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Article by DailyStocks_admin    (04-21-08 09:41 AM)

Filed with the SEC from Apr 10 to Apr 16:

Silicon Storage Technology (SSTI)
Riley Investment Management wrote to SSTI nominating four directors for election to the board at the "08 annual meeting; nominated were Bryant R. Riley, Eric Singer, Melvin Keating and Bob D'Agostino. If elected, Riley said the nominees would take "an active role." Riley holds (5.4%)

BUSINESS OVERVIEW

Overview

Silicon Storage Technology, Inc. (SST, us or we) is a leading supplier of NOR flash memory semiconductor devices for the digital consumer, networking, wireless communications and Internet computing markets. NOR flash memory is a form of nonvolatile memory that allows electronic systems to retain information when the system is turned off. NOR flash memory is used in hundreds of millions of consumer electronics and computing products annually.

We produce and sell many products based on our SuperFlash design and manufacturing process technology. Our products are incorporated into products sold by many well-known companies including Apple, Asustek, BenQ, Cisco, Dell, First International Computer, or FIC, Gigabyte, Haier, Huawei, Infineon, Intel, IBM, Inventec, Legend Lenovo, LG Electronics, Freescale Semiconductor, NEC, Nintendo, Panasonic, Philips, Quanta, Samsung, Sanyo, Seagate, Sony, Sony Ericsson, Toshiba, Texas Instruments, VTech and ZTE.

We also produce and sell other semiconductor products including smartcard integrated circuits, or ICs, and modules, NAND flash controllers and NAND-controller based modules, radio frequency, or RF, ICs and modules.

We license our SuperFlash technology for applications in semiconductor devices that integrate flash memory with other functions on a monolithic chip to leading semiconductor companies including X-Fab, Analog Devices, IBM, Freescale Semiconductor, Inc., National Semiconductor Corporation, NEC Corporation, Oki Electric Industry Co., Samsung Electronics Co. Ltd., Sanyo Electric Co., Ltd., or Sanyo, Seiko Epson Corporation, Shanghai Grace Semiconductor Manufacturing Corporation, or Grace, Shanghai Huahong NEC Electronics Co., Ltd., Taiwan Semiconductor Manufacturing Co., Ltd., or TSMC, Toshiba Corporation, Vanguard International Semiconductor Corporation, Powerchip Semiconductor Corporation and Winbond Electronics Corporation.

We have installed our semiconductor manufacturing processes at several leading wafer foundries and semiconductor manufacturers including Advanced Wireless Semiconductor, Grace, Samsung Electronics Co., Ltd., Sanyo, Seiko Epson Corporation, Shanghai Hua Hong NEC Electronics Co. Ltd., TSMC and Yasu Semiconductor Corporation, or Yasu. These companies produce semiconductor wafers for us that contain our intellectual property and technology. These wafers are electrically tested and then subdivided into many small rectangular chips, or die. We work with leading semiconductor assembly and test companies to finish our products by encapsulating them in a package and testing them. We are working with Grace, Powerchip Semiconductor Corporation and TSMC, among others, to develop new technology for manufacturing our products.

The semiconductor industry has historically been cyclical, characterized by periodic changes in business conditions caused by product supply and demand imbalance. When the industry experiences downturns, they often occur in connection with, or in anticipation of, maturing product cycles and declines in general economic conditions. These downturns are characterized by weak product demand, excessive inventory and accelerated decline of selling prices. We experienced a decrease in the average selling price, or ASP, of our products as a result of the industry-wide oversupply and excessive inventory in the market in the second half of 2004 and the first half of 2005. We saw strengthening of market demand in the second half of 2005 and pricing remained relatively stable in 2006 and 2007. Our business could be further harmed by industry-wide prolonged downturns in the future.

The consumer electronics manufacturing industry is concentrated in Asia. We manufacture virtually all of our products in Asia and we sell most of our products in Asia. We derived 87.6%, 87.7% and 88.8% of our net product revenues during 2005, 2006 and 2007, respectively, from product shipments to Asia.

Industry Background

Semiconductor integrated circuits are critical components used in an increasingly wide variety of applications, such as computers and computer systems, communications equipment, consumer products and industrial automation and control systems. As integrated circuit performance has improved and physical size and costs have decreased, the use of semiconductors in many applications has grown significantly.

Historically, the demand for semiconductors has been driven by the PC market. In recent years, growth in demand for semiconductors relating to PCs has been outpaced by growth in demand for semiconductors that are used in digital electronic devices for communication and consumer applications. Communications applications include digital subscriber line modems, cable modems, networking equipment, wireless local area network, or WLAN, devices, cellular phones and Global Positioning Systems, or GPS. Consumer-oriented digital electronic devices include digital cameras, DVD players, MP3 players, personal data assistants, or PDAs, set-top boxes, Digital TVs and video games.

In order to function correctly, PCs and other digital electronic devices require program code. The program code defines how devices function and affects how they are configured. Nonvolatile memory devices were originally used by the personal computer, or PC, industry to provide the BIOS (basic input/output system) to give the PC sufficient information to start up (boot) and to facilitate its access to its high volume nonvolatile memory stored in magnetic media including hard disk drives. In PCs, the code stored in the nonvolatile memory or BIOS, initiates the loading of the PC's operating system, which is then read from the disk drive. In the case of other digital electronic devices, the program code is stored in its entirety in nonvolatile memory, generally flash memory. As a result, virtually every digital electronic system that uses a processor or controller for computing, consumer electronics, communications, and industrial applications requires nonvolatile memory. The predominant forms of nonvolatile memory include Read-Only Memory (ROM), Programmable Read-Only Memory (PROM) and flash memory.

System manufacturers generally prefer nonvolatile memory devices that can be reprogrammed efficiently in the system in order to achieve several important advantages. With reprogrammable memory, manufacturers can cost effectively change program codes in response to faster product cycles and changing market specifications. This in turn greatly simplifies inventory management and manufacturing processes. Reprogrammable memory also allows the manufacturer to reconfigure or update a system either locally or through a network connection. In addition, in-system reprogrammable devices can be used for data storage functions, such as storage of phone numbers for speed dialing in a cellular phone or captured images in a digital camera. Flash memory provides these features better than other forms of nonvolatile memory.

Flash memory is the predominant reprogrammable nonvolatile memory device used to store program code and data. Flash memory can electrically erase select blocks of data on the device much faster and more simply than with alternative solutions, such as Erasable Programmable Read-Only Memory, or EPROM. Moreover, flash memory is significantly less expensive than other re-programmable solutions, such as Electrically Erasable Programmable Read-Only Memory, or EEPROMs. There are two types of flash memories; NOR and NAND, in terms of memory cell array architecture. NOR flash memories are typically used for storing program code and NAND flash memories are typically used for data storage. The rapid growth of flash memory has been fueled by the explosive growth of digital electronic devices that adopted flash memory as the main storage medium for code and data. According to a November 2007 Webfeet Research report, worldwide flash memory revenue was estimated at $25.7 billion in 2007 and is expected to grow to $30.1 billion in 2008 and to $52.7 billion in 2012.

Our Solution

We are a leading supplier of NOR flash memory semiconductor devices. We believe our proprietary flash memory technology, SuperFlash, offers superior performance, high reliability and a fast, fixed erase time. We further believe that our SuperFlash technology can be scaled to use the semiconductor industry's most advanced technology nodes and can employ the industry's lowest cost manufacturing processes.

Our NOR flash devices have densities ranging from 256,000 bits (256 Kb) to 64 million bits (64 Mb). These products are generally used to store the instruction set used by the microprocessor or controller in the electronic system product to direct its function. NOR memory can also be used to store mass data in a system, but it is generally less expensive to use NAND memory for this purpose. While NOR memory can be used to store data, NAND memory is generally not useful for the storage of execute-in-place instruction code due to its block data access and existence of defective memory cells that require special error detection and correction management. As a result, electronic systems often use NOR alone or NOR (with RAM, or controller) and NAND together but virtually never NAND memory alone.

Our Strategy

Our objective is to become the leading worldwide supplier of NOR flash memory devices, a leading supplier of other semiconductor products in the portable consumer electronics market and the leading licensor of embedded flash technology. We intend to achieve our objectives by:

Maintaining a leading position in the program code storage market. We believe that program code storage is an attractive segment of the flash memory market. The number, variety and performance of digital electronic applications continue to increase. Virtually all of these devices need some sort of nonvolatile memory to direct the function of the product's microprocessor or controller. We believe that our proprietary SuperFlash technology is superior because it offers higher reliability and better performance at a lower cost than competing solutions. We regularly introduce additional standard and application specific memory products, including our ComboMemory products. ComboMemory products are used for wireless and portable applications that combine volatile and nonvolatile memory on a single monolithic device or on multiple die in a common package for optimized performance. We are extending our family of serial flash products which offer smaller form factors for manufacturers that are producing ever smaller and more compact consumer devices. In addition, we are continuing to develop versions of our products that consume less power. These lower voltage devices are particularly desirable when applied in battery-powered electronic systems.

Continuing to enhance our leading flash memory technology. We believe that our proprietary SuperFlash technology is less complicated, more reliable, more scalable and more cost-effective than competing NOR flash memory technologies. Our ongoing research and development efforts are focused on enhancing our leading flash memory technology by working closely with technology partners who operate wafer fabrication facilities with advanced lithographic and other manufacturing equipment. As consumer electronics companies produce more complex and more compact products, we intend to meet their needs and continue to produce some of the smallest and thinnest semiconductor products. We are also developing and reducing the cost of the associated assembly technologies.

Leveraging our technology and supply chain to become a premier provider of additional semiconductor products. Many consumer electronics products incorporate our flash memory products. We are expanding our product line to include additional devices that these manufacturers need for their products. We provide RF power amplifier and transceiver products for wireless applications such as cellular phones, WLAN, Bluetooth, data pagers and cordless telephones. We also provide NAND flash controllers that we believe give electronics systems manufacturers superior flexibility in the design and manufacture of their systems. Many digital electronic devices currently being introduced, such as MP3 players, digital cameras and PDAs, require high-density NAND flash memory for storing music, pictures and other data that require large data storage capacities in addition to the NOR memory required to operate the system's controller. We believe that the application market for high-density NAND flash memory is attractive based on its potential size and growth. We are further developing our NAND controllers with embedded NOR flash to address the high-density memory market.

We also offer a selection of our products in die form. This allows our customers to develop multi-chip module products for unusual or small form factor products such as Bluetooth earsets and GPS receivers. We also provide multi-chip module products that incorporate die from other semiconductor manufacturers. We intend to continue to develop new products and leverage our supply chain to take advantage of the significant growth opportunities in the wireless applications market with specific focus on cellular phone, GPS, WLAN and Bluetooth applications.

Maintaining a leading position in licensing embedded flash technology. We believe that our proprietary SuperFlash technology is well-suited for embedded memory applications, which integrate flash memory and other functions onto a monolithic chip. Many electronic system manufacturers have incorporated our technology into the semiconductor devices that are at the heart of their products. We are expanding our licensing of SuperFlash technology to additional semiconductor wafer foundries at ever finer technology nodes for embedded flash applications to enhance the value of our technology to these electronic system manufacturers.

Our Products

Currently, we offer low to medium density NOR flash devices (256 Kbit to 64 Mbit) and other products that target a broad range of existing and emerging applications in the digital consumer, networking, wireless communications and Internet computing markets. Our products are segmented largely based upon attributes such as density, voltage, access speed, package and target application. We divide our products into two reportable segments: Memory Products and Non-Memory Products.

Our Memory Product segment, which is comprised of NOR flash memory products, includes the Multi-Purpose Flash, or MPF, family, the Multi-Purpose Flash Plus, or MPF+ family, the Concurrent SuperFlash, or CSF family, the Firmware Hub, or FWH family, the Serial Flash family, the ComboMemory family, the Many-Time Programmable, or MTP family, and the Small Sector Flash, or SSF family.

Our Non-Memory Products segment includes other semiconductor products including flash microcontrollers, smartcard ICs and modules, radio frequency ICs and modules, NAND controllers and NAND-controller based modules.

Technology Licensing

We license our SuperFlash technology to semiconductor manufacturers for use in embedded flash applications. We intend to increase our market share by entering into additional license agreements for our SuperFlash process and memory cell technology with leading wafer foundries and semiconductor manufacturers. We expect to continue to receive licensing fees and royalties from these agreements. We design our products using our patented memory cell technology and fabricate them using our patented process technology. As of December 31, 2007, we held 237 patents in the United States relating to certain aspects of our products and processes, with expiration dates ranging from 2010 to 2027 and have filed for several more. In addition, we hold several patents in Europe, Japan, Korea, Taiwan, and China.

Customers

We provide high-performance flash memory solutions and other products to customers in four major markets: digital consumer, networking, wireless communications and Internet computing. Our customers benefit by obtaining products that we believe are highly reliable, technologically advanced and have attractive cost structures. As a result of these highly desirable benefits, we have developed relationships with many of the industry's leading companies. In digital consumer products, we provide products for consumer electronic companies including LG, Hon Hai, Micronas, Apple, Samsung, Lite-On, NEC, Funai, Sony, Orion, BenQ, Sigma Design, ALCO, Inventec, Pioneer, Nintendo, BBK, Toshiba, JVC, Mattel, Panasonic (Matsushita), Sanyo, Konka, Canon, Hisense, Creative, Daewoo, Thomson, Sharp, Reigncom, Olympus, TiVO, and Haier. In networking, we provide products for Broadcom, Atheros, Conexant, Alpha Networks, Gemtek, Gongjin, Hon Hai, Edimax, Avocent, TP-Link, ZTE, Senao, Cameo Communications, Sagem Orga, Adtran, Askey, Intel, Asustek, Global Sun, Thomson, Huawei, TCL, Comtrend, Buffalo, Tecom, Mitsumi, Arris, Cybertan, and Samsung. In wireless communications, we provide products for companies including Syscom, Samsung, Sirf, Crestfounder, USI, GN Netcom, Sagem Orga, Alps, Gemalto, ZTE, Hon Hai, Cambridge Silicon Radio, Watchdata System, Pansun Infotech, Haier, CCT, Wuhan Tienyu Information Industry, Magnificent Mile, Taiyo Yuden, Mitsumi, Ningbo Bird, Logitech, VTech,and Garmin. In Internet computing, we provide a wide array of products for companies including Asustek, Seagate, Western Digital, TPV Technology, Hon Hai, Quanta, Intel, Giga-Byte, Quanta, ECS, Inventec, Titanic, Lenovo, Matsushita, Sharp, Fujitsu-Siemens, Wistron, Mitac, Microstar, Fujitsu, Epson, Buffalo, Samsung, Brother, USI, Canon, Lite-On, NEC, IBM, and Toshiba.

Sales and Distribution

We sell a majority of our products to customers in Asia through our representatives. We distribute a majority of our products through our logistics center. We also sell and distribute our products in North America and Europe through manufacturers' representatives and distributors. Our manufacturer representative and distributor relationships are generally cancelable, with reasonable notice, by either party.

Backlog

Our product sales are made primarily using short-term cancelable purchase orders. The quantities actually purchased by the customer, as well as shipment schedules, are frequently revised to reflect changes in the customer's needs and in our supply of products. Accordingly, the dollar amount associated with our backlog of open purchase orders at any given time is not a meaningful indicator of future sales. Changes in the amount of our backlog do not necessarily reflect a corresponding change in the level of actual or potential sales.

Applications

Manufacturing

We purchase wafers and sorted die from semiconductor manufacturing foundries, have these products shipped directly to subcontractors for packaging, testing, and finishing, and then ship the final product to our customers. Virtually all of our subcontractors are located in Asia.

Wafer and Sorted Die. During 2007, our major wafer fabrication foundries were TSMC, Grace, Sanyo, HHNEC and Seiko-Epson. In 2007, wafer sort, which is the process of testing individual die on silicon wafer, was performed at King Yuan Electronics Company, Limited, or KYE, Lingsen, HHNEC, Sanyo, Seiko-Epson and TSMC. In order to obtain, on an ongoing basis, an adequate supply of wafers, we have considered and will continue to consider various possible options, including equity investments in foundries in exchange for secure production volumes, the formation of joint ventures to own and operate foundries and the licensing of our proprietary technology. We hold an equity investment in Grace Semiconductor Manufacturing Corporation, or GSMC, a Cayman Islands company. Grace is GSMC's wafer foundry subsidiary and is located in Shanghai, People's Republic of China.

Packaging, Testing and Finishing. In the assembly process, the individual dies are separated and assembled into packages. Following assembly, the packaged devices require testing and finishing to segregate conforming from nonconforming devices and to identify devices by performance levels. Currently, all devices are tested and inspected pursuant to our quality assurance program at our international subcontracted test facilities before shipment to customers. Certain facilities currently perform consolidated assembly, packaging, test and finishing operations all at the same location. During 2007, most subcontracted facilities performing the substantial majority of our operations were in Taiwan. The subcontractors with the largest amount of our activity are KYE, Lingsen, and Powertech Technology, Incorporated, or PTI. We hold equity investments in three subcontractors: Apacer Technology, Inc., or Apacer, KYE and PTI. For newly released products, the initial test and finishing activities are performed at our Sunnyvale facility.

Research and Development

We believe that our future success will depend in part on the development of next generation technologies with reduced feature size. During 2005, 2006 and 2007, we spent $48.7 million, $53.0 million and $58.7 million, respectively, on research and development. Our research efforts are focused on process development and product development. Our research strategy is to collaborate with our partners to advance our technologies. We work simultaneously with several partners on the development of multiple generations of technologies. In addition, we allocate our resources and personnel into category-specific teams to focus on new product development. From time to time we invest in, jointly develop with, license or acquire technology from other companies in the course of developing products.

Competition

The semiconductor industry is intensely competitive and has been characterized by price erosion, rapid technological change and product obsolescence. We compete with major domestic and international semiconductor companies, many of whom have substantially greater financial, technical, marketing, distribution, manufacturing and other resources than us. Our low density memory products, sales of which presently account for substantially all of our revenues, compete against products offered by Macronix, ST Microelectronics, PMC, EON, and Winbond. Our medium-density memory products compete with products offered by Spansion, Macronix, Winbond, Samsung and ST Microelectronics. If we are successful in developing our high-density products, these products will compete principally with products offered by Spansion, Intel, Samsung, and ST Microelectronics, as well as any new companies who may enter the market. In addition, competition may come from alternative technologies such as ferroelectric random access memory device, or FRAM, technology.

The competition in the existing markets for some of our other product families, such as the FlashFlex51 microcontroller product family, is extremely intense. We compete principally with major companies such as Atmel, Microchip Technology, Freescale Semiconductor, Inc, Philips and Winbond in the microcontroller market. We may, in the future, also experience direct competition from our foundry partners. We have licensed to our foundry partners the rights to fabricate certain products based on our proprietary technology and circuit design, and to sell such products worldwide, subject to royalty payments back to us. Our smartcard products compete with Masked ROM and flash or EEPROM offerings primarily from Infineon, Renesas, Samsung and STMicroelectronics. For radio frequency IC products, the competition in the existing markets is also extremely intense. Our radio frequency IC products compete primarily with Microsemi, SiGe, Richwave, and Anadigics, especially in the WLAN markets.

We compete principally on price, reliability, functionality and the ability to offer timely delivery to customers. While we believe that our low density memory products currently compete favorably on the basis of cost, reliability and functionality, it is important to note that some of our principal competitors have a significant advantage over us in terms of greater financial, technical and marketing resources. Our long-term ability to compete successfully in the evolving flash memory market will depend on factors both within and beyond our control, including access to advanced process technologies at competitive prices, successful and timely product development, wafer supply, product pricing, actions of our competitors and general economic conditions.

Employees

As of December 31, 2007, we employed 715 individuals on a full-time basis, 402 of whom reside in the United States. Of these 715 employees, 120 were employed in manufacturing support, 386 in engineering, 112 in sales and marketing and 97 in administration, finance and information technology. Our employees are not represented by a collective bargaining agreement, nor have we ever experienced any work stoppage related to strike activity. We believe that our relationship with our employees is good.

CEO BACKGROUND

Bing Yeh , one of our co-founders, has served as our President and Chief Executive Officer and has been a member of our board of directors since our inception in 1989. Prior to that, Mr. Yeh served as a senior research and development manager of Xicor, Inc., a nonvolatile memory semiconductor company. From 1981 to 1984, Mr. Yeh held program manager and other positions at Honeywell Inc. From 1979 to 1981, Mr. Yeh was a senior development engineer of EEPROM technology of Intel Corporation. He was a Ph.D. candidate in Applied Physics and earned an Engineer Degree in Electrical Engineering at Stanford University. Mr. Yeh holds a M.S. and a B.S. in Physics from National Taiwan University.

Yaw Wen Hu, Ph.D., joined us in July 1993 as Vice President, Technology Development. In 1997, he was given the additional responsibility of wafer manufacturing and, in August 1999, he became Vice President, Operations and Process Development. In January 2000, he was promoted to Senior Vice President, Operations and Process Development. In April 2004, he was promoted to Executive Vice President and Chief Operating Officer. Dr. Hu has been a member of our board of directors since September 1995. From 1990 to 1993, Dr. Hu served as deputy general manager of technology development of Vitelic Taiwan Corporation. From 1988 to 1990, he served as FAB engineering manager of Integrated Device Technology, Inc. From 1985 to 1988, he was the director of technology development at Vitelic Corporation. From 1978 to 1985, he worked as a senior development engineer in Intel Corporation's Technology Development Group. Dr. Hu holds a B.S. in Physics from National Taiwan University and a M.S. in Computer Engineering and a Ph.D. in Applied Physics from Stanford University.

Derek J. Best joined us in June 1997 as Vice President of Sales and Marketing. In June 2000 he was promoted to Senior Vice President, Sales & Marketing. Prior to joining SST he worked for Micromodule Systems, a manufacturer of high-density interconnect technology, as vice president marketing and sales world wide from 1992 to 1996. From 1987 to 1992 he was a co-founder and owner of Mosaic Semiconductor, a SRAM and module semiconductor company. Mr. Best holds an Electrical Engineering degree from Portsmouth University in England.

Michael S. Briner joined us as Vice President, Design Engineering in November 1997, and became Vice President, Products during 1999. He was promoted to Senior Vice President of Application Specific Product Group in February 2001. From 1993 to 1997, he served as vice president of design engineering for Micron Quantum Devices, Inc., a subsidiary of Micron Technology, Inc., chartered to develop and manufacture flash memory products. From 1986 through 1992, he served as director of design engineering for the Nonvolatile Division of Advanced Micro Devices, Inc. In this position, he was instrumental in helping AMD become a major nonvolatile memory manufacturer. Mr. Briner holds a B.S. in Electrical Engineering from the University of Cincinnati.

Chen Tsai joined us in August 1996 as Senior Manager, Yield Enhancement and became Director, Product and Test Engineering the same year. In 1999, he became Director of Worldwide Backend Operations and in 2000 he was promoted to Vice President of Worldwide Backend Operations. In October 2004, Mr. Tsai was appointed Senior Vice President of Worldwide Backend Operations. From 1992 to 1996, Mr. Tsai was Manager of Process Development at Atmel Corporation, a manufacturer of semiconductors, where he was also a staff engineer of E2PROM from 1989 to 1992. From 1988 to 1989, he was vice president of technology at Tristar Technology, Inc., a wireless systems company. From 1980 to 1988 he held various positions at Xicor, Inc. and Teledyne Semiconductor. Mr. Tsai holds a B.S. in Physics from Show Chu University and a M.S. in both Physics and Electrical Engineering from Florida Institute of Technology.

Paul S. Lui joined us as Vice President and General Manager of the Linvex Product Line in June 1999 and became Vice President, Special Product Group in June 2001. In May 2006, he was promoted to Senior Vice President, Standard and Special Product Group. From 1994 to 1999, he was the president and founder of Linvex Technology Corporation. From 1987 to 1994, he was the president and chief executive officer of Macronix, Inc. From 1981 to 1985, he served as group general manager at VLSI Technology, Inc. where he was responsible for transferring that company's technology to Korea. In addition, Mr. Lui has held senior engineering positions at the Synertek Division of Honeywell and McDonnell Douglas. Mr. Lui holds an M.S.E.E. degree from University of California, Berkeley and a B.S. degree in Electrical Engineering and Mathematics from California Polytechnic State University, San Luis Obispo.

James B. Boyd joined us as Chief Financial Officer and Senior Vice President, Finance in June 2007. Before joining SST, Mr. Boyd spent seven years as chief financial officer for ESS Technology, a manufacturer of DVD and image sensor chips, where he was responsible for all financial and legal functions. Prior to that, he was chief financial officer for Gatefield Corp., a manufacturer of nonvolatile reprogrammable FPGAs. Mr. Boyd has also held finance positions at companies ranging in size from Fortune 100 firms to start-ups. Mr. Boyd holds a Bachelor of Science degree and master's degree in business from the University of Wisconsin and a law degree from Golden Gate University School of Law.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We are a leading supplier of NOR flash memory semiconductor devices for the digital consumer, networking, wireless communications and Internet computing markets. NOR flash memory is a form of nonvolatile memory that allows electronic systems to retain information when the system is turned off. NOR flash memory is now used in hundreds of millions of consumer electronics and computing products annually.

We produce and sell many products based on our SuperFlash design and manufacturing process technology. Our products are incorporated into products sold by many well-known companies including Apple, Asustek, Cambridge Silicon Radio, Canon, Compal, Dell, Epson, First International Computer, or FIC, Foxconn, or Honhai, Fujitsu, Funai, Garmin, Gigabyte, GN Netcom, Haier, Hewlett Packard, Huawei, Infineon, Intel, IBM, Inventec, JVC, Lenovo, Lexmark, LG Electronics, Lite-On IT, Matsushita, or Panasonic, Micronas, Motorola, NEC, Nintendo, Philips, Pioneer, Quanta, Sagem, Samsung, Sanyo, Seagate, Sony, Sony Ericsson, TCL, Thomson, TiVO, Toshiba, USI, Western Digital, and ZTE.

We also produce and sell other semiconductor products including flash microcontrollers, smartcard ICs and modules, RF ICs and modules, NAND controllers and NAND-controller based memory modules.

One of our key initiatives is the further development of our non-memory business. Our objective is to transform SST from a pure play in flash memory to become a multi-product line semiconductor company and a leading licensor of embedded flash technology. We continue to execute on our plan to derive a significant portion of our revenue from non-memory products, including embedded controllers, NAND-controller based modules, smartcard ICs and radio frequency ICs and modules. We believe non-memory products represent an area in which we have significant competitive advantages and also an area that can yield, in the long run, profitable revenue with higher ASPs and more stable gross margins than our memory products.

2007 in Review

We are focusing our attention on executing a growth strategy that we began more than three years ago. With the recognition that our core memory business will continue to experience average selling price pressure that would limit our revenue growth potential, we began in late 2004 investing in products and technologies that are expected to yield average selling prices, or ASPs, that are expected to be substantially higher than our current products. While our memory business continues to be healthy, we believe that a strategy of diversification will allow for better growth opportunities and higher return for our shareholders. We have invested internally and externally on new technologies designed to enhance our competitive position. These new products include the following:

•
NANDrive, a high-performance, small form-factor solid state drive. NANDrive contains an integrated ATA Controller and NAND Flash die in a multichip package and is used as a basic building block of storage for a wide variety of applications. It is currently available in multiple densities up to 4GB with higher density 8GB, 16GB and 32GB in development. To date, we have more than 20 design wins for this product family and we expect to see its revenue gradually ramp up in the later part of 2008.

•
All-In-OneMemory. This is a memory subsystem that blends key benefits of NOR, NAND, and RAM in a unified architecture which offers very high-density execute-in-place code storage and is designed to satisfy the growing data storage needs of embedded applications. Our first commercial samples of this product are expected to be available in June 2008, with the first product in this family expected to be released to production in the third quarter of 2008.

•
FlashMate. A technology, jointly developed with InSyde Software that combines our expertise in NAND flash controllers and memory subsystem design with Insyde Software's expertise in PC BIOS, system software and power management to create a complete application subsystem. With more than 100 million notebooks sold each year worldwide, the revenue potential for this product is favorable given that the average selling price is likely to be significantly higher than any of our current products. We expect to tape out the FlashMate design in mid-2008 and to have the first series of product samples available in the second half of 2008.

•
MelodyWing, a wireless audio solution. This product offers uncompressed, wire-equivalent sound quality for use in both home theater surround sound and multi-room audio broadcasting applications and allows significantly enhanced sound quality over other wireless audio products on the market.

As the design-in cycle with major accounts for all of these products is at least 12 months, we expect to see revenue from NANDrive and MelodyWing in the second half of 2008 and with FlashMate and All-in-OneMemory beginning to contribute revenue in 2009. We will continue to introduce new, value-added products throughout the course of 2008.

Our core memory business remains robust. For the past 10 years, an increasing number of electronic products have been designed around microprocessors and microcontrollers and virtually all of these products incorporate some low density NOR flash memory for code storage. In some cases, the code size for each product is also increasing as consumers demand more features and functionality. Further, as the definition of low-density continues to expand into 16, 32 and 64 mbit densities, the addressable market for our products grows steadily. We believe this creates an opportunity for us and gives strong evidence that our core business will benefit from a growing market. We are continually driving towards these increasing densities and smaller geometries through the advantages of our SuperFlash technology. Currently, the range for low density NOR is between 512 kilobits up to sixteen megabits of memory. We address this market with feature-rich, cost-effective products which allow us to support a very broad range of applications. For applications requiring smaller memory, we offer embedded SuperFlash technology through licensing agreements.

In our application categories, for 2007 as compared to 2006, revenue from wireless communications increased by 10.2% while revenue from of our digital consumer applications declined by 19.1%, Internet computing applications declined by 27.5% and networking applications increased by 27.0%.

Outlook

We expect to see a substantial decline in the first quarter of 2008 in our higher margin business as a result of seasonal weakness and the uncertainty in the U.S. and world economies. Further, our decision to focus on high-margin business opportunities as a result of our capacity shortage in 2007 expectedly resulted in the loss of market share in some of our high-volume, commodity customers which we expect to affect our revenue over the next several quarters.

To alleviate some of the manufacturing capacity constraints we experienced in 2007, we have been working with several foundries to bring up additional capacity at the 180 and 250 nanometer technology nodes. As we enter 2008, we expect the normal seasonality in the first half to bring our capacity back in line with demand. Currently, we have started a 120-nanometer pilot production at both Grace and PowerChip. By gradually converting our products from 180 nanometer to 120 nanometer, we expect our unit output from Grace to increase by the fourth quarter of 2008.

Concentrations

We derived 87.6%, 87.7% and 88.8% of our net product revenues during 2005, 2006 and 2007, respectively, from product shipments to Asia. In addition, substantially all of our wafer suppliers and packaging and testing subcontractors are located in Asia.

Shipments to our top ten end customers, which exclude transactions through stocking representatives and distributors, accounted for 27.2%, 20.1% and 17.8% of our net product revenues in 2005, 2006 and 2007, respectively.

No single end customer, which we define as original equipment manufacturers, or OEMs, original design manufacturers, or ODMs, contract electronic manufacturers, or CEMs, or end users, represented 10.0% or more of our net product revenues during 2005, 2006 and 2007.

We ship products to, and have accounts receivable from, OEMs, ODMs, CEMs, stocking representatives, distributors, and our logistics center. Our stocking representatives, distributors and logistics center reship our products to our end customers, including OEMs, ODMs, CEMs and end users. Shipments, by us or our logistic center, to our top three stocking representatives for reshipment accounted for 40.3%, 48.5% and 60.3% of our product shipments in 2005, 2006 and 2007, respectively.

In addition, the same three stocking representatives solicited sales, for which they received a commission, for 18.3%, 10.3% and 9.1% of our product shipments to end users in 2005, 2006 and 2007, respectively.

We out-source our end customer service logistics in Asia to Silicon Professional Technology Ltd., or SPT, which supports our customers in Taiwan, China and other Southeast Asia countries. SPT provides forecasting, planning, warehousing, delivery, billing, collection and other logistic functions for us in these regions. SPT is a wholly-owned subsidiary of one of our stocking representatives in Taiwan, Professional Computer Technology Limited, or PCT. Please see a description of our relationship with PCT under "Related Party Transactions." Products shipped to SPT are accounted for as our inventory held at our logistics center, and revenue is recognized when the products have been delivered and are considered as a sale to our end customers by SPT. For the years ended December 31, 2005, 2006 and 2007, SPT serviced end customer sales accounting for 58.5%, 59.1% and 60.1% of our net product revenues recognized. As of December 31, 2005, 2006 and 2007, SPT represented 69.6%, 68.9% and 65.3% of our net accounts receivable, respectively.

Our product sales are made primarily using short-term cancelable purchase orders. The quantities actually purchased by the customer, as well as shipment schedules, are frequently revised to reflect changes in the customer's needs and in our supply of products. Accordingly, our backlog of open purchase orders at any given time is not a meaningful indicator of future sales. Changes in the amount of our backlog do not necessarily reflect a corresponding change in the level of actual or potential sales.

Results of Operations

Memory Products

Memory revenue decreased in 2007 from 2006 primarily due to supply constraints due to wafer shortages from our foundry sources. These shortages led to orders that could not be fulfilled and forced us to be more selective in order acceptance. As a result, certain revenue opportunities were lost due to our inability to produce an adequate supply of products. While overall unit shipments increased 3.4% for 2007, average selling prices declined 8.8% due to continuing competitive pricing pressures in low density markets.

Memory revenue increased 5.6% for 2006 from 2005 primarily due to a 3.7% increase in unit shipments. Increased demand for wireless communication products and networking applications led to the results. Average selling prices also increased 1.6%.

Non-Memory Products

Non-memory revenue decreased substantially for 2007 from 2006. Supply constraints, a 15.0% decrease in units shipped and a 27.8% decrease in average selling prices all led to the steep decline. The decline was led by NAND controller shipments which declined 77.5% for 2007. We expect non-memory revenue to be relatively flat until we begin volume shipment of recently introduced products in the second half of 2008. Decreases of average selling prices in non-memory products in 2007 were mainly due to pricing pressures on smartcard ICs.

Non-memory revenue increased 4.7% for 2006 from 2005 primarily due to a 30.8% increase in unit shipments. The increase in unit shipments was somewhat offset by a 24.5% decrease in average selling prices due to product mix and price erosion, primarily on smartcard ICs.

Technology Licensing Revenue

Technology license revenue includes primarily a combination of up-front fees and royalties. Technology licensing revenue for 2007 increased 7.5% over 2006 primarily due to increased royalties from our licensees. Although there will be some fluctuations in royalty revenue on a quarterly basis, we expect technology license revenue to grow in 2008. Technology licensing revenue remained relatively flat for 2006 from 2005 as a result of lower upfront fees as well as some upward fluctuation in royalties.

Product Gross Profit

Memory products

Gross profit for memory products in 2007 rose $8.6 million in comparison to 2006. While supply constraints caused a loss of revenue, it also forced us to review existing business carefully and allowed us to pursue the most profitable opportunities. As a result, we concentrated on sales of higher margin products with just a 3.4% increase in units shipped over 2006. Overall memory gross margins also rose 3.5% as a result of shipping more profitable products despite a 8.8% decrease in average selling prices.

Gross profit for memory products increased $37.9 million for 2006 compared to 2005 largely due to a 3.7% increase in the number of units shipped, the continued transition to smaller geometries and lower write downs of inventory in 2006 as compared to 2005.

Non-memory products

Gross profit for non-memory products declined nearly 56.0% for 2007. NAND controller shipments declined by 9.5 million units leading to the majority decline in gross profit. Additionally, supply constraints led to a overall 15.0% decrease in unit shipments coupled with continuing pricing pressures on smartcards contributed to a 27.8% decrease in average selling prices as well as a 6.8% decrease in our overall non-memory gross margins.

Gross profit for non-memory products increased $2.2 million in 2006 compared to 2005 as total unit shipments increased 30.8%, led by our RF IC products. This was partially offset by a 24.5% decline in average selling prices which was largely a result of changes in product mix. We expect some revenue fluctuation in non-memory business as we expect to grow and diversify our revenue and customer base.

For other factors that could affect our gross profit, please also see Item 1A. "Risk Factors—We incurred significant inventory valuation and adverse purchase commitment adjustments in 2005, 2006 and 2007 and we may incur additional significant inventory valuation adjustments in the future."

Research and development expenses include costs associated with the development of new products, enhancements to existing products, quality assurance activities and occupancy costs. These costs consist primarily of employee salaries, stock-based compensation expense and other benefit-related costs and the cost of materials such as wafers and masks.

For 2007 in comparison to 2006, research and development spending increased due to higher depreciation expense of $626,000, increased salaries and wages of $1.3 million, additional software license fees of $617,000 and accruals for bonus programs of $999,000. Increased research and developments expenses were generally due to the ramp up of next generation products we expect to produce in the second half of 2008. We expect that research and development expenses will fluctuate based on the timing of engineering projects for new product introductions and the development of new technologies to support future growth.

For 2006 compared to 2005, research and development spending increased due to stock-based compensation expense of $3.8 million as a result of the implementation of SFAS No. 123(R). Accruals in profit sharing of $540,000 from increased operational profitability in 2006 also contributed to the increase.

Sales and marketing

For 2007 sales and marketing expenses rose slightly over 2006 due to increases in salaries and wages of $1.4 million and accruals for bonus programs of $231,000. Partially offsetting these expenses were lower commission expenses of $781,000 and lower logistic fees of $339,000 due to the decline in revenue from 2006. We expect that future sales and marketing expenses may increase in absolute dollars. In addition, fluctuations in revenues will cause fluctuations in sales and marketing expenses due to our commission expenses.

Sales and marketing expense increased in 2006 compared to 2005 due to stock-based compensation expense of $1.2 million. These expenses were partially offset by lower commission related expenses of $411,000.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Overview

We are a leading supplier of NOR flash memory semiconductor devices for the digital consumer, networking, wireless communications and Internet computing markets. NOR flash memory is a form of nonvolatile memory that allows electronic systems to retain information when the system is turned off. NOR flash memory is now used in hundreds of millions of consumer electronics and computing products annually.

We produce and sell many products based on our SuperFlash design and manufacturing process technology. Our products are incorporated into products sold by many well-known companies including Apple, Asustek, Cambridge Silicon Radio, Canon, Compal, Dell, Epson, First International Computer, or FIC, Foxconn, or Honhai, Fujitsu, Funai, Garmin, Gigabyte, GN Netcom, Haier, Hewlett Packard, Huawei, Infineon, Intel, IBM, Inventec, JVC, Lenovo, Lexmark, LG Electronics, Lite-On IT, Matsushita, or Panasonic, Micronas, Motorola, NEC, Nintendo, Philips, Pioneer, Quanta, Sagem, Samsung, Sanyo, Seagate, Sony, Sony Ericsson, TCL, Thomson, TiVO, Toshiba, USI, Western Digital, and ZTE.

We also produce and sell other semiconductor products including flash microcontrollers, smartcard ICs and modules, radio frequency, or RF, ICs and modules, NAND controllers and NAND-controller based modules.

One of our key initiatives is the active development of our non-memory business. Our objective is to transform SST from a pure play in flash memory to a multi-product line semiconductor company and a leading licensor of embedded flash technology. We continue to execute on our plan to derive, by mid-2008, a significant portion of our revenue from non-memory products, which includes embedded controllers, NAND-controller based modules, smartcard ICs and radio frequency ICs and modules. We believe non-memory products represent an area in which we have significant competitive advantages and also an area that can yield profitable revenue with higher and more stable gross margins than our memory products in the long run.

Sequentially from the prior quarter, revenue from networking applications increased by 19% while revenue from our digital consumer applications increased by 21%, Internet computing applications decreased by 10% and wireless communications increased by 7%. Compared with the same quarter a year ago, wireless communications revenue increased by 14%, networking applications revenue increased 23%, Internet computing revenues declined by 31% and digital consumer revenue declined by 15%.

During the first nine months of 2007, we continued to make product announcements that we initially began in October 2006. We recently announced jointly with Insyde Software our new Flashmate technology. This is our third NAND-controller based product line after the Nandrive and All-in-OneMemory product lines that were announced within the past twelve months. Flashmate is a PC subsystem platform with fully integrated firmware and software to provide alternative hybrid-drive functionality and enable new mobile computing usage model to notebook computers. Flashmate technology provides additional flexibility beyond that of a hybrid-drive by giving users the ability to instantly access the content on the hard disk drive without having to power-on the notebook. Recent demonstrations have generated interest from major notebook manufacturers and we expect to tapeout the design in mid-2008 and to have the first series of products available in the second half of 2008.

The NANDrive and All-in-OneMemory products that we announced earlier this year continue to pick up momentum in design-in activities with the availability of more samples. We are currently working on many opportunities to design in our NAND module products.

During the third quarter ended September 30, 2007, we expanded our NAND controller offerings with two new products, the ATA Flash Disk Controller and the CompactFlash Card Controller. Featuring an advanced error correction code engine, these high-performance controllers are positioned for managing current and future high-density NAND flash requirements. We also announced in September a new addition to our SuperFlash-based FlashFlex family of 8-bit, 8051-compatible microcontrollers. This new device is the smallest 8051-based microcontroller currently on the market. As the sophistication of mobile devices increases, size reduction and low power consumption become even larger issues for product design teams, making this product ideal for small form factor mobile applications, such as notebook PCs, MP3 players and GPS systems, as well as home entertainment devices including HDMI products.

In the area of memory technologies, we are continuing to reduce manufacturing costs through the transition to smaller process technologies that generally carry a lower cost per die. Wafer starts are primarily now in the 0.18 and 0.25 micron geometry. We are also in the process of developing 0.13 micron and 0.12 micron process technologies.

The semiconductor industry has historically been cyclical, characterized by periodic changes in business conditions caused by product supply and demand imbalance. When the industry experiences downturns, they often occur in connection with, or in anticipation of, maturing product cycles and declines in general economic conditions. These downturns are characterized by weak product demand, excessive inventory and accelerated decline of selling prices.

The first nine months of 2007 saw our share of challenges:

•
In March 2007 we announced a voluntary review of our historical stock option grant practices covering the time from our initial public offering in 1995 through 2007. The Chairman of the Audit Committee of the Board of Directors completed his review with the assistance of independent outside legal counsel. The results of this review required us to restate our consolidated financial statements for prior periods. We incurred material expenses in relation to this review of $2.3 million and $6.3 million for the three and nine months ended September 30, 2007, respectively. For further information, please see Note 2. "Restatement of Financial Statements" to our condensed consolidated financial statements in this Quarterly Report on Form 10-Q and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Form 10-K for the year ended December 31, 2006.

•
We continue to monitor changes in the competitive landscape for NOR flash memory. As we noted in prior quarters, at least one major player is becoming very active in gaining market
share at densities of 16MB and above. We expect that this intensified competition could cause aggressive pricing by our competitors, negatively impacting the higher density portion of our core business. While we continue to believe that the demand will remain strong in the low density NOR business, we expect the pricing environment could become more volatile.

•
Our wafer capacity at one of our major foundries, Grace Semiconductor, reached its limit in 2007. We have been working with several foundries to bring up additional capacity at 180 and 250 nanometer. However, due to manufacturing cycle-time, we do not expect this additional output to meet demand until the first quarter of 2008. The supply situation to is expected to be substantially improved next year, as we plan to start 120-nanometer pilot production in early 2008. By gradually converting a significant portion of our products from 180 nanometer to 120 nanometer, we expect our unit output from Grace Semiconductor to increase by at least 25% by the end of 2008.

With these factors in mind, we made a decision to focus on our most profitable revenue opportunities while still maintaining a broad presence in the market place of our product lines. This plan will allow us to best utilize our resources and manufacturing capacity. This has resulted in the reduction of our revenue plans for 2007 but it allowed us to maintain our gross margin and limit our cash usage.

Our product sales are made primarily using short-term cancelable purchase orders. The quantities actually purchased by the customer, as well as shipment schedules, are frequently revised to reflect changes in the customer's needs and in our supply of product. Accordingly, our backlog of open purchase orders at any given time is not a meaningful indicator of future sales. Changes in the amount of our backlog do not necessarily reflect a corresponding change in the level of actual or potential sales.

We derived 87.6%, 87.7% and 89.0% of our net product revenues during 2005, 2006 and the nine months ended September 30, 2007, respectively, from product shipments to Asia. Additionally, substantially all of our wafer suppliers and packaging and testing subcontractors are located in Asia.

Our top ten end customers, excluding stocking representatives and distributors, accounted for 27.2%, 20.1% and 18.9% of our net product revenues in 2005, 2006 and the nine months ended September 30, 2007, respectively.

No single end customer, which we define as original equipment manufacturers, or OEMs, original design manufacturers, or ODMs, contract electronic manufacturers, or CEMs, or end users, represented 10.0% or more of our net product revenues during 2005, 2006 or the nine months ended September 30, 2007.

We ship products to, and have accounts receivable from, OEMs, ODMs, CEMs, stocking representatives, distributors, and our logistics center. Our stocking representatives, distributors and logistics center reship our products to our end customers, including OEMs, ODMs, CEMs and end users. Shipments, by us or our logistic center, to our top three stocking representatives for reshipment accounted for 40.3%, 48.5% and 49.5% of our product shipments in 2005, 2006 and the nine months ended September 30, 2007, respectively. In addition, the same three stocking representatives solicited sales, for which they received a commission, for 18.3%, 10.3% and 10.2% of our product shipments to end users in 2005, 2006 and the nine months ended September 30, 2007, respectively.

We out-source our end customer service logistics in Asia to Silicon Professional Technology Ltd., or SPT, which supports our customers in Taiwan, China and other Southeast Asia countries. SPT provides forecasting, planning, warehousing, delivery, billing, collection and other logistic functions for us in these regions. SPT is a wholly-owned subsidiary of one of our stocking representatives in Taiwan, Professional Computer Technology Limited, or PCT. Please see a description of our relationship with PCT under "Related Party Transactions." Products shipped to SPT are accounted for as our inventory held at our logistics center, and revenue is recognized when the products have been delivered and are considered as a sale to our end customers by SPT. For the years ended December 31, 2005 and 2006, and the nine months ended September 30, 2007, SPT serviced end customer sales accounting for 58.5%, 59.1% and 58.6% of our net product revenues recognized. As of December 31, 2005 and 2006, and the period ended September 30, 2007, SPT represented 69.6%, 68.9% and 70.8% of our net accounts receivable, respectively.

Critical Accounting Estimates

For information related to our revenue recognition and other critical accounting estimates, please refer to the "Critical Accounting Estimates" section of Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Annual Report on Form 10-K for the year ended December 31, 2006.

We adopted the provisions of FASB Interpretation Number 48, Accounting for Uncertainty in Income Taxes , or FIN No. 48, on January 1, 2007. The cumulative effect of adopting FIN No. 48 was a $3.2 million decrease to the opening balance of retained earnings. Upon adoption, the total amount of gross unrecognized tax benefits was $22.4 million. Included in the balance were approximately $9.5 million of unrecognized tax benefits that, if recognized, would affect the effective tax rate. We are currently under audit by the Internal Revenue Service. It is possible that the amount of the liability for unrecognized tax benefits, including the unrecognized tax benefits related to the audits referenced above, may change within the next 12 months. Based on the status of the case, we expect to reduce our unrecognized tax benefits by approximately $5.0 million within the next twelve months.

In accordance with our accounting policy, we recognize accrued interest and penalties related to unrecognized tax benefits in the Provision for income taxes. This policy did not change as a result of the adoption of FIN No. 48. We have accrued interest and penalties as of the date of adoption of FIN No. 48. These amounts are not material.

Results of Operations: Three and Nine months ended September 30, 2007

Memory Products

Memory revenue increased 7.2% in the third quarter of 2007 from the second quarter of 2007 primarily due to an 8.0% increase in unit shipments. Seasonal demand for several consumer electronic and computer applications led to the results. Memory revenue decreased in the third quarter of 2007 compared to the third quarter of 2006 due to a 10.7% decrease in average selling prices, partially offset by increased unit shipments of 4.7%. The decrease in average selling prices was primarily a result of product mix coupled with some price erosion from continuing competitive pricing pressures in the low density markets. For the nine months ended September 30, 2007 in comparison to the prior year, memory revenue decreased due to a 10.7% decrease in average selling prices due to competitive pricing environments.

Non-Memory Products

Non-memory revenue increased in the third quarter of 2007 from the second quarter of 2007 due to a 9.4% increase in average selling prices and a 4.9% increase in unit shipments. Seasonal demand and the introduction of new products led to the increases. Non-memory revenue decreased in the third quarter of 2007 compared to the third quarter of 2006 due to a 22.5% decrease in unit shipments couple with a 7.6% decrease in average selling prices largely from product mix, as well as pricing pressures on smartcard ICs. For the nine months ended September 30, 2007, non-memory revenue decreased $23.9 million due to a 35.9% decrease in average selling prices coupled with a 8.4% decline in unit shipments.

Technology Licensing Revenue

Technology license revenue includes a combination of up-front fees and royalties. Technology licensing revenue for the third quarter of 2007 increased from the second quarter of 2007 due to timing of royalty payments and the achievement of certain milestones. Technology licensing revenue for the third quarter of 2007 increased compared to the third quarter of 2006 as a result of timing of some royalties. For the nine months ended September 30, 2007 technology license revenue increased from the nine months ended September 30, 2006 due to some fluctuation and timing in royalties. We anticipate revenues from technology licensing may fluctuate significantly in the future.

Product Gross Profit

Memory products

Gross profit for memory products increased substantially in the third quarter of 2007 compared to the second quarter of 2007 largely due to an 8.0% increase in the number of units shipped although average selling prices were flat. Compared to the third quarter of 2006, gross profit increased by 28.1% due to a 4.7% increase in unit shipments partially offset by a 10.7% decrease in average selling prices. For the nine months ended September 30, 2007 in comparison to the prior year, memory product gross profit increased $2.9 million based on a 7.2% increase in unit shipments coupled with a 10.7% decrease in average selling prices from product mix.

Non-memory products

Gross profit for non-memory products increased in the third quarter of 2007 compared to the second quarter of 2007 as total unit shipments increased by 4.9% and average selling prices increased 9.4%. In comparison to the third quarter of 2006, unit shipments decreased 22.5% as well as average selling prices declined 7.6%, led by product mix and smartcard ICs pricing pressures. For the nine months ended September 30, 2007, non-memory product gross profit declined $8.8 million as average selling prices declined 35.9% coupled with a 8.4% decrease in unit shipments. We expect some revenue fluctuation in non-memory business until at least mid 2008 as we expect to grow and diversify our revenue and customer base.

For other factors that could affect our gross profit, please also see Item 1A. "Risk Factors—We incurred significant inventory valuation and adverse purchase commitment adjustments in 2004, 2005 and 2006 and we may incur additional significant inventory valuation adjustments in the future."

Operating Expenses (in thousands)

Research and development expenses include costs associated with the development of new products, enhancements to existing products, quality assurance activities and occupancy costs. These costs consist primarily of employee salaries, stock-based compensation expense and other benefit-related costs and the cost of materials such as wafers and masks.

In comparison to the second quarter of 2007, research and development spending increased primarily due to increased wafers and evaluation parts of $519,000 and $209,000 respectively, offset partially by decreased mask and reticle costs of $345,000. Also increased profit sharing accruals of $241,000 and patent expenses of $206,000 led to the changes. For the three months ended September 30, 2007 in comparison to the same quarter in 2006, research and development spending increased due to higher salaries and employee-related benefit costs of $801,000, increased wafer expense of $426,000, masks and reticles of $360,000, higher software license fees and expensed software of $302,000, depreciation expense increase of $208,000 and increase patent fees of $322,000.

For the nine months ended September 30, 2007 in comparison to the nine months ended September 30, 2006, research and development spending increased due to payroll tax expense related to stock-based compensation expenses of $638,000, increased salaries and wages of $573,000, additional software license fees of $512,000, increased patent expenses of $355,000 and accruals for the executive bonus program of $325,000. We expect that research and development expenses will fluctuate based on the timing of engineering projects for new product introductions and the development of new technologies to support future growth.

Sales and marketing expenses consist primarily of commissions, employee salaries, stock-based compensation expense and other benefit-related costs, as well as travel and entertainment expenses.

Sales and marketing expense decreased in the third quarter of 2007 compared to the second quarter of 2007 due to lower commission expense of $277,000, partially offset by increased salaries and wages of $131,000, and logistic fees of $84,000. In comparison to the third quarter in 2006, sales and marketing expenses increased due to higher salaries and wage related expenses of $422,000, greater accruals for bonus programs of $183,000, offset by lower commission related expenses of $227,000.

For the nine months ended September 30, 2007, sales and marketing expenses declined due to lower commission expenses of $960,000 and lower logistic fees of $301,000, offset by increases in salaries and wages of $649,000. We expect that future sales and marketing expenses may increase in absolute dollars. In addition, fluctuations in revenues will cause fluctuations in sales and marketing expenses due to our commission expenses

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