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, 2009
 or
 [  ]      Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 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 Grand Cayman KY1-1209, Cayman Islands
 (Address of Principal Executive Offices)
 
 Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
 Title of Each Class
Name of Each Exchange On Which RegisteredAmerican Depositary Shares

Ordinary Shares, par value $0.00002 per share
NASDAQ Global Select Market

Cayman Islands Stock Exchange
 
 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, 2009, there were 1,809,461,200 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           [x]                     No           [  ]
  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.
  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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 Yes           [  ]                      No           [x]
  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 basis of accounting the registrant has used to prepare the financial statements included in this filing:
 U.S. GAAP [x]                  International Financial Reporting Standards as issuedOther [ ]
 by the International Accounting Standards Board  [ ]
 
 If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
 Item 17                      [  ]                      Item 18                      [  ]
  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
  TABLE OF CONTENTS
 
 PART I
 
 Item 1.
Identity of Directors, Senior Management and Advisors
5Item 2.
Offer Statistics and Expected Timetable
5Item 3.
Key Information
5Item 4.
Information on the Company
14Item 4A.
Unresolved Staff Comments
21Item 5.
Operating and Financial Review and Prospects
21Item 6.
Directors, Senior Management and Employees
29Item 7.
Major Shareholders and Related Party Transactions
34Item 8.
Financial Information
35Item 9.
The Offer and Listing
35Item 10.
Additional Information
36Item 11.
Quantitative and Qualitative Disclosures About Market Risk
44Item 12.
Description of Securities Other Than Equity Securities
45
 PART II
 
 Item 13.
Defaults, Dividend Arrearages and Delinquencies
46Item 14.
Material Modifications to the Rights of Security Holders and Use of Proceeds
46Item 15.
Controls and Procedures
47Item 16A
Audit Committee Financial Expert
48Item 16B
Code of Ethics
48Item 16C
Principal Accountant Fees and Services
48Item 16D
Exemptions from the Listing Standards for Audit Committee
49Item 16E
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
49Item 16F
Change in Registrant’s Certifying Accountant
50Item 16G
Corporate Governance
50
 PART III
 Item 17.
Financial Statements
51Item 18.
Financial Statements
51Item 19.
Exhibits
51Index to Consolidated Financial Statements
F-1
  Signatures
  3
 Certain Definitions and Conventions
 
 In this Annual Report on Form 20-F (“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 target and design products for specific applications, to increase expenses for personnel and 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 we will need to expand our facilities to accommodate the growth in our personnel, our expectation that non-U.S. operations and sales will continue to grow and account for a substantial percentage of our net sales, our expectation that competition for qualified personnel will remain intense, our expectation that we will continue to incur substantial legal expenses that vary with the level of activity in legal proceedings, 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, that 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, 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 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 expectations regarding the outcome of litigation matters and their effects on us, our belief that our cash generated from operations, together with the liquidity provided by existing cash, cash equivalents balances and short-term investment 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, 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 anticipation that we will not declare any dividend in the foreseeable future, 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 intentions to acquire additional real estate for future operations, 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, our intention to diversify our customer base and market focus by providing new products used in particular markets, our statements regarding the effect of adoption of certain accounting policies, our expectation that our ADSs will satisfy the “readily tradeable” requirement, our expectation not to become a passive foreign investment company in the future, our intention to use the cash we have raised and conduct our business to reduce the risk of classification as a passive foreign investment company, our statements regarding the withdrawal of ordinary shares from the Main Board of the Stock Exchange of Hong Kong Limited  (“SEHK”), that we expect to retain our existing primary listing of American Depositary Share (“ADS”) on the NASDAQ Global Select Market (“NASDAQ”) in the United States for the foreseeable future.  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, changes in employment rates, changes in availability and cost of facilities,
  4
 unpredictability of and inability to control the outcome or timing of litigation, changes in applicable laws or accounting standards, potential delisting of our ADSs or ordinary shares from existing exchanges, specific product manufacturing costs, increased competition, introduction of new competitors or 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, 2007, 2008 and 2009, and the selected consolidated financial data as of December 31, 2008 and 2009, 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.  The selected consolidated financial data for the years ended December 31, 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 and related notes which do not appear in this Annual Report.  Our consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States of America.
  Years Ended December 312005

2006


2007


2008


2009(in thousands, except per share data)Consolidated Statement of Income Data:Net sales

$
105,552

$
124,915


$
165,540


$
138,825


$
127,498Cost of sales


40,741


56,772



71,099



58,110



52,020Gross profit


64,811


68,143



94,441



80,715



75,478Operating expenses (income):Research and development


25,421


31,751



34,624



37,424



33,017Selling, general and administrative


30,453


40,171



45,560



39,003



45,049Goodwill impairment


-


-



-



2,782



-Write-off of prepayments to foundry services


-


-



-



2,942



-Litigation income


-


-



(9,364
)


(2,000
)


-Stock Exchange of Hong Kong listing expenses


2,460


786



-



-



-Total operating expenses


58,334


72,708



70,820



80,151



78,066Income (loss) from operations


6,477


(4,565
)


23,621



564



(2,588
)Non-operating income (expenses)– net


2,704


2,858



2,819



(12,133
)


1,373Income (loss) before income tax


9,181


(1,707
)


26,440



(11,569
)


(1,215
)Income tax expense (benefit)


1,034


(2,450
)


1,456



2,240



1,602Net income (loss)


8,147


743



24,984



(13,809
)


(2,817
)Earnings (loss) per share (1):Basic


-


-



0.01



(0.01
)


-Diluted


-


-



0.01


NA


NAShares used to compute basic earnings (loss) per share (1):


1,961,168


1,932,575



1,905,725



1,862,831



1,840,995Shares used to compute diluted earnings per share (1):


1,997,459


1,946,896



1,943,785



1,862,831



1,840,995Earnings (loss) per ADS (2):Basic


0.21


0.02



0.66



(0.37
)


(0.08
)
  5
 Diluted


-



-



0.01


NA


NAShares used to compute basic earnings (loss) per share (1):


1,961,168



1,932,575



1,905,725



1,862,831



1,840,995Shares used to compute diluted earnings per share (1):


1,997,459



1,946,896



1,943,785



1,862,831



1,840,995Earnings (loss) per ADS (2):Basic


0.21



0.02



0.66



(0.37
)


(0.08
)Diluted


0.20



0.02



0.64


NA


NAADS equivalents used to compute basic earnings (loss) per ADS (2):


39,223



38,652



38,115



37,257



36,820ADS equivalents used to compute diluted earnings per ADS(2):


39,949



38,938



38,876



37,257



36,820
 December 31,2005


2006


2007


2008


2009(in thousands)Consolidated Balance Sheet Data:Cash and cash equivalents

$
46,375


$
45,438


$
52,597


$
31,844


$
38,831Short-term investments


55,653



19,697



28,650



72,344



74,502Working capital


117,942



90,865



118,777



122,006



124,022Total assets


199,655



197,020



228,412



193,273



197,314Long-term liabilities, excluding current portion


-



455



730



878



968Net assets


175,896



173,511



204,179



179,780



179,444Ordinary shares and additional paid-in capital


138,275



140,262



144,982



141,821



142,715
 
 (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 ADS
 
 CAPITALIZATION AND INDEBTEDNESS
 
 Not applicable.
 
 REASONS FOR THE OFFER AND USE OF PROCEEDS
 
 Not applicable.
 
 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 have also targeted and are designing products for applications such as LCD monitors, LCD televisions, notebook computers, Internet security, mobile phones, energy efficient technology relating to sophisticated batteries and LED lighting, 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 or that a significant slowdown in these markets will not occur.
  6
 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 ADSs.
  If our quarterly operating results fail to meet the expectations of securities analysts, the trading price of 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 highly cyclical 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.  For example, the level of legal expenses is not entirely within our control as we may need to respond to legal actions by opposing parties or scheduling decisions by the judges.  It is difficult for us to forecast our legal expenses for any given quarter, which adversely affects our ability to forecast our expected results of operations in general.
  In addition, the trading price of our ADSs may be affected by factors such as: significant price and volume fluctuations in our ADSs and financial markets in the U.S. and other countries, as well as relatively thin trading volume of our ADSs on the NASDAQ Global Select Market and the Cayman Islands Stock Exchange. Further, the trading markets for 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 ADSs, the price of 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 ADSs or trading volume to decline.
  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.
  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.
  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.
  7
 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, China 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.”
  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, CR Micro, X-FAB, and SMIC, manufactured most of the integrated circuit products that we sold in 2009. 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 China and 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 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 analog and 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
  8
 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.
  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, 2009, 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 China and Taiwan.  In addition, sales outside the United States as a percentage of net sales accounted for almost all of our sales in the years ended December 31, 2005, 2006, 2007, 2008 and 2009.  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 natural disasters such as the earthquake in China affecting our offices in Chengdu, 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; unpredictable consequences on the economic conditions in the U.S. and the rest of the world arising from terrorist attacks and other military or security operations, unexpected changes in regulatory requirements or legal uncertainties regarding tax regimes, that resulted in 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 and our functional currency is the local currency of the respective entities. Therefore, a significant portion of our operating expenses is denominated in currencies other than the U.S. dollar, primarily the Chinese Renminbi and the New Taiwan dollar. 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.
  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 may 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.
  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
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 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.
  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 present 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.
  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 2009, one customer accounted for 11.3% of our net sales and no other single customer accounted for more than 10% of our net sales. In 2008, two customers accounted for 23.8% of our net sales, and in 2007, one customer accounted for 11.1% of our net sales. The changes in sales to these customers as a percentage of our total net sales have been caused by a number of factors, such as the reduction, delay or cancellation of orders from one or more of our significant customers, 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.
  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 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 fines and/or damages we may owe, cause product shipment delays, prevent us and/or our customers from selling some or all of our products, cause our customers or end-users not to use our products 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
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 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.
  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.”
  We may be subject to lawsuits from third parties, which could harm our earnings and expose us to additional uncertainties.
  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.
  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.
  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 could be adversely affected. 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.
  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. This report contains, 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. In addition, our independent registered public accountants must attest to and report on the operating effectiveness of our internal control over financial reporting as of the end of our fiscal year.
  During this process, if our management or our independent auditors 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 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 trading price of our ADSs.
  Our transfer pricing procedures may be challenged by tax or regulatory authorities or “taxing authorities”, 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
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 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. 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, China, 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. 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.
  Sales of our products could decline if our products fail to support evolving industry standards or environmental requirements.
  Our net sales are mainly 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 Express (“PCIe”), 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 that conform to these new standards or specifications in a timely manner. Additionally, new products we develop to conform to new specifications may not be accepted in the market.
  In addition, a large percentage of our business is based on products that are used in systems that contain cold cathode fluorescent lamps (“CCFL”).  CCFL tubes contain mercury, which is the subject of environmental concerns, particularly in Europe.  Environmental issues may affect the use of our products being applied to CCFL applications and our business and results of operations could be adversely affected.
  Climate change, other environmental concerns and green initiatives also presents other commercial challenges, economic risks and physical risks that could harm our results of operations or affect the manner in which we conduct our business.
  Increasing climate change and environmental concerns could affect the results of our operations if any of our customers would request us to exceed any standard(s) set for environmentally compliant products and services. For example, we have been working with our suppliers, customers, and several industry consortia to develop and provide EU “RoHS” (European Union Restriction of Hazardous Substances) compliant products.  If we are unable to offer such products or offer products that are compliant, but are not as reliable due to the lack of reasonably available alternative technologies or materials, we may lose market share to our competitors.
  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 or ADSs. As a result, these provisions may prevent the trading price of our 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.
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 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 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 on behalf of the 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 said discretionary proxy.  Examples where we would not want to receive or exercise a discretionary proxy include, without limitation, instances where 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.
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 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.
  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 the Cayman Islands. Our registered office is located at Maples Corporate Services Limited, Ugland House, P.O. Box 309, South Church Street, Grand Cayman KY1-1104, Cayman Islands. Our principal executive offices are located at Grand Pavilion Commercial Centre, West Bay Road, P.O. Box 32331 Grand Cayman KY1-1209, 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 O2Micro, Inc. After the exchange, we held all of the outstanding capital stock of O2Micro, Inc., our wholly owned subsidiary in the United States.  Our shares were initially listed on the NASDAQ on August 23, 2000 and on the Cayman Islands stock Exchange on February 1, 2001. 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 the NASDAQ, with each ADS representing 50 ordinary shares.  We delisted our ordinary shares from the NASDAQ on November 25, 2005 and listed our ADSs on the NASDAQ on November 28, 2005, the next trading day.  We subsequently listed our ordinary shares on the SEHK on March 2, 2006 by way of introduction. On February 27, 2009, we submitted an application for the voluntary withdrawal of the listing of ordinary shares (“Shares”) on the Main Board of the SEHK (collectively referred to as the “Proposed Withdrawal”) for reasons of cost and utility. We have retained our existing primary listing of ADSs on the NASDAQ Global Select Market in the United States following the Proposed Withdrawal and for the foreseeable future. The Proposed Withdrawal was approved at the Extraordinary General Meeting of Shareholders held on May 30, 2009 and the listing of the Shares on SEHK was withdrawn on September 9, 2009.
 
 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.
 We have 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”), O2Micro (China) Co., Ltd. (“O2Micro-China”), and O2Security Limited (“O2Security”).  O2Micro-Taiwan is engaged in operations and sales support services. O2Micro-Japan is engaged in sales support services. O2Micro-Singapore, O2Micro-China, and other subsidiaries are mostly engaged in research and development services.  O2Security is primarily engaged in operations and sales of network security products. To assure its testing capacity and flexibility, we also established a subsidiary, OceanOne Semiconductor (Ningbo) Limited (“OceanOne”) in Ningbo of the People’s Republic of China (“China”) in August 2005.  OceanOne is engaged in semiconductor testing service and has commenced its operations in January 2007.  In June, 2008, we entered into a share transfer agreement with Sigurd Microelectronics (Cayman) Co., Ltd. (“Sigurd Cayman”) to dispose of 100% ownership of OceanOne for $6.7 million.  The share transfer was subsequently completed on July 2, 2008.
  Since January 1, 2007, our principal capital expenditures were investments in various private companies of approximately $5.7 million in the aggregate, and $12.2 million in the purchase of property and equipment.
  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 LCD lighting, provide connections between notebook computers and external plug-in cards provide Internet security,
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 control and monitor battery charging and discharging, DC/DC conversion, and provide select and switch functionality 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.
  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, 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.
  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 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
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 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 0.09 micron, 0.065 micron, 0.04 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 0.18 micron and 0.5 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 controllercomponents and system security for the Consumer, Computer, Industrial and Communications markets. Our power management and cardbus controllerproducts include ICs to provide power for LCD and LED lighting, control and monitor battery charging and discharging, DC/DC conversion, provide connections between notebook computers and external plug-in cards, and provide select and switch functionality between power sources. Our system security solutions include VPNs and firewalls, which provide security functions for communications between computer systems and networks, including the transmission of data across the Internet.Our system security products are designed to provide high-speed and comprehensive security protection.  In particular, our core technologies in the Application Specific Integrated Circuit (“ASIC”) chips are exclusive to us and deliver enhanced performance and service to our customers. We sell our products into the following four end-markets:
 
 •
Consumer electronics market, including desktop monitors, LCD televisions, digital cameras and camcorders and portable media players;
  •
Computer market, including notebook computers, desktop computers and servers;
  •
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 (zero degrees to 70 degrees centigrade). Products include industrial tools, automobile GPS systems, and other automobile systems; and
  •
Communications market, including portable GPS systems, mobile phone handsets, data communications security and networking systems, and Internet and Internet-related systems.
  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, Singapore, Taiwan and the United States, as well as distributors in China and 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-
  16
 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 terms 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 China and 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 no 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 the United States, Taiwan, China, Japan and Korea for post order servicing and applications support.
 
 Seasonality
  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 no long-term volume sales 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 and other regions:
 
 Years Ended December 31(In Thousands)Location of customers

2007


2008


2009Asia

$
165,391


$
138,285


$
127,099North America


130



252



216Other regions


19



288



183$
165,540


$
138,825


$
127,498
 
 The table below sets forth, for the periods indicated, the dollar amount of our net sales by category of activity.
 
 Years Ended December 31(In Thousands)2007


2008


2009Integrated Circuit Group

$
163,573


$
135,438


$
124,294Network Security Group


1,967



3,387



3,204$
165,540


$
138,825


$
127,498
  We generally extend to our customers credit terms varying from 40 to 60 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
  17
 payments or material write-offs of accounts receivable due to uncollectability.
 
 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 unprocessed wafers, or silicon substrates, and processes them according to mutually agreed manufacturing specifications to fabricate the wafers used in our products. Currently, the majority of our wafers are fabricated using 0.18 to 1.0 micron CMOS semiconductor processes. 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 or to an electrical wafer sort service provider.
 
 Our major semiconductor foundry providers are CR Micro, X-FAB, and SMIC. 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 the manufacturing process technologies as well as order size and foundry capacity utilization.
 
 Assembly and Testing
  The fabricated wafers may or may not require electrical wafer sort prior to assembly. The completed wafers 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 wafer form because it is at this manufacturing stage that most time has been invested, with much of the cost not yet incurred, 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 a testing service provider 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 or trays, several to a tube or tray, 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, China 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. Typically analog and mixed-signal products have a greater portion of their product cost associated with product testing than digital products. We also operated a semiconductor testing facility to test a portion of our products prior to shipment. In June, 2008, we entered into a share transfer agreement with Sigurd Microelectronics (Cayman) Co., Ltd, a subsidiary of Sigurd Microelectronics Corporation, to dispose of 100% ownership of OceanOne for $6,700,000 to become their strategic partner. The share transfer was subsequently completed on July 2, 2008.
 
 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
  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
  18
 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 circuit 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.  From time to time, we may seek acquisitions to acquire businesses or technologies where synergies exist. 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, 2009, we had approximately 206 patents issued in the United States and approximately 402 patents issued in other countries.  In addition, we had approximately 227 patent applications pending in the United States Patent and Trademark Office, and approximately 552 patent applications pending in various countries other than the United States which may or may not be issued. Even if these patents are issued, taken together with our existing patents, they may not be sufficiently broad to protect all of 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 we 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.
  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 and 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 the United States and Taiwan. As of December 31, 2009, the Company deposited an amount of New Taiwan dollars equivalent to approximately $1.4 million with the Taiwan court for court bonds, which was accounted for as restricted assets, in connection with those actions and related preliminary injunction actions.  The court bonds provide security for the enjoined party to claim damages against the Company incurred from the preliminary injunctions or the provision of a countersecurity in the event the Company does not ultimately succeed in the underlying infringement actions. We are currently in the process to retrieve the court bonds as related actions are closed.
  We have several pending patent infringement actions in the United States.  On April 3, 2008, the United States Court of Appeals for the Federal Circuit vacated a jury verdict, final judgment of infringement, and permanent injunction against defendants Beyond Innovation Technology Company Limited, SPI Electronic Company Limited and FSP Group, and Lien Chang Electronic Enterprise Company Limited.  The Federal Circuit further remanded the case to the Eastern District of Texas. The trial was concluded in July 2009, and the matter is still under submission by the District Court.   O2Micro International Ltd. v. Beyond Innovation Technology Co. et al.,Civil Action No. 2:04-CV-32 (TJW).  On October 1, 2008, Monolithic Power Systems, Inc. filed a complaint for declaratory judgment that certain claims of O2Micro’s patents are invalid and not infringed.  O2Micro has filed counterclaims for patent infringement.  Monolithic Power Systems, Inc. v. O2Micro International Limited, Case No. C 08-4567 CW.  On December 15, 2008, O2Micro filed a complaint with the United States International Trade Commission in Washington, D.C.  O2Micro alleges that MPS, Microsemi, AsusTek, LG and BenQ have engaged in unfair acts through the unlicensed importation of certain products with MPS or Microsemi inverter controllers covered by O2Micro’s patents.  O2Micro seeks an order preventing the importation of the products into the United States. See In the Matter of Certain Cold Cathode Fluorescent Lamp Inverter Circuits And Products Containing Same,Investigation No. 337-TA-666.  On March 5, 2009, the United States Court of Appeals for the Federal Circuit affirmed the judgment of the District Court for the Northern District of California that certain claims of O2Micro’s U.S. Patent Number 6,396,722 are invalid as obvious under 35 U.S.C. § 103.  We filed an appeal on April 6, 2009.  Monolithic Power Sys. v. O2Micro Int'l Ltd., 2009 U.S. App. LEXIS 4528 (Fed. Cir. Mar. 5, 2009).  In a companion case involving Taiwan Sumida Electronics, Inc., the Federal Circuit vacated a judgment of infringement from the District Court for the Eastern District of Texas because the Federal Circuit had held in the MPS case that the same claims of the ‘722 patent were invalid.  We filed an appeal in the United States Court of Appeals, and in March 2009, the court upheld the Federal Circuit’s ruling, and a judgment to that effect was entered by the Eastern District Court of Texas.  O2Micro Int'l Ltd. v. Taiwan Sumida Elecs., Inc., 2009 U.S. App. LEXIS 4382 (Fed. Cir. Mar. 5, 2009).On August 7, 2009, Powertech
 
 19
 Association LLC, an entity formed by MPS and Microsemi, filed a complaint in the United States District Court in the Eastern District of New York, alleging certain products by Company infringe on three of their patents.  To date, we have not been served by the Plaintiffs, so our defense obligations under the lawsuit have not begun.  Powertech Association LLC v.  O2Micro International Limited, et al., Case No. 09-439.On December 9, 2008, we filed a suit against HonHai Precision Industry for breach of a settlement agreement entered into by the parties in October 2007, terminating an earlier patent infringement action initiated by us.  We allege fraud, misrepresentation and interference with business relationships by HonHai.  The case is scheduled to go to trial in November 2010.O2Micro International Limited v. HonHai Precision Industry, Ltd., et al., Case No. C -08-CV-466DF.On August 20, 2008, the Regional Court of Hamburg issued a temporary restraining order prohibiting us from using the trademark “O2Micro” and “O2Micro Breathing Life into Mobility” in Germany.  A hearing was held, and on November 4, 2009, the initial order was upheld.  We oppose this ruling and are currently appealing the matter before the Court of Appeals in Hamburg.O2 Holdings Limited v. O2Micro International Ltd., Germany, District of Hamburg.
  Given the inherent uncertainties in litigation, there cannot be any assurance that we will prevail in any of the pending litigation matters, 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:
  Significant Subsidiary
Country of Incorporation
Date of IncorporationO2Micro, Inc.
U.S.A.
March 1995O2Micro Electronics, Inc.
Taiwan
March 1999O2Micro International Japan Limited
Japan
August 1999O2Micro Pte Ltd.
Singapore
September 1999O2 Micro (Wuhan) Co., Ltd.
China
January 2001O2Security (Wuhan) Co., Ltd.
China
December 2008O2Micro (Beijing) Co., Ltd.
China
February 2001O2Micro (China) Co., Ltd.
China
April 2001O2Micro (Chengdu) Co., Ltd.
China
July 2004
 
 PROPERTY, PLANT AND EQUIPMENT
  The table below describes our headquarters and the facilities where the above subsidiaries are located as of December 31, 2009:
  Location

Approx. Available Square Feet
Lease ExpirationCalifornia, USA

37,180
not applicableTaipei, Taiwan

33,786
2011Hsin-Chu, Taiwan

26,246
2010Tokyo, Japan

1,420
2012Singapore

7,104
2010Wuhan, China

23,217
2012Beijing, China

14,051
2014Shanghai, China

30,448
not applicableChengdu, China

26,372
2010Grand Cayman, Cayman Islands

600
2010
  20
 We maintain our Cayman Islands office to process invoices and receive payments.  Research and development, marketing, applications and administrative staff are located in California.  We also have sales offices in Pflugerville, 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 in 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 undeveloped land in Hsin-Chu, Taiwan for approximately $8.8 million. In August 2009, we sold the land in Hsin-Chu, Taiwan, to a developer in exchange for a pre-sale of a portion of the real estate after it is developed, which will include a portion of an office building and a portion of a parking lot, valued at approximately $8.9 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 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.
  Our net sales have decreased from $165.5 million in 2007, $138.8 million in 2008 to 127.5 million in 2009.  The decrease in net sales since 2008 was due primarily to the deterioration in the general demand for electronic products as a result of worldwide financial crises and associated macro-economic decline. Although we can not estimate the extent to which our business will be affected in the future, we will continue to diversify our customer base and market focus by providing new products that are used in 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 were $70.8 million in 2007, $80.2 million in 2008, and $78.1 million in 2009. Our operating expenses decreased in 2009 primarily due to decreased one-time expenses, including goodwill impairment and write-off of prepayments, and our efforts on cost reductions.
  Our net income was $25.0 million in 2007 and our net loss was $13.8 million in 2008 and $2.8 million in 2009.  The net loss in 2009 was primarily due to decreased sales and gross profit, and increased selling, general and administrative expenses.
  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, Singapore, Korea, Taiwan and the United States, as well as distributors in Japan and China. 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 upon shipment to end customers.  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
  Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.
 
 The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, net sales and expenses, and related disclosure of contingent assets and liabilities. We
 21
 evaluate our estimates on an on-going basis, including those related to valuation allowance for deferred tax assets, allowance for doubtful accounts, inventory valuation, useful lives for property and equipment, impairment on long-lived assets, accruals for sales adjustments, other liabilities, contingencies, fair value, goodwill, and stock-based compensation. We base our estimates and judgments on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information. Because our estimates may vary in each situation, our actual results may differ from our estimates under different assumptions and conditions.
  Our management considers the following factors in reviewing our financial statements:
  •
the selection of critical accounting policies; and
  •
the judgments and other uncertainties affecting the application of those critical accounting policies.
  The selection of critical accounting policies, the judgments and other uncertainties affecting the application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors to be considered when reviewing our financial statements. Our principal accounting policies are set forth in detail in Note 2 to our consolidated financial statements included elsewhere in this annual report.
  We believe the following critical accounting policies affect our more significant judgments used in the preparation of our financial statements.
  Revenue Recognition and Accounts Receivable Allowances
  We recognize revenue on sales to direct customers in accordance with 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) collectability is reasonably assured.  Determination of criteria (3) and (4) is based on management's judgments regarding the ability to estimate returns and the collectability 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.
  We make allowances for future product returns at the time revenue is recognized. 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  collectability 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 uncollectability.
  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 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.  For the years ended December 31, 2007, 2008, and 2009, inventory write-downs were $3.2 million, $2.2 million, and $1.8million, respectively.
  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.  For the years ended December 31, 2007, 2008, and 2009, no additional impairment charges were recorded.
  Income Taxes
  22
 Effective January 1, 2007, we adopted standards that changed the accounting for uncertain tax positions. The new standards contain a two step approach to recognizing and measuring uncertain tax positions. 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 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 year. Deferred income tax assets are primarily the tax effects of the operating loss carry-forwards, research and development credit carry-forwards 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 its financial statements, accordingly.
  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 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 reserve the right to 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 will record a contingent loss by taking into consideration the 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 to our employees and certain non-employees, and we estimate the fair value of share-based payment awards on the date of grant using an option-pricing model.  The value of the portion of the award that is ultimately expected to vest is recognized as expense ratably over the requisite service periods.  We have elected to use the Black-Scholes option pricing model to determine the fair value of stock options on the date of grant.  The option pricing module requires the input of highly subjective assumptions, including the expected stock price volatility, risk-free interest rate and expected option life, and by estimated option shares to be vested at the end of the vesting schedule.  We also grant restricted stock units (“RSU”) to our employees and the RSU are measured based on the fair market value of the underlying stock on the dates of grant.
  Fair Value Measurements
  We measure our cash equivalents and marketable securities at fair value. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:
  Level 1 – Observable inputs such as quoted prices for identical instruments in active markets;
  Level 2 – Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly;
  Level 3 – Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
  Recent Accounting Pronouncements
  In December 2008, the Financial Accounting Standards Board (“FASB”) issued accounting update relating to the disclosure requirements for defined benefit plans, which provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan.  The new accounting standard is effective for annual reporting periods ending after December 15, 2009.  We have adopted the standard effective for its December 31, 2009 annual report on Form 20-F, however, information on how investment allocation decisions are made, inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets is not fully made available to the companies by the government. Therefore, we are unable to provide the required fair value disclosures related to pension plan assets
  In April 2009, the FASB issued a standard that provides guidance on the recognition and presentation of other-than-temporary impairments of debt securities classified as available-for-sale and held-to-maturity. This standard is effective for
 23
 interim and annual reporting periods ending after June 15, 2009. This guidance is effective for us for the year ending December 31, 2009. The adoption of the guidance did not have a material effect on our results of operations, financial position and cash flows.
  In May 2009 and subsequently updated in February 2010, the Financial Accounting Standards Board (“FASB”) issued new guidance on subsequent events that establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. This standard defines two types of subsequent events, recognized or nonrecognized. The new guidance is effective for us for the year ending December 31, 2009.
  In June 2009, the FASB issued new guidance to improve financial reporting by enterprises involved with variable interest entities (“VIE”). The new guidance modifies the approach for determining the primary beneficiary of a VIE. Under the modified approach, an enterprise is required to make a qualitative assessment whether it has (1) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. If an enterprise has both of these characteristics, the enterprise is considered the primary beneficiary and must consolidate the VIE.  The new guidance becomes effective for annual reporting periods beginning after November 15, 2009.  Based on our analysis, we currently do not anticipate that the new guidance will have a material effect on our results of operations and financial position or cash flows.
  In June 2009, the FASB issued its Accounting Standards Codification (“ASC”) 105, which became the source of authoritative U.S. generally accepted accounting principles (“U.S. GAAP”) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities law are also sources of authoritative U.S. GAAP for SEC registrants. The ASC became effective for the financial statements issued for interim and annual periods ending after September 15, 2009 and superseded all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the ASC will become nonauthoritative. The FASB will not issue new standards in the form of Statements (“SFAS’s”) FASB Staff Positions (“FSP’s”) or Emerging Issues Task Force Abstracts (“EITF’s”), but rather it will issue Accounting Standards Updates (“ASU’s”).  The FASB will not consider the ASU’s as authoritative in their own right as they will only serve to update the ASC, provide background information about guidance and provide the bases for conclusions on the changes in the ASC.  We have adopted the ASC effective for its December 31, 2009 annual report on Form 20-F and have revised the disclosure of the U.S. GAAP source references in our financial reporting upon such adoption.
  In June 2009, the FASB issued new guidance relating to the transfer of financial assets. The new guidance requires entities to provide more information regarding sales of securitized financial assets and similar transactions, particularly if the entity has continuing exposure to the risks related to the transferred financial assets. It also eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets and requires additional disclosures. The new guidance becomes effective for annual reporting periods beginning after November 15, 2009. Based on our analysis, we currently do not anticipate that the new guidance will have a material effect on our results of operations and financial position or cash flows.
  In June 2009, the FASB issued new guidance relating to the disclosure requirements for transfers of financial assets. This guidance is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about transfers of financial assets. The new guidance becomes effective for annual reporting periods beginning after November 15, 2009.  Based on our analysis, we currently do not anticipate that the new guidance will have a material effect on the results of operations and financial position or cash flows.
  In September 2009, the FASB issued an accounting standard update which provides guidance on how to separate consideration in multiple-deliverable arrangements and significantly expands disclosure requirements. The standard establishes a hierarchy for determining the selling price of a deliverable eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The update is effective for annual reporting periods beginning on or after June 15, 2010. Based on our analysis, we currently do not anticipate that the new guidance will have a material effect on our results of operations and financial position or cash flows.
  In September 2009, the FASB issued an accounting standard update on arrangements that include software elements. Tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. The update is effective for annual reporting periods beginning on or after June 15, 2010.  Based on our analysis, we do not anticipate that the new guidance will have a material effect on our results of operations and financial position or cash flows.  24
 In January 2010, the FASB issued amended standards that require additional fair value disclosures. These amended standards require disclosures about inputs and valuation techniques used to measure fair value as well as disclosures about significant transfers, beginning in the first quarter of 2010. Additionally, these amended standards require presentation of disaggregated activity within the reconciliation for fair value measurements using significant unobservable inputs (Level 3), beginning in the first quarter of 2011.  We do not expect these new standards to significantly impact the consolidated financial statements.
  Operating Results
  The following table summarizes historical results of operations as a percentage of net sales for the periods shown.
  Years Ended December 312007


2008


2009Consolidated Statement of Income Data:Net sales


100.0
%


100.0
%


100.0
%Cost of sales


42.9



41.9



40.8Gross margin


57.1



58.1



59.2Operating expenses (income):Research and development


20.9



27.0



25.9Selling, general and administrative


27.6



28.0



35.3Goodwill impairment


-



2.0



-Write-off of prepayment to foundry services


-



2.1



-Litigation income


(5.7
)


(1.4
)


-Total operating expenses


42.8



57.7



61.2Income (loss) from operations


14.3



0.4



(2.0
)Non-operating income (expenses)–net


1.7



(8.7
)


1.0Income tax (expenses) benefit


(0.9
)


(1.6
)


(1.0
)Net income (loss)


15.1
%


(9.9
%)


(2.0
%)
 
 The following table sets forth the breakdown of our net sales by product category for the periods shown:
  Years Ended December 312007


2008


2009(in thousands)Integrated Circuits:Analog

$
126,436


$
98,779


$
61,944Mixed-signal


13,280



26,222



56,028Digital


23,856



8,672



2,664Network Security Solutions


1,967



3,369



3,112Licensed Intellectual Property


1



1,783



3,750Total

$
165,540


$
138,825


$
127,498
 
 Years Ended December 31, 2009 and 2008
  Net Sales.  Net sales consisted of product revenues generated principally by sales of our integrated circuit products and network security products. Net sales for the year ended December 31, 2009 were $127.5 million, a decrease of $11.3 million or 8.2% from $138.8 million for the year ended December 31, 2008. The decrease in sales resulted primarily from the deterioration in the general demand for electronic products as a result of worldwide financial crises and associated macro-economic decline. In particular, the proportion of our net sales derived from the products that go into consumer electronics applications continued to decrease from 2008 to 2009. This decrease resulted primarily from the decrease in demand for our analog and digital integrated circuit products and a continuing shift in the industry to the use of our mix-signal designs for such products.  Net sales from analog integrated circuit products in 2009 were $61.9 million, a decrease of $36.8 million or 37.3% from $98.8 million in 2008.  In 2009, net sales from our digital integrated circuit products were $2.7 million, a decrease of $6.0 million or 69.3% from $8.7 million in 2008, which resulted primarily from decreased sales of our CardBus controller products in 2009. In 2009, net sales from our mixed-signal integrated circuit products were $56.0 million, an increase of $29.8 million or 113.7% from $26.2 million in 2008, which primarily resulted from our success on the backlighting market penetrations from our CCFL and LED driver products that go into the applications on notebook and LCD TV.  In 2009, net sales from our system network products were $3.1
 
 25
 million, a decrease of $257,000 or 7.6% from $3.4 million in 2008, which primarily resulted from the declining demand from our customers due to their adjustments on capital budgeting.  In 2009, net sales from our licensed intellectual property were $3.8 million, an increase of $2.0 million or 110.3% from $1.8 million in 2008, which primarily resulted from increased shipments of third party’s products which are licensed with our intellectual property.
  Gross Profit.  Gross profit represents net sales less cost of sales. Cost of sales primarily consists of the costs 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, 2009 was $75.5 million, a decrease of $5.2 million or 6.5% from $80.7 million for the year ended December 31, 2008. This decrease was primarily due to the decline of our integrated circuit products sales in 2009.  Gross profit as a percentage of net sales for the year ended December 31, 2009 increased to 59.2% from 58.1% for the year ended December 31, 2008 primarily due to a good product mix with sales of new products with high gross margins. 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 non-recurring engineering expenses (e.g. one-time pilot run, engineering sample, tooling and testing expenses).  Research and development expenses for the year ended December 31, 2009 were $33.0 million, a decrease of $4.4 million or 11.8% from $37.4 million for the year ended December 31, 2008. The decrease primarily resulted from our efforts on expense controls in personnel expenditures.  As a percentage of net sales, research and development expenses were 25.9% for the year ended December 31, 2009, a decrease from 27.0% for the year ended December 31, 2008.  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 may also have internal research and development projects underway, which may or may not lead to new product designs.  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 in research and development in the future.
  Selling, General and Administrative Expenses.  Selling, general and administrative expenses consist primarily of employee-related expenses, patent litigation expenses, office facilities costs, travel expenses, professional fees paid to independent auditors, and consulting fees.  Selling, general and administrative expenses for the year ended December 31, 2009 were $45.0 million, an increase of $6.0 million or 15.5% from $39.0 million for the year ended December 31, 2008.  This increase was primarily due to increased patent litigation expenses paid to external legal counsel, offset by decreased personnel and promotional expense as a result of our cost reduction efforts.  As a percentage of net sales, selling, general and administrative expenses were 35.3% for the year ended December 31, 2009, an increase from 28.0% for the year ended December 31, 2008.
  Goodwill Impairment.    Goodwill impairment is the impairment charge as a result of our goodwill impairment analysis. Goodwill impairment for the year ended December 31, 2009 was nil, a decrease of $2.8 million or 100.0% from $2.8 million for the year ended December 31, 2008.
  Write-off of Prepayment to Foundry Services.    Write-off of prepayment to foundry services consists of the write-offs of prepayments in relation to our review on the collectability of the prepayments. Write-off prepayment to foundry service for the year ended December 31, 2009 was nil, a decrease of $2.9 million or 100.0% from $2.9 million for the year ended December 31, 2008.
  Litigation Income.    Litigation income consists primarily of amounts received from settlement, damage awards, award of costs and related interest.  Litigation income for the year ended December 31, 2009 was nil, a decrease of $2.0 million or 100.0% from $2.0 million for the year ended December 31, 2008.
  Non-operating Income (expenses)-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 $1.4 million for the year ended December 31, 2009, increasing from non-operating expense-net of $12.1 million for the year ended December 31, 2008 primarily due to the fact that we did not provide any impairment loss on long-term investments in 2009.  The impairment loss on long-term investments in 2008 was due to the recognition of impairment charge of $14.1 million on our investments in Asia Sinomos and CR Micro.
 
 Income Tax Expense.    Income tax expense was $1.6 million for the year ended December 31, 2009, compared to an income tax expense of $2.2 million for the year ended December 31, 2008. This decrease in income tax expense was primarily due to decreased taxable income reported in our global taxing entities located in China, Taiwan, and USA.
  Years Ended December 31, 2008 and 2007
  Net Sales.  Net sales consisted of product revenues generated principally by sales of our integrated circuit products and network security products. Net sales for the year ended December 31, 2008 were $138.8 million, a decrease of $26.7 million or 16.1% from $165.5 million for the year ended December 31, 2007. The decrease in sales resulted primarily from the deterioration
 26
 in the general demand for electronic products as a result of inventory adjustments in supply chain due to macro-economic decline. In particular, the proportion of our net sales derived from the products that go into consumer electronics applications decreased from 2007 to 2008. This decrease resulted primarily from the decrease in shipments of analog integrated circuit products in the second half year of 2008.  Net sales from analog integrated circuit products in 2008 were $98.8 million, a decrease of $27.7 million or 21.9% from $126.4 million in 2007. In 2008, net sales from our digital integrated circuit products were $8.7 million, a decrease of $15.2 million or 63.6% from $23.9 million in 2007, which resulted primarily from decreased sales of CardBus controller products in 2008. In 2008, net sales from our mixed-signal integrated circuit products were $26.2 million, an increase of $12.9 million or 97.5% from $13.3 million in 2007, which primarily resulted from increased shipments for our power switch, and battery products. In 2008, net sales from our network security products were $3.4 million, an increase of $1.4 million or 71.3% from $2.0 million in 2007, which primarily resulted from the introduction of new products and expansion of our customer base from OEM products.
  Gross Profit.  Gross profit represents net sales less cost of sales. Cost of sales primarily consists of the costs 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, 2008 was $80.7 million, a decrease of $13.7 million or 14.5% from $94.4 million for the year ended December 31, 2007. This decrease was primarily due to decreased sales of our integrated circuit products in the second half year of 2008. Gross profit as a percentage of net sales for the year ended December 31, 2008 increased to 58.1% from 57.1% for the year ended December 31, 2007 primarily due to our success with the set up of our China supply chain, as well as efficient designs, and new products.
 
 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 non-recurring engineering expenses (e.g. one-time pilot run, engineering sample, tooling and testing expenses).  Research and development expenses for the year ended December 31, 2008 were $37.4 million, an increase of $2.8 million or 8.1% from $34.6 million for the year ended December 31, 2007. The increase primarily resulted from increased hiring of design engineers and increased engineering related expenses in respect to certain research and development projects. As a percentage of net sales, research and development expenses were 27.0% for the year ended December 31, 2008, an increase from 20.9% for the year ended December 31, 2007.  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 may also have internal research and development projects underway, which may or may not lead to new product designs.
  Selling, General and Administrative Expenses.  Selling, general and administrative expenses consist primarily of employee-related expenses, patent litigation expenses, promotional expenses, professional fees paid to independent auditors and consulting fees.  Selling, general and administrative expenses for the year ended December 31, 2008 were $39.0 million, a decrease of $6.6 million or 14.4% from $45.6 million for the year ended December 31, 2007.  This decrease was primarily due to decreased patent litigation expenses paid to external legal counsels, and consultants and decreased promotional expenses. As a percentage of net sales, selling, general and administrative expenses were 28% for the year ended December 31, 2008, an increase from 27.6% for the year ended December 31, 2007.
  Goodwill Impairment.    Goodwill impairment is the impairment charge as a result of our goodwill impairment analysis. Goodwill impairment for the year ended December 31, 2008 was $2.8 million, an increase of $2.8 million or 100.0% from nil for the year ended December 31, 2007. The increase was primarily due to the global economic crisis and the resulting declines in customer demand in the fourth quarter of 2008 that resulted in the deterioration in our market capitalization. Therefore, it was necessary to review whether goodwill was impaired.  Upon the completion of our goodwill impairment analysis, we recognized a goodwill impairment charge of $2.8 million for the year ended December 31, 2008.
  Write-off of Prepayment to Foundry Services.    Write-off of prepayment to foundry services consists of the write-offs of prepayments in relation to our review on the collectability of the prepayments. Write-off prepayment to foundry service for the year ended December 31, 2008 was $2.9 million, an increase of $2.9 million or 100.0% from nil for the year ended December 31, 2007. This increase was due to our decision to write-off our prepayments to Asia Sinomos as a result of the review of Asia Sinomos’ operating status and recurring financial losses in 2008.
  Litigation Income.    Litigation income consists primarily of amounts received from settlement, damage awards, award of costs and related interest.  Litigation income for the year ended December 31, 2008 was $2.0 million, a decrease of $7.4 million or 78.6% from $9.4 million for the year ended December 31, 2007. This decrease was due to decreased payments received from the litigation cases in 2008.
  Non-operating Income (expenses)-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 expenses-net was $12.1 million for the year ended December 31, 2008, decreasing from non-operating income of $2.8 million for the year ended December 31, 2007 primarily due to increased impairment loss on long-term investments and decreased interest income.  The increased impairment loss on long-term investments was due to the recognition of impairment charge of $14.1 million on our investments in Asia Sinomos and CR Micro.  The decreased interest income of $934,000 was primarily due to decreasing interest rates in 2008.  27
 Income Tax Expense.    Income tax expense was $2.2 million for the year ended December 31, 2008, compared to an income tax expense of $1.5 million for the year ended December 31, 2007. This increase in income tax expense was primarily due to increased income before income tax in global taxing entities in China and USA.
  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 $113.3 million at December 31, 2009 as compared to $104.2 million at December 31, 2008. Our operating activities provided cash in the amount of $12.7 million in the year ended December 31, 2009, $24.9 million in the year ended December 31, 2008, and $20.2 million in the year ended December 31, 2007.
  Non-cash charges primarily consist of depreciation of property and equipment, amortization of stock-based compensation, loss on disposal of property and equipment, and changes of deferred income tax assets. The working capital components that have a significant impact on our cash flows are accounts receivable, inventories, notes and accounts payable, prepaid expenses and other current assets, prepayment for testing service and deferred charges, and accrued expense and other current liabilities. We believe our cash generated from operations, together with the liquidity provided by existing cash, cash equivalents balances and short-term investment will be sufficient to meet our working capital needs for at least the next 12 months.
  Net cash inflows from operations resulted from net income adjusted by non-cash changes and changes in inventories, accounts receivable, notes and accounts payable, accrued expenses and other current liabilities and income tax payable.
  In 2009, we had a net cash outflow from investing activities of $2.5 million as compared to a net cash outflow of $35.2 million in 2008.  This decrease in net cash used in investing activities between 2008 and 2009 was principally due to a decrease of $42.3 million in net purchase of short-term investments , a decrease of $5.7 million in acquisition of long-term investments, and a decrease of $1.3 million in acquisition of property and equipment, offset by the decrease in restricted assets and cash of $16.6 million in 2009.
  In 2008, we had a net cash outflow from investing activities of $35.2 million as compared to a net cash outflow of $13.1 million in 2007.  This increase in net cash used by investing activities between 2007 and 2008 was principally due to an increase of net purchase of short-term investments of $34.5 million, an increase of purchases of long-term investments of $5.7 million, and an increase of $6.5 million in cash paid in acquisition, offset by a decrease of $5.7 million in acquisition of property and equipment, the decrease in restricted assets and cash of $12.9 million, and an increase of the proceeds from disposal of a subsidiary.
  Net cash outflow from our financing activities in 2009 was $3.2 million which was primarily due to the repurchase of $3.9 million of our Shares and ADSs under a share repurchase program 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. Net cash outflow from our financing activities in 2008 was $10.8 million which was primarily due to the repurchase of $11.8 million of our Shares and ADSs under a share repurchase program 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.
  We believe our cash generated from operations, together with the liquidity provided by existing cash, cash equivalents balances and short-term investment will be sufficient to meet our capital requirements for at least the next 12 months. We incurred capital expenditure of $8.1 million, $2.4 million, and $1.1 million in 2007, 2008, and 2009, respectively. Our future capital expenditure 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, 2009, we had approximately 536 full-time employees world-wide engaged in research and development efforts.  Our total expenditures for research and development were $33.0 million for the year ended December 31, 2009, $37.4 million for the year ended December 31, 2008, and $34.6 million for the year ended December 31, 2007.  We believe that our research and development staffing will increase in the next 12 months primarily due to greater investment in our existing design efforts.  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.  28
 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.
  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 Taiwan and China.  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, 2009:
  Payments due by periodContractual Obligations

Total


Less than

1 year


1-3 years


3-5 years


More than

5 years(in thousands)Operating Lease Obligations

$
3,025


$
1,672


$
1,283


$
70


$
-Licenses, Maintenance and Support


2,218



1,461



757



-



-Pension


498



-



-



-



498Total

$
5,741


$
3,133


$
2,040


$
70


$
498
 
 In addition to the above, we recognized long-term income tax payable of $350,000 related to uncertain tax positions as of December 31, 2009. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes.
  ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
  Directors and Senior Management
  Our executive officers and directors and their ages as of December 31, 2009, were as follows:
  Name
Age
PositionSterling Du
50
Chief Executive Officer, Class I Director and Chairman of the BoardChuan Chiung “Perry” Kuo
50
Chief Financial Officer, Joint Secretary and Class I DirectorJames Keim
65
Class II Director and Head of Marketing and SalesMichael Austin
74
Independent Non-executive Director, Class III Director and member of Compensation CommitteeLawrence Lin
59
Independent Non-executive Director, Class II Director and member of Audit Committee and Compensation CommitteeJi Liu
74
Independent Non-executive Director, Class II DirectorTeik Seng Tan
55
Independent Non-executive Director, Class I Director and member of Audit CommitteeKeisuke Yawata
75
Independent Non-executive Director, Class III Director and Chairman of Audit Committee
  29
 Xiaolang Yan
63
Independent Non-executive Director and Class III DirectorIvan Chang
47
Vice-President, FinanceJohnny Chiang
52
Vice-President, Logistics and Backend
 
 Our Class I Directors have held office from the date of the annual general meeting in 2008 for a three year term until 2011; our Class II Directors have held office from the date of the annual general meeting in 2009 for a three year term until 2012; and our Class III Directors have held office from the date of the annual general meeting in 2007 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 secretarysince 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.  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.
  Lawrence Lin has served as a Class II Director, and member of the audit committee and chairman of the compensation committee since June 2003. He is a Certified Public Accountant in Taiwan. Since 1990, Mr. Lin has been a partner of UHY L&C Company, Certified Public Accountants, which is an independent member firm of Urbach Hacker Young International. Mr. Lin was a director of Urbach Hacker Young International from October 1994 to October 1998. Prior to UHY L&C Company, he was a partner at T N Soong & Co. Mr. Lin serves as director and chairman of the audit committee of Yageo Corporation, director of Arima Communications Corporation, and corporate supervisor of Tex Year Industries Inc., all of which are Taiwan listed public companies. He graduated from Taipei Vocational Commercial School in 1969.
  Ji Liu has served as a Class II Director since June 2007.  Mr. Liu has been an Honorary President of the China Europe International Business School since 2005.  He has been the Chairman of China Europe International Business School Education Development Foundation since 2005.  From 1999 to 2004, Mr. Liu was Executive President and President of the China Europe International Business School.  From 1993 to 1999, Mr. Liu was a Research Fellow, Member of the Academic Board, Graduate
  30
 Supervisor and Deputy Chairman of the Chinese Academy of Social Sciences. He received a B.S. in power mechanical engineering from Tsinghua University in China.
  Teik Seng Tanhas served as a Class I Director and a member of audit committee since June 2008. Mr. Tan was previously employed by AMD Singapore Pte Ltd. from 1984 to 2007 where he held various positions, the last position being Senior Executive Managing Director.  Mr. Tan currently serves as a director of HMC Associates Asia-Pacific Pte Ltd, AYP Associates Pte Ltd and V-Golf Pte Ltd.   He also has been Chairman of the Board of Directors for Bizlink Centre Singapore Ltd. since 2001 and a member of the Board of Directors since 1999.  Mr. Tan is a member of the Advisory Council for the Singapore Human Resource Institute and a member of the Advisory Council of the School of Engineering at Temasek Polytechnic.  Mr. Tan received a B.E. in Electrical Engineering from the National University of Singapore and an M.S. in Industrial Engineering from the National University of Singapore.
  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 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, 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.
  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.
  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 2009 to our directors and members of our administrative, supervisory or management bodies as a group equal to approximately $2,818,138.  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, 2009, the aggregate number of ordinary shares beneficially owned by our directors and members of our administrative, supervisory or management bodies was 247,688,900. This number includes options to purchase an aggregate of 140,252,600 ordinary shares under our 1997 Stock Plan, 1999 Stock Plan and 2005 Share Option Plan exercisable within 60 days of December 31, 2009.
  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
  31
 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, 2009, options outstanding and exercisable under the 1997 stock plan were 5,625,400.  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 SEHK; 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 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, 2009, 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, 2009, options outstanding under the 1999 stock plan were 221,190,850, of which 217,389,350 were exercisable.  Our 1999 stock plan was terminated effective on March 2, 2006, the date of the listing of our ordinary shares on the SEHK; 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 SEHK.  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 SEHK. 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.  At the annual general meeting in June 2008, the shareholders approved, adopted and ratified an amendment to the 1999 purchase plan to increase the number of shares issuable pursuant to the 1999 purchase plan from 50,000,000 to 70,000,000 shares.  As of December 31, 2009, 59,195,450 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.
  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.
  32
 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 $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 $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.
  2009 Employee Stock Purchase Plan.As approved at the Extraordinary General Meeting held on May 30, 2009, we adopted the 2009 Employee Stock Purchase Plan (“2009 Purchase Plan”) along with our delisting from SEHK in September 2009.  The terms and provisions of 2009 Purchase Plan are generally the same as the 1999 Purchase Plan.  The 2009 Purchase Plan will also have a term of 10 years, if not terminated earlier.  A total of 25,000,000 ordinary shares were reserved for issuance under the 2009 Purchase Plan starting November 2009.
  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, 2009, 95,053,600 options were outstanding, of which 45,821,250 were exercisable 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 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, 2009, 42,888,600 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
  33
 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 ordinary 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.
  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 five meetings in 2009.  Currently, Messrs. Lin, Tan and Yawata 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, 2009, we had 850 full-time employees, of which 536 are engineers.  101 of our employees were based in the United States, 714 in Asia, 31 in Europe and 4 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 and well-maintained.
   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, 2010, by each shareholder known by us to own beneficially more than 5% of our ordinary shares based on SEC filings as of March 31, 2010.
  34
 Shares Beneficially OwnedName of Beneficial Owner

Number


PercentWasatch Advisors, Inc.


282,886,500



15.63
%Sparta Asset Management, LLC


192,389,650



10.63
%DNB NOR Asset Management/DNB NOR Kapitalforvaltning ASA


156,185,900



8.63
%Fidelity Management & Research


132,485,000



7.32
%Directors and members of our administrative, supervisory or management bodies


114,405,150



6.32
%
 
 Based on SEC filings as of March 31, 2009, Wasatch Advisors, Inc. beneficially owned 311,041,900 of our ordinary shares or 16.91%, Fidelity Management & Research beneficially owned 185,770,000 of our ordinary shares or 10.10%, and Sparta Asset Management, LLC beneficially owned 167,443,450 of our ordinary shares or 9.10%.
  Based on SEC filings as of March 31, 2008, Wasatch Advisors, Inc. beneficially owned 314,431,750 of our ordinary shares or 16.43%, Trivium Capital Management LLC beneficially owned 206,250,000 of our ordinary shares or 10.77%, and RS Investment Management Co. beneficially owned 137,929,800 of our ordinary shares or 7.21%.
  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
  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, and James Keim, the Head of marketing and Sales, pursuant to which these officers would be entitled to, among other things, one times base salary and annual target bonus and immediate vesting of 50% of unvested equity awards if terminated under certain circumstances.  In addition, Mr. Kuo and Mr. Keim would be entitled to, among other things, one and a half times base salary and annual target bonus and immediate vesting of 50% of 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, but not traded, on 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  35
 The following information 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 pricesHigh


LowJanuary 1, 2005 through November 25, 2005 *

$
17.72


$
8.74November 28, 2005** through December 31, 2005

$
13.18


$
9.24January 1, 2006 through December 31, 2006

$
13.55


$
5.07January 1, 2007 through December 31, 2007

$
18.00


$
7.06January 1, 2008 through December 31, 2008

$
11.60


$
1.77January 1, 2009 through December 31, 2009

$
5.60


$
1.96*    the date of close of trading in ordinary shares**  the date of commencement of trading in ADS(b)
Quarterly high and low market pricesFirst Quarter 2008

$
11.60


$
7.59Second Quarter 2008

$
9.75


$
6.27Third Quarter 2008

$
6.64


$
3.32Fourth Quarter 2008

$
3.77


$
1.77First Quarter 2009

$
3.50


$
1.96Second Quarter 2009

$
5.60


$
3.02Third Quarter 2009

$
5.50


$
4.51Fourth Quarter 2009

$
5.29


$
4.01First Quarter 2010

$
7.22


$
4.53(c)
Monthly high and low market pricesDecember 1, 2009

$
5.29


$
4.26January 1, 2010

$
5.48


$
4.60February 1, 2010

$
6.31


$
4.53March 1, 2010

$
7.22


$
5.98April 1, 2010

$
7.68


$
6.65
 ITEM 10.   ADDITIONAL INFORMATION
  The following are summaries of material provisions of our memorandum and articles of association and the Companies Law (2007 Revision of the Cayman Islands (as amended, the “Companies Law”)). 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 MC-72204by the registrar of companies in the Cayman Islands.  The registered office is located at the offices of Maples Corporate Services Limited, Ugland House, P.O. Box 309, South Church Street, Grand Cayman KY1-1104, 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 unrestricted and the Company may perform all corporate activities not prohibited by any law as provided by the Companies Law.
  Directors
  Article 122 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 or prior to consideration of such contract or arrangement by the board.  Article 129 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 138 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.
  36
 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.  The outstanding 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.  There is no exchange control legislation in the Cayman Islands or any laws or regulations which 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 entitles the holder thereof to one vote on a show of hands and one vote in respect to each ordinary share held by that shareholder on a poll, 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.
  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.  Subject to the articles of association, advanced notice of at least ten days (but not more than sixty days) 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 divide among the shareholders in cash or in kind the whole or any part of our assets, in a manner proportionate to their shareholdings.
  Preference Shares
  The articles of association authorize 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 allot, issue, grant options over or otherwise dispose of shares of the Company with or without preferred, deferred or other special rights  or restrictions  whether in regard to dividend rights voting, return of capital or otherwise, 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.
  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 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 has 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,
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 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. The Companies Law provides that a merger or consolidation may occur between any of the following: (a) one or more companies incorporated under the Companies Law and one or more companies incorporated under the laws of a jurisdiction outside the Cayman Islands, provided that the Cayman Islands company is the surviving entity; or (b) two or more companies incorporated under the Companies Law.  For these purposes, (i) "merger" means the merging of two or more constituent companies and the vesting of their undertaking, property and liabilities in one of such companies as the surviving company and (ii) "consolidation" means the combination of two or more constituent companies into a consolidated company and the vesting of the undertaking, property and liabilities of such companies to the consolidated company. Such a merger or consolidation does not need court approval for a company limited by shares (but not segregated portfolio companies)
  A merger or consolidation will involve, amongst other things, the directors of each company participating in a merger or consolidation approving a written plan of merger or consolidation on behalf of that company which complies with the requirements of the Companies Law.  The written plan of merger or consolidation approved by the directors must generally be authorised by resolution of the shareholders of each company participating in the merger or consolidation , subject to and in accordance with the Companies Law.The consent of each holder of a fixed or floating security interest of a company participating in a proposed merger or consolidation should also be obtained, although the courts of the Cayman Islands have a discretion to waive such requirement upon such terms as to the security to be issued by the consolidated or surviving company as the court considers reasonable.
  A dissenting member of a Cayman Islands company proposing to participate in a merger or consolidation has a limited entitlement provide written objection to the proposed action and to receive payment of the fair value of his shares in accordance with the provisions of the Companies Law.
  If a merger or consolidation is effected in accordance with the Companies Law:
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the rights, the property of every description and the business, undertaking, goodwill, benefits, immunities and privileges of each of the constituent companies, shall immediately vest in the surviving or consolidated company;
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subject to any specific arrangements entered into by the relevant parties, the surviving or consolidated company shall be liable for and subject, in the same manner as the constituent companies, to all mortgages, charges or security interests, and all contracts, obligations, claims, debts, and liabilities of each of the constituent companies;
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an existing claim, cause or proceeding, whether civil (including arbitration) or criminal pending at the time of the merger or consolidation by or against a constituent company, shall not be abated or discontinued by the merger or consolidation but shall be continued by or against the surviving or consolidated company; and
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a conviction, judgment, ruling, order or claim, due or to become due, against a constituent company, shall not be released or impaired by the merger or consolidation, but shall apply to the surviving or consolidated company instead of to the constituent company.
  Cayman Islands law also provides statutory provisions which 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:
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the parties have complied with the statutory provisions regarding majority vote;
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the shareholders have been fairly represented at the meeting in question; and
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the arrangement is one that a businessman would reasonably approve.
 
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 When a take-over offer is made and accepted by holders of 90% in value 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.  In principle, we will normally be the proper plaintiff in respect of wrongs done to the Company and a derivative action may not be brought by a minority shareholder.  However, exceptions to the foregoing principle may apply in circumstances in which:
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a company is acting or proposing to act illegally or outside of its powers;
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the act complained of, although not outside of its powers, could be affected only if authorized by more than a simple majority vote;
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the individual rights of the plaintiff shareholders have been infringed or are about to be infringed; or
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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:
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political and economic stability;
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an effective judicial system;
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unlike some jurisdictions which impose taxes on worldwide income, no taxation of companies based upon profits, income, gains or appreciation;
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the absence of exchange control or currency restrictions; and
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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.  Under Cayman Islands law, our directors have a duty of loyalty to act honestly and 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. The remedies which may be pursued if our directors do not comply with their duties to us are well settled matters of Cayman Islands law.
  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
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 States or any state thereof.  Nevertheless, the courts of the Cayman Islands would be competent to hear original actions brought by us against our officers and directors predicated upon alleged breaches of duties to us.
  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 authorize 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, 1,809,461,200 shares were issued and outstanding as of December 31, 2009, 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.  There is no exchange control legislation in the Cayman Islands or any  laws or regulations which 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.  There are no exchange control regulations or currency restrictions in the Cayman Islands.
  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 (2007 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:
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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;
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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;
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an estate the income of which is subject to U.S. federal income taxation regardless of its source;
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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;
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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
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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.
  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:
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life insurance companies;
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tax-exempt investors;
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banks and financial institutions;
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dealers in securities or foreign currencies;
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traders in securities that elect to use a mark-to-market method of accounting for their securities holdings;
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persons liable for alternative minimum tax;
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U.S. investors who or that actually or constructively hold 10% or more of our voting shares or ADSs;
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investors who hold our ordinary shares or ADSs as part of straddles, hedging or integrated or conversion transactions; or
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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 under 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 non-corporate 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 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
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 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.
  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 non-corporate 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
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 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.
  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:
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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
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any gain realized on the sale or other disposition, including a pledge, of ordinary shares or ADSs.
  Under these special tax rules:
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the excess distribution or gain would be allocated ratably over the U.S. Investor’s holding period for the ordinary shares or ADSs;
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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 in the current year;
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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
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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 or ADSs 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
  43
 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.
  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 3 World Financial Center, Suite 400, New York, New York 10281 and 175 W. Jackson Boulevard, Suite 900, Chicago, Illinois 60604.  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 collectability of accounts receivable.
  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, corporate bonds, 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, 2009, 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, 2009.  44
 (In Thousands)
  2010

2011

2012

2013

2014

Thereafter

Total

Fair

ValueTime Deposit:Fixed rate (US$)

$
60,318

$
23


-


-


-


-

$
60,341

$
60,341Corporate BondsFixed rate (US$)

$
1,095


-


-


-


-


-

$
1,095

$
1,095
 
 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, 2009, 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, 2009, we held approximately $27.8 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, 2009, we experienced a net foreign exchange gain of approximately $28,000 due to foreign currency exchange fluctuations, which are reflected in our results of operations.
  ITEM12.           DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
 
 A. Debt Securities
 
 Not applicable.
 
 B. Warrants and Rights
 
 Not applicable.
 
 C. Other Securities
 
 Not applicable.
 
 D. American Depositary Shares
 
 Our American Depositary Receipt (“ADR”) facility is maintained by the Bank of New York Mellon (the “Depositary”).  A copy of the form of Deposit Agreement (the “Deposit Agreement”) among us, the Depositary and the owners and beneficial owners of ADSs evidenced by ADRs was filed as Exhibit 1 to our Registration Statement on Form S-6 filed with the SEC on November 7, 2005. The Hong Kong and Shanghai Banking Corporation (the “Custodian”) acts as an agent of the Depositary for the purposes of the Deposit Agreement.
 
 Fees and charges payable by our ADS holders
 
 Under the Deposit Agreement, the Depositary collects fees for the delivery and surrender of American Depositary Shares ("ADSs") directly from investors depositing ordinary shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them.  The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for depositary services by deductions from cash distributions, directly billing investors or charging the book-entry system accounts of participants acting for them.  The depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.  The charges of our Depositary payable by our ADS holders are as follows:
 
 45
 ADS holders must pay:

For:$5.00 (or less) per 100 ADSs (or portion of 100 ADSs)

§Each delivery or issuance of ADSs, including deliveries or issuances resulting from a distribution of shares or rights or other property§Each surrender or cancellation of ADSs for the purpose of withdrawal, including if the deposit agreement terminates$0.02 (or less) per ADS

§Any cash distribution to ADS registered holdersA fee equivalent to the fee that would be payable if securities distributed to holders of deposited securities had been ordinary shares and the ordinary shares had been deposited for issuance of ADSs

§Each distribution of securities, other than ordinary shares or ADSs, to holders of deposited securities which are distributed by the Depositary to ADS registered$0.02 (or less) per ADS per calendar year (to the extent that the depositary has not collected a cash distribution fee of US$0.02 per ADS during that year)

§Depositary servicesRegistration or transfer fees

§Transfer and registration of shares on the share register of our transfer agent to or from the name of the Depositary or its agent when an ADS holder deposits or withdraws sharesExpenses of the depositary

§Cable, telex and facsimile transmissions as are expressly provided in the deposit agreement§Converting foreign currency to U.S. dollarsTaxes and other governmental charges the Depositary or the Custodian have to pay on any ADS or ordinary share underlying an ADS, for example, stock transfer taxes, stamp duty or withholding taxes

§As necessaryAny charges incurred by the Depositary or its agents for servicing the deposited securities

§As necessary
 
 Fees and payments made by the Depositary to us
 
 In February 2010, we received from the Depositary a one-time reimbursement of $54,395.63, net of withholding tax, for our annual NASDAQ Stock Market continued listing fees for calendar years 2007–2009.
 
 The Depositary has waived certain of its standard out-of-pocket administrative, maintenance, shareholder services and secondary market support services fees and expenses for providing services to registered ADS holders and us (excluding those fees and expenses set forth in the table above).  These waived fees and expenses include, without limitation, the Depositary’s annual administration charges and fees, custody fees, issuance of dividend checks and replacements, if necessary, preparation and filing of U.S. tax information returns, stationery, postage, notification mailing, photocopying, facsimile and telephone calls, and certain investor relationship programs and investor relations promotional activities. We are responsible for paying for postage and envelopes for mailing annual and interim financial reports and all non-standard out-of-pocket administration and maintenance expenses of the Depositary, including any and all reasonable legal fees and disbursements.
  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 USEOF PROCEEDS.
  RIGHTS OF SECURITY HOLDERS  46
 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, as is described in the report on Form 6-K filed on March 1, 2006.  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, 2009, 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.
  ITEM 15.           CONTROLS AND PROCEDURES
  Disclosure 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, 2009, 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.
  Management’s Annual Report on Internal Control over Financial Reporting
  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, 2009. This Annual Report includes an attestation report of our registered public accounting firm regarding internal control over financial reporting.
  Changes in Internal Control over Financial Reporting
  There has been no change in our internal control over financial reporting that occurred during our fiscal year 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
  Attestation Report of The Independent Registered Public Accounting Firm
  REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 To the Board of Directors and the Shareholders of O2Micro International Limited:
 
 We have audited the internal control over financial reporting of O2Micro International Limited and subsidiaries (the “Company”) as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  The Company’s management is responsible for maintaining effective
  47
 internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting.  Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
 
 We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects.  Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances.  We believe that our audit provides a reasonable basis for our opinion.
 
 A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
 Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis.  Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
 In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2009 of the Company and our report dated April 23, 2010 expressed an unqualified opinion on those financial statements.
  /s/ Deloitte & Touche
 
 Taipei, Taiwan
 Republic of China
 April 23, 2010
  ITEM 16A.           AUDIT COMMITTEE FINANCIAL EXPERT
  We have at least one audit committee financial expert serving on the audit committee. The Board of Directors has determined that Mr. Lawrence Lin is the "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, 2009. 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, 2008 and 2009.  48
 (In Thousands)
  Year Ended

December 31, 2008

Year Ended

December 31, 2009Audit Fees

$
643

$
533Audit-related Fees


27


54Tax Fees


22


23Total

$
692

$
610
  Audit Fees.   This category includes the audit of our annual financial statements, review of quarterly financial statements, audit of our internal control over financial reporting 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.
  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, 2009, the audit committee pre-approved all audit and non-audit-fees of Deloitte & Touche.
  ITEM 16D.           EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEE
  Not applicable.
  ITEM 16E.           PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PERSONS
  Period
Total Number of

Shares Purchased (2)
Average Price Paid

per Share (2)
Total Number of

Shares Purchased as

Part of Publicly

Announced Plans or

Programs (1) (2) (3)
Maximum Number

of Shares that May

Yet Be Purchased

Under the Plans or

Programs (1) (2) (3)September 1, 2009 to September 30, 2009
3,250,000
0.1032
3,250,000
181,020,200 (6)November 1, 2009 to November 30, 2009
21,344,450
0.0866
21,344.450
159,675,750 (6)December 1, 2009 to December 31, 2009
18,726,400
0.0919
18,726,400
140,949,350 (6)
  (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 and June 21, 2007, 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
 
 49
 the Company in issue and to be issued.  On June 21, 2007, the maximum number of shares that may yet be purchased was 190,859,415 shares.
  (5) On June 5, 2008, 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 5, 2008, the maximum number of shares that may yet be purchased was 188,794,110 shares.
  (6) On June 1, 2009, 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 1, 2009, the maximum number of shares that may yet be purchased was 184,270,200 shares.
  ITEM 16F.           CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT
  Not applicable.
  ITEM 16G.           CORPORATE GOVERNANCE
  We are a foreign private issuer whose ADSs are listed on the NASDAQ Global Market. As such, we are required to comply with U.S. federal securities laws, including the Sarbanes-Oxley Act, and the NASDAQ rules, including the NASDAQ corporate governance requirements. While we are generally in compliance with all of the NASDAQ corporate governance requirements, the NASDAQ rules provide that foreign private issuers may follow home country practice in lieu of certain qualitative listing requirements subject to certain exceptions and except to the extent that such exemptions would be contrary to U.S. federal securities laws, so long as the foreign issuer discloses that it does not follow such listing requirement and describes the home country practice followed in its reports filed with the SEC.  Below is a concise summary of the significant ways in which our corporate governance practices differ from the corporate governance requirements of NASDAQ applicable to domestic U.S. listed companies:
  •
We are not required under Cayman Islands law, and do not distribute interim reports directly to shareholders.
  In addition, please also see Item 6 “Directors, Senior Management and Employees” and Item 10 “Additional Information” for further discussion on our corporate governance practices.  50
 PART III
  ITEM 17.           FINANCIAL STATEMENTS
 
 The Company’s Consolidated Financial Statements have been prepared in accordance with Item 18 hereof.
  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, 2009 and 2008
  Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2009, 2008 and 2007
  Consolidated Statements of Shareholders' Equity for the years ended December 31, 2009, 2008 and 2007
  Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008 and 2007
  Notes to Consolidated Financial Statements
  ITEM 19.           EXHIBITS
  1.
Amended and Restated Memorandum and Articles of Association of the registrant adopted pursuant to a special resolution passed on May 29, 2009, which took effect upon the withdrawal of the listing of the ordinary shares of the registrant on the Main Board of The Stock Exchange of Hong Kong Limited on September 9, 2009.
  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  51
 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 LIMITEDDate:  May 24, 2010
By:
/s/ sterling duName:
Sterling DuTitle:
Chief Executive Officer
 52
 O2MICRO INTERNATIONAL LIMITED
 
 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
   
 
 PageReport of Independent Registered Public Accounting Firm
F-1Consolidated Balance Sheets
F-2Consolidated Statements of Operations and Comprehensive Income
F-3Consolidated Statements of Shareholders’ Equity
F-5Consolidated Statements of Cash Flows
F-6Notes to Consolidated Financial Statements
F-8
  
  
 
 
 O2Micro International Limited and Subsidiaries
 
 Consolidated Financial Statements as of
 December 31, 2009 and 2008 and for the Three Years Ended December 31, 2009, 2008 and 2007, and
 Report of Independent Registered Public
 Accounting Firm
 
  
 REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  To the Board of Directors and the Shareholders of O2Micro International Limited:
 
 We have audited the accompanying consolidated balance sheets of O2Micro International Limited and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009 (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.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes 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, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.
 
 We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated April 23, 2010 expressed an unqualified opinion on the Company’s internal control over financial reporting.
  /s/ Deloitte & Touche
 Taipei, Taiwan
 Republic of China
 April 23, 2010
  F-1
 O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
 
 CONSOLIDATEDBALANCE SHEETS
 (In Thousand US Dollars, Except Per Share Amounts and Share Data)
 
 December 31ASSETS

2009


2008CURRENT ASSETSCash and cash equivalents (notes 3 and 4)

$
38,831


$
31,844Restricted cash


236



1,153Short-term investments (notes 3 and 5)


74,502



72,344Accounts receivable, net (note 6)


14,556



10,578Inventories (note 7)


9,457



16,388Prepaid expenses and other current assets (note 8)


3,342



2,314Total current assets


140,924



134,621LONG-TERM INVESTMENTS (notes 3 and 9)


15,190



13,199PROPERTY AND EQUIPMENT, NET (note 10)


30,570



34,353OTHER ASSETSRestricted assets


1,443



1,411Intangible assets, net (note 11)


4,266



4,929Other assets (note 12)


4,921



4,760Total other assets


10,630



11,100TOTAL ASSETS

$
197,314


$
193,273LIABILITIES AND SHAREHOLDERS’ EQUITYCURRENT LIABILITIESNotes and accounts payable

$
8,760


$
4,120Income tax payable


411



226Accrued expenses and other current liabilities (note 13)


7,731



8,269Total current liabilities


16,902



12,615OTHER LONG-TERM LIABILITIESAccrued pension liabilities (note 15)


498



553Long-term income tax payable (note 14)


341



302Other liabilities


129



23Total long-term liabilities


968



878Total liabilities


17,870



13,493COMMITMENTS AND CONTINGENCIES (notes 18 and 19)SHAREHOLDERS’ EQUITYPreference 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 and outstanding – 1,809,461,200 and 1,832,788,400 shares as of

December 31, 2009 and 2008, respectively


36



37Additional paid-in capital


142,679



141,784Retained earnings


33,214



36,746Accumulated other comprehensive income


3,515



1,213Total shareholders’ equity


179,444



179,780TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

$
197,314


$
193,273
 
 The accompanying notes are an integral part of the consolidated financial statements.
  F-2
 O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
 
 CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
 (In Thousand US Dollars, Except Per Share Amounts and Share Data)
 
 Years Ended December 312009


2008


2007NET SALES

$
127,498


$
138,825


$
165,540COST OF SALES


52,020



58,110



71,099GROSS PROFIT


75,478



80,715



94,441OPERATING EXPENSES (INCOME)Research and development (a)


33,017



37,424



34,624Selling, general and administrative (a)


45,049



39,003



45,560Goodwill impairment


-



2,782



-Write-off of prepayment to foundry services


-



2,942



-Litigation income


-



(2,000
)


(9,364
)Total operating expenses


78,066



80,151



70,820INCOME (LOSS) FROM OPERATIONS


(2,588
)


564



23,621NON-OPERATING INCOME (EXPENSES)Interest income


1,319



2,328



3,262Impairment loss on long-term investments (note 9)


-



(14,146
)


-Foreign exchange gain (loss), net


28



(412
)


(548
)Other, net


26



97



105Total non-operating income (expenses)


1,373



(12,133
)


2,819INCOME (LOSS) BEFORE INCOME TAX


(1,215
)


(11,569
)


26,440INCOME TAX EXPENSE (note 14)


1,602



2,240



1,456NET INCOME (LOSS)


(2,817
)


(13,809
)


24,984OTHER COMPREHENSIVE INCOME (LOSS)Foreign currency translation adjustments


287



1,466



1,667Unrealized gain (loss) on available-for-salesecurities


2,006



(3,776
)


2,702Unrealized pension gain (loss)


9



(123
)


(95
)Total other comprehensive income (loss)


2,302



(2,433
)


4,274COMPREHENSIVE INCOME (LOSS)

$
(515
)

$
(16,242
)

$
29,258EARNINGS (LOSS) PER SHARE (note 17)Basic

$
-


$
(0.01
)

$
0.01Diluted

NA


NA


$
0.01
  (Continued)
  F-3
 O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
 
 CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
 (In Thousand US Dollars, Except Per Share Amounts and Share Data)
 
 Years Ended December 312009


2008


2007NUMBER OF SHARES USED IN EARNINGS PERSHARE CALCULATION:Basic (in thousands)


1,840,995



1,862,831



1,905,725Diluted (in thousands)


1,840,995



1,862,831



1,943,785(a) INCLUDES STOCK-BASEDCOMPENSATION CHARGE AS FOLLOWS:Research and development

$
1,180


$
1,067


$
1,058Selling, general and administrative

$
2,215


$
1,621


$
1,408
  The accompanying notes are an integral part of the consolidated financial statements.             (Concluded)
  F-4
 O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
 
 CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY
 (In Thousand US Dollars, Except Share Data)
 
 Accumulated OtherComprehensive Income (Loss)Additional





Unrealized


Cumulative


UnrealizedOrdinary Shares


Paid – in


Retained


Investment


Translation


Pension





Treasury


Shareholders’Shares


Amount


Capital


Earnings


Gain (Loss)


Adjustment


Loss


Total


Stock


EquityBALANCE, JANUARY 1, 2007


1,906,969,950


$
38


$
140,224


$
33,877


$
(1,129
)

$
501


$
-


$
(628
)

$
-


$
173,511Issuance of:Shares for exercise of stock options


13,564,800



-



2,565



-



-



-



-



-



-



2,565Shares for Employee Stock Purchase Plan


5,060,300



-



809



-



-



-



-



-



-



809Shares vested under restricted share units


1,922,100



-



-



-



-



-



-



-



-



-Acquisition of treasury stock – 20,649,000 shares


-



-



-



-



-



-



-



-



(4,330
)


(4,330
)Retirement of treasury stock


(15,649,000
)


-



(1,120
)


(1,914
)


-



-



-



-



3,034



-Stock-based compensation


-



-



2,466



-



-



-



-



-



-



2,466Cumulative effect of adopting uncertain tax positions standards


-



-



-



(100
)


-



-



-



-



-



(100
)Net income for 2007


-



-



-



24,984



-



-



-



-



-



24,984Pension loss


-



-



-



-



-



-



(95
)


(95
)


-



(95
)Foreign currency translation adjustments


-



-



-



-



-



1,667



-



1,667



-



1,667Unrealized gain on available-for-sale securities


-



-



-



-



2,702



-



-



2,702



-



2,702BALANCE, DECEMBER 31, 2007


1,911,868,150



38



144,944



56,847



1,573



2,168



(95
)


3,646



(1,296
)


204,179Issuance of:Shares for exercise of stock options


712,500



1



64



-



-



-



-



-



-



65Shares for Employee Stock Purchase Plan


9,301,700



-



869



-



-



-



-



-



-



869Shares vested under restricted share units


3,914,700



-



-



-



-



-



-



-



-



-Acquisition of treasury stock – 88,008,650 shares


-



-



-



-



-



-



-



-



(11,779
)


(11,779
)Retirement of treasury stock


(93,008,650
)


(2
)


(6,781
)


(6,292
)


-



-



-



-



13,075



-Stock-based compensation


-



-



2,688



-



-



-



-



-



-



2,688Net loss for 2008


-



-



-



(13,809
)


-



-



-



-



-



(13,809
)Pension loss


-



-



-



-



-



-



(123
)


(123
)


-



(123
)Foreign currency translation adjustments


-



-



-



-



-



1,466



-



1,466



-



1,466Unrealized loss on available-for-sale securities


-



-



-



-



(3,776
)


-



-



(3,776
)


-



(3,776
)BALANCE, DECEMBER 31, 2008


1,832,788,400



37



141,784



36,746



(2,203
)


3,634



(218
)


1,213



-



179,780Issuance of:Shares for exercise of stock options


2,397,000



-



114



-



-



-



-



-



-



114Shares for Employee Stock Purchase Plan


10,685,400



-



575



-



-



-



-



-



-



575Shares vested under restricted share units


6,911,250



-



-



-



-



-



-



-



-



-Acquisition of treasury stock – 43,320,850 shares


-



-



-



-



-



-



-



-



(3,905
)


(3,905
)Retirement of treasury stock


(43,320,850
)


(1
)


(3,189
)


(715
)


-



-



-



-



3,905



-Stock-based compensation


-



-



3,395



-



-



-



-



-



-



3,395Net loss for 2009


-



-



-



(2,817
)


-



-



-



-



-



(2,817
)Pension gain


-



-



-



-



-



-



9



9



-



9Foreign currency translation adjustments


-



-



-



-



-



287



-



287



-



287Unrealized gain on available-for-sale securities


-



-



-



-



2,006



-



-



2,006



-



2,006BALANCE, DECEMBER 31, 2009


1,809,461,200


$
36


$
142,679


$
33,214


$
(197
)

$
3,921


$
(209
)

$
3,515


$
-


$
179,444
 
 The accompanying notes are an integral part of the consolidated financial statements.
  F-5
 O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
 
 CONSOLIDATEDSTATEMENTS OF CASH FLOWS
 (In Thousand US Dollars)
 
 Years Ended December 312009


2008


2007OPERATING ACTIVITIESNet income (loss)

$
(2,817
)

$
(13,809
)

$
24,984Adjustments to reconcile net income (loss) to net cash provided byoperating activities:Depreciation and amortization


5,929



6,876



6,927Stock-based compensation


3,395



2,688



2,466Impairment loss on long-term investments


-



14,146



-Loss on disposal of property and equipment


203



56



18Goodwill impairment


-



2,782



-Deferred income taxes


(15
)


46



(194
)Other, net


47



57



78Changes in operating assets and liabilities:Accounts receivable, net


(3,978
)


13,605



(5,613
)Inventories


6,931



5,720



(8,164
)Prepaid expenses and other current assets


(499
)


4,981



(66
)Prepayment for testing service and deferred charges


(757
)


(2,192
)


(1,157
)Notes and accounts payable


4,640



(6,716
)


990Income tax payable


176



(893
)


191Accrued expenses and other current liabilities


(510
)


(2,463
)


(195
)Accrued pension liabilities


(64
)


(88
)


(32
)Long-term income tax payable


48



92



(7
)Net cash provided by operating activities


12,729



24,888



20,226INVESTING ACTIVITIESLong-term notes receivable from employees


-



-



8Acquisition of:Short-term investments


(38,245
)


(99,263
)


(75,499
)Long-term investments


-



(5,700
)


-Property and equipment


(1,123
)


(2,408
)


(8,123
)Intangible assets


-



(293
)


-Cash paid in acquisition


-



(6,500
)


-(Increase) decrease in:Restricted assets


-



10,877



2,207Restricted cash


(80
)


5,723



1,532Other assets


(144
)


211



100Increase (decrease) in other liabilities


(23
)


23



-Proceeds from:Sale of short-term investments


37,116



55,849



66,604Sale of long-term investments


-



-



60Disposal of a subsidiary–net of cash disposed


-



6,181



-Disposal of property and equipment


20



51



-Net cash used in investing activities


(2,479
)


(35,249
)


(13,111
)FINANCING ACTIVITIESAcquisition of treasury stock


(3,905
)


(11,779
)


(4,330
)Proceeds from:Exercise of stock options


114



65



2,565Issuance of ordinary shares under the Employee Stock Purchase Plan


575



869



809Net cash used in financing activities


(3,216
)


(10,845
)


(956
)
 
 (Continued)
  F-6
 O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
 
 CONSOLIDATEDSTATEMENTS OF CASH FLOWS
 (In Thousand US Dollars)
 
 Years Ended December 312009


2008


2007EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATE

$
(47
)

$
453


$
1,000NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS


6,987



(20,753
)


7,159CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR


31,844



52,597



45,438CASH AND CASH EQUIVALENTS AT END OF THE YEAR

$
38,831


$
31,844


$
52,597SUPPLEMENTAL DISCLOSURES OF CASH FLOWSCash paid for interest

$
-


$
-


$
-Cash paid for tax

$
1,366


$
2,871


$
1,528NON-CASH INVESTING AND FINANCING ACTIVITIESRestricted assets reclassified to short-term investments

$
-


$
317


$
-Restricted cash reclassified to short-term investments

$
1,000


$
-


$
-Long-term investment in exchange for acquisition

$
-


$
1,305


$
-Land in exchange for building

$
8,918


$
-


$
-
  The accompanying notes are an integral part of the consolidated financial statements.                        (Concluded)
  F-7
 O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
 
 NOTESTO 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 market high performance semiconductor components for power management and security 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’s ordinary shares (“Shares”) were initially listed on The NASDAQ National Market (“NASDAQ”) on August 23, 2000 and on the Cayman Islands Stock Exchange on February 1, 2001.  At the Extraordinary General Meeting of Shareholders (“EGM”) held on November 14, 2005, the shareholders approved a public global offering of the Company’s Shares and the proposed listing of the Company's Shares on the Main Board of The Stock Exchange of Hong Kong Limited (“SEHK”) and various matters related to the proposed listing and offering.  Following the approval of these matters, the Company ceased trading its Shares on the NASDAQ, effected a 50-for-1 share split of Shares, created an American depositary share (“ADS”) program for the ADSs to be quoted on the NASDAQ, and delisted the Shares from the NASDAQ on November 25, 2005. The Company commenced trading of ADSs on the NASDAQ on November 28, 2005 and subsequently listed the Shares on the SEHK on March 2, 2006 by way of introduction.
 
 On February 27, 2009, the Company submitted an application for the voluntary withdrawal of the listing of Shares on the Main Board of SEHK (collectively referred to as “Proposed Withdrawal”) for reasons of cost and utility.  The Company will retain its existing primary listing of ADSs on the NASDAQ Global Select Market in the United States following the Proposed Withdrawal and for the foreseeable future.  The Proposed Withdrawal has been approved at the EGM held on May 30, 2009 and the listing of the Shares on SEHK was withdrawn on September 9, 2009.
 
 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”), O2Micro (China) Co., Ltd. (“O2Micro-China”), and O2Security Limited (“O2Security”). O2Micro-Taiwan is engaged in operations and sales support services. O2Micro-Japan is engaged in sales support services. O2Micro-Singapore, O2Micro-China, and other subsidiaries are mostly engaged in research and development services.  O2Security is primarily engaged in operations and sales of network security products.  To assure its testing capacity and flexibility, the Company also established a subsidiary, OceanOne Semiconductor (Ningbo) Limited (“OceanOne”) in Ningbo of the People’s Republic of China (“China”) in August 2005.  OceanOne is engaged in semiconductor testing service and has commenced its operations in January 2007. In June, 2008, the Company entered into a share transfer agreement with Sigurd Microelectronics (Cayman) Co., Ltd. (“Sigurd Cayman”) to dispose of 100% ownership of OceanOne for $6,700,000.  The share transfer was subsequently completed on July 2, 2008.
  2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  F-8
 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.
 
 Significant accounting estimates reflected in the Company’s consolidated financial statements include valuation allowance for deferred income tax assets, allowance for doubtful accounts, inventory valuation, useful lives for property and equipment, impairment on long-lived assets, identified intangible assets, and goodwill, allowances for sales adjustments, other liabilities, contingencies and stock-based compensation.
 
 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 time deposits and 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 based upon a review of the expected collectability of individual accounts.
 
 Fair Value of Financial Instruments
 
 The Company’s financial instruments include cash and cash equivalents, restricted cash, accounts receivable, and notes and accounts payable. The carrying amounts approximate the fair value due to the short-term maturity of those instruments.  Fair value of available-for-sale investments including short-term investments and long-term investments is based on 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 financing, 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 government bonds, negotiable certificates of deposit and cash, is estimated based on the combination of fair value of each component.
 
 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. Investments with maturities of more than three months are classified as short-term investments.
 
 Restricted Assets/Cash
 
 The Company classifies deposits made for customs and 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 from the balance sheet date.  Restricted assets consist of deposits made for Taiwan court cases in the form of Taiwan
  F-9
 Government bonds, negotiable certificates of deposit and cash (note 19).  Restricted assets can be released only upon the resolution of the related litigation.
 
 Short-term Investments
 
 The Company maintains its excess cash in time deposits, US 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, 2009, all the above-mentioned investments were classified as available-for-sale securities and were recorded at fair 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.
 
 Investment transactions are recorded on the trade date.
 
 Inventories
 
 Inventories are stated at the lower of standard cost or market value.  The cost of inventories comprises cost of purchasing raw materials and where applicable, those overheads that have been incurred in bringing the inventories to their present location and condition.  Cost is determined on a currently adjusted standard basis, which approximates actual cost on a first-in, first-out basis.The Company assesses its inventory for estimated obsolescence or unmarketable inventory based upon management’s assumptions about future demand and market conditions and writes down inventory as needed.
 
 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. Management evaluates related information, 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 financing 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-sale securities and are recorded at fair 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.
 
 Property and Equipment
 
 Property and equipment are stated at cost less accumulated depreciation. Major additions and betterments are capitalized, while maintenance and repairs are expensed as incurred.
 
 Depreciation is computed on a straight-line basis over estimated service lives that range as follows: buildings - 35 to 49.7 years, equipment - 3 to 10 years, furniture and fixtures - 3 to 9 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
  F-10
 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 the asset is separately identifiable and is less than the carrying value.  If impairment occurs, a loss based on the excess of the carrying value over the fair value of the long-lived asset is recognized.  Fair value is determined by reference to quoted market prices, if available, or discounted cash flows, as appropriate.
 
 Goodwill
 
 The Company records goodwill when the purchase price of an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired.  The Company performs an annual impairment review for each reporting unit using a fair value approach.  Reporting units may be operating segments as a whole or an operation one level below an operating segment, referred to as a component.  Goodwill impairment is tested using a two-step approach.  The first step compares the fair value of a reporting unit to its carrying amount, including goodwill.  If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired and the second step is not required.  If the fair value of the reporting unit is less than its carrying amount, the second step of the impairment test measures the amount of the impairment loss, if any, by comparing the implied fair value of goodwill to its carrying amount.  If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess.  The implied fair value of goodwill is calculated in the same manner that goodwill is calculated in a business combination, whereby the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit, with the excess purchases price over the amounts assigned to assets and liabilities.  Estimating fair value is performed by utilizing various valuation approaches, such as income approach or market approach.
 
 Identified Intangible Assets
 
 Intellectual property assets primarily represent customer relationship, tradename, and developed technologies acquired, and are recorded based on a purchase price allocation analysis on the fair value of the assets acquired. The Company amortizes acquired intangible assets using straight-line method over the estimated life ranging from 3 to 10 years.
 
 The intangible assets, subject to amortization, are reviewed for impairment whenever circumstances indicate that the useful life is shorter than the Company had originally estimated or that the carrying amount of assets may not be recoverable.  If such facts and circumstances exist, the Company assesses the recoverability of identified intangible assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairments, if any, are based on the excess of the carrying amount over the fair value of those assets.  The Company determines the fair value using the income approach which includes the discounted cash flow and other economic factors as inputs.
 
 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 is allocated between additional paid-in capital and retained earnings based on the average issuance price of the shares repurchased.  A repurchase of ADS 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 collectability.
  F-11
 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.
 
 Freight Costs
 
 Shipping and handling costs billed to a customer are included in net revenue. Distribution costs related to revenues are included in cost of revenue.
 
 Research and Development
 
 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 construction of prototypes.  All expenditures related to research and development activities of the Company are charged to operating expenses when incurred.
 
 Advertising Expenses
 
 The Company expenses all advertising and promotional costs as incurred.  These costs were approximately $827,000 in 2009, $2,127,000 in 2008, and $3,892,000 in 2007, respectively.  A portion of these costs was for advertising, which approximately amounted to $361,000 in 2009, $549,000 in 2008, and $229,000 in 2007, respectively.
 
 Pension Costs
 
 For employees under defined contribution pension plans, pension costs are recorded based on the actual contributions made to employees’ pension accounts.  For employees under defined benefit pension plans, pension costs are recorded based on the actuarial calculation.
 
 Income Tax
 
 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 and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards.  The Company believes that uncertainty exists regarding the realizability of certain deferred income tax assets and, accordingly, has established a valuation allowance for those deferred income tax assets to the extent the realizability is not deemed to be more likely than not.  Deferred income tax assets and liabilities are measured using enacted tax rates. 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.
  F-12
 Effective January 1, 2007, the Company adopted standards that changed the accounting for uncertain tax positions. The new standards contain a two step approach to recognizing and measuring uncertain tax positions. 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.
 
 Stock-based Compensation
 
 The Company grants stock options to its employees and certain non-employees and estimates the fair value of share-based payment awards on the date of grant using an option-pricing model.  The value of the portion of the award that is ultimately expected to vest is recognized as expense ratably over the requisite service periods.  The Company has elected to use the Black-Scholes option pricing model to determine the fair value of stock options on the date of grant.  The Company also grants restricted stock units (“RSU”) to its employees and the RSU are measured based on the fair market value of the underlying stock on the dates of grant.
 
 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 recorded 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 US dollar.  Accordingly, the financial statements of the foreign subsidiaries are translated into US 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 (loss) represents net income (loss) 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 income.
 
 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.
 
 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
  F-13
 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 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 both parties and may only be terminated with respect to the Company’s products.
 
 Recent Accounting Pronouncements
 
 In December 2008, the Financial Accounting Standards Board (“FASB”) issued updated accounting standards relating to the disclosure requirements for defined benefit plans, which provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. The new accounting standards are effective for annual reporting periods ending after December 15, 2009. The Company has adopted the updated standards effective for its December 31, 2009 annual report on Form 20-F; however the Company is not able to provide the required fair value disclosure related to pension plan assets. See Note 15 to the Consolidated Financial Statements for further discussion.
 
 In April 2009, the FASB issued updated standards that provide guidance on the recognition and presentation of other-than-temporary impairments of debt securities classified as available-for-sale and held-to-maturity. These standards are effective for interim and annual reporting periods ending after June 15, 2009. This guidance is effective for the Company for the year ending December 31, 2009. The adoption of the guidance did not have a material effect on the Company’s results of operations, financial position and cash flows.
 
 In May 2009 and subsequently updated in February 2010, the FASB issued new guidance on subsequent events that establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. This standard defines two types of subsequent events, recognized or nonrecognized. The new guidance is effective for the Company for the year ending December 31, 2009.
 
 In June 2009, the FASB issued new guidance to improve financial reporting by enterprises involved with variable interest entities (“VIE”). The new guidance modifies the approach for determining the primary beneficiary of a VIE. Under the modified approach, an enterprise is required to make a qualitative assessment whether it has (1) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. If an enterprise has both of these characteristics, the enterprise is considered the primary beneficiary and must consolidate the VIE.  The new guidance becomes effective for annual reporting periods beginning after November 15, 2009.  Based on the Company’s analysis, the Company currently does not anticipate that the new guidance will have a material effect on the Company’s results of operations and financial position or cash flows.
 
 
 In June 2009, the FASB issued its Accounting Standards Codification (“ASC”) 105, which became the source of authoritative U.S. generally accepted accounting principles (“U.S. GAAP”) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities law are also sources of authoritative U.S. GAAP for SEC registrants. The ASC became effective for the financial statements issued for interim and annual periods ending after September 15, 2009 and superseded all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the ASC will become nonauthoritative. The FASB will not issue new standards in the form of Statements (“SFAS’s”) FASB Staff Positions (“FSP’s”) or Emerging Issues Task Force Abstracts (“EITF’s”), but rather it will issue Accounting Standards Updates (“ASU’s”).  The FASB will not consider the ASU’s as authoritative in their own right as they will only serve to update the ASC, provide background information about guidance and provide the bases for conclusions on the
  F-14
 changes in the ASC.  The Company has adopted the ASC effective for its December 31, 2009 annual report on Form 20-F and has revised the disclosure of the U.S. GAAP source references in its financial reporting upon such adoption.
 
 In June 2009, the FASB issued new guidance relating to the transfer of financial assets. The new guidance requires entities to provide more information regarding sales of securitized financial assets and similar transactions, particularly if the entity has continuing exposure to the risks related to the transferred financial assets. It also eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets and requires additional disclosures. The new guidance becomes effective for annual reporting periods beginning after November 15, 2009. Based on the Company’s analysis, the Company currently does not anticipate that the new guidance will have a material effect on the Company’s results of operations and financial position or cash flows.
 
 In September 2009, the FASB issued an accounting standard update which provides guidance on how to separate consideration in multiple-deliverable arrangements and significantly expands the related disclosure requirements. The standard establishes a hierarchy for determining the selling price of a deliverable, eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The update is effective for annual reporting periods beginning on or after June 15, 2010. Based on the Company’s analysis, the Company currently does not anticipate that the new guidance will have a material effect on the Company’s results of operations and financial position or cash flows.
 
 In September 2009, the FASB issued an accounting standard update on arrangements that include software elements. Tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. The update is effective for annual reporting periods beginning on or after June 15, 2010.  Based on the Company’s analysis, the Company currently does not anticipate that the new guidance will have a material effect on the Company’s results of operations and financial position or cash flows.
  In January 2010, the FASB issued amended standards that require additional fair value disclosures. These amended standards require disclosures about inputs and valuation techniques used to measure fair value as well as disclosures about significant transfers, beginning in the first quarter of 2010. Additionally, these amended standards require presentation of disaggregated activity within the reconciliation for fair value measurements using significant unobservable inputs (Level 3), beginning in the first quarter of 2011.  The Company does not expect these new standards to significantly impact the consolidated financial statements.
 
 Reclassifications
 
 Increases in other assets that was previously included in investing activities of the Consolidated Statements of Cash Flows for the years ended 2008 and 2007 have been reclassified to conform to the 2009 presentation and are included in operating activities.  Such reclassification is not material to the consolidated financial statements as a whole.
  3.
FAIR VALUE MEASUREMENTS
 
 The Company measures its cash equivalents and marketable securities at fair value. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:
  F-15
 Level 1 – Observable inputs such as quoted prices for identical instruments in active markets;
 Level 2 – Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly;
 Level 3 – Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
 
 Assets and liabilities measured at fair value were as follows:
  (In Thousands)
 Level 1


Level 2


Level 3


TotalItems measured at fair value on a recurring

basis at December 31, 2009Cash and cash equivalentsMoney market mutual funds

$
-


$
514


$
-


$
514Corporate bonds


-



1,392



-



1,392Treasury bills


1,000



-



-



1,000Short-term investmentsCorporate bonds


-



7,099



-



7,099Long-term investmentsAvailable-for-sale securities


3,437



-



-



3,437Total

$
4,437


$
9,005


$
-


$
13,442
 
 (In Thousands)
 Level 1


Level 2


Level 3


TotalItems measured at fair value on a recurring

basis at December 31, 2008Cash and cash equivalentsMoney market mutual funds

$
221


$
-


$
-


$
221Corporate bonds


4,000



-



-



4,000Short-term investmentsGovernment bonds


-



305



-



305Corporate bonds


6,026



-



-



6,026Long-term investmentsAvailable-for-sale securities


1,446



-



-



1,446Total

$
11,693


$
305


$
-


$
11,998
  F-16
 4.
CASH AND CASH EQUIVALENTS  (In Thousands)
 December 312009


2008Time deposits

$
6,561


$
2,627Savings and checking accounts


29,348



24,975Money market mutual funds and corporate bonds


1,906



4,221Treasury bills


1,000



-Petty cash


16



21$
38,831


$
31,844
 
  F-17
  5.
SHORT-TERM INVESTMENTS
 
 (In Thousands)
  December 31, 2009Gross


GrossUnrealized


Unrealized


FairCost


Gains


Losses


ValueTime deposits

$
67,403


$
-


$
-


$
67,403Available-for-sale securitiesCorporate bonds


7,104



-



(5
)


7,099$
74,507


$
-


$
(5
)

$
74,502
 
 (In Thousands)
 
 December 31, 2008Gross


GrossUnrealized


Unrealized


FairCost


Gains


Losses


ValueTime deposits

$
66,013


$
-


$
-


$
66,013Available-for-sale securitiesCorporate bonds


6,043



4



(21
)


6,026Government bonds


304



1



-



3056,347



5



(21
)


6,331$
72,360


$
5


$
(21
)

$
72,344
 
 Short-term investments by contractual maturity were as follows:
 
 (In Thousands)
 
 December 31, 2009FairCost


ValueTime depositsDue within one year

$
67,381


$
67,381Due after two years


22



2267,403



67,403Available-for-sale securitiesDue within one year


7,104



7,099$
74,507


$
74,502
  F-18
 (In Thousands)
 
 December 31, 2008FairCost


ValueTime depositsDue within one year

$
65,993


$
65,993Due after two years


20



2066,013



66,013Available-for-sale securitiesDue within one year


6,347



6,331$
72,360


$
72,344
  The Company’s gross realized gains and losses on the sale of investments for the year ended December 31, 2009 were $1,000 and $0, respectively, for the year ended December 31, 2008 were $1,000 and $0, respectively, and for the year ended December 31, 2007 were both $0.  Gross unrealized gains and losses at December 31, 2009 were $10,000 and $6,000, respectively, and at December 31, 2008 were $10,000 and $21,000, respectively.
 
 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, 2009 and 2008.  The Company presently does not intend to sell the debt securities listed below and believes that it is not more likely than not that the Company will be required to sell these securities that are in an unrealized loss position before recovery of the Company’s amortized cost. Furthermore, the Company has the intent and ability to hold the equity securities listed below for a sufficient period of time to allow for recovery in market value.
 
 (In Thousands)
 
 December 312009


2008Less Than 12 Months


12 Months or Greater


Total


Less Than 12 MonthsUnrealized





Unrealized





Unrealized





UnrealizedFair Value


Losses


Fair Value


Losses


Fair Value


Losses


Fair Value


LossesCorporate bonds

$
7,099


$
5


$
-


$
-


$
7,099


$
5


$
2,027


$
21Investment in China Resources

Microelectronics Limited

(“CR Micro”) (Note 9)


-



-



2,246



472



2,246



472



983



1,735Investment in Etrend Hitech

Corporation (“Etrend”) (Note 9)


-



-



-



-



-



-



463



457-



-



2,246



472



2,246



472



1,446



2,192$
7,099


$
5


$
2,246


$
472


$
9,345


$
477


$
3,473


$
2,213
 
  F-19
 6.
ACCOUNTS RECEIVABLE, NET
 
 (In Thousands)
 
 December 312009


2008Accounts receivable

$
15,124


$
11,144Allowances forDoubtful accounts


(84
)


(283
)Sales returns and discounts


(484
)


(283
)$
14,556


$
10,578
 
 The changes in the allowances are summarized as follows:
 (In Thousands)
 
 December 312009


2008Allowances for doubtful accountsBalance, beginning of the year

$
283


$
88Additions


-



195Reversal and write-off


(199
)


-Balance, end of the year

$
84


$
283Allowances for sales returns and discountsBalance, beginning of the year

$
283


$
897Additions


1,794



534Write-off


(1,593
)


(1,148
)Balance, end of the year

$
484


$
283
  7.
INVENTORIES
 
 (In Thousands)
 
 December 312009


2008Finished goods

$
3,885


$
9,612Work-in-process


2,920



1,247Raw materials


2,652



5,529$
9,457


$
16,388
 
  F-20
 8.
PREPAID EXPENSES AND OTHER CURRENT ASSETS
 (In Thousands)
 
 December 312009


2008Prepaid expenses

$
1,247


$
957Interest receivable


706



621Other receivable


549



235Value-added-tax recoverable


50



36Deferred income tax assets


11



86Other


779



379$
3,342


$
2,314
  9.
LONG-TERM INVESTMENTS
 (In Thousands)
 
 December 312009


2008Cost methodSigurd Cayman

$
5,700


$
5,700X-FAB Semiconductor Foundries AG (“X-FAB”)


4,968



4,968Philip Ventures Enterprise Fund (“PVEF”)


585



585GEM Services, Inc. (“GEM”)


500



500Asia Sinomos Semiconductor Inc. (“Sinomos”)


-



-Silicon Genesis Corporation (“SiGen”)


-



-11,753



11,753Available-for-sale securities – noncurrentCR Micro


2,246



983Etrend


1,191



4633,437



1,446$
15,190


$
13,199
 
 The following table shows the gross realized gains and losses and fair value of the Company’s long-term investments in available-for-sale securities at December 31, 2009 and 2008.
 
 F-21
 (In Thousands)
  December 31, 2009Gross


GrossUnrealized


Unrealized


FairCost


Gains


Losses


ValueCR Micro

$
2,718


$
-


$
(472
)

$
2,246Etrend


920



271



-



1,191$
3,638


$
271


$
(472
)

$
3,437
  (In Thousands)
 
 December 31, 2008Gross


GrossUnrealized


Unrealized


FairCost


Gains


Losses


ValueCR Micro

$
2,718


$
-


$
(1,735
)

$
983Etrend


920



-



(457
)


463$
3,638


$
-


$
(2,192
)

$
1,446
 
 In July 2008, the Company invested in preferred shares of Sigurd Cayman for $5,700,000 to become a strategic partner of Sigurd Microelectronics Corporation (“Sigurd”).  Upon completion of the transaction, the Company obtained a 19.54% ownership of Sigurd Cayman.  The Company accounts for the investment under the cost method as the Company does not exercise significant influence over operating and financial policies of Sigurd Cayman and management of Sigurd holds the controlling interests.  As of December 31, 2009, the Company held 7,671,602 shares, which represented approximately 20.26% ownership of Sigurd Cayman.  In April 2010, the Company further invested in Sigurd Cayman’s preferred shares for $1,500,000 in view of its strategic business developments with Sigurd.  Along with this investment, the Company obtained 2,018,843 shares of Sigurd Cayman and its ownership of Sigurd Cayman becomes 18.88% upon the completion of the transaction.
 
 The Company invested in X-FAB’s ordinary shares in July 2002.  X-FAB is a European-American foundry group that specializes in mixed signal application. As of December 31, 2009, the Company held 530,000 shares at the cost of $4,968,000 (4,982,000 EURO), which represented a 1.60% ownership of X-FAB.
 
 In November 2005, the Company invested in PVEF, a fund management company in Singapore, with investment amount of $585,000 (SG$1,000,000) for 20 units in the placement at SG$50,000 per unit. The Company held 2.77% of the fund as of December 31, 2009.
 
 The Company invested in GEM’s preference shares in August 2002. GEM is a multinational semiconductor assembly and test company. As of December 31, 2009, the Company held 333,334 shares at the value of $500,000, which represented a 0.92% ownership of GEM.
 
 In January 2005, the Company invested in 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 in preferred shares of $3,288,000 and $4,785,000, respectively. In September 2008, in view of Sinomos’ operating status and recurring financial losses, the Company determined that the decline in fair value of the investment in Sinomos was other-than-temporary and recognized an impairment charge of $13,073,000.  Along with the recognition of impairment charge, the Company also wrote-off the outstanding prepayments in relation to Sinomos’ foundry service of $2,942,000.  As of December 31, 2009, the Company held 30,101,353 of ordinary and preference shares, representing an 18.41% ownership of Sinomos.
  F-22
 In August 2004, the Company invested in CR Micro’s ordinary shares which are listed on the SEHK at a purchase price of $4,547,000. CR Micro (formerly known as CSMC Technology Corporation) is a semiconductor foundry company. As of December 31, 2009, the Company held 70,200,000 shares, which represented approximately 0.80% ownership of CR Micro.  The Company considered the investment to be other-than-temporarily impaired at June 30, 2006 and recognized an impairment loss of $756,000 based on the quoted market price of HK$0.42 per share on June 30, 2006. On February 23, 2009, CR Micro announced that it is presently considering placing a privatization proposal with a cash offering price of HK$0.30 per share.  In respect to this subsequent event, the Company considered this a Type I subsequent event and the investment to be other-than-temporarily impaired and recognized an impairment loss of $1,073,000 as of December 31, 2008.  CR Micro, however, is remained listed on the SEHK as its privatization proposal was disapproved by over 10% of its shareholders’ in June 2009.
 
 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, 2009, the Company held an 8.65% ownership of Etrend.  In August 2007, Etrend’s shares were listed on the Emerging Stock Gretai Security Market of Taiwan and the Company reclassified the investment in Etrend to available-for-sale securities.
 
 The Company invested in SiGen preferred shares in December 2000.  SiGen is an advanced nanotechnology company that develops Silicon-on-insulator, 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, 2009, representing a 0.06% ownership of SiGen.
  10.
PROPERTY AND EQUIPMENT, NET
 
 (In Thousands)
 
 December 312009


2008CostLand

$
2,510


$
11,299Buildings


8,055



8,055Equipment


31,360



31,828Furniture and fixtures


1,314



1,356Leasehold improvements


2,333



3,511Transportation equipment


569



590Prepayment for property and equipment


8,878



45155,019



57,090Accumulated depreciationBuildings


854



674Equipment


20,313



18,299Furniture and fixtures


1,079



1,000Leasehold improvements


1,767



2,418Transportation equipment


436



34624,449



22,737$
30,570


$
34,353
  F-23
 Depreciation expense recognized during the years ended December 31, 2009, 2008, and 2007 was approximately $4,442,000, $$5,931,000 and $6,580,000, respectively.
 In August 2009, the Company sold its land, located in Hsin-Chu, Taiwan, to a developer in exchange for a portion of the real estate after it is developed, which portion will include a portion of an office building and a portion of a parking lot, valued at approximately $8.9 million a portion of the real estate after it is developed, which portion will include a portion of an office building and a portion of a parking lot, with a total fair value of $8,918,000. The Company consummated this transaction to acquire office building space and parking lot space for the purpose of future operations and business growth.  The Company determined to defer the transaction gain of $129,000 as the building was still under the design and planning stage as of December 31, 2009.
  F-24
 11.
INTANGIBLE ASSETS, NET
 
 In March 2008, the Company entered into an agreement with 360 Degree Web to acquire certain software products, sales and licensing contracts, registered trademarks, issued patents, patent applications, and proprietary technology in exchange for $6,500,000 and all of the shares of 360 Degree Web held by the Company with a carrying value of $1,305,000.  As a result of the acquisition, the Company obtained certain core technologies that are essential to the future growth of the Company’s business.
 
 The Company determined that such acquisition meets the criteria for a business transfer and accounted for the transaction by the standards for business combinations.
 
 The total purchase price was allocated as follows:
 
 (In Thousands)
 
 Developed technologies

$
4,706Customer relationship


261Tradename


56Goodwill


2,782Total consideration

$
7,805
 
 The above purchase price allocation was based on an analysis of the fair value of the assets acquired.  The customer relationship and tradename are all amortized over 3 years.  The developed technologies, including security access control, full disk encryption, and virtual private network (“VPN”) technologies, are amortized from 8 to 10 years.  The goodwill of $2,782,000 was fully assigned to the reporting unit of Integrated Circuit Group. The goodwill was primarily comprised of buyer-specific synergies.  Given that the Company’s products already incorporated certain of 360 Degree Web’s technologies, management anticipated achieving higher revenue growth as a result of this acquisition.  In addition, the Company also acquired other intangible assets of $293,000 during year ended December 31, 2008.
 
 Intangible assets consisted of the following as of December 31, 2009:
  (In Thousands)
 
 GrossCarrying


AccumulatedAmount


Amortization


NetDeveloped technologies

$
4,706


$
(790
)

$
3,916Customer relationship


261



(138
)


123Tradename


56



(29
)


27Other


293



(93
)


200$
5,316


$
(1,050
)

$
4,266
  F-25
 Intangible assets consisted of the following as of December 31, 2008:
 
 (In Thousands)
 
 GrossCarrying


AccumulatedAmount


Amortization


NetDeveloped technologies

$
4,706


$
(291
)

$
4,415Customer relationship


261



(51
)


210Tradename


56



(11
)


45Other


293



(34
)


259$
5,316


$
(387
)

$
4,929
 
 Amortization expense of the intangible assets acquired was $663,000 and 387,000 for years ended December 31, 2009 and 2008, respectively.  The estimated amortization expense of the intangible assets as of December 31, 2009 for the coming five years was as follows:
 
 (In Thousands)
 
 Year2011


6632012


6002013


5572014


5262015


499Total

$
2,845
 
 As a result of the global economic crisis and the resulting decline in customer demand in the fourth quarter of 2008, the overall decline in equity values and the resulting deterioration in the Company’s market capitalization made it necessary to review whether there was an indication that goodwill was impaired. The fair value of the Integrated Circuit Group reporting unit was estimated using the market approach-guideline public company method.  The information used in the valuation was obtained through discussions and a review of historical financial statements, prospective financial information, product descriptions and other relevant documents.  In addition, external research and data was considered.  Upon the completion of the goodwill impairment analysis, the Company recognized a goodwill impairment of $2,782,000 for the quarter ended December 31, 2008.
 
 12.
OTHER ASSETS
 (In Thousands)
 
 December 312009


2008Land use rights

$
1,293


$
1,322Deferred charges


1,650



1,386Prepayment for testing service


979



1,316Refundable deposits


593



449Deferred income tax assets - noncurrent


406



287$
4,921


$
4,760
 
 F-26
 All land within municipal zones in China is owned by the 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 a straight-line basis over the term of the land use rights agreement which is 49.7 years.  Amortization expense of the land use rights for the years ended December 31, 2009, 2008, and 2007 was approximately $29,000, $28,000 and $29,000, respectively.
 
 In view of the expansion of its supply chain in China, the Company entered into a testing service agreement with Sigurd Cayman to obtain certain manufacturing and testing services.  The total prepayment amounts to $1,450,000 for the service period from July 2008 to June 2011.
 
 Deferred charges consist of consultant and maintenance contracts and are amortized over the term of the contract which is 3 to 8 years.
 
  F-27
 13.
ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
 
 (In Thousands)
 
 December 312009


2008Salaries, bonus and benefits

$
2,931


$
3,028Legal and audit fees


1,366



1,840Engineering related expenses


832



1,019Consulting fees


499



487Shipping expenses


361



132Withholding tax payable


178



370Value-added tax payable


150



56Promotional expenses


109



373Payable for acquisition of equipment


48



105Deferred income tax liabilities


35



6Other accrued expenses


1,222



853$
7,731


$
8,269
 
 14.      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 (loss) before income taxes consisted of:
 (In Thousands)
 
 Years Ended December 312009


2008


2007Cayman Islands

$
(6,809
)

$
(18,493
)

$
20,832Foreign


5,594



6,924



5,608$
(1,215
)

$
(11,569
)

$
26,440
 
 Income tax expense consisted of:
 (In Thousands)
 
 Years Ended December 312009


2008


2007Current

$
1,617


$
2,194


$
1,650Deferred


(15
)


46



(194
)Income tax expense

$
1,602


$
2,240


$
1,456
  F-28
 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) was as follows:
 
 Years Ended December 312009


2008


2007Cayman statutory rate


0
%


0
%


0
%Foreign rates in excess of statutory rates


(133.99
%)


(15.75
%)


5.36
%Changes in deferred income tax assets


53.00
%


(7.91
%)


(2.22
%)Adjustments to prior years’ taxes


18.77
%


0.22
%


(0.42
%)Change in valuation allowance for deferred income tax assets


(51.77
%)


6.62
%


(2.96
%)Other


(17.86
%)


(2.54
%)


5.75
%Effective tax rate


(131.85
%)


(19.36
%)


5.51
%
  The deferred income tax assets and liabilities as of December 31, 2009 and 2008 consisted of the following:
 
 (In Thousands)
 
 December 312009


2008Deferred income tax assetsResearch and development credits

$
4,474


$
4,182Net operating loss carryforwards


494



1Accrued vacation


173



58Depreciation and amortization


495



498Deferred interest deductions


-



97Other


4



1315,640



4,967Valuation allowance


(5,223
)


(4,594
)Total net deferred income tax assets


417



373Deferred income tax liabilitiesUnrealized capital allowance


3



6Unrealized foreign exchange


32



-Total deferred income tax liabilities


35



6Net deferred income tax assets

$
382


$
367
  The valuation allowance shown in the table above relates to net operating losses, credit carryforwards and temporary differences for which the Company believes that realization is not more than likely. The valuation allowance increased by $629,000 for the year ended December 31, 2009 and decreased by $766,000 for the year ended December 31, 2008, respectively.  The increase in the valuation allowance is primarily due to the new research and development credits generated that cannot be fully utilized by the Company.
  F-29
 As of December 31, 2009, O2Micro, Inc. had US federal and state research and development credit carryforwards of approximately $4,189,000 and $4,636,000, respectively.  The US federal research and development credit will expire from 2020 through 2029 if not utilized, while the state research and development credit will never expire.
 
 Effective at the beginning of the first quarter of 2007, the Company adopted standards that changed the accounting for uncertain tax positions.  The Company recognized a cumulative adjustment in the liability for unrecognized income tax benefits in the amount of $100,000, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings and an adjustment of income tax liabilities for unrecognized income tax benefits in the amount of $117,000, which was accounted for as a reduction to the January 1, 2007 balance of income tax payable.  At the adoption date of January 1, 2007, the Company had $217,000 of unrecognized tax benefits, all of which would affect its effective tax rate if recognized.  At December 31, 2009, the Company had $350,000 of unrecognized tax benefits, all of which would affect its effective tax rate if recognized.  For the years ended December 31, 2009, 2008 and 2007, the total amount of interest expense and penalties related to tax uncertainty recorded in the provision for income expense was approximately $21,000, $81,000 and $0, respectively.  The total amount of interest and penalties recognized as of December 31, 2009 and 2008 was $102,000 and $81,000, respectively.
 
 A reconciliation of the beginning and ending amount of unrecognized tax benefits was as follows:
 
 (In Thousands)
 
 Years Ended

December 312009


2008Balance, beginning of the year

$
302


$
210Increase in tax position balance during current year


48



92Decrease in tax position balance during current year


-



-Balance, end of the year

$
350


$
302
 
 Uncertain tax positions were primarily related to the allocation of income and deductions amongst the Company’s global entities. The Company estimates that there will be no material changes in its uncertain tax positions in the next 12 months.
 
 The Company files income tax returns in various foreign jurisdictions.  The Company is generally no longer subject to income tax examinations by tax authorities for years prior to 2004 because of the statute of limitations.
  15.
RETIREMENT AND PENSION PLANS
 
 The Company has a savings plan that qualifies under Section 401(k) of the US Internal Revenue Code. Participating employees may defer up to the US 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 offices are located to comply with local statutes and practices.  For the years ended December 31, 2009, 2008, and 2007, pension costs charged to income in relation to the contributions to
  F-30
 these schemes were $1,335,000, $$1,880,000, and $1,675,000, respectively.  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 Labor Standards 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 Bank of Taiwan.  The measurement date of the plan is December 31.
 
 The government is responsible for the administration of all the defined benefit plans for the companies in Taiwan under the Labor Standards Law. The government also sets investment policies and strategies, determines investment allocation and selects investment managers. As of December 31, 2008 and 2009, the asset allocation was primarily in cash, equity securities and debt securities. Furthermore, under the Labor Standards Law, the rate of return on assets shall not be less than the average interest rate on a two-year time deposit published by the local banks and the government is responsible for any shortfall in the event that the rate of return is less than the required rate of return. However, information on how investment allocation decisions are made, inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets is not fully made available to the companies by the government. Therefore, the Company is unable to provide the required fair value disclosures related to pension plan assets.
 
 The percentage of major category of plan assets as of December 2009 and 2008 were as follows:
 
 December 312009


2008Cash


44
%


39
%Equity securities


11
%


12
%Debt securities


15
%


25
%
 
 Changes in projected benefit obligation and plan assets for the years ended December 31, 2009 and 2008 were as follows:
 (In Thousands)
 
 Years Ended

December 312009


2008Projected benefit obligation, beginning of the year

$
724


$
582Service cost


6



5Interest cost


19



17Benefits paid


-



-Actuarial loss


11



120Projected benefit obligation, end of the year

$
760


$
724Fair value of plan assets, beginning of the year

$
171


$
62Employer contributions


86



106Actual return on plan assets


5



3Fair value of plan assets, end of the year

$
262


$
171
 
 
 The component of net periodic benefit cost was as follows:
 
 (In Thousands)
 
 Years Ended

December 312009


2008Service cost

$
6


$
5Interest cost


19



17Expected return on plan assets


(5
)


(2
)Amortization of net pension loss


6



2Net periodic benefit cost

$
26


$
22
 
 The funded status of the plan was as follows:
 (In Thousands)
 
 December 312009


2008Accumulated benefit obligation

$
(537
)

$
(503
)Project benefit obligation


(760
)


(724
)Plan assets at fair value


262



171Funded status of the plan

$
(498
)

$
(553
)
 
 The actuarial assumptions to determine the benefit obligations were as follows:
 
 December 312009


2008Discount rate


2.3
%


2.5
%Rate of compensation increases


2.0
%


2.0
%
 
 The actuarial assumptions to determine the net periodic benefit cost were as follows:
 
 Years Ended

December 312009


2008Discount rate


2.3
%


2.5
%Rate of compensation increases


2.0
%


2.0
%Expected long-term rate of return on plan assets


2.0
%


2.5
%
  F-31
 The expected long-term rate of return shown for the plan assets was weighted to reflect a two-year deposit interest rate of local banking institutions.
 
 Estimated future benefit payments are as follows:
 (In Thousands)
 
 Year2010

$
-2011


-2012


122013


32014


72015-2019


81Total estimated future benefit payments

$
103
  16.
STOCK-BASED COMPENSATION
 
 Employee Stock Purchase Plan
 
 In October 1999, the Board of Directors (the “Board”) adopted the 1999 Employee Stock 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 were 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.  In June 2008, an additional 20,000,000 shares were reserved for issuance as also 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 on the first day of February, May, August and November.  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 2009 and 2008, 10,685,400 and 9,301,700 ordinary shares, respectively, had been purchased under the 1999 Purchase Plan.
 
 As approved by the EGM held on May 30, 2009, the Company adopted the 2009 Employee Stock Purchase Plan (“2009 Purchase Plan”) along with the Company delisting from SEHK in September 2009.  The terms and provisions of 2009 Purchase Plan are generally the same as the 1999 Purchase Plan.  The 2009 Purchase Plan will also have a
  F-32
 term of 10 years, if not terminated earlier.  A total of 25,000,000 ordinary shares were reserved for issuance under the 2009 Purchase Plan starting November 2009.
  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.
 
 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, 2009, the number of options outstanding and exercisable was 5,625,400 and 5,625,400, respectively, under the 1997 Stock Plan, and 221,190,850 and 217,389,350, respectively, under the 1999 Stock Incentive Plan.
 
 The Board adopted the 2005 Share Option Plan (“2005 SOP”) which was effective on March 2, 2006, the date the Company completed the listing on the SEHK, and then the Board 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.  As approved by the EGM held on May 30, 2009, the number of shares available for issue was increased from 100,000,000 to 175,000,000 shares.  The references to Hong Kong and Hong Kong related rules and regulations were also removed along with the completion of the Company’s delisting from the SEHK.  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, 2009, the number of options outstanding and exercisable was 95,053,600 and 45,821,250, respectively, under the 2005 SOP.
 
 A summary of the Company’s stock option activity under the plans as of December 31, 2009 and changes during the year then ended is presented as follows:
 
 Weighted


WeightedAverage


Average

AggregateNumber of


Exercise


Remaining

IntrinsicOptions Shares


Price


Contract Life

ValueOutstanding Options, January 1, 2009


306,400,700


$
0.2274Granted


40,710,650


$
0.0481Exercised


(2,397,000
)

$
0.0478Forfeited or expired


(22,844,500
)

$
0.1959Outstanding Options, December 31, 2009


321,869,850


$
0.2083


4.60

$
2,321,000Vested and Expected to Vest Options atDecember 31, 2009


298,790,900


$
0.2170


4.48

$
1,555,000Exercisable Options at December 31, 2009


268,836,000


$
0.2284


4.25

$
518,000
 
 The total intrinsic value of options exercised during the years ended December 31, 2009, 2008, and 2007 were $60,000, $38,000, and $1,301,000, respectively.
 
 
 The following table summarizes information about outstanding and vested stock options:
 Options Outstanding
Options ExercisableWeightedAverage
Weighted

WeightedRemaining
Average
Number
AverageNumber
Contractual
Exercise
Exercisable
ExerciseRange of Exercise Prices
Outstanding
Life
Price
and Vested
Price$0.0460 - $0.0622
39,754,300
7.13
$ 0.0465
8,931,000
$ 0.0466$0.0780 - $0.1198
3,460,700
4.65
$ 0.1075
1,823,000
$ 0.1163$0.1292 - $0.1948
79,345,850
3.95
$ 0.1664
65,805,800
$ 0.1669$0.2013 - $0.2994
157,265,100
4.64
$ 0.2318
151,714,550
$ 0.2313$0.3076 - $0.4836
42,043,900
3.28
$ 0.3610
40,561,650
$ 0.3625Balance, December 31, 2009
321,869,850
4.60
$ 0.2083
268,836,000
$ 0.2284
 
 Share Incentive Plan
 
 The Board adopted the 2005 Share Incentive Plan (“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.  As approved by the EGM held on May 30, 2009, the number of shares available for issue was increased from 75,000,000 to 125,000,000 shares.  The references to Hong Kong and Hong Kong related rules and regulations were also removed along with the completion of the Company’s delisting from the SEHK. Awards may be granted to employees, directors and consultants.  The RSUs vest over a requisite service period of 4 years.
 
 A summary of the status of the Company’s RSUs as of December 31, 2009, and changes during the year ended December 31, 2009 is presented as follows:
 
 WeightedNumber of


AverageOutstanding


Price/FairAwards


ValueNonvested at January 1, 2009


24,110,950


$
0.1821Granted


29,904,300


$
0.0462Vested


(6,911,250
)

$
0.0711Forfeited and expired


(4,215,400
)

$
0.1497Nonvested at December 31, 2009


42,888,600


$
0.0904
 
 As of December 31, 2009, there was $3,869,000 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 2.03 years. The total fair value of RSUs vested during the years ended December 31, 2009, 2008, and 2007 was $492,000,000, $741,000, and $334,000, respectively.
 
 Cash received from option exercise under all share-based payment arrangements for the years ended December 31, 2009, 2008, and 2007 was $689,000, $934,000, and $3,374,000, respectively.
 
 
  F-33
 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 US Treasury yield curve in effect at the time of grant.  The Company uses the simplified method to estimate the expected life because the Company had limited relevant historical information to support the expected sale and exercise behavior of the employees who had been granted options under the 2005 SOP.  Expected volatilities are based on historical volatility of stock prices for a period equal to the options’ expected term.  The dividend yield is zero as the Company has never declared or paid dividends on the ordinary shares or other securities and does not anticipate paying dividends in the foreseeable future.
 
 Stock Options
Employee Stock Purchase PlanYears Ended December 31
Years Ended December 312009
2008
2007
2009
2008
2007Risk-free interest rate
1.85%-2.69%
1.93%-3.41%
3.41%-4.92%
0.06%-0.27%
0.49%-2.10%
3.81%-5.13%Expected life
5
5
5
0.25-0.26
0.25-0.26
0.25-0.26years
years
years
Years
Years
yearsVolatility
53%-58%
53%-56%
58%-66%
33%-103%
43%-82%
38%-50%Dividend
-
-
-
-
-
-
 
 The weighted-average grant-date fair values of options granted during the years ended December 31, 2009, 2008, and 2007 were $0.0242, $0.0767, and $0.1135, respectively.  The weighted-average fair values of options granted under the 1999 Purchase Plan during the years ended December 31, 2009, 2008, and 2007 were $0.0176, $0.0236, and $0.0436, respectively.
 
 Ordinary Shares Reserved
 
 As of December 31, 2009, ordinary shares reserved for future issuance were as follows:
 
 Outstanding stock options


321,869,850Outstanding RSUs


42,888,600Shares reserved for future stock option grants


79,378,900Shares reserved for Employee Stock Purchase Plan


25,000,000Shares reserved for Awards


69,363,350538,500,700
 
 17.
EARNINGS (LOSS) PER SHARE
 
 Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of ordinary shares outstanding during the period.  Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of ordinary and dilutive ordinary equivalent shares outstanding during the period, using the treasury stock method for options.
 
 A reconciliation of the numerator and denominator of basic and diluted earnings (loss) per share calculations was as follows:
 
 
 Years Ended December 312009


2008


2007Net income (loss) (in thousands)

$
(2,817
)

$
(13,809
)

$
24,984Weighted average shares outstanding (in thousands) – basic


1,840,995



1,862,831



1,905,725Effect of dilutive securities:Options and RSUs (in thousands)


-



-



38,060Weighted average shares outstanding (in thousands) – diluted


1,840,995



1,862,831



1,943,785Earnings (loss) per share – basic

$
-


$
(0.01
)

$
0.01Earnings per share – diluted

NA


NA


$
0.01
 
 Certain outstanding options and RSUs 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 298,316,025 shares at $0.0522 to $0.4836 as of December 31, 2009, 297,832,900 shares at $0.0522 to $0.4836 as of December 31, 2008, and 166,279,163 shares at $0.1198 to $0.4836 as of December 31, 2007.
  18.
COMMITMENTS
 
 Lease Commitments
 
 The Company leases office space and certain equipment under noncancelable operating lease agreements that expire at various dates through December 2014.  For the years ended December 31, 2009, 2008, and 2007, leasing costs charged to income in relation to these agreements were $2,051,000, $2,218,000, and $2,509,000, respectively.  The Company’s office lease provides for periodic rental increases based on the general inflation rate.
 
 As of December 31, 2009, future minimum lease payments under all noncancelable operating lease agreements were as follows:
 
 Year

Operating Leases(In Thousands)2010

$
1,6722011


5962012


4752013


2122014


70Total minimum lease payments

$
3,025
 
 Purchase obligations and commitments include payments due under various types of license, maintenance and support agreements with contractual terms from one to three years.  As of December 31, 2009, those purchase commitments were as follows:
 
 Year(In Thousands)2010

$
1,4612011


757Total

$
2,218
  F-34
 19.
CONTINGENCIES
 
 Legal Proceedings
  The Company is involved in several litigation matters relating to its intellectual property, as detailed below. While the Company cannot make any assurances regarding the eventual resolution of these matters, the Company does not believe at this time that the final outcomes will have a material adverse effect on its consolidated results of operations or financial condition.
 
 Certain Cold Cathode Fluorescent Lamp Inverter Circuits And Products Containing Same, Investigation No. 337-TA-666.  On December 15, 2008, the Company filed a complaint with the United States International Trade Commission (“ITC”) in Washington, D.C. The Company alleges that Monolithic Power Systems, Inc. (“MPS”), Microsemi Corporation (“Microsemi”), Asustek, LG and BenQ have engaged in unfair acts through the unlicensed importation of certain products with MPS or Microsemi inverter controllers covered by the Company’s patents.  The Company seeks an order preventing the importation of the products into the United States.  On April 20, 2010, the ITC judge issued an initial determination that the products of Microsemi, MPS and Asustek do not infringe on one of Company’s patents; however the Company has requested that the ITC’s full commission review the ruling prior to making a final determination.  The Initial Determination does not have any effect on Company’s other outstanding patent litigation efforts, and does not apply to the hundreds of other patents in the Company’s patent portfolio.
 
 Monolithic Power Systems, Inc. v.O2MicroInternational Limited,Case No. C 08-4567 CW.   On October 1, 2008, MPS filed a complaint in the United States District Court in the Northern District of California for declaratory judgment that certain claims of the Company’s patents are invalid and not infringed.  The Company has filed counterclaims for patent infringement. The matter is scheduled for trial in July 2010.
 
 Monolithic Power Sys. v. O2Micro Int'l Ltd., 2009 U.S. App. LEXIS 4528 (Fed. Cir. Mar. 5, 2009). On March 5, 2009, the United States Court of Appeals for the Federal Circuit affirmed the judgment of the District Court for the Northern District of California that certain claims of the Company’s U.S. Patent Number 6,396,722 are invalid as obvious under 35 U.S.C. § 103.  The Company filed an appeal on April 6, 2009.
 
 O2Micro Int'l Ltd. v. Taiwan Sumida Elecs., Inc., 2009 U.S. App. LEXIS 4382 (Fed. Cir. Mar. 5, 2009), and Case No. 03-CV-007TW, Eastern District of Texas.  In a companion case involving Taiwan Sumida Electronics, Inc., the Federal Circuit vacated a judgment of infringement from the District Court for the Eastern District of Texas because the Federal Circuit had held in the MPS case that the same claims of the ‘722 patent were invalid.  The Company filed an appeal in the United States Court of Appeals, and in March 2009, the court upheld the Federal Circuit’s ruling, and a judgment to that effect was entered by the Eastern District Court of Texas.
 
 O2Micro International Ltd. v. Beyond Innovation Technology Co. et al., Case No. 2:04-CV-32 (TJW).   On April 3, 2008, the United States Court of Appeals for the Federal Circuit vacated a jury verdict and final judgment of infringement, including a permanent injunction, against defendants Beyond Innovation Technology Company Limited, SPI Electronic Company Limited and FSP Group, and Lien Chang Electronic Enterprise Company Limited.  The Federal Circuit further remanded the case to the Eastern District of Texas, and the case was tried and submitted to the court in July 2009, and the parties are awaiting a decision from the court.
  F-35
 O2MicroInternational Limited v. HonHai Precision Industry, Ltd., et al.,Case No. C -08-CV-466DF.  On December 9, 2008, the Company filed a suit against HonHai Precision Industry for breach of a settlement agreement entered into by the parties in October 2007, terminating an earlier patent infringement action initiated by the Company.  The Company alleges fraud, misrepresentation and interference with business relationships by HonHai.  The case is scheduled to go to trial in November 2010.
  Powertech Association LLC v.O2MicroInternational Limited, et al., Case No. 09-4391.  On August 7, 2009, Powertech Association LLC, an entity formed by MPS and Microsemi, filed a complaint in the United States District Court in the Eastern District of New York, alleging certain products manufactured by the Company infringe upon three of their patents.  The Company has not been served by the Plaintiffs to date, so its defense obligations under the lawsuit have not begun.
 
 O2Holdings Limited v. O2Micro International Ltd., Germany, District of Hamburg.On August 20, 2008, the Regional Court of Hamburg issued a temporary restraining order prohibiting the Company from using the trademark “O2Micro” and “O2Micro Breathing Life into Mobility” in Germany.  A hearing was held, and on November 4, 2009, the initial order was upheld.  The Company opposes this ruling and is currently appealing the matter before the Court of Appeals in Hamburg.
 
 As of December 31, 2009, the Company deposited an amount of New Taiwan dollars equivalent to $1,443,000 with the Taiwan court for court bonds, which was accounted for as restricted assets, in connection with those actions and related preliminary injunction actions. The court bonds provide security for the enjoined party to claim damages against the Company incurred from the preliminary injunctions or the provision of a countersecurity in the event the Company does not ultimately succeed in the underlying infringement actions. The Company is currently in the process to retrieve the court bonds as related actions were closed.
 
 In 2007, the Company received $9,364,000 litigation proceeds from the MPS, Sony Corporation, and Samsung Electronics Co., Ltd. litigation cases in the United States.  In March 2008, the Company further received $2,000,000 from a litigation case with Rohm Co. Ltd. settled in the United States.
 
 The Company, as a normal course of business, is a party to litigation matters, legal proceedings, and claims. These actions may be in various jurisdictions and may involve patent protection and/or 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, 2009 and 2008, no provision for any litigation has been provided.
  20.
FINANCIAL INSTRUMENTS
 
 Information on the Company’s financial instruments was as follows:
 
 
 (In Thousands)
 
 December 312009


2008Carrying


Fair


Carrying


FairAmount


Value


Amount


ValueAssetsCash and cash equivalents

$
38,831


$
38,831


$
31,844


$
31,844Restricted cash


236



236



1,153



1,153Short-term investments


74,502



74,502



72,344



72,344Long-term investments in available-for-sale securities


3,437



3,437



1,446



1,446Restricted assets


1,443



1,443



1,411



1,407
 
 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 investments in available-for-sale securities 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 investments in available-for-sale securities, are in privately-held companies where there is no readily determinable market value and are recorded using the cost method.  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.
 
 21.
RELATED PARTY TRANSACTIONS
 
 Executive Severance and Change of Control Agreements
 
 In April 2007, the Company entered into an Executive Severance and Change of Control Agreement with Sterling Du, the Chief Executive Officer and Chairman of the 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 the Company.
 
 In April 2007, the Company entered into Executive Severance and Change of Control Agreements with Chuan Chiung “Perry” Kuo, the Chief Financial Officer, and James Keim, the Head of Marketing and Sales, pursuant to which these officers would be entitled to, among other things, one time base salary and annual target bonus and immediate vesting of 50% of unvested equity awards if terminated under certain circumstances.  In addition, Mr. Kuo and Mr. Keim would be entitled to, among other things, one and a half times base salary and annual target bonus and immediate vesting of 50% of unvested equity awards if terminated under certain circumstances within twelve months of a change of control of the Company.
 
 
 22.
SEGMENT INFORMATION
 
 In September 2008, the Board approved a plan to transfer Network Security business to O2Security along with its Series A preference shares financing.  In anticipation of the business transfer, management identified two reportable segments as of December 31, 2008, including Integrated Circuit Group and Network Security Group.  The Integrated Circuit Group’s core products and principal source of revenue are its power management semiconductors.  These semiconductor products are produced with digital, analog, and mixed signal integrated circuit manufacturing processes.  The Network Security Group’s system security solution products include support for VPN and firewalls, which provide security functions between computer systems and networks, including the transmission of data across the Internet.
 F-36
 Prior to the approval of the transfer plan of O2Seucrity, the Company’s Chief Operating Decision Maker (“CODM”), the Chief Executive Officer, reviewed information on an enterprise-wide basis to assess performance and allocate resources.  Commencing in the fourth quarter of 2008, the CODM began to manage the Company on the basis of the new segment structure and assessed the performance of each operating segment using information of its net sales and income from operations.  Historical presentation has been adjusted to reflect the new segment structure.
 The Company does not identify or allocate assets by operating segment, nor does the CODM evaluate operating segments using discrete asset information.  The Company does not have inter-segment revenue, and, accordingly, there is none to be reported.  The Company does not allocate gains and losses from interest and other income, or income taxes to operating segments.  The accounting policies for segment reporting are the same as for the Company as a whole.
 
 Operating segment net sales and operating income (loss) were as follows:
 (In Thousands)
 
 Years Ended December 312009


2008


2007Net salesIntegrated Circuit Group

$
124,294


$
135,438


$
163,573Network Security Group


3,204



3,387



1,967$
127,498


$
138,825


$
165,540Income (loss) from operationsIntegrated Circuit Group

$
3,973


$
7,308


$
30,234Network Security Group


(6,561
)


(6,744
)


(6,613
)$
(2,588
)

$
564


$
23,621
 
 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 312009


2008


2007China

$
100,205


$
109,083


$
133,887Korea


14,327



10,742



13,435Japan


9,360



12,952



11,992Taiwan


1,966



2,606



4,232Other


1,640



3,442



1,994$
127,498


$
138,825


$
165,540
 
 For the year ended December 31, 2009, one customer accounted for 10% or more of net sales.  For the year ended December 31, 2008, two customers accounted for 10% or more of net sales.  For the year ended December 31, 2007, one customer accounted for 10% or more of net sales. Sales to these major customers were generated from the Integrated Circuit Group.  The percentage of net sales to those customers was as follows:
 
 
 Years Ended December 312009


2008


2007Customer A


11.3
%


11.5
%


11.1
%Customer B


5.4
%


12.3
%


9.4
%
 
 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 312009


2008


2007China

$
12,784


$
13,873


$
19,807Taiwan


12,807



14,994



16,665U.S.A.


4,873



5,348



6,347Singapore


32



73



232Other


74



65



97$
30,570


$
34,353


$
43,148
  23.
SUBSEQUENT EVENT
 
 In April 2010, the Company entered into an investment agreement with Excelliance MOS Co., Ltd. (“EMC”).  EMC is a fables power device design company in Taiwan. Under the agreement, the Company will invest in EMC’s ordinary shares for $2,000,000, which represents approximately 12.7% ownership of EMC.  As of April 23, 2010, the transaction has not been completed as the Company is in still in the process of obtaining approval from the Taiwan government.
  F-37