Overview

We are a fabless semiconductor company that designs and markets high performance integrated circuits for the following key markets: (i) digital consumer electronics, (ii) networking, (iii) mobile communications, (iv) automotive electronics and (v) industrial. Our primary products are high speed and low power SRAM and low and medium density DRAM. In the three months ended December 31, 2008 and in fiscal 2008, approximately 87% and 88%, respectively, of our revenue was derived from our SRAM and DRAM products. We also design and market application specific standard products (ASSP) primarily EEPROMs and SmartCards focused on our key markets. We were founded in October 1988 and initially focused on high performance, low cost SRAM for PC cache memory applications. In 1997, we introduced our first low and medium density DRAM products. Prior to fiscal 2003, our SRAM product family generated a majority of our revenue. However, sales of our low and medium density DRAM products have represented a majority of our net sales in each year since fiscal 2003.

In order to control our operating expenses, in recent years we limited our headcount in the U.S. and transferred various functions to Taiwan and China. Our acquisition of Integrated Circuit Solution, Inc. (ICSI) was a key part of this strategy. We believe this strategy has enabled us to limit our operating expenses while simultaneously locating these functions closer to our manufacturing partners and our customers. As a result of these efforts, we currently have significantly more employees in Asia than we do in the U.S. We intend to continue these strategies going forward.

As a fabless semiconductor company, our business model is less capital intensive because we rely on third parties to manufacture, assemble and test our products. Because of our dependence on third-party wafer foundries, our ability to increase our unit sales volumes depends on our ability to increase our wafer capacity allocation from current foundries, add additional foundries and improve yields of good die per wafer.

The average selling prices of our SRAM and DRAM products are very sensitive to supply and demand conditions in our target markets and have generally declined over time. We experienced declines in the average selling prices for many of our products in the first quarter of fiscal 2009 and in fiscal 2008. We expect average selling prices for our products to decline in the future, principally due to weak market demand, market competition and an increased supply of competitive products in the market. Any future decreases in our average selling prices could have an adverse impact on our revenue growth rate, gross margins and operating margins. Our ability to maintain or increase revenues will be highly dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in quantities sufficient to compensate

for the anticipated declines in average selling prices of existing products. Declining average selling prices will adversely affect our gross margins unless we are able to offset such declines with commensurate reductions in per unit costs or changes in product mix in favor of higher margin products.

Revenue from product sales to our direct customers is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed and determinable, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations. A portion of our sales is made to distributors under agreements that provide the possibility of certain sales price rebates and limited product return privileges. Given the uncertainties associated with credits that will be issued to these distributors, we defer recognition of such sales until our products are sold by the distributors to their end customers. Revenue from sales to distributors who do not have sales price rebates or product return privileges is recognized at the time our products are sold by us to the distributors.

We market and sell our products in Asia, the U.S., Europe and other locations through our direct sales force, distributors and sales representatives. The percentage of our sales shipped outside the U.S. was approximately 79%, 86%, 84%, 82% and 83% in the first quarter of fiscal 2009, the first quarter of fiscal 2008, and in fiscal 2008, fiscal 2007 and fiscal 2006, respectively. We measure sales location by the shipping destination, even if the customer is headquartered in the U.S. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. The percentages of our net sales by region are set forth in the following table:

                           Three Months Ended           Fiscal Years Ended
                              December 31,                September 30,
                           2008           2007       2008       2007     2006
                Asia           62 %           70 %      66 %      67 %     73 %
                Europe         16             16        17        15       10
                U.S.           21             14        16        18       17
                Other           1             -          1        -        -

                Total         100 %          100 %     100 %     100 %    100 %

Our sales are generally made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog is not a good indicator of our future sales. Cancellations of customer orders or changes in product specifications could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses.

Since a significant portion of our revenue is from the digital consumer electronics market, our business may be subject to seasonality, with increased revenues in the third and fourth calendar quarters of each year, when customers place orders to meet year-end holiday demand. However, due to the complex nature of the markets we serve and the recent adverse economic conditions in the U.S. and other countries, it is difficult for us to assess the impact of seasonal factors on our business.

We are subject to the risks of conducting business internationally, including economic conditions in Asia, particularly Taiwan and China, changes in trade policy and regulatory requirements, duties, tariffs and other trade barriers and restrictions, the burdens of complying with foreign laws and, possibly, political instability. All of our foundries and assembly and test subcontractors are located in Asia. Although our international sales are largely denominated in U.S. dollars, we do have sales transactions in New Taiwan dollars, in Hong Kong dollars and in Chinese renminbi. In addition, we have foreign operations where expenses are generally denominated in the local currency. Such transactions expose us to the risk of exchange rate fluctuations. We monitor our exposure to foreign currency fluctuations, but have not adopted any hedging strategies to date. There can be no assurance that exchange rate fluctuations will not harm our business and operating results in the future.

Due to the tightening of the credit markets starting in late 2008 and continuing concerns regarding the availability of credit, our current or potential customers have delayed or reduced purchases of our products which is adversely affecting our revenues and harming our business and financial results. In addition, the recent turmoil in the financial markets has had and is expected to continue to have an adverse effect on the U.S. and world economies, which is negatively impacting the spending

patterns of businesses including our current and potential customers. There can be no assurances that the government responses to the disruptions in the financial markets will restore confidence in the U.S. and global markets. Many economists and other experts have concluded that a recession in the U.S. and global economies began in 2008 and is continuing. We are unable to predict how deep or how long the recession will last. We expect our business to be adversely impacted by any significant or prolonged downturn in the U.S. or global economies. In particular, we currently expect our revenue for the quarter ending March 31, 2009 to decline from our revenue in the quarter ended December 31, 2008. In the past, industry downturns have resulted in reduced demand and declining average selling prices for our products which adversely affected our business. We are experiencing and expect to continue to experience these adverse business conditions. The uncertainty regarding the U.S. and global economies has also made it more difficult for us to forecast and manage our business. Although we are continuing actions in the March quarter relating to controlling our expenses and inventory levels, there can be no assurance that these actions will be sufficient to address the impact of any economic slowdown and allow us to meet our operating objectives.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make difficult and subjective estimates, judgments and assumptions. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. The estimates and judgments that we use in applying our accounting policies have a significant impact on the results we report in our financial statements. We base our estimates and judgments on our historical experience combined with knowledge of current conditions and our beliefs of what could occur in the future, considering the information available at the time. Actual results could differ from those estimates and such differences may be material to our financial statements. We reevaluate our estimates and judgments on an ongoing basis.

Our critical accounting policies which are impacted by our estimates are:
(i) the valuation of our inventory, which impacts cost of goods sold and gross profit; (ii) the valuation of our allowance for sales returns and allowances, which impacts net sales; (iii) the valuation of our allowance for doubtful accounts, which impacts general and administrative expense; (iv) accounting for acquisitions and related intangibles and goodwill, which impacts operating expense when we record impairments and (v) accounting for stock-based compensation which impacts costs of goods sold, research and development expense and selling, general and administrative expense. Each of these policies is described in more detail below. We also have other key accounting policies that may not require us to make estimates and judgments that are as subjective or difficult. For instance, our policies with regard to revenue recognition, including the deferral of revenues on sales to distributors with sales price rebates and product return privileges. These policies are described in the notes to our financial statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

Valuation of inventory. Our inventories are stated at the lower of cost or market value. Determining market value requires us to project unit prices and volumes for future periods in which we expect to sell inventory on hand as of the balance sheet date. As a result of these estimates, we may record a charge to cost of goods sold, which decreases our gross profit, in advance of when the inventory is actually sold to reflect market values, net of sales commission costs, that are below our manufacturing costs. Conversely, if we sell inventory that has previously been written down to the lower of cost or market at more favorable prices than we had forecasted at the time of the write-down, our gross profit may be higher. In addition to lower of cost or market write-downs, we also analyze inventory to determine whether any of it is excess, obsolete or defective. We write down to zero dollars (which is a charge to cost of goods sold) the carrying value of inventory on hand that has aged over one year to cover estimated excess and obsolete exposures, unless adjustments are made based on our judgments for newer products, end of life products, planned inventory increases or strategic customer supply. In making such judgments to write down inventory, we take into account the product life cycles which can range from six to 30 months, the stage in the life cycle of the product and the impact of competitors' announcements and product introductions on our products. Once established, these adjustments are considered permanent.

Valuation of allowance for sales returns and allowances. Net sales consist principally of total product sales less estimated sales returns and allowances. To estimate sales returns and allowances, we analyze potential customer specific product application issues, potential quality and reliability issues and historical returns. We evaluate quarterly the adequacy of the allowance for sales returns and allowances. This allowance is reflected as a reduction to accounts receivable in our consolidated balance sheets. Increases to the allowance are recorded as a reduction to net sales. Because the allowance for sales returns and allowances is based on our judgments and estimates, particularly as to product application, quality and reliability issues, our allowances may not be adequate to cover actual sales returns and other allowances. If our allowances are not adequate, our net sales could be adversely affected.

Valuation of allowance for doubtful accounts. We maintain an allowance for doubtful accounts for losses that we estimate will arise from our customers' inability to make required payments for goods and services purchased from us. We make our estimates of the uncollectibility of our accounts receivable by analyzing historical bad debts, specific customer creditworthiness and current economic trends. Once an account is deemed unlikely to be fully collected, we write down the carrying value of the receivable to the estimated recoverable value, which results in a charge to general and administrative expense, which decreases our profitability.

Accounting for acquisitions and goodwill. We account for acquisitions using the purchase accounting method in accordance with Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations." Under this method, the total consideration paid, excluding, if any, the contingent consideration that has not been earned, is allocated over the fair value of the net assets acquired, including in-process research and development, with any excess allocated to goodwill. Goodwill is defined as the excess of the purchase price over the fair value allocated to the net assets. Our judgments as to fair value of the assets will, therefore, affect the amount of goodwill that we record. Management is responsible for the valuation of tangible and intangible assets. For tangible assets acquired in any acquisition, such as plant and equipment, the useful lives are estimated by considering comparable lives of similar assets, past history, the intended use of the assets and their condition. In estimating the useful life of the acquired intangible assets with definite lives, we consider the industry environment and unique factors relating to each product relative to our business strategy and the likelihood of technological obsolescence. Acquired intangible assets primarily include core and current technology, customer relationships and customer contracts. We are currently amortizing our acquired intangible assets with definite lives over periods generally ranging from six months to six years.

We perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances where indicators of impairment may exist. For instance, in response to changes in industry and market conditions, we could be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of tangible and intangible assets, including goodwill. In this regard, in fiscal 2008, we recorded charges for impairment of goodwill in the amount of $25.3 million.

Accounting for stock-based compensation. We account for stock-based compensation arrangements in accordance with the provisions of Statement of Financial Accounting Standard No. 123(R), "Share-Based Payment" (SFAS 123R). Under SFAS 123R, stock option cost is calculated on the date of grant using the Black-Scholes valuation model. The compensation cost is then recognized on a straight-line basis over the requisite service period of the option, which is generally the option vesting term of four years. We use the Black-Scholes valuation model to determine the fair value of our stock options at the date of grant. The Black-Scholes valuation model requires us to estimate key assumptions such as expected term, volatility, dividend yield and risk free interest rates that determine the stock option fair value. In addition, SFAS 123R requires forfeitures to be estimated at the time of grant. In subsequent periods, if actual forfeitures differ from the estimate, the forfeiture rate may be revised. We estimate our expected forfeitures rate based on our historical activity and judgment regarding trends. We utilized the simplified calculation of expected life under the provisions of the Securities and Exchange Commission's (SEC) Staff Accounting Bulletin 107 through December 2007. For option grants subsequent to December 2007, the expected term is based upon historical exercise data. If we determined that another method used to estimate expected life was more reasonable than our current method, or if another method for calculating these inputs assumptions was prescribed by authoritative guidance, the fair value calculated could change materially.

Impact of Recently Issued Accounting Standards

In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations". This Statement replaces SFAS No. 141, Business Combinations. This Statement retains the fundamental requirements in Statement 141 that the acquisition method of accounting (which Statement 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. This Statement also establishes principles and requirements for how the acquirer: a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase and c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) will apply prospectively to business combinations for which the acquisition date is on or after our fiscal year beginning October 1, 2010. The impact of the adoption of SFAS No. 141(R) will depend on the nature and extent of our business combinations occurring on or after the beginning of fiscal 2010.

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements". This Statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling (minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. We have not yet determined the impact, if any, that SFAS No. 160 will have on our consolidated financial statements. SFAS No. 160 is effective for our fiscal year beginning October 1, 2010.

Three Months Ended December 31, 2008 Compared to Three Months Ended December 31, 2007

Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales decreased by 41% to $37.7 million in the three months ended December 31, 2008 from $63.3 million in the three months ended December 31, 2007. The decrease in net sales of $25.7 million was principally due to a significant decrease in unit shipments of our DRAM products in the three months ended December 31, 2008 compared to the three months ended December 31, 2007. In addition, unit shipments of both our SRAM products and our application specific standard products (ASSP) which include our EEPROM, Smart Card and logic products decreased in the three months ended December 31, 2008 compared to the three months ended December 31, 2007 which contributed to the decline in our sales. We anticipate that our revenue will decline in the March 2009 quarter compared to the December 2008 quarter as a result of the adverse global economic conditions. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for certain products. There can be no assurance that any future price declines will be offset by higher volumes or by higher prices on newer products.

In the three months ended December 31, 2008, revenue recognized for one distributor accounted for 12% of our net sales. In the three months ended December 31, 2007, no single customer accounted for 10% or more of our net sales.

Gross profit. Cost of sales includes die cost from the wafers acquired from foundries, subcontracted package, assembly and test costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit decreased by $5.5 million to $7.7 million in the three months ended December 31, 2008 from $13.2 million in the three months ended December 31, 2007. Our gross margin decreased to 20.5% in the three months ended December 31, 2008 from 20.8% in the three months ended December 31, 2007. Our gross profit for the three months ended December 31, 2008 included inventory write-downs of $4.3 million compared to $2.5 million of inventory write-downs in the three months ended December 31, 2007. The inventory write-downs were for lower of cost or market accounting and excess and obsolescence issues on certain of our products. Excluding the impact of our inventory write-downs, our gross margin increased in the three months ended December 31, 2008 compared to the three months ended December 31, 2007 primarily as a result of a shift in our product mix to higher margin SRAM products from low margin commodity DRAM products. In addition, declines in the cost of our SRAM products more than offset declines in the average selling prices of our SRAM products in the three months ended December 31, 2008 compared to the three months ended December 31, 2007 which contributed to an increase in our SRAM gross margin. Declines in the cost of our DRAM products more than offset declines in the average selling prices of our DRAM products in the three months ended December 31, 2008 compared to the three months ended December 31, 2007 as we limited our shipments of lower margin commodity DRAM products. This contributed to an increase in our DRAM gross margin over such period. The decrease in our gross profit in the three months ended December 31, 2008 compared to December 31, 2007 was primarily a result of a decrease in unit shipments across all our products but more significantly for our DRAM products. Our gross profit for the three months ended December 31, 2008 and December 31, 2007 benefited from the sale of $0.3 million and $0.6 million, respectively, of previously written down products. Our gross profit for the three months ended December 31, 2007 benefited from approximately $0.4 million for a DRAM development project. We believe that the average selling prices of our products will decline over time and, unless we are able to reduce our cost per unit to the extent necessary to offset such declines, the decline in average selling prices will result in a material decline in our gross margin. Although we have product cost reduction programs in place that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. We do not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our products or the level of service provided by us.

Research and Development. Research and development expenses increased by 9% to $5.2 million in the three months ended December 31, 2008 compared to $4.8 million in the three months ended December 31, 2007. As a percentage of net sales, research and development expenses increased to 13.8% in the three months ended December 31, 2008 from 7.5% in the three months ended December 31, 2007. The increase in research and development expenses of $0.4 million can be attributed to an increase in expenditures for the development costs of our DRAM products in the three months ended December 31, 2008 compared to the three months ended December 31, 2007. As a result of cost reduction measures, we expect the dollar amount of our research and development expenses to decline in the March 2009 quarter and expect such expenses to fluctuate as a percentage of net sales depending on our overall level of sales.

Selling, General and Administrative. Selling, general and administrative expenses decreased by 5% to $7.3 million in the three months ended December 31, 2008 from $7.7 million in the three months ended December 31, 2007. As a percentage of net sales, selling, general and administrative expenses increased to 19.4% in the three months ended December 31, 2008 from 12.1% in the three months ended December 31, 2007. The decrease in selling, general and administrative expenses of $0.4 million was mainly attributable to approximately $0.5 million of expenses incurred in the December 2007 quarter related to our tender offer announced in November 2007 and a reduction in the December 2008 quarter of commissions partially offset by an increase in payroll related expenses. As a result of our recent cost reduction measures, we expect the dollar amount of our selling, general and administrative expenses to decline in the March 2009 quarter and expect such expenses to fluctuate as a percentage of net sales depending on our overall level of sales.

Interest and other income, net. Interest and other income, net was $0.6 million in the three months ended December 31, 2008 compared to $2.1 million in the three months ended December 31, 2007. The $0.6 million of interest and other income in the three months ended December 31, 2008 is comprised primarily of net interest income of $0.2 million and $0.4 million in rental income from the lease of excess space in our Taiwan facility. The $2.1 million of interest and other income in the three months ended December 31, 2007 is comprised primarily of interest income of $1.7 million and $0.4 million in rental income from the lease of excess space in our Taiwan facility. The decrease in interest income is primarily attributable to lower cash balances and a decrease in the interest rates in the three months ended December 31, 2008 compared to the three months ended December 31, 2007.

Gain on sale of investments. In the three months ended December 31, 2008, there were no sales of investments. In the three months ended December 31, 2007, we sold 22.0 million shares of SMIC for approximately $2.7 million which resulted in a pre-tax gain of approximately $0.2 million.

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