UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the transition period from          to

0-21488

(Commission File Number)

CATALYST SEMICONDUCTOR, INC.

(Exact name of Registrant as specified in its charter)

(408) 542-1000

 (Registrant’s telephone number, including area code)

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o    No x

The number of shares outstanding of the registrant’s common stock as of February 29, 2008 was 16,415,056.

CATALYST SEMICONDUCTOR, INC.

TABLE OF CONTENTS

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Part I. Financial Information

Item 1. Financial Statements

CATALYST SEMICONDUCTOR, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and par value data)

See accompanying notes to the unaudited condensed consolidated financial statements.

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CATALYST SEMICONDUCTOR, INC.

 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(A)      Results for the three and nine months ended January 27, 2008 and January 28, 2007 include stock-based compensation expense as follows (in thousands):

See accompanying notes to the unaudited condensed consolidated financial statements.

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CATALYST SEMICONDUCTOR, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See accompanying notes to the unaudited condensed consolidated financial statements.

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CATALYST SEMICONDUCTOR, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1—Basis of Presentation

Catalyst Semiconductor, Inc. (the “Company”) designs, develops and markets a broad line of reprogrammable non-volatile memory and analog/mixed-signal products.  The Company was incorporated in October 1985 in California and reincorporated in Delaware in May 1993.

In the opinion of the management of the Company, the unaudited condensed consolidated interim financial statements included herein have been prepared on the same basis as the Company’s April 29, 2007 audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly state the information set forth herein.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended April 29, 2007.  The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”).  The condensed consolidated statements of operations for the periods presented are not necessarily indicative of results to be expected for any future period, nor for the entire year.

The Company’s fiscal year is the 52 or 53-week period ending on the Sunday closest to April 30.  In a 52 week year, each fiscal quarter consists of 13 weeks.  Fiscal year 2007 was comprised of 52 weeks.  Fiscal year 2008 will be comprised of 52 weeks.

Principles of Consolidation

The consolidated financial statements include the accounts of Catalyst Semiconductor, Inc. and its wholly owned subsidiaries.  All significant intercompany accounts and transactions are eliminated in consolidation.

Uses of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Estimates in these financial statements include inventory valuation, stock-based compensation, deferral of gross profit on shipments of inventory not sold by the distributors at the end of the period, reserves for stock rotation on sales to distributors, the original equipment manufacturers (“OEMs”) sales return reserve, reserve for warranty costs, allowances for doubtful accounts receivable and income taxes.  Actual results could differ from those estimates.

Note 2—Significant Accounting Policies

Cash and Cash Equivalents

All highly liquid investments purchased with a remaining maturity of 90 days or less are considered cash equivalents.

Short-term Investments

All of the Company’s short-term investments are classified as available-for-sale.  Investments in available-for-sale securities are reported at fair value with unrealized gains and losses, being recorded net of related tax, as a component of accumulated other comprehensive income (loss).

Accounts Receivable

The Company’s accounts receivable are reported net of an allowance for doubtful accounts.  The Company estimates the collectibility of its accounts receivable at the end of each reporting period.  The Company analyzes the aging of accounts receivable and bad debt history, payment history, customer concentration, customer credit worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts.  The Company maintains an allowance for doubtful accounts, which is created by charges to selling, general and administrative expenses in the condensed consolidated statements of operations.

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Fair Value of Financial Instruments

The Company measures its financial assets and liabilities in accordance with U.S. GAAP.  For financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses, the carrying amounts approximate fair value due to their short maturities.

Foreign Currency Translation

The Company uses the U.S. dollar as its functional currency.  All of the Company’s sales and a substantial majority of its costs are transacted in U.S. dollars.  The Company purchases wafers and has test and assembly activities in Asia and supports sales and marketing activities in various countries outside of the United States.  Research and development costs in Romania are paid in Romanian leu.  Sales and marketing activities in Japan are paid in Japanese yen.  Foreign currency transaction gains and losses, from remeasuring local currency to the U.S. dollar, are included in determining net income (loss) for the period.  Foreign exchange gains and losses were not material for the periods presented.

Revenue Recognition

The Company generally recognizes revenues as products are shipped if evidence of a sales arrangement exists, the customer has taken title to the products, services, if any, have been rendered, the sales price is fixed or determinable, collection of the resulting receivable is reasonably assured and product returns are reasonably estimable.

The Company markets and sells its products through its direct sales force and sales representatives to OEMs and indirectly through distributors and resellers who sell to their end customers.  Revenues are recognized upon transfer of title to OEMs and resellers who have no, or limited, product return rights and no price protection rights.  Reserves for estimated returns and allowances are provided against net revenues at the time of recognition of revenues.  The Company also sells products to certain distributors under agreements that provide for product return and price protection rights.  These agreements generally permit the distributor to return up to 10% by value of the total products they purchased from the Company every six months, in exchange for credit on a replacement order of the same value.  As a result, the Company defers recognition of revenues until the time the distributor sells the product to an end-customer, at which time the sales price becomes fixed.  Upon shipment to a distributor, the Company records an account receivable from the distributor, relieves inventory for the cost of the product shipped, and records the gross profit, which equals revenues less the cost of revenues, on the condensed consolidated balance sheet as “deferred gross profit on shipments to distributors” until such time as the inventory is resold by the distributor to its end-customers.

In assessing the timing of revenue recognition from sales to distributors and resellers, the Company considers both direct and indirect risks of returns and price protection associated in our business dealings with them.  The Company recognizes that it may accept returns or grant price protection to certain resellers, even though the sales contracts do not explicitly provide for such rights.  Accordingly, the Company accounts for sales to such resellers on a sell through basis.

Inventories

Inventories are stated at the lower of standard cost or net realizable value.  Standard cost approximates actual cost on a first-in, first-out basis.  The Company periodically reviews its inventory for slow moving or obsolete items and writes down the related products to estimated net realizable value.  Inventory writedown or provisions once established are not reversed until the related inventory has been sold or physically scrapped.  Purchases of inventory from three of the Company’s vendors represented 74.2% and 76.4% of total purchases of inventory for the three months ended January 27, 2008 and January 28, 2007, respectively.  Purchases of inventory from three of the Company’s vendors represented 73.6% and 78.4% of total purchases of inventory for the nine months ended January 27, 2008 and January 28, 2007, respectively.

Shipping and Handling Costs

The Company charges inbound freight shipments within the supply chain and associated handling costs to the “cost of revenues” on its condensed consolidated statements of operations.  The Company charges outbound freight shipments and associated handling costs to “selling, general and administrative” on its condensed consolidated statements of operations.  Such outbound freight costs aggregated to $171,000 and $189,000 for the three months ended January 27, 2008 and January 28, 2007, respectively, and $579,000 and $508,000 for the nine months ended January 27, 2008 and January 28, 2007, respectively.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation and amortization.  Depreciation and amortization

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are calculated on a straight-line basis over the estimated useful lives of the assets.  Furniture, office equipment and engineering/test equipment are depreciated over five years with the exception of production mask sets which are depreciated over two years.  Computer hardware is depreciated over three years.  Computer software is depreciated over three or five years.  Buildings are generally depreciated over 30 years.  Amortization of leasehold improvements is computed on a straight-line basis and amortized over the shorter of the remaining lease term or the estimated useful lives of the assets.

Income Taxes

The provision for income taxes is determined using the asset and liability approach of accounting for income taxes.  Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid.  The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year.  Deferred taxes result from differences between the financial and tax basis of our assets and liabilities and are adjusted for changes in tax rates and tax laws when changes are enacted.  Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.

The Company has not provided for U.S. income taxes and foreign withholding taxes on a cumulative total of approximately $460,000 of undistributed earnings for certain non-U.S. subsidiaries as of January 27, 2008.  The Company intends to reinvest these earnings indefinitely in operations outside the United States.  These earnings include 100% of the accumulated undistributed earnings of the Company’s subsidiaries in Japan, Romania and Thailand.  The calculation of the taxes that would be payable on these undistributed earnings is impracticable at present.  The Company’s internal test operations in Thailand operate under a tax holiday that expires in October 2014.

The calculation of tax liabilities involves dealing with uncertainties in the application of complex global tax regulations.  The Company recognizes potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on its estimate of whether, and the extent to which, additional taxes will be due.  If payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when the Company determines the liabilities are no longer necessary.  If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.

Concentration of Credit Risk

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents, short-term investments and accounts receivable.  Cash and cash equivalents and short-term investments are maintained with high quality financial institutions.  The Company’s accounts receivable are denominated in U.S. dollars and are derived from sales to customers located principally in North America, Europe, Japan and Asia.  The Company performs ongoing credit evaluations of its customers and generally does not require collateral.

As of January 27, 2008, two customers accounted for 11.2% and 10.7% of gross accounts receivable.  As of April 29, 2007, one customer accounted for approximately 15.0% of gross accounts receivable.

For the three months ended January 27, 2008 and January 28, 2007, Avnet, Inc., an international distributor, represented 9.4% and 11.0% of the Company’s net revenues, respectively.  For the nine months ended January 27, 2008 and January 28, 2007, Avnet represented 9.5% and 10.8% of the Company’s net revenues, respectively.

Concentration of Other Risks

The semiconductor industry is characterized by rapid technological change, competitive pricing pressures and cyclical market patterns.  The Company’s financial results are affected by a wide variety of factors, including general economic conditions worldwide, economic conditions specific to the semiconductor industry, the timely implementation of new manufacturing process technologies and the ability to safeguard patents and intellectual property in a rapidly evolving market.  In addition, the semiconductor market has historically been cyclical and subject to significant economic downturns at various times.  As a result, the Company may experience significant period to period fluctuations in operating results due to the factors mentioned above or other factors.

Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income (loss) includes all changes in stockholders’ equity during a period from non-owner sources.  Accumulated other comprehensive income (loss) for the Company is comprised of unrealized gains (losses) on securities available-for-sale, net of tax.

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Stock-Based Compensation

The Company accounts for stock-based compensation under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment,” (“SFAS No. 123(R)”) and related interpretations which requires the measurement and recognition of expense related to the fair value of stock-based compensation awards.  Accordingly, stock-based compensation is measured at the grant date and re-measured upon modification, as appropriate, based on the fair value of the award using the Black-Scholes option pricing model (“Black-Scholes model”), and is recognized as expense over the requisite services period of the award.  Black-Scholes requires the use of highly subjective, complex assumptions, including expected term and the price volatility of the Company’s stock.  See Note 4—Stock-Based Compensation for further discussion.

Segment Reporting

The Company reports in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”).  SFAS No. 131 requires the management approach in identifying reportable segments.  The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the company’s reportable segments.  Based on its operating structure and management reporting, the Company has concluded it has one reporting segment: the semiconductor manufacturing segment.

New Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”).  SFAS No. 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements.  SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  In February 2008, the FASB granted a one year deferral for non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis, at least annually, to comply with SFAS No. 157.  However, the effective date for financial assets and liabilities remains intact.  The Company is currently evaluating the impact, if any, of adopting this standard on the Company’s financial position, results of operations and liquidity.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (“SFAS No. 159”).  SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  The Company is currently evaluating the impact, if any, of adopting this standard on the Company’s financial position, results of operations and liquidity.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”).  SFAS No. 141(R) requires an acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination.  SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008.  The Company is currently evaluating the impact, if any, of adopting this standard on the Company’s financial position, results of operations and liquidity.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS No. 160”).  SFAS No. 160 clarifies that a noncontrolling or minority interest in a subsidiary is considered an ownership interest and, accordingly, requires all entities to report such interests in subsidiaries as equity in the consolidated financial statements.  SFAS No. 160 is effective for fiscal years beginning after December 15, 2008.  The Company is currently evaluating the impact, if any, of adopting this standard on the Company’s financial position, results of operations and liquidity.

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Note 3—Adoption of New Accounting Standard

In the first fiscal quarter ended July 29, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”), and related guidance.  See Note 7—Income Taxes for further discussion.

Note 4—Stock-Based Compensation

The Company measures employee stock-based compensation cost using the provisions of SFAS No. 123(R).  Accordingly, stock-based compensation cost is measured at the grant date, based on the fair value of the awards, and is recognized as expense over the requisite employee service period using the straight-line attribution method.

The effect of recording stock-based compensation for the three and nine months ended January 27, 2008 and January 28, 2007 was as follows (in thousands):

During the three months ended January 27, 2008, the Company granted approximately 19,000 stock options with an estimated total grant date fair value of $29,000 and a weighted average grant date fair value of $1.55 per share and during the three months ended January 28, 2007, the Company granted approximately 154,000 stock options with an estimated total grant date fair value of $183,000 and a weighted average grant date fair value of $1.19 per share.

During the nine months ended January 27, 2008, the Company granted approximately 647,000 stock options with an estimated total grant date fair value of $777,000 and a weighted average grant date fair value of $1.20 per share and during the nine months ended January 28, 2007, the Company granted approximately 769,000 stock options with an estimated total grant date fair value of $879,000 and a weighted average grant date fair value of $1.14 per share.

As of January 27, 2008, the aggregate amount of unrecognized stock-based compensation expense, net of estimated forfeitures, related to stock options was $2.6 million, which the Company will recognize over an estimated weighted average amortization period of 2.3 years.

During the three and nine months ended January 27, 2008, there were no new grants of restricted stock.  During the three months ended January 27, 2008, 83,000 shares of restricted stock became vested.  The Company reacquired 12,501 shares to satisfy the statutory minimum tax withholding requirement for these vested shares.

As of January 27, 2008, the aggregate amount of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock was $357,000, which the Company will recognize over an estimated weighted average amortization period of 1.9 years.

Stock-based compensation expense capitalized in inventory at January 27, 2008 and April 29, 2007 was immaterial.

Valuation Assumptions

During the three and nine months ended January 27, 2008 and January 28, 2007, the Company utilized the Black-Scholes model for calculating the estimated fair value of stock-based compensation awards granted under stock option plans.  Option-pricing models require the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock.  The expected life of each option was determined by analyzing historical exercise and post-vest forfeiture patterns.  The risk-free interest rate was determined using the rates for United States Treasury notes for similar terms.  The expected stock price volatility assumption was determined using the historical volatility of the Company’s common stock.

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Equity Incentive Programs

The Company’s 2003 Stock Incentive Plan (“SIP”), 2003 Director Stock Option Plan (“DSOP”) and 1998 Special Equity Incentive Plan (“SEIP”) that were outlined in the Company’s Form 10-K for the year ended April 29, 2007 did not change during the three and nine months ended January 27, 2008.

A summary of stock option activity under the SIP, the DSOP and the SEIP is as follows (in thousands, except per share and term amounts):

The aggregate intrinsic value in the table above represents the total pretax intrinsic value for in-the-money options, based on the $3.96 closing stock price of the Company’s common stock on the NASDAQ Global Market at January 27, 2008, which would have been received by the option holders had all option holders exercised their options as of that date.  As of January 27, 2008, the total number of in-the-money options outstanding was 3,006,000, of which 2,061,000 options were exercisable.

Common Stock Repurchase Programs and Other Changes in Treasury Shares

In September 2001 and subsequent periods, the Company’s board of directors authorized programs for the open market repurchase of up to 5.5 million shares of its common stock.  In January 2008, the board of directors amended the current program and increased the aggregate number of authorized shares by 3.2 million.  The purpose of the share repurchase programs is to reduce the long-term potential dilution in earnings per share that might result from issuances under the Company’s stock option plans and to take advantage of the relatively low price of the Company’s common stock.  There were no repurchases during the three months ended January 27, 2008.  During the three months ended January 28, 2007, the Company repurchased 134,600 shares for an approximate cost of $472,000.  As of January 27, 2008, 4.0 million of authorized shares remained available for repurchase.  The Company accounts for treasury stock using the cost method.

In the quarter ended January 27, 2008, the Company reacquired 12,501 shares to satisfy the statutory minimum tax withholding requirement for restricted stock that vested during the quarter.  The cost associated with the reacquisition was approximately $72,000 or an average cost of $5.74 per share.

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Note 5—Net Income Per Share

Basic net income per share is computed by dividing net income available to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period.  Diluted net income per share is computed using the weighted number of common shares and potentially dilutive common shares outstanding during the period under the treasury stock method.  Under the treasury stock method, the effect of stock options outstanding is not included in the computation of diluted net income per share for periods when their effect is anti-dilutive, which in the current period includes consideration of unearned stock-based compensation as required by SFAS No. 123(R).  In computing diluted net income per share, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options.  A reconciliation of the basic and diluted per share computations was as follows (in thousands, except per share data):

Options to purchase approximately 1,762,000 shares of common stock with an exercise price and net proceeds in excess of $4.92 per share outstanding during the three months ended January 27, 2008 were not included in the computation of diluted income per share because they were anti-dilutive.

Options to purchase 3,634,000 shares of common stock with an exercise price and net proceeds in excess of $5.49 per share outstanding during the three months ended January 28, 2007 were not included in the computation of diluted income per share because they were anti-dilutive.

A reconciliation of the basic and diluted per share computations was as follows (in thousands, except per share data):

Options to purchase 1,589,000 shares of common stock with an exercise price and net proceeds in excess of $4.99 per share outstanding during the nine months ended January 27, 2008 were not included in the computation of diluted income per share because they were anti-dilutive.

Options to purchase 3,571,000 shares of common stock with an exercise price and net proceeds in excess of $5.52 per share outstanding during the nine months ended January 28, 2007 were not included in the computation of diluted income per share because they were anti-dilutive.

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Note 6—Balance Sheet Components

The Company did not have any bad debts written off to the allowance for doubtful accounts in the three or nine months ended January 27, 2008 and January 28, 2007, respectively.

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Note 7—Income Taxes

The provision for income taxes was $93,000, or 20.8% of income before taxes, for the three months ended January 27, 2008.  The provision for income taxes was $161,000, or 59.2% of income before taxes, for the three months ended January 28, 2007.  The lower effective income tax rate for the three months ended January 27, 2008 was due to a decline in the amount of non-deductible stock compensation charges associated with incentive stock options for U.S. employees and non-qualified stock options for non-U.S. employees compared to the three months ended January 28, 2007.  The Company also had higher non-taxable income associated with its new internal test operations in Thailand, which operate under a tax holiday that expires in October 2014.

The provision for income taxes was $1.2 million, or 35.9% of income before taxes, for the nine months ended January 27, 2008.  The benefit from income taxes was $7,000, or 33.3% of income before taxes, for the nine months ended January 28, 2007.  The change in effective tax rate for the nine months ended January 27, 2008 is attributable to the increase in income before taxes and a decline in the amount of non-deductible stock compensation charges associated with incentive stock options for U.S. employees and non-qualified stock options for non-U.S. employees compared to the nine months ended January 28, 2007.  The Company also had higher non-taxable income associated with its new internal test operations in Thailand.

The Company adopted the provisions of FIN 48 effective April 30, 2007.  FIN 48 clarifies the accounting for uncertainty in tax positions.  The interpretation prescribes a recognition threshold and measurement criteria for financial statement recognition of a tax position taken or expected to be taken in a tax return.  FIN 48 requires the Company to recognize in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position.  The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting interim periods, disclosure and transition.

As a result of adoption, the Company recognized a decrease in deferred income tax assets of approximately $66,000 and a corresponding decrease in retained earnings as of April 30, 2007.  As of the adoption date, the Company had gross unrecognized tax benefits of approximately $1.1 million and accrued interest expense of $6,000.  As of January 27, 2008, the Company had gross unrecognized tax benefits of approximately $1.2 million.  Consistent with the provision of FIN 48, in the first fiscal quarter of 2008 the Company reclassified approximately $157,000 of current income tax liabilities resulting in a $157,000 increase to non-current income taxes payable included in other non-current liabilities.

If such amounts ultimately prove to be unnecessary, the resulting reversal of such reserves would generate tax benefits to be recorded in the period the reserves are no longer deemed necessary.  If such amounts ultimately prove to be less than the final assessment, a future charge to expense would be recorded in the period in which the assessment is determined.  Although timing of the resolution and/or closure on audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.

The Company recognizes interest and penalties related to unrecognized tax benefits within its income tax provision (benefit).

The Company conducts business globally and, as a result, the Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions.  In the normal course of business the Company is subject to examination by taxing authorities throughout the world.  The Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before fiscal 2004, other than for carryforwards of research and development tax credits and net operating losses generated in fiscal 1998, 1999 and 2002.

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Note 8—Segment Reporting

The Company operates in one business segment, the semiconductor manufacturing segment.  Sales transactions are denominated in U.S. dollars.

Net revenues by product group were as follows (in thousands):

Net revenues by geography were as follows (in thousands):

For the three months ended January 27, 2008 and January 28, 2007, Avnet represented 9.4% and 11.0% of the Company’s net revenues, respectively.  For the nine months ended January 27, 2008 and January 28, 2007, Avnet represented 9.5% and 10.8% of the Company’s net revenues, respectively.

Property and equipment, net, geographical breakdown was as follows (in thousands):

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Note 9—Commitments and Contingencies

Purchase Commitments

Purchase commitments for open purchase orders at January 27, 2008 and April 29, 2007 for which goods and services had not been received were approximately $10.4 million and $5.9 million, respectively.

Litigation and Other Claims

In the normal course of business, the Company may receive notification of threats of legal action in relation to claims of patent infringement by the Company.  Currently there are no active actions.

Guarantees

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”).  The Company applies the disclosure provisions of FIN 45 to its agreements that contain guarantee or indemnification clauses.  FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee.  In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities.  These disclosure provisions expand those required by SFAS No. 5, “Accounting for Contingencies” by requiring that guarantors disclose certain types of guarantees, even if the likelihood of requiring the guarantor’s performance is remote.  The following is a description of significant arrangements through which the Company is a guarantor:

Indemnification Obligations

The Company is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters.  Typically, these obligations arise in the context of contracts entered into by the Company, under which the Company customarily agrees to hold the other party harmless against losses arising from a breach of representations and covenants related to such matters as title to assets sold and certain intellectual property rights.  Generally, payment by the Company is conditioned on the other party making a claim pursuant to the procedures specified in the particular contract, which procedures typically allow the Company to challenge the other party’s claims.  Further, the Company’s obligations under these agreements may be limited in terms of time and/or amount, and in some instances, the Company may have recourse against third parties for certain payments made by it under these agreements.

It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement.  Historically, payments made by the Company under these agreements have not had a material effect on its business, financial condition, cash flows or results of operations.  The Company believes that if it were to incur a loss in any of these matters, such loss should not have a material effect on its business, financial condition, cash flows or results of operations.

Product Warranties

The Company estimates its product warranty costs based on historical warranty claim experience and applies this estimate to the revenue stream for products under warranty.  Included in the Company’s sales returns reserves are estimated return exposures associated with product warranties.  Estimated future costs for warranties applicable to revenues recognized in the current period are charged to the Company’s cost of revenues.  The warranty accrual is reviewed quarterly to verify that it properly reflects the remaining obligations based on the anticipated expenditures over the balance of the obligation period.  Adjustments are made when actual claim experience differs from estimates.  Warranty cost was not material for the three and nine months ended January 27, 2008 and January 28, 2007.

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Note 10—Related Party Transactions

Elex N.V.

The Company purchases wafers fabricated at X-FAB Texas, Inc. (“X-FAB”), a majority-owned subsidiary of Xtrion N.V. (“Xtrion”), a Belgium holding company.  X-FAB was formerly owned by Elex N.V. (“Elex”), a Belgium holding company.  Elex’s ownership in X-FAB was transferred to Xtrion.  Roland Duchâtelet, the chairman and chief executive officer of Elex, serves as a member of the Company’s board of directors and is a major shareholder in both Elex and Xtrion.  The wafers provided by X-FAB include most of the Company’s analog/mixed-signal products and supplement some of the same EEPROM designs fabricated at various other foundries the Company utilizes.  Other than purchase orders currently open with X-FAB, there are no purchasing agreements in place with X-FAB.

During the nine months ended January 27, 2008 and January 28, 2007, the Company purchased $1.5 million and $824,000 of wafers, respectively, from X-FAB.  As of January 27, 2008 and April 29, 2007, the total amount due X-FAB was $363,000 and $68,000, respectively.

As of January 27, 2008, Elex held approximately 4.6% of the outstanding shares of common stock of the Company.

Note 11—Other Comprehensive Income

The components of other comprehensive income, net of tax, are presented in the following table (in thousands):

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”)  and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which involve risks and uncertainties.  Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors that include, but are not limited to, the risks discussed in Part II. Item 1A “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q and similar discussions in our other filings with the Securities and Exchange Commission including our Annual Report on Form 10-K for the year ended April 29, 2007.  These forward-looking statements include, but are not limited to: the statements relating to demand for and supply of our company’s products; the statements relating to downward pricing trends and average selling prices; the statements relating to reduction of expenses related to our Thailand subsidiary; the statements relating to the increasing portion of our net revenues from analog/mixed-signal products; the statements relating to the sufficiency of our cash resources and cash flows to fund our operating and capital requirements and the risks associated with seeking additional financing.  These forward-looking statements are based on current expectations and entail various risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements.  In addition, historical information should not be considered an indicator of future performance.  We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur.

Overview

We design, develop and market a broad line of reprogrammable non-volatile memory products and analog/mixed-signal products.  Our products are used by manufacturers of electronic products in a wide range of consumer, computing, communications, industrial and automotive applications.  We generally target high volume markets for our cost effective, high quality products.  Through periods of tight manufacturing capacity and cyclical downturns, we have demonstrated long-term commitment to the memory products market.

The market for our non-volatile memory is highly competitive and market participants have relatively weak pricing power.  Average selling prices of our non-volatile memory products have declined over time and prices are sensitive to conditions in our OEM customers’ target markets.  In the year ended April 29, 2007, we experienced an increase in total unit volume sold to end customers, driven by strong demand particularly for our EEPROM and analog/mixed-signal products.  This continued in the first and second quarters of fiscal year 2008.  However, during the third quarter of fiscal year 2008, net revenues decreased by 13.9% sequentially from second quarter net revenues of $20.7 million, due in large part to the seasonality of our business.  On a year-to-date basis, net revenues increased by $10.5 million or 21.8%.  In general, we expect the average selling price for a given memory product to decline in the future, primarily due to market competition, product availability and manufacturing capacity.  In response to that trend, we continue to work with our foundries and other vendors to increase the manufacturing efficiency of our products.

We have leveraged our extensive experience in high volume, reprogrammable memory products to develop complementary analog/mixed-signal products that offer our customers a more complete system solution.  We have strengthened and expanded the expertise of our research and development team by establishing our own development center in Bucharest, Romania and by hiring additional engineers in Romania and in our Santa Clara, California headquarters.  We continue to make substantial investments in research and development to advance our non-volatile memory products, as well as develop broader solutions with our line of analog/mixed-signal products.  In fiscal 2007, we formed a subsidiary in Thailand that we expect will provide a majority of the inventory management and manufacturing test functions that are currently subcontracted to Trio-Tech.  This is expected to reduce our manufacturing and tax expense and improve our control over the personnel and assets located in Thailand.

For the nine months ended January 27, 2008, net revenues from our analog/mixed signal products increased by $4.7 million or 115.6% over the same period last year.  However, during the third fiscal quarter of 2008, net revenues from analog/mixed signal products declined by 40.3% to $2.3 million over the previous quarter due in large part to the seasonality of our business.  For the nine months ended January 27, 2008, net revenues from our analog/mixed signal products represented 14.9% of total net revenues as compared to 8.4% of net revenues for the same period in the prior year.  We expect net revenues from analog/mixed-signal products to comprise a larger portion of our net revenues in the future.

Our business is less capital intensive than traditional semiconductor companies since we outsource to third parties the wafer fabrication, assembly and approximately 50% of the testing of our products.  We strive to maintain long-term relationships with our suppliers to ensure stability in our supply of products at a competitive cost.  In addition, in an effort to alleviate any potential wafer capacity constraints, we maintain a supply of wafers in a die bank for selected products.

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We market and sell our products directly through our sales force and sales representatives to OEMs and indirectly through distributors and resellers who sell to their end customers.  Indirect sales represented 60.8% and 55.8% of net revenues for the nine months ended January 27, 2008 and January 28, 2007, respectively.  Our total customer base, including OEMs and end-customers of our distributors and resellers, is relatively diverse and consists of more than 3,000 end customers.  We have approximately 49 distributors and resellers.

Distributors and resellers have accounted for a significant portion of our net revenues in the past.  For the nine months ended January 27, 2008 and January 28, 2007, Avnet represented 9.5% and 10.8% of our net revenues, respectively.

Our sales are initiated by purchase orders received from our customers and are typically shipped within a few weeks of receiving the order.  Cancellations of customer orders and distributor price protection, both of which are standard semiconductor industry practices, could result in the loss of future net revenues without allowing us sufficient time to reduce our inventory and operating expenses.

Sales to customers outside the United States comprised 92.2% and 91.3% of our net revenues for the nine months ended January 27, 2008 and January 28, 2007, respectively.  All sales of our products are denominated in U.S. dollars.

Description of Operating Accounts

Net Revenues.  Net revenues consist of product sales, net of returns and allowances and any recoveries from sales of previously written down inventories.

Cost of Revenues.  Cost of revenues consists primarily of costs of manufacturing, assembly and testing of our products, compensation (including stock-based compensation) and associated costs related to manufacturing support, inbound freight shipments and quality assurance personnel, as well as provision for excess and obsolete inventories.  It also can include, on occasion, adjustments to inventory valuations based on demand and average selling prices expected in future periods.

Gross Profit.  Gross profit is net revenues less cost of revenues and is affected by a number of factors, including competitive pricing, product mix, foundry pricing, the cost of test and assembly services and manufacturing yields.

Research and Development.  Research and development expense consists primarily of compensation (including stock-based compensation) and associated costs for engineering, technical and support personnel, contract engineering services, depreciation of equipment and cost of wafers and mask sets used to evaluate new products and new versions of current products.

Selling, General and Administrative.  Selling, general and administrative expense consists primarily of compensation (including stock-based compensation) and associated costs for sales, marketing and administrative personnel, commissions, promotional activities, bad debt expense, outbound freight shipments, professional fees including audit and costs associated with Sarbanes-Oxley compliance, and director and officer insurance.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, cost of revenues, expenses and related disclosure of contingencies.  On an on-going basis, we evaluate our estimates, including those related to revenue recognition, inventory valuation, accounts receivable and allowance for doubtful accounts, stock-based compensation and income taxes.  We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, and apply them on a consistent basis.  We believe that such consistent application results in condensed consolidated financial statements and accompanying notes that fairly state our financial condition, operating results and cash flows for all periods presented.  However, any factual errors or errors in these estimates and judgments may have a material impact on our financial conditions, operating results and cash flows.  Other than the adoption of FIN 48, there have been no significant changes to our critical accounting policies and estimates since April 29, 2007.

Recognition of Revenues

We generally recognize revenues as products are shipped if all of the following criteria are met:

·    we have evidence that a sales arrangement exists;

·    our customer has taken title to the products;

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·    we have performed the services, if any;

·    the sales price is fixed or determinable;

·    we believe that collection of the resulting receivable is reasonably assured; and

·    we can reasonably estimate product returns.

We sell our products directly through our sales force and sales representatives to OEMs and indirectly through distributors and resellers who sell to their end customers.  We recognize revenues upon delivery to OEM customers and resellers who have no, or limited, product return rights and no price protection rights.  We deem that delivery occurs when legal title and the risk of loss transfers to the customer.  Delivery is generally defined by the customers’ shipping terms, as stated in the related purchase order.  If the customers’ purchase orders do not define the shipping terms, the shipping terms will be Ex-Works as defined in our invoice.  We record an estimated allowance for returns from OEM customers and resellers, based on a percentage of our revenues.  This estimate is based on historical averages and management’s estimate of future trends.

We sell products to certain distributors under agreements that provide for product return and price protection rights.  These agreements generally permit the distributor to return up to 10% by value of the total products that the distributor has purchased from us every six months, in exchange for credit on a replacement order of the same value.  We defer recognition of revenues until the time the distributor resells the product to an end-customer, at which time the sales price becomes fixed.  On a monthly basis, we receive point of sales and ending inventory information from each distributor.  Using this information, we determine the amount of revenues to recognize.  For distributors who have product return rights, we also record an inventory reserve to address the cost of products we anticipate that we will not be able to resell after their return by the distributors.  For distributors who have price protection rights, distributors may take the associated credits immediately and in general, we process the credits one or two months after the credit is earned by the distributor.  We record a reserve to cover the estimated liability of those unprocessed credits.

In assessing the timing of revenue recognition from sales to distributors and resellers, we consider both direct and indirect risks of returns and price protection associated in our business dealings with them.  We recognize that we may accept returns or grant price protection to certain resellers, even though the sales contracts do not explicitly provide for such rights.  Accordingly, we account for sales to such resellers on a sell through basis.

We re-evaluate our revenue recognition policies on an ongoing basis.

Inventory Valuation

We value our inventory at the lower of standard cost or net realizable value.  Standard cost approximates actual cost on a first-in, first-out basis.  We routinely evaluate the value and quantities of our inventory in light of the current market conditions and market trends and we record reserves for quantities in excess of demand, cost in excess of market value and product age.  Our analysis may take into consideration historical usage, expected demand over the next 12 months, anticipated sales price, new product development schedules, the effect new products might have on the sales of existing products, product age, customer design activity, customer concentration and other factors.  Our forecasts for our inventory may differ from actual inventory use.

We reduce the value of our inventory by analyzing on-hand quantities and open purchase orders which are in excess of demand equal to the cost of inventory that exceeds expected demand for the next 12 months.  We make judgments in establishing these provisions and do not establish provisions if we believe we can sell the excess inventory.  If market conditions are less favorable than those we estimate, we may be required to write down inventory.  If we overestimate the future selling prices, we will incur additional losses when the inventory is sold for a lower price or when we establish additional write downs to cover the even lower estimated sales price.  Once written down, we do not reverse inventory provisions until the associated inventory has been sold or physically scrapped.

Allowance for Doubtful Accounts

We estimate the collectibility of our accounts receivable at the end of each reporting period.  We analyze the aging of accounts receivable and bad debt history, payment history, customer concentration, customer credit worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts.  We maintain an allowance for doubtful accounts, which is created by charges to selling, general and administrative expenses.  Our accounts receivable balance was $12.3 million, net of allowance for doubtful accounts of $109,000 as of January 27, 2008.

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Stock-Based Compensation

Effective May 1, 2006, we adopted the provisions of SFAS No. 123(R).  We estimate the fair value of stock options using the Black-Scholes model, consistent with the provisions of SFAS No. 123(R) and Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 107, “Share-Based Payment.”  Option-pricing models require the input of highly subjective assumptions, including the price volatility of the underlying stock.  The expected term assumption used in calculating the estimated fair value of our stock-based compensation awards using the Black-Scholes model is based primarily on detailed historical data about employees’ exercise behavior and vesting schedules.  In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest.  We estimate the forfeiture rate based on historical experience of our stock-based awards that have been granted and forfeited prior to vesting.  Stock-based compensation is amortized on a straight-line basis and allocated to cost of revenues, research and development and selling, general and administrative expenses in the accompanying consolidated statements of operations based on the related employee’s function.

Income Taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate.  This process involves estimating our current tax exposure and assessing temporary differences resulting from differing treatment of items, such as deferred revenues, for tax and accounting purposes.  These differences result in deferred tax assets and liabilities, which are included on our balance sheet on a net basis.  We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we establish a valuation allowance or increase this allowance in a period, we will include an additional tax provision in the statement of operations.

The calculation of tax liabilities involves dealing with uncertainties in the application of complex global tax regulations.  We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on its estimate of whether, and the extent to which, additional taxes will be due.  If payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities that would result in tax benefits being recognized in the period when we determine that liabilities are no longer necessary.  If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.

We make significant judgments in determining our provision for income taxes, our deferred tax assets and any valuation allowance recorded against our net deferred tax asset.  As of January 27, 2008 and April 29, 2007, our net deferred tax assets, consisting primarily of net operating loss carryforwards, tax credit carryforwards and currently nondeductible reserves and accruals, were valued at $5.8 million and $6.8 million, respectively.  Our valuation allowance was zero as we have concluded that it is more likely than not that all of our deferred tax assets will be realizable, based on available objective evidence and our history of taxable income.

In June 2006, the FASB issued FIN 48 which provides for a two-step approach to recognize and measure uncertain tax positions accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes.”  We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.  The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any.  The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement.  Whether the more-likely-than-not recognition threshold is met for a tax position is a matter of judgment based on the individual facts and circumstances of that position evaluated in light of all available evidence.  We adopted the provisions of FIN 48 effective April 30, 2007, resulting in a decrease in income tax assets of approximately $66,000 and a corresponding decrease in retained earnings as of April 30, 2007.  Consistent with the provision of FIN 48, in the first fiscal quarter of 2008 we reclassified approximately $157,000 of current income tax liabilities resulting in a $157,000 increase to non-current income taxes payable included in other non-current liabilities on our condensed consolidated balance sheet.  See Note 7—Income Taxes to the accompanying unaudited condensed consolidated financial statements for further discussion.

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Results of Operations

The following table sets forth the results of our operations as a percentage of net revenues for the periods indicated:

The following table sets forth net revenues (in thousands) and percentage of net revenues by product group:

Comparison of the Three Months Ended January 27, 2008 and January 28, 2007

Net Revenues.  Our net revenues increased approximately $1.4 million, or 8.6%, to $17.8 million for the three months ended January 27, 2008 from $16.4 million for the three months ended January 28, 2007.  Unit volume increased by 21% for the three months ended January 27, 2008.  Our blended unit average selling prices decreased by 10%.

In terms of product mix, our net revenues for EEPROM increased by approximately $778,000, or 5.6%, to $14.8 million and represented 82.8% of our total net revenues for the three months ended January 27, 2008.  The growth was driven by higher demand for our EEPROM products due to increased acceptance of our current product offerings.  Unit volume increased by 18%.

Our analog/mixed-signal products, which have higher gross margins, increased by approximately $948,000 or 72.6% to $2.3 million, and represented 12.6% of our total net revenues for the three months ended January 27, 2008.  The growth was primarily due to increased demand for our LED driver products.  Unit volume increased by 58%.

Net revenues for our line of flash memory products, which are a legacy business with declining industry utilization, decreased by $306,000, or 27.2%, to $818,000 and represented 4.6% of our total net revenues for the three months ended January 27, 2008.  Unit volume decreased by 35%.

Our customers’ and end-users’ overseas activities continue to be our major source of revenues.  Sales to customers outside the United States represented approximately 91.5% of net revenues for the three months ended January 27, 2008 as compared to 93.8% of net revenues for the three months ended January 28, 2007.

Gross Profit.  Gross profit increased $1.1 million, or 17.6%, to $6.9 million for the three months ended January 27, 2008 from $5.8 million for the three months ended January 28, 2007.  On a percentage basis, gross margins increased from 35.6% for the three months ended January 28, 2007 to 38.5% for the three months ended January 27, 2008.

The increase in gross profit was mainly due to the overall growth in sales, specifically of higher margin analog/mixed

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signal products.  Additionally, we reduced our back-end manufacturing costs and experienced lower inventory write downs of excess and old date code material compared to the same period in the prior year.

Research and Development.  Research and development expense increased approximately $281,000, or 14.7%, to $2.2 million for the three months ended January 27, 2008 from $1.9 million for the three months ended January 28, 2007.  As a percentage of net revenues, research and development expense was 12.3% and 11.7% for the three months ended January 27, 2008 and January 28, 2007, respectively.  The increase for the three month period ended January 27, 2008 was primarily attributable to an increase in compensation costs to existing and new employees of $348,000.  The increase was partially offset by a $72,000 reduction in stock-based compensation expense.

Selling, General and Administrative.  Selling, general and administrative expense increased $622,000, or 15.6%, to $4.6 million for the three months ended January 27, 2008 from $4.0 million for the three months ended January 28, 2007.  As a percentage of net revenues, selling, general and administrative expense was 25.8% and 24.3% for the three months ended January 27, 2008 and January 28, 2007, respectively.  The increase was principally attributable to $634,000 in non-recurring professional service fees for investment banking and legal services related to strategic transaction activities.  In July 2007, our board of directors formed a Strategy Committee and shortly thereafter engaged the services of an investment banker to assist in evaluating various strategic alternatives.  In January 2008, the board terminated further activities related to the discussions that occurred during the third quarter of fiscal year 2008 due to changes in market conditions.  Compensation costs to existing and new employees increased by $226,000 and inside sales commission expense rose by $59,000 due to higher revenues. The increase in these expenses was offset by reductions of $206,000 in auditing and Sarbanes-Oxley compliance costs, $99,000 in marketing and outside sales representative commission expenses, and $42,000 in stock-based compensation expense.

Interest Income and Other, net.  We earned interest and other income, net, of $384,000 for the three months ended January 27, 2008 as compared to interest and other income, net, of $333,000 for the three months ended January 28, 2007.  The increase resulted from a higher average balance on our cash, cash equivalents and short-term investments.  Our rate of return was approximately 4.5% for the three months ended January 27, 2008 compared to approximately 4.9% for the three months ended January 28, 2007.