**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**

**(Mark one)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe fiscal year ended December 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe transition period from                    to                    **

**Commissionfile number 000-52014**

**TECHWELL, INC.**

(Exact name of Registrantas specified in its charter)

| **Delaware**                              |   | **77-0451738**       |
|-------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of          |   | (I.R.S Employer      |
| incorporation or  organization)           |   | Identification  No.) |
| **408 E. Plumeria Drive**                 |   |                 |
| **San  Jose, California**                 |   | **95134**            |
| (Address of  principal executive offices) |   | (Zip Code)           |

 

Registrant’s telephone number, including areacode:**(408) 435-3888**

**Securities registered pursuant to Section 12(b) ofthe Act:**

| **Title of each class:**                  |   | **Name of  each exchange on which registered** |
|-------------------------------------------|--------|------------------------------------------------|
| Common Stock, par  value $0.001 per share |   | The NASDAQ Stock  Market LLC                   |

 

**Securitiesregistered pursuant to section 12(g) of the Act:**

**None**(Titleof class)

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.  o Yes   x No

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act.  o Yes   x No

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  x Yes   oNo

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter)is not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

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

Large Acceleratedfiler o      Accelerated filer o      Non-Accelerated filer x

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act).  oYes   xNo

The aggregate market value of the registrant’s commonstock held by non-affiliates of the registrant, based upon the closing price ofa share of the registrant’s common stock on June 30, 2006 as reported bythe NASDAQ Global Market on that date, was $153,436,478. Shares of common stockheld by each executive officer, director, and stockholders known by theregistrant to own 10% or more of the outstanding stock based on Schedule 13Gfilings and other information known to us, have been excluded since suchpersons may be deemed affiliates. This determination of affiliate status is notnecessarily a conclusive determination for other purposes.

Number of shares of the registrant’s common stockoutstanding as of February 28, 2007: 20,740,357

**DOCUMENTSINCORPORATED BY REFERENCE**

Items 10 (as to directors, audit committee financialexpert and Section 16(a) Beneficial Ownership Reporting Compliance),11, 12, 13 and 14 of Part III of this Annual Report on Form 10-Kincorporate by reference information from the Registrant’s proxy statement tobe filed with the Securities and Exchange Commission within 120 days of thefiscal year ended December 31, 2006 in connection with the solicitation ofproxies for the Registrant’s 2007 Annual Meeting of Stockholders.

 

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**Tableof Contents**
| **PART I**   | ** ** | ** **                                                                                                                      | ** ** | ** ** | ** ** |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| Item 1.      |       | Business                                                                                                                        |       | 3          |       |
|              |       | Overview                                                                                                                        |       | 3          |       |
|              |       | Industry Background                                                                                                             |       | 4          |       |
|              |       | Our Strengths                                                                                                                   |       | 5          |       |
|              |       | Our Growth Strategy                                                                                                             |       | 6          |       |
|              |       | Products                                                                                                                        |       | 7          |       |
|              |       | Technology                                                                                                                      |       | 9          |       |
|              |       | Customers                                                                                                                       |       | 9          |       |
|              |       | Sales and Marketing                                                                                                             |       | 10         |       |
|              |       | Backlog                                                                                                                         |       | 10         |       |
|              |       | Research and  Development                                                                                                       |       | 11         |       |
|              |       | Intellectual  Property                                                                                                          |       | 11         |       |
|              |       | Manufacturing                                                                                                                   |       | 11         |       |
|              |       | Competition                                                                                                                     |       | 12         |       |
|              |       | Employees                                                                                                                       |       | 13         |       |
|              |       | Executive  Officers and other Key Employees                                                                                     |       | 13         |       |
| Item 1A.          |       | Risk Factors                                                                                                                    |       | 14         |       |
| Item 1B.          |       | Unresolved  Staff Comments                                                                                                      |       | 28         |       |
| Item 2.      |       | Properties                                                                                                                      |       | 28         |       |
| Item 3.      |       | Legal  Proceedings                                                                                                              |       | 28         |       |
| Item 4.      |       | Submission  of Matters to a Vote of Security Holders                                                                            |       | 28         |       |
| **PART II**  |       |                                                                                                                            |       |       |       |
| Item 5.      |       | Market  for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases  of Equity Securities       |       | 29         |       |
| Item 6.      |       | Selected  Financial Data                                                                                                        |       | 30         |       |
| Item 7.      |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations       |       | 31         |       |
| Item 7A.     |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                     |       | 43         |       |
| Item 8.      |       | Financial  Statements and Supplementary Data                                                                                    |       | 44         |       |
| Item 9.      |       | Changes  in and Disagreements With Accountants on Accounting and Financial Disclosure             |       | 45         |       |
| Item 9A.     |       | Controls  and Procedures                                                                                                        |       | 45         |       |
| Item 9B.     |       | Other  Information                                                                                                              |       | 45         |       |
| **PART III** |       |                                                                                                                            |       |       |       |
| Item 10.     |       | Directors,  Executive Officers of the Registrant and Corporate Governance                                                       |       | 46         |       |
| Item 11.     |       | Executive  Compensation                                                                                                         |       | 46         |       |
| Item 12.     |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters            |       | 46         |       |
| Item 13.     |       | Certain  Relationships, Related Transactions and Director Independence                                                          |       | 46         |       |
| Item 14.     |       | Principal  Accountant Fees and Services                                                                                         |       | 46         |       |
| **PART IV**  |       |                                                                                                                            |       |       |       |
| Item 15.     |       | Exhibits  and Financial Statement Schedules                                                                                     |       | 47         |       |
|              |       | Signatures                                                                                                                      |       | 70         |       |

 

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*This Annual Report on Form 10-Kcontains forward-looking statements that involve risks and uncertainties. Thesestatements relate to future periods, future events or our future operating orfinancial plans or performance. These statements can often be identified by theuse of forward-looking terminology such as “expects,” “believes,” “intends,” “anticipates,”“estimates,” “plans,” “may,” or “will,” or the negative of these terms, andother similar expressions. These forward-looking statements include statementsas to the source of our revenues, our ability to generate revenues, our abilityto sustain our growth rate and profitability, our expectation regarding theincrease in certain expenses, our cash needs, our capital requirements, ourmarket risk sensitivity, our business and product strategies, our anticipatedtax rate, industry trends and our anticipation that developments in ourtechnologies and new products will increase our target market share.*

*These forward-lookingstatements reflect our current views with respect to future events, are basedon assumptions and are subject to risks and uncertainties. These risks anduncertainties could cause actual results to differ materially from thoseprojected and include, but are not limited to, fluctuations in our revenue andoperating results, the demand for digital video applications for the consumer,security surveillance and automotive markets, our ability to compete, ourdependence on key and highly skilled personnel, the ability to develop newproducts and to enhance our existing products, the continued seasonality of ourbusiness due to our target markets and location of our customers, our abilityto integrate businesses that we may acquire, our ability to estimate andpredict customer demand, economic volatility in either domestic or foreignmarkets, the impact of any change in United States federal income tax laws andthe loss of any beneficial tax treatment that we currently enjoy, our relianceon independent foundries and subcontractors for the manufacture, assembly andtesting of our products, the length of our sales cycle and reliance ondistributors, our ability to protect our intellectual property, the cyclicalnature of the semiconductor industry, our ability to raise capital, thepotential volatility of our stock, the outcome of future litigation and therisks set forth under Item 1A. “Risk Factors.” Given these risks anduncertainties, you should not place undue reliance on these forward-lookingstatements. Except as required by federal securities laws, we undertake noobligation to update any forward-looking statements for any reason, even if newinformation becomes available or other events occur in the future.*

*In this report allreferences to “Techwell,” “we,” “us” or “our” mean Techwell, Inc.*

*Techwell is ourregistered trademark. We also refer to trademarks of other corporations andorganizations in this Form 10-K.*

**PART I**

**ITEM 1.**                Business

**Overview**

Weare a fabless semiconductor company that designs, markets and sells mixedsignal integrated circuits for multiple video applications in the consumer,security surveillance and automotive markets. We target video applicationsbased on digital technologies that receive and process analog video signals.These video applications include advanced TVs, multifunction LCD monitors, DVDrecorders, camcorders, security surveillance systems and in-car displays. Theseapplications receive analog video signals commonly generated by over-the-air TVbroadcasts, by consumer electronics devices such as set-top boxes, DVD players,VCRs and camcorders and by surveillance cameras. We design both general purposeand application specific products that enable the conversion of analog videosignals to digital form and perform advanced digital video processing to facilitatethe display, storage and transport of video content. We believe this productstrategy allows us to better address varying customer requirements, fullyleverage our technology capabilities and achieve greater share within ourtarget markets. Our semiconductors are based on our proprietary architectureand mixed signal technologies that we believe provide high video quality undera wide range of signal conditions, enable high levels of integration and arecost effective.

We were incorporated in California in March 1997and reincorporated in Delaware in March 2006. The mailing address of ourheadquarters is 408 E. Plumeria Drive, San Jose, California 95134, and ourtelephone number at that location is (408) 435-3888. Our Website iswww.techwellinc.com. Through a link 

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on the Investor Relationssection of our Website, we make available the following filings as soon asreasonably practicable after they are electronically filed with or furnished tothe Securities and Exchange Commission (“SEC”): our Annual Report on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports on Form 8-K,and any amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934. All such filings areavailable free of charge.

**Industry Background**

***Growthin Video Applications Based on Digital Technology***

Videoapplications based on digital technology are experiencing rapid growth in theconsumer, security surveillance and automotive markets. For example, in theconsumer market, there has been a significant increase in demand for digitalvideo systems such as advanced TVs, multifunction LCD monitors and DVDrecorders. Similarly, security surveillance systems and in-car displays arealso experiencing substantial growth. This growth is largely attributable tosignificant improvements in the user experience, including enhanced videoquality, increased functionality and reduced form factors as well as the lowercost of such systems.

TVrepresents one of the largest and most established applications within theconsumer market with a significant installed base worldwide. The majority ofthe installed base is comprised of TVs based on analog technology. TVs thatdisplay video in a digital format, which we refer to as advanced TVs, are rapidlyreplacing these analog TVs. Consumer demand for higher quality video,increasing availability of higher definition content, improved form factors anddeclining TV prices are driving this replacement. TVs based on flat paneldisplay technologies such as liquid crystal displays, or LCDs, and plasmadisplay panels are the most popular types of advanced TVs. Cathode ray tube TVsthat utilize digital technology are also considered advanced TVs. According toDisplaySearch, the advanced TV market is expected to grow from13.2 million units in 2004 to 101.8 million units in 2009,representing a compound annual growth rate of 50%.

Thesecurity surveillance market is comprised of systems that receive video frommultiple surveillance cameras. Security surveillance systems are increasinglyincorporating digital technologies that provide advanced functionalities suchas video motion detection, hard disk drive storage, intelligent video contentanalysis and remote monitoring over the Internet. In addition, a heightenedfocus on security and declining system prices are driving increased demand forsecurity surveillance systems. According to J.P. Freeman, the market forrecorders, servers and multiplexers used in security surveillance systems thatcan incorporate our mixed signal video semiconductors is expected to grow from$2.5 billion in 2004 to $6.0 billion in 2009, representing a compoundannual growth rate of 19%.

Applications such as navigation, entertainment anddriver information systems are causing the proliferation of in-car LCD displaysin the automotive market. These displays are capable of displaying video andgraphics signals from a variety of sources, including navigation systems, DVDs,game consoles, TV tuners and cameras. According to Telematics Research Group,shipments of navigation, entertainment and driver information systems areexpected to grow from a combined 16.5 million units in 2004 to a combined47.2 million units in 2009, representing a compound annual growth rate of23%. In addition to being incorporated into new automobiles by manufacturers,these systems are also increasingly being purchased by consumers in theaftermarket.

***TheComplexity of Video***

Todisplay, store and transport video content, digital video applications receiveanalog video signals based on multiple standards from a variety of sources. Forexample, an advanced TV receives analog TV signals from terrestrial broadcaststations and popular analog video signals from other consumer electronicsdevices such as set-top boxes, DVD players, VCRs and camcorders. Similarly, asecurity surveillance system receives analog video signals from multiplesurveillance cameras for storage on a hard 

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disk drive, display on a TV or PC monitor or transportover the Internet. In addition, an in-car display typically receives analogsignals from navigation systems, DVDs, game consoles, TV tuners and cameras.

Terrestrial TV broadcast stations generate videosignals that conform to standards varying by region, with over ten standardsand sub-standards utilized worldwide. Examples of these standards includeNational Television Systems Committee, or NTSC, phase alternation line, or PAL,and sequential color with memory, or SECAM. Video applications such as set-topboxes, VCRs, DVD players, game consoles, camcorders and surveillance camerasgenerate video signals that conform to popular analog video standards such ascomposite, S-video, component and Syndicate of Radio and TelevisionManufacturers, or SCART. However, these sources may generate video signals thatare off-specification or weak, both of which deteriorate video quality.Off-specification signals are signals that have been generated with slightvariations to specifications under a particular standard. Weak signals aresignals that conform to specifications but result in high levels of noise.Digital video applications must support these standard analog video signals,even if they are off-specification or weak, without sacrificing video quality.

***Opportunityfor Mixed Signal Video Semiconductors***

Mixed signal video semiconductors are criticalcomponents of digital video applications and enable the conversion of standardanalog video signals to digital form, even if they are off-specification orweak. In addition, these semiconductors incorporate advanced digital videoprocessing to improve video quality and provide enhanced functionality.Designing these semiconductors requires an extensive knowledge of TV broadcastand popular analog video standards as well as significant digital videoprocessing expertise and advanced analog design capability. We believe that thegrowth in digital video applications will benefit semiconductor companies thatpossess the combination of these capabilities.

**Our Strengths**

Sinceour inception, we have internally developed the combination of technologies,expertise and capabilities necessary for the conversion and processing of videosignals. We do not depend on third parties for any material technology,expertise or capability. We believe we have the following technology strengths:

*Advanced Analog DesignCapability.**  *Asa result of our advanced analog design capability, we have developed multipletechnologies that enable analog video signals to be processed digitally. One ofthe key analog technologies we have developed internally is our highperformance, cost effective and low power analog front-end that conditions andconverts analog video signals into a digital format. The multiple corefunctions performed within our analog front-end are anti-aliasing filtering,automatic gain control signal clamping and analog to digital conversion. Otherkey analog technologies we have developed internally are phase lock loops, highfrequency and delta sigma analog to digital converters, video and audio digitalto analog converters and low voltage differential signaling.

*Advanced Digital VideoProcessing Technology.**  *Wehave a proprietary video decoding architecture for decoding analog video. Thisarchitecture allows us to cost effectively implement two dimension, or 2D, andthree dimension, or 3D, comb filtering, color demodulating and sync processing,which are the key technologies required for high performance video decoding.Comb filtering enables improved video quality, while sync processing enablessupport of weak and off-specification signals. In addition, we have developed anumber of digital technologies targeted at specific applications in theconsumer, security surveillance and automotive markets. For example, we havedeveloped deinterlacing, scaling and image enhancement algorithms, which areimportant technologies for displaying video signals in advanced TV and in-cardisplay applications. Similarly, we have developed multiplexing, motiondetection, multiple picture-in-picture and motion JPEG compression technologiesfor security surveillance systems.

*Expertise in TV Broadcastand Popular Analog Video Standards.**  *Our focus on video has enabled usto develop expertise in analog TV broadcast and popular analog video signals,including off-specification and 

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weaksignals that are difficult to support. As a result, we have the extensiveknowledge base required to perform the analog, mixed signal and digitalprocessing necessary for the display, storage and transport of video signals.This is particularly important because no standards body exists to determineand qualify products developed to meet analog video standards.

*Integrated Analog andDigital Technologies in a Standard CMOS Process.**  *We integrate our advanced digitaltechnologies with our analog technologies on a single semiconductor using astandard complementary metal-oxide semiconductor, or CMOS, process. We believethis provides us with performance, cost and power advantages over otherprocesses such as bipolar.

Webelieve that the combination of the technology strengths listed above allows usto provide our customers with significant benefits, including:

*High Performance.**  *We enable our customers to achievehigh video quality by limiting artifacts such as cross-color, crawling ordangling dots and stair-stepping or jagging that are commonly found whenprocessing analog video signals. Our technology also enables our customers’products to support multiple standard signals, even if off-specification orweak, without sacrificing video quality. The result is high video quality undera wide range of signal conditions.

*High Levels of Integration.**  *We integrate our analog conversionand digital processing technologies into a single semiconductor. For example,in the security surveillance market, we integrate multiple video decoders and asystem controller into a single highly integrated semiconductor, allowing forincreased functionality and enabling our customers to reduce system-level costssignificantly. Similarly, in the automotive market, we integrate a videodecoder, display processor and a timing controller into a single semiconductor,also enabling our customers to reduce system-level costs.

*Cost Effectiveness.**  *Our proprietary video decodingarchitecture and our standard CMOS process design expertise allow us to reducethe number of transistors required to design semiconductors cost effectively.

**Our Growth Strategy**

Ourobjective is to be the leading provider of high performance, cost effectivemixed signal semiconductors for multiple digital video applications. To achievethis objective, we expect to continue to pursue the following strategies:

*Target Multiple HighGrowth Digital Video Applications.**  *We address a number of digitalvideo applications in the consumer, security surveillance and automotivemarkets that provide us with multiple high growth opportunities. Our productsare incorporated into numerous applications that are experiencing significantgrowth, including advanced TVs, multifunction LCD monitors, DVD recorders,camcorders, security surveillance systems and in-car displays.

*Develop Additional GeneralPurpose and Application Specific Products.**  *We provide our customers with bothgeneral purpose and application specific products. Our general purpose productsprincipally decode analog video signals and can be used in all of our targetapplications. Our application specific products integrate our video decoderwith our advanced digital processing technologies and target LCD display andsecurity surveillance. We believe that our general purpose and applicationspecific product strategy allows us to better address varying customerrequirements, fully leverage our technology capabilities and achieve greatershare within our target markets. We plan to maintain and expand upon thisproduct strategy in the future. For example, in 2007, we plan to introduce ageneral purpose audio/video decoder that decodes the audio and video portionsof an analog TV broadcast signal. The challenges associated with decoding audioare similar to those associated with decoding video. We believe that we canleverage our extensive expertise in TV broadcast signals as well as ourexpertise in developing video decoder products to develop audio decoderproducts.

*Develop New Technologies.**  *We plan to continue to developadditional technologies to address evolving customer requirements. For example,we are developing advanced display processing 

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technologies,including motion adaptive deinterlacing and color management, which areimportant functions in advanced TV applications. In addition, we have expandedour research and development efforts and are developing HDTV demodulating anddecoding technologies, which are important functions for receiving andprocessing digital TV broadcast signals. Consistent with our product strategy,we intend to incorporate these HDTV technologies into our general purpose andapplication specific products in the future.

*Expand Customer Relationships.**  *Our mixed signal semiconductors areused by over 95 companies in the consumer, security surveillance and automotivemarkets. We sell our semiconductors through sales and customer supportpersonnel and sales and marketing offices in the United States, South Korea,Taiwan and China. We intend to continue to expand our sales, marketing andtechnical support capabilities to pursue additional design wins with ourexisting customers and to develop relationships with new customers in ourtarget markets.

**Products**

We design, market and sell mixed signal semiconductorproducts that enable the conversion of analog video signals to digital form andperform advanced digital video processing to facilitate the display, storageand transport of video content. Our general purpose products currently includeour line of video decoders. In 2007, we intend to expand our general purposeproducts to include a line of mixed signal audio products that decode the audioportion of an analog TV broadcast signal. Our application specific productscurrently include our security surveillance and LCD display product lines. Weintend to continue to develop new generations of products for each of theseapplication specific product lines.

***GeneralPurpose Products***

*Video Decoders.**  *Our video decoder products are highperformance mixed signal semiconductors that decode analog TV broadcastsignals, including NTSC, PAL and SECAM, and popular analog video signals,including composite, S-Video, component and SCART, into a standard digitalformat. Our video decoder products integrate proprietary sync processing, colordemodulating and digital 2D and 3D comb filtering, which are the keytechnologies required for high performance video decoding. We offer a broadrange of video decoder products at various price points and with varyingfeatures. We currently sell our video decoder products to customers across thefollowing digital video applications: advanced TV, multifunction LCD monitor,DVD recorder, camcorder, security surveillance systems and in-car display. Inaddition, we are targeting to sell our video decoder products for use in mobileTV phones and portable media players.

***ApplicationSpecific Products***

*Security Surveillance.**  *Our security surveillance productsintegrate important functions required to display, store and transport analogvideo signals from security surveillance cameras. For example, we integratemultiple video decoders into a single semiconductor. As a result, thissemiconductor is able to receive and decode analog video signals from multiplecameras into a standard digital format. In addition, we integrate amultiplexer, a key technology required to combine multiple video signals into asingle video signal. In 2006, we introduced two new security surveillanceproducts, each of which includes four video decoders and a system controller ona single semiconductor. We also have developed a motion JPEG, or MJPEG,encoder/decoder, or CODEC, that facilitates the storage and playback of videofrom a hard disk drive and transport of video over the Internet. We currentlysell our security surveillance products to customers for the followingapplications: embedded digital video recorders, or DVRs, PC-based DVRs,networked video recorders, or NVRs, and multiplexers.

*LCD Display.**  *Our LCD display products integrateimportant functions required to display analog TV broadcast, popular analogvideo, high definition video and PC graphics signals on a LCD display. Thesekey functions include a video decoder, deinterlacer and scaler. In addition,our newer generation LCD display products integrate a timing controller tointerface directly with certain types of LCD displays 

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andimage enhancement functionality to improve overall video quality. In January 2006,we announced the introduction of three new LCD display processors designed forthe automotive end market. These new products are designed to provide advancedimage processing, an integrated programmable timing controller and multipleanalog and digital video inputs. We currently sell our LCD display products tocustomers for digital video applications, including LCD TVs and in-cardisplays.

The following tablesummarizes the features and diverse applications of our general-purpose andapplication specific semiconductor product lines:
| Product Line             | ** ** | **Key Features**                                                                                                        | ** ** | **Representative Applications**                                                                             |
|--------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|
| **General Purpose**      |
| Video Decoder            |       | ·  Supports NTSC, PAL and SECAM analog TV  broadcast formats                                                  |       | Advanced TV, DVD  recorder, multifunction LCD monitor, camcorder, security surveillance and  in-car display |
|                     |       | ·  Supports composite, component, S-video and  SCART video formats                                            |       |                                                                                                        |
|                     |       | ·  Incorporates either 2D or 3D comb filter and  either 9 or 10 bit analog to digital converter          |       |                                                                                                        |
|                     |       | ·  Available with 100mW to 800mW power  consumption                                                           |       |                                                                                                        |
| **Application Specific** |
| Security Surveillance    |       | ·  Integrates  four NTSC and PAL video decoders                                                               |       | Embedded  DVR, PC based DVR, NVR and multiplexer                                                            |
|                     |       | ·  Incorporates  motion detection, scaling and/or audio analog to digital converters                          |       |                                                                                                        |
|                     |       | ·  Integrates  a multiplexer and a MJPEG video CODEC                                                          |       |                                                                                                        |
| LCD Display              |       | ·  Integrates  NTSC, PAL, SECAM video decoder, deinterlacer, scaler, timing controller and  image enhancement |       | LCD  TV and in-car display                                                                                  |
|                     |       | ·  Supports  composite, component, S-video and SCART video formats                                            |       |                                                                                                        |
|                     |       | ·  Incorporates  image enhancement and analog and digital timing controller                                   |       |                                                                                                        |

 

Our other products include contract developmentprojects, early generation mixed signal semiconductors for digital videoapplications and a PCI video decoder product, which is a video decoder thatutilizes peripheral component interconnect, or PCI, technology for personalcomputer applications.

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**Technology**

We have several core competencies that enable us todesign important analog, mixed signal and digital technologies that can beimplemented across our general purpose and application specific product lines.Over the last eight years, we have internally developed the combination oftechnologies, expertise and capabilities necessary for the conversion andprocessing of video signals. We do not depend on third parties for any materialtechnology, expertise or capability.

We have developed a proprietary high performance andcost effective video decoder technology that receives and converts variousanalog video signals, including TV broadcast, composite video, S-video,component and SCART, into a standard digital format. Our video decoder usesboth analog and digital circuitry. Our video decoder uses our high performance,cost effective and low power analog front-end for signal conditioning andsampling the analog signal into digital format. It uses our advanced digitalprocessing circuitry, including a 2D and 3D comb filter, a color demodulatorand a sync processor for deciphering the raw digital stream into the fourprincipal components: luminance, U, V and synchronization. These are importanttechnologies required for high performance video decoding. Comb filtering is atechnique for separating TV broadcast and composite video signals intoluminance and modulated chrominance. Our advanced comb filter providesseparation resulting in high-resolution image with minimal visible artifactssuch as cross color and crawling or dangling dots. Our color demodulatorconverts the modulated chrominance signals based on NTSC, PAL and SECAMstandards and sub-standards into baseband U and V components. Our syncprocessor extracts the vertical and horizontal synchronization information fromthe video stream, which is required for the display device to reconstruct theoriginal video content. Both our advanced color demodulator and our advancedsync processor are critical to our decoder’s ability to support off-specificationand weak signals.

We have expertise in analog TV broadcast and popularanalog video standards. These standards typically define video signalcharacteristics such as line period, field rate, signal amplitude, chrominancemodulation scheme and frequency, among others. Notwithstanding the existence ofstandards, terrestrial TV stations and video applications such as TVs, VCRs,DVD players, game consoles, camcorders and security cameras sometimes generatesignals that are off-specification due to their mechanical nature or othercharacteristics. In addition, these video sources sometimes contain noise frominterference, additional modulation/de-modulation processing or RFtransmission. These variations in signal standards and signal strength createsignificant challenges for OEMs and, in turn, semiconductor companies. Todeal with these challenges, we believe these semiconductor companies requireexpertise in analog TV broadcast and popular analog video standards to assuremanufacturers that their products can support these signals, even if they areoff-specification or weak.

We design semiconductorsthat receive an analog signal, convert the analog signal to a digital signalrepresented by ones and zeroes and then use digital circuitry to process thesignal. Using digital circuitry to process analog video signals allows us toachieve high performance video, integrate more functionality and reduce costs.As a result, we combine analog functionality on the same semiconductorsubstrate with digital functionality. Digital circuits perform high speedswitching between logic states that generate transients known aselectromagnetic interference as well as electrical noise on the substrate andon the power bus. By contrast, analog circuits are extremely sensitive to noise.There are significant design and development challenges involved in mixingnoisy digital circuits with noise-sensitive analog circuits on the samesemiconductor substrate. Our design engineers are skilled at solving theseproblems to achieve high quality video performance on a mixed signalsemiconductor.

**Customers**

We principally sell our products to distributors who,in turn, sell to OEMs, ODMs, contract manufacturers and design houses. Inaddition, we sell our products, though to a lesser extent, directly to 

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OEMs and ODMs. ODMstypically design and manufacture electronic products to sell to OEMs. Inthe three years ended December 31, 2006, our largest customers have beendistributors. Our largest customer in 2004 was IC Land, accounting for 11% ofrevenues. Our largest customers in 2005 were IC Land and Lacewood eachaccounting for 10% of our revenues. Our largest customers in 2006 wereLacewood, Regulus and Gentech accounting for 15%, 12% and 10% of our revenues,respectively. Our agreements to sell our products through distribution channelsgenerally provide for a non-exclusive right to sell, and to promote and developa market for our products in a specified geographic area. These agreementsgenerally may be terminated by either party on 30 days’ notice and do not includeprice protection. Our direct sales to OEMs and ODMs are accomplished throughpurchase orders.

Substantiallyall of our sales are to customers in Asia, which sales accounted forapproximately 98% of our revenues for 2004, approximately 99% of our revenuesfor 2005 and approximately 98% of our revenues for 2006. The table belowindicates the percentage of total revenue by geographic location for theperiods indicated:

| ** **  | ** ** | **Year Ended  December 31,** | ** ** |
|-------------|------------|----------------------------------------|------------|
| ** **  | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2006** | ** ** |
| South Korea |       |                                   | 52         | % |   |   | 41 | % |   |   | 31 | % |   |
| Taiwan      |       |                                   | 25         |   |   |   | 38 |   |   |   | 43 |   |   |
| China       |       |                                   | 7          |   |   |   | 16 |   |   |   | 21 |   |   |
| Japan       |       |                                   | 14         |   |   |   | 4 |   |   |   | 3 |   |   |
| Other       |       |                                   | 2          |   |   |   | 1 |   |   |   | 2 |   |   |

 

**Sales and Marketing**

We sell our products worldwide through multiplechannels, including our direct sales force and applications engineering staffand our network of domestic and international independent distributors andsales representatives. Each of these sales channels is supported by ourcustomer service and marketing organizations. We have sales and customersupport personnel in the United States as well as China, Japan, South Korea andTaiwan. We intend to expand our sales and support capabilities and our networkof independent sales representatives in key regions domestically andinternationally.

Our sales cycle typicallyranges from six to 12 months. We work directly with system designers tocreate demand for our semiconductors by providing them withapplication-specific product information for their system design, engineeringand procurement groups. We actively engage these groups during their designprocesses to introduce them to our semiconductors. We endeavor to design ourproducts to meet anticipated, increasingly complex and specific designrequirements, but which will also support widespread demand for the productsand future enhancements to them. If successful, this process culminates in asystem designer deciding to use our products in their system, which we refer toas a design win. Once our product is accepted and designed into an application,the system designer is likely to continue to use the same or enhanced versionsof our product across a number of their models, which tends to extend the lifecycles of our product. If we fail to achieve an initial design win, we may losethe opportunity for sales to a customer for a number of its products and for alengthy period of time.

**Backlog**

Our sales are madeprimarily pursuant to standard individual purchase orders. Our backlog consistsof orders that we have received from customers that have not yet shipped.Historically, management has not used backlog as an indicator of futurebusiness. As our order lead times may vary and as industry practice allowscustomers to reschedule or cancel orders on relatively short notice, we believethat backlog is not necessarily a good indicator of future sales. In addition,our quarterly revenues depend on orders booked and shipped in that quarter.

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**Research andDevelopment**

Our research anddevelopment efforts are focused on the development of new technologies as wellas general purpose and application specific products. As of December 31,2006, we had 39 persons engaged in research and development. Our research anddevelopment expense was $6.3 million in 2004, $8.7 million in 2005and $9.2 million in 2006.

**IntellectualProperty**

We seek to protect ourproprietary technology, documentation and other written materials primarilyunder trade secret and copyright laws. We also typically require employees andconsultants with access to our proprietary information to executeconfidentiality agreements. The steps taken by us to protect our proprietaryinformation may not be adequate to prevent misappropriation of our technology.

Although we rely primarily on trade secret laws andcontractual restrictions to protect the technology in the semiconductors wecurrently design and market, our success and ability to compete in the futuremay also depend to a significant degree upon obtaining and enforcing patentprotection for our video decoding architecture and other mixed signaltechnologies. As of December 31, 2006, we had three issued patents andfive patent applications pending in the United States and three patentapplications pending in foreign jurisdictions. These patents and patentapplications cover aspects of the technology in the semiconductors we currentlydesign and market, including a patent for our video decoding architecture. Ourissued patents have expiration dates ranging from September 2, 2019 to March 27,2020. Patents that we currently own do not cover all of the semiconductors thatwe presently design and market. Our present and future patents may provide onlylimited protection for our technology and may not be sufficient to providecompetitive advantages to us. For example, competitors could be successful inchallenging any issued patents or, alternatively, could develop similar or moreadvantageous technologies on their own or design around our patents.

The laws of other countries in which we market oursemiconductors, such as some countries in the Asia/Pacific region, may offerlittle or no protection for our proprietary technologies. Reverse engineering,unauthorized copying or other misappropriation of our proprietary technologiescould enable third parties to benefit from our technologies without paying usfor doing so. Any inability to protect our proprietary rights could harm ourability to compete, generate revenue and grow our business.

We may be required toresort to litigation to enforce our intellectual property rights. We may alsobe subject to legal proceedings and claims relating to our intellectualproperty in the ordinary course of our business. Intellectual propertylitigation is expensive and time-consuming and could divert management’sattention away from running our business. This litigation could also require usto pay substantial damages to the party claiming infringement, stop sellingproducts or using technology that contains the allegedly infringingintellectual property, develop non-infringing technology or enter into royaltyor license arrangements.

**Manufacturing**

We do not own or operate a semiconductor fabrication,packaging or testing facility. We depend on third-party vendors to manufacture,package and test our products. By outsourcing manufacturing, we are able toavoid the cost associated with owning and operating our own manufacturingfacility. This allows us to focus our efforts on the design and marketing ofour products.

*SemiconductorFabrication.**  *Wecurrently outsource our semiconductor manufacturing principally to TaiwanSemiconductor Manufacturing Company, or TSMC. We work closely with TSMC toforecast on a monthly basis our manufacturing capacity requirements. Oursemiconductors are currently fabricated in several advanced, sub-micronmanufacturing processes. Because finer manufacturing processes lead to 

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enhanced performance,smaller silicon chip size and lower power requirements, we continually evaluatethe benefits and feasibility of migrating to smaller geometry processtechnologies in order to reduce cost and improve performance. We believe thatour fabless manufacturing approach provides us with the benefits of superiormanufacturing capability as well as flexibility to move the manufacturing,assembly and testing of our products to those vendors that offer the bestcapability at an attractive price. Nevertheless, because we do not have aformal, long-term pricing agreement with TSMC, our wafer costs and services aresubject to sudden price fluctuations based on the cyclical demand forsemiconductors. Our engineers work closely with TSMC to increase yields, lowermanufacturing costs and improve quality. We intend to qualify and retainadditional foundries to manufacture our semiconductors in the future.

*Assemblyand Test.**  *Ourproducts are shipped from TSMC to third-party sort, assembly and testfacilities where they are assembled into finished semiconductors and tested. Weoutsource all packaging and testing of our products to assembly and testsubcontractors, principally Advanced Semiconductor Engineering, Inc., orASE, in Taiwan. Our products are designed to use low cost, standard packagesand to be tested with widely available test equipment.

*Quality Assurance.**  *We are committed to maintaining thehighest level of quality in our products. We have designed and implemented aquality management system that provides the framework for continual improvementof products, processes and customer service. We also rely on in-depthsimulation studies, testing and practical application testing to validate andverify our semiconductors. To ensure consistent product quality, reliabilityand yield, together with our manufacturing logistics partners we closelymonitor the production cycle by reviewing manufacturing process data from eachwafer foundry and assembly subcontractor. Both TSMC and ASE have been awardedISO 9000 certificates.

**Competition**

The market in which we operate is extremelycompetitive, and is characterized by rapid technological change, continuouslyevolving customer requirements and declining average selling prices. We may notbe able to compete successfully against current or potential competitors. Wecompete with numerous domestic and international semiconductor manufacturersand designers, including Philips Electronics N.V., Micronas SemiconductorHolding AG and Texas Instruments Incorporated. Most of our current andpotential competitors have longer operating histories, significantly greaterresources and name recognition and a larger base of customers than we do. Thismay allow them to respond more quickly than us to new or emerging technologiesor changes in customer requirements. Some of our competitors currently offerproduct features or technologies that we do not currently offer but intend tosell in the future, such as general purpose audio decoders. We must, therefore,compete against competitors that have more experience in developing and sellingproducts and technologies that we do not currently offer but intend to offer inthe future. Some of our competitors also use smaller geometry processtechnologies in their products, which can result in better manufacturing yieldsand decreased costs. In addition, these competitors may have greatercredibility with our existing and potential customers. Many of our current andpotential customers have their own internally developed semiconductorsolutions, and may choose not to purchase products from third party supplierslike us. Increased competition could harm our business, by, for example, increasingpressure on our profit margins or causing us to lose customers. In addition,delivery of products with defects or reliability, quality or compatibilityproblems may damage our reputation and competitive position. For example, in2003, we were unable to sell certain products to a customer for whom theseproducts were specifically designed as a result of our failure to produce aproduct that met this customer’s specifications. We believe this customereventually secured this product from another vendor. Although we no longerdesign and tailor specific chips for customers, our ability to competesuccessfully depends in part on our ability to deliver products withoutreliability, quality or compatibility problems.

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Our ability tocompete successfully depends on a number of factors, including:

·       performanceand robustness;

·       functionality;

·       priceand cost effectiveness;

·       rapidtime-to-market; and

·       customerservice and support.

We believe we currentlycompete favorably with respect to these factors in the aggregate. However, wecannot assure you that our semiconductor products will continue to competefavorably or that we will be successful in the face of increasing competitionfrom new products and enhancements introduced by existing competitors or new companiesentering our market.

**Employees**

As of December 31,2006, we employed 96 full-time employees, including 39 in research anddevelopment, 29 in sales, marketing and support, 18 in operations and 10 ingeneral and administration. We have never had a work stoppage and none ofour employees is represented by a labor organization or under any collectivebargaining arrangements. We consider our employee relations to be good.

**Executive Officersand other Key Employees**

Thefollowing table shows information about our executive officers and other keyemployees as of February 28, 2007: 
| Name                  | ** ** | ** ** | ** ** | **Age**                                                                   | ** ** | **Position(s)** |
|-----------------------|------------|------------|------------|---------------------------------------------------------------------------|------------|-----------------|
| Fumihiro Kozato       |       | 47         |       | President, Chief  Executive Officer and Director                          |
| Mark Voll             |       | 52         |       | Vice President of  Finance and Administration and Chief Financial Officer |
| Dr. Feng Kuo     |       | 49         |       | Chief Technical Officer                                                   |
| Dong Wook (David) Nam |       | 39         |       | Vice President of Sales  and Marketing                                    |
| Tom Krause            |       | 29         |       | Director of Business  Development                                         |
| Joe Kamei             |       | 50         |       | Director of Manufacturing                                                 |

 

*FumihiroKozato* founded Techwell in 1997 and has served as ourpresident and chief executive officer since inception. From 1995 to 1996, Mr. Kozatowas president of Sigmax Technologies, Inc., a CD-ROM controller chipdevelopment company. From 1991 to 1995, Mr. Kozato was the businesscontrol manager for Ricoh Co., Ltd, a global manufacturer of officeautomation equipment. Mr. Kozato holds a B.S. in mathematics from theUniversity of California, Santa Barbara.

*MarkVoll* has served as our vice president of finance andadministration and chief financial officer since November 2005. From June 2002to November 2005, Mr. Voll served as chief financial officer atMonolithic System Technology, Inc., a semiconductor intellectual propertylicensing company. From December 2004 to July 2005, Mr. Vollserved as the interim chief executive officer of Monolithic System Technology, Inc.From June 2000 to June 2002, Mr. Voll served as the chieffinancial officer for Axis Systems, Inc., a developer of semiconductor verificationtools. Mr. Voll holds a B.S. in accounting from Providence College.

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***Dr. Feng Kuo******has served as our chief technicalofficer since 2000 and our vice president of engineering from 1998 to 2000.From 1994 to 1996, Dr. Kuo was the vice president of engineering of SigmaxTechnologies, Inc., a CD-ROM controller chip development company. From1991 to 1994, Dr. Kuo was a design manager at S-MOS systems, a Seiko EpsonCorporation affiliated company responsible for semiconductor development andsilicon foundry service. Dr. Kuo holds a B.S. in electrical engineeringfrom National Taiwan University and an M.S. and Ph.D. from Stony BrookUniversity of New York.***

***Dong Wook (David) Nam******has served as our vice presidentof sales and marketing since July 2005. From October 2002 toJune 2005, Mr. Nam served as our director of sales and from January 2001to February 2002, he served as our field applications engineer manager.From January 1994 to January 2001, Mr. Nam was a technicalapplications and marketing engineer at Samsung Electronics Co., Ltd., alarge consumer electronics company. Mr. Nam holds a B.S. in electricalengineering from KyungPook National University in South Korea.***

***Tom Krause******has served as our director ofbusiness development since April 2004. From March 2002 toMarch 2004, Mr. Krause was an associate at Technology Crossover Ventures,a venture capital firm. From July 2000 to February 2002,Mr. Krause was an investment banking analyst at Robertson Stephens Inc.,an investment banking firm. Mr. Krause holds a. B.A. in economics fromPrinceton University.***

***Joe Kamei******has served as our director ofmanufacturing since May 2000. From 1998 to 2000, Mr. Kamei was amanager at Kanematsu USA Inc., a Japanese general trading company. From 1991 to1998, Mr. Kamei was an engineering manager at Ricoh Co., Ltd., aglobal manufacturer of office automation equipment. Mr. Kamei holds a B.S.of precise machinery engineering from Tokyo University.***

**ITEM 1A.**        RiskFactors

If any of the followingrisks actually occur, our business, results of operations and financialcondition could suffer significantly.

**Risks Related toOur Business**

***Fluctuations in our revenue and operating results on aquarterly basis could cause the market price of our common stock to decline.***

Our revenue andoperating results are difficult to predict, have in the past fluctuated, and mayin the future fluctuate from quarter to quarter. It is possible that ouroperating results in some quarters will be below market expectations. Thiswould likely cause the market price of our common stock to decline. Ourquarterly operating results are affected by a number of factors, including:

·       unpredictablevolume and timing of customer orders, which are not fixed by contract but varyon a purchase order basis;

·       uncertaindemand in the consumer market for LCD display products;

·       theloss of one or more of our customers, causing a significant reduction orpostponement of orders from these customers;

·       decreasesin the overall average selling prices of our products;

·       changesin the relative sales mix of our products;

·       changesin our cost of finished goods;

·       theavailability, pricing and timeliness of delivery of other components used inour customers’ products;

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·       ourcustomers’ sales outlook, purchasing patterns and inventory adjustments basedon consumer demands and general economic conditions;

·       productobsolescence and our ability to manage product transitions;

·       ourability to successfully develop, introduce and sell new or enhanced products ina timely manner; and

·       thetiming of new product announcements or introductions by us or by our competitors.

We base our plannedoperating expenses in part on our expectations of future revenue, and asignificant portion of our expenses is relatively fixed in the short term. Wehave limited historical financial data from which to predict future sales forour products. As a result, it is difficult for us to forecast our futurerevenue and budget our operating expenses accordingly. If revenue for aparticular quarter is lower than we expect, we likely will be unable toproportionately reduce our operating expenses for that quarter, which wouldharm our operating results for that quarter.

***We have a history of losses, have only recently becomeprofitable and may not sustain or increase profitability in the future whichmay cause the market price of our common stock to decline.***

We first became profitablein the second quarter of 2005. We incurred significant net losses prior to thatquarter. As of December 31, 2006, we had an accumulated deficit ofapproximately $10.0 million. To sustain or increase profitability, we will needto generate and sustain substantially higher revenue while maintainingreasonable cost and expense levels. We currently expect to increase expenselevels in each of the next several quarters to support increased research anddevelopment and sales and marketing efforts. These expenditures may not resultin increased revenue or customer growth. Because many of our expenses are fixedin the short term, or are incurred in advance of anticipated sales, we may notbe able to decrease our expenses in a timely manner to offset any shortfall ofsales. We may not be able to sustain or increase profitability on a quarterlyor an annual basis. This may, in turn, cause the price of our common stock todecline.

***If the growth of demand for digital video applicationsfor the consumer, security surveillance and automotive markets does notcontinue, our ability to increase our revenue could suffer.***

Our ability toincrease our revenue will depend on increased demand for digital videoapplications in the consumer, security surveillance and automotive markets. Ifour target markets do not grow as rapidly or to the extent we anticipate, ourbusiness could suffer. The growth of our target markets is uncertain and willdepend in particular upon:

·       consumerconfidence and the continued increase of consumer spending levels;

·       thepace at which new digital video applications are adopted;

·       acontinued reduction in the costs of products in these markets; and

·       the availability, at areasonable price, of components required by such products, such as liquidcrystal display, or LCD, panels.

***The average selling prices of our semiconductorproducts may be subject to rapid price declines which could harm our revenueand gross profits.***

The semiconductor productswe develop and sell may be subject to rapid declines in average selling prices.From time to time, we have had to reduce our prices significantly to meetcustomer requirements, and we may be required to reduce our prices in thefuture. This would cause our gross margins to decline which in turn maynegatively impact our operating results. Our financial results will suffer ifwe are unable 

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tooffset any reductions in our average selling prices by increasing our salesvolumes, reducing our costs or developing new or enhanced products on a timelybasis with higher selling prices or gross margins.

***We face intense competition and may not be able tocompete effectively, which could reduce our market share and decrease our netrevenue and profitability.***

The markets in which weoperate are extremely competitive and are characterized by rapid technologicalchange, continuously evolving customer requirements and declining averageselling prices. We may not be able to compete successfully against current orpotential competitors. If we do not compete successfully, our market share andrevenue may decline. We compete with large semiconductor manufacturers anddesigners. Most of our current and potential competitors have longer operatinghistories, significantly greater resources and name recognition and a largerbase of customers than we do. This may allow them to respond more quickly thanwe can to new or emerging technologies or changes in customer requirements. Inaddition, these competitors may have greater credibility with our existing andpotential customers. Many of our current and potential customers have their owninternally developed semiconductor solutions and may choose not to purchaseproducts from third party suppliers like us.

***We depend on key and highly skilled personnel tooperate our business, and if we are unable to retain our current personnel andhire additional personnel, our ability to develop and market our products couldbe harmed.***

We believe our futuresuccess will depend in large part upon our ability to attract and retain highlyskilled managerial, engineering and sales and marketing personnel. The loss ofany key employees or the inability to attract or retain qualified personnel,including engineers and sales and marketing personnel, could delay thedevelopment and introduction of, and harm our ability to sell, our products andharm the market’s perception of us. We believe that our future success ishighly dependent on the contributions of Fumihiro Kozato, our president andchief executive officer, and Dr. Feng Kuo, our chief technical officer. Wedo not have long-term employment contracts with these or any other keypersonnel, and their knowledge of our business and industry would be extremelydifficult to replace.

***If we fail to develop new products and enhance ourexisting products in order to react to rapid technological change and marketdemands, our business will suffer.***

We must develop new products and enhance our existingproducts with improved technologies to meet rapidly evolving customerrequirements. We need to design products for customers who continually requirehigher performance and functionality at lower costs. We must, therefore,continue to cost-effectively add features that enhance performance andfunctionality to our products. The development process for these advancementsis lengthy and requires us to accurately anticipate market trends. Our failureto accurately anticipate market trends in a timely manner will harm the marketacceptance of our products and the sales of our products.

Developing and enhancingthese products is uncertain and can be time-consuming, costly and complex.There is a risk that these developments and enhancements will be late, fail tomeet customer or market specifications or not be competitive with products fromour competitors that offer comparable or superior performance andfunctionality. Any new products or product enhancements may not be accepted innew or existing markets. Our business will suffer if we fail to develop andintroduce new products or product enhancements on a cost-effective basis.

***If we fail to achieve initial design wins for ourproducts, we may lose the opportunity for sales for a significant period oftime to customers and be unable to recoup our investments in our products.***

We expend considerableresources in order to achieve design wins for our products, especially our newproducts and product enhancements. Once a customer designs a semiconductor intoa product, it is 

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likelyto continue to use the same semiconductor or enhanced versions of thatsemiconductor from the same supplier across a number of similar and successorproducts for a lengthy period of time due to the significant costs associatedwith qualifying a new supplier and potentially redesigning the product toincorporate a different semiconductor. If we fail to achieve an initial designwin in a customer’s qualification process, we may lose the opportunity forsignificant sales to that customer for a number of its products and for alengthy period of time. This may cause us to be unable to recoup ourinvestments in our products, which would harm our business.

***If we fail to develop, in a timely manner, or at all,technologies that address the demands of a shift from analog broadcast TV todigital broadcast TV, our operating results could suffer.***

Our semiconductors areprincipally designed to decode analog broadcast TV signals into digital images.We believe the transmission of broadcast TV signals will over time shift fromanalog signals to digital signals. We are in the process of developing mixed signaland digital technology to decode digital signals. However, transmission ofdigital video involves a combination of emerging technologies. The complexitiesof these technologies and the variability in implementations betweenmanufacturers may cause our development of semiconductors to be costly andtime-consuming. We may never obtain the benefits of our investment indeveloping this technology. The complexities of digital broadcast technologiesmay also cause some of the semiconductors we are developing to ultimately workincorrectly for reasons that may be either related or unrelated to ourproducts, or not be interoperable with other key products. Delays ordifficulties in integrating our semiconductors into digital broadcast TVproducts or the failure of products incorporating digital broadcast TV toachieve broad market acceptance could have an adverse effect on our business.

***A significant portion of our products are sold intothe consumer and security surveillance markets, and if sales of our semiconductorsinto these markets decline or do not increase, or if we do not increase oursales into the automotive market, our business and financial results couldsuffer.***

We sell semiconductorstargeted for the consumer, security surveillance and automotive markets. Webelieve that for the year ended December 31, 2006 more than 80% of oursales were derived from the sale of our products designed for the consumer andsecurity surveillance markets. If sales of semiconductors into these marketsdecline or do not increase, or if demand slows in these markets generally, ouroperating results would suffer. In addition, we have increased our focus on theautomotive market and devoted substantial resources to the development ofsemiconductors for digital video applications that address this market. If weare not successful in selling our semiconductors into this market, we may notrecover the costs associated with our efforts in this area and our operatingresults could suffer.

***Our business is subject to seasonality, which islikely to cause our revenues to fluctuate.***

Our business is subject toseasonality as a result of our target markets and the location of ourcustomers. We sell a significant number of our semiconductors into the consumermarket. Our customers who manufacture products for the consumer marketexperience seasonality in the sales of their products, which in turn may affectthe timing and volume of orders for our semiconductors. Because the consumermarket for digital video applications is characterized by this seasonality, ouroperating results may vary significantly from quarter to quarter. For example,we generally experience lower sales in the first calendar quarter with ourvideo decoder and LCD display products as a result of the seasonality associatedwith the consumer markets. In addition, a significant number of oursemiconductors are sold to customers located in Asia, primarily to customerslocated in regions who observe the Lunar New Year holiday, also referred to asChinese New Year. Typically, our foreign offices and those of our customers areclosed for a week or more during the extended holiday period. For the yearended December 31, 2006, approximately 95% of our revenues wereattributable to customers located in regions that observe the Lunar New Yearholiday. 

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As aresult, we typically experience fluctuations in our first calendar quarter duein part to a slowing of business activity around the period of the Lunar NewYear holiday. These sales fluctuations are expected to continue.

***We manufacture our products based on our estimates ofcustomer demand, and if our estimates are incorrect our financial results couldbe negatively impacted.***

Our sales are made on thebasis of purchase orders rather than long-term purchase commitments. Inaddition, our customers may cancel purchase orders or defer the shipments ofour products. We manufacture our products according to our estimates ofcustomer demand. This process requires us to make multiple demand forecastassumptions, each of which may introduce error into our estimates. If weoverestimate customer demand, we may manufacture products that we may not beable to sell. As a result, we would have excess inventory, which would increaseour losses. Conversely, if we underestimate customer demand or if sufficientmanufacturing capacity were unavailable, we would forego revenue opportunities,lose market share and damage our customer relationships.

***We do not expect to sustain the growth rate of ourrecent revenues.***

Our revenues increasedapproximately 109% in 2005 from 2004 and approximately 49% in 2006 from 2005.We do not expect to achieve similar growth rates in future periods. You shouldnot rely on the results of any prior quarterly or annual periods as anindication of our future operating performance. If we are unable to maintainadequate revenue growth, our stock price may decline and we may not haveadequate financial resources to execute our business objectives.

***We may pursue acquisitions or investments incomplementary technologies and businesses, which could harm our operatingresults and may disrupt our business.***

In the future, we maypursue acquisitions of, or investments in, complementary technologies andbusinesses. Acquisitions present a number of potential risks and challengesthat could, if not met, disrupt our business operations, increase our operatingcosts and reduce the value to us of the acquired company. Even if we aresuccessful, we may not be able to integrate the acquired businesses, productsor technologies into our existing business and products. Furthermore, potentialacquisitions and investments, whether or not consummated, may divert ourmanagement’s attention and require considerable cash outlays at the expense ofour existing operations. In addition, to complete future acquisitions, we mayissue equity securities, incur debt, assume contingent liabilities or haveamortization expenses and write-downs of acquired assets, which could adverselyaffect our profitability.

***Changes in our tax rates will affect our futureresults.***

Our future effective taxrates will be favorably or unfavorably affected by the absolute amount andfuture geographic distribution of our pre-tax income, our ability to takeadvantage of the available tax planning strategies and our ability to utilizeour net operating loss carryforwards. For example, at December 31, 2006,we had federal and state tax net operating loss carryforwards of approximately$6.7 million and $3.2 million, respectively. These net operating losscarryforwards may be used to offset future taxable income and thereby reduceour income taxes otherwise payable. Section 382 of the Internal RevenueCode of 1986, as amended (the “Code”), imposes an annual limit on the abilityof a corporation that undergoes an ‘‘ownership change’’ to use its net operatingloss carryforwards to reduce its tax liability. Due in part to equityfinancings, we experienced ‘‘ownership changes’’ as defined in Section 382of the Code. Accordingly, our use of the net operating loss carryforwards andcredit carryforwards is limited by the annual limitations as described inSections 382 and 383 of the Code. Our plans for continued internationalexpansion may further limit our ability to utilize our net operating losscarryforwards as our net income increases. Our effective tax rate for the yearsended December 31, 2006 and 2005 was 8.9% and 

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3.4%,respectively. As a result of the factors discussed above, we anticipate theeffective tax rate for 2007 to be approximately 25%. In addition, we aresubject to the examination of our income tax returns by the Internal RevenueService and other tax authorities. The outcomes of these examinations, if theyoccur, could harm our net income and financial condition.

***We may not be able to manage our future growtheffectively, and we may need to incur significant expenditures to address theadditional operational and control requirements of our growth.***

We are experiencinga period of significant growth and expansion, which has placed, and any futureexpansion will continue to place, a significant strain on our management,personnel, systems and financial resources. We plan to hire additionalemployees to support an increase in research and development as well asincrease our sales and marketing efforts. To manage our growth successfully andhandle the responsibilities of being a public company, we believe we musteffectively:

·       hire,train, integrate and manage additional qualified engineers for research anddevelopment activities, sales and marketing personnel and financial andinformation technology personnel;

·       continueto enhance our customer resource management and manufacturing managementsystems;

·       implementadditional and improve existing administrative, financial and operationssystems, procedures and controls, including the requirements of theSarbanes-Oxley Act of 2002;

·       expandand upgrade our technological capabilities; and

·       managemultiple relationships with our customers, distributors, suppliers and otherthird parties.

Our efforts may requiresubstantial managerial and financial resources and may increase our operatingcosts even though these efforts may not be successful. If we are unable tomanage our growth effectively, we may not be able to take advantage of marketopportunities, develop new products, satisfy customer requirements, execute ourbusiness plan or respond to competitive pressures.

***We may experience unforeseen delays, expenses or lowerthan expected product yields for our semiconductors manufactured by our thirdparty vendors, which could increase our costs and prevent us from recognizingthe benefits of new technologies we develop.***

We occasionally haveexperienced delays in completing the development and introduction of newproducts and product enhancements, and we could experience delays in the futurethat may render our new or enhanced products, when introduced, obsolete andunmarketable. In addition, it is often difficult for semiconductor foundries toachieve satisfactory product yields. Product yields depend on both our productdesign and the manufacturing process technology unique to the semiconductorfoundry. Since low yields may result from either design or processdifficulties, identifying yield problems can only occur well into theproduction cycle after a product that can be physically analyzed and tested exists.Poor yields from our foundry could cause us to sell our products at lower grossmargins and therefore harm our financial results.

***Defects in our products could increase our costs,cause customer claims and delay our product shipments.***

Although we test ourproducts, they are complex and may contain defects and errors. In the past, wehave encountered defects and errors in our products. For example, in 2003 wewere unable to sell certain products to a customer for whom these products werespecifically designed as a result of our failure to produce a product that metthis customer’s specifications. We believe this customer secured the productfrom another vendor. Delivery of products with defects or reliability, qualityor compatibility problems may damage our reputation and our ability to retainexisting customers and attract new customers. In addition, product defects anderrors could result in additional development costs, diversion of technicalresources, 

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delayedproduct shipments, increased product returns and product liability claimsagainst us, which may not be fully covered by insurance. Any of these couldharm our business.

***We rely on a limited number of independentsubcontractors for the manufacture, assembly and testing of our semiconductors,and the failure of any of these third-party vendors to deliver products orotherwise perform as requested could damage our relationships with ourcustomers, decrease our sales and limit our growth.***

We do not have ourown manufacturing or assembly facilities and have very limited in-house testingfacilities. Therefore, we must rely on third-party vendors to manufacture,assemble and test the products we design. We currently rely on TaiwanSemiconductor Manufacturing Corporation, or TSMC, to produce the majority ofour semiconductors. We rely on Advanced Semiconductor Engineering, Inc.,or ASE, to assemble, package and test many of our products. If these vendors donot provide us with high-quality products, services and production and testcapacity in a timely manner, or if one or more of these vendors terminates itsrelationship with us, we may be unable to obtain satisfactory replacements tofulfill customer orders on a timely basis, our relationships with our customerscould suffer and our sales could decrease. Other significant risks associatedwith relying on these third-party vendors include:

·       reducedcontrol over product cost, delivery schedules and product quality;

·       potentialprice increases;

·       inabilityto achieve required production or test capacity and achieve acceptable yieldson a timely basis;

·       longerdelivery times;

·       increasedexposure to potential misappropriation of our intellectual property;

·       shortagesof materials that foundries use to manufacture products;

·       laborshortages or labor strikes; and

·       quarantinesor closures of manufacturing facilities due to the outbreak of viruses, such asSARS, the avian flu or any similar future outbreaks in Asia.

We currently do not havelong-term supply contracts with any of our third-party vendors. Therefore, theyare not obligated to perform services or supply products to us for any specificperiod, in any specific quantities or at any specific price, except as may beprovided in a particular purchase order. Neither TSMC nor ASE has providedcontractual assurances to us that adequate capacity will be available for us tomeet future demand for our products. These third party vendors may allocatecapacity to the production of other companies’ products while reducingdeliveries to us on short notice. In particular, other customers that arelarger and better financed than we are or that have long-term agreements withTSMC or ASE may cause either or both of them to reallocate capacity to thosecustomers, decreasing the capacity available to us.

***We plan to retain additional foundries to manufactureour semiconductors, which could disrupt our current manufacturing process andnegatively impact our sales volumes and net revenue.***

As a result of thecomplexity in manufacturing our semiconductors, it is difficult to retain andrely on a new foundry. We may not be able to enter into a relationship with anew foundry that produces satisfactory yields on a cost-effective basis. If weneed another foundry because of increased demand, or the inability to obtaintimely and adequate deliveries from our current provider, we might not be ableto cost-effectively and quickly retain other vendors to satisfy ourrequirements. Any failure to successfully integrate a new foundry couldnegatively impact our sales volumes and net revenue.

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***We may experience difficulties in transitioning tosmaller geometry process technologies or in achieving higher levels of designintegration, which may result in reduced manufacturing yields, delays inproduct deliveries and increased expenses.***

To reduce costs andmaintain our gross margins, we intend to transition our semiconductors toincreasingly smaller geometries and achieve higher levels of designintegration. This transition requires us to modify the manufacturing processesfor our products and to redesign some products, which may result in delays inproduct deliveries. We periodically evaluate the benefits, on aproduct-by-product basis, of migrating to smaller geometry process technologiesto reduce our costs. In the past, we have experienced some difficulties inshifting to smaller geometry process technologies and new manufacturingprocesses, which resulted in reduced manufacturing yields, delays in productdeliveries and increased expenses. We may face similar difficulties, delays andexpenses in the future. If our foundry, or we, experience significant delays inthese transitions or fail to efficiently implement these transitions, ourbusiness, financial condition and results of operations could suffer.

***Our business depends on international customers,suppliers and operations in Asia, and as a result we are subject to regulatory,operational, financial and political risks, which could adversely affect ourfinancial results.***

The percentage of our revenues attributable to salesto customers in Asia was approximately 98% in 2006, 99% in 2005 and 98% in2004. We expect that revenues from customers in Asia will continue to accountfor substantially all of our revenues. All our sales currently are denominatedin U.S. dollars. As a result, an increase in the value of the U.S. dollarrelative to foreign currencies could make our products less competitive ininternational markets.

Currently, wemaintain international sales offices in Asia, and we rely on a network ofthird-party sales representatives to sell our products internationally. We havealso established offices in China, Taiwan and South Korea, which serve variousaspects of our business. Moreover, we have in the past relied on, and expect tocontinue to rely on, suppliers, manufacturers and subcontractors located inAsia, including Taiwan. Accordingly, we are subject to several risks andchallenges, any of which could harm our business and financial results. Theserisks and challenges include:

·       difficultiesand costs of staffing and managing international operations across differentgeographic areas and cultures;

·       compliancewith a wide variety of domestic and foreign laws and regulations, includingthose relating to the import or export of semiconductor products;

·       legaluncertainties regarding taxes, tariffs, quotas, export controls, exportlicenses and other trade barriers;

·       ourability to receive timely payment and collect our accounts receivable;

·       political,legal and economic instability, foreign conflicts and the impact of regionaland global infectious illnesses, such as the SARS outbreak or avian flu in thecountries in which we and our customers, suppliers, manufacturers andsubcontractors are located;

·       legaluncertainties regarding protection for intellectual property rights in somecountries; and

·       fluctuations in freightrates and transportation disruptions.

***Our sales cycle can be lengthy, which could result inuncertainty and delays in generating revenue.***

Because our products arebased on constantly evolving technologies, we have experienced a lengthy salescycle for some of our semiconductors, particularly those designed for digitalvideo applications in the automotive market. Our sales cycle typically rangesfrom six to 12 months. We may experience a delay 

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betweenthe time we increase expenditures for research and development, sales andmarketing efforts and inventory and the time we generate revenue, if any, fromthese expenditures. In addition, because we do not have long-term commitmentsfrom our customers, we must repeat our sales process on a continual basis evenfor current customers looking to purchase a new product. As a result, ourbusiness could be harmed if a customer reduces or delays its orders, choosesnot to release products incorporating our semiconductors or elects not topurchase a new product or product enhancements from us.

***We primarily sell our semiconductors throughdistributors, and if our relationships with one or more of those distributorswere to terminate, our operating results may be harmed.***

We market and distribute our products primarilythrough distributors. This distribution channel has been characterized by rapidchange and consolidations. Distributors have accounted for a significantportion of our revenues in the past. Sales to our distributors representedapproximately 79% of our revenues in 2006 and 65% of our revenues in 2005.

Our operating results andfinancial condition could be significantly disrupted by the loss of one or moreof our current distributors and sales representatives, volume pricing discounts,order cancellations, delays in shipment by one of our major distributors orsales representatives or the failure of our distributors or salesrepresentatives to successfully sell our products.

***We rely primarily upon copyright and trade secret lawsand contractual restrictions to protect our proprietary rights, and, if theserights are not sufficiently protected, our ability to compete and generaterevenue could suffer.***

We seek to protectour proprietary design processes, documentation and other written materialsprimarily under trade secret and copyright laws. We also typically requireemployees and consultants with access to our proprietary information to executeconfidentiality agreements. The steps taken by us to protect our proprietaryinformation may not be adequate to prevent misappropriation of our technology.In addition, our proprietary rights may not be adequately protected because:

·       thelaws of other countries in which we market our semiconductors, such as somecountries in the Asia/Pacific region, may offer little or no protection for ourproprietary technologies;

·       peoplemay not be deterred from misappropriating our technologies despite theexistence of laws or contracts prohibiting these actions; and

·       policingunauthorized use of our intellectual property may be difficult, expensive andtime-consuming, and we may be unable to determine the extent of anyunauthorized use.

Reverse engineering,unauthorized copying or other misappropriation of our proprietary technologiescould enable third parties to benefit from our technologies withoutcompensating us for doing so. For example, if the foundry that manufactures oursemiconductors loses control of our intellectual property, it would be moredifficult for us to take remedial measures since it is located in Taiwan, whichdoes not have the same protection for intellectual property as is provided inthe United States. Any inability to adequately protect our proprietary rightscould harm our ability to compete, generate revenue and grow our business.

***We may not obtain sufficient patent protection on thetechnology embodied in the semiconductors we currently manufacture and market,which could harm our competitive position and increase our expenses.***

Although we rely primarilyon trade secret laws and contractual restrictions to protect the technology inthe semiconductors we currently manufacture and market, our success and abilityto compete in the future may also depend to a significant degree upon obtainingpatent protection for our proprietary technology. As of December 31, 2006,we had three issued patents in the United States and five patent applicationspending in the United States and three applications pending in foreignjurisdictions. These 

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patentsand patent applications cover aspects of the technology in the semiconductorswe currently manufacture and market, including a patent for our video decodingarchitecture. Patents that we currently own do not cover all of thesemiconductors that we presently manufacture and market. Our patent applicationsmay not result in issued patents, and even if they result in issued patents,the patents may not have claims of the scope we seek. In addition, any issuedpatents may be challenged, invalidated or declared unenforceable. The term ofany issued patents would be 20 years from its filing date and if ourapplications are pending for a long time period, we may have a correspondinglyshorter term for any patent that may issue. Our issued patents have expirationdates ranging from September 2, 2019 to March 27, 2020. Our presentand future patents may provide only limited protection for our technology andmay not be sufficient to provide us with competitive advantages. For example,competitors could be successful in challenging any issued patents or, alternatively,could develop similar or more advantageous technologies on their own or designaround our patents. Also, patent protection in certain foreign countries maynot be available or may be limited in scope and any patents obtained may not beas readily enforceable as in the United States, making it difficult for us toeffectively protect our intellectual property from misuse or infringement byanyone in these countries. Our inability to obtain and enforce our intellectualproperty rights in some countries may harm our business. In addition, given thecosts of obtaining patent protection, we may choose not to protect certaininnovations that later turn out to be important to our business or ourcompetitive position.

***Intellectual property litigation, which is common inour industry, could be costly, harm our reputation, limit our ability to sellour products and divert the attention of management and technical personnel.***

Our industry is characterized by frequent litigationregarding patent and other intellectual property rights. In September 2000,we received a letter from another entity claiming to have patents in certaintechnology and inviting us to take a license under these patents that apply tocomb filters, phase demodulation, oversampling and interpolation or scaling anddeinterlacing. This third party, however, has failed to specify which of ourproducts or technologies allegedly infringe on its patents. We cannot assessthe potential impact on our business because we cannot currently identify whichof our products and technologies, if any, might be impacted by the potentialclaim. Our discussions with this third party are ongoing. We also were recentlya party to an administrative proceeding in front of the intellectual propertytribunal in South Korea in which another party unsuccessfully sought adetermination that our TW2824 and TW2834 products infringed a South Koreanpatent allegedly held by that party. We have certain indemnificationobligations to customers under our contract development projects with respectto any infringement of third-party patents and intellectual property rights byour products. If a lawsuit were to be filed against us in connection with anoffer to license technology or claims of infringement, our business would beharmed.

Questions of infringementin the digital video applications market involve highly technical andsubjective analyses. Litigation may be necessary in the future to enforce anypatents we may receive and other intellectual property rights, to protect ourtrade secrets, to determine the validity and scope of the proprietary rights ofothers or to defend against claims of infringement or invalidity, and we maynot prevail in any future litigation. Litigation, whether or not determined inour favor or settled, could be costly, could harm our reputation, could causeour customers to use our competitors’ products and could divert the efforts andattention of our management and technical personnel from normal businessoperations. In addition, adverse determinations in litigation could result inthe loss of our proprietary rights, subject us to significant liabilities,require us to seek licenses from third parties or prevent us from licensing ourtechnology or selling our products, any of which could seriously harm ourbusiness.

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***Our headquarters are located in the State ofCalifornia and our third-party manufacturing, assembly and testing vendors havefacilities in the State of Washington and in Asia, areas subject to significantearthquake risks. Any disruption to our or their operations resulting fromearthquakes or other natural disasters could cause significant delays in theproduction or shipment of our products.***

TSMC, which manufacturesour semiconductors, has facilities in the State of Washington and in Taiwan. Ourassembly and testing vendors’ facilities are primarily located in Taiwan. Inaddition, our headquarters are located in Northern California. The risk of anearthquake or extreme weather in the Pacific Rim region or an earthquake inNorthern California or Washington state is significant due to the proximity ofmajor earthquake fault lines. In September 1999, a major earthquake inTaiwan affected the facilities of TSMC and ASE, our primary assembly vendor, aswell as other providers of foundry, packaging and test services. In 2005,several typhoons also disrupted the operations of TSMC and ASE. As a result ofthese natural disasters, these contractors suffered power outages anddisruptions that impaired their production capacity. In March 2002 and June 2003,additional earthquakes occurred in Taiwan. The occurrence of earthquakes orother natural disasters could result in the disruption of our foundry orassembly and test capacity. We may not be able to obtain alternate capacity onfavorable terms, if at all, which could harm our operating results.

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

We prepare our financialstatements to conform with accounting principles generally accepted in theUnited States of America, or GAAP. These accounting principles are subject tointerpretation by the Financial Accounting Standards Board, or FASB, theSecurities and Exchange Commission, or SEC, and various bodies formed tointerpret and create appropriate accounting policies. A change in thosepolicies can have a significant effect on our reported results and may affectour reporting of transactions completed before a change is announced. Changesto those rules or the questioning of current practices may adverselyaffect our reported financial results or the way we conduct our business. Forexample, accounting policies affecting many aspects of our business, including rules relatingto employee stock option grants, have recently been revised. The FASB and otheragencies have made changes to GAAP that required us, starting in our firstquarter of fiscal 2006, to record a charge to earnings for the estimated fairvalue of employee stock option grants and other equity incentives, whereasunder prior accounting rules charges were required only for the intrinsicvalue, if any, of such awards to employees. We may have significant and ongoingaccounting charges under the new rules resulting from option grant andother equity incentive expensing, which could reduce our overall net income. Inaddition, since we historically have used equity-related compensation as acomponent of our total employee compensation program, the accounting changecould make the use of equity-related compensation less attractive to us orrequire us to pay more cash compensation and therefore make it more difficultfor us to attract and retain employees.

***Management may apply our cash and equivalents,short-term and long-term investments to uses that do not increase our marketvalue or improve our operating results.***

We intend to use our cashand equivalents, short-term and long-term investments for general corporatepurposes, including working capital and capital expenditures. We may also use aportion of our cash and equivalents, short-term and long-term investments toacquire or invest in complementary technologies, businesses or other assets. Wehave not reserved or allocated our cash and equivalents, short-term andlong-term investments for any specific purpose, and we cannot state withcertainty how our management will use our cash and equivalents, short-term andlong-term investments. Accordingly, our management has considerable discretionin applying our cash and equivalents, short-term and long-term investments andmay use our cash and equivalents, short-term and long-term investments forpurposes that do not result in any increase in our results of operations ormarket value. Until the cash and equivalents, 

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short-termand long-term investments are used, they may be placed in investments that donot produce income or that lose value.

**Risks Related toOur Industry**

***Due to the cyclical nature of the semiconductorindustry, our operating results may fluctuate significantly, which couldadversely affect the market price of our common stock.***

The semiconductor industryis highly cyclical and subject to rapid change and evolving industry standardsand, from time to time, has experienced significant downturns. These downturnsare characterized by decreases in product demand, excess customer inventoriesand accelerated erosion of prices. These factors have caused and could causesubstantial fluctuations in our net revenue and in our operating results. Anydownturns in the semiconductor industry may be severe and prolonged, and anyfailure of this industry to fully recover from downturns could harm ourbusiness. The semiconductor industry also periodically experiences increaseddemand and production capacity constraints, which may affect our ability toship products. Accordingly, our operating results have varied and may varysignificantly as a result of the general conditions in the semiconductorindustry, which could cause our stock price to decline.

***The demand for semiconductors is affected by generaleconomic conditions, which could impact our business.***

The United States andinternational economies have recently experienced a period of slow economicgrowth. A sustained economic recovery is uncertain. In addition, terrorist actsand similar events, turmoil in the Middle East or war in general, couldcontribute to a slowdown of the market demand for our products. If the economicrecovery slows down as a result of the recent economic, political and socialturmoil, or if there are further terrorist attacks in the United States orelsewhere, we may experience decreases in the demand for our products, whichmay harm our operating results. Our business has been adversely affected byprevious economic downturns. For example, during the global economic downturnin 2002 to 2003, demand for many semiconductor and consumer electronicsproducts suffered as consumers delayed purchasing decisions or changed orreduced their discretionary spending. As a result, demand for our productssuffered and we had to implement restructuring initiatives to align our corporatespending with a slower than anticipated revenue growth during that timeframe.

**Risks Related toOur Common Stock**

***Our stock price has been volatile and you may not beable to resell shares of our common stock at or above the price you paid, or atall.***

The trading price of ourcommon stock has experienced wide fluctuations due to the factors discussed inthis risk factors section and elsewhere in this Annual Report on Form 10-K.For example, in the three months ended December 31, 2006, the closingprice of our stock ranged from $14.07 on November 2, 2006 to $18.96 on November 16,2006. In addition, the stock market in general has, and The Nasdaq GlobalMarket and technology companies in particular have, experienced extreme priceand volume fluctuations. These trading prices and valuations may not besustainable. These broad market and industry factors may decrease the marketprice of our common stock, regardless of our actual operating performance. Inaddition, in the past, following periods of volatility in the overall marketand the market price of a company’s securities, securities class actionlitigation has often been instituted against companies that experienced suchvolatility. This litigation, if instituted against us, regardless of itsoutcome, could result in substantial costs and a diversion of our management’sattention and resources.

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***If securities or industry analysts do not publishresearch or reports about our business, or if they change their recommendationsregarding our stock adversely, our stock price and trading volume coulddecline.***

The trading market for ourcommon stock is influenced by the research and reports that industry orsecurities analysts publish about us or our business. If one or more of theanalysts who cover us downgrade our stock, our stock price would likelydecline. If one or more of these analysts cease coverage of our company or failto regularly publish reports on us, we could lose visibility in the financialmarkets, which in turn could cause our stock price or trading volume todecline.

***Our ability to raise capital in the future may belimited and our failure to raise capital when needed could prevent us fromexecuting our growth strategy.***

We believe that ourexisting cash and cash equivalents, short-term investments and long-terminvestments will be sufficient to meet our anticipated cash needs for at leastthe next 12 months. The timing and amount of our working capital and capitalexpenditure requirements may vary significantly depending on numerous factors,including:

·       marketacceptance of our products;

·       theneed to adapt to changing technologies and technical requirements;

·       theexistence of opportunities for expansion; and

·       accessto and availability of sufficient management, technical, marketing andfinancial personnel.

If our capital resourcesare insufficient to satisfy our liquidity requirements, we may seek to selladditional equity securities or debt securities or obtain debt financing. Thesale of additional equity securities or convertible debt securities wouldresult in additional dilution to our stockholders. Additional debt would resultin increased expenses and could result in covenants that would restrict ouroperations. We have not made arrangements to obtain additional financing andthere is no assurance that financing, if required, will be available in amountsor on terms acceptable to us, if at all.

***Substantial future sales of our common stock in thepublic market could cause our stock price to fall.***

Additional sales of our common stock in the publicmarket, or the perception that these sales could occur, could cause the marketprice of our common stock to decline. At December 31, 2006, we had20,528,468 shares of common stock outstanding. A substantial portion of theseshares of common stock are entitled to rights to cause us to register the saleof those shares under the Securities Act. Registration of these shares underthe Securities Act would result in these shares, other than shares purchased byour affiliates, becoming freely tradable without restriction under theSecurities Act immediately upon the effectiveness of the registration.

Some of our officers anddirectors have entered into 10b5-1 trading plans, which generally providefor pre-determined sales of stock by these officers. The sales of stock by ourofficers and directors, even if made pursuant to these 10b5-1 tradingplans may cause our stock price to fall.

***Our corporate actions are substantially controlled byofficers, directors, principal stockholders and affiliated entities.***

Our directors, executiveofficers and their affiliated entities beneficially own a significantpercentage of our outstanding common stock. These stockholders, if they actedtogether, could exert substantial control over matters requiring approval byour stockholders, including electing directors and approving mergers or otherbusiness combination transactions. This concentration of ownership may alsodiscourage, delay or prevent a change in control of our company, which coulddeprive our stockholders of an 

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opportunityto receive a premium for their stock as part of a sale of our company and mightreduce our stock price. These actions may be taken even if they are opposed byour other stockholders.

***Delaware law and our corporate charter and bylawscontain anti-takeover provisions that could delay or discourage takeoverattempts that stockholders may consider favorable.***

Provisions in ourcertificate of incorporation, as amended and restated, may have the effect ofdelaying or preventing a change of control or changes in our management. Theseprovisions include the following:

·       theright of the board of directors to elect a director to fill a vacancy createdby the expansion of the board of directors;

·       theprohibition of cumulative voting in the election of directors, which wouldotherwise allow less than a majority of stockholders to elect directorcandidates;

·       therequirement for advance notice for nominations for election to the board ofdirectors or for proposing matters that can be acted upon at a stockholders’meeting;

·       theability of the board of directors to alter our bylaws without obtainingstockholder approval;

·       theability of the board of directors to issue, without stockholder approval, up to10,000,000 shares of preferred stock with terms set by the board of directors,which rights could be senior to those of common stock;

·       therequired approval of holders of at least two-thirds of the shares entitled tovote at an election of directors to adopt, amend or repeal our bylaws or amendor repeal the provisions of our certificate of incorporation regarding theindemnification of directors and officers and the ability of stockholders totake action;

·       therequired approval of holders of at least a majority of the shares entitled tovote at an election of directors to remove directors for cause; and

·       theelimination of the right of stockholders to call a special meeting ofstockholders and to take action by written consent.

In addition, because weare incorporated in Delaware, we are governed by the provisions of Section 203of the Delaware General Corporation Law. These provisions may prohibit orrestrict large stockholders, in particular those owning 15% or more of ouroutstanding voting stock, from merging or combining with us. These provisionsin our certificate of incorporation and bylaws and under Delaware law coulddiscourage potential takeover attempts and could reduce the price thatinvestors might be willing to pay for shares of our common stock in the futureand result in our market price being lower than it would without theseprovisions.

***We have incurred and will continue to incur increasedcosts as a result of being a public company.***

As a public company, wehave incurred and will continue to incur significant legal, accounting andother expenses that we did not incur as a private company. In addition, theSarbanes-Oxley Act of 2002, as well as new rules subsequently implementedby the SEC and Nasdaq, have required changes in corporate governance practicesof public companies. We expect these new rules and regulations to increaseour legal and financial compliance costs and to make some activities moretime-consuming and costly. For example, as a result of becoming a publiccompany, we have added an independent director, created additional boardcommittees and adopted policies regarding internal controls and disclosurecontrols and procedures. In addition, we have incurred and will continue toincur additional costs associated with our public company reportingrequirements. We are currently evaluating and monitoring developments withrespect 

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to thesenew rules, and we cannot predict or estimate the amount of additional costs wemay incur or the timing of such costs.

**ITEM 1B.**       UnresolvedStaff Comments

Not applicable.

**ITEM 2.**                Properties

Our corporate headquarters and primary research anddevelopment and operations facilities occupy approximately 27,900 square feetin San Jose, California under leases that expire in December 2011. Wealso lease properties in Taiwan, South Korea and China. We do not own any manufacturingfacilities, and we contract and license to third parties the production anddistribution of our semiconductors. We believe our space is adequate for ourcurrent needs and that suitable additional or substitute space will beavailable to accommodate foreseeable expansion of our operations.

For additional informationregarding obligations under operating leases, see our consolidated financialstatements and related notes included elsewhere in this report.

**ITEM 3.**                LegalProceedings

On September 26, 2005, we filed an administrativeaction on behalf of an original equipment manufacturer (OEM) in South Koreaagainst Alogics Co., Ltd. (Alogics), a semiconductor company in South Korea,seeking a determination that the OEM’s product offering which incorporates ourTW2834 product does not infringe a patent held by Alogics. On February 13,2006, the South Korean Intellectual Property Tribunal rendered a decisionin the action determining that the OEM’s product offering whichincorporates our TW2834 product does not infringe the patent held byAlogics. On March 10, 2006, Alogics filed an appeal with the Korean PatentCourt (KPC). On November 16, 2006, the KPC concluded the action bydetermining that the OEM’s product offering which incorporates our TW2834product does not infringe the patent held by Alogics. Alogics did notfile an appeal with the Korean Supreme Court within the time periods prescribedby applicable rules thus concluding the matter.

We are currently not aparty to any other material legal proceedings. We may from time to time becomeinvolved in litigation relating to claims arising from our ordinary course ofbusiness. These claims, even if not meritorious, could result in theexpenditure of significant financial and managerial resources.

**ITEM 4.**                Submissionof Matters to a Vote of Security Holders

No matters were submitted to a vote of securityholders during the fourth quarter of 2006.

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**PART II**

**ITEM 5.**                Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities

**Market Informationfor Common Stock**

The information required by this item regarding equitycompensation plans is set forth under the caption Equity Compensation PlanInformation in our 2007 Proxy Statement and is incorporated herein byreference.

On June 26,2006, we completed an initial public offering of shares of our common stock andissued 2,540,225 shares of our common stock at a price of $9.00 per share. OurRegistration Statement was declared effective by the Securities and ExchangeCommission on June 21, 2006. We received approximately $17.5 million incash, net of underwriting discounts, commissions and other offering costs. In July 2006,we received aggregate proceeds of $1.1 million, net of underwriting discountsand commissions, from the sale of an additional 130,000 shares following theunderwriters’ partial exercise of their over-allotment option received inconnection with our initial public offering in June 2006.

Ourcommon stock began trading on the Nasdaq Global Market on June 21, 2006under the symbol “TWLL.” The following table sets forth for the periodsindicated the high and low closing sale prices of our common stock, as reportedby the Nasdaq Global Market.

| ** **            | ** ** | **Low** | ** ** | **High** | ** ** |
|-----------------------|------------|---------|------------|----------|------------|
| **Fiscal Year 2006:** |       |    |       |     |       |
| Second Quarter        |       | $       | 8.75       |     | $          | 10.65 |   |
| Third Quarter         |       | $       | 9.70       |     | $          | 16.74 |   |
| Fourth Quarter        |       | $       | 14.07      |     | $          | 18.96 |   |

 

**Holders of Record**

At December 31, 2006,there were approximately 180 shareholders of record.

**Dividend Policy**

To date, we have not paidcash dividends on our capital stock and we have no current intention to do so.

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

Information regarding thesecurities authorized for issuance under our equity compensation plans can befound under Item 12 of Part III of this Report.

**Sales ofUnregistered Securities and Purchases of Equity Securities**

During the three months ended December 31, 2006,we did not sell any equity securities that were not registered under theSecurities Act nor did we repurchase any of our equity securities. However,during the fiscal year ended December 31, 2006, the period covered by thisreport, we had sales of unregistered equity securities. These transactions aredisclosed in our quarterly reports on Form 10-Q as filed with theSEC.

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**ITEM 6.**                SelectedFinancial Data

Thefollowing selected consolidated financial data should be read together with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in Item 7 and our consolidated financial statements and related notesincluded elsewhere in this report. The selected consolidated balance sheet dataat December 31, 2006 and 2005 and the selected consolidated statements ofoperations data for each year ended December 31, 2006, 2005 and 2004 havebeen derived from our audited consolidated financial statements that areincluded elsewhere in this report. The selected consolidated balance sheet dataat December 31, 2003 and 2002 and the selected consolidated statements ofoperations data for each year ended December 31, 2003 and 2002 have beenderived from our audited consolidated financial statements not included in thisreport. Historical results are not necessarily indicative of the results to beexpected in the future.

| ** **                                                             | ** ** | **Year Ended December 31,**                            | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                             | ** ** | **2002**                                                              | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                             | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Consolidated Statements of Operations Data:**                        | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                               |       | $                                                                     | 4,844      |   | $ | 11,128 |   | $ | 17,251 |   | $ | 36,051 |   | $ | 53,712 |   |
| Cost of revenues(1)                                                    |       | 3,237                                                                 |       | 8,862 |   | 8,780 |   | 17,304 |   | 22,977 |   |
| Gross profit                                                           |       | 1,607                                                                 |       | 2,266 |   | 8,471 |   | 18,747 |   | 30,735 |   |
| Operating expenses:                                                    |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Research and  development(1)                                           |       | 4,680                                                                 |       | 4,651 |   | 6,319 |   | 8,684 |   | 9,183 |   |
| Selling, general and  administrative(1)                                |       | 2,918                                                                 |       | 2,909 |   | 3,798 |   | 5,730 |   | 8,702 |   |
| Restructuring costs                                                    |       | —                                                                |       | — |   | 224 |   | — |   | — |   |
| Total operating expenses                                               |       | 7,598                                                                 |       | 7,560 |   | 10,341 |   | 14,414 |   | 17,885 |   |
| Income (loss) from  operations                                         |       | (5,991                                                                | )          | (5,294 | ) | (1,870 | ) | 4,333 |   | 12,850 |   |
| Interest income                                                        |       | 76                                                                    |       | 95 |   | 179 |   | 368 |   | 1,670 |   |
| Income (loss) before  income taxes                                     |       | (5,915                                                                | )          | (5,199 | ) | (1,691 | ) | 4,701 |   | 14,520 |   |
| Income taxes                                                           |       | 48                                                                    |       | — |   | 51 |   | 160 |   | 1,298 |   |
| Net income (loss)                                                      |       | $                                                                     | (5,963     | ) | $ | (5,199 | ) | $ | (1,742 | ) | $ | 4,541 |   | $ | 13,222 |   |
| Basic net income (loss)  per share                                     |       | $                                                                     | (2.81      | ) | $ | (2.16 | ) | $ | (0.49 | ) | $ | 1.14 |   | $ | 1.04 |   |
| Weighted shares used in  computing basic net income (loss) per share   |       | 2,120                                                                 |       | 2,405 |   | 3,591 |   | 3,993 |   | 12,772 |   |
| Diluted net income  (loss) per share                                   |       | $                                                                     | (2.81      | ) | $ | (2.16 | ) | $ | (0.49 | ) | $ | 0.25 |   | $ | 0.64 |   |
| Weighted shares used in computing diluted net income  (loss) per share |       | 2,120                                                                 |       | 2,405 |   | 3,591 |   | 18,434 |   | 20,538 |   |

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(1)          Amountsinclude stock-based compensation as follows:

| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Costs and expenses:**    | ** ** | **(in thousands)**                    | ** ** |
| Cost of revenues                     |       | $                                          | 42         |   | $ | 48 |   | $ | 22 |   | $ | 31 |   | $ | 117 |   |
| Research and development             |       | 719                                        |       | 447 |   | 474 |   | 427 |   | 1,100 |   |
| Selling, general and  administrative |       | 748                                        |       | 638 |   | 426 |   | 442 |   | 1,050 |   |
|                                      |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                          | ** ** | **December 31,**   | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **2002**                | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Consolidated Balance Sheet Data:** | ** ** | **(in thousands)** | ** ** |
| Cash and cash  equivalents                          |       | $                       | 5,013      |   | $ | 8,248 |   | $ | 2,069 |   | $ | 15,982 |   | $ | 13,201 |   |
| Short and long-term  investments                    |       | —                  |       | 3,007 |   | 8,356 |   | 804 |   | 41,327 |   |
| Working capital                                     |       | 4,986                   |       | 12,005 |   | 12,023 |   | 21,152 |   | 51,473 |   |
| Total assets                                        |       | 6,242                   |       | 15,507 |   | 14,143 |   | 25,644 |   | 63,993 |   |
| Redeemable convertible  preferred stock             |       | 20,641                  |       | 37,889 |   | 37,868 |   | 40,777 |   | — |   |
| Total stockholders’ equity (deficit)           |       | $                       | (15,339    | ) | $ | (24,800 | ) | $ | (25,458 | ) | $ | (19,210 | ) | $ | 57,146 |   |

 

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**ITEM 7.**                Management’sDiscussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial conditionand results of operations should be read in conjunction with our consolidatedfinancial statements and the related notes included elsewhere this AnnualReport on Form 10-K.

**Overview**

Weare a fabless semiconductor company that designs, markets and sells mixedsignal integrated circuits for multiple video applications in the consumer,security surveillance and automotive markets. We target video applicationsbased on digital technologies that receive and process analog video signals.These video applications include advanced TVs, multifunction LCD monitors, DVDrecorders, camcorders, security surveillance systems and in-car displays. Theseapplications receive analog video signals commonly generated by over-the-air TVbroadcasts, by consumer electronics devices such as set-top boxes, DVD players,VCRs and camcorders and by surveillance cameras. We design both general purposeand application specific products that enable the conversion of analog videosources to digital form and perform advanced digital video processing tofacilitate the display, storage and transport of video content. We believe thisproduct strategy allows us to better address varying customer requirements,fully leverage our technology capabilities and achieve greater share within ourtarget markets. Our semiconductors are based on our proprietary architectureand mixed signal technologies that we believe provide high video quality undera wide range of signal conditions, enable high levels of integration and arecost effective.

Wecommenced operations in 1997. From 1997 to 1999, we were primarily involved indeveloping our technology. We shipped our first generation video decoder in1999. Since 1999, our business has experienced significant growth primarily asa result of our ability to develop new products, obtain design wins and convertthese design wins into revenues. We generated revenues from the sale of over 20different products in the year ending December 31, 2006.

Wehave three principal semiconductor product lines: video decoder products,security surveillance products and liquid crystal display, or LCD, products.Our video decoder products, which we view as general purpose products, arehigh-performance mixed signal semiconductors that decode analog TV broadcastsignals, including National Television Systems Committee, or NTSC, phasealternation line, or PAL, and sequential color with memory, or SECAM, andpopular analog video signals, including composite, S-Video, component andSyndicate of Radio and Television Manufacturers, or SCART, into a standarddigital format. Our security surveillance products integrate importantfunctions required to display, store and transport analog video signals fromsecurity surveillance cameras. In 2006, we introduced two new securitysurveillance products, each of which includes four video decoders and a systemcontroller on a single semiconductor. We also have developed a motion JPEG, orMJPEG, encoder/decoder, or CODEC, that facilitates the storage and playback ofvideo from a hard disk drive and transport of video over the Internet. Our LCDdisplay products integrate important functions required to display analog TVbroadcast, popular analog video, high definition video and PC graphics signalson an LCD display. In the first quarter of 2006, we announced the introductionof three new LCD display processors designed for rear seat entertainment in theautomotive market. In the first quarter of 2007, we plan to introduce two newLCD display processors that can be used in navigation systems for front seatconsoles in the automotive market. These new products are designed to provideadvanced image processing, an integrated programmable timing controller andmultiple analog and digital video inputs. Our other products include earlygeneration mixed signal semiconductors for digital video applications and a PCIvideo decoder product, which is a video decoder that utilizes peripheralcomponent interconnect, or PCI, technology for personal computer applications.

Althoughour revenues have grown rapidly in a short period of time, we do not expect toachieve similar growth rates in the future. We currently expect to increase ourexpense levels in each of the next several quarters to support increasedresearch and development and sales and marketing efforts. These expendituresmay not result in increased revenue or profitability in the future. Inaddition, our ability to 

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increase our revenues will depend on increased demandfor digital video applications in the consumer, security surveillance andautomotive markets. The growth of our target markets is uncertain. In addition,the timing of orders by and shipments to our customers, as well as generaltrends in our target markets, can cause our revenue growth to be inconsistent.

Weundertake significant product development efforts well in advance of a product’srelease, and in advance of receiving purchase orders from our customers. Ourproduct development efforts, which are focused on developing new designs withbroad demand and potential for future derivative products, typically take fromsix months to two years until production begins, depending on the product’scomplexity. If we secure a design win, the system designer is likely tocontinue to use the same or enhanced versions of our product across a number oftheir models, which tends to extend the life cycles of our product. Conversely,if a competitor secures the design win, it may be difficult for us to sell intothe customer’s application for an extended period. Our sales cycle typicallyranges from six to 12 months. Due to the length of our product development andsales cycle, the majority of our revenues for any period is generally weightedtoward products introduced for sale, meaning products for which we commencedplacing orders with our manufacturing subcontractors, in the prior one or twoyears. As a result, our present revenues are not necessarily representative offuture sales because our future sales are likely to be comprised of a differentmix of products, some of which are now in the development stage.

As afabless semiconductor company, we outsource all of our manufacturing, assemblyand test functions to third-party vendors primarily located in Taiwan. Thisbusiness model enables us to reduce our capital expenditures and fixed costs,while focusing our engineering and design resources on our core strength, thedesign of mixed signal semiconductors for digital video applications.

Wesell our products to distributors that fulfill third-party orders for ourproducts. We also sell directly, using independent sales representatives, toOEMs such as Samsung and LG Electronics, which have historically been some ofour largest customers, and to original design manufacturers, or ODMs. In2005, we derived 65% of our revenues from products sold to distributors and 35%from products sold to OEMs or ODMs. In 2006, we derived approximately 79%of our revenues from products sold to distributors and 21% from products soldto OEMs or ODMs. Our gross margins have not historically beensignificantly different between sales to distributors and sales to OEMs or ODMsthrough orders procured by independent sales representatives. However, ouroperating profit on sales through orders procured by independent salesrepresentatives can be less due to the payment of commissions to salesrepresentatives which we record as sales and marketing expense.

Wereceived an aggregate of 63%, 67% and 76% of our revenues from our ten largestcustomers in 2004, 2005 and 2006, respectively. In 2004, one of our customersaccounted for 11% of our revenues. In 2005, two of our customers, both of whichare distributors, each accounted for 10% of our revenues. In 2006, three of ourcustomers, all of which are distributors, accounted for 15%, 12% and 10% of ourrevenues, respectively.

We derive substantially all of our revenues from salesto foreign customers, particularly in Asia, which sales accounted forapproximately 98% of our revenues in 2004, approximately 99% of our revenues in2005 and approximately 98% of our revenues in 2006. The table below indicatesthe percentage of total revenue by geographic location for the periodsindicated:

| ** **  | ** ** | **Year Ended December 31,** | ** ** |
|-------------|------------|--------------------------------------------|------------|
| ** **  | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| South Korea |       |                                       | 52         | % |   |   | 41 | % |   |   | 31 | % |   |
| Taiwan      |       |                                       | 25         |   |   |   | 38 |   |   |   | 43 |   |   |
| China       |       |                                       | 7          |   |   |   | 16 |   |   |   | 21 |   |   |
| Japan       |       |                                       | 14         |   |   |   | 4 |   |   |   | 3 |   |   |
| Other       |       |                                       | 2          |   |   |   | 1 |   |   |   | 2 |   |   |

 

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We believe that a substantial majority of our revenueswill continue to come from customers located in Asia, where most of theconsumer electronic devices that use our integrated circuits, or ICs, aremanufactured. As a result of this regional customer concentration, we may besubject to economic, cultural and political events and other developments thatimpact our customers in Asia. All of our sales currently are denominated inU.S. dollars. Therefore, an increase in the value of the U.S. dollar relativeto foreign currencies could make our products less competitive in internationalmarkets. Substantially all of our cost of revenues and a majority of ouroperating expenses are also denominated in U.S. dollars. As a consequence, webelieve that our overall exposure to foreign exchange risk is low.

We have two international branches, one in South Koreaand one in Taiwan and we have a subsidiary in China. At December 31, 2006,36 of our 96 employees were located in our international subsidiary and twointernational branches. Our South Korea branch is primarily involved in productdevelopment and is also involved in technical sales support. Our Chinasubsidiary and our Taiwan branch provide sales and marketing support.

It is difficult for us to forecast the demand for ourproducts, in part because of the highly complex supply chain between us and theend markets that incorporate our products. Demand for new features changesrapidly. Distributors and ODMs add an additional layer of complexity. We must,therefore, forecast demand not only from our direct customers, but also fromother participants in this multi-level distribution channel. Because of ourlengthy product development cycle, it is critical for us to anticipate changesin demand for our various product features and the applications they serve, toallow sufficient time for product design. Our failure to accurately forecastdemand can lead to product shortages that can impede production by ourcustomers and harm our relationship with these customers. Conversely, ourfailure to forecast declining demand or shifts in product mix can result inexcess or obsolete inventory.

Generally, the average selling price of our productswill decline over the life of the product. Our experience to date is that thedecline has not had a material effect on our gross margins, as price reductionshave been mitigated by lower per unit costs associated with both high unitvolume and the transition of our products to smaller process geometries. Ourvideo decoder and LCD display products that are sold into consumer applicationsare subject to the seasonality connected with the consumer market. As a result,we expect revenues from these products to be lower in the first calendarquarter of the year. In addition, a significant number of our semiconductorsare sold to customers located in Asia, primarily to customers located in regionswho observe the Lunar New Year holiday. Typically, our customers are closed fora week or more during the extended holiday period, which negatively impacts ourbusiness. As a result of seasonality associated with the consumer market andour customer concentration in Asia, we expect our revenues to lower in thefirst calendar quarter of each year.

Our revenues increased by49% for the year ended December 31, 2006 compared to the year ended December 31,2005 and our net income increased to $13.2 million for the year ended December 31,2006 from $4.5 million for the year ended December 31, 2005. However, wehad an accumulated deficit of $10.0 million at December 31, 2006 and wemay not be able to maintain our recent growth and profitability. In the past, wehave been able to utilize our net operating loss carryforwards to offset ourtaxable income and thereby reduce our income taxes otherwise payable. However,our use of the net operating loss carryforwards and credit carryforwards islimited by the annual limitations as described in Sections 382 and 383 of theInternal Revenue Code, or the Code. Our plans for continued internationalexpansion may further limit our ability to utilize our net operating losscarryforwards as our net income increases. Our limited operating history makesthe prediction of future operating results very difficult. We believe thatperiod-to-period comparisons of operating results should not be relied upon aspredictive of future performance.

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**Critical AccountingPolicies**

Ourdiscussion and analysis of our financial condition and results of operationsare based upon our condensed consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amount of assets,liabilities, revenues and expenses and related disclosure of contingent assetsand liabilities. We evaluate our estimates on an on-going basis, includingthose related to inventory valuations, income taxes, warranty obligations andstock-based compensation. We base our estimates on historical experience and onvarious other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making the judgments wemake about the carrying values of assets and liabilities that are not readilyapparent from other sources. Because these estimates can vary depending on thesituation, actual results may differ from the estimates.

Webelieve the following critical accounting policies affect our more significantjudgments used in the preparation of our condensed consolidated financialstatements.

*Revenue Recognition.**  *Revenues from product sales arerecognized upon shipment, provided title and risk of loss has passed to thecustomer, when persuasive evidence of an arrangement exists, the price is fixedor determinable and collectibility is probable. We do not allow for priceprotection or stock rotation rights with any of our distributors.

*Warranty.**  *We offer a one-year productreplacement warranty against any defective product. We accrue for estimatedreturns of defective products at the time revenue is recognized, based on therate of return for the prior 12 months. As a consequence of standardizedmanufacturing processes and product testing procedures, returns of defectiveproduct are infrequent and the quantities have not been significant.Accordingly, historical warranty costs have not been significant in the fiscalperiods presented.

*Inventory Valuation.**  *Inventory is valued at the lower ofcost or market, computed on a first-in, first-out basis. We evaluate inventoryfor excess and obsolescence and write-off units that are unlikely to be soldbased upon a six months’ demand forecast. This evaluation may take into accountmatters including expected demand, anticipated sales price, productobsolescence and other factors. If actual future demand for our products isless than currently forecasted, additional inventory adjustments may berequired. Once a reserve is established, it is maintained until the product towhich it relates is sold or scrapped. If a unit that has been written down oroff is subsequently sold, the cost associated with the revenue from this unitis reduced to the extent of the write-off, resulting in an increase in grossprofit.

*Accountingfor Income Taxes.**  *Weaccount for income taxes under the provisions of Statement of FinancialStandards, or SFAS, No. 109,*Accountingfor Income Taxes*. In applying SFAS No. 109, we are required toestimate our current tax expense together with assessing temporary differencesresulting from differing treatments of items for tax and accounting purposes.These differences result in deferred tax assets and liabilities. We must assessthe likelihood that our deferred tax assets will be recovered from futuretaxable income and to the extent we believe that recovery is not likely, wemust establish a valuation allowance. Significant management judgment isrequired to assess the likelihood that our deferred tax assets will berecovered from future taxable income. At December 31, 2006, our totaldeferred tax assets were principally comprised of net operating losscarryforwards, research and other credit carryforwards and expense accruals. Toassess the likelihood that our deferred tax assets will be recovered fromtaxable income, we applied the guidance provided in SFAS No. 109 andconsidered both positive evidence that indicates a valuation allowance is notneeded and negative evidence that indicates a valuation allowance is needed.The factors considered include the following:

·       Despite our pre-tax incomefor the years ended December 31, 2006 and 2005, we have incurredcumulative pre-tax losses in all prior years and have a retained deficit of$10.0 million at December 31, 2006.

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·       Section 382of the Code, imposes an annual limit on the ability of a corporation thatundergoes an ‘‘ownership change’’ to use its net operating loss carryforwardsto reduce its tax liability. Due in part to equity financings, we experienced ‘‘ownershipchanges’’ as defined in Section 382 of the Code. Accordingly, our use ofthe net operating loss carryforwards and credit carryforwards is subject toannual limitation which could reduce our ability to utilize these losses.

·       Thesemiconductor industry in which we operate is highly cyclical and hasexperienced significant downturns that are characterized by decreases inproduct demand, excess customer inventories and accelerated erosion of prices.Any downturn in the semiconductor industry may be severe and prolonged andcould harm our operating results. Thus current profitability does not provideassurance of continued profitability.

At December 31, 2006 based on the availableobjective evidence, we believed it is more likely than not that our deferredtax assets will not be realizable. Accordingly, we continued to provide a fullvaluation allowance against our net deferred tax assets at December 31,2006. Should sufficient positive, objectively verifiable evidence of therealization of our net deferred tax assets exist at a future date, we wouldreverse any remaining valuation allowance to the extent supported by estimatesof future taxable income at that time.

At December 31, 2006, we had approximately $6.7million of federal and $3.2 million of state net operating loss carryforwardsavailable to offset future taxable income. If not utilized, these carryforwardswill expire beginning in 2021 for federal tax purposes and in 2013 for statetax purposes. We also have research and other tax credit carryforwards ofapproximately $0.8 million for federal and $1.1 million for state income taxpurposes. If not utilized, the federal carryforwards will expire in variousamounts beginning in 2012. The state tax credits can be carried forwardindefinitely.

*Stock-BasedCompensation.**  *EffectiveJanuary 1, 2006, we adopted SFAS No. 123 (revised 2004),*Share-Based Payment*, or SFAS 123(R),which requires that we measure compensation expense for all share-based paymentawards made to employees and directors, including employee stock options, basedon estimated fair values and recognize that expense over the required serviceperiod. Prior to adoption of SFAS 123(R), we accounted for stock-basedcompensation awards issued to our employees using the intrinsic valuemeasurement provisions of Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,or Opinion 25.

We adopted SFAS 123(R) using the prospectivetransition method. Under this method, SFAS 123(R) is applied to new awardsand to awards modified, repurchased or cancelled after January 1, 2006.Compensation cost previously recorded under Opinion 25 for unvested optionswill continue to be recognized as the required services are rendered.Accordingly, for the year ended December 31, 2006, stock based compensationexpense includes compensation costs related to estimated fair values of awardsgranted after the date of adoption of SFAS 123(R) and compensation costsrelated to unvested awards at the date of adoption based on the intrinsicvalues as previously recorded under Opinion 25.

For options granted after January 1, 2006, andvalued in accordance with SFAS 123(R), we use the straight-line method forexpense attribution. For options granted prior to January 1, 2006, we usethe multiple grant approach for expense attribution, which results insubstantially higher amounts of amortization in earlier years as opposed to thestraight-line method, which results in equal amortization over the vestingperiod of the options. Under the multiple grant method, the amortization in anygiven period is significantly impacted by the number and timing of grantswithin the period and the amount by which the estimated fair value of our stockexceeds the exercise price of the option and, to a lesser extent, from theamortization of options granted in previous periods.

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Upon adoption of SFAS 123(R), we were required toestimate the number of outstanding options that are not expected to vest. Insubsequent periods, if actual forfeitures differ from these estimates, we willrevise our estimates. No compensation cost is recognized for options that donot vest. Under the multiple grant approach, forfeitures of unvested optionsresulting from employee terminations result in the reversal of previouslyexpensed stock compensation associated with the unvested options during theperiod in which the termination occurred. Stock compensation expense fromvested options is not reversed.

We estimated the fair value of options granted after January 1,2006 using the Black-Scholes option valuation model. This valuation modelrequires us to make assumptions and judgments about the variables used in thecalculation. These variables and assumptions include the weighted averageperiod of time that the options granted are expected to be outstanding, thevolatility of our common stock, the risk free interest rate and the estimatedrate of forfeitures of unvested stock options. If actual results differ fromour estimates, we will record the difference as a cumulative adjustment in theperiod we revise our estimates. Since our stock has a limited trading history,we used the simplified calculation of expected term described in the Securitiesand Exchange Commission Staff Accounting Bulletin No. 107 and we estimatedour stock’s volatility based on an average of the historical volatilities ofthe common stock of several entities with characteristics similar to us. Therisk-free interest rate is based on U.S. Treasury securities. We estimated ourexpected forfeiture rate of 10% based on our historical experience.

The followingassumptions are used to value stock options granted after adoption of SFAS123(R):

| ** **               | ** ** | **Year Ended**             | ** **     |
|--------------------------|------------|---------------------------------|----------------|
| ** **               | ** ** | **December 31, 2006** | ** **     |
| Expected term in  years  |       |                            | 6.08           |   |   |
| Risk-free  interest rate |       |                            | 4.55–5.0  | % |   |
| Expected  volatility     |       |                            | 72.6–74.1 | % |   |
| Dividend yield           |       |                            | 0              | % |   |

 

Weaccount for stock-based compensation awards issued to our employees prior toour adoption of SFAS 123(R) on January 1, 2006 using theintrinsic value measurement provisions of Opinion 25. Accordingly, we haverecorded compensation expense for stock options granted with exercise pricesless than the fair value of the underlying common stock at the option grantdate. From April 2005 through December 2005, the Company grantedoptions with exercise prices equal to the fair value of the common stock determinedby the board of directors at the time of the grants. Techwell subsequentlyobtained valuations from an unrelated valuation specialist, that were used toestablish retroactively the fair value of its common stock. This retroactivefair value exceeded the fair value established by the board of directors at thetime of the grants. As a result, the Company recorded deferred stock-basedcompensation. For options granted in earlier periods, the fair value of thecommon stock was originally based on estimates made by the board of directorsat the date of each grant. The Company did not obtain valuations by a valuationspecialist. Subsequent to the grant date, when the Company prepared itsfinancial statements, it performed retrospective valuations of its common stockusing the probability-weighted expected return method. The Company used thevalues determined to record retroactively stock compensation based on thedifference between the subsequently determined fair value and the exerciseprice.

As aresult of adopting SFAS 123(R), our operating income and net income forthe year ended December 31, 2006 were reduced by approximately $835,000and $793,000, respectively and basic and diluted net income per share werereduced by $0.06 and $0.04, respectively.

Stock-basedcompensation expense is allocated among cost of revenues, research anddevelopment expenses and selling, general and administrative expenses,respectively, based upon the employee’s job function. We expect to continue torecognize substantial amounts of stock-based compensation expense relating toour employee stock options in future periods primarily as a result of ouradoption of SFAS 123(R).

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**Results ofOperations**

Thefollowing table is derived from our selected consolidated financial data andsets forth our historical operating results as a percentage of revenues for theperiods indicated:

| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Consolidated Statement of  Operations Data:** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                        |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost of  revenues(1)                            |       | 50.9                                       |       | 48.0 |   | 42.8 |   |
| Gross profit                                    |       | 49.1                                       |       | 52.0 |   | 57.2 |   |
| Operating expenses:                             |       |                                       |       |   |   |   |   |
| Research and development(1)                     |       | 36.6                                       |       | 24.1 |   | 17.1 |   |
| Selling, general and administrative(1)          |       | 22.0                                       |       | 15.9 |   | 16.2 |   |
| Restructuring costs                             |       | 1.3                                        |       | — |   | — |   |
| Total operating expenses                        |       | 59.9                                       |       | 40.0 |   | 33.3 |   |
| Income (loss)  from operations                  |       | (10.8                                      | )          | 12.0 |   | 23.9 |   |
| Interest and  other income                      |       | 1.0                                        |       | 1.0 |   | 3.1 |   |
| Income (loss) before income taxes               |       | (9.8                                       | )          | 13.0 |   | 27.0 |   |
| Income taxes                                    |       | 0.3                                        |       | 0.4 |   | 2.4 |   |
| Net income (loss)                               |       | (10.1                                      | )%         | 12.6 | % | 24.6 | % |

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(1)*         *Percentagesinclude stock-based compensation. The table below indicates the percentage ofstock-based compensation attributed to each item as a percentage of revenuesfor the periods indicated:

| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Costs and expenses:**              | ** ** |                                       | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Cost of revenues                     |       |                                       | 0.1        | % |   |   | 0.1 | % |   |   | 0.2 | % |   |
| Research and development             |       |                                       | 2.7        |   |   |   | 1.2 |   |   |   | 2.0 |   |   |
| Selling, general  and administrative |       |                                       | 2.5        |   |   |   | 1.2 |   |   |   | 2.0 |   |   |

 

**Revenues ByPrincipal Product Lines**

Thefollowing table illustrates our revenues by our principal product lines (dollaramounts in thousands):

| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|
| ** **                | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                | ** ** | **Amount**                                 | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** |
| Security  Surveillance(1) |       | $                                          | 3,615      |   |   | 21.0 | % |   | $ | 13,804 |   |   | 38.3 | % |   | $ | 27,684 |   |   | 51.5 | % |   |
| Video Decoder(2)          |       | 7,986                                      |       |   | 46.3 |   |   | 16,142 |   |   | 44.8 |   |   | 18,183 |   |   | 33.9 |   |   |
| LCD Display(3)            |       | 4,818                                      |       |   | 27.9 |   |   | 4,997 |   |   | 13.8 |   |   | 6,916 |   |   | 12.9 |   |   |
| Other(4)                  |       | 832                                        |       |   | 4.8 |   |   | 1,108 |   |   | 3.1 |   |   | 929 |   |   | 1.7 |   |   |
| Total Revenues            |       | $                                          | 17,251     |   |   | 100.0 | % |   | $ | 36,051 |   |   | 100.0 | % |   | $ | 53,712 |   |   | 100.0 | % |   |

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(1)*         *Consists of our application specificproducts designed for use in security surveillance systems.

(2)*         *Consists of our general purpose video decodersdesigned for use in the consumer, security surveillance and automotive markets.Revenues from general purpose video decoders used in security surveillancesystems and LCD displays are reported under our video decoder product line andnot our security surveillance or LCD display product lines.

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(3)*         *Consists of our application specificproducts designed for use in LCD displays.

(4)*         *Consists of contract developmentprojects, early generation mixed signal semiconductors for digital videoapplications and a PCI video decoder product.

**Comparison of YearsEnded December 31, 2006, 2005 and 2004**

*Revenues.**  *Our revenues consist of sales ofour mixed signal integrated circuits for digital video applications. We havethree principal product lines: video decoder, security surveillance and LCDdisplay. All of our sales are denominated in U.S. dollars.

Revenues were $53.7 million in 2006 and $36.1 millionin 2005, an increase of 49% primarily from the increased revenues from oursecurity surveillance products that increased approximately $13.9 million, or101%, in 2006 compared to 2005. The percentage of revenues attributable to oursecurity and surveillance products was 51.5% in 2006 as compared to 38.3% in2005. The increased revenues in security surveillance are primarily a result ofthe increase in sales of our four-in-one video decoders and our recentlyintroduced more highly integrated security surveillance products. The increasein the percentage of revenues attributable to our security and surveillanceproducts reflects continuing market acceptance of our more highly integratedproducts and a shift in sales from general-purpose video decoders toapplication specific products specifically designed for the securitysurveillance market. We expect that our security and surveillance products willalso represent a significant proportion of our revenues in 2007. Revenues fromour video decoder products increased approximately $2.0 million, or 13%, in2006 compared to 2005, primarily as a result of a general increase in demandfrom the markets for products such as multi-function monitors and DVDrecorders, offset by a shift in sales from general-purpose video decoders toapplication specific products specifically designed for the securitysurveillance market. Revenues from our LCD display products increasedapproximately $1.9 million, or 38%, in 2006 compared to 2005, primarily as aresult of a continuing ramp of customer projects begun from earlier design winsin the automotive market. Other revenues decreased $0.2 million, or 16%, in2006 as compared to 2005, primarily as a result of decreased sales of our PCIvideo decoder products.

Revenues increased 109% in 2005 to $36.1 million fromthe $17.3 million achieved in 2004 and were also a result of the increasedrevenues from our security surveillance products which increased approximately$10.2 million, or 282%, in 2005 compared to 2004. The increase in securitysurveillance revenues are due to the increased demand for our first generationsecurity surveillance product as well as an introduction of more highlyintegrated products throughout 2005. Revenues from our video decoder productsincreased approximately $8.2 million, or 102%, in 2005 compared to 2004,primarily due to the increase in sales of new general purpose video decoderproducts which we introduced in late 2004. Revenues from our LCD displayproducts increased by $0.2 million, or 4%, in 2005 compared to 2004, primarilyas a result of an increase in sales of our LCD display products in the consumerand automotive markets partially offset by the decline in our sales of $0.7million to a single OEM customer. The decline in our sales in 2005 to this OEMcustomer was primarily due to our decision in 2004 not to create productsspecifically designed for a single customer. Other revenues increased $0.3million, or 33%, in 2005 as compared to 2004, primarily as a result ofincreased sales of our PCI video decoder products.

*GrossProfit and Gross Margin.*   Gross profit is thedifference between revenues and cost of revenues, and gross margin representsgross profit as a percentage of revenues. Cost of revenues, also known as costof goods sold, consists primarily of cost of processed silicon wafers, costsassociated with assembly, test and shipping of our production integrated circuits,or ICs, cost of personnel and related expenses associated with supporting ouroutsourced manufacturing activities and write-downs for excess and obsoleteinventory.

Gross profit was $30.7 in 2006, $18.7 million in 2005and $8.5 million in 2004. The increase in gross profit was also attributable tothe increase in revenues for each successive year since 2004.

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Gross margin was 57% for 2006, 52% for 2005 and 49%for 2004. The increase in gross margin in 2006 from 2005 was primarily a resultof reduced materials costs and production costs in 2006 as compared to 2005partially attributable to increased volume purchases. The increase in grossmargin in 2005 from 2004 was primarily attributable to increased sales in 2005of several new, higher margin products that were introduced in 2004 and thefirst half of 2005.

We incurred stock-based compensation included in costof revenues associated with outsourced manufacturing support and qualityassurance personnel of $0.1 million in 2006 and less than $0.1 million in both2005 and 2004.

*Researchand Development.*   Research and developmentexpenses consist primarily of compensation and associated costs of employeesengaged in research and development, contractor costs, tape out costs,development testing and evaluation costs, occupancy costs and depreciationexpense. Before releasing new products, we incur charges for mask sets,prototype wafers and mask set revisions, which we refer to as tape-outcosts. Tape-out costs cause our research and development expenses tofluctuate because they are not incurred uniformly every quarter. We expectour research and development costs to increase in absolute dollars in 2007 aswe increase our investment in developing new products.

Research and development expenses were $9.2 million,or 17% of revenues, in 2006, $8.7 million, or 24% of revenues, in 2005 and $6.3million, or 37% of revenues, in 2004. Research and development expensesdecreased as a percent of revenues, despite the increase in expenses, asrevenues grew more than the increase in expenses. The increase in research anddevelopment expense in 2006 from 2005 was primarily attributable to increasedcompensation expense of $1.2 million to support the development of newtechnologies. The increase in compensation related expenses was partiallyoffset by a decrease of $0.9 million in tape-out expenses for newproducts. The increase in research and development expense in 2005 from 2004was primarily attributable to an increase of approximately $1.2 million in newproduct development expenses for the development and integration intoproduction of several new products introduced in 2005 or expected to beintroduced in 2006. Compensation related expenses increased by approximately$1.2 million primarily due to an increase in bonuses year over year and anincrease in engineering headcount from 26 at the end of 2004 to 39 at the endof 2005.

We incurred stock-based compensation expenseassociated with research and development personnel of $1.1 million in 2006,$0.4 million in 2005 and $0.5 million in 2004. Stock-based compensation expenseincreased by $0.7 million in 2006 from 2005 primarily as a result of stockoptions and awards granted in 2006 to certain consultants as compensation forproduct development services of $0.6 million.

*Selling,General and Administrative.*   Selling, general andadministrative expenses consist primarily of compensation and associated costsfor marketing, selling and administrative personnel, sales commissions toindependent sales representatives, contractor compensation, public relations,promotional and other marketing expenses, insurance and fees paid forprofessional services, travel, depreciation expenses and occupancy costs. Costsassociated with audit and tax services, corporate governance and compliance andfinancial reporting are also selling, general and administrative expenses. Weexpect selling, general and administrative expenses to continue to increase inthe future in support of our anticipated growth and to cover additional costsassociated with operating as a public company, such as improvements to ourinformation technology infrastructure and increased costs associated with ourefforts to comply with the Sarbanes-Oxley Act of 2002.

Selling, general and administrative expenses were $8.7million, or 16% of revenues, in 2006, $5.7 million, or 16% of revenues, in 2005and $3.8 million, or 22% of revenues, in 2004. The $3.0 million increase in2006 from 2005 was primarily attributable to an increase of $1.1 millionin compensation related expenses associated with the growth in our business,$1.0 million in professional services expenses primarily for audit, tax andlegal services and $0.4 million in insurance and administrative fees reflectingcosts associated with being a public company, $0.2 of travel expenses tosupport increasing customer 

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interest in our productsand the growth of our business, and $0.3 million associated with our foreignbranches and our subsidiary in China. These increases in expenses were offsetin part by a decrease of $0.2 million in commission expense paid to ouroutside sales representatives reflecting a larger proportion of sales todistributors in the period. The $1.9 million increase in 2005 from 2004 wasprimarily attributable to a $0.5 million increase in compensation relatedexpenses as well as an increase in professional service expenses for audit andlegal services associated with the growth in our business, $0.2 million incommissions paid to our outside sales representatives and approximately $0.4million in expenses from the increase of sales and marketing personnel in ourTaiwan office; all of these costs were incurred to support increasing customerinterest in our products.

We incurred stock-based compensation expenseassociated with selling, general and administrative personnel of $1.0 millionin 2006 and $0.4 million in both 2005 and 2004.

*RestructuringCosts.*   Restructuring costs were $0.2 million, or1% of revenues, in 2004 and there were no restructuring costs in 2006 or 2005.Restructuring costs in 2004 related entirely to costs accrued for the remaininglease payments associated with our former office facility lease resulting fromour move into our current leased facility.

*InterestIncome.*   Interest income was $1.7 million in2006, $0.4 million in 2005 and $0.2 million in 2004. The increase in 2006 from2005 was attributable to higher cash, cash equivalent and short and long-terminvestment balances primarily as a result of our initial public offering andhigher interest rates in 2006 as compared to 2005. The increase in 2005 from2004 was primarily attributable to higher cash balances as a result of increasedcash generated from operations, the closing of our Series F preferredstock financing in March 2005 and higher interest rates.

*Income Taxes.**  *Our provision for income taxes was$1.3 million in 2006, $0.2 million in 2005 and $0.1 million in 2004. Theeffective tax rate for all periods differed from the statutory federal incometax rate primarily because we utilized prior net operating losses to offsetprofits. Our future effective income tax rate will be subject to manyvariables, including the absolute amount and future geographic distribution ofour pre-tax income, our ability to take advantage of the available tax planningstrategies and our ability to utilize our net operating loss carryforwards. Asa result of these factors, we anticipate the effective tax rate for 2007 to beapproximately 25%.

**Liquidity andCapital Resources**

Since our inception, we have financed our growthprimarily with proceeds from the issuance of preferred stock and common stock.In June 2006, we received approximately $17.5 million in cash, net ofunderwriting discounts, commissions and other offering costs, from our initialpublic offering of common stock. In July 2006, we received aggregateproceeds of $1.1 million, net of underwriting discounts and commissions, fromthe sale of an additional 130,000 shares following the underwriters’ partialexercise of their over-allotment option related to our initial public offering.Our cash and cash equivalents and short-term investments were$49.6 million as of December 31, 2006, $16.8 million as of December 31,2005 and $10.4 million as of December 31, 2004.

Net cash provided by operating activities was$18.3 million in 2006. The cash provided by our operating activities inthe 2006 was primarily due to our net income of $13.2 million, an increasein accounts payable of $2.1 million associated with increasing customer demandas a result of new product introductions and increased sales of existingproducts, an increase in accrued liabilities of $1.7 million primarilyrelated to compensation costs and payments we have received from our customersin advance of product shipment and a decrease of accounts receivable of $0.3million attributable to the timing of customer collections. These werepartially offset by an increase in inventory of $1.5 million in responseto increasing customer demand and an increase in prepaid expenses and othercurrent assets of $1.0 million reflecting interest earned on our investmentsbut not received, advance payments for insurance expense 

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and excess tax benefitsfrom stock-based compensation. We incurred non-cash expenses of$2.3 million for stock-based compensation expense and $0.3 million indepreciation expense in 2006. We also recognized a tax benefit of $0.9 millionattributable to our equity incentive plans.

Net cash provided by operating activities was$3.6 million in 2005. The cash provided by our operating activities in2005 was primarily due to our net income of $4.5 million and an increasein accrued liabilities of $1.0 million and accounts payable of$0.4 million and prepaid expenses and other current assets of$0.8 million, which was substantially offset by increases in accountsreceivable of $2.5 million and inventory of $1.7 million. Theincreases in inventory, accounts receivable and accounts payable wereassociated with the increase in revenues during the period as a result of newproduct introductions and increased sales of existing products. The increase inaccrued liabilities was due to compensation costs associated with our increasedheadcount and inventory purchases and taxes payable associated with achievingprofitability. We incurred non-cash expenses of $0.9 million for stock-basedcompensation expense and $0.2 million in depreciation expenses in 2005.

Net cash used in our operating activities was$0.7 million in 2004. Net cash used in our operating activities in 2004consisted primarily of our net loss of $1.7 million, and a decrease inaccounts payable of $0.7 million and an increase in inventory of$0.4 million. These were offset in part by $0.9 million ofstock-based compensation expense and $0.2 million of depreciation expense,which are non-cash transactions. Despite the growth of our business in 2004,accounts payable and inventory decreased due to the timing in the receipts ofinventory and the payment of accounts payable.

Net cash used in our investing activities was$41.0 million in 2006 reflecting purchases of short and long-terminvestments of $102.5 million and purchases of capital equipment of $0.5million offset by maturities of short-investments of $61.9 million.

Net cash provided by our investing activities was$7.4 million in 2005 due to the maturities of short-term investments of$7.6 million and a $0.1 million decrease in restricted cash,partially offset by the purchase of capital equipment of $0.3 million.

Net cash used in our investing activities was$5.6 million in 2004. Net cash used in our investing activities in 2004was primarily for purchases of short-term investments of $8.3 million andpurchases of $0.3 million of engineering and computer equipment andfurniture and fixtures to support our growth, partially offset by maturities ofshort-term investments of $3.0 million.

Net cash provided by financing activities was$20.0 million in 2006 reflecting proceeds from our initial stock offering,net of underwriting discounts, commissions and offering costs of$19.4 million and proceeds from the exercise of stock options of$0.6 million.

Net cash provided by our financing activities was$2.9 million in 2005 and $0.1 million in 2004. Net cash provided byour financing activities in 2005 consisted of proceeds of $2.9 millionfrom the issuance of Series F preferred stock, $0.4 million from theexercise of common stock options, $0.4 million from collections ofstockholders’ notes receivable, partially offset by payment of deferredoffering costs of $0.8 million. Net cash provided by our financingactivities in 2004 primarily consisted of proceeds from the exercise of commonstock options.

We believe our existing cash balances, as well as cashexpected to be generated from operating activities, will be sufficient to meetour anticipated cash needs for at least the next 12 months.

Our long-term futurecapital requirements will depend on many factors, including our level ofrevenues, the timing and extent of spending to support our product developmentefforts, the expansion of sales and marketing activities, the timing of ourintroductions of new products, the costs to ensure access to adequatemanufacturing capacity and the continuing market acceptance of our products. Wecould be 

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required,or could elect, to seek additional funding through public or private equity ordebt financing and additional funds may not be available on terms acceptable tous or at all.

**Off-Balance SheetArrangements**

As of December 31,2006, we have no off-balance sheet arrangements as defined in Item 303(a)(4) ofthe Securities and Exchange Commission’s Regulation S-K.

**ContractualObligations**

Thefollowing table describes our commitments to settle contractual obligations asof December 31, 2006:

| ** **                       | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less Than  1 Year** | ** ** | **1 to 3  Years** | ** ** | **3 to 5  Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **                       | ** ** | **(in thousands)**                   | ** ** |
| Operating leases                 |       | $                                         | 1,876      |   |   | $ | 534 |   |   | $ | 1,023 |   | $ | 319 |   |   | $ | — |   |   |
| Purchase  obligations            |       | 1,913                                     |       |   | 1,913 |   |   | — |   | — |   |   | — |   |   |
| Total                            |       | $                                         | 3,789      |   |   | $ | 2,447 |   |   | $ | 1,023 |   | $ | 319 |   |   | $ | — |   |   |
|                                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Recent AccountingPronouncements**

In June 2006, the Financial Accounting StandardsBoard, or FASB, issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes,*or FIN No. 48. Thisinterpretation clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s financial statements in accordance with SFAS No. 109,*Accounting for Income Taxes.*FIN No. 48prescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN No. 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition. FIN No. 48 is effective for fiscal yearsbeginning after December 15, 2006. Adoption of FIN No. 48 is notexpected to have a significant impact on our results of operations andfinancial position.

On September 13, 2006, the Securities andExchange Commission issued Staff Accounting Bulletin No. 108, *Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*,or SAB No. 108, which provides interpretive guidance on the considerationof the effects of prior year misstatements in quantifying current yearmisstatements for the purpose of a materiality assessment. SAB No. 108 iseffective for annual financial statements for the first fiscal year endingafter November 15, 2006. However, early application is encouraged in anyreport for an interim period of the first fiscal year ending after November 15,2006, filed after the publication of this guidance. The adoption of SAB No. 108did not have a significant impact on our results of operations and financialposition.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements,* or SFAS No. 157. SFAS No. 157defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. This statement applies under other accountingpronouncements that require or permit fair value measurements, the FASB havingpreviously concluded in those accounting pronouncements that fair value is therelevant measurement attribute. Accordingly, this Statement does not requireany new fair value measurements. SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years. We are required to adopt thisstatement in our first fiscal quarter of 2008. We are evaluating the potentialimpact of SFAS No. 157 on our results of operations and financial position.

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In February 2007, theFASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities—including an Amendment of FASBStatement No. 115*, or SFAS No. 159, to permit all entitiesto choose to elect, at specified election dates, to measure eligible financialinstruments at fair value, to report unrealized gains and losses on items forwhich the fair value option has been elected in earnings at each subsequentreporting date, and recognize upfront costs and fees related to those items inearnings as incurred and not deferred. SFAS No. 159 applies to fiscalyears beginning after November 15, 2007, with early adoption permitted foran entity that has also elected to apply the provisions of SFAS No. 157.An entity is prohibited from retrospectively applying SFAS No. 159, unlessit chooses early adoption. We are evaluating the potential impact of SFASNo. 159 on our results of operations and financial position.

**ITEM 7A.**        Quantitativeand Qualitative Disclosures About Market Risk

The primary objectives of our investment activity areto preserve principal, provide liquidity and maximize income withoutsignificantly increasing the risk. Some of the securities we invest in aresubject to market risk. This means that a change in prevailing interest ratesmay cause the principal amount of the investment to fluctuate. To minimize thisrisk, we maintain our portfolio of cash equivalents, short and long-terminvestments in demand accounts, money market funds, commercial paper, corporatebonds, U.S. government agency securities and auction rate securities which areinvestment grade securities with a maximum dollar weighted maturity of twoyears or less. The risk associated with fluctuating interest rates is limitedto our investment portfolio, and we believe that a 10% change in interest rateswould not have a significant impact on our interest income.

To date, our internationalcustomer agreements have been denominated solely in U.S. dollars, andaccordingly, we have not been exposed to foreign currency exchange ratefluctuations from customer agreements, and do not currently engage in foreigncurrency hedging transactions. However, the functional currency of ouroperations in Taiwan, South Korea and China is the U.S. dollar and our localaccounts are maintained in the local currency in Taiwan, South Korea and China,respectively, and thus we are subject to foreign currency exchange ratefluctuations associated with remeasurement to U.S. dollars. Such fluctuationshave not been significant historically and we believe that a 10% change inexchange rates would not have a significant impact on our operating expenses.

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**ITEM 8.**                FinancialStatements and Supplementary Data

The following table sets forth selected unauditedquarterly information for our last eight fiscal quarters, which has beenprepared on the same basis as the audited financial statements. We believe thatall necessary adjustments consisting only of normal recurring adjustments, havebeen included in the amounts stated below to present fairly the results of suchperiods when read in conjunction with our audited consolidated financialstatements and related notes included elsewhere herein. Operating results forany quarter are not necessarily indicative of results for any future period.

| ** **                                                    | ** ** | **Quarters Ended**  | ** ** |
|---------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                    | ** ** | **March 31,  2005** | ** ** | **June 30,  2005** | ** ** | **September 30,  2005** | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** | **June 30,  2006** | ** ** | **September 30,  2006** | ** ** | **December 31,  2006** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**       | ** ** |
| REVENUES                                                      |       |                     | $          | 5,700 |   |   | $ | 9,682 |   |   | $ | 9,877 |   |   |   | $ | 10,792 |   |   |   | $ | 9,801 |   |   | $ | 12,800 |   |   | $ | 15,101 |   |   |   | $ | 16,010 |   |   |
| COST OF REVENUES(2)                                           |       |                     | 3,224      |   |   | 4,226 |   |   | 4,994 |   |   |   | 4,860 | (1) |   |   | 4,497 |   |   | 5,241 |   |   | 6,374 |   |   |   | 6,.865 |   |   |
| GROSS PROFIT                                                  |       |                     | 2,476      |   |   | 5,456 |   |   | 4,883 |   |   |   | 5,932 |   |   |   | 5,304 |   |   | 7,559 |   |   | 8,727 |   |   |   | 9,145 |   |   |
| OPERATING EXPENSES:                                           |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development(2)                                   |       |                     | 1,941      |   |   | 1,960 |   |   | 2,217 |   |   |   | 2,566 |   |   |   | 2,490 |   |   | 2,461 |   |   | 2,033 |   |   |   | 2,199 |   |   |
| Selling, general and administrative(2)                        |       |                     | 1,336      |   |   | 1,315 |   |   | 1,396 |   |   |   | 1,683 |   |   |   | 1,818 |   |   | 1,884 |   |   | 2,362 |   |   |   | 2,638 |   |   |
| Total operating expenses                                      |       |                     | 3,277      |   |   | 3,275 |   |   | 3,613 |   |   |   | 4,249 |   |   |   | 4,308 |   |   | 4,345 |   |   | 4,395 |   |   |   | 4,837 |   |   |
| INCOME (LOSS) FROM OPERATIONS                                 |       |                     | (801       | ) |   | 2,181 |   |   | 1,270 |   |   |   | 1,683 |   |   |   | 996 |   |   | 3,214 |   |   | 4,332 |   |   |   | 4,308 |   |   |
| INTEREST INCOME                                               |       |                     | 63         |   |   | 80 |   |   | 105 |   |   |   | 120 |   |   |   | 155 |   |   | 252 |   |   | 617 |   |   |   | 646 |   |   |
| INCOME (LOSS) BEFORE INCOME TAXES                             |       |                     | (738       | ) |   | 2,261 |   |   | 1,375 |   |   |   | 1,803 |   |   |   | 1,151 |   |   | 3,466 |   |   | 4,949 |   |   |   | 4,954 |   |   |
| INCOME TAXES                                                  |       |                     | 5          |   |   | 63 |   |   | 52 |   |   |   | 40 |   |   |   | 166 |   |   | 588 |   |   | 440 |   |   |   | 104 |   |   |
| NET INCOME (LOSS)                                             |       |                     | $          | (743 | ) |   | $ | 2,198 |   |   | $ | 1,323 |   |   |   | $ | 1,763 |   |   |   | $ | 985 |   |   | $ | 2,878 |   |   | $ | 4,509 |   |   |   | $ | 4,850 |   |   |
| Basic net income (loss) per share                             |       |                     | $          | (0.20 | ) |   | $ | 0.56 |   |   | $ | 0.33 |   |   |   | $ | 0.41 |   |   |   | $ | 0.22 |   |   | $ | 0.52 |   |   | $ | 0.22 |   |   |   | $ | 0.24 |   |   |
| Shares used in computing basic net income (loss) per  share   |       |                     | 3,753      |   |   | 3,901 |   |   | 4,046 |   |   |   | 4,281 |   |   |   | 4,470 |   |   | 5,521 |   |   | 20,093 |   |   |   | 20,187 |   |   |
| Diluted net income (loss) per  share                          |       |                     | $          | (0.20 | ) |   | $ | 0.12 |   |   | $ | 0.07 |   |   |   | $ | 0.09 |   |   |   | $ | 0.05 |   |   | $ | 0.15 |   |   | $ | 0.21 |   |   |   | $ | 0.22 |   |   |
| Shares used in  computing diluted net income (loss) per share |       |                     | 3,753      |   |   | 18,398 |   |   | 18,572 |   |   |   | 18,772 |   |   |   | 18,905 |   |   | 19,163 |   |   | 21,787 |   |   |   | 22,206 |   |   |

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(1)*            *Includes a $0.4 million charge for purchase commitments in excessof forecasted requirements and the write-down of inventory.

(2)             Amounts include stock-based compensationas follows:

| ** **              | ** ** | **Quarters Ended**        | ** ** |
|-------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **March 31,   2005** | ** ** | **June 30,   2005** | ** ** | **September 30,   2005** | ** ** | **December 31,   2005** | ** ** | **March 31,   2006** | ** ** | **June 30,   2006** | ** ** | **September 30,   2006** | ** ** | **December 31,   2006** | ** ** |
| ** **              | ** ** | **(in thousands)**             | ** ** |
| **Costs and expenses:** | ** ** |                           | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   |
|                         |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

| Cost of revenues                     |   |   | $   | 9          | ** ** |   | $      | 9      |   |   | $      | 8      |   |       |   | $      | 5   | ** ** |   |   | $      | 13     | ** ** |       | $      | 24     |   |       | $      | 35 | ** ** |   |   | $ | 45 | ** ** |   |
|--------------------------------------|--------|--------|-----|------------|------------|--------|--------|--------|--------|--------|--------|--------|--------|------------|--------|--------|-----|------------|--------|--------|--------|--------|------------|------------|--------|--------|--------|------------|--------|----|------------|--------|--------|---|----|------------|--------|
| Research and development             |   |   | 84  | ** ** |       | 122    |   |   | 109    |   |   |   | 112    | ** ** |   |   | 597 | ** ** |   | 138    |   |   | 174        | ** ** |   |   | 191    | ** ** |   |
| Selling, general  and administrative |   |   | 157 | ** ** |       | 129    |   |   | (21    | )      |   |   | 177    | ** ** |   |   | 213 | ** ** |   | 252    |   |   | 342        | ** ** |   |   | 243    | ** ** |   |

 

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**ITEM 9.**                Changesin and Disagreements with Accountants on Accounting and Financial Disclosure

None.

**ITEM 9A.**        Controlsand Procedures

(a)***   Evaluationof disclosure controls and procedures.***   We maintain “disclosurecontrols and procedures,” as such term is defined in Rule 13(a)-15(e) underthe Securities Exchange Act of 1934 (the “Exchange Act”), that are designed toensure that information required to be disclosed by us in reports that we fileor submit under the Exchange Act is recorded, processed, summarized, andreported within the time periods specified in Securities and ExchangeCommission rules and forms, and that such information is accumulated andcommunicated to our management, including our chief executive officer and chieffinancial officer, as appropriate, to allow timely decisions regarding requireddisclosure. In designing and evaluating our disclosure controls and procedures,management recognized that disclosure controls and procedures, no matter howwell conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the disclosure controls and procedures aremet. Our disclosure controls and procedures have been designed to meet thereasonable assurance standards. Additionally, in designing disclosure controls andprocedures, our management necessarily was required to apply its judgment inevaluating the cost-benefit relationship of possible disclosure controls andprocedures. The design of any disclosure controls and procedures also is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions.

Based on their evaluation as of the end of the periodcovered by this Annual Report on Form 10-K, our chief executiveofficer and chief financial officer have concluded that, as of such date, ourdisclosure controls and procedures were effective at the reasonable assurancelevel.

(b)***   Changesin internal control over financial reporting.***   There was nochange in our internal control over financial reporting (as defined in Rule 13(a)-15(f) underthe Exchange Act) that occurred during the period covered by this annual reportthat has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

This annual report doesnot include a report of management’s assessment regarding internal control overfinancial reporting or an attestation report of the company’s registered publicaccounting firm due to a transition period established by rules of theSecurities and Exchange Commission for newly public companies.

**ITEM 9B.**       OtherInformation

Our chief executiveofficer, chief financial officer, chief technical officer, vice president ofsales marketing, director of business development and a member of our board ofdirectors, have entered into stock selling plans intended to qualify for thesafe harbor under Rule 10b5-1 under the Exchange Act. The Plansare intended to comply with Rule 10b5-1 of the Exchange Act and ourinsider trading policy. Rule 10b5-1 allows corporate insiders toestablish pre-arranged written stock trading plans at a time when the insideris not aware of material, non-public information. Subsequent receipt by theinsider of material, non-public information will not prevent pre-arrangedtransactions under the Rule 10b5-1 plan from being executed.

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**PART III**

**ITEM 10.**         Directors,Executive Officers of the Registrant and Corporate Governance

The informationrequired by this item is included under the captions “Nominees”, “BoardMeetings”, “Committees of the Board of Directors,” “Director Nominations,” “StockholderCommunications with the Board of Directors,” “Director Compensation,” “CompensationCommittee Interlocks and Insider Participation,” in our Proxy Statement relatedto the 2007 Annual Meeting of Stockholders and is incorporated herein byreference.

Item 405 of Regulation S-K calls for disclosure of anyknown late filing or failure by an insider to file a report required by Section16(a) of the Exchange Act. This disclosure is contained under the caption“Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statementand is incorporated herein by reference.

We have adopted a Code ofBusiness Conduct that applies to all of our directors, officers (including ourprincipal executive officer and principal financial and accounting officer) andemployees. The Code of Business Conduct is available on our web site at www.techwellinc.com.A copy of the Code of Business Conduct will be provided without charge to anyperson by contacting Techwell, Inc. Attn: Investor Relations 408 E.Plumeria Drive, San Jose, California 95134. We will disclose on our web siteamendments to, or waivers from, our Code of Business Conduct applicable to ourdirectors and executive officers, in accordance with applicable laws andregulations.

**ITEM 11.**         ExecutiveCompensation

The information required by this item is includedunder the section “Executive Compensation” in our Proxy Statement related tothe 2007 Annual Meeting of Stockholders and is incorporated herein byreference.

**ITEM 12.**         SecurityOwnership of Certain Beneficial Owners and Management and RelatedStockholder Matters

The information required by this item relating tosecurity ownership of certain beneficial owners and management is includedunder the caption “Security Ownership of Certain Beneficial Owners” and “Management”and the information required by this item relating to securities authorized forissuance under equity compensation plans is included under the caption “EquityCompensation Plan Information” in each case in our Proxy Statement related tothe 2007 Annual Meeting of Stockholders, and is incorporated herein byreference.

**ITEM 13.**         CertainRelationships, Related Transactions and Director Independence

The information required by this item is includedunder the captions “Certain Relationships and Related Party Transactions” and“Director Independence” in our Proxy Statement related to the 2007 AnnualMeeting of Stockholders and is incorporated herein by reference.

**ITEM 14.**         PrincipalAccountant Fees and Services

The information required by this item is includedunder the captions “Principal Accounting Fees and Services” and “AuditCommittee Pre-Approval Policies and Procedures” in our Proxy Statement relatedto the 2007 Annual Meeting of Shareholders and is incorporated herein byreference.

46

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**PART IV**

**ITEM 15.**         Exhibitsand Financial Statement Schedules

(a)***   Documents filed as part of thisreport***

(1)   *Financial Statements*

The following financialstatements and related report are included in Item 8 of this Report:

·       Reportof Independent Registered Public Accounting Firm

·       ConsolidatedBalance Sheets

·       ConsolidatedStatements of Operations

·       ConsolidatedStatements of Stockholders’ Equity and Comprehensive Income

·       ConsolidatedStatements of Cash Flows

·       Notesto Consolidated Financial Statements

47

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders of   Techwell, Inc.:

We have audited the accompanying consolidated balancesheets of Techwell, Inc. and subsidiaries (the “Company”) as of December 31,2005 and 2006, and the related consolidated statements of operations,stockholders’ equity (deficit) and redeemable convertible preferred stock, andcash flows for each of the three years in the period ended December 31,2006. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal controls over financial reporting.Accordingly, we express no such opinion. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the consolidated financial positionof Techwell, Inc. and subsidiaries as of December 31, 2005 and 2006,and the results of their operations and their cash flows for each of the threeyears in the period ended December 31, 2006, in conformity with accountingprinciples generally accepted in the United States of America.

As described in Note 1 tothe consolidated financial statements, the Company adopted Statement ofFinancial Accounting Standards No. 123(revised 2004), *Share-Based Payment,*effective January 1, 2006*.*

/s/  DELOITTE & TOUCHE LLP

San Jose, CaliforniaMarch 16, 2007

48

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**TECHWELL, INC.CONSOLIDATED BALANCE SHEETS(In thousands, except share amounts)**

| ** **                                                                                                                                                                                              | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                              | ** ** | **2005**              | ** ** | **2006** | ** ** |
| **ASSETS**                                                                                                                                                                                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                                         |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                                               |       | $                     | 15,982     |   | $ | 13,201 |   |
| Short-term investments                                                                                                                                                                                  |       | 804                   |       | 36,364 |   |
| Accounts receivable                                                                                                                                                                                     |       | 3,052                 |       | 2,765 |   |
| Inventory                                                                                                                                                                                               |       | 3,113                 |       | 4,584 |   |
| Prepaid expenses and other current assets                                                                                                                                                               |       | 2,224                 |       | 1,406 |   |
| Total current assets                                                                                                                                                                                    |       | 25,175                |       | 58,320 |   |
| Property and  equipment, net                                                                                                                                                                            |       | 434                   |       | 625 |   |
| Long-term  investments                                                                                                                                                                                  |       | —                |       | 4,963 |   |
| Other assets                                                                                                                                                                                            |       | 35                    |       | 85 |   |
| **TOTAL**                                                                                                                                                                                               |       | $                     | 25,644     |   | $ | 63,993 |   |
| **LIABILITIES,  REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                        | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                                                                                    |       |                  |       |   |   |
| Accounts payable                                                                                                                                                                                        |       | $                     | 1,336      |   | $ | 3,503 |   |
| Accrued liabilities                                                                                                                                                                                     |       | 2,687                 |       | 3,344 |   |
| Total current liabilities                                                                                                                                                                               |       | 4,023                 |       | 6,847 |   |
| Deferred rent                                                                                                                                                                                           |       | 54                    |       | — |   |
| Total liabilities                                                                                                                                                                                       |       | 4,077                 |       | 6,847 |   |
| Commitments and  contingencies (Note 8)                                                                                                                                                                 |       |                  |       |   |   |
| Redeemable convertible preferred stock, $0.001 par  value; 12,787,118 shares authorized; 12,777,118 shares issued and  outstanding; $41,402 aggregate liquidation preference at December 31,  2005 |       | 40,777                |       | — |   |
| Stockholders’  equity (deficit)                                                                                                                                                                    |       |                  |       |   |   |
| Preferred stock, $0.001 par value; 10,000,000 shares  authorized and no shares issued and outstanding at December 31, 2006                                                                         |       | —                |       | — |   |
| Common stock, $0.001 par value; 25,000,000 and  250,000,000 shares authorized; 4,369,058 and 20,528,468 shares issued and  outstanding at December 31, 2005 and 2006, respectively                 |       | 4                     |       | 21 |   |
| Additional paid-in capital                                                                                                                                                                              |       | 5,355                 |       | 67,734 |   |
| Deferred stock-based compensation                                                                                                                                                                       |       | (1,323                | )          | (546 | ) |
| Accumulated other comprehensive loss                                                                                                                                                                    |       | —                |       | (39 | ) |
| Accumulated deficit                                                                                                                                                                                     |       | (23,246               | )          | (10,024 | ) |
| Total stockholders’ equity (deficit)                                                                                                                                                               |       | (19,210               | )          | 57,146 |   |
| **TOTAL**                                                                                                                                                                                               |       | $                     | 25,644     |   | $ | 63,993 |   |

 

See accompanying notes to consolidated financial statements.

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**TECHWELL, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share amounts)**

| ** **                                                              | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                              | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                                                                |       | $                                           | 17,251     |   | $ | 36,051 |   | $ | 53,712 |   |
| Cost of revenues                                                        |       | 8,780                                       |       | 17,304 |   | 22,977 |   |
| Gross profit                                                            |       | 8,471                                       |       | 18,747 |   | 30,735 |   |
| Operating  expenses:                                                    |       |                                        |       |   |   |   |   |
| Research and development                                                |       | 6,319                                       |       | 8,684 |   | 9,183 |   |
| Selling, general and administrative                                     |       | 3,798                                       |       | 5,730 |   | 8,702 |   |
| Restructuring charges                                                   |       | 224                                         |       | — |   | — |   |
| Total operating expenses                                                |       | 10,341                                      |       | 14,414 |   | 17,885 |   |
| Income (loss)  from operations                                          |       | (1,870                                      | )          | 4,333 |   | 12,850 |   |
| Interest income                                                         |       | 179                                         |       | 368 |   | 1,670 |   |
| Income (loss)  before income taxes                                      |       | (1,691                                      | )          | 4,701 |   | 14,520 |   |
| Income taxes                                                            |       | 51                                          |       | 160 |   | 1,298 |   |
| Net income (loss)                                                       |       | $                                           | (1,742     | ) | $ | 4,541 |   | $ | 13,222 |   |
| Basic net income  (loss) per share                                      |       | $                                           | (0.49      | ) | $ | 1.14 |   | $ | 1.04 |   |
| Diluted net  income (loss) per share                                    |       | $                                           | (0.49      | ) | $ | 0.25 |   | $ | 0.64 |   |
| Weighted average  shares used in computing net income (loss) per share: |       |                                        |       |   |   |   |   |
| Basic                                                                   |       | 3,591                                       |       | 3,993 |   | 12,772 |   |
| Diluted                                                                 |       | 3,591                                       |       | 18,434 |   | 20,538 |   |

 

See accompanying notes to consolidated financial statements.

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**TECHWELL, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) ANDREDEEMABLE CONVERTIBLE PREFERRED STOCK(In thousands, except share amounts)**

| ** **                                                                                           | ** ** | ** **               | ** ** | ** ** | ** ** | ** **            | ** ** | ** **  | ** ** | ** ** | ** ** | ** **      | ** ** | ** **      | ** ** | ** **        | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **                | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|------------|------------|-----------------------|------------|-------------|------------|------------|------------|-----------------|------------|-----------------|------------|-------------------|------------|-------------------|------------|-----------------|------------|---------------------------|------------|
| ** **                                                                                           | ** ** | **Redeemable**           | ** ** | ** ** | ** ** | ** **            | ** ** | ** **  | ** ** | ** ** | ** ** | **Stockholder** | ** ** | **Deferred**    | ** ** | ** **        | ** ** | **Other**         | ** ** | **Total**       | ** ** |
| ** **                                                                                           | ** ** | **Preferred Stock** | ** ** | ** ** | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Notes**  | ** ** | **Stock-Based** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | **Stockholders'** | ** ** |
| ** **                                                                                           | ** ** | **Shares**               | ** ** | **Amount** | ** ** | ** **            | ** ** | **Shares**  | ** ** | **Amount** | ** ** | **Capital**     | ** ** | **Receivable**  | ** ** | **Compensation**  | ** ** | **Deficit**       | ** ** | **Loss**        | ** ** | **Equity (Deficit)** | ** ** |
| BALANCES: January  1, 2004                                                                           | 12,231,664 |                     | $          | 37,889     |       |                  |       | 3,455,156   |       |       | $          | 3               |       |            | $          | 2,751             |       |              | $          | (523            | )          |                      |       | $ | (986 | ) |   |   | $ | (26,045 | ) |   |   | $ | — |   |   |   | $ | (24,800 | ) |   |
| Net loss                                                                                             |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            |       |                      |       |   | (1,742 | ) |   |   |   |   |   |   | (1,742 | ) |   |
| Issuance costs of  Series E redeemable preferred shares                                              |       |                     |       | (21        | )          |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | — |   |   |
| Issuance of common stock upon exercise of stock options                                              |       |                     |       |       |       |                  |       | 133,645     |       |       | 1          |            |       | 105             |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 106 |   |   |
| Issuance of common stock upon exercise of stock options for notes  receivable                        |       |                     |       |       |       |                  |       | 227,778     |       |       |       |            |       | 86              |       |              | (86        | )                 |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | — |   |   |
| Repurchase of  common stock upon cancellation of notes receivable                                    |       |                     |       |       |       |                  |       | (128,125    | )          |       |       |            |       | (115            | )          |              | 115        |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | — |   |   |
| Payments received  on stockholder notes receivable                                                   |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              | 56         |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 56 |   |   |
| Deferred  stock-based compensation                                                                   |       |                     |       |       |       |                  |       |        |       |       |       |            |       | 1,586           |       |              |       |              |       |            | (1,586     | )                         |       |   |   |   |   |   |   |   |   |   | — |   |   |
| Deferred  stock-based compensation in relation to notes receivable with below market  interest rates |       |                     |       |       |       |                  |       |        |       |       |       |            |       | 13              |       |              |       |              |       |            | (13        | )                         |       |   |   |   |   |   |   |   |   |   | — |   |   |
| Amortization of  deferred stock-based compensation                                                   |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            | 1,101      |                      |       |   |   |   |   |   |   |   |   |   | 1,101 |   |   |
| Forfeitures of  deferred stock-based compensation                                                    |       |                     |       |       |       |                  |       |        |       |       |       |            |       | (465            | )          |              |       |              |       |            | 286        |                      |       |   |   |   |   |   |   |   |   |   | (179 | ) |   |
| BALANCES: December  31, 2004                                                                         |       | 12,231,664               |       | 37,868     |       |                  |       | 3,688,454   |       |       | 4          |            |       | 3,961           |       |              | (438       | )                 |       |            | (1,198     | )                         |       |   | (27,787 | ) |   |   | — |   |   |   | (25,458 | ) |   |
| Net income                                                                                           |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            |       |                      |       |   | 4,541 |   |   |   |   |   |   |   | 4,541 |   |   |
| Issuance of Series  F redeemable preferred shares, net of issuance costs of $91                      |       | 545,454                  |       | 2,909      |       |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | — |   |   |
| Issuance of common stock upon exercise of stock options                                              |       |                     |       |       |       |                  |       | 680,604     |       |       |       |            |       | 369             |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 369 |   |   |
| Payments received  on stockholder notes receivable                                                   |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              | 438        |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 438 |   |   |
| Deferred  stock-based compensation                                                                   |       |                     |       |       |       |                  |       |        |       |       |       |            |       | 1,515           |       |              |       |              |       |            | (1,515     | )                         |       |   |   |   |   |   |   |   |   |   | — |   |   |
| Amortization of  deferred stock-based compensation                                                   |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            | 1,098      |                      |       |   |   |   |   |   |   |   |   |   | 1,098 |   |   |
| Forfeitures of  deferred stock-based compensation                                                    |       |                     |       |       |       |                  |       |        |       |       |       |            |       | (490            | )          |              |       |              |       |            | 292        |                      |       |   |   |   |   |   |   |   |   |   | (198 | ) |   |
| BALANCES: December  31, 2005                                                                         |       | 12,777,118               |       | 40,777     |       |                  |       | 4,369,058   |       |       | 4          |            |       | 5,355           |       |              | —     |              |       |            | (1,323     | )                         |       |   | (23,246 | ) |   |   | — |   |   |   | (19,210 | ) |   |
| Net income                                                                                           |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            |       |                      |       |   | 13,222 |   |   |   |   |   |   |   | 13,222 |   |   |
| Unrealized loss on  investments                                                                      |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            |       |                      |       |   |   |   |   |   | (39 | ) |   |   | (39 | ) |   |
| Other  comprehensive loss                                                                            |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 13,183 |   |   |
| Initial public  offering of common stock, net of issuance costs of $5,442                            |       |                     |       |       |       |                  |       | 2,670,225   |       |       | 3          |            |       | 18,587          |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 18,590 |   |   |
| Conversion of  preferred stock to common stock                                                       |       | (12,777,118              | )          | (40,777    | )          |                  |       | 12,777,118  |       |       | 13         |            |       | 40,764          |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 40,777 |   |   |
| Issuance of common stock upon exercise of stock options                                              |       |                     |       |       |       |                  |       | 707,067     |       |       | 1          |            |       | 620             |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 621 |   |   |
| Equity-based  compensation                                                                           |       |                     |       |       |       |                  |       | 5,000       |       |       |       |            |       | 1,429           |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 1,429 |   |   |
| Amortization of  deferred stock-based compensation                                                   |       |                     |       |       |       |                  |       |        |       |       |       |            |       |            |       |              |       |              |       |            | 1,029      |                      |       |   |   |   |   |   |   |   |   |   | 1,029 |   |   |
| Forfeitures of  deferred stock-based compensation                                                    |       |                     |       |       |       |                  |       |        |       |       |       |            |       | (281            | )          |              |       |              |       |            | 92         |                      |       |   |   |   |   |   |   |   |   |   | (189 | ) |   |
| Correction of  deferred stock-based compensation (see Note 7)                                   |       |                     |       |       |       |                  |       |        |       |       |       |            |       | 342             |       |              |       |              |       |            | (344       | )                         |       |   |   |   |   |   |   |   |   |   | (2 | ) |   |
| Tax benefits from  stock-based compensation                                                          |       |                     |       |       |       |                  |       |        |       |       |       |            |       | 918             |       |              |       |              |       |            |       |                      |       |   |   |   |   |   |   |   |   |   | 918 |   |   |
| BALANCES: December  31, 2006                                                                         |       | —                   |       | $          | —     |                  |       |        | 20,528,468 |       |       | $               | 21         |            |       | $                 | 67,734     |              |       | $               | —     |                      |       |   | $ | (546 | ) |   |   | $ | (10,024 | ) |   |   | $ | (39 | ) |   |   | $ | 57,146 |   |   |

 

See accompanying notes to consolidated financial statements

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**TECHWELL, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**

| ** **                                                                                          | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Cash flows from operating activities**                                                            | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                   |       | $                                           | (1,742     | ) | $ | 4,541 |   | $ | 13,222 |   |
| Adjustments to reconcile  net income (loss) to net cash provided by (used in) operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                                                      |       | 186                                         |       | 192 |   | 321 |   |
| Loss on disposal  of equipment                                                                      |       | 16                                          |       | — |   | — |   |
| Stock-based  compensation                                                                           |       | 922                                         |       | 900 |   | 2,267 |   |
| Tax benefit from  employee equity incentive plan                                                    |       | —                                      |       | — |   | 902 |   |
| Excess tax  benefits from stock-based compensation                                                  |       | —                                      |       | — |   | (15 | ) |
| Changes in assets and  liabilities:                                                                 |       |                                        |       |   |   |   |   |
| Accounts  receivable                                                                                |       | 236                                         |       | (2,471 | ) | 287 |   |
| Inventory                                                                                           |       | (378                                        | )          | (1,675 | ) | (1,471 | ) |
| Prepaid expenses  and other current assets                                                          |       | 5                                           |       | 756 |   | (970 | ) |
| Other assets                                                                                        |       | 749                                         |       | 10 |   | (49 | ) |
| Accounts payable                                                                                    |       | (673                                        | )          | 416 |   | 2,137 |   |
| Accrued  liabilities                                                                                |       | 83                                          |       | 987 |   | 1,680 |   |
| Deferred income                                                                                     |       | (224                                        | )          | — |   | — |   |
| Restructuring  accrual                                                                              |       | 103                                         |       | (103 | ) | — |   |
| Deferred rent                                                                                       |       | 26                                          |       | 20 |   | (54 | ) |
| Net cash provided  by (used in) operating activities                                                |       | (691                                        | )          | 3,573 |   | 18,257 |   |
| **Cash flows from investing activities**                                                            | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of  property and equipment                                                                 |       | (280                                        | )          | (250 | ) | (481 | ) |
| Change in  restricted cash                                                                          |       | —                                      |       | 100 |   | — |   |
| Purchase of  investments                                                                            |       | (8,279                                      | )          | — |   | (102,476 | ) |
| Proceeds from  maturities of short-term investments                                                 |       | 2,930                                       |       | 7,552 |   | 61,914 |   |
| Net cash provided  by (used in) investing activities                                                |       | (5,629                                      | )          | 7,402 |   | (41,043 | ) |
| **Cash flows from financing activities**                                                            |       |                                        |       |   |   |   |   |
| Proceeds from  initial public offering of common stock, net of offering costs                       |       | —                                      |       | — |   | 19,368 |   |
| Proceeds from  issuance of Series F redeemable preferred shares                                |       | —                                      |       | 2,909 |   | — |   |
| Proceeds from  exercise of stock options                                                            |       | 106                                         |       | 369 |   | 622 |   |
| Excess tax  benefits from stock-based compensation                                                  |       | —                                      |       | — |   | 15 |   |
| Series E  redeemable preferred shares issuance costs                                           |       | (21                                         | )          | — |   | — |   |
| Collections on  notes receivable from stockholders                                                  |       | 56                                          |       | 438 |   | — |   |
| Payment of  deferred offering costs                                                                 |       | —                                      |       | (778 | ) | — |   |
| Net cash provided  by financing activities                                                          |       | 141                                         |       | 2,938 |   | 20,005 |   |
| Net increase  (decrease) in cash and cash equivalents                                               |       | (6,179                                      | )          | 13,913 |   | (2,781 | ) |
| Cash and cash  equivalents, beginning of the year                                                   |       | 8,248                                       |       | 2,069 |   | 15,982 |   |
| Cash and cash  equivalents, end of the year                                                         |       | $                                           | 2,069      |   | $ | 15,982 |   | $ | 13,201 |   |
| **Supplemental  cash flow information: income taxes paid**                                          |       | $                                           | 9          |   | $ | 18 |   | $ | 897 |   |
| **Supplemental disclosure of non-cash investing  and financing activities**                         | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Conversion of  redeemable convertible preferred stock to common stock                               |       | $                                           | —     |   | $ | — |   | $ | 40,777 |   |
| Net change in fair  value of common stock associated with notes receivable                          |       | $                                           | 13         |   | $ | — |   | $ | — |   |
| Common stock  issued for notes receivable                                                           |       | $                                           | 86         |   | $ | — |   | $ | — |   |
| Cancellation of  notes receivable upon repurchase of common stock                                   |       | $                                           | 115        |   | $ | — |   | $ | — |   |
| Deferred  stock-based compensation related to stock option grants                                   |       | $                                           | 1,586      |   | $ | 1,515 |   | $ | — |   |
| Reversals of deferred  stock-based compensation for cancellation of stock options                   |       | $                                           | 465        |   | $ | 490 |   | $ | 281 |   |
| Accrued offering  costs                                                                             |       | $                                           | —     |   | $ | 1,024 |   | $ | — |   |
| Accrued equipment  costs                                                                            |       | $                                           | —     |   | $ | — |   | $ | 31 |   |

 

See accompanying notes to consolidated financial statements.

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**TECHWELL, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.   ORGANIZATIONAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

***Organization.******  ***Techwell, Inc.(“Techwell” or the “Company”), was incorporated in California on March 7,1997 and reincorporated in Delaware on March 30, 2006. As a result of thereincorporation, the consolidated financial statements have been adjusted togive retroactive effect to the establishment of par value for the Company’scommon stock. Techwell is a fabless semiconductor company that designs, marketsand sells mixed signal integrated circuits for multiple video applications inthe consumer, security surveillance and automotive markets.

The Company’s international offices include branchoffices in South Korea and Taiwan and a subsidiary in China. The South Koreaoffice is primarily involved in product development and is also involved intechnical sales support. The China office and the Taiwan office primarilyprovide sales and marketing support.

***Principles ofConsolidation.******  ***The consolidated financial statementsinclude the accounts of the Company and its subsidiaries. All significantintercompany accounts and transactions have been eliminated.

***Use of Estimates.******  ***Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andreported amounts of revenues and expenses during the reporting period. Actualresults could differ from those estimates.

***Cash and CashEquivalents.******  ***The Company considers all highlyliquid investments purchased with a remaining maturity of three months or lessto be cash equivalents.

***Investments.******  ***The Company accounts for itsinvestments in debt and equity securities under the provisions of Statement ofFinancial Accounting Standards (“SFAS”) No. 115, *Accountingfor Certain Investments in Debt and Equity Securities* and SFAS No. 115-1,*The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments.* Investments purchased with aremaining maturity of greater than three months are consideredavailable-for-sale and are carried at fair market value based on market quotes.Unrealized gains and losses, net of tax, are reported as a separate componentof stockholders’ equity and included in “Accumulated other comprehensive loss”.Realized gains and losses are recorded based on the specific identificationmethod and are not significant in any period presented.

***Concentration ofCredit Risk.******  ***Financialinstruments that potentially subject the Company to concentrations of creditrisk consist principally of cash and cash equivalents, investments and tradereceivables. Risks associated with cash and cash equivalents are mitigated bybanking with creditworthy institutions and the Company’s investments haveinvestment grade ratings. Additionally, the Company limits the amount investedby maturity, type of security and issuer. The Company’s accounts receivable aresubstantially derived from customers located in Asia. The Company generallyrequires letters of credit or advance payments from customers. The Company alsoperforms credit evaluations of its customers and provides credit to certaincustomers in the normal course of business. The Company has not incurred baddebt write-offs during any of the periods presented.

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Theaccounts receivable and revenues from customers representing 10% or more oftotal revenues and accounts receivables are as follows:

| ** **   | ** ** | **Accounts  Receivable** | ** ** | **Revenues**                                | ** ** |
|--------------|------------|--------------------------|------------|---------------------------------------------|------------|
| ** **   | ** ** | **December 31,**    | ** ** | **Years Ended December 31,** | ** ** |
| **Customer** | ** ** | ** **               | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| A            |       |                     | *          | %                                           |       |   | 16 | % |   |   | * | % |   |   | 10 | % |   |   | 15 | % |   |
| B            |       |                     | *          |                                        |       |   | * |   |   |   | * |   |   |   | * |   |   |   | 12 |   |   |
| C            |       |                     | *          |                                        |       |   | * |   |   |   | * |   |   |   | * |   |   |   | 10 |   |   |
| D            |       |                     | 15         |                                        |       |   | * |   |   |   | 11 |   |   |   | 10 |   |   |   | * |   |   |
| E            |       |                     | 18         |                                        |       |   | 27 |   |   |   | * |   |   |   | * |   |   |   | * |   |   |
| F            |       |                     | 12         |                                        |       |   | * |   |   |   | * |   |   |   | * |   |   |   | * |   |   |
| G            |       |                     | 11         |                                        |       |   | 14 |   |   |   | * |   |   |   | * |   |   |   | * |   |   |
|              |            |                          |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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****                   *less than 10%

***Concentration ofSupplier Risk.******  ***TheCompany is a fabless producer of semiconductors and is dependent on twosubcontractors for substantially all of its production requirements. Thefailure of either subcontractor to fulfill the production requirements of theCompany on a timely basis would adversely impact future results. Although thereare other subcontractors that are capable of providing similar services, anunexpected change in either subcontractor would cause delays in the Company’sproducts and potential significant loss of revenue.

***Inventory.******  ***Inventory isvalued at the lower of cost or market, computed on a first-in, first-out basis.Inventory consists of work in process (principally processed wafers andproducts at third party assembly and test subcontractors) and finished goods.The Company’s products are subject to rapid technological obsolescence andsevere price competition. Should the Company experience a substantialunanticipated decline in the selling price of, or demand for, its products, asignificant charge to operations could result. The Company evaluates inventoryfor excess and obsolescence and writes off units which are not expected to besold based upon demand forecasts. If actual future demand for the Company’sproducts is less than amounts forecasted, additional inventory adjustments maybe required. Once a reserve is established, it is maintained until the productto which it relates is sold or scrapped. In the years ended December 31,2004, 2005 and 2006, the Company recorded inventory write-downs of $84,000,$474,000 and $700,000 respectively, due to excess and obsolete inventory andlower-of-cost or market markdown.

***Prepaid Expensesand Other Current Assets.******  ***Prepaidexpenses and other current assets include deferred offering costs at December 31,2005 that were reclassified to equity upon completion of the Company’s initialpublic offering “(IPO”).

***Property andEquipment.***   Property and equipment, includingleasehold improvements, are recorded at historical cost, less accumulateddepreciation. Depreciation is computed using the straight-line method over theestimated useful lives of the assets, generally ranging from three to fiveyears, or in the case of leasehold improvements, over the shorter of the leaseperiod or the estimated useful life.

***Long-Lived Assets.******  ***Long-livedassets include equipment and furniture and fixtures. The Company evaluateslong-lived assets for impairment in accordance with SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Assets*, whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. When theundiscounted future net cash flows expected to result from the use of the assetand its eventual disposition is less than its carrying amount, the Companywould measure an impairment loss in an amount equal to the excess of thecarrying amount over the fair value.

***Other Assets.***   Otherassets consist primarily of long-term lease deposits.

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***Revenue Recognition.***   Revenuesfrom product sales are recognized upon shipment, provided title and risk ofloss has passed to the customer, when persuasive evidence of an arrangementexists, the price is fixed or determinable and collectibility is probable. TheCompany does not allow for price protection or stock rotation rights with anyof its customers.

Customers have no rights of return except pursuant tothe Company’s product warranty. The Company has no other post-shipmentobligations and sales are not subject to customer acceptance provisions.

Prior to the fourth quarter of 2004, the Companyrecognized revenues on shipments to distributors only upon resale by thosedistributors. Beginning in the fourth quarter of 2004, the Company hadsufficient historical evidence with respect to returns made by distributors toenable it reasonably to estimate returns and recognize revenues at the time ofshipment to its distributors instead of at the time of resale by itsdistributors. The effect on 2004 of this change in accounting estimate is torecognize additional revenues of $864,000 and gross profit of $224,000 that hadbeen deferred at December 31, 2003.

The Company has in the past entered into developmentagreements with a limited number of its customers. Development revenues arerecognized under the percentage of completion method when persuasive evidenceof an arrangement exists (as evidenced by a written contract), the fee is fixedor determinable and collectibility is probable. During the year ended December 31,2004, the Company recognized development revenue of approximately $500,000. TheCompany did not recognize development revenue in the years ended December 31,2005 and 2006.

***Product Warranty.***   TheCompany offers a one-year product replacement warranty. The Company accrues forestimated returns of defective products based on historical activity for theprior twelve months at the time revenue is recognized. The determination ofthese accruals requires the Company to make estimates of the frequency andextent of warranty activity and estimated future costs to replace the productsunder warranty. If the actual warranty activity and/or repair and replacementcosts differ significantly from these estimates, adjustments to recognizeadditional cost of sales may be required in future periods. However, returns ofdefective products were infrequent and the quantities have not beensignificant. Accordingly, historical warranty costs have not been material forthe periods presented. A summary of the accrued warranty, which is included inaccrued liabilities is as follows (in thousands):

| ** **                          | ** ** | **Years Ended  December 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** ** | **2005**                                | ** ** | **2006** | ** ** |
| Balance at  beginning of the period |       | $                                       | 20         |   | $ | 50 |   |
| Accruals for sales in the period    |       | 66                                      |       | 24 |   |
| Costs incurred                      |       | (36                                     | )          | (27 | ) |
| Balance at end of the  period       |       | $                                       | 50         |   | $ | 47 |   |

 

***Research andDevelopment.******  ***Research and development costs areexpensed as incurred.

***Advertising Costs.******  ***Advertisingcosts are expensed as incurred and were not significant in any of the periodspresented.

***Income Taxes.******  ***The Companyaccounts for income taxes under the provisions of SFAS No. 109, *Accounting for Income Taxes*. In applyingSFAS 109, the Company is required to estimate its current tax expensetogether with assessing temporary differences resulting from differingtreatments of items for tax and accounting purposes. These differences resultin deferred tax assets and liabilities. Significant management judgment isrequired to assess the likelihood that its deferred tax assets will berecovered from future taxable income. As of December 31, 2006, the Company’stotal deferred tax assets were principally comprised of net operating losscarryforwards, research and other credit carryforwards and 

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expense accruals.To assess the likelihood that the deferred tax assets will be recovered fromtaxable income, the Company applied the guidance provided in SFAS No. 109and considered both positive evidence that indicates a valuation allowance isnot needed and negative evidence that indicates a valuation allowance isneeded. The factors considered include the following:

·       Althoughthe Company recorded pre-tax income for the years ended December 31, 2006and 2005, it has incurred cumulative pre-tax losses in all prior years and hasa retained deficit of $10.0 million at December 31, 2006.

·       Section 382of the Internal Revenue Code, imposes an annual limit on the ability of acorporation that undergoes an ‘‘ownership change’’ to use its net operatingloss carryforwards to reduce its tax liability. Due in part to equityfinancings, Techwell experienced ‘‘ownership changes’’ as defined in Section 382of the Code. Accordingly, Techwell’s use of the net operating losscarryforwards and credit carryforwards is subject to annual limitation whichcould reduce its ability to utilize these losses.

·       Thesemiconductor industry in which the Company operates is highly cyclical and hasexperienced significant downturns that are characterized by decreases inproduct demand, excess customer inventories and accelerated erosion of prices.Any downturn in the semiconductor industry may be severe and prolonged and couldharm the Company’s operating results. Thus current profitability does notprovide assurance of continued profitability.

Therefore, at December 31, 2006 based on theavailable objective evidence, the Company believed it is more likely than notthat its deferred tax assets will not be realizable. Accordingly, the Companycontinued to provide a full valuation allowance against its net deferred taxassets at December 31, 2006. Should sufficient positive, objectivelyverifiable evidence of the realization of our net deferred tax assets exist ata future date, the Company would reverse any remaining valuation allowance tothe extent supported by estimates of future taxable income at that time.

***Stock-BasedCompensation.******  ***Effective January 1, 2006, theCompany adopted SFAS No. 123 (revised 2004),*Share-Based Payment*, which requires the measurement andrecognition of compensation expense for all share-based payment awards made toemployees and directors, including employee stock options, based on estimatedfair values recognized over the requisite service period. Prior to adoption ofSFAS 123(R), the Company accounted for stock-based compensation awardsissued to its employees using the intrinsic value measurement provisions ofAccounting Principles Board Opinion No. 25 (“APB Opinion No. 25”),*Accounting for Stock Issued to Employees*  and complied with the disclosure requirementsof SFAS No. 123,*Accounting forStock-Based Compensation*. In March 2005, the Securities andExchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SABNo. 107”) relating to SFAS 123(R). The Company has applied the provisionsof SAB No. 107 in its adoption of SFAS 123(R). The Company accounts forstock-based awards to non-employees in accordance with Emerging Issues Task Force(“EITF”) Issue No. 96-18,*Accounting for Equity Instruments that are Issued to Other Than Employees forAcquiring or in Conjunction with Selling Goods or Services* and SFAS No. 123(R).

The Company adopted SFAS 123(R) using theprospective transition method. Under this method, SFAS 123(R) is appliedto new awards and to awards modified, repurchased or cancelled after theadoption date of January 1, 2006. Compensation cost previously recordedunder APB Opinion No. 25 for awards outstanding at the adoption date, suchas unvested options, will continue to be recognized as the optionsvest. Accordingly, for the year ended December 31, 2006, stock basedcompensation expense includes compensation cost related to estimated fairvalues of awards granted after the date of adoption of SFAS 123(R) andcompensation costs related to unvested awards at the date of adoption based onthe intrinsic values as previously recorded under APB Opinion No. 25.

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Thefair value of options granted after January 1, 2006 is estimated on thegrant date using the Black-Scholes option valuation model. This valuationmodel for stock compensation expense requires the Company to make assumptionsand judgments about the variables used in the calculation including theexpected term (weighted average period of time that the options granted areexpected to be outstanding), the volatility of Techwell’s common stock, anassumed risk free interest rate and the estimated forfeiture rate of unvestedstock options. To the extent actual results differ from the estimates, thedifference will be recorded as a cumulative adjustment in the period estimatesare revised. No compensation cost is recorded for options that do notvest. Since the Company’s stock has not been actively traded in the past,the Company uses the simplified calculation of expected term described in SAB No. 107and volatility is based on an average of the historical volatilities of thecommon stock of several entities with characteristics similar to those of theCompany. The risk-free rate is based on the U.S. Treasury yield curve ineffect at the time of grant for periods corresponding with the expected term ofthe option. The forfeiture rate is based on the Company’s historicalturnover experience and is estimated at 10%. The Company uses thestraight-line method for expense attribution for options granted after January 1,2006, and valued in accordance with SFAS 123(R).

The following assumptionsare used to value stock options granted in the year ended December 31,2006:

| Expected term in  years  |   | 6.08           |   |
|--------------------------|--------|----------------|--------|
| Risk-free  interest rate |   | 4.55–5.0  | %      |
| Expected  volatility     |   | 72.6–74.1 | %      |
| Dividend yield           |   | 0              | %      |

 

Under the provisions of APB Opinion No. 25, theCompany recognized deferred stock-based compensation based on the excess of thedeemed fair value of the underlying stock over the stock option exercise priceat the date of grant. From April 2005 through December 2005, theCompany granted options with exercise prices equal to the fair value of thecommon stock determined by the board of directors at the time of the grants.Techwell subsequently obtained valuations from an unrelated valuationspecialist that were used to establish retroactively the fair value of itscommon stock. This retroactive fair value exceeded the fair value establishedby the board of directors at the time of the grants. As a result, the Companyrecorded deferred stock-based compensation. For options granted in earlierperiods, the fair value of the common stock was originally based on estimatesmade by the board of directors at the date of each grant. The Company did notobtain valuations by a valuation specialist. Subsequent to the grant date, whenthe Company prepared its financial statements, it performed retrospectivevaluations of its common stock using the probability-weighted expected returnmethod. The Company used the values determined to record retroactively stockcompensation based on the difference between the subsequently determined fairvalue and the exercise price. For options granted prior to January 1,2006, the Company uses the multiple grant approach for expense attribution,which results in substantially higher amounts of amortization in earlier yearsas opposed to the straight-line method, which results in equal amortizationover the vesting period of the options. Under the multiple grant approach,forfeitures of unvested options resulting from employee terminations result inthe reversal of previously expensed stock compensation associated with theunvested options during the period in which the forfeiture occurs. Stock-basedcompensation expense from vested options, whether forfeited or not, is notreversed.

As a result of adopting SFAS 123(R), Techwell’soperating income and net income for the year ended December 31, 2006 werereduced by approximately $835,000 and $793,000, respectively and basic anddiluted net income per share were reduced by $0.06 and $0.04, respectively.

SFAS 123(R) requires the cash flows resultingfrom the tax benefits for tax deductions resulting from the exercise of stockoptions in excess of the compensation expense recorded for those options(excess tax benefits) to be classified as cash from financing activities. TheCompany recorded excess tax benefits of $15,000 in the year ended December 31,2006.

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***Net Income (Loss) Per Share.***   TheCompany calculates net income (loss) per share in accordance with SFAS No. 128,*Earnings Per Share*. Under SFAS No. 128,basic net income (loss) per common share is calculated by dividing net income(loss) by the weighted-average number of common shares outstanding during thereporting period excluding shares subject to repurchase. Diluted net income(loss) per common share reflects the effects of potentially dilutivesecurities, which consist of convertible preferred stock, common stock options,and common stock subject to repurchase. A reconciliation of shares used in thecalculation of basic and diluted net income (loss) per share is as follows (inthousands):

| ** **                                                                              | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                              | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| Weighted average common  shares outstanding                                             |       | 3,674                                       |       | 4,041 |   | 12,845 |   |
| Weighted average shares  subject to repurchase                                          |       | (83                                         | )          | (48 | ) | (73 | ) |
| Shares used to calculate  basic net income (loss) per share                             |       | 3,591                                       |       | 3,993 |   | 12,772 |   |
| Effect of dilutive securities:                                                          |       |                                        |       |   |   |   |   |
| Convertible preferred  stock                                                            |       | —                                      |       | 12,674 |   | 6,143 |   |
| Common  stock options and unvested common shares subject to repurchase or  cancellation |       | —                                      |       | 1,767 |   | 1,623 |   |
| Dilutive potential  common stock                                                        |       | —                                      |       | 14,441 |   | 7,766 |   |
| Shares used to calculate diluted net income (loss)  per share                           |       | 3,591                                       |       | 18,434 |   | 20,538 |   |

 

Forthe year ended December 31, 2004, outstanding common stock options of2,615,062 shares and convertible preferred stock of 12,231,664 shares have beenexcluded as they are antidilutive due to the Company’s net loss. For the yearended December 31, 2005, the weighted shares used to calculate diluted netincome per share include the effect of the convertible preferred stock. Thecompletion of the Company’s IPO in June 2006 resulted in the conversion tocommon stock of all outstanding shares of convertible preferred stock. Asa consequence, the shares used to calculate basic net income per share haveincreased by the weighted average impact of the 12,777,118 shares of commonstock issued on conversion of the convertible preferred stock and the 2,540,225shares of common stock issued in the IPO and 130,000 shares of common stockissued in July 2006 following the underwriters’ partial exercise of theirover-allotment option related to the IPO. No additional potentially dilutivesecurities were outstanding at December 31, 2006.

***Other ComprehensiveLoss.******  ***The Company accounts for comprehensiveincome (loss) under the provisions SFAS No. 130, *Reporting Comprehensive Income (Loss),*which establishes standards for reporting and displaying comprehensive income(loss) and its components in the financial statements. Comprehensive income(loss), as defined, includes all changes in equity during a period fromnon-owner sources. At December 31, 2006, accumulated other comprehensiveloss consists of net unrealized losses on available-for-sale investments. Therewere no unrealized gains or losses on investments in the years ended December 31,2005 and 2004.

***RecentAccounting Pronouncements.***

In June 2006,the Financial Accounting Standards Board, (“FASB”) issued Interpretation No. 48,*Accounting for Uncertainty in Income Taxes,*(“FINNo. 48”). This interpretation clarifies the accounting for uncertainty inincome taxes recognized in an enterprise’s financial statements in accordancewith SFAS No. 109,*Accounting forIncome Taxes.*FIN No. 48 prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. FIN No. 48also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition. FIN No. 48is effective for fiscal years beginning after December 15,2006. Adoption of FIN No. 48 is not expected to have a significantimpact on the Company’s results of operations and financial position.

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On September 13, 2006, the Securities andExchange Commission issued Staff Accounting Bulletin No. 108, *Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*,(“SAB No. 108”), which provides interpretive guidance on the considerationof the effects of prior year misstatements in quantifying current yearmisstatements for the purpose of a materiality assessment. SAB No. 108 iseffective for annual financial statements for the first fiscal year endingafter November 15, 2006. However, early application is encouraged in anyreport for an interim period of the first fiscal year ending afterNovember 15, 2006, filed after the publication of this guidance. Theadoption of SAB No. 108 did not have a significant impact on the Company’sresults of operations and financial position.

In September 2006, the FASB issued SFASNo. 157,*Fair Value Measurements,* (“SFAS No. 157”). SFAS No. 157 defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.This statement applies under other accounting pronouncements that require orpermit fair value measurements, the FASB having previously concluded in thoseaccounting pronouncements that fair value is the relevant measurementattribute. Accordingly, this Statement does not require any new fair valuemeasurements. SFAS No. 157 is effective for financial statements issuedfor fiscal years beginning after November 15, 2007, and interim periodswithin those fiscal years. The Company is required to adopt this statement inour first fiscal quarter of 2008. The Company is evaluating the potentialimpact of SFAS No. 157 on our results of operations and financialposition.

In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assets andFinancial Liabilities—including an Amendment of FASB Statement No. 115*,(“SFAS No. 159”), to permit all entities to choose to elect, at specifiedelection dates, to measure eligible financial instruments at fair value, toreport unrealized gains and losses on items for which the fair value option hasbeen elected in earnings at each subsequent reporting date, and recognizeupfront costs and fees related to those items in earnings as incurred and notdeferred. SFAS No. 159 applies to fiscal years beginning after November 15,2007, with early adoption permitted for an entity that has also elected toapply the provisions of SFAS No. 157. An entity is prohibited fromretrospectively applying SFAS No. 159, unless it chooses early adoption.The Company is evaluating the potential impact of SFAS No. 159 on ourresults of operations and financial position.

**2.   INVESTMENTS**

The following is a summary of Techwell’s cashequivalents and investments at December 31, 2006 (in thousands):

| ** **                           | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|--------------------------------------|------------|---------------------|------------|-----------------------|------------|------------------------|------------|--------------------------------|------------|
| Commercial paper                     |       |                | $          | 18,476                |       |                   |       | $                              | —     |   |   |   | $ | (22 | ) |   |   | $ | 18,454 |   |   |
| Auction rate securities              |       |                | 15,375     |                  |       |                   | —     |                           |       |   | — |   |   |   | 15,375 |   |   |
| Corporate bonds                      |       |                | 2,962      |                  |       |                   | —     |                           |       |   | (8 | ) |   |   | 2,954 |   |   |
| U.S. Treasury and agency  securities |       |                | 5,977      |                  |       |                   | —     |                           |       |   | (10 | ) |   |   | 5,967 |   |   |
| Money market funds                   |       |                | 5,923      |                  |       |                   | 1          |                           |       |   | — |   |   |   | 5,924 |   |   |
| Total                                |       |                | $          | 48,713                |       |                   |       | $                              | 1          |   |   |   | $ | (40 | ) |   |   | $ | 48,674 |   |   |
| Amounts included in:                 |       |                |       |                  |       |                   |       |                           |       |   |   |   |   |   |   |   |   |
| Cash equivalents                     |       |                |       |                  |       |                   |       |                           |       |   |   |   |   |   | $ | 7,347 |   |   |
| Short-term investments               |       |                |       |                  |       |                   |       |                           |       |   |   |   |   |   | 36,364 |   |   |
| Long-term investments                |       |                |       |                  |       |                   |       |                           |       |   |   |   |   |   | 4,963 |   |   |
| Total securities                     |       |                |       |                  |       |                   |       |                           |       |   |   |   |   |   | $ | 48,674 |   |   |

 

Each of the securities in the above table haveinvestment grade ratings and are in an unrealized loss position due primarilyto interest rate changes. At maturity, the Company expects to receive the fullprincipal and interest on these securities. At December 31, 2006, each ofthe securities has been in a loss position for less than 12 months. Theeffective maturities of Techwell’s investments are $43.7 million within oneyear and $5.0 million in two years at December 31, 2006.

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At December 31, 2005,the Company had $804,000 invested in certificates of deposit with banks withremaining maturity periods greater than 90 days at the time of purchase.The market value of the investments approximated carrying value and there is nounrealized gain or loss.

**3.   DETAILS OFCERTAIN BALANCE SHEET COMPONENTS**

**Inventory:**

| ** **      | ** ** | **December 31,**   | ** ** |
|-----------------|------------|-------------------------|------------|
| ** **      | ** ** | **2005**                | ** ** | **2006** | ** ** |
| ** **      | ** ** | **(in thousands)** | ** ** |
| Finished goods  |       | $                       | 1,306      |   | $ | 1,702 |   |
| Work in process |       | 1,807                   |       | 2,882 |   |
|            |       | $                       | 3,113      |   | $ | 4,584 |   |

 

**Property and equipment, net:**

| ** **                                      | ** ** | **December 31,**   | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **2005**                | ** ** | **2006** | ** ** |
| ** **                                      | ** ** | **(in thousands)** | ** ** |
| Equipment                                       |       | $                       | 829        |   | $ | 1,029 |   |
| Software                                        |       | 62                      |       | 215 |   |
| Furniture and fixtures                          |       | 273                     |       | 317 |   |
| Leasehold improvements                          |       | 91                      |       | 146 |   |
|                                            |       | 1,255                   |       | 1,707 |   |
| Less accumulated  depreciation and amortization |       | (821                    | )          | (1,082 | ) |
|                                            |       | $                       | 434        |   | $ | 625 |   |

 

**Accrued liabilities:**

| ** **                            | ** ** | **December 31,**   | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **2005**                | ** ** | **2006** | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Accrued compensation                  |       | $                       | 551        |   | $ | 1,988 |   |
| Accrued inventory  purchases          |       | 239                     |       | 279 |   |
| Legal and professional  services fees |       | 1,274                   |       | 271 |   |
| Exercise of unvested  stock options   |       | 159                     |       | 110 |   |
| Income taxes payable                  |       | 135                     |       | — |   |
| Customer advances                     |       | 29                      |       | 325 |   |
| Other                                 |       | 300                     |       | 371 |   |
|                                  |       | $                       | 2,687      |   | $ | 3,344 |   |

 

**4.   RESTRUCTURING COSTS**

During the year ended December 31,2004, the Company moved its corporate headquarters and business operations toanother leased office facility in the United States. The Company incurredrestructuring costs for the remaining lease payments for its previous officefacility lease. Restructuring costs are as follows (in thousands):

| ** **                                            | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Restructuring  costs accrued at beginning of the year |       |                        | $          | —                      |       |   |   | $ | 103 |   |   |
| Restructuring costs expensed                          |       |                        | 224        |                        |       |   | — |   |   |
| Restructuring costs paid in the year                  |       |                        | 121        |                        |       |   | 103 |   |   |
| Restructuring costs  accrued at end of the year       |       |                        | $          | 103                         |       |   |   | $ | — |   |   |

 

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**5.   STOCKHOLDERS’EQUITY**

***Initial PublicOffering of Common Stock.***   In June 2006,the Company completed its IPO and issued 2,540,225 shares of its common stockat a price of $9.00 per share. The Company received approximately $17.5 millionin cash, net of underwriting discounts, commissions and other offering costs.In July 2006, the Company received aggregate proceeds of $1.1 million, netof underwriting discounts and commissions, from the sale of an additional130,000 shares following the underwriters’ partial exercise of theirover-allotment option related to the Company’s IPO.

***Redeemable Convertible Preferred Stock.******  ***Simultaneously with theclosing of the IPO in June 2006, each outstanding share of redeemableconvertible preferred stock was automatically converted into one share ofcommon stock. At December 31, 2005, the redeemable convertible preferredstock was as follows (in thousands, except share and per share amounts):

| **Series** | ** ** | ** ** | ** ** | **Issuance  Price  per Share** | ** ** | **Shares  Authorized** | ** ** | **Shares  Outstanding** | ** ** | **Liquidation  Amount** | ** ** | **Balance** | ** ** | **Common Shares  Reserved for  Conversion** | ** ** |
|------------|------------|------------|------------|-------------------------------------|------------|------------------------|------------|-------------------------|------------|-------------------------|------------|-------------|------------|-------------------------------------------------------|------------|
| A          |       |       | $          | 0.50                                |       |                   | 3,004,219  |                    | 3,004,219  |                    |       | $           | 1,502      |                                                  |       | $ | 1,498 |   |   | 3,004,219 |   |   |
| B          |       |       | $          | 1.50                                |       |                   | 2,457,980  |                    | 2,457,980  |                    |       | 3,687       |       |                                                  | 3,638      |   |   | 2,457,980 |   |   |
| C          |       |       | $          | 4.50                                |       |                   | 1,279,465  |                    | 1,269,465  |                    |       | 5,713       |       |                                                  | 5,540      |   |   | 1,269,465 |   |   |
| D          |       |       | $          | 5.00                                |       |                   | 1,500,000  |                    | 1,500,000  |                    |       | 7,500       |       |                                                  | 7,402      |   |   | 1,500,000 |   |   |
| E          |       |       | $          | 5.00                                |       |                   | 2,400,000  |                    | 2,400,000  |                    |       | 12,000      |       |                                                  | 11,866     |   |   | 2,400,000 |   |   |
| E-1        |       |       | $          | 5.00                                |       |                   | 1,600,000  |                    | 1,600,000  |                    |       | 8,000       |       |                                                  | 7,924      |   |   | 1,600,000 |   |   |
| F          |       |       | $          | 5.50                                |       |                   | 545,454    |                    | 545,454    |                    |       | 3,000       |       |                                                  | 2,909      |   |   | 545,454 |   |   |
|       |       |       |       |                                |       | 12,787,118             |       | 12,777,118              |       |                    | $          | 41,402      |       |                                                  | $          | 40,777 |   |   | 12,777,118 |   |   |

 

**6.    STOCKINCENTIVE PLANS**

In 1997 and 2001, the Company adopted stock optionplans (the “Plans”) and reserved a total of 6,500,000 shares of common stockfor issuance under the Plans. In November 2005, the Company adopted the2006 Stock Incentive Plan (the “2006 Plan”) and reserved an aggregate of1,990,000 shares of common stock for issuance under the 2006 Plan. The 2006Plan became effective upon the completion of the Company’s IPO at which time898,726 shares of common stock originally authorized for issuance under thePlans were cancelled. The Plans and the 2006 Plan (collectively the “IncentivePlans”) provide for the grant stock options, restricted stock, stock units andstock appreciation rights to employees, consultants and directors. The 2006 Plan contains a provision thatautomatically increases the number of shares of common stock reserved forissuance on January 1 of each succeeding year. At December 31,2006, the Company had reserved 4,055,399 shares of common stock for issuanceunder the Incentive Plans. On January 1, 2007, the shares reserved forissuance under the Company’s Incentive Plans increased by 823,372 shares.

Under the terms of the Incentive Plans, incentiveoptions may be granted only to employees at a price not to be less than100 percent of the fair market value on the grant date. Nonstatutoryoptions may be granted at a price that is not less than 85 percent of thefair market value on the date of grant. Options and restricted stock grantedunder the Incentive Plans have a contractual term up to ten years, generallyvest over four years at the rate of 25 percent on the one-year anniversaryof the vesting commencement date and ratably each month thereafter and areexercisable under conditions determined by the Board as permissible under theterms of the Incentive Plans.

Certain options granted under the Incentive Plans arefully exercisable on and after the date of grant, subject to the Company’sright to repurchase from an optionee, at the optionee’s original per shareexercise price, any unvested shares which the optionee has purchased and holdsin the event of the termination of the optionee’s employment, with or withoutcause. The Company’s right lapses as shares 

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subject to the optionbecome vested. At December 31, 2006, 55,834 shares were subject torepurchase pursuant to these provisions.

At December 31, 2006, 1,770,470 shares wereavailable for grant under the Incentive Plans.

Stockoption activity is summarized as follows:

| ** **                                                                                                                 | ** ** | **Number  Outstanding** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|
| Options  outstanding at January 1, 2004 (1,682,319 shares exercisable at a  weighted-average price of $0.46)          |       |                    | 2,242,840  |                                    |       |   | $ | 0.56 |   |   |
| Options granted                                                                                                            |       |                    | 835,000    |                                    |       |   | $ | 0.90 |   |   |
| Options exercised                                                                                                          |       |                    | (361,423   | )                                       |       |   | $ | 0.53 |   |   |
| Options cancelled                                                                                                          |       |                    | (101,355   | )                                       |       |   | $ | 0.31 |   |   |
| Shares  repurchased                                                                                                        |       |                    |       |                                    |       |   |   |   |   |
| Options  outstanding at December 31, 2004 (1,890,016 shares exercisable at a  weighted-average price of $0.60)        |       |                    | 2,615,062  |                                    |       |   | $ | 0.69 |   |   |
| Options granted                                                                                                            |       |                    | 763,062    |                                    |       |   | $ | 2.39 |   |   |
| Options exercised                                                                                                          |       |                    | (680,604   | )                                       |       |   | $ | 0.54 |   |   |
| Options cancelled                                                                                                          |       |                    | (279,792   | )                                       |       |   | $ | 1.07 |   |   |
| Options  Outstanding at December 31, 2005 (1,244,418 shares exercisable at a  weighted-average price of $0.66)        |       |                    | 2,417,728  |                                    |       |   | $ | 1.22 |   |   |
| Options granted                                                                                                            |       |                    | 757,000    |                                    |       |   | $ | 10.41 |   |   |
| Options exercised                                                                                                          |       |                    | (707,067   | )                                       |       |   | $ | 0.88 |   |   |
| Options cancelled                                                                                                          |       |                    | (245,232   | )                                       |       |   | $ | 3.54 |   |   |
| Options  outstanding at December 31, 2006 (959,283 shares exercisable at a  weighted-average exercise price of $1.02) |       |                    | 2,222,429  |                                    |       |   | $ | 4.20 |   |   |
| Options vested  and expected to vest at December 31, 2006                                                             |       |                    | 2,012,840  |                                    |       |   | $ | 4.00 |   |   |

 

The aggregate intrinsic value of options outstanding,options vested and expected to vest and options exercisable at December 31,2006, is $26.4 million, $24.3 million and $14.4 million,respectively. The weighted average remaining contractual life of optionsoutstanding, options vested and expected to vest and options exercisable at December 31,2006, is 7.42 years, 7.29 years and 5.57 years, respectively.

Thestock options outstanding and exercisable by exercise price at December 31,2006, are as follows:

| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Outstanding and Exercisable** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|--------------------------------------------------------|------------|
| **Exercise Price**                     | ** ** | ** **                   | ** ** | **Number  Outstanding**                                | ** ** | **Weighted-  Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  Outstanding** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| $  0.15  – $  0.45 |       |                         | 518,966    |                                                   |       |   | 3.71 |   |   |   | $ | 0.45 |   |   |   | 518,966 |   |   |   | $ | 0.45 |   |   |
| $  0.90                           |       |                         | 477,191    |                                                   |       |   | 7.29 |   |   |   | $ | 0.90 |   |   |   | 254,137 |   |   |   | $ | 0.90 |   |   |
| $  1.50                           |       |                         | 334,188    |                                                   |       |   | 8.51 |   |   |   | $ | 1.50 |   |   |   | 121,643 |   |   |   | $ | 1.50 |   |   |
| $  3.00  – $  9.00 |       |                         | 298,084    |                                                   |       |   | 8.91 |   |   |   | $ | 4.91 |   |   |   | 64,537 |   |   |   | $ | 5.18 |   |   |
| $10.00 – $11.00                        |       |                         | 482,000    |                                                   |       |   | 9.33 |   |   |   | $ | 10.75 |   |   |   | — |   |   |   | $ | — |   |   |
| $12.38 – $17.24                        |       |                         | 112,000    |                                                   |       |   | 9.74 |   |   |   | $ | 13.67 |   |   |   | — |   |   |   | $ | — |   |   |
|                                        |       |                         | 2,222,429  |                                                   |       |   | 7.42 |   |   |   | $ | 4,20 |   |   |   | 959,283 |   |   |   | $ | 1.02 |   |   |
|                                             |            |                              |            |                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Restrictedstock award activity is summarized as follows:

| ** **                                                     | ** ** | **Number   of   Shares** | ** ** | **Weighted-   Average   Fair Value** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------|------------|
| Restricted stock  awards outstanding at January 1, 2006   |       | —                             |       |                                                | $          | — |   |   |
| Restricted stock awards granted                                |       | 92,500                             |       |                                                | $          | 14.83 |   |   |
| Restricted stock awards vested                                 |       | (5,000                             | )          |                                                | $          | 10.00 |   |   |
| Restricted stock awards cancelled                              |       | (25,000                            | )          |                                                | $          | 15.11 |   |   |
| Restricted stock awards  outstanding at December 31, 2006 |       | 62,500                             |       |                                                | $          | 15.11 |   |   |

 

**7.   STOCK-BASEDCOMPENSATION**

As discussed inNote 1, the Company adopted SFAS 123(R) effectiveJanuary 1, 2006 using the prospective transition method. UnderSFAS 123(R), the Company estimates the fair value of stock options grantedafter December 31, 2005 on the grant date using the Black-Scholes optionvaluation model and applies the straight-line method of expense attribution.

The total intrinsic valueof options exercised during the years ended December 31, 2004, 2005 and2006 was $819,000, $2.5 million and $7.7 million respectively.

Prior to adoption ofSFAS 123(R), the Company accounted for its stock-based awards to employeesusing the intrinsic value method in accordance with APB Opinion No. 25.Accordingly, the Company recorded deferred stock compensation equal to thedifference between the exercise price and deemed fair value of the Company’scommon stock on the date of grant.

***Adjustments during the quarter ended March 31,2006.***   Subsequent to the issuance of the 2005financial statements, management determined that it had underestimated the fairvalue of its common stock at the time of its stock option grants inNovember and December 2005. As a consequence, at December 31,2005 deferred stock-based compensation, additional paid-in capital andoperating expenses were understated by $422,000, $466,000 and $44,000,respectively, for employee stock options and additional paid-in capital andoperating expenses were understated by $3,000 for nonemployee stock options. Inaddition, management found that variable accounting had been incorrectly usedfor certain foreign employee stock options resulting in overstatements ofdeferred stock-based compensation, additional paid-in capital and operatingexpenses by $78,000, $127,000 and $49,000, respectively. The aggregate impactof these adjustments as of December 31, 2005 is an understatement ofdeferred stock-based compensation, additional paid-in capital and operatingexpenses of $344,000, $342,000 and $2,000, respectively. Management hasdetermined that the impact of these errors on the 2005 annual financialstatements and on the fourth quarter of 2005 is not material using the guidanceof SEC Staff Accounting Bulletin No. 99. Accordingly, the financialstatements for the quarter ended March 31, 2006 include the cumulativeadjustment to correct these errors. The correction of these errors was notmaterial to the financial statements for the quarter ended March 31, 2006or the year ended December 31, 2006.

***Employee Options.***   Inconnection with certain employee stock option grants prior to adoption of SFAS123(R) on January 1, 2006, the Company recognized deferredstock-based compensation based on the excess of the deemed fair value of theunderlying stock over the stock option exercise price at the date of grant,which is being amortized over the vesting periods of the related options andstock, generally four years, using the multiple grant method described inNote 1. Future compensation charges are subject to reduction for anyemployee who terminates employment prior to such employee’s option vestingdate. Stock compensation from vested options, whether forfeited or not, is notreversed. For example, for an option that vests as to 25% of the full grantupon the first anniversary from the vesting start date and the remaining 75% ofthe shares in equal monthly installments over the next three years, themultiple grant approach results in slightly more than 50% of the aggregatedeferred stock compensation being expensed during the first year after grant.If an employee terminates before one year when the initial 25% of the 

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option vests, allpreviously expensed stock compensation is reversed in the period oftermination. If an employee terminates after one year from grant, the previouslyexpensed compensation in excess of the amount relating to the straight lineamortization associated with the vested 25% of the options is reversed.

Duringthe years ended December 31, 2004 and 2005, the Company granted stockoptions with exercise prices as follows:

| **Grants Made During Quarter Ended** | ** ** | ** **              | ** ** | **Number of  Options  Granted** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Fair Value  per Share** | ** ** | **Weighted-  Average  Intrinsic Value  per Share** | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                               | ** ** | **(in thousands)** | ** ** |
| March 31, 2004                                      |       |                    | —     |                                 |       |                                    | $          | —                                                  |       |                                                         |       | $ | — |   |   |   | $ | — |   |   |
| June 30, 2004                                       |       |                    | 500,500    |                                 |       |                                    | $          | 0.90                                                    |       |                                                         |       | $ | 2.80 |   |   |   | $ | 1.90 |   |   |
| September 30, 2004                                  |       |                    | 212,500    |                                 |       |                                    | $          | 0.90                                                    |       |                                                         |       | $ | 2.80 |   |   |   | $ | 1.90 |   |   |
| December 31, 2004                                   |       |                    | 122,000    |                                 |       |                                    | $          | 0.90                                                    |       |                                                         |       | $ | 2.80 |   |   |   | $ | 1.90 |   |   |
| March 31, 2005                                      |       |                    | 30,000     |                                 |       |                                    | $          | 0.90                                                    |       |                                                         |       | $ | 2.80 |   |   |   | $ | 1.90 |   |   |
| June 30, 2005                                       |       |                    | 312,062    |                                 |       |                                    | $          | 1.50                                                    |       |                                                         |       | $ | 3.35 |   |   |   | $ | 1.85 |   |   |
| September 30, 2005                                  |       |                    | 80,000     |                                 |       |                                    | $          | 1.50                                                    |       |                                                         |       | $ | 3.99 |   |   |   | $ | 2.49 |   |   |
| December 31, 2005                                   |       |                    | 291,000    |                                 |       |                                    | $          | 3.75                                                    |       |                                                         |       | $ | 5.26 |   |   |   | $ | 1.51 |   |   |

 

Theweighted-average fair value per share of options granted during the years endedDecember 31, 2004 and 2005, and accounted for using the intrinsic valuemeasurement provisions of APB Opinion No. 25, was $2.80 and $4.17,respectively. The intrinsic value per share is being recognized as compensationexpense over the applicable vesting period (which equals the service period).

Asdiscussed in Note 1, the Company adopted SFAS 123(R) effective January 1,2006 using the prospective transition method. The weighted-average grant-datefair value of options granted in the year ended December 31, 2006 andaccounted in accordance with SFAS 123(R) is $7.08 per share. Thefair value per share is being recognized as compensation expense over theapplicable vesting period (which equals the service period).

***Consultant Options and Awards.***   Inboth of the years ended December 31, 2005 and 2006, the Company grantedstock options to purchase 50,000 of common stock to consultants in exchange forservices at exercise prices ranging from nil to $6.00 per share. No optionswere granted to consultants for the year ended December 31, 2004. In yearended December 31, 2006, the Company granted a restricted stock award of5,000 shares of common stock to a consultant in exchange for services.

The Company determined thevalue of the options granted to consultants based on the Black-Scholes optionpricing model. The following table sets forth assumptions that were used indetermining the fair value of options granted to consultants for the yearsended December 31, 2005 and 2006:

| ** **                | ** ** | **Years Ended  December 31,** | ** ** |
|---------------------------|------------|-----------------------------------------|------------|
| ** **                | ** ** | **2005**                                | ** ** | **2006** | ** ** |
| Contractual life          |       | 10 years                                |       | 10 years |   |
| Risk-free  interest rates |       | 3.88% - 4.39%                           |       | 4.55% |   |
| Volatility                |       | 50%                                     |       | 74.1% |   |
| Dividend yield            |       | 0%                                      |       | 0% |   |

 

The Company recorded $177,000, and $92,000 fromamortization of deferred stock compensation expense for consultants during theyears ended December 31, 2004 and 2005, respectively. The Company recorded$594,000 of stock compensation expense for consultants for options andrestricted stock awards granted in the year ended December 31, 2006 thatwere immediately vested at grant. At December 31, 2006, there is nounamortized deferred stock-based compensation related to stock options orawards granted to consultants.

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***Stock-Based Compensation Expense.******  ***The followingtable summarizes the distribution of stock-based compensation expense (inthousands):

| ** **                              | ** ** | **Years Ended  December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                              | ** ** | **2004**                                | ** ** | **2005** | ** ** | **2006** | ** ** |
| Cost of revenues                        |       | $                                       | 22         |   | $ | 31 |   | $ | 117 |   |
| Research and  development               |       | 474                                     |       | 427 |   | 1,100 |   |
| Selling, general  and administrative    |       | 426                                     |       | 442 |   | 1,050 |   |
| Related tax  effect                     |       | —                                  |       | — |   | (68 | ) |
| Total stock-based  compensation expense |       | $                                       | 922        |   | $ | 900 |   | $ | 2,199 |   |

 

Thetotal compensation cost attributable to activities capitalized in inventory wasnot significant in any of the periods presented.

***Future Amortizationof Deferred Stock-based Compensation.***   Totalcompensation cost of options granted but not yet vested as of December 31,2006 was $4.7 million, which is expected to be recognized over theweighted-average period of 1.70 years. Total compensation cost ofrestricted stock awards granted but not yet vested as of December 31, 2006was $889,000, which is expected to be recognized over the weighted-averageperiod of 2.02 years.

**8.   COMMITMENTS ANDCONTINGENCIES**

***Leases.******  ***The Companyhas agreements to lease office space under non-cancellable operating leaseswith expiration dates in July and September 2007, for Korea, June 2008,for Taiwan, June and October 2008 for China, and December 2011,for the United States (California) and December 2008 for the United States(Illinois).

Rentexpense for the years ended December 31, 2004, and 2005 and 2006 was$571,000, $461,000, $468,000 and respectively. The Company recognizes rentexpense on a straight-line basis over the lease period.

Future minimum leasepayments under non-cancellable operating leases are as follows (in thousands):

| ** **                          | ** ** | **Operating  Leases** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| Year ending  December 31, 2007 |       |                  | $          | 534 |   |   |
| Year ending  December 31, 2008 |       |                  | 421        |   |   |
| Year ending  December 31, 2009 |       |                  | 295        |   |   |
| Year ending  December 31, 2010 |       |                  | 307        |   |   |
| Year ending  December 31, 2011 |       |                  | 319        |   |   |
| Thereafter                          |       |                  | —     |   |   |
|                                |       |                  | $          | 1,876 |   |   |

 

***PurchaseCommitments.***   As of December 31, 2006,the Company has purchase commitments of $1.9 million with its inventorysuppliers with due dates within the next twelve months. Both the quantities andpurchase prices are fixed in the noncancelable commitments.

***Legal Proceedings.***   OnSeptember 26, 2005, we filed an administrative action on behalf of anoriginal equipment manufacturer (“OEM”) in South Korea against Alogics Co.,Ltd. (“Alogics”), a semiconductor company in South Korea, seeking adetermination that the OEM’s product offering which incorporates our TW2834product does not infringe a patent held by Alogics. On February 13,2006, the South Korean Intellectual Property Tribunal rendered a decisionin the action determining that the OEM’s product offering whichincorporates our TW2834 product does not infringe the patent held byAlogics. On 

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March 10,2006, Alogics filed an appeal with the Korean Patent Court (“KPC”). On November 16,2006, the KPC concluded the action by determining that the OEM’s productoffering which incorporates our TW2834 product does not infringe thepatent held by Alogics. Alogics did not file an appeal with the KoreanSupreme Court within the time periods prescribed by applicable rules thusconcluding the matter.

**9.   STOCKHOLDERNOTES RECEIVABLE**

At December 31, 2004,the Company held full recourse promissory notes receivable totaling $438,000due from certain officers and employees of the Company. These notes were repaidin full in 2005. The full recourse promissory notes bore interest at ratesranging from 3 percent to 6 percent, which rates were deemed to bebelow market rates for the individuals. Interest and principal on the noteswere payable at the maturity dates of the notes, which ranged from December 2007to January 2008. In accordance with FASB Interpretation No. (“FIN”)44,*Accounting for Certain Transactionsinvolving Stock Compensation, an interpretation of APB Opinion No. 25*  and EITF 00-23,*Issues Related to the Accounting for StockCompensation under APB Opinion No. 25 and FASB Interpretation No. 44*, during the years ended December 31, 2004 and 2005, the Company recordeddeferred compensation of $13,000 and none, respectively. During the years endedDecember 31, 2004 and 2005, the Company amortized $25,000 and none ofdeferred stock compensation for the full-recourse promissory notes,respectively.

**10.   INCOMETAXES**

Thecomponents of income (loss) before income taxes are as follows (in thousands):

| ** **                         | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| United States                      |       | $                                           | (1,731     | ) | $ | 4,680 |   | $ | 14,451 |   |
| Foreign                            |       | 40                                          |       | 21 |   | 69 |   |
| Income (loss) before  income taxes |       | $                                           | (1,691     | ) | $ | 4,701 |   | $ | 14,520 |   |

 

Thecomponents of the provision for income taxes are as follows (in thousands): 

| ** **                  | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2004**              | ** ** | **2005** | ** ** | **2006** | ** ** |
| Current:                    |       |                  |       |   |   |   |   |   |   |
| Federal                     |       |                  | $          | — |   |   | $ | 110 |   | $ | 1,258 |   |
| State                       |       |                  | 1          |   |   | 33 |   | 30 |   |
| Foreign                     |       |                  | 50         |   |   | 17 |   | 10 |   |
| Total current               |       |                  | 51         |   |   | 160 |   | 1,298 |   |
| Deferred—net           |       |                  | —     |   |   | — |   | — |   |
| Provision for income  taxes |       |                  | $          | 51 |   |   | $ | 160 |   | $ | 1,298 |   |

 

The components of deferredtax assets for federal and state income taxes are as follows(in thousands):

| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Deferred tax  assets:            |       |                  |       |   |   |
| Net operating loss carryforwards |       | $                     | 5,116      |   | $ | 2,526 |   |
| Research and other credits       |       | 1,045                 |       | 1,238 |   |
| Accruals                         |       | 1,770                 |       | 1,718 |   |
| Other                            |       | 351                   |       | 49 |   |
| Total deferred tax assets        |       | 8,282                 |       | 5,531 |   |
| Valuation allowance              |       | (8,282                | )          | (5,531 | ) |
| Deferred tax assets              |       | $                     | —     |   | $ | — |   |

 

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Based on the available evidence, management believesit is more likely than not that the net deferred tax assets will not berealized. Accordingly, the Company has provided a full valuation allowanceagainst its deferred tax assets for all periods presented. The valuationallowance decreased by $2.8 million in 2006 primarily from the use of netoperating loss carryforwards.

At December 31, 2006, the Company hadapproximately $6.7 million of federal and $3.2 million of state netoperating loss carryforwards available to offset future taxable income. If notutilized, these carryforwards will begin to expire beginning in 2021 forfederal and and 2013 for state tax purposes. As of December 31, 2006, theCompany also has research and other tax credit carryforwards of approximately$757,000 and $1.1 million for federal and state income tax purposes,respectively. If not utilized, the federal carryforwards will expire in variousamounts beginning in 2012. The state tax credits can be carried forwardindefinitely. The Company also has federal and California alternative minimumtax credits carryover of $84,000 and $53,000, respectively, and these creditsdo not expire.

Theeffective tax rate differs from the applicable U.S. statutory federal incometax rate as follows:

| ** **                                                         | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                         | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| U.S. statutory  federal taxes at statutory rate (benefit)          |       | (34.0                                       | )%         | 34.0 | % | 35.0 | % |
| State taxes—net  of federal benefit                           |       | (5.8                                        | )          | 5.8 |   | 1.6 |   |
| Research and  development credits (benefit)                        |       | (7.3                                        | )          | (2.6 | ) | (2.6 | ) |
| Difference  between U.S. statutory rate and foreign effective rate |       | 2.2                                         |       | 0.2 |   | — |   |
| Stock-based  compensation                                          |       | 13.2                                        |       | 3.3 |   | 1.4 |   |
| Other                                                              |       | 1.7                                         |       | 0.9 |   | (2.9 | ) |
| Change in  valuation allowance                                     |       | 33.0                                        |       | (38.2 | ) | (23.6 | ) |
| Effective tax rate                                                 |       | 3.0                                         | %          | 3.4 | % | 8.9 | % |

 

The Company’s ability to use its federal and state netoperating loss carryforwards and federal and state tax credit carryforwards tooffset future taxable income and future taxes is subject to restrictionsattributable to equity transactions that result from changes in ownership asdefined by Internal Revenue Code Sections 382 and 383. As a consequence, aportion of the Company’s net operating loss carryforwards are subject to anannual limitation on utilization of approximately $3 million, which iscumulative.

United States federalincome taxes have not been provided for the undistributed earnings of theCompany’s foreign subsidiary. These undistributed earnings aggregated less than$0.1 million at December 31, 2006, and it is the Company’s intention thatsuch undistributed earnings be permanently reinvested offshore. The Companywould be subject to additional United States taxes if these earnings wererepatriated. Determination of the amount of unrecognized deferred income taxliability related to these earnings is not practicable.

**11.   EMPLOYEEBENEFIT PLAN**

The Company sponsors a 401(k) savingsplan for all employees who meet certain eligibility requirements. Participantsmay contribute, on a pretax basis, an amount of their annual compensation, notto exceed a maximum contribution pursuant to Section 401(k) of theInternal Revenue Code. The Company may contribute to the plan on adiscretionary basis, but is not required, nor has it contributed, to the planfor the years ended December 31, 2004, 2005 and 2006. The contributions tothe 401(k) Plan, and income earned on plan contributions, are not taxableto employees until withdrawn from the 401(k) Plan.

67

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**12.   RELATEDPARTY TRANSACTIONS**

One of the Company’s Boardmembers is a partner in a law firm that provides services to the Company. TheCompany incurred fees of $149,000, $286,000, and $168,000 from this law firmfor legal services in the years ended December 31, 2004, 2005, and 2006,respectively. The amount payable to this law firm was $53,000 and $17,000 at December 31,2005 and 2006, respectively.

**13.   SEGMENTINFORMATION**

The Company currentlyoperates in one reportable segment, the designing, marketing and selling ofmixed signal integrated circuits for multiple video applications in theconsumer, security surveillance and automotive markets. The Company’s chiefoperating decision maker is the CEO.

Thepercentage of total revenues by geographic location are as follows:

| ** **      | ** ** | **Years Ended December 31,** | ** ** |
|-----------------|------------|---------------------------------------------|------------|
| ** **      | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| Taiwan          |       |                                        | 25         | % |   |   | 38 | % |   |   | 43 | % |   |
| South Korea     |       |                                        | 52         |   |   |   | 41 |   |   |   | 31 |   |   |
| China/Hong Kong |       |                                        | 7          |   |   |   | 16 |   |   |   | 21 |   |   |
| Japan           |       |                                        | 14         |   |   |   | 4 |   |   |   | 3 |   |   |
| United States   |       |                                        | 2          |   |   |   | 1 |   |   |   | 1 |   |   |
| Other           |       |                                        | —     |   |   |   | — |   |   |   | 1 |   |   |

 

Revenuesby product line are as follows (in thousands):

| ** **                | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------|------------|---------------------------------------------|------------|
| ** **                | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| Security  Surveillance(1) |       | $                                           | 3,615      |   | $ | 13,804 |   | $ | 27,684 |   |
| Video Decoders(2)         |       | 7,986                                       |       | 16,142 |   | 18,183 |   |
| LCD Display(3)            |       | 4,818                                       |       | 4,997 |   | 6,916 |   |
| Other(4)                  |       | 832                                         |       | 1,108 |   | 929 |   |
| Total revenues            |       | $                                           | 17,251     |   | $ | 36,051 |   | $ | 53,712 |   |

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*(1)**         *Consists of application specific productsdesigned for use in security surveillance systems.

*(2)**         *Consists of general purpose videodecoders designed for use in the consumer, security surveillance and automotivemarkets. Revenues from general purpose video decoders used in securitysurveillance systems and LCD displays are reported under the video decoderproduct line and not the security surveillance or LCD display product lines.

*(3)**         *Consists of application specific productsdesigned for use in LCD displays.

*(4)**         *Consists of contract developmentprojects, early generation mixed signal semiconductors for digital videoapplications and a PCI video decoder product.

Thefollowing is a summary of long-lived assets by geographic region (inthousands):

| ** **    | ** ** | **December 31,** | ** ** |
|---------------|------------|-----------------------|------------|
| **Country**   | ** ** | ** **            | ** ** | **2005** | ** ** | **2006** | ** ** |
| United States |       | $                     | 306        |   | $ | 544 |   |
| Taiwan        |       | 91                    |       | 64 |   |
| South Korea   |       | 37                    |       | 12 |   |
| China         |       | —                |       | 5 |   |
| Total         |       | $                     | 434        |   | $ | 625 |   |
|               |            |                       |            |  |  |  |  |  |  |

 

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(2)         ***Schedules***

Schedules areomitted because they are not required or the information is included in thefinancial statements.

(3)         ***Exhibits***

Theexhibits listed on the accompanying index to exhibits in Item 15(b) beloware filed as part of, or hereby incorporated by reference into, this Report.
| Exhibit  Number      | ** ** | **Description**                                                                                                                                                                   |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   3.(i)1*  |       | Restated Certificate of Incorporation of the  Registrant.                                                                                                                         |
|   3.(ii)1* |       | Amended and Restated Bylaws of the Registrant.                                                                                                                                    |
|   4.1*     |       | Specimen Common Stock Certificate.                                                                                                                                                |
| 10.1*                |       | Form of Indemnification Agreement between the  Registrant and its officers and directors.                                                                                    |
| 10.2*                |       | 1997 Stock Plan (as amended) and form of agreements  thereunder.                                                                                                                  |
| 10.3*                |       | 2001 Stock Plan (as amended) and form of agreements  thereunder.                                                                                                                  |
| 10.4*                |       | Form of 2006 Stock Incentive Plan and form of  agreements thereunder.                                                                                                        |
| 10.5*                |       | Fourth Amended and Restated Rights Agreement, dated  March 11, 2005.                                                                                                         |
| 10.6*                |       | Offer Letter dated November 1, 2005 between the  Registrant and Mark Voll.                                                                                                   |
| 10.7*                |       | First Amendment to the Fourth Amended and Restated  Rights Agreement, dated March 27, 2006.                                                                                  |
| 10.8*                |       | Offer Letter dated September 8, 2000 between  the Registrant and Dong-Wook (David) Nam.                                                                                      |
| 10.9*                |       | Second Amendment to the Fourth Amended and Restated  Rights Agreement, dated June 21, 2006.                                                                                  |
| 10.10**              |       | Lease Agreement by and between Registrant and FSP  Montague Business Center Corp. dated November 6, 2006                                                                     |
| 21.1                 |       | List of Subsidiaries.                                                                                                                                                             |
| 23.1                 |       | Consent of Deloitte & Touche LLP,  independent registered public accounting firm.                                                                                        |
| 24.1                 |       | Power of Attorney (see page 70)                                                                                                                                                   |
| 31.1                 |       | Certification of Chief Executive Officer pursuant to  Securities Exchange Act Rules 13(a)-15(e), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2                 |       | Certification of Chief Financial Officer pursuant to  Securities Exchange Act Rules 13(a)-15(e), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1***              |       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                    |
| 32.2***              |       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                    |

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*                    Incorporatedby reference to the same number exhibit filed with the Registrant’sRegistration Statement on Form S-1 (Registration No. 333-130965), declared effectiveby the Securities and Exchange Commission on June 21, 2006.

**             Incorporated byreference from the Company’s Current Report on Form 8-K (CommissionFile No. 000-52014)filed with the Securities and Exchange Commission on November 8, 2006.

***      The material contained in Exhibits32.1 and 32.2 is not deemed “filed” with the SEC and is not to beincorporated by reference into any filing of the Company under the SecuritiesAct of 1933 or the Securities Exchange Act of 1934, whether made before orafter the date hereof and irrespective of any general incorporation languagecontained in such filing, except to the extent that the registrant specificallyincorporates it by reference.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, Techwell, Inc. has duly caused this Report on Form 10-Kto be signed on its behalf by the undersigned, thereunto duly authorized.
|                     |   |   | ** ** | **TECHWELL, INC.** |
|---------------------|--------|--------|------------|-------------------------|
| March 16, 2007 |   |   |       | By                      |   | /s/  FUMIHIRO KOZATO |
|                |   |   |       |                    |   | Fumihiro Kozato |
|                |   |   |       |                    |   | *President  and Chief Executive Officer* |

 

**POWER OF ATTORNEY**

KNOW ALL PERSONS BY THESE PRESENTS, that each personwhose signature appears below constitutes and appoints Fumihiro Kozato and MarkVoll, jointly and severally, his attorney-in-fact, each with the full power ofsubstitution, for such person, in any and all capacities, to sign any and allamendments to this Annual Report on Form 10-K, and to file the same,with all exhibits thereto and other documents in connection therewith, with theSecurities and Exchange Commission, granting unto said attorney-in-fact andagent full power and authority to do and perform each and every act and thingrequisite and necessary to be done in connection therewith, as fully to allintents and purposes as he might do or could do in person hereby ratifying andconfirming all that each of said attorneys-in-fact and agents, or hissubstitute, may do or cause to be done by virtue hereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this Report on Form 10-Khas been signed below by the following persons on behalf of the registrant inthe capacities and on the dates indicated.
|                                    | **Name** | ** **                                        | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------------------|----------|---------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/  FUMIHIRO  KOZATO    |     | President, Chief  Executive Officer               |       | March 16,  2007 |
| Fumihiro  Kozato                   |     | (Principal Executive  Officer) and Director       |       |                 |
| /s/  MARK  VOLL          |     | Vice President of  Finance and Administration and |       | March 16,  2007 |
| Mark  Voll                         |     | Chief Financial Officer                           |       |                 |
|                               |     | (Principal Financial and  Accounting Officer)     |       |                 |
| /s/  ROBERT  D. COCHRAN  |     | Director                                          |       | March 16,  2007 |
| Robert  D. Cochran                 |     |                                              |       |                 |
| /s/  RICHARD  H. KIMBALL |     | Director                                          |       | March 16,  2007 |
| Richard  H. Kimball                |     |                                              |       |                 |
| /s/ C.J.  KOOMEN                   |     | Director                                          |       | March 15,  2007 |
| Dr. C.J.  Koomen              |     |                                              |       |                 |
| /s/  JUSTINE  LIEN       |     | Director                                          |       | March 16,  2007 |
| Justine  Lien                      |     |                                              |       |                 |
| /s/ PHILLIP J.  SALSBURY           |     | Director                                          |       | March 16,  2007 |
| Dr. Phillip  J. Salsbury      |     |                                              |       |                 |

 

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**INDEXTO EXHIBITS**
| Exhibit  Number      | ** ** | **Description**                                                                                                                                                                   |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   3.(i)1*  |       | Restated Certificate of Incorporation of the  Registrant.                                                                                                                         |
|   3.(ii)1* |       | Amended and Restated Bylaws of the Registrant.                                                                                                                                    |
|   4.1*     |       | Specimen Common Stock Certificate.                                                                                                                                                |
| 10.1*                |       | Form of Indemnification Agreement between the  Registrant and its officers and directors.                                                                                    |
| 10.2*                |       | 1997 Stock Plan (as amended) and form of agreements  thereunder.                                                                                                                  |
| 10.3*                |       | 2001 Stock Plan (as amended) and form of agreements  thereunder.                                                                                                                  |
| 10.4*                |       | Form of 2006 Stock Incentive Plan and form of  agreements thereunder.                                                                                                        |
| 10.5*                |       | Fourth Amended and Restated Rights Agreement, dated  March 11, 2005.                                                                                                         |
| 10.6*                |       | Offer Letter dated November 1, 2005 between the  Registrant and Mark Voll.                                                                                                   |
| 10.7*                |       | First Amendment to the Fourth Amended and Restated  Rights Agreement, dated March 27, 2006.                                                                                  |
| 10.8*                |       | Offer Letter dated September 8, 2000 between  the Registrant and Dong-Wook (David) Nam.                                                                                      |
| 10.9*                |       | Second Amendment to the Fourth Amended and Restated  Rights Agreement, dated June 21, 2006.                                                                                  |
| 10.10**              |       | Lease Agreement by and between Registrant and FSP  Montague Business Center Corp. dated November 6, 2006                                                                     |
| 21.1                 |       | List of Subsidiaries.                                                                                                                                                             |
| 23.1                 |       | Consent of Deloitte & Touche LLP,  independent registered public accounting firm.                                                                                        |
| 24.1                 |       | Power of Attorney (see page 70)                                                                                                                                                   |
| 31.1                 |       | Certification of Chief Executive Officer pursuant to  Securities Exchange Act Rules 13(a)-15(e), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2                 |       | Certification of Chief Financial Officer pursuant to  Securities Exchange Act Rules 13(a)-15(e), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1***              |       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                    |
| 32.2***              |       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                    |

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*                    Incorporatedby reference to the same number exhibit filed with the Registrant’sRegistration Statement on Form S-1 (Registration No. 333-130965), declared effectiveby the Securities and Exchange Commission on June 21, 2006.

**             Incorporated byreference from the Company’s Current Report on Form 8-K (CommissionFile No. 000-52014)filed with the Securities and Exchange Commission on November 8, 2006.

***      The material contained in Exhibits32.1 and 32.2 is not deemed “filed” with the SEC and is not to beincorporated by reference into any filing of the Company under the SecuritiesAct of 1933 or the Securities Exchange Act of 1934, whether made before orafter the date hereof and irrespective of any general incorporation languagecontained in such filing, except to the extent that the registrant specificallyincorporates it by reference.

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