UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 20-F (Mark One) [_] Registration statement pursuant to Section 12(b) or 12(g) of the Securities Exchange Act of 1934 or [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2007 or [_] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 or [_] Shell company report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of event requiring this shell company report Commission file number: 0-30910 O2MICRO INTERNATIONAL LIMITED (Exact Name of Registrant as Specified in Its Charter) The Cayman Islands (Jurisdiction of Incorporation or Organization) Grand Pavilion Commercial Centre, West Bay Road P.O. Box 32331 Grand Cayman KY1-1209, Cayman Islands (Address of Principal Executive Offices) Securities registered or to be registered pursuant to Section 12(b) of the Act: Name of Each Exchange On Which Title of Each Class Registered ------------------- ----------------------------------------- American Depositary Shares Nasdaq Global Select Market Ordinary Shares, par value $0.00002 per The Stock Exchange of Hong Kong Limited share Cayman Islands Stock Exchange Securities registered or to be registered pursuant to Section 12(g) of the Act: None (Title of Class) Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None (Title of Class) Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report. As of December 31, 2007, there were 1,911,868,150 ordinary shares, par value US$0.00002 per share, outstanding. Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [_] No [X] If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes [_] No [X] Note - Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections. Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [_] Accelerated filer [X] Non-accelerated filer [_] Indicate by check mark which financial statement item the registrant has elected to follow: Item 17 [_] Item 18 [X] If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [_] No [X]

TABLE OF CONTENTS PART I Item 1. Identity of Directors, Senior Management and Advisors........................... 3 Item 2. Offer Statistics and Expected Timetable......................................... 4 Item 3. Key Information................................................................. 4 Item 4. Information on the Company...................................................... 13 Item 4A. Unresolved Staff Comments....................................................... 20 Item 5. Operating and Financial Review and Prospects.................................... 20 Item 6. Directors, Senior Management and Employees...................................... 27 Item 7. Major Shareholders and Related Party Transactions............................... 32 Item 8. Financial Information........................................................... 33 Item 9. The Offer and Listing........................................................... 33 Item 10. Additional Information.......................................................... 35 Item 11. Quantitative and Qualitative Disclosures About Market Risk...................... 42 Item 12. Description of Securities Other Than Equity Securities.......................... 43 PART II Item 13. Defaults, Dividend Arrearages and Delinquencies................................. 43 Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds.... 43 Item 15. Controls and Procedures......................................................... 43 Item 16. Reserved........................................................................ 45 Item 16A Audit Committee Financial Expert................................................ 45 Item 16B Code of Ethics.................................................................. 45 Item 16C Principal Accountant Fees and Services.......................................... 45 Item 16D Exemption from the Listing Standards for Audit Committee........................ 46 Item 16E Purchases of Equity Securities by the Issuer and Affiliated Purchasers.......... 46 PART III Item 17. Financial Statements............................................................ 47 Item 18. Financial Statements............................................................ 47 Item 19. Exhibits........................................................................ 47 Index to Consolidated Financial Statements Signatures................................................................................ 48 2

Certain Definitions and Conventions In this annual report on Form 20-F ("Annual Report"), references to "$" and "dollars" are to United States dollars. Percentages and certain amounts contained herein have been rounded for ease of presentation. Any discrepancies in any table between totals and the sums of amounts listed are due to rounding. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This Annual Report contains statements of a forward-looking nature. These statements are made under the "safe harbor" provisions of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by terminology such as "may," "will," "expects," "should," "could," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of these terms and other comparable terminology. These forward-looking statements include, without limitation, statements regarding our expectation to increase expenses for personnel, new product development, to protect our technology and to expand our product offerings, our anticipation that sales to a relatively small number of customers will continue to account for significant portion of net sales, our expectation that non-U.S. operations and sales will continue to grow and account for a substantial percentage of our net sales, our statements regarding the growing popularity of thinner displays, mobile computing and portable devices, and the emergence and continued development of the Internet and wireless communications networks, our belief that we participate in large and growing markets, our belief that potential future growth in the LCD television market, especially units with larger-size panels, represents an attractive growth opportunity for us, our belief that manufacturers are turning to innovative new semiconductor technologies to manage the available power source capacity more efficiently, our belief that there is an increasing need for higher levels of system integration, our belief in the need for mixed-signal and analog integrated circuits specifically designed to optimize the power system usage in devices, our belief in the need to use advanced design methodologies to allow manufacturers to achieve rapid time-to-market with their new products, our expectation that our markets will be dominated by a small number of major brand name companies, our expectation that we will experience the highest sales volume in the third and fourth quarter of each year, our ability to develop and introduce products in a timely manner to meet customer demands, our expectation that analog and mixed-signal circuits have substantially longer life-cycles than digital integrated circuits, our ability to take advantage of cost-efficiencies associated with the "fabless" semiconductor business model, our future gross profit, our expectation that gross margin on products we sell will typically decline over the life of the products, our expectation that gross profit as a percentage of net sales will continue to fluctuate, our expectation that research and development expenses as a percentage of net sales will continue to fluctuate, our expectation to continue development of innovative technologies and processes, and continued expansion and investment of our engineering, research and development resources, our expectation to continue to invest significant resources into research and development in the future, our expectation that selling, general and administrative expenses will continue to increase in absolute dollars,, our expectations regarding the outcome of litigation matters, our belief that cash balances will be sufficient to meet our capital requirements for at least the next 12 months, our belief that our research and development staffing will increase in the next 12 months primarily due to expansion of existing design centers, our intention to continue expanding research and development operations, our intention to expand the scope of our international operations, our expectation that semiconductor companies will increasingly be subject to infringement claims as the number of products and competitors in the semiconductor industry grows, our belief that we operate in compliance with all applicable transfer pricing laws in all of the jurisdictions in which we operate, our belief regarding our efforts to remediate concerns relating to our internal controls, our anticipation that we will not declare any dividend in the foreseeable future, our belief that our system-level expertise and extensive experience with power management systems allow us to develop proprietary solutions and foster long-term relationships with our customers, our intention to continue to evaluate additional investment opportunities in our supply chain, our belief that our current facilities are adequate for our needs for the foreseeable future, and that any additional space required will be available to us on commercially reasonable terms, our expectation that our results of operations or cash flows will not be affected to any significant degree by a sudden short-term change in market interest rates, and our statements regarding the effect of adoption of certain accounting policies. These forward-looking statements are based on our current assumptions and beliefs in light of the information currently available to us. Actual results, levels of activity, performance or achievements may differ materially from those expressed or implied in these forward-looking statements for a variety of reasons, including: changes in demand for devices that use our products; market conditions in the semiconductor industry and the economy as a whole; the stages of our products in their life cycles, variations, expansions or reductions in the mix of our product offerings, the timing of our product introductions, specific product manufacturing costs, increased competition, introduction of new competing technologies and the increase of unexpected expenses, and such other factors discussed under "Key Information--Risk Factors," "Operating and Financial Review and Prospects" and elsewhere in this Annual Report. We assume no obligation to update or revise any forward-looking information, whether as a result of new information, future events or otherwise. You are cautioned not to place undue reliance on these forward-looking statements which apply only as of the date of this Annual Report. PART I ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS Not applicable. 3

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE Not applicable. ITEM 3. KEY INFORMATION SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data for the years ended December 31, 2005, 2006 and 2007, and the selected consolidated financial data as of December 31, 2006 and 2007, set forth below, are derived from our audited consolidated financial statements included herein, and should be read in conjunction with, and are qualified in their entirety by reference to, these consolidated financial statements, including the notes to these consolidated financial statements and "Item 5. Operating and Financial Review and Prospects" included elsewhere in this Annual Report. The selected consolidated financial data for the years ended December 31, 2003 and 2004 and the selected consolidated financial data as of December 31, 2003, 2004 and 2005, set forth below, are derived from our audited consolidated financial statements and related notes which do not appear in this Annual Report. Our consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the United States of America. Year Ended December 31, ------------------------------------------------------- 2003 2004 2005 2006 2007 ---------- ---------- ---------- ---------- ---------- (in thousands, except per share data) Consolidated Statement of Income Data: Net sales........................................................ $ 88,599 $ 92,196 $ 105,552 $ 124,915 $ 165,540 Cost of sales.................................................... 38,314 37,403 40,741 56,772 71,099 ---------- ---------- ---------- ---------- ---------- Gross profit..................................................... 50,285 54,793 64,811 68,143 94,441 Operating expenses (income): Research and development...................................... 19,219 20,260 25,421 31,751 34,624 Selling, general and administrative........................... 13,522 16,348 20,279 29,209 34,712 Patent related litigation..................................... 3,954 5,334 10,174 10,962 10,848 Litigation income............................................. -- -- -- -- (9,364) Stock Exchange of Hong Kong listing expenses.................. -- -- 2,460 786 -- Total operating expenses.................................. 36,695 41,942 58,334 72,708 70,820 ---------- ---------- ---------- ---------- ---------- Income (loss) from operations.................................... 13,590 12,851 6,477 (4,565) 23,621 Non-operating income - net....................................... 1,437 2,705 2,704 2,858 2,819 ---------- ---------- ---------- ---------- ---------- Income (loss) before income tax.................................. 15,027 15,556 9,181 (1,707) 26,440 Income tax expense (benefit)..................................... 1,826 1,472 1,034 (2,450) 1,456 ---------- ---------- ---------- ---------- ---------- Net income....................................................... 13,201 14,084 8,147 743 24,984 ========== ========== ========== ========== ========== Earnings per share(1): Basic..................................................... 0.0069 0.0072 0.0042 0.0004 0.0131 Diluted................................................... 0.0066 0.0070 0.0041 0.0004 0.0129 Shares used to compute basic earnings per share(1):.............. 1,918,700 1,957,800 1,961,168 1,932,575 1,905,725 ========== ========== ========== ========== ========== Shares used to compute diluted earnings per share(1):............ 1,986,800 2,005,100 1,997,459 1,946,896 1,943,785 ========== ========== ========== ========== ========== Earnings per ADS(2): Basic..................................................... 0.34 0.36 0.21 0.02 0.66 Diluted................................................... 0.33 0.35 0.20 0.02 0.64 ADS equivalents used to compute basic earnings per ADS(2):....... 38,374 39,156 39,223 38,652 38,115 ========== ========== ========== ========== ========== ADS equivalents used to compute diluted earnings per ADS(2):..... 39,736 40,102 39,949 38,938 38,876 ========== ========== ========== ========== ========== 4

December 31, -------------------------------------------- 2003 2004 2005 2006 2007 -------- -------- -------- -------- -------- (in thousands) Consolidated Balance Sheet Data: Cash and cash equivalents.......... $ 66,489 $ 56,320 $ 46,375 $ 45,438 $ 52,597 Short-term investments............. 53,923 63,768 55,653 19,697 28,650 Working capital.................... 130,510 132,713 117,942 90,865 118,777 Total assets....................... 169,293 185,196 199,655 197,020 228,412 Long-term liabilities, excluding current portion.................. -- -- -- 455 730 Net assets......................... 154,727 170,781 175,896 173,511 204,179 Ordinary shares and additional paid-in capital.................. 137,115 139,620 138,275 140,262 144,982 (1) All share information has been adjusted retroactively to reflect the 50-for-1 share split effected on November 25, 2005. (2) Fifty ordinary shares equal one American Depositary Share ("ADS"). CAPITALIZATION AND INDEBTEDNESS Not applicable. REASONS FOR THE OFFER AND USE OF PROCEEDS Not applicable. RISK FACTORS We wish to caution readers that the following important factors, and those important factors described in other reports submitted to, or filed with, the Securities and Exchange Commission, among other factors, could affect our actual results and could cause our actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf and that such factors may adversely affect our business and financial status and therefore the value of your investment: If the markets for consumer electronics, computers, industrial or communications products do not grow substantially or even decrease, our net sales may be harmed. Our business focuses on designing, developing and marketing high performance integrated circuits for manufacturers of products for the consumer electronics, computer, industrial and communications markets. As many of the leading sellers of these products have an intermediary manufacture their products or those portions of their products containing our components, we currently derive substantially all of our product revenues from sales to these intermediaries or their suppliers. We also have targeted and are designing products for applications such as LCD monitors, LCD televisions, notebook computers, Internet security, mobile phones, GPS and portable media players, such as portable DVD players. We believe that the important factors driving growth in these markets have been the growing popularity of thinner displays, mobile computing and portable devices, and the emergence and continued development of the Internet and wireless communications networks. If demand for products using LCDs or other devices using our products declines, or does not grow as quickly as we anticipate, our customers may experience lower demand for their products that use our products, which may cause our net sales to suffer. We cannot be certain that the markets for these products will continue to grow as rapidly as they have in the past or that a significant slowdown in these markets will not occur. Fluctuations in our quarterly operating results due to factors such as changes in the demand for electronic devices that utilize our products could adversely affect the trading price of our ordinary shares and/or our ADSs. We believe that quarter-to-quarter comparisons of our financial results are not necessarily meaningful indicators of our future results of operations, and they should not be relied upon as an indication of our future performance. If our quarterly operating results fail to meet the expectations of securities analysts, the trading price of our ordinary shares and/or our ADSs could be adversely affected. Our quarterly operating results have varied substantially in the past and may vary substantially in the future depending upon a number of factors described below and elsewhere in this Risk Factors section, including many factors that are beyond our control. These factors include changes in demand for devices that use our products; market conditions in the highly cyclical semiconductor industry and the economy as a whole; the timing and cancellation of customer orders; the level of orders received that can be shipped in a quarter; the availability of third party semiconductor foundry, assembly and test capacities; fluctuations in manufacturing yields; delays in the introduction of new products; changes in the mix of sales of higher margin products and lower margin products; seasonal changes in demand during the year-end holiday season for devices that use our products; and the amount of legal and other expenses incurred in a particular quarter. For example, the level of legal 5

expenses is not entirely within our control as we may need to respond to legal actions by opposing parties or scheduling decisions by the judges. It is difficult for us to forecast our legal expenses for any given quarter, which adversely affects our ability to forecast our expected results of operations in general. In addition, the trading price of our ordinary shares and/or our ADSs may be affected by factors such as: significant price and volume fluctuations in our ordinary shares and/or our ADSs and financial markets in the U.S. and other countries, as well as relatively thin trading volume of our ordinary shares and/or our ADSs on Nasdaq and the SEHK, respectively. Further, the trading markets for our ordinary shares and/or our ADSs are affected by the research reports that securities or industry analysts publish about us or our business. We do not have control over such coverage. If one or more analysts were to downgrade our ordinary shares and/or our ADSs, the price of our ordinary shares and/or our ADSs may decline. If one or more analysts cease coverage of our company or does not regularly publish reports on us, we may lose visibility in the financial markets, which could cause the price of our ordinary shares and/or our ADSs or trading volume to decline. If orders for our products are cancelled or deferred, our net sales, operating margins and net income could be substantially reduced. Orders for our products can be cancelled or deferred with little notice from and without significant penalty to our customers. A significant portion of our net sales in any financial reporting period depends on orders booked and shipped in that period. If a large amount of orders placed is cancelled or deferred, our net sales in that period could be substantially reduced. Since we do not have significant non-cancellable backlog, we typically plan our production and inventory expenses based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. In particular, in response to anticipated lengthy lead times, which in the past have been as much as ten weeks or more, to obtain inventory and materials from our suppliers, we place orders with these suppliers in advance of anticipated customer demand, which can result in excess inventory if the expected orders fail to materialize. We also expect to increase our expenses for personnel and new product development. It is difficult for us to reduce our production, inventory, personnel and new product development expenses quickly in response to any shortfalls in net sales resulting from cancelled or deferred orders. As a result, any cancellation or deferral of orders would not only harm our net sales, it would also likely have a disproportionately adverse effect on our operating margins and net income. We depend on third parties to manufacture, assemble and test our products and, if they are unable to do so, our ability to ship products and our business and results of operations will be harmed. We do not own or operate the integrated circuit fabrication facilities that manufacture the products we design. Four foundries, X-FAB, SinoMos, SMIC and CSMC, manufactured most of the integrated circuit products that we sold in 2007. These foundries manufacture integrated circuit products for us according to purchase orders. We do not have a guaranteed level of production capacity at any of these foundries, and any one or more could raise prices without notice. Although we provide the foundries with rolling forecasts of our production requirements, the ability of each foundry to provide wafers to us is limited by the foundry's available capacity. The term "wafers" refers to slices of silicon used to manufacture integrated circuits, and it is one of the principal raw materials in our products. These foundries could choose to prioritize capacity for other customers, particularly larger customers, reduce or eliminate deliveries to us on short notice or increase the prices they charge us. Accordingly, we cannot be certain that these foundries will allocate sufficient capacity, if any, to satisfy our requirements particularly during any industry-wide capacity shortages. In addition, if any of these foundries were unable to continue manufacturing our products in the required volumes at acceptable quality, yields and costs or in a timely manner, our business and results of operations would be seriously harmed. There are other significant risks associated with our reliance on these foundries, including the disruption in our ability to ship products caused by the length of time, as much as 12-to-18 months, required for us to find alternative foundries for existing or new products; the reduction or elimination of deliveries to us by these outside foundries caused by a sudden increase in demand for semiconductor devices or a sudden reduction or elimination of manufacturing capacity by any existing manufacturers of semiconductor devices; the unavailability of, or delays in obtaining access to, key process technologies used by these foundries; and the susceptibility of our outside foundries to production interruptions resulting from natural disasters, such as the interruptions experienced in Taiwan in the past due to earthquake activity. Any of these events could cause these foundries to reduce or eliminate deliveries to us and cause disruption in our ability to ship products to our customers which could negatively affect our business and results of operations. We also rely on independent subcontractors to assemble and test most of our integrated circuit products. We do not have long-term agreements with any of these subcontractors but obtain services from them primarily on a purchase order basis. Our reliance on these subcontractors involves risks such as reduced control over delivery schedules, quality assurance and costs. These risks could result in product shortages or increase our costs of manufacturing, assembling or testing our products. If these subcontractors were unable or unwilling to continue to provide assembly and test services and deliver products at acceptable quality, yields and costs or in a timely manner, our business would be seriously harmed. We would also have to identify and qualify substitute subcontractors, which would be time consuming and costly and could result in unforeseen operational difficulties. 6

If we cannot compete effectively against new and existing competitors, our net sales and gross margins could be harmed. Our ability to compete successfully in the market for integrated circuit products depends on factors both within and outside our control, including: our success in designing and subcontracting the manufacture of new products that implement new technologies and satisfy our customers' needs; the performance of our products across a variety of parameters such as reliability and cost efficiency; the price of our products and those of our competitors; our ability to control production costs; and the features of our competitors' products. We believe our principal competitors include Intersil Corporation, Linear Technology Corporation, Maxim Integrated Products, Inc., Microsemi Corporation, Monolithic Power Systems, Inc., Ricoh Company, Ltd., Rohm Co., Ltd and Texas Instruments Incorporated. There is also competition from the internal integrated circuit design and manufacturing capabilities of some of our existing and potential customers, such as Toshiba and Fujitsu. In addition to these competitors, other integrated circuit companies may decide to enter the market with mixed-signal integrated circuit products that compete with our products or incorporate functions similar to those provided by our products. Some of our competitors, such as Texas Instruments, have greater name recognition, their own manufacturing capabilities, significantly greater financial and technical resources, and the sales, marketing and distribution strengths that are normally associated with large multinational companies. These competitors may also have pre-existing relationships with our customers or potential customers. These competitors may be able to introduce new technologies more quickly, address customer requirements more rapidly and devote greater resources to the promotion and sale of their products than we do. Further, in the event of a manufacturing capacity shortage, these competitors may be able to manufacture products themselves or obtain third-party manufacturing capability when we are unable to do so. If we do not develop and introduce new products in a timely manner, our net sales and gross margins could be harmed. Our success depends upon our ability to develop and introduce new products selected for design into products for the consumer electronics, computer, industrial and communications markets. If we are unable to develop new products in a timely manner, our net sales will suffer. In addition, because our gross margins typically decline over the life cycle of our products as a result of competitive pressures and voluntary pricing arrangements, any failure to develop new products in a timely manner will likely cause our gross margins to decline. The development of our new products is highly complex, and from time to time we have experienced delays in the introduction of new products of as much as eight-to-twelve weeks or more. Successful product development and introduction of new products depend on a number of factors, including accurate new product definition; timely completion of new product designs; achievement of manufacturing yields; timely and cost-effective production of new products; and timely delivery of new third-party supplied products used as key components in devices that incorporate our products. We often incur significant expenditures in the development of a new product without any assurance that it will be selected for design into our customers' products. If we incur such expenditures but fail to be selected, our results of operations will be adversely affected and may fluctuate significantly from period to period. Furthermore, even if our products were selected for design into our customers' products, we cannot be certain that these products will be commercially successful or that we will benefit from any associated sales. It is difficult to evaluate our future prospects, and we cannot assure you that we will not incur future losses. Our past results cannot be relied upon to predict our future performance. We incurred net losses in each year prior to the year ended December 31, 1999. We then experienced significant quarter-to-quarter sales growth in each of the years ended December 31, 2001, 2002 and 2003. However, since the first quarter ended March 31, 2004, we have experienced fluctuations in net sales compared to the previous quarter. Our net sales are subject to fluctuation from quarter to quarter, our previous overall growth may not continue, and we may not be able to sustain or increase profitability in the future. Our expenses may increase in the foreseeable future as we continue to develop our technology, protect our technology, expand our product offerings and expand our capabilities. These efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our net sales sufficiently to offset our increased expenses. If we fail to increase our net sales to keep pace with our increased expenses, we may again experience net losses in future periods, which could cause the trading price of our ordinary shares and/or our ADSs to decline. If we fail to protect our intellectual property rights, competitors may be able to use our technology or trademarks, and this could weaken our competitive position, increase our costs, reduce our margins and reduce our net sales. Our success is heavily dependent upon our proprietary technology. We rely primarily on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary technology and prevent competitors from using our technology in their products. These laws and procedures provide only limited protection. Our patents may not provide sufficiently broad protection or they may not prove to be enforceable in actions against alleged infringement. Our ability to sell our products and prevent competitors from misappropriating our proprietary technology and trade names is dependent upon protecting our intellectual property. Despite the precautions we take, unauthorized third parties may copy aspects of our current or future products or obtain and use information that we regard as proprietary. Additionally, our competitors may independently develop similar or superior technology. Policing unauthorized use of software, circuit design or 7

semiconductor design is difficult and some countries' laws do not protect our proprietary rights to the same extent as the laws of the United States, Hong Kong and other developed countries. We have in the past and currently have initiated litigation to protect our intellectual property rights. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Litigation could result in substantial costs and diversion of resources, and could also result in a decision that our intellectual property is invalid or unenforceable and, could adversely affect our business, future results of operations and financial condition. See the section headed "Business Overview--Intellectual Property." We have substantial operations outside of the United States that expose us to risks specific to our international operations that could harm our net sales and net income. As of December 31, 2007, a substantial portion of our operations, most of our employees, and most of the third parties we use to manufacture, assemble and test our products were located in Japan, Korea, China, Singapore and Taiwan. In addition, sales outside the United States as a percentage of net sales accounted for almost all of our sales in the years ended December 31, 2003, 2004, 2005, 2006 and 2007. We expect our non-U.S. operations to grow and non-U.S. sales to continue to account for a substantial percentage of our net sales. We are subject to risks specific to our international business operations, including: the risk of supply disruption, production disruption or other disruption arising from natural disasters such as the earthquake in China affecting our offices in Chengdu, the outbreak of any severe communicable disease or other widespread health problems; the risk of potential conflict and further instability in the relationship between Taiwan and China; risks related to international political instability and to the recent global economic turbulence and adverse economic circumstances in Asia, such as in Japan and Korea; unpredictable consequences on the economic conditions in the U.S. and the rest of the world arising from terrorist attacks, such as the attacks of September 11, 2001 in the U.S. and other military or security operations, unexpected changes in regulatory requirements or legal uncertainties regarding tax regimes, such as the change to the tax code of Taiwan in 2001 that resulted in a higher income tax rate on our retained earnings; tariffs and other trade barriers, including current and future import and export restrictions; difficulties in staffing and managing international operations; adverse effects of changes in foreign currency exchange rates on our results of operations; limited ability to enforce agreements and other rights in foreign countries; changes in labor conditions; longer payment cycles and greater difficulty in collecting accounts receivables; burdens and costs of compliance with a variety of foreign laws; expropriation of private enterprises; and reversal of the current policies (including favorable tax and lending policies) encouraging foreign investment or foreign trade by our host countries. In addition, the geographical distances between Asia, the U.S., the Cayman Islands and Europe also create a number of logistical and communication challenges. Although we have not experienced any serious harm in connection with our international operations, we cannot assure you that such problems will not arise in the future. In addition, our reporting currency is the U.S. dollar. However, a significant portion of our operating expenses is denominated in currencies other than the U.S. dollar, primarily the New Taiwan dollar and the Chinese Renminbi. As a result, appreciation or depreciation of other currencies in relation to the U.S. dollar could result in material transaction or translation gains or losses that could adversely affect, or cause fluctuations in, our results of operations. We do not currently engage in currency hedging activities. If we cannot adapt our product offerings to respond to rapid technological changes, our net sales will be harmed. The markets for consumer electronics, computer, industrial and communications products, and the components used in these products, are characterized by rapidly changing technology and very frequent new product introductions by our direct customers and our competitors. For example, the microprocessor, display and battery technologies with which our products inter-operate change very rapidly. Although our products integrate analog and mixed-signal circuits and therefore may have substantially longer life-cycles than digital integrated circuits, we must still update our products or introduce new ones on a regular basis. If we do not respond in a timely manner to technological changes and new product introductions by our direct customers and competitors, we will be unable to maintain and grow our product sales. In addition, the emergence of significantly more efficient or cost-effective microprocessor, display and battery technologies could lessen the need for the power management functionality of our products, which would harm our net sales. We will need to recruit and retain qualified personnel to grow our business successfully. Our future success will depend on our ability to attract and retain experienced sales, research and development, marketing, customer support and management personnel. If we do not attract and retain these personnel, our ability to grow our business, sell our products, enter new markets and increase our share of existing markets could be harmed. There can be no assurance that we will be successful in hiring for these positions in the near future. Our sales strategy requires that we hire additional direct sales persons and independent sales representatives in our major markets. Moreover, our independent sales representatives and direct sales personnel must market our products effectively and be qualified to provide timely and cost-effective customer support and service. If they are unable to do so or if we are unable to expand these organizations, this could harm our ability to increase our net sales and limit our ability to sell our products or expand our market share. Competition for qualified personnel in digital, analog and mixed-signal integrated circuit design is intense. In the past, we have experienced difficulty in recruiting qualified personnel, especially technical and sales personnel. As we intend to expand the scope of our international operations, this will require us to attract experienced management, research and development, marketing, sales and 8

customer support personnel for our international offices. We expect competition for qualified personnel to remain intense, and we may not succeed in attracting or retaining such personnel. In addition, new employees generally require substantial training in our design methodology, design flow and technology, which in turn requires significant resources and management attention. There is a risk that, even if we invest significant resources in attempting to attract, train and retain qualified personnel, we will not be successful in our efforts. In that event, our costs of doing business would increase without a corresponding increase in net sales. Our success will depend to a significant extent on the continued service of our executive officers, including Sterling Du, our chief executive officer and chairman of our board, and other key employees, including key sales, consulting, technical, marketing and legal personnel. If we lose the services of one or more of our executives or key employees, our business and ability to implement our business objectives successfully could be harmed, particularly if one or more of our executives or key employees decide to join a competitor or otherwise compete directly or indirectly with us. Defects in our products could result in significant costs and could impair our ability to sell our products. Detection of any significant defects in our products may result in, among other things, loss of or delay in market acceptance and sales of our products, diversion of development resources, injury to our reputation and increased service and warranty costs. Because our products are complex, they may contain defects that can be detected at any point in a product's life cycle. These defects could harm our reputation, which could result in significant costs to us and could impair our ability to sell our products. The costs we may incur in correcting any product defects may be substantial and could materially adversely affect our results of operations. While we continually test our products for defects and work with customers through our customer support services to identify and correct problems, defects in our products may be found in the future. Testing for defects is complicated in part because it is difficult to simulate the highly complex environments in which our customers may use our products. In the past, we have discovered defects in our products and have experienced delays in the shipment of our products. These delays have principally related to new product update releases. To date, none of these delays has materially affected our business. However, product defects or delays in the future could be material, and could adversely affect our reputation and our ability to sell our products. A substantial portion of our net sales is generated by a small number of customers. If any of these customers delays or reduces its orders, our net sales and earnings may be harmed. Historically, a relatively small number of customers has accounted for a significant portion of our net sales in any particular period. We have no long-term volume purchase commitments from any of our significant customers. We cannot be certain that our current customers will continue to place orders with us, that orders by existing customers will continue at the levels of previous periods or that we will be able to obtain orders from new customers. In addition, some of our customers, acting as intermediary manufacturers, supply products to end-market purchasers, and any of these end-market purchasers could choose to reduce or eliminate orders for our customers' products. This would in turn lower our customers' orders for our products. In 2007, one customer accounted for 11.1% of our net sales and no other single customer accounted for more than 10% of our net sales. In 2006 and 2005, no customer accounted for 10% or more of net sales. The changes in sales to this customer as a percentage of our total net sales have been caused by a number of factors, some of which were outside our control. We anticipate that sales of our products to a relatively small number of customers will continue to account for a significant portion of our net sales. The reduction, delay or cancellation of orders from one or more of our significant customers would have a disproportionately negative impact on our results of operations. Our ability to manage growth will affect our ability to achieve and maintain profitability. Our ability to maintain profitability will depend in part on our ability to implement and expand operational, customer support and financial control systems and to train and manage our employees. We may not be able to augment or improve existing systems and controls or implement new systems and controls in response to future growth, if any. In addition, we will need to expand our facilities to accommodate the growth in our personnel. Any failure to manage growth could divert management attention from executing our business plan and adversely affect our ability to expand our business successfully. Our historical growth has placed, and any further growth is likely to continue to place, a significant strain on our resources. In order to grow successfully, we will need to maintain close coordination among our executive, engineering, accounting, finance, marketing, sales, operations and customer support organizations, particularly in light of the internationally dispersed nature of our operations. Third parties have asserted, and in the future could assert, that our products infringe their intellectual property rights. These claims could harm our ability to sell our products and expose us to litigation. As is typical in the semiconductor industry, we have from time to time received communications from third parties asserting patents that cover certain of our technologies or products and alleging infringement of certain of their intellectual property rights. We may receive similar communications in the future. In the event any third party were to make a valid claim against us or our customers, we could be enjoined from selling selected products such as our inverter or power products or could be required to pay royalties to third parties. Third-party infringement claims, with or without merit, have been and could continue to be time consuming, result in substantial diversion of our resources and potentially significant litigation costs, including costs related to any fines and/or damages we may owe, cause product shipment delays, prevent us and/or our customers from selling 9

some or all of our products, cause our customers or end-users not to use our products or require us to enter into license agreements. Such license agreements may not be available on acceptable terms, or at all. Any such event could seriously harm our business and our results of operations. We expect that semiconductor companies will increasingly be subject to infringement claims as the number of products and competitors in the semiconductor industry grows. See the section headed "Business Overview--Intellectual Property." From time to time, in the normal course of business, we agree to indemnify third parties with whom we enter into contractual relationships, including customers and parties to other transactions with us, with respect to certain matters. We have agreed, under certain conditions, to hold these third parties harmless against specified losses, such as those arising from a breach of representations or covenants, other third-party claims that our products when used for their intended purposes infringe the intellectual property rights of such other third parties or other claims made against certain parties. It is not possible to determine the maximum potential amount of liability under these indemnification obligations due to our limited history of prior indemnification claims and the unique facts and circumstances that are likely to be involved in each particular claim. To date, we have not made any payments under these obligations. Until all outstanding litigation is resolved, we will continue to incur substantial legal expenses that vary with the level of activity in the legal proceedings. This level of activity is not entirely within our control as we may need to respond to legal actions. Consequently, we may find it difficult to predict the legal expenses for any given period, which will impair our ability to forecast our results of operations for that period. Given the inherent uncertainties in litigation, there cannot be any assurance that we will prevail in any particular litigation matter, and we cannot predict the outcome of any such litigation. If any party were to prevail in its claims against us, our rights to certain patents and results of operations could be materially adversely affected. In any litigation arising from claims that we infringe on the intellectual property rights of others, an adverse result could involve an injunction to prevent the sales of a material portion of our products, and a reduction or the elimination of the value of related inventories, any of which could have a material adverse effect on our net sales, results of operations and financial condition. See the section headed "Business Overview--Intellectual Property." We may be subject to lawsuits from third parties, which could harm our earnings and expose us to additional uncertainties. We are a defendant or plaintiff in actions that arise in the normal course of business as well as actions that arose as counterclaims in response to our patent infringement actions, including actions for antitrust, unfair competition and interference. While we currently believe the amount of ultimate liability, if any, with respect to these actions will not materially affect our financial position, overall trends in results of operations, or liquidity, the ultimate outcome of any litigation or claim is uncertain, and the impact of an unfavorable outcome could be material to us. If we fail to maintain an effective system of internal controls, we may not be able to report our financial results accurately. As a result, we may fail to meet our reporting obligations and current and potential holders of ADSs and/or ordinary shares could lose confidence in our financial reporting, which could adversely affect the trading price of our ADS and/or ordinary shares. Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports or prevent fraud, our results of operations could be misstated, our reputation may be harmed and the trading price of our ADSs and/or ordinary shares could be adversely affected. In connection with the restatement of our audited financial statements for the years ended December 31, 2002, 2003 and 2004, in May 2005 our independent registered public accounting firm reported to our audit committee a matter that was a "reportable condition" in our internal controls as defined in standards established by the American Institute of Certified Public Accountants at that time. In general, reportable conditions are significant deficiencies in a company's internal controls that, in the auditor's judgment, could adversely affect the ability to record, process and report financial data consistent with the assertions of management in the financial statements. During 2005, we devoted significant resources to remediate deficiencies and improve our internal controls. We believe that these efforts have remediated the concerns that gave rise to the "reportable condition." However, we cannot be certain that our controls over our financial processes and reporting will continue to be adequate in the future. Any failure of our internal controls over financial reporting could result in a material misstatement in financial statements. In addition, under Section 404 of the Sarbanes-Oxley Act, beginning with our annual report on Form 20-F for the fiscal year ended December 31, 2006, we are required to furnish a report by our management on our internal control over financial reporting. Such a report will contain, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. In addition, beginning with our annual report on Form 20-F for the fiscal year ended December 31, 2007, our independent registered public accountants must attest to and report on the design and operating effectiveness of our internal control over financial reporting. During this process, if our management or our independent auditors identifies one or more material weaknesses in our internal control over financial reporting, we may be unable to assert that such internal control is effective. If we or our 10

independent auditors were unable to assert that our internal control over financial reporting is effective (or if our independent auditors were unable to attest that our management's report is fairly stated or they are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on the price of our ordinary shares and/or our ADSs. We have incurred, and continue to incur, significant costs with respect to corporate governance and financial reporting compliance. The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as new rules subsequently implemented by the Securities and Exchange Commission, or the SEC, and adopted by the Nasdaq in response to the Sarbanes-Oxley Act, have increased and will continue to increase the scope, complexity and costs of our financial reporting, securities disclosure and corporate governance practices. These new or revised rules, regulations, and listing requirements are subject to varying interpretations in many cases and their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. As a result, we may incur further legal and financial compliance costs and be required to make unanticipated changes to our reporting, disclosure and governance practices. In particular, the Sarbanes-Oxley Act requires that, among other things: our chief executive officer and chief financial officer personally certify our annual report on Form 20-F which is filed with the SEC each year, which certification includes statements as to the accuracy and fair presentation of the report's disclosure, the establishment and maintenance of controls and procedures related to our disclosure and issues regarding our internal accounting controls; we refrain from making most types of loans to our officers and directors after the adoption of the Sarbanes-Oxley Act or from making any material modifications to loans that existed prior to the adoption of the Sarbanes-Oxley Act; we furnish a report in certain SEC filings pursuant to Section 404 of the Sarbanes-Oxley Act, and our audit committee pre-approves all audit and non-audit services provided by our independent registered public accounting firm except for de minimis services; be directly responsible for the appointment, compensation and oversight of the work of our independent registered public accounting firm; establish procedures for the receipt and treatment of complaints received by us regarding accounting, controls or auditing matters and any confidential submissions by our employees regarding questionable accounting or auditing; comprise independent directors, as defined under the Sarbanes-Oxley Act and applicable Nasdaq rules. If we fail to comply with new or revised rules, regulations, and listing requirements in a timely manner, we may be exposed to liability and public perception of our financial reporting, securities disclosure and corporate governance practices could be negatively affected. As a result, the price of our ordinary shares and/or our ADSs could decline. Sales of our products could decline if our products fail to support evolving industry standards or environmental requirements. Our net sales are derived from sales of integrated circuit products that are components of electronic devices built to industry standards and widely accepted specifications. For example, the bus interconnect specifications of most notebook computers for attaching integrated peripherals are currently Peripheral Component Interconnect (PCI), Universal Serial Bus (USB) and Low Pin Count (LPC) and the software used to control the power management functions of many notebook computers conforms to the industry's Advanced Configuration Power Interface specification. Our products must be designed to conform to these standards and specifications in order to achieve market acceptance. Technology standards and specifications continually evolve, and we may not be able to successfully design and manufacture new products in a timely manner that conform to these new standards or specifications. Additionally, new products we develop to conform to new specifications may not be accepted in the market. In addition, a large percentage of our business is based on products that are used in systems that contain cold cathode fluorescent lamps (CCFL). CCFL tubes contain mercury, which is the subject of environmental concerns, particularly in Europe. Environmental issues may affect the use of our CCFL-based products and our business and results of operations could be adversely affected. Many customers are also requiring that we offer our products in lead-free packages. Governmental regulations in certain countries and customers' intention to produce products that are less harmful to the environment has resulted in a requirement from many of our customers to purchase integrated circuits that do not contain lead. The transition to lead-free products may produce sudden changes in demand depending on the packaging method used, which may result in excess inventory of products packaged using traditional methods. This may adversely affect our results of operations. In addition, the quality, cost and manufacturing yields of the lead-free products may be less favorable compared to products packaged using more traditional materials which may result in higher costs to us. Our transfer pricing procedures may be challenged, which may subject us to higher taxes and adversely affect our earnings. Transfer pricing refers to the prices that one member of a group of affiliated corporations charges to another member of the group for goods, services or the use of intellectual property. If two or more affiliated corporations are located in different countries, the laws or regulations of each country generally will require that transfer prices be the same as those charged by unrelated corporations dealing with each other at arm's length. If one or more of the countries in which our affiliated corporations are located believe that transfer prices were manipulated by our affiliated corporations in a way that distorts the true taxable income of the corporations, the laws of such countries could require us to redetermine transfer prices and thereby reallocate the 11

income of our affiliate corporations in order to reflect such income clearly. Any reallocation of income from one of our corporations in a lower tax jurisdiction to an affiliated corporation in a higher tax jurisdiction would result in a higher overall tax liability to us. Moreover, if the country from which the income is being reallocated does not agree to the reallocation, the same income could be subject to taxation by both countries. We have adopted transfer pricing agreements with our subsidiaries located in the United States, China, Taiwan, Japan and Singapore to regulate inter-company transfers. A transfer pricing agreement is a contract for the transfer of goods, services or intellectual property from one corporation to a related corporation that sets forth the prices that the related parties believe are those charged by unrelated corporations dealing with each other at arm's length. We have entered into these types of agreements because a portion of our assets, such as intellectual property developed in our U.S. and foreign subsidiaries, is transferred among our affiliated corporations. In such agreements, we have determined transfer prices that we believe are the same as the prices that would be charged by unrelated parties dealing with each other at arm's length. In this regard, we are subject to risks not faced by other companies with international operations that do not create inter-company transfers. If the taxing authorities of any jurisdiction, including Taiwan and the United States, were to challenge these agreements successfully or require changes in our transfer pricing practices, we could become subject to higher taxes and our earnings would be adversely affected. There can be no assurance that we will continue to be found to be operating in compliance with transfer pricing laws, or that such laws will not be modified, which, as a result, may require changes to our transfer pricing practices or operating procedures. Any determination of income reallocation or modification of transfer pricing laws could result in an income tax assessment of the portion of income deemed to be derived from the taxing jurisdiction that so reallocates the income or modifies its transfer pricing laws. Provisions in our Memorandum and Articles of Association may discourage potential acquisition bids for us and prevent changes in our management that our shareholders may favor. Provisions in our Memorandum and Articles of Association could discourage potential acquisition proposals and could delay or prevent a change in control transaction that our shareholders favor. These provisions could have the effect of discouraging others from making offers for our ordinary shares. As a result, these provisions may prevent the market price of our ordinary shares or ADSs from reflecting the effects of actual or rumored takeover attempts and may prevent shareholders from reselling their ordinary shares or ADSs at or above the price at which they purchased their ordinary shares or ADSs. These provisions may also prevent changes in our management that our shareholders may favor. Our Memorandum and Articles do not permit shareholders to act by written consent, do not permit shareholders to call a general meeting and provide for a classified board of directors, which means shareholders can only elect a limited number of our directors in any given year. Furthermore, our board has the authority to issue up to 250,000,000 preference shares in one or more series. Our board can fix the price, rights, preferences, privileges and restrictions of such preference shares without any further vote or action by our shareholders but subject to any direction that may be given by the shareholders in a general meeting. The issuance of preference shares may delay or prevent a change in control transaction without further action by our shareholders or make removal of management more difficult. As we are a Cayman Islands company, it could be difficult for investors to effect service of process on and recover against us or our directors and officers and our shareholders may face difficulties in protecting their interest. We are a Cayman Islands company, and many of our officers and directors are residents of various jurisdictions outside the United States. A substantial portion of our assets and the assets of our officers and directors, at any one time, are and may be located in jurisdictions outside the United States. Although we have irrevocably agreed that we may be served with process in Santa Clara, California with respect to actions arising out of or in connection with United States federal securities laws relating to offers and sales of our ordinary shares and/or our ADSs, it could be difficult for investors to effect service of process within the United States on our directors and officers who reside outside the United States or to recover against us or our directors and officers on judgments of the United States courts predicated upon the civil liability provisions of the United States federal securities laws. Our corporate affairs are governed by our charter documents, consisting of our Memorandum and Articles of Association, and by the companies law and common law of the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors are governed by Cayman Islands law, which are not as clearly established as under statutes or judicial precedent in jurisdictions such as the United States. While there is some case law in the Cayman Islands on these matters, it is not as developed as, for example, in the United States. In addition, the laws of the Cayman Islands relating to the protection of the interests of minority shareholders differ in some respects from those established under statutes or judicial precedent in existence in the United States. Such differences may mean that our minority shareholders may have less protection than they would have under the laws of the United States. Due to the less protective nature of such laws in the Cayman Islands, our shareholders may have more difficulty in protecting their interests in the face of actions by our management or directors than would shareholders of a corporation incorporated in some other jurisdictions. We may become a passive foreign investment company, which could result in adverse U.S. tax consequences to U.S. investors. We may be classified as a passive foreign investment company by the U.S. Internal Revenue Service for U.S. federal income tax purposes. Such characterization could result in adverse U.S. tax consequences to you if you are a U.S. investor. For example, if we are a passive foreign investment company, our U.S. investors will become subject to increased tax liabilities under 12

U.S. tax laws and regulations and will become subject to burdensome reporting requirements. The determination of whether or not we are a passive foreign investment company will be made on an annual basis and will depend on the composition of our income and assets, including goodwill, from time to time. Specifically, we will be classified as a passive foreign investment company for U.S. tax purposes if, after the application of look-through rules, either (a) 75% or more of our gross income in a taxable year is passive income, or (b) the average percentage of our assets (by value) in a taxable year that produce or are held for production of passive income is at least 50%. Our judgment is not binding on the Internal Revenue Service. In the future, the valuation of our intangible assets will be based in part on the then market value of our ADSs and ordinary shares which is subject to change. We cannot assure you that we will not be a passive foreign investment company for the current or any future taxable year. See "Taxation--United States Federal Income Taxation--Passive Foreign Investment Company." Holders of ADSs may not be able to exercise their right to vote. Holders of our ADSs may instruct the depositary of our ADSs to vote the ordinary shares underlying their ADSs but only if we ask the depositary to ask for instructions. Otherwise, they will not be able to exercise their right to vote unless they withdraw the ordinary shares underlying the ADSs they hold. However, they may not know about the meeting sufficiently enough in advance to withdraw those ordinary shares. If we ask for instructions, the depositary will notify the holders of the upcoming vote and arrange to deliver our voting materials to them. We cannot assure you that holders will receive the voting materials in time to ensure that they can instruct the depositary to vote their ordinary shares. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions. This means that holders may not be able to exercise their right to vote, and there is no guarantee that the ordinary shares underlying your ADSs would be voted as requested. The depositary for our ADSs may give us a discretionary proxy to vote the ordinary shares underlying your ADSs if holders of ADSs do not vote at shareholders' meetings which could adversely affect their interests. Under the deposit agreement for the ADSs, the depositary will give us a discretionary proxy to vote the ordinary shares underlying ADSs at shareholders' meetings if the holder of the ADSs did not vote, unless we notify the depositary that we do not wish to receive a discretionary proxy, we think there is substantial shareholder opposition to the particular question, or we think the particular question would have a material adverse impact on our shareholders. The effect of this discretionary proxy is that holders of ADSs cannot prevent the ordinary shares underlying their ADSs from being voted, absent the situation described above, and it may make it more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to a discretionary proxy. Holders of ADSs may not receive distributions on ordinary shares or any value for them if it is illegal or impractical to make them available. The depositary of our ADSs has agreed to pay to ADS holders the cash dividends or other distributions it or the custodian for our ADSs receives on ordinary shares or other deposited securities after deducting its fees and expenses. Holders of our ADSs will receive these distributions in proportion to the number of ordinary shares the ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. We have no obligation to take any other action to permit the distribution of our ADSs, ordinary shares, rights or anything else to holders of our ADSs. This means that ADS holders may not receive the distributions we make on ordinary shares or any value for them if it is illegal or impractical for us to make them available. These restrictions may have a material adverse effect on the value of the ADSs. Holders of ADSs may be subject to limitations on transfer of ADSs. ADSs represented by American Depositary Receipts, or ADRs, are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or any government or governmental body, or under any provision of the deposit agreement, or for any other reason. ITEM 4. INFORMATION ON THE COMPANY HISTORY AND DEVELOPMENT OF THE COMPANY Our legal name is O2Micro International Limited. We are incorporated in Cayman Islands. Our registered office is located at Maples Corporate Services Limited, Ugland House, P.O. Box 309, South Church Street, Grand Cayman KY1-1104, Cayman Islands. Our principal executive offices are located at Grand Pavilion Commercial Centre, West Bay Road, P.O. Box 32331 Grand Cayman KY1-1209, Cayman Islands. Our telephone number is (345) 945-1110. We have a subsidiary, O\\2\\Micro, Inc., which was incorporated as a California corporation in March 1995. In March 1997, O2Micro International Limited was incorporated as a Cayman Islands company. In March 1997, we exchanged our ordinary shares and preference shares for common stock and preferred stock of O\\2 \\Micro, Inc. After the exchange, we held all of the outstanding capital stock of O\\2 \\Micro, 13

Inc., our wholly owned subsidiary in the United States. Our shares were initially listed on the Nasdaq on August 23, 2000 and on the Cayman Islands stock Exchange on February 1, 2001. On November 25, 2005, we effected a 50-for-1 share split of our ordinary shares and created an ADS program for our ADSs to be quoted on Nasdaq, with each ADS representing 50 ordinary shares. We delisted our ordinary shares from Nasdaq on November 25, 2005 and listed our ADSs on Nasdaq on November 28, 2005, the next trading day. We subsequently listed our ordinary shares on the Main Board of the Stock Exchange of Hong Kong Limited (the "SEHK") on March 2, 2006 by way of introduction. Our agent for service of process in the U.S. for the purpose of our securities filings is our chief executive officer, Sterling Du, c/o O\\2\\Micro, Inc., 3118 Patrick Henry Drive, Santa Clara, CA 95054. Since January 1, 2005, our principal capital expenditures were investments in various private companies of approximately $13.9 million in the aggregate, and $47.2 million in the purchase of property and equipment. BUSINESS OVERVIEW We design, develop and market high performance integrated circuits for power management and security applications, as well as systems security solutions. We focus our product design efforts on integrated circuits for consumer electronics, computer, industrial and communications products, including LCD computer monitors, LCD televisions, notebook computers, Internet security devices, GPS, mobile phones and portable DVD players. Our integrated circuit products manage and provide power for lighting of LCDs, provide connections between notebook computers and external plug-in cards, provide Internet security, control and monitor battery charging and discharging, and select and switch between power sources. We believe that our focus on these products provides us with an opportunity to participate in large and growing markets. Potential future growth in the LCD television market, especially units with larger-size panels, represents an attractive growth opportunity for us because larger LCD panels require more of our inverters for cold cathode fluorescent lamps, or CCFLs. Our integrated circuit products use analog, digital or mixed-signal designs that combine analog and digital circuits on a single chip, reducing the number of components needed and allowing our customers to reduce the size, weight, power requirements or cost of their products. We offer a wide range of proprietary application specific standard products as well as customized products. We work closely with our customers to identify their product needs and establish engineering priorities for new product designs and development. We believe that our system-level expertise and extensive experience with power management systems allow us to develop proprietary solutions and foster long-term relationships with our customers. We sell our products to OEMs, ODMs and module makers. Our integrated circuits have been incorporated into products sold by Acer, Apple Computer, Dell, Fujitsu, Hewlett-Packard, Lenovo, LG Electronics, NEC, Samsung Electronics, Sharp, Sony and Toshiba, among others. We sell our products through our direct sales force, independent sales representatives and distributors in China, Hong Kong, Japan, Korea, Singapore, Taiwan and the United States. We also have design centers in many of our key markets to provide design and engineering support to our customers. We outsource the fabrication of our products to standard, high volume semiconductor foundries. This "fabless" approach allows us to focus on product development, minimize fixed costs and capital expenditures, and access diverse manufacturing technologies. Our net sales have grown from $105.6 million in 2005 to $124.9 million in 2006 and $165.5 million in 2007. As disclosed in our press release dated April 30, 2008, in the three months ended March 31, 2008, our unaudited net sales were $37.6 million, an increase of 7.2% as compared with our unaudited net sales of $35.0 million in the same period in 2007. Industry Background The markets for consumer electronics, mobile computing and communications products, such as LCD monitors, LCD televisions, notebook computers, mobile handsets and portable entertainment devices, are large and growing as functionality increases and prices decrease. One of the most significant challenges in these markets remains the efficient management of power. As the number of applications and features available for these products has increased, the number and variety of power loads, or individual subsystems requiring voltage or current regulation, has also grown. Each additional application or feature can require multiple functions and circuits that, in turn, require more individually-regulated and managed power sources. Increasingly, manufacturers are turning to innovative new semiconductor technologies to manage the available power source capacity more efficiently. Power management integrated circuits deliver power and regulate voltage, controlling the flow of electrical energy among the various power loads and energy sources in a product or system. Power management requires a combination of two distinct technological disciplines: digital integrated circuit design and analog integrated circuit design. Digital circuits, such as microprocessor and memory semiconductors, provide most of the functionality of computer processing. However, digital circuits generally cannot handle significant amounts of current or multiple voltage levels. In contrast, analog circuits use and manipulate continuously varying voltage and current levels. Battery power systems, which have relatively high and continuously varying power levels, are inherently analog systems. Digital integrated circuit technology can be used to manage power systems more intelligently and efficiently and help to prolong battery life in mobile applications. However, since battery power systems are analog by nature, mixed-signal integrated circuits, or circuits that incorporate both digital and analog technologies, are necessary in order to harness the 14

intelligence provided by digital technology. Designing mixed-signal integrated circuits poses a number of difficulties: analog circuits are more sensitive than digital circuits to the physical layout and electrical characteristics of the circuit; analog circuit designers must have a very high level of circuit design experience; and basic differences in the technologies used in digital and analog circuit design make combining the technologies problematic. In addition, mixed-signal integrated circuits comprise both digital and analog components, and the trend toward more complex devices has increased the number of components substantially. Integrating the functions of those components on a single chip, known as a system-on-a-chip, can enable manufacturers to make products smaller, lighter and more reliable. Thus, as mobile computing and communications devices grow in complexity and functionality, there is an increasing need for higher levels of systems integration. In addition, variances in battery designs among manufacturers make it more difficult to design intelligent systems that are optimized for particular power systems. Most consumer electronics, mobile computing and communications product manufacturers need mixed-signal and analog integrated circuits specifically designed to optimize the power system usage in their devices to enable them to offer new devices with richer functionality and longer battery lives. These semiconductors should also be highly integrated and standards-based to help manufacturers create products that are smaller, lighter, easier to use, more reliable and more cost-efficient to design and produce. In addition, in mobile device markets where product life cycles can be less than one year, these solutions typically need to be developed using advanced design methodologies to allow manufacturers to achieve rapid time-to-market with their new products. Several different process technologies are available for designing and fabricating analog and digital integrated circuits. Of these, complementary metal oxide semiconductor, or CMOS, is the most widely used process technology, especially for purely digital integrated circuits. CMOS processes are described in terms of feature size, or geometry, and are measured in microns. One micron equals one millionth of a meter. Currently, the most advanced process technologies achieve feature sizes of 0.13 micron, 0.09 micron, 0.065 micron and smaller. However, small feature size circuits can become damaged when exposed to high voltages and therefore power management integrated circuits are typically fabricated using larger feature sizes. For this reason, older manufacturing facilities, or fabs, having feature sizes of 0.25 micron and 0.80 micron or greater, have traditionally been used in fabricating power management integrated circuits, while the most advanced, and most expensive fabs are used for digital and non-power management analog integrated circuits. Products We market power management and cardbus controller components for the Consumer, Computer, Industrial and Communications markets and also market system security solutions. Our power management and cardbus controller products include ICs to provide power for lighting of LCDs and LEDs, control and monitor battery charging and discharging, DC / DC conversion, and provide connections between notebook computers and external plug-in cards including product to select and switch between power sources. Our system security solutions products include VPNs and firewalls which provide security functions for communications between computer systems and networks, including the transmission of data across the Internet. Our system security products are designed to provide high-speed and comprehensive security protection. In particular, our core technologies in the Application Specific Integrated Circuit ("ASIC") chips are exclusive to us and deliver enhanced performance and service to our customers. We sell our products into the following four end-markets: . Consumer electronics market, including desktop monitors, LCD televisions, digital cameras and camcorders and portable media players; . Computer market, including notebook computers, desktop computers and desktop servers; . Industrial market, including any product that is specified to operate over an extended temperature range, for instance, beyond the standard commercial operating temperature range of standard semiconductor products of zero degrees to 70 degrees centigrade. Products that operate over an extended temperature range include industrial tools, automobile GPS systems, and other automobile systems; and . Communications market, including portable GPS systems, data communications security and networking systems, Internet and Internet related systems and mobile phone handsets. The majority of our revenue is derived from the sale of our products in the consumer and computer markets. Additionally, we have increased our efforts to expand our product portfolio addressing opportunities in the communications and industrial markets. Marketing, Sales, and Customer Support Our marketing strategy is focused on the sale of proprietary analog and mixed-signal integrated circuits to customers in the consumer electronics, computer, industrial and communications markets. These markets tend to be dominated by a small number of major brand name companies. As a result, we focus our resources on the major vendors in each market. We primarily sell proprietary application specific products to our customers and work with them on new product development. We also design customized products for our customers. We work directly with our customers to create demand for our products by 15

providing them with application specific product information for their system design, engineering and procurement groups. We actively participate in their design processes to introduce them to our products and the target applications our products address. We endeavor to design products that will meet increasingly complex and specific design requirements, but which will also support widespread demand for these future products. We typically undertake a four-to-eight month development process with our customers. If successful, this process culminates in a customer deciding to use our product in its system, which we refer to as a design win. Volume production generally takes an additional three-to-six months after the initial design win confirmation. Once our products are accepted and designed into an application, the customer is likely to continue to use the same power architecture and derivative products in a number of its models, which tends to extend our product life cycles. We sell our products to OEMs, ODMs and module makers. We market and sell these products through a combination of our direct sales force, independent sales representatives and distributors in Asia, Europe and North America. We sell most of our products through direct sales. We maintain direct sales offices in most of our major markets which include Texas, California, China, Taiwan, Korea and Japan. Additionally, we have sales representatives in China, Hong Kong, Singapore, Taiwan and the United States, as well as two distributors in Japan. We pay our direct sales force on a salary and performance bonus basis only. Our independent sales representatives are paid on a commission basis, based on a percentage of the actual sales referred by them. For sales through sales representatives, we invoice and deliver our products directly to the customers. We have entered into distributorship arrangements with distributors on a non-exclusive basis for the sale of our products in Japan as a principal at the request of certain of our major end-customers in Japan. For our other customers in Japan, sales are made through our direct sales offices in Japan. In Japan, it is customary practice for OEMs, ODMs and module makers to purchase products like ours through distributors because of the ancillary services provided by them such as inventory storage, payment terms and conditions and just-in-time delivery. We may provide a discount on the prices of the products we sell to our distributors (as compared to the prices we offer to end customers), depending on the term and conditions of the individual purchases. We defer recognition of such sales until the product is sold by the distributors to its end customers. In addition, products held by the distributors are considered part of our inventory and included in our inventory balance. Sales to the distributors are recognized and inventory is adjusted upon shipment to its end-customers as title to inventories generally transfers upon shipment. We receive monthly inventory and sales reports from the distributors in Japan, which we use as part of our overall inventory control. We evaluate our inventory on a quarterly basis and full provision is made for inventory which is over six months old and for which there is no end customer demand based on forecasted product demand and market conditions. Our marketing efforts include market analysis, participation in industry trade shows and technical conferences, sales training, publication of technical articles, maintenance of our web site and advertising. In addition, we maintain customer support staff in the United States, Taiwan, China, Japan and Korea for post order servicing and applications support. Seasonality The consumer electronics and computer markets are characterized by seasonal volume increases in the latter part of the year primarily driven by increased consumer spending during the holiday season. We normally experience the highest sales volume to our customers in these markets in the third and fourth quarter of each year, when such customers increase their inventories in anticipation of increased seasonal demand. Our customers in the industrial and communications markets are to a lesser extent subject to seasonal consumer demand. As a result, our sales volume to those customers has been largely consistent from quarter-to-quarter. Customers We focus on the major OEMs (or brand owners) in the consumer electronics, computer, industrial and communications markets. Many of these major OEMs use third-party providers, such as ODMs, module makers or other intermediaries, to produce their products or portions of their products containing our components. Hence, the majority of our direct sales are to these third-party providers. We have no long-term volume purchase contracts with any of our major customers. The majority of our sales to customers are conducted on the basis of purchase orders, which set out the specific terms for a particular sale. We price our products primarily with reference to the prevailing market conditions, taking into consideration the complexity, technology and features of the product, the order size and the relationship with the customer. The table below sets forth, for the periods indicated, the dollar amount of our net sales derived from Asia, North America and other regions: Years Ended December 31 -------------------------- (In Thousands) Location of customers 2005 2006 2007 - --------------------- -------- -------- -------- Asia............... $105,517 $124,761 $165,391 North America...... 29 32 130 Other regions...... 6 122 19 -------- -------- -------- $105,552 $124,915 $165,540 ======== ======== ======== 16

We generally extend to our customers credit terms varying from 45 to 60 days. We may adjust our usual credit terms according to each customer's credit history as well as local market practice. Our customers generally pay us either by direct wire transfer or under letter of credit arrangement. To date, we have not experienced any material problems relating to customer payments or material write-offs of accounts receivable due to uncollectibility. Manufacturing We subcontract the manufacture of our products and most of the testing for our products to semiconductor foundries, assembly and testing service providers. This "fabless" approach allows us to focus on product development, reduce fixed costs and capital expenditures, and access diverse manufacturing technologies. We use established mainstream processes for the manufacture of our products. This approach reduces our technical risks and minimizes the risks related to production capacity constraints. Wafer Manufacturing Wafer manufacturing is a capital intensive and complex operation which takes place at dedicated facilities of semiconductor foundries. After we have designed our integrated circuits, we place orders with a semiconductor foundry to fabricate wafers with our integrated circuits embedded in them. The semiconductor foundry purchases raw unprocessed wafers, or silicon substrates, and processes them according to our specifications to fabricate the wafers used in our products. Currently, the majority of our wafers are fabricated using 0.25 to 0.80 micron CMOS semiconductor processes, which are the standard semiconductor processes used by semiconductor foundries. The wafer fabrication process generally takes six to 10 weeks. Fabricated wafers are then shipped by the semiconductor foundry, according to our instructions, to either an assembly service provider for electrical wafer sort and assembly or to an electrical wafer sort service provider for electrical wafer sort only. Our major semiconductor foundry providers are X-FAB, SinoMos, SMIC and CSMC. We do not enter into long-term contracts with our semiconductor foundry providers. They manufacture our products on a purchase-order basis in accordance with our specifications and requirements. In general, the cost charged to us for the foundry services depends on prevailing wafer costs, which, in turn, depends on industry capacity and the state of manufacturing process technologies as well as on the complexity of our product designs, order size, cycle time and foundry capacity utilization. Assembly and Testing After the fabricated wafers have been electrically sorted, they are ready for assembly and are either sent to an assembly service provider for assembly or held at our warehouse facilities, or an "inventory hub," for assembly at a later date. An inventory hub is a provider of warehousing services. We often hold inventory of our semi-finished products in the form of electrically sorted wafers because it is at this manufacturing stage that most time has been invested, with the least costs, and we then have the flexibility of choosing the type of packaging into which they are to be assembled. The wafer sort and assembly process generally takes three to six weeks. Once our integrated circuits are assembled and packaged, they are ready for final electrical testing. We instruct the assembly service provider to send our packaged integrated circuits to either a testing service provider or our testing facilities for final testing or our warehouse facilities (or an inventory hub) for testing at a later date. The electrical testing process generally takes a few days. Once our products have been tested, they are ready for use by our customers. Finished products may be sent to our customers or their designees such as third party service providers that manufacture their products or a portion of their products containing our integrated circuits. Our customers may request for our integrated circuits to be shipped in plastic tubes, several to a tube, or use a form of packaging called "tape and reel" that more readily provides for automated assembly of our integrated circuits into their products. If a customer orders "tape and reel" packaging, this is done either at a testing service provider or a "tape and reel" service provider prior to shipment of our products to the customer. We utilize several assembly and testing service providers in Taiwan and other parts of Asia on a purchase order basis. They assemble and test our products based on our specifications and requirements. In general, the cost charged to us for these assembly and testing services depends on prevailing market rates for these services and our relationship with the service provider. Typically analog and mixed-signal products have a greater portion of their product cost associated with product testing than digital products. We operate a semiconductor testing facility to test a portion of our products prior to shipment. In July 2007, we signed a Memorandum of Understanding with Sigurd Microelectronics (Cayman) Co., Ltd, a subsidiary of Sigurd Microelectronics Corporation. They are a leading provider of semiconductor assembly and test services in Taiwan. Under the Memorandum of Understanding, we will divest our investment in our semiconductor testing facility by selling 100% ownership of our wholly owned subsidiary holding the facility to them, invest up to $10.3 million in them to become their strategic partner and offer them favorable supplier treatment for 36 months. The transaction has not been completed as they are still in the process of obtaining approval from the Taiwan government. Our current credit terms with our foundry, assembly and testing service providers vary from 30 to 45 days, depending on our relationships with each of them. We generally pay our service providers by direct wire transfer. We also have made investments in certain of our current suppliers and potential future suppliers, including software developers, foundries and testing service providers. These investments enable us to enhance our business relationships with these suppliers to ensure the adequacy of foundry capacity allocation and quality of services provided to us. We plan to continue to evaluate additional investment opportunities in our supply chain. 17

Competition We compete in the market for analog and mixed-signal integrated circuits based on such factors as product performance, power efficiency, new technologies, functional innovation, reliability, price and availability. We believe our principal competitors include Intersil Corporation, Linear Technology Corporation, Maxim Integrated Products, Inc., Microsemi Corporation, Monolithic Power Systems, Inc., Ricoh Company, Ltd., Rohm Co., Ltd and Texas Instruments Incorporated. There is also competition from internal integrated circuit design and manufacturing capabilities of some of our existing and potential customers, such as Toshiba and Fujitsu. In addition to these competitors, other integrated circuit companies may decide to enter the market with analog and mixed signal integrated products that compete with our products or incorporate functions similar to those provided by our products. Intellectual Property Our intellectual property is primarily developed in-house. We do, from time to time, acquire intellectual property from third parties which we believe is instrumental or complementary to our business. We also on occasion license our intellectual property to third parties in exchange for royalties or other consideration. From time to time, we may seek acquisitions to acquire businesses or technologies where synergies exist. For example, in March 2008, we acquired all of their right, title and interest in, to and under the assets, goodwill and rights used in the conduct of the software security business of 360 Degree Web Ltd. in exchange for $6.5 million and all of shares of 360 Degree Web Ltd held by us including 1,583,333 shares of Series B preferred stock, 500,000 shares of Series B2 Preferred Stock and 180,769 shares of Series D preferred Stock totally valued at $1.6 million. Our success depends significantly upon our ability to protect our intellectual property. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. Competitors may recruit our employees who have access to our proprietary technologies, processes and operations. We rely in part on patents to protect our intellectual property. As of December 31, 2007, we had approximately 127 patents issued in the United States and approximately 280 patents issued in other countries. In addition, we had approximately 217 patent applications pending in the United States Patent and Trademark Office. We also had approximately 409 patent applications pending in various countries other than the United States. These patents may never be issued. Even if these patents are issued, taken together with our existing patents, they may not be sufficiently broad to protect our proprietary rights, or they may prove to be unenforceable. To protect our proprietary rights, we also rely on a combination of copyrights, trademarks, trade secret laws, contractual provisions, licenses and maskwork protection under the Federal Semiconductor Chip Protection Act of 1984 and similar laws in other jurisdictions. We also enter into confidentiality agreements with our employees, consultants and customers and seek to control access to, and distribution of, our proprietary information. We may from time to time grant rights to third parties for our patents and other intellectual property. In March 2003, we granted a limited non-exclusive license to Ricoh Company, Ltd. for our patents entitled "Integrated PC Card Host Controller for the Detection and Operation of a Plurality of Expansion Cards" (U.S. Patent No. 6,470,284 and Taiwan Patent No. 155891) and their foreign counterparts. In April 2007, we entered into a Memorandum of Agreement with Samsung Electronics Co., Ltd. and its subsidiaries pursuant to which we agreed not to bring a patent infringement claim against Samsung or its customers during a specified term. In September 2007, we granted a non-exclusive license to Sony Corporation for certain U.S. inverter patents. In October 2007, we granted a covenant not to sue to Hon Hai Precision Industries, Ltd. for certain U.S. inverter patents. In November 2007, we granted a covenant not to sue or assert any claims of U.S. Patent Numbers 6,259,615, 6,396,722, 6,804,129 and their reissues to Microsemi Corporation. In March 2008, we granted a non-exclusive license to Rohm Co., Ltd. for certain U.S. inverter controller patents. The laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and many companies have encountered substantial infringement problems in these countries, including countries in which we have sold and continue to sell a significant portion of our products. There is a risk that our means of protecting our proprietary rights may not be adequate. For example, our competitors may independently develop similar technology, duplicate our products or design around our patents or our other intellectual property rights. If we fail to protect our intellectual property adequately, it would make it easier for our competitors to sell competing products. We are involved in a variety of litigation matters involving intellectual property. For example, we have initiated and are pursuing certain patent infringement actions in Taiwan. We have obtained preliminary injunctions and provisional attachment orders against numerous competitors, their customers and users. As of December 31, 2007, we have deposited an amount of New Taiwan dollars equivalent to approximately $12.4 million with the Taiwan courts for court bonds in connection with the preliminary injunction actions and related provisional attachment actions. The court bonds provide security for the enjoined party to claim damages incurred from the preliminary injunctions, provisional attachments or the provision of a countersecurity against us in the event we do not ultimately succeed in the underlying infringement actions. However, these preliminary injunctions or provisional attachments may be rescinded if the relevant court allows the opposing party to make its own deposit or countersecurity with the court. In February 2007, Monolithic Power Systems, Inc. amended its complaint in the Intermediate People's Court in Chengdu, China alleging that two of our customers infringe Chinese Patent Number ZL03140709.9. In May 2007, a jury in the United States District Court in the Northern District of California found Claims 1, 2, 9, 12, 14 and 18 of our U.S. Patent Number 6,396,722 to be invalid. In April 2008, the United States Court of Appeals for the Federal Circuit vacated the jury verdict, the final judgment of infringement and the permanent injunction we obtained against Beyond Innovation 18

Technology Co., Ltd., FSP Group, SPI Electronic Co., Ltd. and Lien Chang Electronic Enterprise Co., Ltd. and remanded to the district court for further proceedings. We have filed a petition for rehearing with the court. We are also involved in several other patent litigation matters in the United States. Given the inherent uncertainties in litigation, there cannot be any assurance that we will prevail in any of the pending litigation, and we cannot predict the outcome of any such litigation. Litigation is costly, time consuming, and may distract management from other important tasks and, in patent litigation where we are the plaintiff, there is a risk that our patents may be held invalid or unenforceable. In addition, in any litigation arising from claims that we infringe on the intellectual property rights of others, an adverse result could involve an injunction to prevent the sales of a material portion of our products, a reduction or the elimination of the value of related inventories, and the assessment of a substantial monetary award for damages related to past sales, any of which could have a material adverse effect on our result of operations and financial condition. ORGANIZATIONAL STRUCTURE We are incorporated under the laws of the Cayman Islands and we are the parent company for the various subsidiaries that conduct our business on a worldwide basis. Our significant subsidiaries, all of which are wholly-owned, are: Significant Subsidiary Country of Incorporation Date of Incorporation ---------------------- ------------------------ --------------------- O\\2\\ Micro, Inc. U.S.A. March 1995 O\\2\\ Micro Electronics, Inc. Taiwan March 1999 O\\2\\ Micro International Japan Limited Japan August 1999 O\\2\\ Micro PTE Limited-Singapore Singapore September 1999 Aotu Micro (Wuhan) Co., Ltd. China January 2001 O\\2\\ Micro (Beijing) Co., Ltd. China February 2001 O\\2\\ Micro (China) Co., Ltd. China April 2001 O\\2\\ Micro (Chengdu) Co., Ltd. China July 2004 OceanOne Semiconductor (Ningbo) Limited China August 2005 PROPERTY, PLANT AND EQUIPMENT The table below describes our headquarters and the facilities where the above subsidiaries are located as of December 31, 2007: Approx. Available Location Square Feet Lease Expiration - -------- ----------------- ---------------- California, USA................................... 37,180 not applicable Taipei, Taiwan.................................... 33,786 2011 Hsin-Chu, Taiwan.................................. 26,246 2008 Singapore......................................... 7,104 2008 Shanghai, China................................... 30,448 not applicable Beijing, China.................................... 26,286 2010 Wuhan, China...................................... 21,290 2010 Chengdu, China.................................... 26,372 2008 Grand Cayman, Cayman Islands...................... 600 2008 Tokyo, Japan...................................... 1,302 2008 Ningbo, China..................................... 7,944 2008 We maintain our Cayman Islands office to process invoices and receive amounts payable. Research and development, marketing, applications and administrative staff are located in California. We also have sales offices in Pfluggerville, Texas and Houston, Texas. Marketing, sales, applications, design, worldwide production support, final inspection and shipping, and general and administrative staff are located in Taiwan. We have offices in Japan, Singapore, Korea and China for marketing, sales, design, warehousing and applications. We believe our current facilities are adequate for our needs for the foreseeable future, and that any additional space required will be available to us on commercially reasonable terms. In May 2004, we purchased a 37,180 square foot building in Santa Clara, California housing our California operations. The purchase price was approximately $4.6 million. In October 2005, we purchased a 30,448 square foot facility in 19

Shanghai, China for approximately $7.1 million. In April 2006, we purchased 29,935 square feet of land in Hsin-Chu, Taiwan for approximately $8.8 million. ITEM 4A.UNRESOLVED STAFF COMMENTS None. ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS Overview We design, develop and market high performance integrated circuits for power management and security applications, as well as systems security solutions. We also license a limited portion of our proprietary intellectual property from and to third parties. Our net sales have been derived primarily from the sale of analog and mixed-signal integrated circuit products to customers in the consumer electronics, computer, industrial and communications markets. Our net sales have grown from $105.6 million in 2005 to $124.9 million in 2006 and $165.5 million in 2007. This increase in net sales was due primarily to higher unit shipments of our existing products, expansion of our customer base and the introduction of new products. We have continued to diversify our customer base and market focus by providing new products that are used in consumer electronics, computer, industrial and communications markets. Our overall gross margin has fluctuated in the past and is likely to fluctuate in the future due to the stages of our products in their life cycles, variations in our product mix, the timing of our product introductions and specific product manufacturing costs. New products typically have higher gross margins than products that are more mature. Gross margins on the products we sell will typically decline over the life of these products due to competitive pressures and volume pricing agreements. Operating expenses grew from $58.3 million in 2005 to $72.7 million in 2006 and decreased to $70.8 million in 2007. Our operating expenses increased primarily from new product development efforts, hiring additional personnel and expanding our operations and recognized stock-based compensation due to adoption of Statement of Financial Accounting Standards ("SFAS") No. 123 (R), "Share-Based Payment." Our operating expenses decreased primarily due to the offset from litigation income received in 2007. Our net income was $8.1 million in 2005, $743,000 in 2006 and $25.0 million in 2007. We have been profitable in each quarter since the quarter ended September 30, 1999 except for the quarter ended June 30, 2006. We believe this profitability has been the result of our strategy to make investments to develop new products and grow net sales, while maintaining a high level of fiscal control, product quality and customer satisfaction as well as recent litigation income from certain litigation matters. Our profitability resulted in retained earnings of $56.8 million as of December 31, 2007. We utilize a fabless semiconductor business model, which means we focus on designing, developing and marketing products, while having these products manufactured by large independent semiconductor foundries. As a fabless semiconductor company, we do not need to invest significant capital to manufacture semiconductor devices, and can take advantage of some of the cost-efficiencies of third-party foundries. We place purchase orders for specific quantities of packaged semiconductor devices or wafers at set prices. We currently use third parties to test and assemble most of our products, which reduces the capital we need to invest in these activities. We also use independent assembly suppliers for the production of our systems security solutions products. We sell our products through a combination of direct sales offices, sales representatives and distributors. We have sales representatives in China, Hong Kong, Singapore, Taiwan and the United States, as well as two distributors in Japan. Revenue from product sales to customers, other than distributors, is recognized at the time of shipment, including revenue that has been realized and earned. Sales through distributors are recognized when the distributors make a sale. Under certain conditions, customers may return defective products. Allowances for sales returns are provided on the basis of past experience. These provisions are deducted from sales. Critical Accounting Policies-- Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, net sales and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to valuation allowance for deferred tax assets, allowance for doubtful accounts, inventory valuation, useful lives for property and equipment, impairment on long-lived assets, accruals for sales adjustments, other liabilities, contingencies and stock-based compensation. We base our estimates and judgments on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information. Because our estimates may vary in each situation, our actual results may differ from our estimates under different assumptions and conditions. 20

Our management considers the following factors in reviewing our financial statements: . the selection of critical accounting policies; and . the judgments and other uncertainties affecting the application of those critical accounting policies. The selection of critical accounting policies, the judgments and other uncertainties affecting the application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors to be considered when reviewing our financial statements. Our principal accounting policies are set forth in detail in Note 2 to our consolidated financial statements included elsewhere in this annual report. We believe the following critical accounting policies affect our more significant judgments used in the preparation of our financial statements. Revenue Recognition and Accounts Receivable Allowances We recognize revenue on sales to direct customers in accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements" ("SAB 104"). SAB 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an agreement exists, (2) delivery has occurred or services have been rendered, (3) the fee is fixed and determinable, and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) is based on management's judgments regarding the ability to estimate returns and the collectibility of those fees. For sales made through distributors, we defer recognition of such sales until the product is sold by the distributors to their end customers. Since we have limited control over these distributors' sales to third parties, we recognize revenues on these sales only when the distributors sell the products. In addition, products held by distributors are included in our inventory balance. Accounts receivable from distributors are recognized and inventory is relieved upon shipment to end customers as title to inventories generally transfers upon shipment. We make allowances for future product returns at the time revenue is recognized. We analyze historical returns, changes in current demand and acceptance of products when evaluating the adequacy of such allowances. Estimates may differ from actual product returns and allowances and these differences may materially affect our reported revenue and amounts ultimately collected on accounts receivable. In addition, we monitor collectibility of accounts receivable primarily through review of the accounts receivable aging. When facts and circumstances indicate the collection of specific amounts or from specific customers is at risk, we assess the impact on amounts recorded for bad debts and, if necessary, will record a charge in the period such determination is made. To date, we have not experienced material write-offs of accounts receivable due to uncollectibility. Inventories Our inventories are stated at the lower of standard cost or market value. Cost is determined on a currently adjusted standard basis, which approximates actual cost on a first-in first-out basis. Because of the cyclicality of the market, inventory levels, obsolescence of technology and product life cycles, we write down inventories to net realizable value based on backlog, forecasted product demand and historical sales levels. Backlog is subject to revisions, cancellations and rescheduling. Actual demand and market conditions may be lower than those projected by us. This difference could have a material adverse effect on our gross margin should additional inventory write downs become necessary. Long-Lived Assets We evaluate the recoverability of property and equipment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." We perform periodic reviews to determine whether facts and circumstances exist that would indicate that the carrying amounts of property and equipment might not be fully recoverable. If facts and circumstances indicate that the carrying amount of property and equipment might not be fully recoverable, we compare projected undiscounted net cash flows associated with the related assets over their estimated remaining useful life against their respective carrying amounts. In the event that the projected undiscounted cash flows are not sufficient to recover the carrying value of the assets, the assets are written down to their estimated fair values based on the expected discounted future cash flows attributable to the assets. Evaluation of impairment of property and equipment requires estimates in the forecast of future operating results that are used in the preparation of the expected future undiscounted cash flows. Actual operating results and remaining economic lives of the property and equipment could differ from the estimates used in assessing the recoverability of these assets. These differences could result in additional impairment charges, which could have a material adverse impact on the results of operations. Income Taxes Financial Accounting Standards Board ("FASB") Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109," establishes financial accounting and reporting standards for the effect of income taxes and was adopted by us on January 1, 2007. The interpretation contains a two step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No.109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position 21

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. Our income taxes are accounted in accordance with SFAS No. 109, "Accounting for Income Taxes". The provision for income tax represents income tax paid and payable for the current year plus the changes in the deferred income tax assets and liabilities during the year. Deferred income tax assets are primarily the tax effects of the operating loss carry-forwards, research and development credit carry-forwards and temporary differences. On a periodic basis we evaluate the deferred tax assets balance for realizability. To the extent we believe it is more likely than not that some portion of deferred tax assets will not be recognized, we will increase the valuation allowance against the deferred tax assets. Realization of the deferred tax assets is dependent primarily upon future taxable income, changes in tax laws and other factors. These changes, if any, may require possible material adjustment to the deferred tax assets, resulting in a reduction in net income in the period when such determinations are made. In addition, we recognize liabilities for potential income tax contingencies based on the estimate of whether, and the extent to which, additional taxes may be due. If we determine that payment of these amounts is unnecessary or if the recorded tax liability is less than its current assessment, we may be required to recognize an income tax benefit or additional income tax expense in its financial statements, accordingly. Legal Contingencies We are currently involved in various claims and legal proceedings. We periodically assess each matter in order to determine if a contingent liability in accordance with SFAS No. 5, "Accounting for Contingencies," should be recorded. In making the determination, we may, depending on the nature of the matter, consult with external counsel and technical experts. Based on the information obtained combined with our judgment regarding all the facts and circumstances of each matter, we determine whether it is probable that a contingent loss may be incurred and whether the amount of such loss can be estimated. Should a loss be probable and estimable, we record a contingent loss in accordance with SFAS No. 5. In determining the amount of a contingent loss, we take into consideration advice received from experts in the specific matter, current status of legal proceedings, prior case history and other factors. Should the judgments and estimates be incorrect, we may need to record additional contingent losses that could materially adversely impact our results of operations. Stock-based compensation We grant stock options and other awards to our employees and certain non-employees. Prior to January 1, 2006, we elected to follow Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and complied with the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" for our employee stock options. Under APB No. 25, compensation expense is measured based on the difference, if any, on the date of the grant, between the fair value of our ordinary shares and the exercise price of the stock option. Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123 (R), "Share-Based Payments," using the modified prospective application method. Under this transition method, compensation cost recognized for the year ended December 31, 2006, includes the applicable amounts of: (a) compensation cost of all stock-based payments granted prior to, but not yet vested as of, December 31, 2005 (based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123 and previously presented in pro forma footnote disclosures), and (b) compensation cost for all stock-based payments granted subsequent to January 1, 2006 (based on the grant-date fair value estimated in accordance with the new provisions of SFAS No. 123 (R)). Results for periods prior to January 1, 2006, have not been restated. We calculated the fair value of each option grant on the date of grant using the Black-Scholes option pricing model that use the following assumptions. Risk-free interest rate is based on the US Treasury yield curve in effect at the time of grant. We use the simplified method as provided by Staff Accounting Bulletin No. 107 by average vesting term and contractual term of the options as their expected term. Expected volatilities are based on historical volatility of stock prices for a period equal to the options' expected term. The dividend yield is zero as we have never declared or paid dividends on the ordinary shares or other securities and do not anticipate paying dividends in the foreseeable future. Recent Accounting Pronouncements In September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and enhances fair value measurement disclosure. In February 2008, the FASB issued FASB Staff Position (FSP) 157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13" (FSP 157-1) and FSP 157-2, "Effective Date of FASB Statement No.157" (FSP 157-2). FSP 157-1 amends SFAS No. 157 to remove certain leasing transactions from its scope. FSP 157-2 delays the effective date of SFAS No. 157 for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2009. The measurement and disclosure requirements related to financial assets and financial liabilities are effective for the Company beginning in the first quarter of fiscal 2008. The adoption of SFAS No. 157 for financial assets and financial liabilities will not have a significant impact on the consolidated financial statements. However, the resulting fair values calculated under SFAS No. 157 after adoption may be different from the fair values that would have been calculated under 22

previous guidance. We are currently evaluating the impact that SFAS No. 157 will have on the consolidated financial statements when it is applied to non-financial assets and non-financial liabilities beginning in the first quarter of 2009. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." SFAS No. 159 expands the use of fair value accounting but does not affect existing standards, which require assets and financial liabilities, on an instrument-by-instrument basis. If the fair value option is elected, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the adoption of SFAS No. 159, changes in fair value are recognized in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We chose not to elect the fair value option under SFAS No. 159 to measure our financial assets and financial liabilities at fair value. In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" (SFAS No. 141(R)). Under SFAS No. 141(R), an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. In addition, acquired in-process research and development (IPR&D) is capitalized as an intangible asset and amortized over its estimated useful life. SFAS No. 141(R) is effective on a prospective basis for business combinations with an acquisition date beginning in the first quarter of fiscal year 2009. We are in the process of evaluating the provisions of this standard and is currently unable to estimate the impact. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements--an amendment of ARB No. 51" (SFAS No.160). SFAS No. 160 changes the accounting and reporting for minority interests, which will be recharacterized as non-controlling interests and classified as a component of equity. SFAS No. 160 is effective on a prospective basis for business combinations with an acquisition date beginning in the first quarter of fiscal year 2009. As of December 31, 2007, the Company did not have any minority interests. The adoption of SFAS No. 160 will not impact the our consolidated financial statements. Operating Results The following table summarizes historical results of operations as a percentage of net sales for the periods shown. Year Ended December 31, ---------------------- 2005 2006 2007 ----- ----- ----- Consolidated Statement of Income Data: Net sales................................................... 100.0% 100.0% 100.0% Cost of sales............................................... 38.6 45.4 42.9 ----- ----- ----- Gross margin................................................ 61.4 54.6 57.1 Operating expenses (income): Research and development................................. 24.1 25.4 20.9 Selling, general and administrative...................... 19.2 23.4 21.0 Patent related litigation................................ 9.6 8.8 6.6 Litigation income........................................ -- -- (5.7) Stock Exchange of Hong Kong listing expenses............. 2.3 0.6 0.0 ----- ----- ----- Total operating expenses............................. 55.2 58.2 42.8 ----- ----- ----- Income (loss) from operations............................... 6.2 (3.6) 14.3 Non-operating income-net.................................... 2.5 2.2 1.7 Income tax expenses (benefit)............................... 1.0 (2.0) 0.9 ----- ----- ----- Net income.................................................. 7.7% 0.6% 15.1% ===== ===== ===== Years Ended December 31, 2007 and 2006 Net Sales. Net sales consisted of product revenues generated principally by sales of our integrated circuit products. Net sales for the year ended December 31, 2007 were $165.5 million, an increase of $40.6 million or 32.5% from $124.9 million for the year ended December 31, 2006. The increase in net sales resulted primarily from increased unit shipments to our existing customers, expansion of our customer base and the introduction of new products. Gross Profit. Gross profit represents net sales less cost of sales. Cost of sales primarily consists of the cost of purchasing packaged integrated circuit products manufactured and assembled for us by independent foundries and packaging vendors and other costs associated with the procurement, storage and shipment of these products. Gross profit for the year ended December 31, 2007 was $94.4 million, an increase of $26.3 million or 38.6% from $68.1 million for the year ended December 31, 2006. This increase was primarily due to increased sales of our integrated circuit products. Gross profit as a percentage of net sales for the year ended December 31, 2007 increased to 57.1% from 54.6% for the year ended December 31, 23

2006 primarily due to increased sales of our higher margin products and the decline of manufacturing unit prices from third-party foundries and assembly and testing service providers. We expect that our gross profit as a percentage of net sales will continue to fluctuate in the future as a result of the stages of our products in their life cycles, variations in our product mix, the timing of our product introductions and specific product manufacturing costs. Research and Development Expenses. Research and development expenses consist primarily of salaries and related costs of employees engaged in research, design and development activities and, to a lesser extent, expenses for outside engineering consultants. Research and development expenses for the year ended December 31, 2007 were $34.6 million, an increase of $2.9 million or 9.0% from $31.8 million for the year ended December 31, 2006. The increase primarily resulted from increased hiring of design engineers and increased consultancy fees paid to outside consultants in respect of certain research and development projects. As a percentage of net sales, research and development expenses were 20.9% for the year ended December 31, 2007, a decrease from 25.4% for the year ended December 31, 2006. Research and development expenses as a percentage of net sales will fluctuate from quarter to quarter depending on the amount of net sales and the success of new product development efforts, which we view as critical to our future growth. At any point in time, we may also have internal research and development projects underway, which may or may not lead to new product designs. We expect to continue the development of innovative technologies and processes for new products and we believe that a continued commitment to research and development is essential in order to maintain the competitiveness of our existing products and to provide innovative new product offerings. Therefore, we expect to continue to invest significant resources in research and development in the future. Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of employee-related expenses, professional fees paid to external auditors, consulting fees, travel and other promotional expenses. Selling, general and administrative expenses for the year ended December 31, 2007 were $34.7 million, an increase of $5.5 million or 18.8% from $29.2 million for the year ended December 31, 2006. This increase was primarily due to increased consulting fees, increased professional fees paid to external auditors due to the audit of our internal control over financial reporting, additional hiring of personnel and increased promotional expense. As a percentage of net sales, selling, general and administrative expenses were 21.0% for the year ended December 31, 2007, a decrease from 23.4% for the year ended December 31, 2006. We expect that selling, general and administrative expenses will continue to increase in absolute dollar terms for the foreseeable future. Patent Related Litigation Expenses. Patent related litigation expenses consist primarily of fees paid to outside counsel and consultants engaged by outside counsel. Patent related litigation expenses for the year ended December 31, 2007 were $10.8 million, a decrease of $114,000 or 1.0% from $11.0 million for the year ended December 31, 2006. As a percentage of net sales, patent related litigation expenses were 6.6% for the year ended December 31, 2007, a decrease from 8.8% for the year ended December 31, 2006. We expect that patent related litigation expenses will continue to fluctuate for the foreseeable future. (Please see also, "Business Overview - Intellectual Property.") Litigation Income. Litigation income consist primarily of amounts received from settlement, damage awards, award of costs and related interest. Litigation income for the year ended December 31, 2007 was $9.4 million, an increase of $9.4 million or 100% from none for the year ended December 31, 2006. This increase was due to payments received from the MPS case which went to trial in 2005, the Sony US case and the Samsung US case since the quarter ended June 30, 2007. We expect that litigation income will continue to fluctuate for the foreseeable future. Stock Exchange of Hong Kong Listing Expenses. The SEHK listing expenses consist primarily of expenses incurred in relation to our SEHK listing activities commencing in 2005. SEHK listing expenses for the year ended December 31, 2007 was none, a decrease of $786,000 or 100.0% from $786,000 for the year ended December 31, 2006. Non-operating Income-net. Non-operating income-net reflects primarily interest earned on cash and cash equivalents and short-term investments, impairment loss on long-term investments and foreign exchange transaction losses. Non-operating income-net was $2.8 million for the year ended December 31, 2007 decreasing from $2.9 million for the year ended December 31, 2006 primarily due to decreased interest income, increased net foreign exchange loss and decreased other net income offset by the absence of impairment loss on long-term investments. Income Tax Expense (benefit). Income tax expense was approximately $1.5 million for the year ended December 31, 2007, compared to an income tax benefit of $2.5 million for the year ended December 31, 2006. This increase in income tax expense was primarily due to increased income before income tax and a reversal of an accrual of income tax payable upon the completion of the examination of our tax filing for 2001 by the Taiwan Tax Authority in 2006. Years Ended December 31, 2006 and 2005 Net Sales. Net sales consisted of product revenues generated principally by sales of our integrated circuit products. Net sales for the year ended December 31, 2006 were $124.9 million, an increase of $19.4 million or 18.3% from $105.6 million for the year ended December 31, 2005. The increase in net sales resulted primarily from increased unit shipments to our existing customers, expansion of our customer base and the introduction of new products. Gross Profit. Gross profit represents net sales less cost of sales. Cost of sales primarily consists of the cost of purchasing packaged integrated circuit products manufactured and assembled for us by independent foundries and packaging 24

vendors and other costs associated with the procurement, storage and shipment of these products. Gross profit for the year ended December 31, 2006 was $68.1 million, an increase of $3.3 million or 5.1% from $64.8 million for the year ended December 31, 2005. This increase was primarily due to increased sales of our integrated circuit products. Gross profit as a percentage of net sales for the year ended December 31, 2006 decreased to 54.6% from 61.4% for the year ended December 31, 2005 primarily due to increased sales of our lower margin products. We expect that our gross profit as a percentage of net sales will continue to fluctuate in the future as a result of the stages of our products in their life cycles, variations in our product mix, the timing of our product introductions and specific product manufacturing costs. Research and Development Expenses. Research and development expenses consist primarily of salaries and related costs of employees engaged in research, design and development activities and, to a lesser extent, expenses for outside engineering consultants. Research and development expenses for the year ended December 31, 2006 were $31.8 million, an increase of $6.3 million or 24.9% from $25.4 million for the year ended December 31, 2005. This increase primarily resulted from increased hiring of design engineers, increased consultancy fees paid to outside consultants in respect of certain research and development projects and the stock-based compensation expense recognized due to adoption of SFAS No, 123 (R). As a percentage of net sales, research and development expenses were 25.4% for the year ended December 31, 2006, an increase from 24.1% for the year ended December 31, 2005. Research and development expenses as a percentage of net sales will fluctuate from quarter to quarter depending on the amount of net sales and the success of new product development efforts, which we view as critical to our future growth. At any point in time, we may also have internal research and development projects underway, which may or may not lead to new product designs. We expect to continue the development of innovative technologies and processes for new products and we believe that a continued commitment to research and development is essential in order to maintain the competitiveness of our existing products and to provide innovative new product offerings. Therefore, we expect to continue to invest significant resources in research and development in the future. Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of employee-related expenses, sales commissions to agents, professional fees, travel and other promotional expenses. Selling, general and administrative expenses for the year ended December 31, 2006 were $29.2 million, an increase of $8.9 million or 44.0% from $20.3 million for the year ended December 31, 2005. This increase was primarily due to additional hiring of sales, operations and administrative personnel, increased promotional expense, increased traveling expense and the stock-based compensation expense recognized due to adoption of SFAS No. 123 (R). As a percentage of net sales, selling, general and administrative expenses were 23.4% for the year ended December 31, 2006, an increase from 19.2% for the year ended December 31, 2005. We expect that selling, general and administrative expenses will continue to increase in absolute dollar terms for the foreseeable future. Patent Related Litigation Expenses. Patent related litigation expenses consist primarily of fees paid to outside counsel and consultants engaged by outside counsel. Patent related litigation expenses for the year ended December 31, 2006 were $11.0 million, an increase of $788,000 or 7.7% from $10.2 million for the year ended December 31, 2005. This increase was primarily due to increased activity in various litigation matters. As a percentage of net sales, patent related litigation expenses were 8.8% for the year ended December 31, 2006, a decrease from 9.6% for the year ended December 31, 2005. We expect that patent related litigation expenses will continue to fluctuate for the foreseeable future. (Please see also, "Business Overview - Intellectual Property.") Stock Exchange of Hong Kong Listing Expenses. The SEHK listing expenses consist primarily of expenses incurred in relation to our SEHK listing activities commencing in 2005. SEHK listing expenses for the year ended December 31, 2006 was $786,000, a decrease of $1.7 million or 68.0% from $2.5 million for the year ended December 31, 2005. Non-operating Income-net. Non-operating income-net reflects primarily interest earned on cash and cash equivalents and short-term investments, impairment loss on long-term investments and foreign exchange transaction losses. Non-operating income-net was $2.9 million for the year ended December 31, 2006 increasing from $2.7 million for the year ended December 31, 2005, reflecting increased interest earned on cash and cash equivalents, and short term investments. Income Tax Expense (benefit). Income tax benefit was approximately $2.5 million for the year ended December 31, 2006, compared to an income tax expense of $1.0 million for the year ended December 31, 2005. This difference was primarily due to a reversal of an accrual of income tax payable upon the completion of examination of our 2001 tax filing by the Taiwan Tax Authority in 2006. Liquidity and Capital Resources Since our inception, we have financed our operations primarily through private sales of securities and through our initial public offering in August 2000 and our public offering in November 2001 as well as cash provided by operating activities in recent years. Cash, cash equivalents and short-term investments were $81.2 million at December 31, 2007 as compared to $65.1 million at December 31, 2006. Our operating activities provided cash in the amount of $21.4 million in the year ended December 31, 2007, $3.3 million in the year ended December 31, 2006, and $11.0 million in the year ended December 31, 2005. Non-cash charges primarily consist of depreciation of property and equipment, impairment loss of long-term investments, changes of deferred income tax assets, reversal of income tax payable, and amortization of stock-based compensation from stock options. The working capital components that have a significant impact on our cash flows are accounts 25

receivable, inventories, notes and accounts payable, prepaid expenses and other current assets, income tax payable and accrued expense and other current liabilities. Net cash inflows from operations resulted from net income adjusted by changes in inventory, accounts receivable, notes and accounts payable, accrued expenses and other current liabilities and income tax payable. In 2007, we had a net cash outflow from investing activities of $14.3 million as compared to a net cash inflow of $1.7 million in 2006. This increase in net cash used by investing activities between 2006 and 2007 was principally due to a net purchase of short-term investments of $8.9 million in 2007 as compared to net sales of short-term investments of $35.5 million in 2006 offset by a decrease of $15.2 million in acquisition of property and equipment and a decrease in acquisition of long-term investments of $8.1 million. In 2006, we had a net cash inflow from investing activities of $1.7 million as compared to a net cash outflow of $19.3 million in 2005. This increase in net cash provided by investing activities between 2005 and 2006 was principally due to an increase of $29.0 million in net sales of short-term investments. This increase was partially offset by an increase of $8.5 million in net acquisitions of property and equipment. Net cash outflow from our financing activities in 2005 was $2.1 million, primarily due to the repurchase of our shares and ADSs under a share repurchase program, which was partially offset by proceeds from the exercise of stock options and warrants and issuance of shares under our Employee Stock Purchase Plan. Net cash outflow from our financing activities in 2006 was $6.2 million, primarily due to the repurchase of $7.6 million of our ordinary shares and American depositary shares under a share repurchase program in 2006 which was partially offset by proceeds from the exercise of stock options and issuance of shares under our existing Employee Stock Purchase Plan for the year. Net cash outflow from our financing activities in 2007 was $956,000 which was primarily due to the repurchase of $4.3 million of our Shares and American depositary shares under a share repurchase program which was partially offset by proceeds from the exercise of stock options and issuance of shares under our existing employee stock purchase plan for the year. The listing of our ordinary shares on the Main Board of the SEHK may or may not enhance our ability to obtain additional financing in the future. We believe our cash balances will be sufficient to meet our capital requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including the inventory levels we maintain, the level of investments we make in new technology and improvements to existing technology, the levels of promotion and advertising required to launch new products and attain a competitive position in the marketplace, and the market acceptance of our products. Thereafter, we may need to raise additional funds through public or private financing. No assurance can be given that additional funds will be available or that we can obtain additional funds on terms favorable to us. Research and Development, Patents and Licenses, etc. We believe that the continued introduction of new products in our target markets is essential to our growth. As of December 31, 2007, we had approximately 627 full-time employees world-wide engaged in research and development efforts. Our total expenditures for research and development were $34.6 million for the year ended December 31, 2007, $31.8 million for the year ended December 31, 2006, and $25.4 million for the year ended December 31, 2005. We believe that our research and development staffing will increase in the next 12 months primarily due to the expansion of our existing design centers. We intend to continue to expand our research and development operations, including increasing the number of design engineers. We employ designers who are experienced in system architecture, analog, digital, mixed signal and software design and development. We also utilize independent contractors from time-to-time for specific research and development projects. Our internal research and development personnel thoroughly review the external development processes and the design of these products as part of our quality assurance process. All development is carried out using ISO 9001 certified design processes, and our design tools are continuously enhanced to improve design, fabrication and verification of our products. Our research and development activities are a constantly evolving process which reflects the results of our ongoing projects, our expectations regarding market developments and changes in customer demand and industry specifications. We commence new projects or alter the scope or direction of existing projects on a regular basis under the guidance of our management and senior research personnel. 26

We work with our customers to monitor the performance of our product designs and to provide support at each stage of customer product development. Due to the complexity of our products, we maintain a significant direct applications support staff for customer technical support in our key markets including in Japan, Taiwan, China, Korea and the United States. These direct applications engineering personnel assist with supporting existing products at key customers. Additionally, we work closely with our customers to develop highly efficient power management products for specific applications. Trend Information See "Risk Factors" and "Operating and Financial Review and Prospects" above. Off-Balance Sheet Arrangements There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. Tabular Disclosure of Contractual Obligations The table below describes our contractual obligations as of December 31, 2007: Payments due by period ---------------------------------------------- Less than More than Total 1 year 1-3 years 3-5 years 5 years Contractual Obligations ------ --------- --------- --------- --------- (in thousands) Operating Lease Obligations....................... $3,858 $2,274 $1,522 $62 $ -- Purchase Obligations.............................. 537 537 -- -- -- Licenses, Maintenance and Support................. 1,178 1,078 100 -- -- Pension........................................... 520 -- -- -- 520 Total............................................. 6,093 3,889 1,622 62 520 We recognized long-term taxes payable of $210,000 related to uncertain tax positions as of December 31, 2007. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES Directors and Senior Management Our executive officers and directors and their ages as of December 31, 2007, were as follows: Name Age Position - ---- --- -------- Sterling Du................... 48 Chief Executive Officer, Class I Director and Chairman of the Board Chuan Chiung "Perry" Kuo...... 48 Chief Financial Officer, Joint Secretary and Class I Director James Keim.................... 63 Class II Director and Head of Marketing and Sales Michael Austin................ 72 Independent Non-executive Director, Class III Director and member of Compensation Committee Lawrence Lin.................. 57 Independent Non-executive Director, Class II Director and member of Audit Committee and Compensation Committee Ji Liu........................ 72 Independent Non-executive Director, Class II Director Teik Seng Tan................. 53 Independent Non-executive Director, Class I Director and member of Audit Committee Keisuke Yawata................ 73 Independent Non-executive Director, Class III Director and Chairman of Audit Committee Xiaolang Yan.................. 61 Independent Non-executive Director and Class III Director Ivan Chang.................... 45 Vice-President, Finance Johnny Chiang................. 50 Vice-President, Logistics and Backend Jane Liang.................... 39 Qualified Accountant 27

Our Class I Directors have held office from the date of the annual general meeting in 2008 for a three year term until 2011; our Class II Directors have held office from the date of the annual general meeting in 2006 for a three year term until 2009; and our Class III Directors have held office from the date of the annual general meeting in 2007 for a three year term until 2010. Executive Directors Sterling Du has served as our chief executive officer and chairman of our board of directors since March 1997 and as a Class I Director since June 2001. He also served as our chief financial officer from March 1997 to March 1999. From May 1995 to March 1997, Mr. Du was president and chief executive officer of O\\2\\Micro, Inc., our predecessor entity. From October 1993 to April 1995, Mr. Du was vice president of engineering at GreenLogic, Inc., a semiconductor design company, which he co-founded. Mr. Du received a B.S. in chemical engineering from National Taiwan University and an M.S. in electrical engineering from the University of California, Santa Barbara. Chuan Chiung "Perry" Kuo has served as our general manager of Taiwan operations since January 1997, as chief financial officer and a director since March 1999, as secretary since October 1999 and as a Class I director since June 2001. From February 1992 to December 1996, he was executive vice president of Pac Net Group, a holding company with investments in chemicals, electronics and real estate. From July 1983 to February 1992, he held various positions at Formosan Rubber Group, a rubber manufacturer, including product design engineer, plant manager, research and development director, and vice president. Mr. Kuo received a B.S. in chemical engineering from National Taiwan University and an M.B.A. from the Rotterdam School of Management, Erasmus University in The Netherlands. James Keim has served as a director since March 1999 and as Head of Marketing and Sales since December 2001 and a Class II director since June 2001. He also served as our chief operating officer from June 1998 to June 2001. From March 1995 to June 1998, Mr. Keim was a principal in Global Marketing Associates, an international consulting firm. Prior to March 1995, he had been vice president of sales at Alliance Semiconductor Corporation, vice president of marketing at Performance Semiconductor Corporation and worldwide linear marketing manager at Fairchild Semiconductor Corporation. Mr. Keim received a B.S. in engineering from Iowa State University, an M.S. in electrical engineering and an M.B.A. from the University of Illinois. Independent Non-Executive Directors Michael Austin has served as a director since October 1997 and as a Class III director since June 2001. He currently serves on the compensation committee and nominating committee. Mr. Austin is a resident of the Cayman Islands and is a Chartered Accountant. Mr. Austin was admitted as an Associate of the Institute of Chartered Accountants in England and Wales in 1964 and as a Fellow in 1974. Mr. Austin is also an Associate Member of The Chartered Institute of Taxation, a Member of the Society of Trust and Estate Practitioners, and a Notary Public of the Cayman Islands. Mr. Austin served as the managing partner of the Cayman Islands office of KPMG Peat Marwick, an international accounting firm, for 23 years. Since retiring in July 1992, Mr. Austin has been a consultant and currently serves as a non-executive director on several company boards, including those of a number of mutual funds, trust and insurance companies. Mr. Austin served as a director of the Cayman Islands Monetary Authority from January 1997, and was appointed Chairman of the Board in January 2003, a position he held until his retirement on July 31, 2004. He has also served on a variety of other government committees and government related boards, including the Cayman Islands Agricultural and Industrial Development Board, as Chairman; the Stock Exchange Committee; and the Government/Private Sector Consultative Committee. In 1990 Mr. Austin was awarded an M.B.E. by Her Majesty the Queen in recognition of services to the public and business community. Lawrence Lin has served as a Class II Director and a member of the audit committee since June 2003. He currently also serves as Chairman of the Compensation Committee. He is a Certified Public Accountant in Taiwan. Since 1990, Mr. Lin has been a partner of L&C Company, Certified Public Accountants, which is a member firm of Urbach Hacker Young International, and a director of Urbach Hacker Young International from October 1994 to October 1998. Prior to L&C Company, he was a partner at T N Soong & Co. Mr. Lin serves as an independent non-executive director and chairman of the audit committee for Yageo Corporation and corporate supervisor for Tex Year Industries Inc., both of which are Taiwan public companies. He graduated from Taipei Vocational Commercial School in 1969. Ji Liu has served as a Class II Director since June 2007. Mr. Liu has been an Honorary President of the China Europe International Business School since 2005. From 1999 to 2004, Mr. Liu was Executive President and President of the China Europe International Business School. From 1993 to 1999, Mr. Liu was a Research Fellow, Member of the Academic Board, Graduate Supervisor and Deputy Chairman of the Chinese Academy of Social Sciences. He received a B.S. in power mechanical engineering from Tsinghua University in China. Teik Seng Tan was recently elected as a Class I Director in the annual general meeting in June 2008. He was also recently appointed to the Audit Committee in June 2008. Mr. Tan was previously employed by AMD Singapore Pte Ltd. from 1984 to 2007 where he held various positions, the last position being Senior Executive Managing Director. Mr. Tan currently serves as a director of HMC Associates Pte Ltd. He also has been Chairman of the Board of Directors for Bizlink Centre 28

Singapore Ltd. since 2001 and a member of the Board of Directors since 1999. Mr. Tan is a member of the Advisory Council for the Singapore Human Resource Institute and a member of the Advisory Council of the School of Engineering at Temasek Polytechnic. Mr. Tan received a B.S. in Electrical Engineering from the University of Singapore and an M.S. in Industrial Engineering from the National University of Singapore. Keisuke Yawata has served as a director since October 1999, as a member of the audit committee since August 2000, as Chairman of the audit committee since July 2001 and as a Class III director since June 2001. Mr. Yawata has been a partner and director of Start-up101, a venture capital firm, since 1999 and is the Chief Executive Officer of The Future International, a consulting firm he founded in 1997. From 1995 to 1997, he was the president and chief executive officer of Applied Materials Japan and a senior vice president of Applied Materials, Inc. From 1985 to 1994, he was at LSI Logic KK, serving as president and chief executive officer from 1985 to 1992, and as chairman of the board from 1993 to 1994. From 1958 to 1984, he was employed by NEC Corporation and its subsidiaries where he held various positions, the last position being president and chief executive officer of NEC Electronics, Inc. from 1981 to 1984. In addition, Mr. Yawata was a vice president of the Semiconductor Industry Association Japan Chapter from 1989 to 1994. Mr. Yawata serves as a director on the boards of U10 Networks, DigiPub Japan, Sequence Design KK and NanoGeometry Research. He received a B.S. in electrical engineering from Osaka University in Osaka, Japan and an M.S. in electrical engineering from Syracuse University. Xiaolang Yan has served as a Class III Director since July 2005 and currently serves on the nominating committee. Mr. Yan is a professor and Dean of the Electrical Engineering College, Dean of the Information Science & Engineering College and Director of Institute of VLSI Design at Zhejiang University in China. He is also the Director of China's National Integrated Circuit Talent Education Program and Vice President of China Semiconductor Industry Association. From May 2002 to October 2006, he was the Director of the Strategic Expert Committee for VLSI Design of the China State High Technology Program (863 Program). From May 1994 to March 1999, he was Professor and Dean of Hangzhou Institute of Electronic Engineering and Director of its ICCAD Research Institute. From September 1993 to May 1994, he was a visiting scholar at Stanford University. From March 1990 to September 1993, he was Executive Vice-President and Chief Engineer at Beijing IC Design Center in Beijing, China. Mr. Yan received his bachelor of science and master of science degrees in electrical engineering from Zhejiang University in Hangzhou, China. Senior Management Ivan Chang has served as our Vice-President, Finance since February 2003. He also served as our Controller from July 1999 until February 2003. From August 1996 to July 1999, he was Finance Manager at Siemens Limited in Taiwan. Mr. Chang received a B.S. in Accounting from Soochow University and an M.S. in Accounting Information from University of Maryland, College Park. Johnny Chiang has served as our Vice-President, Logistics and Backend since February 2003. He also served as our Director of Operations from March 1999 to February 2003 and our Operations Manager from November 1997 to March 1999. Mr. Chiang received a B.S. in Industrial Engineering from Chung Yung University. Jane Liang has served as our Qualified Accountant since November 2005. She is a fellow of the Association of Chartered Certified Accountants and a member of the Chinese Institute of Certified Public Accountants. From July 2000 to October 2003, she was senior finance manager at Bausch & Lomb (Shanghai) Trading Co. From August 1999 to June 2000, she was an accounting supervisor at Exxon Chemical (Shanghai) Trading Co. Ms. Liang received her bachelors and masters degree in Philosophy from Fudan University. There are no family relationships among any of our directors or executive officers. There are no arrangements or understandings with major shareholders, customers, suppliers or others, pursuant to which any person referred to above was selected as a director or member of senior management. Compensation We paid an aggregate amount of compensation during 2007 to our directors and members of our administrative, supervisory or management bodies as a group equal to approximately $3,480,593. All of our officers and directors are eligible to participate in our employee benefit plans except non-employee directors are not eligible to participate in our ESPP plan. Share Ownership of Directors and Senior Management As of December 31, 2007, the aggregate number of ordinary shares beneficially owned by our directors and members of our administrative, supervisory or management bodies was 220,248,750. This number includes options to purchase an aggregate of 118,934,150 ordinary shares under our 1997 Stock Plan, 1999 Stock Plan and 2005 Share Option Plan exercisable within 60 days of December 31, 2007. Employee Benefit Plans 1997 Stock Plan. Our 1997 stock plan was adopted by our board of directors and approved by our shareholders in 1997. The 1997 stock plan provides for the granting to our employees of incentive stock options within the meaning of Section 422 of the United States Internal Revenue Code, and for the granting to employees and independent contractors of nonstatutory stock options and stock purchase rights. Our board of directors and our shareholders authorized a total of 3,700,000 ordinary 29

shares for issuance pursuant to the 1997 stock plan, as amended or 185,000,000 ordinary shares after taking into account the 50-to-1 stock split on November 25, 2005. As of December 31, 2007, options outstanding and exercisable under the 1997 stock plan were 15,041,650. No more grants have been made under this plan after the consummation of our initial public offering on August 23, 2000. Our 1997 stock plan was terminated effective on March 2, 2006, the date of the listing of our ordinary shares on the Hong Kong Stock Exchange; provided that options granted under the plan remain outstanding in accordance with their terms. 1999 Stock Incentive Plan. Our 1999 stock plan was adopted by our board of directors in October 1999 and was approved by our shareholders prior to the consummation of our initial public offering in August 2000. The 1999 stock plan provides for the granting to employees of incentive stock options within the meaning of Section 422 of the Internal Revenue Code and the granting of nonstatutory stock options, stock appreciation rights, dividend equivalent rights, restricted stock, performance units, performance shares and other equity-based rights to our employees, directors and consultants. Initially, we have reserved 3,000,000 ordinary shares for issuance under the 1999 stock plan or 150,000,000 ordinary shares after taking into account the 50-to-1 stock split on November 25, 2005. Commencing January 1, 2001, the number of ordinary shares of stock reserved for issuance under the 1999 stock plan will be increased annually by a number equal to 4% of the fully-diluted number of ordinary shares outstanding as of December 31 of the immediately preceding calendar year or a lesser number determined by the administrator. However, the maximum number of ordinary shares available for issuance as incentive stock options will be increased by the least of 4% of the fully-diluted number of ordinary shares outstanding on December 31 of the immediately preceding calendar year, 1,500,000 ordinary shares (or 75,000,000 ordinary shares after taking into account the 50-to-1 stock split on November 25, 2005) or a smaller number as determined by the administrator. In the year ended December 31, 2007, the number of shares reserved under the 1999 stock plan was not increased. Where an award agreement permits the exercise or purchase of the award for a specified period of time following the recipient's termination of service with us, or the recipient's disability or death, the award will terminate to the extent not exercised or purchased on the last day of the specified period or the last day of the original term of the award, whichever occurs first. As of December 31, 2007, options outstanding under the 1999 stock plan were 247,296,700, of which 221,273,550 were exercisable. Our 1999 stock plan was terminated effective on March 2, 2006, the date of the listing of our ordinary shares on the Hong Kong Stock Exchange; provided that options granted under the plan remain outstanding in accordance with their terms. 1999 Employee Stock Purchase Plan. Our 1999 purchase plan was approved by our board of directors in October 1999, was approved by our shareholders prior to the consummation of our initial public offering in August 2000 and is intended to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code and to provide our employees with an opportunity to purchase ordinary shares or ADSs through payroll deductions. In May 2005, our board of directors adopted certain amendments to the 1999 purchase plan and in October 2005 our board of directors adopted and approved an amendment and restatement of 1999 purchase plan to amend various administrative terms in anticipation of our listing on the Hong Kong Stock exchange. We have reserved 50,000,000 ordinary shares for issuance under our 1999 purchase plan, subject to adjustment upon certain changes in our capitalization. The number of ordinary shares which shall be made available for sale under the 1999 purchase plan, any share options granted pursuant to our 2005 share option plan and any other plan (but not including our 2005 share incentive plan) will not exceed 10% of the number of ordinary shares to be issued and outstanding immediately following the listing of our ordinary shares on the Hong Kong Stock Exchange. In no event may an option be granted under our 1999 purchase plan if such grant would result in the total aggregate number of ordinary shares subject to all then outstanding purchase rights granted by us pursuant to our 1999 purchase plan, any share option granted pursuant to our 2005 share option plan or any other plan (but not including our 2005 share incentive plan) to exceed 30% of the issued and outstanding ordinary shares from time to time. At the annual general meeting in June 2008, the shareholders approved, adopted and ratified an amendment to the 1999 purchase plan to increase the number of shares issuable pursuant to the 1999 purchase plan from 50,000,000 to 70,000,000 shares. As of December 31, 2007, 39,208,350 shares had been issued under the 1999 purchase plan. Our board of directors or a committee designated by our board of directors, referred to as the "plan administrator", administers our 1999 purchase plan. All of our employees who are regularly employed for more than five months in any calendar year and work more than 20 hours per week are eligible to participate in our 1999 purchase plan, subject to a 10 day waiting period after hiring. Non-employee directors, consultants and employees subject to the rules or laws of a non-U.S. jurisdiction that prohibit or make impractical their participation in the plan will not be eligible to participate. Our 1999 purchase plan designates offer periods, purchase periods and exercise dates. Offer periods are periods of three months commencing in February, May, August and November. Purchase periods will generally be three month periods. Exercise dates are the last day of each purchase period. In the event of a corporate transaction, the plan administrator may elect to shorten the offer periods then in progress and set a new exercise date for the purchase of ordinary shares or ADSs. On the first day of each offer period, a participating employee will be granted a purchase right. A purchase right is a form of option to be automatically exercised on the forthcoming exercise dates within the offer period during which authorized deductions are to be made from the pay of participants and credited to their accounts under our 1999 purchase plan. When the purchase right is exercised, the participant's withheld salary is used to purchase the ordinary shares or ADSs. The price per share at which the ordinary shares or ADSs are to be purchased under our 1999 purchase plan during any purchase period will be expressed as a percentage not less than the lower of (a) 90% of the fair market value of the ordinary shares or ADSs on the date of grant of the purchase right (which is the commencement of the offer period) or (b) 90% of the fair market value of the ordinary 30

shares or ADSs on the date the purchase right is exercised. Purchase rights may not be assigned, transferred, pledged or otherwise disposed of in any way by the participant, other than by will or the laws of descent and distribution. Payroll deductions may range from 1% to 10% in whole percentage increments of a participant's regular base pay. The maximum number of ordinary shares or ADSs that any employee may purchase under our 1999 purchase plan during a purchase period is 100,000 ordinary shares or 2,000 ADSs. In addition, Section 423 of the U.S. Internal Revenue Code imposes a US$25,000 limit on the maximum amount of ordinary shares or ADSs that may be purchased under a tax-qualified employee stock purchase plan during any calendar year. The US$25,000 limit is determined at the fair market value of the ordinary shares or ADSs at the time such option is granted for each calendar year in which such option is outstanding. The plan administrator has the authority to amend or terminate our 1999 purchase plan. The plan administrator may terminate any offer period on any exercise date if the plan administrator determines that the termination of the offer period is in the best interests of our company and its shareholders. 2005 Share Option Plan. Our 2005 share option plan was adopted by our board of directors in August 2005, was approved by our shareholders in November 2005 and took effect on March 2, 2006. The 2005 share option plan provides for the granting to employees of incentive stock options within the meaning of Section 422 of the Internal Revenue Code and the granting of nonstatutory stock options to our employees, directors and consultants. Initially, the maximum aggregate number of shares reserved for issuance pursuant to all options (including incentive stock options) under the 2005 share option plan is 100,000,000 ordinary shares after taking into account the 50-to-1 stock split on November 25, 2005 and such number of shares shall not, when added to the remaining number of ordinary shares available for the grant of options under any other plan or employee share purchase plan, be greater than 10% of the number of ordinary shares outstanding as of the date of adoption of the 2005 share option plan. The maximum number of shares that may be issued upon exercise of all outstanding (and unexercised) options under the 2005 share option plan and any other plan of ours and any purchase rights granted by us pursuant to any employee share repurchase plan must not, in aggregate, exceed 30% of the number of ordinary shares outstanding from time to time. Where an award agreement permits the exercise or purchase of the award for a specified period of time following the recipient's termination of service with us, or the recipient's disability or death, the award will terminate to the extent not exercised or purchased on the last day of the specified period or the last day of the original term of the award, whichever occurs first. As of December 31, 2007, 45,169,900 options were outstanding under the 2005 share option plan. 2005 Share Incentive Plan. Our 2005 share incentive plan was adopted by our board of directors in August 2005, was approved by our shareholders in November 2005 and took effect on March 2, 2006. The 2005 share incentive plan provides for the granting to our employees, directors and consultants of restricted shares, cash dividend equivalent rights, restricted share units or stock appreciation rights or similar right with a fixed or variable price related to the fair market value of our ordinary shares and with an exercise or conversion privilege related to the passage of time, the occurrence of one or more events, or the satisfaction of performance criteria or other conditions. Initially, the maximum aggregate number of shares which may be issued pursuant the 2005 share incentive plan is 75,000,000 ordinary shares after taking into account the 50-to-1 stock split on November 25, 2005. In addition, a right entitling a grantee to compensation measured by dividends paid with respect to ordinary shares shall be payable solely in cash and shall not be deemed to reduce the maximum aggregate number of shares which may be issued under our 2005 share incentive plan. Where an award agreement permits the exercise or purchase of the award for a specified period of time following the recipient's termination of service with us, or the recipient's disability or death, the award will terminate to the extent not exercised or purchased on the last day of the specified period or the last day of the original term of the award, whichever occurs first. As of December 31, 2007, 14,327,550 shares were outstanding under the 2005 share incentive plan. Board Practices Duties of Directors Under Cayman Islands law, our directors have a duty of loyalty to act honestly in good faith with a view to promoting our best interests. Our directors also have a duty of care to exercise the care, diligence and skills that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association and the class rights vested under our memorandum and articles of association in the holders of the shares. Terms of Directors and Officers Our articles of association provide for not less than five nor more than nine directors although the holders of a majority of our shares may increase or reduce such limits. Our articles of association provide for our board of directors to be divided into three classes, designated Class I, Class II and Class III, with each class consisting of an equal number of directors or as nearly equal in number as the then total number of directors permits. The directors of each class have been elected for terms of three years ending in consecutive years. At each annual general meeting, successors to the class of directors whose terms expire at that annual general meeting are elected for new three year terms. If the number of directors is changed, any increase or decrease is apportioned among the classes so as to maintain the number of directors in each class as nearly equal as possible and any additional directors of any class elected to fill a vacancy resulting from an increase in such class shall hold office for a term that shall coincide with the remaining term of that class, but in no case will a decrease in the number of directors shorten the term of 31

any incumbent directors. The term of executive officers is determined by our board of directors. There are no provisions of Cayman Islands law which require the term of executive officers to be for a particular period. Our board of directors has the power at any time and from time to time to appoint any person to be a director, either to fill a casual vacancy or as an additional to the existing directors provided that the appointment does not cause the number of directors to exceed any number fixed by or in accordance with the articles of association as a maximum number of directors. Any director so appointed shall hold office only until one next annual general meeting and is then eligible for re-election at that meeting. Our shareholders may by special resolution remove any directors before the expiration of his period of office notwithstanding anything in the articles of association or in any agreement we have entered into with such director (but without prejudice to any claim for damages under any such agreement). There is no shareholding qualification for directors. Subject to any retirement rules, statutes or provisions provided by applicable law, any individual who reaches the age of seventy-five (75) years or older at the time of election or re-election will not be eligible for recommendation for nomination to our board. Subject to any retirement rules, statutes or provisions provided by applicable law, upon reaching seventy-five (75) years of age, any existing director will be allowed to complete his or her term in office but will not be eligible for recommendation for nomination to our board for a subsequent term. Committees of the Board of Directors We have an audit committee, a compensation committee and a nominating committee. Each of our audit committee members qualifies as an "independent" director for purposes of the rules and regulations of Nasdaq. The audit committee is established by the Board primarily for the purpose of overseeing the accounting and financial reporting processes of the Company and audits of the financial statements of the Company. The Committee's responsibilities include (1) the appointment, retention, compensation and oversight of the work of our independent auditors, and for review of its qualifications, and (2) review of our system of internal controls. The Committee also maintains procedures for the receipt, retention and treatment of complaints received by the Company regarding accounting, internal controls, or auditing matters and for the confidential, anonymous submission by employees of the company of concerns regarding accounting or auditing matters. The audit committee meets at least four times per year, and also meets separately with the representatives of management at least annually. The audit committee held seven meetings in 2007. Currently, Messrs. Lin, Tan and Yawata serve on the audit committee. The compensation committee establishes remuneration levels for our officers, performs the functions that are provided under our employee benefit programs and administers our long-term incentive, compensation and equity plans including our 1999 stock incentive plan, our 1999 employee stock purchase plan, our 2005 share incentive plan and 2005 share option plan. Currently, Messrs. Lin and Austin serve on the compensation committee. The nominating committee assists our board of directors in selecting nominees for election to our board of directors and makes recommendations to our board of directors from time to time, or whenever it shall be called upon to do so, regarding nominees for our board of directors. Currently, Messrs. Austin and Yan serve on the nominating committee. Compensation Committee Interlocks and Insider Participation No member of our compensation committee serves as a member of the board of directors or the compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or our compensation committee. Employees As of December 31, 2007, we had 1,107 full-time employees, 115 of which were based in the United States, 957 in Asia, 31 in Europe and 4 in Cayman Islands. Our employees are not represented by any collective bargaining agreements, and we have never experienced a work stoppage. We believe our employee relations are good. ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS MAJOR SHAREHOLDERS The following table sets forth information known to us with respect to the beneficial ownership of our ordinary shares, as of March 31, 2008, by each shareholder known by us to own beneficially more than 5% of our ordinary shares based on SEC filings as of March 31, 2008. 32

Shares Beneficially Owned ------------------------ Name of Beneficial Owner Number Percent - ------------------------ ----------- ------- Wasatch Advisors, Inc............................. 314,431,750 16.43% Trivium Capital Management LLC.................... 206,250,000 10.77% RS Investment Management Co....................... 137,929,800 7.21% Directors and members of our administrative, supervisory or management bodies................ 101,909,050 5.32% Based on SEC filings as of March 31, 2007, Wasatch Advisors, Inc. beneficially owned 356,712,650 of our ordinary shares or 18.73%, Wellington Management Co. LLP beneficially owned 187,601,500 of our ordinary shares or 9.85%, Capital Research & Management Co. beneficially owned 152,750,000 of our ordinary shares or 8.02% and RS Investment Management Co. beneficially owned 116,456,350 of our ordinary shares or 6.11%. Based on SEC filings as of March 31, 2006, Wasatch Advisors, Inc. beneficially owned 342,407,750 of our ordinary shares or 17.4%, Fidelity Management & Research Company beneficially owned 249,053,900 of our ordinary shares or 12.7%,RS Investment Management LP beneficially owned 200,665,550 of our ordinary shares or 10.2% and Capital Research & Management Co. beneficially owned 194,750,000 of our ordinary shares or 9.9%. None of the major shareholders listed above have differing voting rights with respect to the ordinary shares of the Company. We do not know of any arrangements the operation of which may at a subsequent date result in a change in control of the Company. To our knowledge, we are not directly or indirectly owned or controlled by another corporation, by a foreign government or any other natural or legal person. RELATED PARTY TRANSACTIONS Executive Severance and Change of Control Agreements In April 2007, we entered into an Executive Severance and Change of Control Agreement with Sterling Du, our chief executive officer and chairman of our board, pursuant to which Mr. Du would be entitled to, among other things, two times his base salary and annual target bonus and immediate vesting of 50% of his unvested equity awards if terminated under certain circumstances. In addition, Mr. Du would be entitled to, among other things, three times his base salary and annual target bonus and immediate vesting of 100% of his unvested equity awards if terminated under certain circumstances within twenty-four months of a change of control of our company. In April 2007, we entered into an Executive Severance and Change of Control Agreement with Chuan Chiung "Perry" Kuo, our chief financial officer, pursuant to which Mr. Kuo would be entitled to, among other things, one times his base salary and annual target bonus and immediate vesting of 50% of his unvested equity awards if terminated under certain circumstances. In addition, Mr. Kuo would be entitled to, among other things, one and a half times his base salary and annual target bonus and immediate vesting of 50% of his unvested equity awards if terminated under certain circumstances within twelve months of a change of control of our company. In April 2007, we entered into an Executive Severance and Change of Control Agreement with James Keim, our head of marketing and sales, pursuant to which Mr. Keim would be entitled to, among other things, one times his base salary and annual target bonus and immediate vesting of 50% of his unvested equity awards if terminated under certain circumstances. In addition, Mr. Keim would be entitled to, among other things, one and a half times his base salary and annual target bonus and immediate vesting of 50% of his unvested equity awards if terminated under certain circumstances within twelve months of a change of control of our company. ITEM 8. FINANCIAL INFORMATION CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION Consolidated Financial Statements Our financial statements set forth in the accompanying index to Consolidated Financial Statements included in this Annual Report following Part IV beginning on page F-1 are hereby incorporated in this Annual Report. Our Consolidated Financial Statements are filed as part of this Annual Report. DIVIDEND POLICY We have never declared or paid any cash dividends on our ordinary shares or other securities and do not anticipate paying cash dividends in the foreseeable future. ITEM 9. THE OFFER AND LISTING ADS AND ORDINARY SHARE PRICES AND RELATED MATTERS 33

Our ADSs are quoted and traded on the Nasdaq Global Select Market and the Cayman Islands Stock Exchange. Our ordinary shares are listed on the SEHK and the Cayman Islands Stock Exchange. Ordinary Shares Prior to Close of Trading on November 25, 2005 and ADSs After Commencement of Trading on November 28, 2005 The following information set forth for the periods indicated the high and low last reported sales prices per ordinary share prior to the close of trading on November 25, 2005 and the high and low last reported sales prices per ADS after the commencement of trading on November 28, 2005 as furnished by the Nasdaq Global Select Market. (a)Annual high and low market prices High Low ------ ----- January 1, 2003 through December 31, 2003.... $25.29 $8.01 January 1, 2004 through December 31, 2004.... $24.98 $9.04 January 1, 2005 through December 31, 2005.... $17.72 $8.74 January 1, 2006 through December 31, 2006.... $13.55 $5.07 January 1, 2007 through December 31, 2007.... $18.00 $7.06 (b)Quarterly high and low market prices First Quarter 2006........................... $13.55 $ 9.95 Second Quarter 2006.......................... $10.98 $ 7.20 Third Quarter 2006........................... $ 7.87 $ 5.07 Fourth Quarter 2006.......................... $ 8.64 $ 6.40 First Quarter 2007........................... $ 8.90 $ 7.06 Second Quarter 2007.......................... $11.53 $ 7.61 Third Quarter 2007........................... $15.86 $11.18 Fourth Quarter 2007.......................... $18.00 $11.30 First Quarter 2008........................... $11.60 $ 7.59 (c)Monthly high and low market prices December 2007................................ $14.54 $11.30 January 2008................................. $11.60 $ 7.97 February 2008................................ $ 9.09 $ 8.00 March 2008................................... $ 8.84 $ 7.59 April 2008................................... $ 8.35 $ 7.30 May 2008..................................... $ 9.75 $ 8.56 Ordinary Shares After Commencement of Trading On March 2, 2006 The following tables set forth for the periods indicated the high and low last reported sales prices per ordinary share in Hong Kong dollars (HK$) as furnished by the Hong Kong Stock Exchange. Our ordinary shares commenced trading on the Hong Kong Stock Exchange on March 2, 2006 (a)Annual high and low market prices High Low ------- ------- January 1, 2007 through December 31, 2007.... HK$2.66 HK$1.00 (b)Quarterly high and low market prices High Low ------- ------- Second Quarter 2006.......................... HK$1.70 HK$1.11 Third Quarter 2006........................... HK$1.16 HK$0.84 Fourth Quarter 2006.......................... HK$1.31 HK$0.94 First Quarter 2007........................... HK$1.32 HK$1.05 Second Quarter 2007.......................... HK$1.65 HK$1.16 Third Quarter 2007........................... HK$2.35 HK$1.72 Fourth Quarter 2007.......................... HK$2.66 HK$1.00 First Quarter 2008........................... HK$2.25 HK$1.01 34

(c)Monthly high and low market prices December 2007................................ HK$2.40 HK$1.00 January 2008................................. HK$2.25 HK$1.09 February 2008................................ HK$2.20 HK$1.24 March 2008................................... HK$1.39 HK$1.01 April 2008................................... HK$1.40 HK$1.00 May 2008..................................... HK$1.60 HK$1.18 ITEM 10. ADDITIONAL INFORMATION The following are summaries of material provisions of our memorandum and articles of association and the Companies Law (2004 Revision). The summary is qualified in its entirety by reference to our memorandum and articles of association (see Item 19-Exhibit 1). Registered Office The Company has been assigned registration number CR-72204 by the registrar of companies in the Cayman Islands. The registered office is located at the offices of Maples Corporate Services Limited, Ugland House, P.O. Box 309, South Church Street, Grand Cayman KY1-1104, Cayman Islands. The telephone number at that location is (345) 949-8066. Objects and Purposes Paragraph 3 of the memorandum of association provides that the objects and purposes of the Company are unlimited and the Company may perform all corporate activities not prohibited by any law as provided by the Companies Law. Directors Article 117 of the articles of association of the Company provides that a director will not be disqualified by his office from contracting with the Company notwithstanding such director's interest and that such an interested director will not be liable to the Company for any profit realized through such contract or arrangement, provided, the interested director declares such interest at the earliest meeting of the board. Article 127 provides that directors' compensation shall from time to time be determined by the Company in general meeting or by the board in accordance with the articles of association. Article 136 provides that the directors may exercise all the powers of the Company to borrow money and to mortgage or charge its undertaking, property and uncalled capital or any part thereof and to issue debentures, debenture stock and other securities whether outright or as security for any debt, liability or obligation of the Company or of any third party. Ordinary Shares General. The Company's articles of association authorize the issuance of 4,750,000,000 ordinary shares with a par value of US $0.00002. All the outstanding ordinary shares are fully paid and nonassessable and accordingly no further capital may be called for by the Company from any holder of the ordinary shares outstanding. Certificates representing the ordinary shares are issued in registered form. The ordinary shares are not entitled to any sinking fund or pre-emptive or redemption rights. Under Cayman Islands Law, non-residents may freely hold, vote and transfer ordinary shares in the same manner as Cayman Islands residents, subject to the provisions of the Companies Law and the articles of association. No Cayman Islands laws or regulations restrict the export or import of capital or affect the payment of dividends to non-residents holders of the ordinary shares. Dividends. The holders of our ordinary shares are entitled to receive the dividends that are declared by the board of directors. Dividends may be paid only out of profits, which include net earnings and retained earnings undistributed in prior years, and out of share premium, a concept analogous to paid-in-surplus in the United States, subject to a statutory solvency test. Voting Rights. Each ordinary share is entitled to one vote on all matters upon which the ordinary shares are entitled to vote, including the election of directors. Voting at any meeting of shareholders is by show of hands unless a poll is demanded. A poll may be demanded by the chairman of the meeting or any shareholder present in person or by proxy, before or on the declaration of the result of the show of hands. A quorum required for a meeting of shareholders consists of at least a number of shareholders present in person or by proxy and entitled to vote representing the holders of not less than a majority of our issued voting share capital. Shareholders' meetings are held annually and may be convened by the board of directors on its own initiative. Advanced notice of at least twenty-one days in the case of annual general meetings or any meeting at which the passing of a special resolution is to be considered and fourteen days in all other cases is required for the convening of shareholders' meetings. Any ordinary resolution to be made by the shareholders requires the affirmative vote of a simple majority of the votes attaching to the ordinary shares and preference shares, if any, cast in a general meeting, while a special resolution requires the affirmative vote of two-thirds of the votes cast attaching to the ordinary shares and preference shares, if any. Holders of ordinary shares, which are currently the only shares, carrying the right to vote at our general meetings, have the power, among other things, to elect directors, appoint auditors and make changes in the amount of our authorized share capital. 35

Material issues that require a special resolution of the shareholders under the Companies Law include resolutions to alter the memorandum of association with respect to any objects, powers or other matters specified therein, any alteration of the articles of association, any reduction of capital, any change of name, the appointment of an inspector for examining into the affairs of the company, requiring the company to be wound up by a court, any voluntary winding up, delegating to creditors the power of appointing liquidators, making binding arrangements between the company and its creditors, and sanctioning the transfer of the business or property of the company being wound up to another company whether established in the Cayman Islands or in any other jurisdiction. Liquidation. If we are to be liquidated, the liquidator may, with the approval of the shareholders, divide among the shareholders in cash or in kind the whole or any part of our assets, in a manner proportionate to their shareholdings, and may vest the whole or any part of those assets in trustees of those trusts for the benefit of the shareholders that the liquidator, with the approval of the shareholders, thinks fit, provided that, in practice, a shareholder may not be compelled to accept any shares or other assets that would subject that shareholder to liability. Preference Shares The articles of association authorizes the issuance of 250,000,000 preference shares with a par value of $0.00002 per share. Pursuant to our articles of association, the board of directors has the authority, without further action by the shareholders, to issue preference shares in one or more series. It also has the authority to fix the designations, powers, preferences, privileges and relative participating, optional or special rights and the qualifications, limitations or restrictions of those shares, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights of the ordinary shares. The board of directors, without shareholder approval, can issue preference shares with voting, conversion or other rights that could harm the voting power and other rights of the holders of ordinary shares. Subject to the directors' duty of acting in our best interest, preference shares can be issued quickly with terms calculated to delay or prevent a change in control or make removal of management more difficult. Additionally, the issuance of preference shares may have the effect of decreasing the market price of the ordinary shares, and may harm the voting and other rights of the holders of ordinary shares. We have confirmed that as long as our ordinary shares or preference shares are listed on the SEHK, we will comply with the listing rules of the SEHK and any preference shares issued or to be issued shall carry the same voting rights as the ordinary shares. Anti-takeover Effects of Provisions in Our Charter Documents Provisions in our charter documents could discourage potential acquisition proposals and could delay or prevent a change in control transaction that our shareholders favor. These provisions could have the effect of discouraging others from making tender offers for our shares. As a result, these provisions may prevent the market price of our ordinary shares from reflecting the effects of actual or rumored takeover attempts and may prevent shareholders from reselling their shares at or above the price at which they purchased their shares. These provisions may also prevent changes in our management that our shareholders may favor. Our charter documents do not permit shareholders to act by written consent, do not permit shareholders to call a general meeting and provide for a classified board of directors, which means shareholders can only elect, or remove, a limited number of our directors in any given year. Furthermore, as discussed above, our board of directors have the authority to issue up to 250,000,000 preference shares in one or more series. Our board of directors can fix the price, rights, preferences, privileges and restrictions of such preference shares without any further vote or action by our shareholders. The issuance of preference shares may delay or prevent a change in control transaction without further action by our shareholders or make removal of management more difficult. Differences in Corporate Law The Companies Law of the Cayman Islands is modeled after that of England but does not follow recent United Kingdom statutory enactments and differs from laws applicable to United States corporations and their shareholders. The following paragraphs are a summary of the significant differences between the provisions of the Companies Law applicable to us and the laws applicable to companies incorporated in the United States and to their shareholders. Mergers and Similar Arrangements. Cayman Islands law does not provide for mergers as that expression is understood under United States corporate law. However, there are statutory provisions that facilitate the reconstruction and amalgamation of companies, provided that the arrangement in question is approved by a majority in number of each class of shareholders and creditors with whom the arrangement is to be made, and who must in addition represent three-fourths in value of each class of shareholders or creditors, as the case may be, that are present and voting either in person or by proxy at a meeting or meetings convened for that purpose. The convening of the meetings and subsequently the arrangement must be sanctioned by the Grand Court of the Cayman Islands. While a dissenting shareholder would have the right to express to the court the view that the transaction ought not to be approved, the court can be expected to approve the arrangement if it satisfies itself that: . the parties have complied with the statutory provisions regarding majority vote; . the shareholders have been fairly represented at the meeting in question; . the arrangement is one that a businessman would reasonably approve; and 36

. the arrangement is not one that would more properly be sanctioned under some other provision of the Companies Law. When a take-over offer is made and accepted by holders of 90% of the shares within four months, the offeror may, within a two-month period require the holders of the remaining shares to transfer these shares on the terms of the offer. An objection can be made to the Grand Court of the Cayman Islands but this is unlikely to succeed unless there is evidence of fraud, bad faith or collusion. If the arrangement and reconstruction is approved, the dissenting shareholder would have no rights comparable to appraisal rights, which would otherwise ordinarily be available to dissenting shareholders of United States corporations, providing rights to receive payment in cash for the judicially determined value of the shares. Shareholders' Suits. Maples and Calder has advised us that no significant or major reported class action or derivative action has been brought in a Cayman Islands court. In principle, we will normally be the proper plaintiff and a derivative action may not be brought by a minority shareholder. However, based on English authorities, which would in all likelihood be of persuasive authority in the Cayman Islands, exceptions to the foregoing principle apply in circumstances in which: . a company is acting or proposing to act illegally or outside of its powers; . the act complained of, although not outside of its powers, could be effected only if authorized by more than a simple majority vote; . the individual rights of the plaintiff shareholders have been infringed or are about to be infringed; or . those who control the company are perpetrating a "fraud on the minority." Indemnification Cayman Islands law does not limit the extent to which a company's articles of association may provide for indemnification of officers and directors, except to the extent that a provision may be held by the Cayman Islands courts to be contrary to public policy, such as to provide indemnification against civil fraud or the consequences of committing a crime. Our articles of association provide for indemnification of officers and directors for losses, damages, costs and expenses incurred in their capacities as such, except if they acted in a willfully negligent manner or defaulted in any action against them. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers or persons controlling us pursuant to these provisions, we have been informed that, in the opinion of the Securities and Exchange Commission, this indemnification is against public policy as expressed in the Securities Act and therefore is unenforceable. Enforceability of Civil Liabilities We are a Cayman Islands company. We incorporated in the Cayman Islands because of the following benefits associated with being a Cayman Islands company: . political and economic stability; . an effective judicial system; . unlike some jurisdictions which impose taxes on worldwide income, no taxation of companies based upon profits, income, gains or appreciation; . the absence of exchange control or currency restrictions; and . the availability of professional and support services. However, the Cayman Islands has a less developed body of securities laws than the United States and provides less protection for investors. For example, the remedies of shareholders and fiduciary responsibilities of our directors are governed by Cayman Islands law and are not as clearly established as under statutes or judicial precedent in existence in jurisdictions in the United States. While there is some case law in the Cayman Islands on these matters, it is not as developed as, for example, English law. However, we believe that English case law, although not binding in the courts of the Cayman Islands, would be regarded as persuasive. Based on English case law, we believe under Cayman Islands law, our directors have a duty of loyalty to act honestly in good faith with a view to promoting our best interests. Our directors also have a duty of care to exercise the care, diligence and skills that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association and the class rights vested under our memorandum and articles of association in the holders of the shares. 37

A substantial majority of our assets are located outside the United States. In addition, a majority of our directors and officers are nationals and/or residents of countries other than the United States, and all or a substantial portion of our assets and the assets of our directors and officers are located outside the United States. As a result, it may be difficult to effect service of process within the United States upon us or our directors and officers or to enforce against us or against them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state thereof. Maples and Calder, our counsel as to Cayman Islands law, has advised us that there is uncertainty regarding whether the courts of the Cayman Islands would (1) recognize or enforce judgments of United States courts obtained against us or our officers and directors predicated upon the civil liability provisions of the securities laws of the United States or any state thereof or (2) be competent to hear original actions brought in their jurisdiction against us or our officers and directors predicated upon the securities laws of the United States or any state thereof. There is no statutory enforcement in the Cayman Islands of judgments obtained in the United States. Instead, such a judgment must be enforced by action at common law. Maples and Calder have advised us that a final and conclusive judgment in a federal or state court of the United States under which a sum of money is payable, other than a sum payable in respect of taxes, fines, penalties or similar charges, may be subject to enforcement proceedings as a debt in the Courts of the Cayman Islands under the common law doctrine of obligation. Material Contracts Other than the contracts listed under Item 19--Exhibits and the Executive Severance and Change of Control Agreements described in "Related Party Transactions - Executive Severance and Change of Control Agreements", in the past two years we have not entered into any material contracts other than contracts entered into in the ordinary course of business. Exchange Control Our articles of association authorize us to issue an aggregate of 4,750,000,000 ordinary shares with a par value of $0.00002 per share. Of those 4,750,000,000 authorized ordinary shares, 1,911,868,150 shares were issued and outstanding as of December 31, 2007, all of which are fully paid or credited as fully paid. We may not call for any further capital from any holder of ordinary shares outstanding. Under Cayman Islands law, non-residents of the Cayman Islands may freely hold, vote and transfer ordinary shares in the same manner as Cayman Islands residents, subject to the provisions of the Companies Law and our articles of association. No Cayman Islands laws or regulations restrict the export or import of capital, or affect the payment of dividends to non-resident holders of ordinary shares. TAXATION Cayman Islands Taxation The Cayman Islands currently levy no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. There are no other taxes likely to be material to us levied by the Government of the Cayman Islands except for stamp duties that may be applicable on instruments executed in, or after execution brought within, the jurisdiction of the Cayman Islands. The Cayman Islands are not party to any double tax treaties. There are no exchange control regulations or currency restrictions in the Cayman Islands. No stamp duties are payable on the issue or transfer of shares. An agreement to transfer shares may be subject to stamp duty if the agreement is executed in the Cayman Islands or, if executed outside the Cayman Islands, subsequently brought into the Cayman Islands. The Stamp Duty Law (2005 Revision) does not provide who is liable to pay stamp duty on any document but, in practice, the person who seeks to rely on the document in any civil court proceedings will be required to pay stamp duty in order to have the document admitted in evidence. United States Federal Income Taxation The following discussion addresses the material United States federal income tax consequences of the ownership and disposition of ordinary shares or ADSs held as a capital asset by a "U.S. Investor" (as defined below). This summary does not provide a complete analysis of all potential tax consequences. This summary is based on the Internal Revenue Code of 1986, as amended (the "Code"), final, temporary and proposed Treasury Regulations thereunder, and administrative and judicial interpretations thereof, all as in effect as of the date hereof, and all of which are subject to change at any time (possibly on a retroactive basis) by legislative, judicial or administrative action, and to differing interpretations. There can be no assurance that the Internal Revenue Service (the "IRS") will not take a contrary view. This summary does not discuss state, local or foreign tax consequences of the ownership and disposition of ordinary shares or ADSs. This summary is directed solely to U.S Investors that hold ordinary shares or ADSs as capital assets within the meaning of Section 1221 of the Code, which generally means as property held for investment. For purposes of this discussion, a "U.S. Investor" means a beneficial owner of ordinary shares or ADSs who is any of the following: . a citizen or resident of the United States or someone treated as a U.S. citizen or resident for U.S. federal income tax purposes; 38

. a corporation or other entity taxable as a corporation for U.S. federal income tax purposes created or organized in or under the laws of the United States or any political subdivision thereof, including the District of Columbia; . an estate the income of which is subject to U.S. federal income taxation regardless of its source; . a trust that is subject to the primary supervision of a court within the United States and one or more U.S. persons have the authority to control all of its substantial decisions; . a trust in existence on August 20, 1996 that has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person; or . a person that is otherwise subject to U.S. federal income taxation on its net income. If a partnership (including for this purpose any entity treated as a partnership for U.S. federal income tax purposes) is a beneficial owner of ordinary shares or ADSs, the U.S. federal income tax consequences to a partner in the partnership will generally depend on the status of the partner and the activities of the partnership. A holder of ordinary shares or ADSs that is a partnership and partners in such partnership should consult their individual tax advisors about the U.S. federal income tax consequences of holding or disposing of the ordinary shares or ADSs. This summary does not address the United States federal income tax treatment of investors having a special legal status, including without limitation the following types of investors, who may be subject to tax rules that differ significantly from those summarized below: . life insurance companies; . tax-exempt investors; . banks and financial institutions; . dealers in securities or foreign currencies; . traders in securities that elect to use a mark-to-market method of accounting for their securities holdings; . persons liable for alternative minimum tax; . U.S. investors who or that actually or constructively hold 10% or more of our voting shares or ADSs; . investors who hold our ordinary shares or ADSs as part of straddles, hedging or integrated or conversion transactions; or . persons whose "functional currency" is not the U.S. dollar. This summary is not a comprehensive description of all of the tax considerations that may be relevant with respect to your ownership of ordinary shares or ADSs. You are advised to consult your own tax adviser with respect to your particular circumstances and with respect to the effects of federal, state, local or foreign tax laws to which you may be subject. The United States does not have an income tax treaty with the Cayman Islands. As relates to the ADSs, this discussion is based in part upon the representations of the depositary and the assumption that each obligation in the deposit agreement and any related agreement will be performed in accordance to its terms. Generally, a holder of ADSs will be treated as the owner of the underlying ordinary shares represented by those ADSs for U.S. federal income tax purposes. Accordingly, no gain or loss will be recognized if the holder exchanges ADSs for the underlying ordinary shares represented by those ADSs. The holder's adjusted tax basis in the ordinary shares will be the same as the adjusted tax basis of the ADSs surrendered in exchange therefor, and the holding period for the ordinary shares will include the holding period for the surrendered ADSs. Dividends and Other Distribution on Ordinary Shares or ADSs. Subject to the discussion in "Passive Foreign Investment Company Status" below, in the event that a U.S. Investor receives a distribution on the ordinary shares or ADSs, the U.S. Investor will be required to include the distribution in gross income as a taxable dividend on the date of receipt by the depositary, in the case of ADSs, or by the U.S. Investor, in the case of ordinary shares, but only to the extent that a distribution is paid from our current or accumulated earnings and profits as determined for United States federal income tax principles. Dividends paid by us will not be eligible for the corporate dividends received deduction. For taxable years beginning before January 1, 2011, "qualified dividend income" paid to a noncorporate U.S. Investor will be subject to tax at the rates applicable to long-term capital gains (which are currently taxed at the maximum rate of 15%) if (1) our ordinary shares or ADSs are readily tradable on an established securities market in the United States, (2) we are not a passive foreign investment company (as discussed below) for either our taxable year in which the dividend was paid or the preceding taxable year and (3) certain holding period requirements must be met. It is expected that our ADSs will satisfy the "readily tradable" requirement as a result of being traded on the Nasdaq Global Select Market. However, any U.S. Investor that exchanges its ADSs for ordinary shares, or that holds only ordinary shares, may not be eligible for the reduced rate of taxation on dividends if the ordinary shares are not readily tradable on an established securities market in the United States. In order for dividends to constitute "qualified dividend 39

income," a U.S. Investor generally must have held the ADSs for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date; however, because the holding period rules are intricate and because an owner's holding period is reduced for periods during which the risk of loss is diminished, U.S. Investors should consult their own advisors concerning the calculation of their holding periods. Moreover, a dividend will not be treated as a qualified dividend income to the extent that the taxpayer is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property. U.S. Investors should consult their own tax advisers regarding the availability of the lower rate for dividends paid with respect to our ADSs or ordinary shares. The Company has the right to pay dividends in any currency. If dividends are paid in a currency other than the U.S. dollar, the dividends will be included in a U.S. Investor's income as a U.S. dollar amount based on the exchange rate in effect on the date that the U.S. Investor receives the dividend, regardless of whether the payment is in fact converted into U.S. dollars. If the U.S. Investor does not receive U.S. dollars on the date the dividend is distributed, the U.S. Investor will be required to include either gain or loss in income when the U.S. Investor later exchanges the foreign currency for U.S. dollars. The gain or loss will be equal to the difference between the U.S. dollar value of the amount that the U.S. Investor includes in income when the dividend is received and the amount that the US. Investor receives on the exchange of the foreign currency for U.S. dollars. The gain or loss generally will be ordinary income or loss from U.S. sources. If we distribute as a dividend non-cash property, the U.S. Investor will generally include in income an amount equal to the U.S. dollar equivalent of the fair market value of the property on the date that it is distributed. Dividends will constitute foreign source income for foreign tax credit limitation purposes. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. Under current law, for taxable years beginning after December 31, 2006, dividends distributed by us with respect to ordinary shares or ADSs would generally constitute "passive category income" but could, in the case of certain U.S. Investors, constitute "general category income." Special rules apply to individuals whose foreign source income during the taxable year consists entirely of "qualified passive income" and whose creditable foreign taxes paid or accrued during the taxable year do not exceed $300 ($600 in the case of a joint return). Further, in particular circumstances, a U.S. Investor that (i) has held the ordinary shares or ADSs for less than a specified minimum period during which it is not protected from risk of loss, (ii) is obligated to make payments related to the dividends, or (iii) holds the ordinary shares or ADSs in arrangements in which the U.S. Investor's expected economic profit, after non-U.S. taxes, is insubstantial, will not be allowed a foreign tax credit for foreign taxes imposed on dividends paid on the ordinary shares or ADSs. The U.S. Treasury has expressed concerns that parties to whom ADSs are pre-released may be taking actions that are inconsistent with the claiming of foreign tax credits by U.S. Investors of ADSs. Such actions would also be inconsistent with the claiming of the preferential tax rates applicable to qualified dividend income, as defined above. Accordingly, the creditability of foreign withholding taxes and the availability of such preferential tax rates could be affected by future actions that may be taken by the U.S. Treasury or parties to whom ADSs are pre-released. Distributions in excess of our current and accumulated earnings and profits will be treated as a nontaxable return of capital to the extent of the U.S. Investor's basis in the ordinary shares or ADSs and thereafter as gain from the sale or exchange of a capital asset. We do not generally intend to calculate our earnings and profits under U.S. federal income tax principles. Therefore a U.S. Investor should expect that a distribution will generally be treated as a dividend even if that distribution would otherwise be treated as a nontaxable return of capital or as capital gain under the rules described above. Distributions to a U.S. Investor of new ordinary shares or ADSs or rights to subscribe for new ordinary shares or ADSs that are received as part of a pro rata distribution to all our shareholders will not be subject to U.S. federal income tax. The adjusted tax basis of the new ordinary shares or ADSs or rights so received will be determined by allocating the U.S. investor's adjusted tax basis in the old ordinary shares or ADSs between the old ordinary shares or ADSs and the new ordinary shares or ADSs or rights received, based on their relative fair market values on the date of distribution. However, the adjusted tax basis of the new ordinary shares or ADSs or rights will be zero if the fair market value of the new rights is less than 15% of the fair market value of the old ordinary shares or ADSs at the time of distribution and the U.S. Investor does not make an election to determine the adjusted tax basis of the rights by allocation as described above. A U.S. Investor's holding period in the new ordinary shares or ADSs or rights will generally include the holding period of the old ordinary shares or ADSs on which the distribution was made. Dispositions of ordinary shares or ADSs. Subject to the discussion in "Passive Foreign Investment Company Status" below, gain or loss realized by a U.S. Investor on the sale or other disposition of the ordinary shares or ADSs will be subject to United States federal income tax as capital gain or loss in an amount equal to the difference between the amount realized on the disposition and that U.S. Investor's basis in the ordinary shares or ADSs. The capital gain or loss will be long-term capital gain or loss if the U.S. Investor has held the ordinary shares or ADSs for more than one year at the time of the sale or exchange. A noncorporate U.S. investor will be eligible for reduced rates of taxation (currently, at a maximum rate of 15% for sales occurring in taxable years beginning before January 1, 2011) on long-term capital gain. The deductibility of capital losses is subject to limitations. Any gain or loss recognized by a U.S. Investor will generally be treated as U.S. source income or loss for U.S. foreign tax credit purposes. 40

U.S. Investors should consult their own tax advisor regarding the U.S. federal income tax consequences if the U.S. Investor receives currency other than U.S. dollars upon the disposition of ordinary shares or ADSs. Passive Foreign Investment Company Status. We believe that we are not a passive foreign investment company and do not expect to become a passive foreign investment company in the future. We will be classified as a passive foreign investment company if for a taxable year, after the application of "look through" rules, either (a) 75% or more of the gross income of the company in a taxable year is passive income, or (b) the average percentage of assets by value of the company in a taxable year that produce or are held for the production of passive income (which includes cash) is at least 50%, the income or assets test. Whether or not we are a passive foreign investment company will be determined annually based upon the composition of our income and assets including goodwill, from time to time. In determining that we are not a passive foreign investment company, we are relying on the current valuation of our assets, including goodwill. In calculating goodwill, we have valued our total assets based on our total market value determined using the then market price of our ordinary shares and ADSs and have made a number of assumptions regarding the amount of this value allocable to goodwill. Because the determination of goodwill will be based on the price of our ordinary shares and ADSs, it is subject to change. We believe our valuation approach is reasonable. However, it is possible that the Internal Revenue Service will challenge the valuation of our goodwill, which may result in our being classified as a passive foreign investment company. In addition, the composition of our income and assets will be affected by how we spend the cash we have raised, which is a passive asset for purposes of the passive foreign investment company asset test discussed above. We intend to use the cash we have raised in the past and conduct our business activities in an effort to reduce the risk of our classification as a passive foreign investment company. Because the passive foreign investment company determination is made at the end of each taxable year, we cannot determine in advance whether we will be considered a passive foreign investment company for any future taxable year. If we determine that we have become a passive foreign investment company, we will notify the Bank of New York and all U.S. investors who have been record holders of our ordinary shares or ADSs during any period in which we determine that we are a passive foreign investment company, within 60 days of the end of our taxable year for which we make such determination. If we are a passive foreign investment company for any year during which a U.S. Investor holds ordinary shares or ADSs, we generally will continue to be treated as a passive foreign investment company for all succeeding years during which the U.S. Investor holds ordinary shares or ADSs. Special U.S. tax rules apply to U.S. Investors of interests in a passive foreign investment company. Subject to the discussion of the market-to-market election and qualified electing fund election below, if we were a passive foreign investment company for any taxable year during which a U.S. Investor held ordinary shares or ADSs, the U.S. Investor would be subject to special tax rules regardless of whether we meet the income or assets test for any other year with respect to: . any "excess distribution" by us to the U.S. Investor, which means any distributions received by the U.S. Investor on the ordinary shares or ADSs in a taxable year that are greater than 125% of the average annual distributions received by the U.S. Investor in the three preceding taxable years, or, if shorter, the U.S. Investor's holding period for the ordinary shares or ADSs; and . any gain realized on the sale or other disposition, including a pledge, of ordinary shares or ADSs. Under these special tax rules: . the excess distribution or gain would be allocated ratably over the U.S. Investor's holding period for the ordinary shares or ADSs; . the amount allocated to the current taxable year and any taxable year prior to the first taxable year in which we are a passive foreign investment company would be treated as ordinary income; . the amount allocated to each of the other years would be taxed as ordinary income at the highest tax rate in effect for that year; and . the interest charge applicable to underpayments of tax would be imposed with respect to the resulting tax attributable to each prior year in which we were a passive foreign investment company to recover the deemed benefit from the deferred payment of the tax attributable to each prior year. In addition, dividends that a U.S. Investor receives from us will not be eligible for the special tax rates applicable to "qualified dividend income" (see "-- United States Federal Income Taxation -- Dividends") if we are a passive foreign investment company either in the taxable year of the distribution or the preceding taxable year, but will instead be taxable at rates applicable to ordinary income. If we are a passive foreign investment company in any year, a U.S. Investor would be required to file an annual return on Internal Revenue Service Form 8621 regarding distributions received with respect to the ordinary shares or ADSs and any gain realized on the disposition of the ordinary shares or ADSs. A U.S. Investor in a passive foreign investment company is allowed to make a mark-to-market election with respect to the stock of the passive foreign investment company, provided that the stock of the passive foreign investment company is "marketable" within the meaning of the Code. The ordinary shares will be "marketable" as long as they remain listed on the Nasdaq Global Select Market and are "regularly traded." The ordinary shares or ADSs will be considered "regularly traded" for 41

any calendar year during which the ordinary shares or ADSs are traded, other than in de minimis quantities, on at least fifteen days during each calendar quarter. If the election is made, a U.S. Investor would be required to mark the ordinary shares or ADSs to market each taxable year and recognize ordinary income for any increase in market value for that taxable year and would be allowed to recognize an ordinary loss for any decrease in that market value to the extent that prior gains exceed prior losses. The adjusted basis in the ordinary shares or ADSs would be adjusted to reflect that gain or loss. The mark-to-market election will be effective for the taxable year for which the election is made and all subsequent taxable years, unless the ordinary shares cease to be marketable or the Internal Revenue Service consents to the revocation of the election. Alternatively, for each year we meet the income or assets test, a U.S. Investor can make an election to include in income annually its pro rata share of our earnings and net capital gains. This election is referred to as a qualified electing fund election. To make a qualified electing fund election, a U.S. Investor will need to have an annual information statement from us documenting the earnings and capital gain for the year. If we were to become a passive foreign investment company, we would furnish the passive foreign investment company annual information statement to any shareholder or former shareholder who requested it. In general, a U.S. Investor must make a qualified electing fund election on or before the due date for filing its income tax return for the first year to which the qualified electing fund election will apply. U.S. Investors are permitted to make retroactive elections in particular circumstances, including if the U.S. Investor had a reasonable belief that the foreign corporation was not a passive foreign investment company and filed a protective election. As discussed above, we will notify investors if we determine that we have become a passive foreign investment company. This notice will provide U.S. Investors on a calendar tax year with sufficient time to make the qualified electing fund election. U.S. Investors (in particular those with a tax year other than the calendar year) should consult their own tax advisors as to the consequences of making a protective qualified electing fund election or other consequences of the qualified electing fund election. If we are a passive foreign investment company in any year, U.S. Investors should consult with their tax advisers regarding whether to make a mark-to-market or qualified electing fund election. Information Reporting and Backup Withholding. In general, information reporting requirements will apply to dividends in respect of our ordinary shares or ADSs or the proceeds received on the sale, exchange or redemption of our ordinary shares or ADSs paid within the United States (and, in certain cases, outside the United States) to U.S. Investors other than certain exempt recipients, such as corporations, and a backup withholding tax (currently at a rate of 28%) may apply to such amounts if the U.S. Investor fails to provide an accurate taxpayer identification number or to report interest and dividends required to be shown on its U.S. federal income tax returns. U.S. Investors who are required to establish their exempt status generally must provide such certification on IRS Form W-9. Backup withholding is not an additional tax. Amounts withheld as backup withholding from a payment to a U.S. Investor may be allowed as a credit against the U.S. Investor's U.S. federal income tax liability and the U.S. Investor may obtain a refund of any excess amounts withheld by filing the appropriate claim for refund with the IRS and furnishing any required information in a timely manner. DOCUMENTS ON DISPLAY We file annual reports on Form 20-F and furnish current reports on Form 6-K with the SEC. You may read and copy this information at the SEC's Public Reference Room at Judiciary Plaza, 100 F Street N.E., Washington, D.C. 20549, and at the regional offices of the SEC located at 233 Broadway, New York, New York 10279 and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You can also request copies of the documents, upon payment of a duplicating fee, by writing to the Public Reference Section of the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the Public Reference Room. Certain of our SEC filings are also available to the public from the SEC's website at http://www.sec.gov. ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of loss related to adverse changes in market prices, including interest rates and foreign exchange rates, of financial instruments. In the normal course of business, our financial position is routinely subject to a variety of risks, including market risk associated with interest rate movements and currency rate movements on non-U.S. dollar denominated assets and liabilities, as well as collectibility of accounts receivable. We regularly assess these financial instruments and their ability to address market risk and have established policies and business practices to protect against the adverse effects of these and other potential exposures. Interest Rate Risk Our major market risk exposure is changing interest rates. Our exposure to market risk for changes in interest rates relates primarily to our investments in government and corporate bonds. We maintain an investment portfolio consisting mainly of fixed income securities, including time deposits and government bonds. These securities are subject to interest rate risk and will fall in value if market interest rates increase. If market rates were to increase immediately and uniformly by 10.0% from the levels at December 31, 2007, the fair value of our investment portfolio would decline by an immaterial amount. We presently intend to treat our fixed income investments as 42

available for sale, and therefore we do not expect our results of operations or cash flows to be affected to any significant degree by a sudden short-term change in market interest rates. We have not purchased and do not currently hold any derivative financial instruments for hedging or trading purposes. The table below provides information about our financial instruments whose maturity dates are greater than three months as of December 31, 2007. Fair 2008 2009 2010 2011 2012 Thereafter Total Value ------ ------ ---- ---- ---- ---------- ------ ------ (In Thousands) Time Deposit: Fixed rate (US$)........... $9,803 -- -- -- -- -- $9,803 $9,803 Government Bonds Fixed rate (US$)........... -- $1,567 -- -- -- -- $1,567 $1,555 Foreign currency risk Fluctuations in exchange rates may adversely affect our financial results. The functional currency for each of our foreign subsidiaries is the local currency. As a result, certain of our assets and liabilities, including certain bank accounts, accounts receivable, restricted assets, short-term investments and accounts payable, exist in non-US dollar-denominated currencies, which are sensitive to foreign currency exchange rate fluctuations. If exchange rates were to change immediately and uniformly from the levels at December 31, 2007, the fair value of such assets and liabilities would change by an immaterial amount beyond the change reflected by the exchange rates. As of December 31, 2007, we held approximately $24.1 million in government bonds, certificates of deposits and bank demand accounts denominated in foreign currencies. We have not engaged in hedging techniques to mitigate foreign currency exposures and may experience economic losses as a result of foreign currency exchange rate fluctuations. We will monitor currency exchange fluctuations periodically. For the year ended December 31, 2007, we experienced a foreign exchange loss of approximately $548,000 due to foreign currency exchange fluctuations, which are reflected in our results of operations. ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES Not applicable. PART II ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES There are no defaults, dividend arrearages or delinquencies that are required to be disclosed. ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS. RIGHTS OF SECURITY HOLDERS Effective March 2, 2006, upon the listing of our ordinary shares on the Stock Exchange of Hong Kong, certain amendments to our Memorandum and Articles of Association became effective. A summary of material provisions of our Memorandum and Articles of Association is included in Item 10 above. USE OF PROCEEDS As of December 31, 2007, the net proceeds from our initial public offering in August 2000 and our public offering in November 2001 were primarily used for general working capital and investment in interest income producing financial instruments. None of the net proceeds from our initial public offering were paid, directly or indirectly, to any of our directors, officers or general partners or any of their associates, or to any person owning ten percent or more of any class of our equity securities, or any of our affiliates. ITEM 15. CONTROLS AND PROCEDURES Disclosure controls and procedures We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that 43

any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives. As of December 31, 2007, we carried out an evaluation, under the supervision and with the participation of the management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective. Management's Annual report on Internal Control over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting for the company. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Our company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of our company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of our company are being made only in accordance with authorizations of management and directors of our company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management concluded that our company's internal control over financial reporting was effective as of December 31, 2007.This Annual Report includes an attestation report of our registered public accounting firm regarding internal control over financial reporting. Changes in Internal Control Over Financial Reporting There has been no change in our internal control over financial reporting that occurred during our fiscal year 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Attestation Report Of The Independent Registered Public Accounting Firm REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and the Shareholders of O2Micro International Limited: We have audited the internal control over financial reporting of O2Micro International Limited and subsidiaries (the "Company") as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made 44

only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2007 of the Company, and our report dated April 14, 2008 expressed an unqualified opinion on those financial statements and included explanatory paragraphs relating to the adoption of Statement of Financial Accounting Standards No. 123(R), "Share-Based Payment" and Financial Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes--An interpretation of FASB Statement No. 109." /s/ Deloitte & Touche - ---------------------------------------- Taipei, Taiwan Republic of China April 14, 2008 ITEM 16. Not applicable. ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT We have at least one audit committee financial expert serving on the audit committee. The Board of Directors has determined that Mr. Lawrence Lin is the "audit committee financial expert" as defined in Item 16A of Form 20-F. We believe Mr. Lin is "independent" as defined in Rule 4200(a)(15) of the Marketplace Rules of the Nasdaq Stock Market. ITEM 16B. CODE OF ETHICS We have adopted the O2Micro International Limited Code of Business Conduct and Ethics ("Code of Conduct"), a code of business conduct and ethics that applies to our employees, officers and non-employee directors, including our principal executive officer, principal financial officer, principal accounting officer or controller and persons performing similar functions. It is publicly available on our website at www.o2micro.com. If we make any substantive amendments or grant any waiver from a provision of the Code of Conduct to our directors or executive officers, we will disclose the nature of such amendment or waiver on that website or in a report on Form 6-K or in the next annual report on Form 20-F. ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES Deloitte & Touche has served as the Company's independent registered public accounting firm for each of the fiscal years in the two-year period ended December 31, 2007. The appointment of the independent registered public accounting firm is subject to approval and ratification by the Company's shareholders at the annual general meeting of shareholders. The following table presents the aggregate fees for professional services and other services rendered by Deloitte & Touche in each of the years ended December 31, 2006 and 2007. Year ended Year ended December 31, 2006 December 31, 2007 ----------------- ----------------- Audit Fees.................... $436,200 $867,400 Audit-related Fees............ 10,002 66,697 Tax Fees...................... 74,066 20,545 All Other Fees................ 463,766 64 Total......................... $984,034 $954,706 Audit Fees. This category includes the audit of our annual financial statements, review of quarterly financial statements, audit of our internal control over financial reporting and services that are normally provided by Deloitte & Touche in connection with statutory and regulatory filings or engagements for those fiscal years. 45

Audit-related Fees. This category consists of assurance and related services by Deloitte & Touche that are related to the performance of audit or review of our financial statements and are reported above under "Audit Fees." Tax Fees. This category consists of professional services rendered by Deloitte & Touche for tax compliance and tax consultation. The services for fees disclosed under this category include tax return preparation advice and technical tax consultation. All Other Fees: This category consists primarily of fees in connection with the Stock Exchange of Hong Kong listing and Sarbanes-Oxley Act readiness preparation. The audit committee pre-approves all audit and permissible non-audit services provided by the independent registered public accounting firm. These services may include audit services, audit-related services, tax services and other services. During the year ended December 31, 2007, the audit committee pre-approved all audit and non-audit-fees of Deloitte & Touche. ITEM 16D. EXEMPTION FROM THE LISTING STANDARDS FOR AUDIT COMMITTEE Not applicable. ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS Total Number of Shares Maximum Purchased as Number of Shares Part of Publicly that May Yet Be Total Number of Average Announced Purchased Under Shares Price Paid Plans or the Plans or Period Purchased (2) per Share (2) Programs (1) (2) (3) Programs (1) (2) (3) - ------ --------------- ------------- -------------------- -------------------- February 13, 2007............................ 755,000 $0.15040 755,000 139,441,985(4) March 13, 2007 to March 14, 2007............. 3,300,000 $0.14559 3,300,000 136,141,985(4) June 14, 2007 to June 15, 2007............... 11,594,000 $0.21047 11,594,000 124,547,985(4) December 10, 2007 to December 14, 2007....... 5,000,000 $0.25925 5,000,000 185,859,415(4) February 5, 2008 to February 29, 2008........ 17,037,450 $0.17152 17,037,450 168,821,965(4) March 3, 2008 to March 14, 2008.............. 9,550,100 $0.16153 9,550,100 159,271,865(4) (1) In May 2002, we announced a share repurchase program to repurchase up to 3,000,000 shares of our ordinary shares or 150,000,000 shares after taking into account the 50-to-1 stock split on November 25, 2005. There is no expiration date for the share repurchase program. (2) All share and price per share numbers reflect the 50-for-1 stock split which occurred on November 25, 2005 (3) On November 14, 2005, our shareholders adopted a general mandate (the "Repurchase Mandate") to exercise all the powers of our company to repurchase such number of Ordinary Shares not exceeding 10% of the total nominal amount of the share capital of our company in issue and to be issued. The Repurchase Mandate was to only become effective if and when our Ordinary Shares were listed for trading on the SEHK, which occurred on March 2, 2006. On March 2, 2006, the maximum number of shares that may yet be purchased was 198,049,435 shares. (4) On June 15, 2006 and June 21, 2007, our shareholders renewed the Repurchase Mandate to exercise all the powers of the Company to repurchase such number of Ordinary Shares not exceeding 10% of the total nominal amount of the share capital of the Company in issue and to be issued. On June 21, 2007, the maximum number of shares that may yet be purchased was 190,859,415 shares. 46

PART III ITEM 17. FINANCIAL STATEMENTS The Company's Consolidated Financial Statements have been prepared in accordance with Item 18 hereof. ITEM 18. FINANCIAL STATEMENTS The Company's financial statements set forth in the accompanying Index to Consolidated Financial Statements included in this Annual Report on Form 20-F following Part IV beginning on page F-1 are hereby incorporated herein by this reference. Such consolidated financial statements are filed as part of this Annual Report on Form 20-F. Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of December 31, 2006 and 2007 Consolidated Statements of Income and Comprehensive Income for the years ended December 31, 2005, 2006 and 2007 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2005, 2006 and 2007 Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2006 and 2007 Notes to Consolidated Financial Statements ITEM 19. EXHIBITS 1. Memorandum and Articles of Association, as amended, of the registrant (incorporated by reference to Exhibit 1 to the Annual Report on Form 20-F filed by the registrant on June 19, 2007) 4.1 Standard NNN Lease dated July 29, 1999 by and between Limir Realty Corp. #17 as landlord and O\\2\\Micro, Inc. as tenant (incorporated by reference from Exhibit 10.5 to the Registration Statement on Form F-1 (File No. 333-12386) filed by the registrant) 4.2 Lease dated October 16, 1997 by and between Hung Kuo Development Corp. as landlord and O\\2\\Micro, Inc. as tenant (incorporated by reference from Exhibit 10.6 to the Registration Statement on Form F-1 (File No. 333-12386) filed by the registrant) 4.3 Agreement dated October 1, 1999 by and between PSA Corporation Limited as landlord and O\\2\\Micro, Inc. as tenant (incorporated by reference from Exhibit 10.8 to the Registration Statement on Form F-1 (File No. 333-12386) filed by the registrant) 8.1 List of registrant's subsidiaries 12.1 Certification of Chief Executive Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act 12.2 Certification of Chief Financial Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act 13. Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act 15.1 Consent of Deloitte & Touche, independent registered public accounting firm 47

SIGNATURES Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this Annual Report on its behalf. O2MICRO INTERNATIONAL LIMITED Date: June 24, 2008 By: /s/ STERLING DU ----------------------------------- Name: Sterling Du Title: Chief Executive Officer 48

O\\2\\MICRO INTERNATIONAL LIMITED INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page ---- Report of Independent Registered Public Accounting Firm................... F-1 Consolidated Balance Sheets............................................... F-2 Consolidated Statements of Income and Comprehensive Income................ F-3 Consolidated Statements of Shareholders' Equity........................... F-5 Consolidated Statements of Cash Flows..................................... F-6 Notes to Consolidated Financial Statements................................ F-8

O\\2\\Micro International Limited and Subsidiaries Consolidated Financial Statements as of December 31, 2006 and 2007 and Report of Independent Registered Public Accounting Firm

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and the Shareholders of O\\2\\Micro International Limited: We have audited the accompanying consolidated balance sheets of O\\2\\Micro International Limited and subsidiaries (the "Company") as of December 31, 2006 and 2007, and the related consolidated statements of income and comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2007 (expressed in United States dollars). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of O\\2\\Micro International Limited and subsidiaries as of December 31, 2006 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated April 14, 2008 expressed an unqualified opinion on the Company's internal control over financial reporting. As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123(R), "Share-Based Payment." Effective January 1, 2007, the Company also changed its method of accounting for uncertainties in income taxes in accordance with Financial Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-An interpretation of FASB Statement No. 109." /s/ Deloitte & Touche Taipei, Taiwan Republic of China April 14, 2008 F-1

O\\2\\MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousand US Dollars, Except Per Share Amounts) - -------------------------------------------------------------------------------- December 31 ------------------ 2006 2007 -------- -------- ASSETS CURRENT ASSETS Cash and cash equivalents (Note 3) $ 45,438 $ 52,597 Restricted cash 8,342 6,830 Short-term investments (Note 4) 19,697 28,650 Accounts receivable, net (Note 5) 18,987 24,600 Inventories (Note 6) 14,076 22,127 Prepaid expenses and other current assets (Note 7) 7,379 7,476 -------- -------- Total current assets 113,919 142,280 -------- -------- LONG-TERM INVESTMENTS (Note 8) 24,059 26,715 -------- -------- PROPERTY AND EQUIPMENT, NET (Note 9) 41,427 43,148 -------- -------- RESTRICTED ASSETS 14,540 12,393 -------- -------- OTHER ASSETS (Note 10) 3,075 3,876 -------- -------- TOTAL $197,020 $228,412 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Notes and accounts payable $ 9,851 $ 10,841 Income tax payable 991 1,065 Accrued expenses and other current liabilities (Note 11) 12,212 11,597 -------- -------- Total current liabilities 23,054 23,503 -------- -------- OTHER LONG-TERM LIABILITIES Accrued pension liabilities 455 520 -------- -------- FIN 48 tax liabilities -- 210 -------- -------- Total liabilities 23,509 24,233 -------- -------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Preference shares at $0.00002 par value per share; Authorized--250,000,000 shares; Ordinary shares at $0.00002 par value per share; Authorized--4,750,000,000 shares; Issued - 1,906,969,950 shares and 1,911,868,150 shares as of December 31, 2006 and 2007, respectively 38 38 Additional paid-in capital 140,224 144,944 Retained earnings 33,877 56,847 Accumulated other comprehensive (loss) income (628) 3,646 Treasury stock--5,000,000 as of December 31, 2007 -- (1,296) -------- -------- Total shareholders' equity 173,511 204,179 -------- -------- TOTAL $197,020 $228,412 ======== ======== The accompanying notes are an integral part of the consolidated financial statements. F-2

O\\2\\MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (In Thousand US Dollars, Except Per Share Amounts) - -------------------------------------------------------------------------------- Years Ended December 31 ---------------------------- 2005 2006 2007 -------- -------- -------- NET SALES $105,552 $124,915 $165,540 COST OF SALES 40,741 56,772 71,099 -------- -------- -------- GROSS PROFIT 64,811 68,143 94,441 -------- -------- -------- OPERATING EXPENSES (INCOME) Research and development (a) 25,421 31,751 34,624 Selling, general and administrative (a) 20,279 29,209 34,712 Patent related litigation 10,174 10,962 10,848 Litigation income -- -- (9,364) Stock Exchange of Hong Kong listing expenses 2,460 786 -- -------- -------- -------- Total operating expenses 58,334 72,708 70,820 -------- -------- -------- INCOME (LOSS) FROM OPERATIONS 6,477 (4,565) 23,621 -------- -------- -------- NON-OPERATING INCOME (EXPENSES) Interest income 2,824 3,627 3,262 Impairment loss on long-term investments -- (756) -- Foreign exchange loss, net (443) (261) (548) Other, net 323 248 105 -------- -------- -------- Total non-operating income 2,704 2,858 2,819 -------- -------- -------- INCOME (LOSS) BEFORE INCOME TAX 9,181 (1,707) 26,440 INCOME TAX EXPENSE (BENEFIT) (Note 12) 1,034 (2,450) 1,456 -------- -------- -------- NET INCOME 8,147 743 24,984 -------- -------- -------- OTHER COMPREHENSIVE INCOME (LOSS) Foreign currency translation adjustments (238) 695 1,667 Unrealized gain (loss) on available-for-sale securities (770) (205) 2,702 Unrealized pension loss -- -- (95) -------- -------- -------- Total other comprehensive income (loss) (1,008) 490 4,274 -------- -------- -------- COMPREHENSIVE INCOME $ 7,139 $ 1,233 $ 29,258 ======== ======== ======== EARNINGS PER SHARE (Note 15) Basic $ 0.0042 $ 0.0004 $ 0.0131 ======== ======== ======== Diluted $ 0.0041 $ 0.0004 $ 0.0129 ======== ======== ======== (Continued) F-3

O\\2\\MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (In Thousand US Dollars, Except Per Share Amounts) - -------------------------------------------------------------------------------- Years Ended December 31 -------------------------------- 2005 2006 2007 ---------- ---------- ---------- SHARES USED IN EARNINGS PER SHARE CALCULATION: Basic (in thousands) 1,961,168 1,932,575 1,905,725 ========== ========== ========== Diluted (in thousands) 1,997,459 1,946,896 1,943,785 ========== ========== ========== (a)INCLUDES STOCK-BASED COMPENSATION CHARGE AS FOLLOWS: Research and development $ -- $ 1,181 $ 1,058 Selling, general and administrative -- 1,408 1,408 ---------- ---------- ---------- $ -- $ 2,589 $ 2,466 ========== ========== ========== The accompanying notes are an integral part of the consolidated financial statements. (Concluded) F-4

O\\2\\MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In Thousand US Dollars, Except Per Share Amounts) - -------------------------------------------------------------------------------- Ordinary Shares Additional -------------------- Paid-in Retained Shares Amount Capital Earnings ------------- ------ ---------- -------- BALANCE, JANUARY 1, 2005 1,959,403,100 $39 $139,581 $31,271 Issuance of: Shares issued for exercise of stock options 7,422,050 -- 1,185 -- Shares issued for 1999 Purchase Plan 6,389,200 -- 1,110 -- Acquisition of treasury stock--20,420,000 shares -- -- -- -- Retirement of treasury stock (5,390,000) -- (380) (679) Options granted to nonemployees -- -- 36 -- Net income for 2005 -- -- -- 8,147 Foreign currency translation adjustments -- -- -- -- Unrealized loss on available-for-sale securities -- -- -- -- ------------- --- -------- ------- BALANCE, DECEMBER 31, 2005 1,967,824,350 39 141,532 38,739 Issuance of: Shares issued for exercise of stock options 5,643,000 -- 354 -- Shares issued for 1999 Purchase Plan 6,980,050 -- 985 -- Acquisition of treasury stock--58,447,450 shares -- -- -- -- Retirement of treasury stock (73,477,450) (1) (5,240) (5,605) Options granted to nonemployees -- -- 4 -- Stock-based compensation -- -- 2,589 -- Net income for 2006 -- -- -- 743 Foreign currency translation adjustments -- -- -- -- Unrealized loss on available-for-sale securities -- -- -- -- ------------- --- -------- ------- BALANCE, DECEMBER 31, 2006 1,906,969,950 38 140,224 33,877 Issuance of: Shares issued for exercise of stock options 13,564,800 -- 2,565 -- Shares issued for 1999 Purchase Plan 5,060,300 -- 809 -- Shares vested under RSUs 1,922,100 -- -- -- Acquisition of treasury stock--20,649,000 shares -- -- -- -- Retirement of treasury stock (15,649,000) -- (1,120) (1,914) Stock-based compensation -- -- 2,466 -- Cumulative effect of adopting FIN 48 -- -- -- (100) Net income for 2007 -- -- -- 24,984 Pension loss -- -- -- -- Foreign currency translation adjustments -- -- -- -- Unrealized gain on available-for-sale securities -- -- -- -- ------------- --- -------- ------- BALANCE, DECEMBER 31, 2007 1,911,868,150 $38 $144,944 $56,847 ============= === ======== ======= Accumulated Other Comprehensive Income (Loss) ----------------------------------------- Unrealized Investment Cumulative Unrealized Gain Translation Pension Treasury Shareholders' (Loss) Adjustment Loss Total Stock Equity ---------- ----------- ---------- ------- -------- ------------- BALANCE, JANUARY 1, 2005 $ (154) $ 44 $ -- $ (110) $ -- $170,781 Issuance of: Shares issued for exercise of stock options -- -- -- -- -- 1,185 Shares issued for 1999 Purchase Plan -- -- -- -- -- 1,110 Acquisition of treasury stock--20,420,000 shares -- -- -- -- (4,355) (4,355) Retirement of treasury stock -- -- -- -- 1,059 -- Options granted to nonemployees -- -- -- -- -- 36 Net income for 2005 -- -- -- -- -- 8,147 Foreign currency translation adjustments -- (238) -- (238) -- (238) Unrealized loss on available-for-sale securities (770) -- -- (770) -- (770) ------- ------ ---- ------- ------- -------- BALANCE, DECEMBER 31, 2005 (924) (194) -- (1,118) (3,296) 175,896 Issuance of: Shares issued for exercise of stock options -- -- -- -- -- 354 Shares issued for 1999 Purchase Plan -- -- -- -- -- 985 Acquisition of treasury stock--58,447,450 shares -- -- -- -- (7,550) (7,550) Retirement of treasury stock -- -- -- -- 10,846 -- Options granted to nonemployees -- -- -- -- -- 4 Stock-based compensation -- -- -- -- -- 2,589 Net income for 2006 -- -- -- -- -- 743 Foreign currency translation adjustments -- 695 -- 695 -- 695 Unrealized loss on available-for-sale securities (205) -- -- (205) -- (205) ------- ------ ---- ------- ------- -------- BALANCE, DECEMBER 31, 2006 (1,129) 501 -- (628) -- 173,511 Issuance of: Shares issued for exercise of stock options -- -- -- -- -- 2,565 Shares issued for 1999 Purchase Plan -- -- -- -- -- 809 Shares vested under RSUs -- -- -- -- -- -- Acquisition of treasury stock--20,649,000 shares -- -- -- -- (4,330) (4,330) Retirement of treasury stock -- -- -- -- 3,034 -- Stock-based compensation -- -- -- -- -- 2,466 Cumulative effect of adopting FIN 48 -- -- -- -- -- (100) Net income for 2007 -- -- -- -- -- 24,984 Pension loss -- -- (95) (95) -- (95) Foreign currency translation adjustments -- 1,667 -- 1,667 -- 1,667 Unrealized gain on available-for-sale securities 2,702 -- -- 2,702 -- 2,702 ------- ------ ---- ------- ------- -------- BALANCE, DECEMBER 31, 2007 $ 1,573 $2,168 $(95) $ 3,646 $(1,296) $204,179 ======= ====== ==== ======= ======= ======== The accompanying notes are an integral part of the consolidated financial statements. F-5

O\\2\\MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousand US Dollars) - -------------------------------------------------------------------------------- Years Ended December 31 ----------------------------- 2005 2006 2007 --------- -------- -------- OPERATING ACTIVITIES Net income $ 8,147 $ 743 $ 24,984 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,684 4,947 6,927 Amortization of stock options granted for services 264 239 98 Stock-based compensation -- 2,589 2,466 Gain on sale of long-term investments -- -- (20) Gain on sale of short-term investments (10) (24) -- Deferred income taxes 527 (845) (194) Impairment loss on long-term investments -- 756 -- Loss on sale/disposal of property and equipment 18 76 18 Reversal of income tax payable (658) (2,513) -- Changes in operating assets and liabilities: Accounts receivable, net (2,029) (7,527) (5,613) Inventories (4,712) 1,867 (8,164) Prepaid expenses and other current assets (2,721) (819) (66) Notes and accounts payable 2,125 4,091 990 Income tax payable 814 (403) 191 Accrued expenses and other current liabilities 5,570 11 (195) Accrued pension liabilities -- 90 (32) FIN48 tax liabilities -- -- (7) --------- -------- -------- Net cash provided by operating activities 11,019 3,278 21,383 --------- -------- -------- INVESTING ACTIVITIES Long-term notes receivables from employees -- 402 8 Acquisition of: Property and equipment (14,870) (23,367) (8,123) Long-term investments (5,819) (8,073) -- Short-term investments (151,562) (98,755) (75,499) (Increase) decrease in: Restricted assets 306 383 2,207 Restricted cash (3,718) (2,699) 1,532 Other assets (1,750) (496) (1,057) Proceeds from: Sale of short-term investments 158,132 134,297 66,604 Sale of long-term investments -- -- 60 Sale of property and equipment -- 4 -- --------- -------- -------- Net cash (used in) provided by investing activities (19,281) 1,696 (14,268) --------- -------- -------- (Continued) F-6

O\\2\\MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousand US Dollars) - -------------------------------------------------------------------------------- Years Ended December 31 ------------------------- 2005 2006 2007 ------- ------- ------- FINANCING ACTIVITIES Acquisition of treasury stock $(4,355) $(7,550) $(4,330) Proceeds from: Exercise of stock options 1,185 354 2,565 Issuance of ordinary shares under 1999 Purchase Plan 1,110 985 809 ------- ------- ------- Net cash used in financing activities (2,060) (6,211) (956) ------- ------- ------- EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATE 377 300 1,000 ------- ------- ------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (9,945) (937) 7,159 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 56,320 46,375 45,438 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF YEAR $46,375 $45,438 $52,597 ======= ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOWS Cash paid for interest $ -- $ -- $ -- ======= ======= ======= Cash paid for tax $ 292 $ 1,311 $ 1,528 ======= ======= ======= NON-CASH INVESTING AND FINANCING ACTIVITIES Increase in payable for acquisition of equipment $ 1,183 $ -- $ -- ======= ======= ======= Short-term investments reclassified to restricted assets $ 1,430 $ 307 $ -- ======= ======= ======= The accompanying notes are an integral part of the consolidated financial statements. (Concluded) F-7

O\\2\\MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Expressed in United States Dollars Unless Otherwise Noted) - -------------------------------------------------------------------------------- 1. GENERAL Business O\\2\\Micro, Inc. was incorporated in the state of California in the United States of America on March 29, 1995 to design, develop, and deliver semiconductor components primarily for mobile applications. In March 1997, O\\2\\Micro International Limited (the "Company") was formed in the Cayman Islands and all authorized and outstanding common stock, preferred stock and stock options of O\\2\\Micro, Inc. were exchanged for the Company's ordinary shares, preference shares and stock options with identical rights and preferences. O\\2\\Micro, Inc. became the Company's subsidiary after the share exchange. The Company has incorporated various wholly-owned subsidiaries, including (among others) O\\2\\Micro Electronics, Inc. ("O\\2\\Micro-Taiwan"), O\\2\\Micro International Japan Ltd. ("O\\2\\Micro-Japan"), O\\2\\Micro Pte Limited-Singapore ("O\\2\\Micro-Singapore") and O\\2\\Micro (China) Co., Ltd. ("O\\2\\Micro-China"). O\\2\\Micro-Taiwan is engaged in operations. O\\2\\Micro-Japan is engaged in trading. O\\2\\Micro-Singapore, O\\2\\Micro-China and other subsidiaries are mostly engaged in research and development. To assure the testing capacity and flexibility, the Company also established a subsidiary, OceanOne Semiconductor (Ningbo) Limited ("OceanOne") in Ningbo of the People's Republic of China ("China") in August 2005. OceanOne is engaged in semiconductor testing service and has commenced its operations in January 2007. In July 2007, the Company signed a Memorandum of Understanding ("MOU") with Sigurd Microelectronics (Cayman) Co., Ltd ("Sigurd Cayman"), a subsidiary of Sigurd Microelectronics Corporation ("Sigurd"). Sigurd is a leading provider of semiconductor assembly and test services in Taiwan. Under this MOU, the Company intended to divest its investment in OceanOne by selling 100% ownership of OceanOne to Sigurd and to invest up to $10.3 million to Sigurd Cayman to become a strategic partner of Sigurd. As of April 14, 2008, the transaction has not completed as Sigurd is still in the process of obtaining approval from the Taiwan government. At the extraordinary general meeting of shareholders of the Company held on November 14, 2005, the shareholders approved a public global offering of the Company's Ordinary Shares and the proposed listing of the Company's Ordinary Shares on the Main Board of The Stock Exchange of Hong Kong Limited ("SEHK") and various matters related to the proposed listing and offering, including the adoption of an Amended and Restated Memorandum and Articles of Association, the 2005 Share Incentive Plan ("2005 SIP") and the 2005 Share Option Plan ("2005 SOP"), general issue and repurchase mandates which would authorize the Company for a period of time to issue or purchase a limited number of shares in accordance with the Listing Rules of SEHK, and a 50-for-1 share split and the implementation of an American depositary share ("ADS") program with respect to the Company's Ordinary Shares quoted on The Nasdaq National Market ("Nasdaq"). Following approval of these matters, the Company ceased trading its Ordinary Shares on the Nasdaq, effected the share split of Ordinary Shares on November 25, 2005, and commenced trading of ADSs on Nasdaq on November 28, 2005. All share and per share data have been retroactively restated in the accompanying consolidated financial statements and notes to the consolidated financial statements for all periods presented to reflect the share split. On December 30, 2005, the Board determined to file for listing with the SEHK by way of introduction without issuing new shares instead of a global offering after taking market conditions and other factors into consideration. The SEHK listing became effective on March 2, 2006. The adoption of the Amended and Restated Memorandum and Articles of Association, the 2005 SIP, the 2005 SOP, general issue and repurchase mandates became effective upon the listing of the Ordinary Shares on the SEHK. F-8

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated on consolidation. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. Significant accounting estimates reflected in the consolidated financial statements include valuation allowance for deferred tax assets, allowance for doubtful accounts, inventory valuation, useful lives for property and equipment, impairment on long-lived assets, accruals for sales adjustments, other liabilities, contingencies and stock-based compensation. Concentration of Credit Risk Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, short-term investments and accounts receivable. Cash is deposited with high credit quality financial institutions. For cash equivalents and short-term investments, the Company invests in time deposits and debt securities with credit rating of A and better. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and the Company maintains an allowance for doubtful accounts receivable based upon a review of the expected collectibility of individual accounts. Fair Value of Financial Instruments The Company's financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, and notes and accounts payable are carried at cost, which approximates the fair value due to the short-term maturity of those instruments. Fair values of available-for-sale investments including short-term investments and long-term investments represent quoted market prices. Long-term investments in private company equity securities are accounted for under the cost method because the Company does not exercise significant influence over the entities. The Company evaluates related information including operating performance, subsequent rounds of financings, advanced product development and related business plan in determining the fair value of these investments and whether an other-than-temporary decline in value exists. Fair value of restricted assets, which are composed of government bonds, negotiable certificates of deposit and cash, is estimated based on the combination of fair value of each component. Cash and Cash Equivalents The Company considers all highly liquid investments with maturities of not more than three months when purchased to be cash equivalents. Investments with maturities of more than three months are classified as short-term investments. F-9

Restricted Assets The Company classifies deposits made for customs, collateral for obtaining foundry capacity, cash pledged to a bank for the issuance of letters of credit as restricted cash. The deposits are classified as current assets if refundable within a twelve-month period from the balance sheet date. Restricted assets consist of deposits made for Taiwan court cases in the form of Taiwan Government bonds, negotiable certificates of deposit and cash (Note 17). Restricted assets can be released only upon the resolution of the related litigation. Short-term Investments The Company maintains its excess cash in time deposits, US treasury bills, government and corporate bonds issued with high ratings. The specific identification method is used to determine the cost of securities sold, with realized gains and losses reflected in non-operating income and expenses. As of December 31, 2007, all the above-mentioned investments were classified as available-for-sale securities and were recorded at market value. Unrealized gains and losses on these investments are included in accumulated other comprehensive income and loss as a separate component of shareholders' equity, net of any related tax effect, unless unrealized losses are deemed other-than-temporary. Unrealized losses are recorded as a charge to income when deemed other-than-temporary. Investment transactions are recorded on the trade date. Inventories Inventories are stated at the lower of standard cost or market value. Cost is determined on a currently adjusted standard basis, which approximates actual cost on a first-in, first-out basis. The Company assesses its inventory for estimated obsolescence or unmarketable inventory based upon management's assumptions about future demand and market conditions and writes down inventory as needed. Long-term Investments Long-term investments in private companies over which the Company does not exercise significant influence are accounted for under the cost method of accounting. Management evaluates related information in determining the fair value of these investments and whether an other-than-temporary decline in value exists. Factors indicative of an other-than-temporary decline include recurring operating losses, credit defaults and subsequent rounds of financings at an amount below the cost basis of the investment. The list is not all-inclusive and management periodically weighs all quantitative and qualitative factors in determining if any impairment loss exists. Long-term investments in listed companies are classified as available-for-sale securities and are recorded at fair value. Unrealized gains and losses on these investments are included in accumulated other comprehensive income and loss as a separate component of shareholders' equity, net of any related tax effect, unless unrealized losses are deemed other-than-temporary. Unrealized losses are recorded as a charge to income when deemed other-than-temporary. Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Major additions and betterments are capitalized, while maintenance and repairs are expensed as incurred. Depreciation is computed on a straight-line basis over estimated service lives that range as follows: buildings--35 to 49.7 years, equipment--3 to 10 years, furniture and fixtures--3 to 15 years, leasehold improvements--the shorter of the estimated useful life or the lease term, which is 2 to 6 years, and transportation equipment--5 years. F-10

Long-lived Asset Impairment The Company evaluates the recoverability of long-lived assets annually and whenever events or changes in circumstances indicate the carrying value may not be recoverable. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flows from the asset is separately identifiable and is less than the carrying value. If impairment occurs, a loss based on the excess of the carrying value over the fair market value of the long-lived asset is recognized. Fair market value is determined by reference to quoted market prices, if available, or discounted cash flows, as appropriate. Treasury Stock The Company retires ordinary shares repurchased under a share repurchase plan. Accordingly, upon retirement the excess of the purchase price over par value is allocated between additional paid-in capital and retained earnings based on the average issuance price of the shares repurchased. A repurchase of ADSs is recorded as treasury stock until the Company completes the withdrawal of the underlying ordinary shares from the ADS program. Revenue Recognition Revenue from product sales to customers, other than distributors, is recognized at the time of shipment and when title and right of ownership transfers to customers. The four criteria for revenue being realized and earned are the existence of evidence of sale, actual shipment, fixed or determinable selling price, and reasonable assurance of collectibility. Allowances for sales returns and discounts are provided at the time of the recognition of the related revenues on the basis of experience and these provisions are deducted from sales. In certain limited instances, the Company sells its products through distributors. The Company has limited control over these distributors' selling of products to third parties. Accordingly, the Company recognizes revenue on sales to distributors when the distributors sell the Company's products to third parties. Thus, products held by distributors are included in the Company's inventory balance. Research and Development Research and development costs consist of expenditures incurred during the course of planned research and investigation aimed at the discovery of new knowledge that will be useful in developing new products or processes, or at significantly enhancing existing products or production processes as well as expenditure incurred for the design and testing of product alternatives or construction of prototypes. All expenditure related to research and development activities of the Company are charged to operating expenses when incurred. Advertising Expenses The Company expenses all advertising and promotional costs as incurred. These costs were approximately $1,447,000 in 2005, $3,200,000 in 2006 and $3,892,000 in 2007, respectively. A portion of these costs was for advertising, which approximately amounted to $453,000 in 2005, $535,000 in 2006 and $229,000 in 2007, respectively. Pension Costs The Company provides pension benefits and account for the benefit costs on an accrual basis. Pension amounts recognized in the consolidated financial statements are determined on an actuarial basis using several different assumptions. The two most significant assumptions used in the valuation are the discount rate and the long-term rate of return in assets. In determining the net period benefit cost, the Company applies a discount rate in the actuarial valuation of the pension benefit. F-11

Income Tax The Company is not subject to income or other taxes in the Cayman Islands. However, subsidiaries are subject to taxes of the jurisdiction where they are located. Income taxes are accounted for in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes." The provision for income tax represents income tax paid and payable for the current year plus the changes in the deferred income tax assets and liabilities during the relevant years. Deferred income tax assets are recognized for operating loss carryforwards, research and development credits, and temporary differences. The Company believes that uncertainty exists regarding the realizability of certain deferred income tax assets and, accordingly, has established a valuation allowance for those deferred income tax assets to the extent the realizability is not deemed to be more likely than not. In addition, The Company recognizes liabilities for potential income tax contingencies based on its estimate of whether, and the extent to which, additional taxes may be due. If the Company determines that payment of these amounts is unnecessary or if the recorded tax liability is less than its current assessment, the Company may be required to recognize an income tax benefit or additional income tax expense in its financial statements, accordingly. Effective January 1, 2007, the Company adopted Financial Accounting Standards Board ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes--An interpretation of FASB Statement No. 109" ("FIN 48"). The interpretation contains a two step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No.109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. Stock-based Compensation The Company grants stock options to its employees and certain non-employees. Prior to January 1, 2006, the Company accounted for options granted under Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" for its employee stock options. Under APB No. 25, compensation expense is measured based on the difference, if any, on the date of the option grant, between the fair value of the Company's stock and the exercise price of the option. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), "Share-Based Payment," using the modified prospective application method. Under this transition method, compensation cost recognized for the year ended December 31, 2006 and 2007, includes the applicable amounts of: (a) compensation cost of all stock-based payments granted prior to, but not yet vested as of, December 31, 2005 (based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123 and previously presented in pro forma footnote disclosures), and (b) compensation cost for all stock-based payments granted subsequent to January 1, 2006 (based on the grant-date fair value estimated in accordance with the new provisions of SFAS No. 123(R)). Results for periods prior to January 1, 2006, have not been restated. As a result of adopting SFAS No. 123(R) on January 1, 2006, the Company recorded stock-based compensation of $2,589,000 to loss before income tax and net income for the year ended December 31, 2006, and resulted in a decrease of $0.0013 both to basic and diluted earnings per share. Total stock-based compensation includes the impact of stock options, restricted stock units grants and the employee stock purchase plan. The Company's policy for attributing the value of graded vest share-based payments is a straight-line approach. F-12

At the end of June 2005, the Board approved the vesting acceleration of certain options. The Board evaluated the minimal benefit to its employees of accelerating the remaining vesting on these significantly underwater options against the value to shareholders of not having earnings materially affected and the impact that this may have on the Company's market value. In addition, these options had exercise prices in excess of current market values and were not fully achieving their original objectives of incentive compensation and employee retention. Accelerating the vesting of these options accelerated the recognition of any remaining expense associated with these options which was zero under APB No. 25. The following pro forma information, as required by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123," is presented for comparative purposes and illustrates the pro forma effect on net income and related earnings per share for the year ended December 31, 2005, as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation for that period. Year Ended December 31, 2005 ------------ Net income as reported (in thousands) $ 8,147 Add: Stock-based compensation included in net income, including tax expense of $0 for 2005 -- Deduct: Stock-based compensation determined under SFAS No. 123 including tax expense of $0 for 2005 (15,862) ---------- Pro forma net loss $ (7,715) ========== Pro forma shares used in calculation--basic (in thousands) 1,961,168 ========== Pro forma loss per share--basic $ (0.0039) ========== Earnings per share--basic as reported $ 0.0042 ========== Pro forma shares used in calculation--diluted (in thousands) 1,997,459 ========== Pro forma earnings per share--diluted $ NA ========== Earnings per share--diluted as reported $ 0.0041 ========== Pro forma loss per share for the year ended December 31, 2005 was not disclosed because the results were antidilutive. This table includes a pro forma charge of $1,831,000 for the year ended December 31, 2005 related to the above accelerated vesting event. In September, November and December 2005, the Company granted 1,100,000, 100,000 and 70,600,000 stock options, respectively, to employees with the following features: a. Employees will be granted fully vested, immediately exercisable stock options to purchase the Company's ordinary shares. b. The Company has the right but is not required to repurchase exercised stock options upon termination of an employee's service with the Company at the closing market price on the date of repurchase. The shares subject to repurchase are those which qualify as mature shares at the date of such employee's termination. Mature shares are those that have been held by the employee for a period of more than six months. c. Employees are restricted from selling shares which are issued upon the exercise of stock options for a total of four years with 25% of the restriction lapsing each year. d. There is no requisite service period or other performance criteria required by the employee to earn the stock option. F-13

The total pro forma charge for the immediately vested options was $8,588,000 in 2005 and is included in the table above. Foreign Currency Transactions The functional currency is the local currency of the respective entities. Foreign currency transactions are recorded at the rate of exchange in effect when the transaction occurs. Gains or losses, resulting from the application of different foreign exchange rates when cash in foreign currency is converted into the entities' functional currency, or when foreign currency receivable and payable are settled, are credited or charged to income in the period of conversion or settlement. At year-end, the balances of foreign currency monetary assets and liabilities are restated based on prevailing exchange rates and any resulting gains or losses are credited or charged to income. Translation of Foreign Currency Financial Statements The reporting currency of the Company is the US dollar. Accordingly, the financial statements of the foreign subsidiaries are translated into US dollars at the following exchange rates: Assets and liabilities--current rate on balance sheet date; shareholders' equity--historical rate; income and expenses--weighted average rate during the year. The resulting translation adjustment is recorded as a separate component of shareholders' equity. Comprehensive Income (Loss) Comprehensive income represents net income plus the results of certain changes in shareholders' equity during a period from non-owner sources that are not reflected in the consolidated statement of income. Legal Contingencies The Company is currently involved in various claims and legal proceedings. Periodically, the Company reviews the status of each significant matter and assesses the potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, the Company accrues a liability for the estimated loss. In view of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to the pending claims and litigation and revises these estimates as appropriate. Such revisions in the estimates of the potential liabilities could have a material impact on the results of operations and financial position. The Company indemnifies third parties with whom it enters into contractual relationships, including customers; however, it is not possible to determine the range of the amount of potential liability under these indemnification obligations due to the lack of prior indemnification claims. These indemnities typically hold these third parties harmless against specified losses, such as those arising from a breach of representation or covenant, or other third party claims that the Company's products when used for their intended purposes infringe the intellectual property rights of such other third parties. The indemnities are triggered by any claim of infringement of intellectual property rights brought by a third party with respect to the Company's products. The terms of these indemnities may not be waived or amended except by written notice signed by the both parties and may only be terminated with respect to the Company's products. F-14

Recent Accounting Pronouncements In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and enhances fair value measurement disclosure. In February 2008, the FASB issued FASB Staff Position (FSP) 157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13" (FSP 157-1) and FSP 157-2, "Effective Date of FASB Statement No. 157" (FSP 157-2). FSP 157-1 amends SFAS No. 157 to remove certain leasing transactions from its scope. FSP 157-2 delays the effective date of SFAS No. 157 for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2009. The measurement and disclosure requirements related to financial assets and financial liabilities are effective for the Company beginning in the first quarter of fiscal 2008. The adoption of SFAS No. 157 for financial assets and financial liabilities will not have a significant impact on the consolidated financial statements. However, the resulting fair values calculated under SFAS No. 157 after adoption may be different from the fair values that would have been calculated under previous guidance. The Company is currently evaluating the impact that SFAS No. 157 will have on the consolidated financial statements when it is applied to non-financial assets and non-financial liabilities beginning in the first quarter of 2009. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." SFAS No. 159 expands the use of fair value accounting but does not affect existing standards, which require assets and financial liabilities, on an instrument-by-instrument basis. If the fair value option is elected, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the adoption of SFAS No. 159, changes in fair value are recognized in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company chose not to elect the fair value option under SFAS No. 159 to measure its financial assets and financial liabilities at fair value. In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" (SFAS No. 141(R)). Under SFAS No. 141(R), an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. In addition, acquired in-process research and development (IPR&D) is capitalized as an intangible asset and amortized over its estimated useful life. SFAS No. 141(R) is effective on a prospective basis for business combinations with an acquisition date beginning in the first quarter of fiscal year 2009. The Company is in the process of evaluating the provisions of this standard and is currently unable to estimate the impact. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements--an amendment of ARB No. 51" (SFAS No. 160). SFAS No. 160 changes the accounting and reporting for minority interests, which will be recharacterized as non-controlling interests and classified as a component of equity. SFAS No. 160 is effective on a prospective basis for business combinations with an acquisition date beginning in the first quarter of fiscal year 2009. As of December 31, 2007, the Company did not have any minority interests. The adoption of SFAS No. 160 will not impact the Company's consolidated financial statements. Reclassifications Certain amounts reported in previous years have been reclassified to conform to the current year presentation. F-15

3. CASH AND CASH EQUIVALENTS December 31 --------------- 2006 2007 ------- ------- (In Thousands) Time deposits $30,155 $30,378 Savings and checking accounts 13,180 22,203 US treasury bills 2,086 -- Petty cash 17 16 ------- ------- $45,438 $52,597 ======= ======= 4. SHORT-TERM INVESTMENTS December 31 --------------- 2006 2007 ------- ------- (In Thousands) Time deposits $19,697 $28,650 ======= ======= Short-term investments by contractual maturity are as follows: December 31 --------------- 2006 2007 ------- ------- (In Thousands) Due within one year $19,668 $28,650 Due after one year through two years 29 -- ------- ------- $19,697 $28,650 ======= ======= The Company's gross realized gains and losses on the sale of investments for the year ended December 31, 2005 were $12,000 and $2,000, respectively, for the year ended December 31, 2006 were $26,000 and $2,000, respectively, and for the year ended December 31, 2007 were both $0. Gross unrealized gains and losses at December 31, 2005 were $55,000 and $11,000, respectively, at December 31, 2006 were $0 and $6,000, respectively, and at December 31, 2007 were both $0. The following table shows the gross unrealized losses and fair value of the Company's investments with unrealized losses that were not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006 (nil at December 31, 2007). December 31, 2006 Less Than 12 Months --------------------- Unrealized Fair Value Losses ---------- ---------- (In Thousands) Investment in CSMC (Note 8) $2,668 $1,123 ====== ====== F-16

5. ACCOUNTS RECEIVABLE, NET December 31 ---------------- 2006 2007 ------- ------- (In Thousands) Accounts receivable $19,310 $25,585 Allowances for Doubtful receivable (7) (88) Sales returns and discounts (316) (897) ------- ------- $18,987 $24,600 ======= ======= The changes in the allowances are summarized as follows: Years Ended December 31 -------------- 2006 2007 ----- ------- (In Thousands) Allowances for doubtful receivable Balance, beginning of the year $ 34 $ 7 Additions -- 81 Write-off (27) -- ----- ------- Balance, end of the year $ 7 $ 88 ===== ======= Allowances for sales returns and discounts Balance, beginning of the year $ 316 $ 316 Additions 848 1,836 Write-off (848) (1,255) ----- ------- Balance, end of the year $ 316 $ 897 ===== ======= 6. INVENTORIES December 31 --------------- 2006 2007 ------- ------- (In Thousands) Finished goods $ 5,412 $ 7,814 Work-in-process 5,375 5,434 Raw materials 3,289 8,879 ------- ------- $14,076 $22,127 ======= ======= F-17

7. PREPAID EXPENSES AND OTHER CURRENT ASSETS December 31 ------------- 2006 2007 ------ ------ (In Thousands) Prepayment to foundry providers $2,940 $2,680 Interest receivable 2,203 2,445 Prepaid expenses 1,418 1,514 Other receivable 76 311 Deferred tax assets 31 45 Value-added-tax paid 174 32 Others 537 449 ------ ------ $7,379 $7,476 ====== ====== 8. LONG-TERM INVESTMENTS December 31 --------------- 2006 2007 ------- ------- (In Thousands) Cost method X-FAB Semiconductor Foundries AG ("X-FAB") $ 4,968 $ 4,968 360 Degree Web Ltd. ("360 Degree Web") 1,305 1,305 GEM Services, Inc. ("GEM") 500 500 Etrend Hightech Corporation ("Etrend") 960 -- Asia SinoMOS Semiconductor Inc. ("Sinomos") 13,073 13,073 Philip Ventures Enterprise Fund ("PVEF") 585 585 ------- ------- 21,391 20,431 ------- ------- Available for sale securities - noncurrent CSMC Technologies Corporation ("CSMC") 2,668 5,265 Etrend -- 1,019 ------- ------- 2,668 6,284 ------- ------- $24,059 $26,715 ======= ======= The Company invested in X-FAB's ordinary shares in July 2002. X-FAB is a European-American foundry group that specializes in mixed signal application. As of December 31, 2007, the Company held 530,000 shares at the value of $4,968,000 (4,982,000 EURO), which represents a 1.60% ownership of X-FAB. The Company converted its convertible loans in 360 Degree Web to Series B and B2 preference shares of 360 Degree Web in January 2003. 360 Degree Web designs, develops and markets intelligent security software solutions that provide secure computing environment for personal computer mobile devices and the internet. In March 2004, the Company sold 1,000,000 shares of its stock in 360 Degree Web and recognized a gain of $340,000. In January 2005, the Company purchased additional 180,769 Series D preference shares of 360 Degree Web at $1.3 per share. As of December 31, 2007, the Company held 19.52% ownership of 360 Degree Web. The Company invested in GEM's preference shares in August 2002. GEM is a multinational semiconductor assembly and test company. As of December 31, 2007, the Company held 333,334 shares at the value of $500,000, which represented a 0.89% ownership of GEM. F-18

The Company invested in Etrend's ordinary shares in December 2002, July 2003 and March 2004. Etrend is a wafer probing, packing and testing company. As of December 31, 2007, the Company held 8.65% ownership of Etrend. In August 2007, Etrend's shares were listed on the Emerging Stock Gretai Security Market of Taiwan and the Company reclassified the investment in Etrend to available-for-sale securities. As of December 31, 2007, the Company recorded an unrealized gain on investment in Etrend of $99,000. In January 2005, the Company invested in ordinary shares of Sinomos, a privately owned foundry company, at a total amount of $5,000,000. In May and December 2006, the Company further invested preferred shares of $3,288,000 and $4,785,000, respectively. As of December 31, 2007, the Company held 30,101,353 of ordinary and preference shares, representing an 18.41% ownership of Sinomos. In November 2005, the Company invested in PVEF, a fund management company in Singapore, with investment amount of SG$1,000,000 for 20 units in the placement at SG$50,000 per unit. The Company held 2.77% of the fund as of December 31, 2007. The Company invested in Silicon Genesis Corporation ("SiGen") preferred shares in December 2000. SiGen is an advanced nanotechnology company that develops Silicon-on-insulator ("SOI"), stained-silicon products and other engineered multi-layer structures to microelectronics and photonic for advanced electronic and opto-electronic device applications. In 2002 and 2003, the Company reviewed the qualitative factors of the investment, determined that the decline in value was other-than-temporary and the carrying value was decreased to zero. The Company held 23,946 shares of SiGen as of December 31, 2007, representing a 0.06% ownership in SiGen. In August 2004, the Company invested in CSMC's ordinary shares which are listed on the SEHK at a purchase price of $4,547,000. CSMC is a semiconductor foundry company. As of December 31, 2007, the Company held 70,200,000 shares, which represent approximately 2.56% ownership of CSMC. The Company considered the investment to be other-than-temporarily impaired at June 30, 2006 due to the fact that the stock price has been below the cost of HK$0.50 per share for a continuous 12 months and recognized an impairment loss of $756,000 based on the quoted market price of HK$0.42 per share on June 30, 2006. As of December 31, 2007, the Company recognized an unrealized gain of $1,474,000 on investment in CSMC. 9. PROPERTY AND EQUIPMENT, NET December 31 --------------- 2006 2007 ------- ------- (In Thousands) Cost Freehold Land $11,299 $11,299 Buildings 8,055 8,055 Equipment 30,599 38,357 Furniture and fixtures 1,393 1,476 Leasehold improvements 3,385 3,723 Transportation equipment 514 590 Prepayment for property and equipment 1,426 878 ------- ------- 56,671 64,378 ------- ------- Accumulated depreciation Buildings 313 493 Equipment 12,569 17,276 Furniture and fixtures 786 998 Leasehold improvements 1,465 2,235 Transportation equipment 111 228 ------- ------- 15,244 21,230 ------- ------- $41,427 $43,148 ======= ======= F-19

Depreciation expense recognized during the years ended December 31, 2005, 2006 and 2007 were approximately $3,388,000, $4,545,000 and $6,580,000, respectively. In April 2006, the Company purchased 29,935 square feet of freehold land in Hsin-Chu, Taiwan for a future facility for a total purchase price of approximately $8,789,000 (NT$286,421,000) which is included above. 10.OTHER ASSETS December 31 ------------- 2006 2007 ------ ------ (In Thousands) Land use rights, net $1,379 $1,350 Deferred charges, net 618 1,159 Refundable deposits 560 660 Deferred income tax assets--noncurrent 295 477 Prepayment for land use rights 215 230 Long-term notes receivable from employees 8 -- ------ ------ $3,075 $3,876 ====== ====== All land within municipal zones in China is owned by the government. Limited liability companies, joint stock companies, foreign-invested enterprises, privately held companies and individual natural persons must pay fees for granting of rights to use land within municipal zones. Legal use of land is evidenced and sanctioned by land use certificates issued by the local municipal administration of land resources. Land use rights granted for industrial purposes are limited to a term of no more than 50 years. Land use rights are recorded at cost less accumulated amortization. Amortization is provided on the straight-line method over the term of the land use rights agreement which is 49.7 years. In view of the expansion of the Company's operations in China, the Company entered into a purchase contract to acquire land use rights located in Ningbo, China. The total contracted price was $767,000 (RMB5,600,000) (2006: $717,000) of which $230,000 (RMB1,680,000) (2006: $215,000) has been paid as of December 31, 2007 and such amount has been included in the prepayment for land use rights. Deferred charges consist of consultant and maintenance contracts and are amortized over the term of the contract which is 3 to 8 years. In 2001, James Keim, one of the Company's directors, accepted the assignment of Head of Marketing and Sales in the Cayman Islands, and moved to the Cayman Islands in December 2001. In connection with the move and to assist Mr. Keim to purchase a residence in the Cayman Islands, the Company entered into a loan agreement with Mr. Keim in February 2002, under which the Company made an interest free, unsecured loan in the amount of $400,000 to Mr. Keim. The loan has been repaid in December 2006. F-20

11.ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES December 31 --------------- 2006 2007 ------- ------- (In Thousands) Salaries, bonus and benefits $ 3,844 $ 3,717 Legal and audit fees 3,187 2,115 Consulting fees 153 1,122 Promotional expenses 743 533 Withholding tax payable 260 285 Deferred income tax liabilities 107 109 Payable for acquisition of equipment 248 89 Value-added tax payable 243 20 Other accrued expenses 2,959 2,257 Other 468 1,350 ------- ------- $12,212 $11,597 ======= ======= 12.INCOME TAX Income (loss) before income taxes consisted of: Years Ended December 31 ----------------------- 2005 2006 2007 ------ ------- ------- (In Thousands) Cayman Islands $6,226 $(3,395) $20,832 Foreign 2,955 1,688 5,608 ------ ------- ------- $9,181 $(1,707) $26,440 ====== ======= ======= Income tax expense (benefit) consisted of: Years Ended December 31 ---------------------- 2005 2006 2007 ------ ------- ------ (In Thousands) Current $ 507 $(1,605) $1,650 Deferred 527 (845) (194) ------ ------- ------ Income tax expense (benefit) $1,034 $(2,450) $1,456 ====== ======= ====== F-21

The Company and its subsidiaries file separate income tax returns. Reconciliation of the significant differences between the statutory income tax rate and the effective income tax rate on pretax income (loss) is as follows: Years Ended December 31 ------------------------- 2005 2006 2007 ----- ------- ----- Cayman statutory rate 0% 0% 0% Foreign rates in excess of statutory rates 15.69% 35.21% 5.36% Changes in deferred income tax assets (7.12%) (49.56%) (2.22%) Adjustments to prior years' taxes (9.11%) (190.22%) (0.42%) Change in valuation allowance for deferred income tax assets 9.74% 35.62% (2.96%) Others 2.06% 25.42% 5.75% ----- ------- ----- Effective tax rate 11.26% (143.53%) 5.51% ===== ======= ===== The deferred income tax assets and liabilities as of December 31, 2006 and 2007 consisted of the following: December 31 ---------------- 2006 2007 ------- ------- (In Thousands) Deferred income tax assets Research and development credits $ 5,553 $ 3,970 Organization costs -- 576 Net operating loss carryforwards 51 32 Accrued vacation 158 160 Depreciation and amortization 353 612 Deferred interest deductions 326 240 Others 29 292 ------- ------- 6,470 5,882 Valuation allowance (6,144) (5,360) ------- ------- Total net deferred income tax assets 326 522 ------- ------- Deferred income tax liabilities Unrealized foreign exchange 42 71 Unrealized capital allowance 65 38 ------- ------- Total deferred income tax liabilities 107 109 ------- ------- Net deferred income tax assets $ 219 $ 413 ======= ======= Balance sheet caption reported in: Prepaid expenses and other current assets (Note 7) $ 31 $ 45 Other assets (Note 10) 295 477 Accrued expenses and other current liabilities (Note 11) 107 109 ------- ------- $ 219 $ 413 ======= ======= The valuation allowance shown in the table above relates to net operating loss, credit carryforwards and temporary differences for which the Company believes that realization is uncertain. The valuation allowance increased $592,000 and decreased $784,000 for the years ended December 31, 2006 and 2007, respectively. As of December 31, 2007, O\\2\\Micro, Inc. had US federal and state research and development credit carryforwards of approximately $3,716,000 and $3,810,000, respectively. The US federal research and development credit will expire from 2018 through 2027 if not utilized, while the state research and development credit will never expire. F-22

The Company reversed $375,000 and $2,513,000 of income tax payable for the 2000 and 2001 tax years in September 2004 and in September 2006, respectively, due to completion of the examination and approval of its filed Taiwan income tax return for the years ended December 31, 2000 and 2001. The tax authorities also determined a tax refund for 2001 income tax; therefore, the Company recognized additional income tax benefit of $69,000 and received the refund in October 2006. On May 24, 2004, O\\2\\Micro-Taiwan applied to the Taiwan Customs officials for the rectification of the value of the imported goods reported for the period from March 2003 to March 2004. The Company had mistakenly reported a lower value to the Taiwan Customs Authority than the correct value that was reported on O\\2\\Micro-Taiwan's tax return for the tax years of 2003 and 2004. The Taiwan Ministry of Finance approved the rectification of the value of the imported goods in 2005. The completion of the rectification resulted in the reversal of a contingent income tax liability of $658,000 and an income tax benefit was recognized in 2005. As a result of the implementation of FIN 48, the Company recognized a cumulative adjustment in the liability for unrecognized income tax benefits in the amount of $100,000, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings and an adjustment of income tax liabilities for unrecognized income tax benefits in the amount of $117,000, which was accounted for as a reduction to the January 1, 2007 balance of income tax payable. At the adoption date of January 1, 2007, the Company had $217,000 of unrecognized tax benefits, all of which would affect its effective tax rate if recognized. At December 31, 2007, the Company had $210,000 of unrecognized tax benefits, all of which would affect its effective tax rate if recognized. The Company does not recognize any interest and penalty related to uncertain tax positions in income tax expense as the related interests are not deemed material to the financial statements. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: (In Thousands) Balance as of January 1, 2007 $ 217 Increase in tax position balance during current year 110 Decrease in tax position balance during current year (117) ----- Balance as of December 31, 2007 $ 210 ===== Uncertain tax positions relate to the allocation of income amongst the Company's global entities. The Company estimates that there will be no material changes in its uncertain tax positions in the next 12 months. The Company files income tax returns in various foreign jurisdictions. The Company is no longer subject to income tax examinations by tax authorities for years prior to 2003. 13.RETIREMENT AND PENSION PLANS The Company has a savings plan that qualifies under Section 401(k) of the US Internal Revenue Code. Participating employees may defer up to the US Internal Revenue Service statutory limit amounts of pretax salary. The Company may make voluntary contributions to the savings plan but has made no contributions since the inception of the savings plan in 1997. F-23

The Company also participates in mandatory pension funds and social insurance schemes, if applicable, for employees in jurisdictions in which other subsidiaries or offices are located to comply with local statutes and practices. For the years ended December 31, 2005, 2006 and 2007, pension costs charged to income in relation to the contributions to these schemes were $861,000, $1,293,000 and 1,675,000, respectively. In October 2006, the Company adopted a defined benefit pension plan and established an employee pension fund committee for certain employees of O\\2\\Micro-Taiwan who are subject to the Taiwan Standards Labor Law ("Labor Law") to comply with local requirements. This benefit pension plan provides benefits based on years of service and average salary computed based on the final six months of employment. The Labor Law requires the Company to contribute between 2% to 15% of employee salaries to a government specified plan, which the Company currently makes monthly contributions equal to 2% of employee salaries. Contributions are required to be deposited in the name of the employee pension fund committee with the Central Trust of China in Taiwan. The measurement date of the plan is December 31. As of December 31, 2006 and 2007, the asset allocation was primarily in cash, equity securities and debt securities. Furthermore, under the Labor Standards Law, the rate of return on assets shall not be less than the average interest rate on a two-year time deposit published by the local banks. The government is responsible for any shortfall in the event that the rate of return is less than the required rate of return. Changes in projected benefit obligation and plan assets for the years ended December 31, 2006 and 2007 are as follows: Years Ended December 31 ----------- 2006 2007 ---- ---- (In Thousands) Beginning benefit obligation $444 $464 Service cost 4 5 Interest cost 16 16 Benefits paid -- -- Actuarial loss -- 97 ---- ---- Ending benefit obligation $464 $582 ==== ==== Years Ended December 31 ----------- 2006 2007 ---- ---- (In Thousands) Fair value of plan assets, beginning of year $ -- $ 9 Employer contributions 9 52 Actual return on plan assets -- 1 ---- ---- Fair value of plan assets, end of year $ 9 $ 62 ==== ==== F-24

The component of net periodic benefit cost is as follows: Years Ended December 31 ---------- 2006 2007 ---- ---- (In Thousands) Service cost $ 4 $ 5 Interest cost 16 16 Expected return on plan assets -- (1) Amortization of the unrecognized transition obligation 70 -- --- --- Net periodic benefit cost $90 $20 === === The funded status of the plan is as follows: December 31 ------------ 2006 2007 ----- ----- (In Thousands) Accumulated benefit obligation $(332) $(424) ===== ===== Project benefit obligation $(464) $(582) Plan assets at fair value 9 62 ----- ----- Funded status of the plan $(455) $(520) ===== ===== The actuarial assumptions are as follows: Years Ended December 31 ---------- 2006 2007 ---- ---- Discount rate 3.5% 3.0% Rate of compensation increases 2.0% 2.0% Expected long-term rate of return on plan assets 2.5% 2.5% 14.STOCK-BASED COMPENSATION Employee Stock Purchase Plan In October 1999, the Board adopted the 1999 Employee Stock Purchase Plan ("1999 Purchase Plan"), which was approved by the shareholders prior to the consummation of its initial public offering in August 2000. A total of 50,000,000 ordinary shares were reserved for issuance under the 1999 Purchase Plan, plus annual increases on January 1 of each year, commencing in 2001, up to 40,000,000 shares as approved by the Board. The 1999 Purchase Plan is subject to adjustment in the event of a stock split, stock dividend or other similar changes in ordinary shares or capital structure. F-25

The 1999 Purchase Plan permits eligible employees to purchase ordinary shares through payroll deductions, which may range from 1% to 10% of an employee's regular base pay. Beginning November 1, 2005, the 1999 Purchase Plan shall be implemented through consecutive offer periods of 3 months' duration commencing on the first day of February, May, August and November. Under the 1999 Purchase Plan, ordinary shares may be purchased at a price equal to the lesser of 90% of the fair market value of the Company's ordinary shares on the date of grant of the option to purchase (which is the first day of the offer period) or 90% of the fair market value of the Company's ordinary shares on the applicable exercise date (which is the last day of the offer period). Employees may elect to discontinue their participation in the purchase plan at any time; however, all of the employee's payroll deductions previously credited to the employee's account will be applied to the exercise of the employee's option on the next exercise date. Participation ends automatically on termination of employment with the Company. If not terminated earlier, the 1999 Purchase Plan will have a term of 10 years. During 2006 and 2007, 6,980,050 and 5,060,300 ordinary shares, respectively, had been purchased under the 1999 Purchase Plan. As of December 31, 2007, 10,791,650 shares were available for issuance. Stock Option Plans In 1997, the Board adopted the 1997 Stock Plan, and in 1999, adopted the 1999 Stock Incentive Plan. The plans provide for the granting of stock options to employees, directors and consultants of the Company. Under the 1997 Stock Plan, the Board reserved 185,000,000 ordinary shares for issuance. After the completion of an initial public offering, no further options were granted under the 1997 Stock Plan. Under the 1999 Stock Incentive Plan, the maximum aggregate number of shares available for grant shall be 150,000,000 ordinary shares plus an annual increase on January 1 of each year, commencing in 2001, equal to the least of 75,000,000 shares or 4% of the outstanding ordinary shares on the last day of the preceding fiscal year or a smaller number determined by the plan administrator. As of December 31, 2007, the number of options outstanding and exercisable was 15,041,650 and 15,041,650, respectively, under the 1997 Stock Plan, and 247,296,700 and 221,273,550, respectively, under the 1999 Stock Incentive Plan. The Board adopted the 2005 SOP which was effective on March 2, 2006, the date the Company completed the SEHK listing, and then the Board terminated the 1997 Stock Plan and 1999 Stock Incentive Plan. The Company began issuing stock options solely under the 2005 SOP for up to 100,000,000 ordinary shares. Under the terms of the 2005 SOP, stock options are generally granted at fair market value of the Company's ordinary shares. The stock options have a contractual term of 8 years from the date of grant and vest over a requisite service period of 4 years. As of December 31, 2007, the number of options outstanding and exercisable was 45,169,900 and 10,601,000, respectively, under the 2005 SOP. A summary of the Company's stock option activity under the plans as of December 31, 2007, and changes during the year then ended is presented as follows: Weighted Number of Weighted Average Outstanding Average Remaining Aggregate Options Exercise Contract Intrinsic Shares Price Life Value ----------- -------- --------- --------- Outstanding options, January 1, 2006 310,484,350 $0.2364 Granted 21,988,400 $0.1731 Exercised (5,643,000) $0.0630 Forfeited or expired (20,086,750) $0.2451 ----------- Outstanding options, December 31, 2006 (240,858,450 options exercisable at a weighted average exercise price of $0.2354) 306,743,000 $0.2344 Granted 31,149,000 $0.1964 (Continued) F-26

Weighted Number of Weighted Average Outstanding Average Remaining Aggregate Options Exercise Contract Intrinsic Shares Price Life Value ----------- -------- --------- ---------- Exercised (13,564,800) $0.1891 Forfeited or expired (16,818,950) $0.2570 ----------- Outstanding options, December 31, 2007 307,508,250 $0.2313 5.98 $8,815,000 =========== ==== ========== Vested and expected to vest options at December 31, 2007 273,350,559 $0.2321 5.90 $7,808,000 =========== ==== ========== Exercisable options at December 31, 2007 246,916,200 $0.2355 5.76 $6,712,000 =========== ==== ========== (Concluded) The total intrinsic value of options exercised during the years ended December 31, 2005, 2006 and 2007 were $841,000, $177,000 and 1,301,000, respectively. The following table summarizes information about outstanding and vested stock options: Options Outstanding Options Exercisable -------------------------------- -------------------- Weighted Average Weighted Weighted Remaining Average Number Average Number Contractual Exercise Exercisable Exercise Range of Exercise Prices Outstanding Life Price and Vested Price - ------------------------ ----------- ----------- -------- ----------- -------- $0.0050--$0.0100 2,366,650 1.18 $0.0099 2,366,650 $0.0099 $0.0790--$0.1198 6,181,550 2.27 $0.0929 6,048,900 $0.0923 $0.1292--$0.1948 77,144,800 5.42 $0.1664 50,619,750 $0.1692 $0.2013--$0.2994 172,816,050 6.60 $0.2322 144,305,150 $0.2302 $0.3076--$0.4836 48,999,200 5.36 $0.3582 43,575,750 $0.3622 ----------- ----------- Balance, December 31, 2007 307,508,250 5.98 $0.2313 246,916,200 $0.2355 =========== =========== Share Incentive Plan The Board adopted the 2005 SIP which was effective on March 2, 2006, the date the Company completed the SEHK listing. The 2005 SIP provides for the grant of restricted shares, restricted share units ("RSU"), share appreciation rights and dividend equivalent rights (collectively referred to as "Awards") up to 75,000,000 ordinary shares. Awards may be granted to employees, directors and consultants. The RSUs vest over a requisite service period of 4 years. F-27

A summary of the status of the Company's RSUs as of December 31, 2007, and the changes during the year ended December 31, 2007 is presented as follows: Weighted Number of Average Outstanding Exercise Awards Price ----------- -------- Initial shares granted 8,085,250 $0.1736 Vested -- -- Forfeited and expired (170,500) 0.1736 ---------- Nonvested at December 31, 2006 7,914,750 $0.1736 Granted 9,236,500 $0.2041 Vested (1,922,100) $0.1736 Forfeited and expired (901,600) $0.1935 ---------- Nonvested at December 31, 2007 14,327,550 $0.1920 ========== As of December 31, 2007, there was $5,027,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the plans including stock options and RSUs. The cost is expected to be recognized over a weighted-averaged period of 2.95 years. The total fair value of RSUs vested during the year ended December 31, 2006 and 2007 was $0 and $334,000, respectively. Cash received from option exercise under all share-based payment arrangements for the years ended December 31, 2005, 2006 and 2007 was $2,295,000, $1,339,000 and $3,374,000, respectively. For purposes of measuring compensation expense under APB No. 25, the fair value of the shares on the date of grant was determined by the Board for grants prior to August 23, 2000. The fair value of subsequent option grants or RSU grants was based on the market price of ordinary shares on the day of grant. The Company calculated the fair value of each option grant on the date of grant using the Black-Scholes option pricing model that use the assumptions in the following table. Risk-free interest rate is based on the US Treasury yield curve in effect at the time of grant. The Company uses the simplified method as provided by Staff Accounting Bulletin No. 107 by average vesting term and contractual term of the options as their expected term. Expected volatilities are based on historical volatility of stock prices for a period equal to the options' expected term. The dividend yield is zero as the Company has never declared or paid dividends on the ordinary shares or other securities and do not anticipate paying dividends in the foreseeable future. Stock Options Employee Stock Purchase Plan --------------------------------- ----------------------------------------------- Years Ended December 31 Years Ended December 31 --------------------------------- ----------------------------------------------- 2005 2006 2007 2005 2006 2007 --------- ----------- ----------- --------------- --------------- --------------- Risk-free interest rate 4.06% 4.45%-5.10% 3.41%-4.92% 2.20%-3.96% 4.47%-5.12% 3.81%-5.13% Expected life 5-7 years 5-7 years 5 years 0.26-0.51 years 0.25-0.26 years 0.25-0.26 years Volatility 65% 67%-71% 58%-66% 38%-78% 44%-51% 38%-50% Dividend -- -- -- -- -- -- The weighted-average grant-date fair values of options granted during the years ended December 31, 2005, 2006 and 2007 were $0.1338, $0.1062, and $0.1135, respectively. The weighted-average fair values for purchase rights granted pursuant to the 1999 Purchase Plan during the years ended December 31, 2005, 2006 and 2007 were $0.0675, $0.0316 and $0.0436, respectively. F-28

Ordinary Shares Reserved As of December 31, 2007, ordinary shares reserved for future issuance were as follows: Outstanding stock options 307,508,250 Outstanding RSUs 14,327,550 Shares reserved for future stock option grants 54,334,600 Shares reserved for 1999 purchase plan 10,791,650 Shares reserved for Awards 58,750,350 ----------- 445,712,400 =========== 15.EARNINGS PER SHARE Basic earnings per share is calculated by dividing net income by the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted average number of ordinary and dilutive ordinary equivalent shares outstanding during the period, using the treasury stock method for options. A reconciliation of the numerator and denominator of basic and diluted earnings per share calculations is provided as follows: Years Ended December 31 -------------------------------- 2005 2006 2007 ---------- ---------- ---------- Net income (in thousands) $ 8,147 $ 743 $ 24,984 ========== ========== ========== Weighted average shares outstanding (in thousands)--basic 1,961,168 1,932,575 1,905,725 Effect of dilutive securities: Options and RSUs (in thousands) 36,291 14,321 38,060 ---------- ---------- ---------- Weighted average shares outstanding (in thousands)--diluted 1,997,459 1,946,896 1,943,785 ========== ========== ========== Earnings per share--basic $ 0.0042 $ 0.0004 $ 0.0131 ========== ========== ========== Earnings per share--diluted $ 0.0041 $ 0.0004 $ 0.0129 ========== ========== ========== Certain outstanding options were excluded from the computation of diluted EPS since their effect would have been antidilutive. The antidilutive stock options excluded and their associated exercise prices per share were 128,293,200 shares at $0.2538 to $0.4836 as of December 31, 2005, 254,805,913 shares at $0.1198 to $0.4836 as of December 31, 2006 and 166,279,163 shares at $0.1198 to $0.4836 as of December 31, 2007. 16.COMMITMENTS Capital Commitments As described in Note 10, the land use right purchase commitment was $537,000 as of December 31, 2007. The original agreement was expired on October 31, 2007 and the Company has negotiated with the counter party for an extension of additional two years. F-29

Lease Commitments The Company leases office space and certain equipment under noncancelable operating lease agreements that expire at various dates through December 2011. For the years ended December 31, 2005, 2006 and 2007, leasing costs charged to income in relation to agreements were $1,686,000, $2,148,000 and 2,509,000, respectively. The Company's office lease provides for periodic rental increases based on the general inflation rate. As of December 31, 2007, minimum lease payments under all noncancelable leases were as follows: Operating Leases Year -------------- (In Thousands) 2008 $2,274 2009 813 2010 709 2011 62 ------ Total minimum lease payments $3,858 ====== 17.CONTINGENCIES The Company is involved in a variety of litigation matters involving patents. For example, the Company has initiated and is pursuing certain patent infringement actions in Taiwan. The Company has obtained preliminary injunctions and provisional attachment orders against numerous competitors, their customers and users. As of December 31, 2007, the Company has deposited an amount of New Taiwan dollars equivalent to approximately $12.4 million with the Taiwan courts for court bonds, which was accounted for as restricted assets, in connection with those actions, other preliminary injunction actions and related provisional attachment actions. The court bonds provide security for the enjoined party to claim damages against the Company incurred from the preliminary injunctions, provisional attachments or the provision of a countersecurity in the event the Company does not ultimately succeed in the underlying infringement actions. However, these preliminary injunctions or provisional attachments may be rescinded if the relevant court allows the opposing party to make its own deposit or countersecurity with the court. In February 2007, Monolithic Power Systems, Inc. amended its complaint in the Intermediate People's Court in Chengdu, China alleging that two of our customers infringe Chinese Patent Number ZL03140709.9. In May 2007, a jury in the United States District Court in the Northern District of California found Claims 1, 2, 9, 12, 14 and 18 of our U.S. Patent Number 6,396,722 to be invalid. In April 2008, the United States Court of Appeals for the Federal Circuit vacated the jury verdict, the final judgment of infringement and the permanent injunction we obtained against Beyond Innovation Technology Co., Ltd., FSP Group, SPI Electronic Co., Ltd. and Lien Chang Electronic Enterprise Co., Ltd. and remanded to the district court for further proceedings. The Company has filed a petition for rehearing with the court. The Company is also involved in several other patent litigation matters in the United States. In 2007, the Company received $9.4 million litigation proceeds from the Monolithic Power Systems, Inc., Sony Corporation and Samsung Electronics Co., Ltd. litigation cases in the United States. In March 2008, the Company further received $2 million from a litigation case settled in the United States. While the Company cannot make any assurance regarding the eventual resolution of these matters, the Company does not believe the final outcome will have a material adverse effect on its consolidated results of operations or financial condition. The Company, as a normal course of business, is a party to various litigation matters, legal proceedings and claims. These actions may be in various jurisdictions, and may involve patent protection and/or patent infringement. While the results of such litigations and claims cannot be predicted with certainty, the final F-30

outcome of such matters is not expected to have a material adverse effect on its consolidated financial position or results of operations. No assurance can be given, however, that these matters will be resolved without the Company becoming obligated to make payments or to pay other costs to the opposing parties, with the potential for having an adverse effect on the Company's financial position or its results of operations. As of December 31, 2007, no provision for any litigation has been provided. 18.FINANCIAL INSTRUMENTS Information on the Company's financial instruments is as follows: December 31 --------------------------------- 2006 2007 ---------------- ---------------- (In Thousands) Carrying Fair Carrying Fair Amount Value Amount Value -------- ------- -------- ------- Assets Cash and cash equivalents $45,438 $45,438 $52,597 $52,597 Restricted cash 8,342 8,342 6,830 6,830 Short-term investments 19,697 19,697 28,650 28,650 Long-term investment in available-for-sale securities 2,668 2,668 6,284 6,284 Restricted assets 14,540 14,507 12,393 12,380 The carrying amounts of cash and cash equivalents and restricted cash reported in the consolidated balance sheets approximate their estimated fair values. The fair values of short-term investments and long-term investment in available-for-sale securities are based on quoted market prices. Fair value of restricted assets made in the form of Taiwan Government bonds are based on quoted market price; the remaining restricted assets are carried at amounts which approximate fair value. Long-term investments, except for investment in available-for-sale securities, are in privately-held companies where there is no readily determinable market value. The Company periodically evaluates these investments for impairment. If it is determined that an other-than-temporary decline has occurred in the carrying value, an impairment loss is recorded in the period of decline in value. 19.RELATED PARTY TRANSACTIONS Except as disclosed in the consolidated financial statements and other notes, the following are significant related party transactions: Executive Severance and Change of Control Agreements In April 2007, the Company entered into an Executive Severance and Change of Control Agreement with Sterling Du, the Chief Executive Officer and Chairman of the Board, pursuant to which Mr. Du would be entitled to, among other things, two times his base salary and annual target bonus and immediate vesting of 50% of his unvested equity awards if terminated under certain circumstances. In addition, Mr. Du would be entitled to, among other things, three times his base salary and annual target bonus and immediate vesting of 100% of his unvested equity awards if terminated under certain circumstances within twenty-four months of a change of control of the Company. In April 2007, the Company entered into an Executive Severance and Change of Control Agreement with Chuan Chiung "Perry" Kuo, the Chief Financial Officer, pursuant to which Mr. Kuo would be entitled to, among other things, one time his base salary and annual target bonus and immediate vesting of 50% of his unvested equity awards if terminated under certain circumstances. In addition, Mr. Kuo would be entitled to, among other things, one and a half times his base salary and annual target bonus and immediate vesting F-31

of 50% of his unvested equity awards if terminated under certain circumstances within twelve months of a change of control of the Company. In April 2007, the Company entered into an Executive Severance and Change of Control Agreement with James Keim, the Head of Marketing and Sales, pursuant to which Mr. Keim would be entitled to, among other things, one time his base salary and annual target bonus and immediate vesting of 50% of his unvested equity awards if terminated under certain circumstances. In addition, Mr. Keim would be entitled to, among other things, one and a half times his base salary and annual target bonus and immediate vesting of 50% of his unvested equity awards if terminated under certain circumstances within twelve months of a change of control of the Company. 20.SEGMENT INFORMATION The Company designs, develops and markets high performance semiconductors for power management and security applications. The Company's semiconductor products are produced with digital, analog, and mixed signal integrated circuit manufacturing processes. The Company's Chief Operating Decision Maker ("CODM"), the Chief Executive Officer, reviews information on an enterprise-wide basis to assess performance and allocate resources and has determined the Company has one reporting segment. Net sales to unaffiliated customers by geographic region are based on the customer's ship-to location and were as follows: Years Ended December 31 -------------------------- 2005 2006 2007 -------- -------- -------- (In Thousands) China $ 60,889 $ 92,801 $133,887 Korea 22,957 15,018 13,435 Japan 6,323 9,603 11,992 Taiwan 14,891 6,559 4,232 Others 492 934 1,994 -------- -------- -------- $105,552 $124,915 $165,540 ======== ======== ======== For the years ended December 31, 2005 and 2006, no customers accounted for 10% or more of net sales. For the year ended December 31, 2007, one customer accounted for 10% or more of net sales. Long-lived assets consist of property and equipment and are based on the physical location of the assets at the end of each year, and were as follows: December 31 ----------------------- 2005 2006 2007 ------- ------- ------- (In Thousands) China $ 8,244 $13,015 $19,807 Taiwan 7,795 21,261 16,665 U.S.A. 6,804 6,669 6,347 Singapore 274 335 232 Others 202 147 97 ------- ------- ------- $23,319 $41,427 $43,148 ======= ======= ======= F-32

21.SUBSEQUENT EVENT In March 2008, the Company entered into an agreement with 360 Degree Web to acquire certain software products, sales and licensing contracts, registered trademarks, issued patents, patent applications and proprietary technology in exchange for $6.5 million and all of the shares of 360 Degree Web held by the Company, including 1,583,333 shares of Series B, 500,000 shares of Series B2 and 180,769 shares of Series D preference shares totally valued at $1.6 million. Twenty percent of the cash consideration will be held in an escrow account in accordance with the terms of the escrow agreement. As a result of the asset acquisition, the Company is expected to obtain certain core technologies that are essential to the future growth of the Company's security appliance products. The Company is currently in the process of obtaining third party valuations for the allocation of purchase price. F-33

Exhibit 8.1 Significant Subsidiaries of O2 MICRO INTERNATIONAL LIMITED O//2//Micro, Inc., a California corporation O//2//Micro Electronics, Inc., a Taiwan company O//2//Micro International Japan Limited, a Japanese company O//2//Micro PTE Limited-Singapore, a Singapore company Aotu Micro (Wuhan) Co., Ltd., a Chinese company O//2//Micro (Beijing) Co., Ltd., a Chinese company O//2//Micro (China) Co., Ltd., a Chinese company O//2//Micro (Chengdu) Co., Ltd., a Chinese company OceanOne Semiconductor (Ningbo) Limited, a Chinese company International Asset Holding Company, a Cayman Islands company

Exhibit 12.1 CERTIFICATION I, Sterling Du, certify that: 1. I have reviewed this annual report on Form 20-F of O2Micro International Limited; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report; 4. The company's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the company and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the company's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the company's internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting; and 5. The company's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company's auditors and the audit committee of the company's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company's internal control over financial reporting. Date: June 24, 2008 By: /s/ STERLING DU -------------------------- Sterling Du Chief Executive Officer

Exhibit 12.2 CERTIFICATION I, Perry Kuo, certify that: 1. I have reviewed this annual report on Form 20-F of O2Micro International Limited; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report; 4. The company's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the company and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the company's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the company's internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting; and 5. The company's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company's auditors and the audit committee of the company's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company's internal control over financial reporting. Date: June 24, 2008 By: /s/ PERRY KUO -------------------------- Perry Kuo Chief Financial Officer

Exhibit 13 O2Micro International Limited CERTIFICATION In connection with the annual report of O2Micro International Limited (the "Company") on Form 20-F for the period ended December 31, 2007, as filed with the Securities and Exchange Commission (the "Report"), each of Sterling Du, Chief Executive Officer of the Company, and Perry Kuo, Chief Financial Officer of the Company, hereby certify as of the date hereof, solely for purposes of Title 18, Chapter 63, Section 1350 of the United States Code, that to the best of his knowledge: (1)the Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, and (2)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company at the dates and for the periods indicated. This Certification has not been, and shall not be deemed, "filed" with the Securities and Exchange Commission. Date: June 24, 2008 By: /s/ STERLING DU -------------------------------------- Sterling Du Chief Executive Officer Date: June 24, 2008 By: /s/ PERRY KUO -------------------------------------- Perry Kuo Chief Financial Officer

Exhibit 15.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the Registration Statements Nos. 333-12670, 333-12672, 333-98425, 333-101452, 333-107975, 333-116596 and 333-132251 on Form S-8 of our report relating to the financial statements of O2Micro International Limited dated April 14, 2008, appearing in the Annual Report on Form 20-F of O2Micro International Limited for the year ended December 31, 2007. /s/ DELOITTE & TOUCHE - -------------------------- Deloitte & Touche Taipei, Taiwan The Republic of China June 24, 2008