silicon Genesis Corporation ("SiGen") preferred
     shares in December 2000. SiGen is an advanced nanotechnology company that
     develops Silicon-on-insulator ("SOI"), stained-silicon products and other
     engineered multi-layer structures to microelectronics and photonic for
     advanced electronic and opto-electronic device applications. In 2002 and
     2003, the Company reviewed the qualitative factors of the investment,
     determined that the decline in value was other-than-temporary and the
     carrying value was decreased to zero. The Company held 23,946 shares of
     SiGen as of December 31, 2006, representing a 0.09% ownership of SiGen.

     In August 2004, the Company invested in CSMC's ordinary shares which are
     listed on the SEHK at a purchase price of $4,547,000. CSMC is a
     semiconductor foundry company. As of December 31, 2006, the Company held
     70,200,000 shares, which represent approximately 2.58% ownership of CSMC.
     The Company considered that the investment to be other-than-temporary
     impaired at June 30, 2006 due to the fact that the stock price has been
     below the cost of HK$0.50 per share for continuous 12 months and recognized
     an impairment loss of $756,000 based on the quoted market price of HK$0.42
     per share on June 30, 2006. As of December 31, 2006, the Company recognized
     unrealized losses of $1,123,000. No additional impairment loss was
     recognized as the Company does not believe any of the unrealized losses
     represented an other-than-temporary impairment based on its evaluation of
     available evidence as at December 31, 2006.


                                      F-20
<PAGE>

 9.  PROPERTY AND EQUIPMENT, NET
                                                        (In Thousands)

                                                          December 31
                                                   -------------------------
                                                      2005         2006
     Cost
        Land                                       $     2,510  $    11,299
        Buildings                                        8,055        8,055
        Equipment                                       19,056       30,599
        Furniture and fixtures                           1,229        1,393
        Leasehold improvements                           2,045        3,385
        Transportation equipment                           241          514
        Prepayment for property and equipment            3,034        1,426
                                                   -----------  -----------
                                                        36,170       56,671
                                                   -----------  -----------
     Accumulated depreciation
        Buildings                                          132          313
        Equipment                                       11,116       12,569
        Furniture and fixtures                             586          786
        Leasehold improvements                             966        1,465
        Transportation equipment                            51          111
                                                   -----------  -----------
                                                        12,851       15,244
                                                   -----------  -----------
                                                   $    23,319  $    41,427
                                                   ===========  ===========

     Depreciation expense recognized during the years ended December 31, 2004,
     2005 and 2006 were approximately $2,391,000, $3,388,000 and $4,545,000,
     respectively.

     In view of the expansion of the Company's operations in the PRC, the
     Company acquired buildings located in Shanghai, the PRC in October 2005.
     The total purchase price was $7,077,000 of which $1,414,000 was paid for
     land use rights and the balance of $5,663,000 was paid for the building.
     The land use right was accounted for as other assets (see Note 10). In
     April 2006, the Company purchased 29,935 square feet of land in Hsin-Chu,
     Taiwan for a future facility for a total purchase price of approximately
     $8,789,000 (NT$286,421,000).

10.  OTHER ASSETS
                                                        (In Thousands)

                                                         December 31
                                                   -------------------------
                                                      2005         2006

     Land use rights, net                          $     1,407  $     1,379
     Deferred charges, net                                 665          618
     Refundable deposits                                   493          560
     Deferred income tax assets - noncurrent                62          295
     Prepayment for land use rights                        208          215
     Long-term notes receivable from employees             410            8
                                                   -----------  -----------

                                                   $     3,245  $     3,075
                                                   ===========  ===========


                                      F-21

<PAGE>

     All land within municipal zones in the PRC is owned by the PRC government.
     Limited liability companies, joint stock companies, foreign-invested
     enterprises, privately held companies and individual natural persons must
     pay fees for granting of rights to use land within municipal zones. Legal
     use of land is evidenced and sanctioned by land use certificates issued by
     the local municipal administration of land resources. Land use rights
     granted for industrial purposes are limited to a term of no more than 50
     years.

     Land use rights are recorded at cost less accumulated amortization.
     Amortization is provided on the straight-line method over the term of the
     land use rights agreement which is 49.7 years.

     In view of the expansion of the Company's operations in the PRC, the
     Company entered into a purchase contract to acquire land use rights located
     in Ningbo, the PRC. The total contracted price was $717,000 (5,600,000
     Renminbi) of which $215,000 (1,680,000 Renminbi) has been paid as of
     December 31, 2006 and such amount has been included in the prepayment for
     land use rights.

     Deferred charges consist of consultant and maintenance contracts and are
     amortized over the term of the contract which is 3 to 8 years.

     In 2001, James Keim, one of the Company's directors, accepted the
     assignment of Head of Marketing and Sales in the Cayman Islands, and moved
     to the Cayman Islands in December 2001. In connection with the move and to
     assist Mr. Keim to purchase a residence in the Cayman Islands, the Company
     entered into a loan agreement with Mr. Keim in February 2002, under which
     the Company made an interest free, unsecured loan in the amount of $400,000
     to Mr. Keim. The loan is repayable in February 2007 and has been repaid in
     full as of December 31, 2006.


11.  ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

                                                       (In Thousands)

                                                         December 31
                                                   -------------------------
                                                      2005         2006

     Salaries, bonus and benefits                  $     3,424  $     3,844
     Legal and audit fees                                3,916        3,187
     Promotional expenses                                   48          743
     Withholding tax payable                               223          260
     Payable for acquisition of equipment                1,183          248
     Value-added tax payable                               209          243
     Deferred income tax liabilities                       698          107
     Commissions                                           145          105
     SEHK listing expenses                               1,970            -
     Other accrued expenses                              2,276        3,475
                                                   -----------  -----------

                                                   $    14,092  $    12,212
                                                   ===========  ===========

                                      F-22

<PAGE>

12.  INCOME TAX

     Income (loss) before income taxes consisted of:
<TABLE>
<CAPTION>
                                                                     (In Thousands)

                                                                 Years Ended December 31
                                                         ------------------------------------------
                                                             2004           2005           2006

<S>                                                      <C>            <C>            <C>
     Cayman Islands                                      $     15,496   $      6,226   $     (3,395)
     Foreign                                                       60          2,955          1,688
                                                         ------------   ------------   ------------

                                                         $     15,556   $      9,181   $     (1,707)
                                                         ============   ============   ============
</TABLE>

     Income tax expense (benefit) consisted of:
<TABLE>
<CAPTION>
                                                                     (In Thousands)

                                                                  Years Ended December 31
                                                         -------------------------------------------
                                                             2004           2005           2006

<S>                                                      <C>            <C>            <C>
     Current                                             $      1,540   $        507   $     (1,605)
     Deferred                                                     (68)           527           (845)
                                                         ------------   ------------   ------------

     Income tax expense (benefit)                        $      1,472   $      1,034   $     (2,450)
                                                         ============   ============   ============
</TABLE>

     The Company and its subsidiaries file separate income tax returns.
     Reconciliation of the significant differences between the statutory income
     tax rate and the effective income tax rate on pretax income (loss) is as
     follows:
<TABLE>
<CAPTION>
                                                                    Years Ended December 31
                                                         ------------------------------------------
                                                             2004           2005           2006
<S>                                                                <C>            <C>            <C>
     Cayman statutory rate                                         0%             0%             0%
     Foreign in excess of statutory rate                        7.09%         15.69%         35.21%
     Research and development credits                          (6.08%)        (9.56%)       (20.86%)
     Adjustments to prior years' taxes                          3.49%         (9.11%)      (190.22%)
     Change in valuation allowance                              4.59%          9.74%         35.62%
     Others                                                     0.37%          4.50%         (3.28%)
                                                         ------------   ------------   ------------

     Effective tax rate                                         9.46%         11.26%       (143.53%)
                                                         ============   ============   ============
</TABLE>


                                      F-23

<PAGE>

     The deferred income tax assets and liabilities as of December 31, 2005 and
2006 consisted of the following:

                                                             (In Thousands)

                                                              December 31
                                                          2005         2006
     Deferred income tax assets
        Research and development credits               $     5,189  $     5,553
        Net operating loss carryforwards                        46           51
        Accrued vacation                                        30          158
        Depreciation and amortization                          238          353
        Deferred interest deductions                            31          326
        Others                                                  90           29
                                                       -----------  -----------
                                                             5,624        6,470
     Valuation allowance                                    (5,552)      (6,144)
                                                       -----------  -----------
     Total net deferred income tax assets                       72          326
                                                       -----------  -----------
     Deferred income tax liabilities
        Withholding tax liabilities                            647            -
        Unrealized foreign exchange                              -           42
        Unrealized capital allowance                            51           65
                                                       -----------  -----------
     Total deferred income tax liabilities                     698          107
                                                       -----------  -----------

     Net deferred income tax (liabilities) assets      $      (626) $       219
                                                       ===========  ===========
     Balance sheet caption reported in:
        Prepaid expenses and other current assets      $        10  $        31
        Other assets                                            62          295
        Accrued expenses and other current liabilities         698          107
                                                       -----------  -----------

                                                       $      (626) $       219
                                                       ===========  ===========

     The valuation allowance shown in the table above relates to net operating
     loss and credit carryforwards and temporary differences for which the
     Company believes that realization is uncertain. The valuation allowance
     increased $871,000 and $592,000 for the years ended December 31, 2005 and
     2006, respectively.

     As of December 31, 2006, O2 Micro, Inc. had U.S. federal and state research
     and development credit carryforwards of approximately $3,300,000 and
     $2,253,000, respectively. The U.S. federal research and development credit
     will expire from 2012 through 2026 if not utilized, while the state
     research and development credit will never expire.

     The Company reversed $375,000 and $2,513,000 of income tax payable for the
     2000 and 2001 tax years in September 2004 and in September 2006,
     respectively, due to completion of the examination and approval of its
     filed income tax return for the years ended December 31, 2000 and 2001. The
     tax authorities also determined a tax refund for 2001 income tax;
     therefore, the Company recognized additional income tax benefit of $69,000
     and received the refund in October 2006.

     On May 24, 2004, O2Micro-Taiwan applied to the Taiwan Customs officials for
     the rectification of the value of the imported goods reported for the
     period form 2003 to March 2004. The Company had mistakenly reported a lower
     value to the Taiwan Customs Authority than the correct value that was
     reported on O2Micro-Taiwan's tax return for the tax years of 2003 and 2004.
     The Taiwan Ministry of Finance approved the rectification of the value of
     the imported goods in 2005. The completion of the rectification resulted in
     the reversal of a contingent income tax liability of $658,000 and an income
     tax benefit was recognized in 2005.

                                      F-24
<PAGE>

13.  RETIREMENT AND PENSION PLANS

     The Company has a savings plan for that qualifies under Section 401(k) of
     the U.S. Internal Revenue Code. Participating employees may defer up to the
     U.S. Internal Revenue Service statutory limit amounts of pretax salary. The
     Company may make voluntary contributions to the savings plan but has made
     no contributions since the inception of the savings plan in 1997.

     The Company also participates in mandatory pension funds and social
     insurance schemes, if applicable, for employees in jurisdictions in which
     other subsidiaries or office are located to comply with local statutes and
     practices. For the years ended December 31, 2004, 2005 and 2006, pension
     costs charged to income in relation to the contributions to these schemes
     were $568,000, $861,000 and $1,293,000, respectively. In October 2006, the
     Company adopted a defined benefit pension plan and established an employee
     pension fund committee for certain employees of O2Micro-Taiwan who are
     subject to the Taiwan Standards Labor Law ("Labor Law") to comply with
     local requirements. This benefit pension plan provides benefits based on
     years of service and average salary computed based on the final six months
     of employment. The Labor Law requires the Company to contribute between 2%
     to 15% of employee salaries to a government specified plan, which the
     Company currently makes monthly contributions equal to 2% of employee
     salaries. Contributions are required to be deposited in the name of the
     employee pension fund committee with the Central Trust of China in Taiwan.
     The measurement date of the plan is December 31.

     The component of net periodic benefit cost is as follows:

                                                       (In Thousands)

                                                            2006

     Service cost                                        $         4
     Interest cost                                                16
     Expected return on plan assets                                -
     Amortization of the transition obligation                    70
                                                         -----------

     Net Periodic benefit cost                           $        90
                                                         ===========
     The funded status of the plan is as follows:
                                                       (In Thousands)

                                                         December 31,
                                                            2006

     Project benefit obligation                          $      (464)
     Plan assets at fair value                                     9
                                                         -----------

     Funded status of the plan                           $      (455)
                                                         ===========

                                      F-25
<PAGE>

     The change in fair value on plan assets is follows:
                                                       (In Thousands)

                                                            2006

     Employer contributions                              $         9
     Actual return on plan assets                                  -
                                                         -----------

     Fair value of plan assets, end of year              $         9
                                                         ===========

     The actuarial assumptions are as follows:

                                                            2006

     Discount rate                                              3.5%
     Rate of compensation increases                             2.0%
     Expected long-term rate of return on plan assets           2.5%


14.  STOCK-BASED COMPENSATION

     Employee Stock Purchase Plan

     In October 1999, the Board adopted the 1999 Purchase Plan ("1999 Purchase
     Plan"), which was approved by the shareholders prior to the consummation of
     its initial public offering in August 2000. A total of 50,000,000 ordinary
     shares have been reserved for issuance under the 1999 Purchase Plan, plus
     annual increases on January 1 of each year, commencing in 2001, up to
     40,000,000 shares as approved by the Board. The 1999 Purchase Plan is
     subject to adjustment in the event of a stock split, stock dividend or
     other similar changes in ordinary shares or capital structure.

     The 1999 Purchase Plan permits eligible employees to purchase ordinary
     shares through payroll deductions, which may range from 1% to 10% of an
     employee's regular base pay. Beginning November 1, 2005, the 1999 Purchase
     Plan shall be implemented through consecutive offer periods of 3 months'
     duration commencing each February 1, May 1, August 1 and November 1. Under
     the 1999 Purchase Plan, ordinary shares may be purchased at a price equal
     to the lesser of 90% of the fair market value of the Company's ordinary
     shares on the date of grant of the option to purchase (which is the first
     day of the offer period) or 90% of the fair market value of the Company's
     ordinary shares on the applicable exercise date (which is the last day of
     the offer period). Employees may elect to discontinue their participation
     in the purchase plan at any time, however, all of the employee's payroll
     deductions previously credited to the employee's account will be applied to
     the exercise of the employee's option on the next exercise date.
     Participation ends automatically on termination of employment with the
     Company. If not terminated earlier, the 1999 Purchase Plan will have a term
     of 10 years. During 2005 and 2006, 6,389,200 and 6,980,050 ordinary shares,
     respectively, had been purchased under the 1999 Purchase Plan. As of
     December 31, 2006, 15,851,950 shares were available for issuance.

     Stock Option Plans

     In 1997, the Board adopted the 1997 Stock Plan, and in 1999, adopted the
     1999 Stock Incentive Plan. The plans provide for the granting of stock
     options to employees, directors and consultants of the Company.

                                      F-26
<PAGE>

     Under the 1997 Stock Plan, the Board reserved 185,000,000 ordinary shares
     for issuance. After the completion of an initial public offering, no
     further options were granted under the 1997 Stock Plan. Under the 1999
     Stock Incentive Plan, the maximum aggregate number of shares available for
     grant shall be 150,000,000 ordinary shares plus an annual increase on
     January 1 of each year, commencing in 2001, equal to the least of
     75,000,000 shares or 4% of the outstanding ordinary shares on the last day
     of the preceding fiscal year or a smaller number determined by the plan
     administrator. As of December 31, 2006, the numbers of options outstanding
     and exercisable were 17,520,850 and 17,520,850, respectively, under the
     1997 Stock Plan, and 272,942,250 and 221,683,400, respectively, under the
     1999 Stock Incentive Plan.

     The Board adopted the 2005 SOP which was effective on March 2, 2006, the
     date the Company completed the SEHK listing, and then the BOD terminated
     the 1997 Stock Plan and 1999 Stock Incentive Plan. The Company began
     issuing stock options solely under the 2005 SOP for up to 100,000,000
     ordinary shares. Under the terms of the 2005 SOP, stock options are
     generally granted at fair market value of the Company's ordinary shares.
     The stock options have a contractual term of 8 years from the date of grant
     and vest over a requisite service period of 4 years. As of December 31,
     2006, the number of options outstanding and exercisable was 16,279,900 and
     1,654,200, respectively, under the 2005 SOP.

     A summary of the Company's stock option activity under the plans as of
     December 31, 2006, and changes during the year then ended is presented as
     follows:

<TABLE>
<CAPTION>
                                                                          Weighted-        Weighted-
                                                          Number of        average          average           Aggregate
                                                         Outstanding       Exercise        Remaining          Intrinsic
                                                        Option Shares       Price       Contractual Life        Value
<S>                                                   <C>                <C>            <C>               <C>
     Outstanding options at January 1, 2006                  310,484,350  $    0.2364
        Granted                                               21,988,400  $    0.1731
        Exercised                                             (5,643,000) $    0.0630
        Forfeited or expired                                 (20,086,750) $    0.2451
                                                       -----------------

     Outstanding options at December 31, 2006                306,743,000  $    0.2344         6.80          $    1,644,000
                                                       =================                      ====          ==============

     Vested or expected to vest options at
      December 31, 2006                                      286,332,400  $    0.2350         6.74          $    1,546,000
                                                       =================                      ====          ==============

     Exercisable options at December 31, 2006                240,858,450  $    0.2354         6.62          $    1,346,000
                                                       =================                      ====          ==============
</TABLE>

     The total intrinsic value of options exercised during the years ended
     December 31, 2004, 2005 and 2006 was $1,528,000, $841,000 and $177,000,
     respectively.


                                      F-27
<PAGE>

     The following table summarizes information about outstanding and vested
     stock options:
<TABLE>
<CAPTION>
                                                    Options Outstanding                       Options Exercisable
                                                                Weighted-
                                                                 average        Weighted-                      Weighted-
                                                                Remaining        average         Number         average
                                                Number         Contractual      Exercise      Exercisable      Exercise
     Range of Exercise Prices                                                                  and Vested
                                              Outstanding          Life           Price                          Price

<S>                                          <C>              <C>              <C>            <C>               <C>
     $0.0017-$0.0010                              2,758,300        1.99        $    0.0087         2,758,300  $    0.0087
     $0.0790-$0.1198                              8,149,050        3.38        $    0.0945         7,673,650  $    0.0930
     $0.1292-$0.1948                             63,871,700        5.73        $    0.1672        48,746,800  $    0.1711
     $0.2013-$0.2994                            178,082,000        7.54        $    0.2310       136,095,900  $    0.2283
     $0.3076-$0.4836                             53,881,950        6.38        $    0.3577        45,583,800  $    0.3632
                                            ---------------                                  ---------------

     Balance, December 31, 2006                 306,743,000        6.80        $    0.2344       240,858,450  $    0.2354
                                            ===============                                  ===============
</TABLE>

     Share Incentive Plan

     The Board adopted the 2005 SIP which was effective on March 2, 2006, the
     date the Company completed the SEHK listing. The 2005 SIP provides for the
     grant of restricted shares, restricted share units ("RSU"), share
     appreciation rights and dividend equivalent rights (collectively referred
     to as "Awards") up to 75,000,000 ordinary shares. Awards may be granted to
     employees, directors and consultants. The Company granted RSUs to
     employees in 2006. The RSUs vest over a requisite service period of 4
     years and expire 8 years from the date of grant.

     A summary of the status of the Company's RSUs as of December 31, 2006, and
     the changes during the year ended December 31, 2006 is presented as
     follows:

                                                                   Weighted-
                                                   Number of        average
                                                  Outstanding     Grant-Date
                                                    Shares        Fair Value

     Granted                                          8,085,250   $   0.1736
     Vested                                                   -   $   -
     Forfeited                                         (170,500)  $   0.1736
                                                ---------------

     Nonvested at December 31, 2006                   7,914,750   $   0.1736
                                                ===============

     As of December 31, 2006, there was $3,778,000 of total unrecognized
     compensation cost related to nonvested share-based compensation
     arrangements granted under the plans including stock options and RSUs. The
     cost is expected to be recognized over a weighted-averaged period of 3.01
     years. The total fair value of RSUs vested during the year ended December
     31, 2006 was $0.

     Cash received from option exercise under all share-based payment
     arrangements for the years ended December 31, 2004, 2005 and 2006, was
     $2,314,000, $2,295,000 and $1,339,000, respectively.

                                      F-28
<PAGE>

     For purposes of measuring compensation expense under APB No. 25, the fair
     value of the shares on the date of grant was determined by the Board for
     grants prior to August 23, 2000. The fair value of subsequent option or RSU
     grants was based on the market price of ordinary shares on the day of
     grant.

     The Company calculated the fair value of each option grant on the date of
     grant using the Black-Scholes option pricing model that use the assumptions
     in the following table. Risk-free interest rate is based on the U.S.
     Treasury yield curve in effect at the time of grant. The Company uses the
     simplified method as provided by Staff Accounting Bulletin No. 107 by
     average vesting term and contractual term of the options as their expected
     term. Expected volatilities are based on historical volatility for a period
     equal to the options' expected term when the Company has sufficient
     historical data as a public company; otherwise, the Company uses historical
     volatilities of stock prices of companies similar to the Company. The
     dividend yield is zero as the Company has never declared or paid dividends
     on the ordinary shares or other securities and do not anticipate paying
     dividends in the foreseeable future.

<TABLE>
<CAPTION>
                                             Stock Options                           Employee Stock Purchase Plan
                                 --------------------------------------      --------------------------------------------
                                         Years Ended December 31                       Years Ended December 31
                                 --------------------------------------      --------------------------------------------
                                   2004          2005            2006         2004           2005              2006
<S>                                <C>           <C>         <C>   <C>                    <C>   <C>         <C>   <C>
     Risk-free interest rate       3.54%         4.06%       4.45%-5.10%        -         2.20%-3.96%       4.47%-5.12%
     Expected life               5-7 years     5-7 years      5-7 years         -       0.26-0.51 years   0.25-0.26 years
     Volatility                     65%           65%          67%-71%          -           38%-78%           44%-51%
     Dividend                        -             -              -             -              -                 -
</TABLE>

     The weighted-average grant-date fair values of options granted during the
     years ended December 31, 2004, 2005 and 2006 were $0.1726, $0.1338 and
     $0.1062, respectively. The weighted-average fair values for purchase rights
     granted pursuant to the 1999 Purchase Plan during the years ended December
     31, 2005 and 2006 were $0.0675 and $0.0316, respectively. There is no
     purchase rights granted pursuant to the 1999 Purchase Plan during the year
     ended December 31, 2004.

     Ordinary Shares Reserved

     As of December 31, 2006, ordinary shares reserved for future issuance were
     as follows:

     Outstanding stock options                          306,743,000
     Outstanding RSUs                                     7,914,750
     Shares reserved for future stock option grants      83,720,100
     Shares reserved for 1999 Purchase Plan              15,851,950
     Shares reserved for Awards                          67,085,250
                                                       ------------

                                                        481,315,050
                                                       ============

15.  EARNINGS PER SHARE

     Basic earnings per share is calculated by dividing net income by the
     weighted average number of ordinary shares outstanding during the period.
     Diluted earnings per share is calculated by dividing net income by the
     weighted average number of ordinary and dilutive ordinary equivalent shares
     outstanding during the period, using the treasury stock method for options.


                                      F-29
<PAGE>

     A reconciliation of the numerator and denominator of basic and diluted
     earnings per share calculations is provided as follows:

<TABLE>
<CAPTION>
                                                                           Years Ended December 31
                                                              ------------------------------------------------
                                                                  2004              2005             2006
<S>                                                           <C>              <C>              <C>
     Net income (in thousands)                                $       14,084   $        8,147   $          743
                                                              ==============   ==============   ==============

     Weighted average thousand shares outstanding - basic          1,957,800        1,961,168        1,932,575
     Effect of dilutive securities:
        Options (in thousands)                                        47,300           36,291           14,321
                                                              --------------   --------------   --------------

     Weighted average thousand shares outstanding - diluted        2,005,100        1,997,459        1,946,896
                                                              ==============   ==============   ==============

     Earnings per share - basic                               $       0.0072   $       0.0042   $       0.0004
                                                              ==============   ==============   ==============
     Earnings per share - diluted                             $       0.0070   $       0.0041   $       0.0004
                                                              ==============   ==============   ==============
</TABLE>

     Certain outstanding options were excluded from the computation of diluted
     EPS since their effect would have been antidilutive. The antidilutive stock
     options excluded and their associated exercise prices per share were
     61,351,850 shares at $0.2994 to $0.4836 as of December 31, 2004,
     128,293,200 shares at $0.2538 to $0.4836 as of December 31, 2005, and
     254,805,913 shares at $0.1198 to $0.4836 as of December 31, 2006. The
     antidilutive RSUs excluded were 5,295,000 shares as of December 31, 2006.


16.  COMMITMENTS

     Capital Commitments

     As described in note 10, the land use right purchase commitment was
     $502,000 as of December 31, 2006.

     Lease Commitments

     The Company leases office space and certain equipment under non-cancelable
     operating lease agreements that expire at various dates through December
     2011. The Company's office lease provides for periodic rental increases
     based on the general inflation rate.

     As of December 31, 2006, minimum lease payments under all noncancelable
     leases were as follows:

     Year                                                  Operating Leases
                                                           ----------------
                                                              (In Thousands)

     2007                                                       $   1,670
     2008                                                             723
     2009                                                             365
     2010                                                             369
     2011                                                              62
                                                                ---------

     Total minimum lease payments                               $   3,189
                                                                =========

                                      F-30
<PAGE>

17.  CONTINGENCIES

     The Company is involved in a variety of litigation matters involving
     patents. For example, the Company has initiated and is pursuing certain
     patent infringement actions in Taiwan. The Company has obtained preliminary
     injunctions and provisional attachment orders against numerous competitors,
     their customers and users. As of December 31, 2006, the Company has
     deposited an amount of New Taiwan dollars equivalent to approximately
     US$14.5 million with the Taiwan courts for court bonds, which was accounted
     for as restricted assets, in connection with those actions, other
     preliminary injunction actions and related provisional attachment actions.
     The court bonds provide security for the enjoined party to claim damages
     against the Company incurred from the preliminary injunctions, provisional
     attachments or the provision of a countersecurity in the event the Company
     does not ultimately succeed in the underlying infringement actions.
     However, these preliminary injunctions or provisional attachments may be
     rescinded if the relevant court allows the opposing party to make its own
     deposit or countersecurity with the court.

     The Company has been in litigation against Monolithic Power Systems ("MPS")
     in the United States District Court in the Northern District of California.
     MPS has alleged that certain of the Company's products infringe on one of
     its patents and a continuation of that patent. In May 2004, the court
     granted the Company's motion for summary judgment that MPS lacked evidence
     of damages. Trial on MPS' claim commenced in June 2005 and, in July 2005,
     the Company received a jury verdict that all patent claims asserted by MPS
     were invalid and were not infringed by the Company. MPS has appealed the
     jury verdict. As the case currently stands, MPS will not be able to recover
     damages unless it is able to overturn both the summary judgment and the
     jury verdict or seek injunctive relief or attorneys' fees unless it is able
     to overturn the jury verdict.

     In addition, the Company has filed patent infringement actions in the U.S.
     District Court in the Eastern District of Texas, the U.S. District Court in
     the Northern District of California and the Taiwan District Courts against
     various defendants. In response, several defendants have counterclaimed for
     antitrust violations, interference, unfair competition and trade secrets
     misappropriation.

     While the Company cannot make any assurance regarding the eventual
     resolution of these matters, the Company does not believe the final outcome
     will have a material adverse effect on its consolidated results of
     operations or financial condition.

     The Company, as a normal course of business, is a party to various
     litigation matters, legal proceedings and claims. These actions may be in
     various jurisdictions, and may involve patent protection and/or patent
     infringement. While the results of such litigations and claims cannot be
     predicted with certainty, the final outcome of such matters is not expected
     to have a material adverse effect on its consolidated financial position or
     results of operations. No assurance can be given, however, that these
     matters will be resolved without the Company becoming obligated to make
     payments or to pay other costs to the opposing parties, with the potential
     for having an adverse effect on the Company's financial position or its
     results of operations. As of December 31, 2006, no provision for any
     litigation has been provided.


                                      F-31

<PAGE>

18.  FINANCIAL INSTRUMENTS

     Information on the Company's financial instruments is as follows:

<TABLE>
<CAPTION>
                                                      (In Thousands)

                                                        December 31
                                           --------------------------------------------------
                                               2005                      2006
                                           ------------              -----------
                                            Carrying        Fair       Carrying        Fair
                                             Amount         Value       Amount         Value
     Assets
<S>                                        <C>          <C>          <C>          <C>
        Cash and cash equivalents          $    46,375  $    46,375  $    45,438  $    45,438
        Restricted cash                          5,605        5,605        8,342        8,342
        Short-term investments                  55,653       55,653       19,697       19,697
        Long-term investment in CSMC             3,580        3,580        2,668        2,668
        Restricted assets                       14,492       14,416       14,540       14,507
</TABLE>

     The carrying amounts of cash and cash equivalents and restricted cash
     reported in the consolidated balance sheets approximate their estimated
     fair values. The fair values of short-term investments and long-term
     investment in CSMC are based on quoted market prices.

     Fair value of restricted assets made in the form of Taiwan Government bonds
     are based on quoted market price; the remaining restricted assets are
     carried at amounts which approximate fair value.

     Long-term investments, except for investment in CSMC, are in privately-held
     companies where there is no readily determinable market value. The Company
     periodically evaluates these investments for impairment. If it is
     determined that an other-than-temporary decline has occurred in the
     carrying value, an impairment loss is recorded in the period of decline in
     value.

19.  SEGMENT INFORMATION

     The Company designs, develops and markets high performance semiconductors
     for power management and security applications. The Company's semiconductor
     products are produced with digital, analog, and mixed signal integrated
     circuit manufacturing processes. The Company's Chief Operating Decision
     Maker ("CODM"), the Chief Executive Officer, reviews information on an
     enterprise-wide basis to assess performance and allocate resources and has
     determined the Company has one reporting segment.


                                      F-32
<PAGE>

     Net sales to unaffiliated customers by geographic region are based on the
     customer's ship-to location and were as follows:

                                                         (In Thousands)

                                            Years Ended December 31
                               ------------------------------------------------
                                    2004             2005             2006

     PRC                       $       55,930   $       60,889   $       92,801
     Korea                             10,345           22,957           15,018
     Japan                              6,092            6,323            9,603
     Taiwan                            18,898           14,891            6,559
     Others                               931              492              934
                               --------------   --------------   --------------

                               $       92,196   $      105,552   $      124,915
                               ==============   ==============   ==============

     Long-lived assets consist of property and equipment and are based on the
     physical location of the assets at the end of each year, and were as
     follows:

                                                        (In Thousands)

                                                          December 31
                                                -------------------------------
                                                    2005             2006

     Taiwan                                     $        7,795   $       21,261
     PRC                                                 8,244           13,015
     U.S.A.                                              6,804            6,669
     Singapore                                             274              335
     Others                                                202              147
                                                --------------   --------------

                                                $       23,319   $       41,427
                                                ==============   ==============

     For the year ended December 31, 2004, one customer accounted for 17.5% of
     net sales. For the years ended December 31, 2005 and 2006, no customers
     accounted for 10% or more of net sales.

                                      F-33