Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 	 	 	
þ	 	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	
For the quarterly period ended March 31, 2007
Commission file number 000-49602
SYNAPTICS INCORPORATED
(Exact name of registrant as specified in its charter)
 	 	 	
Delaware	 	77-0118518	
 	 	 	
(State or other jurisdiction	 	(I.R.S. Employer	
of incorporation or organization)	 	Identification No.)	
3120 Scott Blvd., Suite 130
Santa Clara, California 95054

(Address of principal executive offices) (Zip code)
(408) 454-5100

(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities 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  þ        No  o
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 o       Accelerated filer þ       Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o       No  þ
Number of shares of Common Stock outstanding at May 4, 2007: 25,658,837

 

 
SYNAPTICS INCORPORATED
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2007
TABLE OF CONTENTS
 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	Page	 	 	 	
Part I.	 	Financial Information	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	Item 1.	 	Financial Statements (Unaudited):	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	Condensed Consolidated Balance Sheets— March 31, 2007 and June 30, 2006	 	 	3	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	Condensed Consolidated Statements of Income— Three and Nine Months Ended March 31, 2007 and 2006	 	 	4	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	Condensed Consolidated Statements of Cash Flows— Nine Months Ended March 31, 2007 and 2006	 	 	5	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	Notes to Condensed Consolidated Financial Statements	 	 	6	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	Item 2.	 	Management’s Discussion and Analysis of Financial Condition and Results of Operations	 	 	17	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	Item 3.	 	Quantitative and Qualitative Disclosures About Market Risk	 	 	29	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	Item 4.	 	Controls and Procedures	 	 	29	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
Part II.	 	Other Information	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	Item 1.	 	Legal Proceedings	 	 	30	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	Item 2.	 	Unregistered Sales of Equity Securities and Use of Proceeds	 	 	30	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
 	 	Item 6.	 	Exhibits	 	 	30	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	
Signatures	 	 	 	 	31	 	 	 	
 EX-31.1	 	 	
 EX-31.2	 	 	
 EX-32.1	 	 	
 EX-32.2	 	 	

Table of Contents
PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SYNAPTICS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
 	 	 	 	 	 	 	 	 	
 	 	March 31,	 	 	June 30,	 	
 	 	2007	 	 	2006	 	
ASSETS	 	 	 	 	 	 	 	 	
Current assets:	 	 	 	 	 	 	 	 	
Cash and cash equivalents	 	$	47,456	 	 	$	38,724	 	
Short-term investments	 	 	197,771	 	 	 	206,452	 	
Accounts receivable, net of allowances of $419 and $189, respectively	 	 	49,103	 	 	 	34,034	 	
Inventories	 	 	9,125	 	 	 	10,010	 	
Income taxes receivable	 	 	8,736	 	 	 	—	 	
Prepaid expenses and other current assets	 	 	4,324	 	 	 	3,407	 	
 	 	 	 	 	 	 	
Total current assets	 	 	316,515	 	 	 	292,627	 	
Property and equipment, net	 	 	18,252	 	 	 	16,038	 	
Goodwill	 	 	1,927	 	 	 	1,927	 	
Other assets	 	 	17,252	 	 	 	20,829	 	
 	 	 	 	 	 	 	
 	 	$	353,946	 	 	$	331,421	 	

LIABILITIES AND STOCKHOLDERS’ EQUITY	 	 	 	 	 	 	 	 	
Current liabilities:	 	 	 	 	 	 	 	 	
Accounts payable	 	$	18,186	 	 	$	16,542	 	
Accrued compensation	 	 	4,343	 	 	 	4,842	 	
Income taxes payable	 	 	8,153	 	 	 	8,078	 	
Other accrued liabilities	 	 	8,343	 	 	 	5,377	 	
Note payable to a related party	 	 	1,500	 	 	 	—	 	
 	 	 	 	 	 	 	
Total current liabilities	 	 	40,525	 	 	 	34,839	 	
Note payable to a related party	 	 	—	 	 	 	1,500	 	
Other liabilities	 	 	2,032	 	 	 	3,040	 	
Convertible senior subordinated notes	 	 	125,000	 	 	 	125,000	 	
Stockholders’ equity:	 	 	 	 	 	 	 	 	
Common stock:	 	 	 	 	 	 	 	 	
$0.001 par value; 60,000,000 shares authorized; 29,003,393 and 27,462,125 shares issued, respectively	 	 	29	 	 	 	27	 	
Additional paid-in capital	 	 	166,451	 	 	 	134,217	 	
Less: 3,588,100 and 2,306,100 common treasury shares, respectively, at cost	 	 	(72,345	)	 	 	(39,999	)	
Accumulated other comprehensive loss	 	 	(110	)	 	 	(464	)	
Retained earnings	 	 	92,364	 	 	 	73,261	 	
 	 	 	 	 	 	 	
Total stockholders’ equity	 	 	186,389	 	 	 	167,042	 	
 	 	 	 	 	 	 	
 	 	$	353,946	 	 	$	331,421	 	
 	 	 	 	 	 	 	
See notes to condensed consolidated financial statement (unaudited).
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SYNAPTICS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Nine Months Ended	 	
 	 	March 31,	 	 	March 31,	 	
 	 	2007	 	 	2006	 	 	2007	 	 	2006	 	
Net revenue	 	$	64,309	 	 	$	40,365	 	 	$	195,211	 	 	$	140,645	 	
Cost of revenue (1)	 	 	39,162	 	 	 	22,257	 	 	 	117,278	 	 	 	76,694	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Gross margin	 	 	25,147	 	 	 	18,108	 	 	 	77,933	 	 	 	63,951	 	

Operating expenses:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Research and development (1)	 	 	9,485	 	 	 	9,106	 	 	 	28,631	 	 	 	25,740	 	
Selling, general, and administrative (1)	 	 	9,339	 	 	 	6,952	 	 	 	26,067	 	 	 	20,593	 	
Restructuring	 	 	—	 	 	 	—	 	 	 	915	 	 	 	—	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total operating expenses	 	 	18,824	 	 	 	16,058	 	 	 	55,613	 	 	 	46,333	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Income from operations	 	 	6,323	 	 	 	2,050	 	 	 	22,320	 	 	 	17,618	 	
Interest income	 	 	2,713	 	 	 	2,179	 	 	 	8,230	 	 	 	5,631	 	
Interest expense	 	 	(488	)	 	 	(485	)	 	 	(1,463	)	 	 	(1,454	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Income before provision for income taxes	 	 	8,548	 	 	 	3,744	 	 	 	29,087	 	 	 	21,795	 	
Provision for income taxes	 	 	2,913	 	 	 	2,121	 	 	 	9,984	 	 	 	9,857	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Net income	 	$	5,635	 	 	$	1,623	 	 	$	19,103	 	 	$	11,938	 	

Net income per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic	 	$	0.22	 	 	$	0.07	 	 	$	0.75	 	 	$	0.49	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Diluted	 	$	0.20	 	 	$	0.06	 	 	$	0.67	 	 	$	0.44	 	

Shares used in computing net income per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic	 	 	25,823	 	 	 	24,737	 	 	 	25,509	 	 	 	24,602	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Diluted	 	 	29,592	 	 	 	29,201	 	 	 	29,512	 	 	 	29,002	 	

 	 	 	
(1)	 	Amounts include share-based compensation costs as follows:	

Cost of revenue	 	$	160	 	 	$	145	 	 	$	492	 	 	$	525	 	
Research and development	 	$	1,262	 	 	$	1,165	 	 	$	3,736	 	 	$	3,700	 	
Selling, general, and administrative	 	$	1,966	 	 	$	1,967	 	 	$	6,169	 	 	$	5,752	 	
See notes to condensed consolidated financial statement (unaudited).
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SYNAPTICS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended	 	
 	 	March 31,	 	
 	 	2007	 	 	2006	 	
Cash flows from operating activities	 	 	 	 	 	 	 	 	
Net income	 	$	19,103	 	 	$	11,938	 	
Adjustments to reconcile net income to net cash provided by operating activities:	 	 	 	 	 	 	 	 	
Share-based compensation costs	 	 	10,397	 	 	 	9,977	 	
Deferred taxes from share-based compensation	 	 	(1,106	)	 	 	(1,964	)	
Tax benefit realized from share-based compensation	 	 	7,843	 	 	 	4,717	 	
Excess tax benefit from share-based compensation	 	 	(7,246	)	 	 	(3,962	)	
Depreciation of property and equipment	 	 	1,637	 	 	 	1,208	 	
Impairment of property and equipment	 	 	102	 	 	 	—	 	
Amortization of debt issuance costs	 	 	645	 	 	 	645	 	
Changes in operating assets and liabilities:	 	 	 	 	 	 	 	 	
Accounts receivable, net	 	 	(15,069	)	 	 	4,070	 	
Inventories	 	 	885	 	 	 	(2,915	)	
Prepaid expenses and other current assets	 	 	(917	)	 	 	(646	)	
Other assets	 	 	4,038	 	 	 	(1,325	)	
Accounts payable	 	 	1,644	 	 	 	1,617	 	
Accrued compensation	 	 	(553	)	 	 	(749	)	
Income taxes	 	 	(8,661	)	 	 	(3,378	)	
Other accrued liabilities	 	 	2,966	 	 	 	130	 	
Other liabilities	 	 	(1,008	)	 	 	91	 	
 	 	 	 	 	 	 	
Net cash provided by operating activities	 	 	14,700	 	 	 	19,454	 	

Cash flows from investing activities	 	 	 	 	 	 	 	 	
Purchases of short-term investments	 	 	(197,307	)	 	 	(188,081	)	
Proceeds from sales and maturities of short-term investments	 	 	206,342	 	 	 	164,332	 	
Purchases of property and equipment	 	 	(3,953	)	 	 	(2,379	)	
 	 	 	 	 	 	 	
Net cash provided by (used in) investing activities	 	 	5,082	 	 	 	(26,128	)	

Cash flows from financing activities	 	 	 	 	 	 	 	 	
Purchase of treasury stock	 	 	(32,346	)	 	 	(18,819	)	
Proceeds from issuance of common stock upon exercise of options and stock purchase plan	 	 	14,050	 	 	 	6,553	 	
Excess tax benefit from share-based compensation	 	 	7,246	 	 	 	3,962	 	
 	 	 	 	 	 	 	
Net cash used in financing activities	 	 	(11,050	)	 	 	(8,304	)	
 	 	 	 	 	 	 	
Net increase (decrease) in cash and cash equivalents	 	 	8,732	 	 	 	(14,978	)	
Cash and cash equivalents at beginning of period	 	 	38,724	 	 	 	72,232	 	
 	 	 	 	 	 	 	
Cash and cash equivalents at end of period	 	$	47,456	 	 	$	57,254	 	

Supplemental disclosures of cash flow information	 	 	 	 	 	 	 	 	
Cash paid for interest	 	$	469	 	 	$	469	 	
 	 	 	 	 	 	 	
Cash paid for income taxes	 	$	8,281	 	 	$	11,494	 	
 	 	 	 	 	 	 	
See notes to condensed consolidated financial statements (unaudited).
.
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SYNAPTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 
(unaudited)
1. Basis of Presentation
     The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and U.S. generally accepted accounting principles. However, certain information or footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such SEC rules and regulations. In our opinion, the financial statements include all adjustments, which are of a normal and recurring nature, necessary for the fair presentation of the results of the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the operating results for the full fiscal year or any future period. These financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our annual report on Form 10-K for the fiscal year ended June 30, 2006.
     The consolidated financial statements include our financial statements and those of our wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated upon consolidation.
     Our fiscal year is the 52- or 53-week period ending on the last Saturday in June. Fiscal 2007 will be a 53-week period ending on June 30, 2007, and fiscal 2006 was a 52-week period ending on June 24, 2006. The fiscal periods presented in this report were 13-week periods for the three months ended March 31, 2007 and March 30, 2006 and 40-week and 39-week periods for the nine months ended March 31, 2007 and March 30, 2006, respectively. For ease of presentation, the accompanying consolidated financial statements have been shown as ending on June 30 and calendar quarter end dates for all annual, interim, and quarterly financial statement captions, unless otherwise indicated.
Use of Estimates
     The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, cost of revenue, inventories, product warranty, share-based compensation costs, provision for income taxes, income taxes payable, and contingencies. We base our estimates on historical experience, applicable laws and regulations, and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
2. Revenue Recognition
     We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred and title has transferred, the price is fixed or determinable, and collection is reasonably assured. We accrue for estimated sales returns and other allowances, based on historical experience, at the time we recognize revenue, which is typically upon shipment. We record contract revenue for research and development as we provide the services under the terms of the contract. We recognize non-refundable contract fees for which no further performance obligations exist and for which there is no continuing involvement by us on the earlier of when the payments are received or when collection is reasonably assured.
3. Net Income Per Share
     Basic net income per share amounts for each period presented were computed using the weighted average number of shares of common stock outstanding. Diluted net income per share amounts for each period presented were computed (1) using the weighted average number of potentially dilutive shares issuable in connection with stock options under the treasury stock method, and (2) using the weighted average number of shares issuable in connection with convertible debt under the if-converted method, when dilutive.
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     The following table presents the computation of basic and diluted net income per share (in thousands, except per share amounts):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Nine Months Ended	 	
 	 	March 31,	 	 	March 31,	 	
 	 	2007	 	 	2006	 	 	2007	 	 	2006	 	
Numerator:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic net income	 	$	5,635	 	 	$	1,623	 	 	$	19,103	 	 	$	11,938	 	
Interest expense and amortization of debt issuance costs on convertible notes (net of tax)	 	 	266	 	 	 	266	 	 	 	798	 	 	 	798	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Diluted net income	 	$	5,901	 	 	$	1,889	 	 	$	19,901	 	 	$	12,736	 	

Denominator:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Shares, basic	 	 	25,823	 	 	 	24,737	 	 	 	25,509	 	 	 	24,602	 	
Effect of dilutive share-based awards	 	 	1,295	 	 	 	1,990	 	 	 	1,529	 	 	 	1,926	 	
Effect of convertible notes	 	 	2,474	 	 	 	2,474	 	 	 	2,474	 	 	 	2,474	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Shares, diluted	 	 	29,592	 	 	 	29,201	 	 	 	29,512	 	 	 	29,002	 	

Net income per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic	 	$	0.22	 	 	$	0.07	 	 	$	0.75	 	 	$	0.49	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Diluted	 	$	0.20	 	 	$	0.06	 	 	$	0.67	 	 	$	0.44	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
     Dilutive net income per share does not include the effect of 2,300,946, 1,895,999, 2,531,225, and 2,034,030 share-based awards that were outstanding during the three months ended March 31, 2007 and 2006 and the nine months ended March 31, 2007 and 2006, respectively. These share-based awards were not included in the computation of diluted net income per share because the proceeds received, if any, from such share-based awards combined with the average unamortized compensation costs adjusted for the hypothetical tax benefit or deficiency creditable or chargeable, respectively, to additional paid-in capital, were greater than the average market price of our common stock, and therefore, their effect would have been antidilutive.
     In April 2007, we made an irrevocable election to cash settle the principal amount of our convertible notes upon conversion of the notes. Our election to cash settle the principal amount of our convertible notes upon conversion will result in us using the “treasury stock” method for calculating diluted shares. Accordingly, we will include on a prospective basis diluted shares underlying the convertible notes in our diluted earnings per share calculation only when the average closing stock price for the period exceeds the conversion price of the notes, which is currently $50.53 per share.
4. Cash Equivalents and Short-Term Investments
     Cash equivalents consist of highly liquid investments with original maturities of three months or less. Short-term investments consist of marketable securities and are classified as securities “available for sale” under Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Such securities are reported at fair value, with unrealized gains and losses, net of taxes, excluded from earnings and shown separately as a component of accumulated other comprehensive loss within stockholders’ equity. We may pay a premium or receive a discount upon the purchase of marketable securities. Interest earned on marketable securities and amortization of discounts received and accretion of premiums paid on the purchase of marketable securities are included in interest income. We determine realized gains and losses on the sale of marketable securities using the specific identification method.
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5. Inventories
     Inventories are stated at the lower of cost (first-in, first-out method) or market (estimated net realizable value) and consisted of the following (in thousands):
 	 	 	 	 	 	 	 	 	
 	 	March 31,	 	 	June 30,	 	
 	 	2007	 	 	2006	 	
Raw materials	 	$	6,700	 	 	$	9,743	 	
Finished goods	 	 	2,425	 	 	 	267	 	
 	 	 	 	 	 	 	
 	 	$	9,125	 	 	$	10,010	 	
 	 	 	 	 	 	 	
     Periodically, we purchase inventory from our subcontractors when a customer’s delivery schedule is delayed or a customer’s order is cancelled. In those circumstances in which our customer has cancelled its order and we purchase inventory from our subcontractors, we consider a write-down to reduce the carrying value of the inventory purchased to its net realizable value. We charge write-downs to reduce the carrying value of obsolete, slow moving, and non-usable inventory to net realizable value to cost of revenue.
6. Product Warranties, Indemnifications, and Legal Proceedings
Product Warranties
     We generally warrant our products for a period of 12 months or more from the date of sale and estimate probable product warranty costs at the time we recognize revenue. Factors that affect our warranty liability include historical and anticipated rates of warranty claims, materials usage, and service delivery costs. Warranty costs incurred have not been material in recent years. However, we assess the adequacy of our warranty obligations periodically and adjust the accrued warranty liability on the basis of our estimates.
     Changes in our accrued warranty liability (included in other accrued liabilities) for the nine-month periods ended March 31, 2007 and 2006 were as follows (in thousands):
 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended	 	
 	 	March 31,	 	
 	 	2007	 	 	2006	 	
Beginning accrued warranty	 	$	357	 	 	$	369	 	
Provision for product warranties	 	 	539	 	 	 	609	 	
Cost of warranty claims and settlements	 	 	(470	)	 	 	(665	)	
 	 	 	 	 	 	 	
Ending accrued warranty	 	$	426	 	 	$	313	 	
 	 	 	 	 	 	 	
Indemnifications
     In connection with certain third-party agreements, we are obligated to indemnify the third party in connection with any technology infringement by us. We have also entered into indemnification agreements with our officers and directors. Maximum potential future payments cannot be estimated because these agreements do not have a maximum stated liability. However, historical costs related to these indemnification provisions have not been significant. We have not recorded any liability in our consolidated financial statements for such indemnification obligations.
Legal Proceedings
     In March 2006, Elantech Devices Corporation (“Elantech”) filed a Complaint for Patent Infringement against us claiming that we infringed one of its patents and seeking damages, attorneys’ fees, and a permanent injunction against us infringing or inducing others to infringe the patent. In April 2006, we filed our Answer to the Complaint and Counterclaims against Elantech claiming that Elantech has infringed and induced infringement of four of our patents and seeking damages, attorneys’ fees, and a permanent injunction against infringing or inducing others to infringe.
     Elantech responded to our counterclaim denying liability and counterclaimed seeking an injunction and damages for alleged violations of California law. We subsequently filed a motion to dismiss the Elantech counterclaims that was granted in July 2006 with leave to amend the counterclaims after the adjudication of the patent infringement claims. We intend to vigorously defend our patents and pursue our counterclaims. We have not recorded
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any liability associated with Elantech’s claims and have expensed as incurred all legal fees associated with the legal proceedings.
7 . Convertible Senior Subordinated Notes
     During December 2004, we issued an aggregate of $125 million of 0.75% Convertible Senior Subordinated Notes maturing December 1, 2024 (the “Notes”) in a private offering pursuant to Rule 144A under the Securities Act of 1933, as amended. In connection with issuing the Notes, we incurred debt issuance costs of $4.3 million, consisting primarily of the initial purchasers’ discount and costs related to legal, accounting, and printing, which are being amortized over five years. We expect to use the net proceeds for working capital and general corporate purposes and potentially for future acquisitions.
     The Notes bear interest at a rate of 0.75% per annum payable on December 1 and June 1 of each year. However, we will pay additional contingent interest on the Notes if the average trading price of the Notes is at or above 120% of the principal amount of the Notes for a specified period beginning with the six-month period commencing December 1, 2009. The amount of contingent interest payable on the Notes with respect to a six-month period, for which contingent interest applies, will equal 0.375% per annum of the average trading price of the Notes for a specified five trading-day period preceding such six-month period.
     The Notes are convertible into shares of our common stock, initially at a conversion rate of 19.7918 shares per $1,000 principal amount of Notes, or a total of 2,473,975 shares of common stock, which is equivalent to an initial conversion price of approximately $50.53 per share of common stock, subject to adjustment in certain events. The denominator of the diluted net income per share calculation includes the weighted average effect of the 2,473,975 shares of common stock issuable upon conversion of the Notes in accordance with SFAS 128 as it applies to the method of settling the principal amount of the notes and Emerging Issues Task Force (“EITF”) Issue No. 04-08 as it applies to the market price conversion trigger embedded in the notes. Through November 30, 2009, upon the occurrence of a fundamental change as defined in the indenture governing the Notes, we could potentially be obligated to issue up to 27.7085 shares per $1,000 of principal amount of Notes, or a total of 3,463,562 shares of common stock, which is equivalent to a conversion price of $36.09 per share of common stock. The additional 989,587 shares, contingently issuable upon a fundamental change, are not included in the calculation of diluted net income per share.
     The Notes may be converted (1) if, during any calendar quarter commencing after December 31, 2004, the last reported sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter is greater than or equal to 120% of the applicable conversion price on such last trading day; (2) on or after January 1, 2020; (3) if we have called the Notes for redemption; or (4) during prescribed periods, upon the occurrence of specified corporate transactions or fundamental changes. On or after December 1, 2009, we may redeem for cash all or a portion of the notes at a redemption price of 100% of the principal amount of the notes plus accrued and unpaid interest, including contingent interest and additional interest, if any. Noteholders have the right to require us to repurchase all or a portion of their notes for cash on December 1, 2009, December 1, 2014, and December 1, 2019 at a price equal to 100% of the principal amount of the notes to be purchased plus accrued and unpaid interest, including contingent interest and additional interest, if any.
     In April 2007, we made an irrevocable election to cash settle the principal amount of our convertible notes upon conversion of the notes. Our election to cash settle the principal amount of our convertible notes upon conversion will result in us using the “treasury stock” method for calculating diluted shares. Accordingly, we will include on a prospective basis diluted shares underlying the convertible notes in our diluted earnings per share calculation only when the average closing stock price for the period exceeds the conversion price of the notes, which is currently $50.53 per share. As of March 31, 2007, none of the conditions for conversion of the Notes had occurred.
     The Notes are unsecured senior subordinated obligations and rank junior in right of payment to all of our existing and future senior indebtedness, equal in right of payment with all of our existing and future indebtedness or other obligations that are not, by their terms, either senior or subordinated to the Notes, including trade debt and other general unsecured obligations that do not constitute senior or subordinated indebtedness, and senior in right of payment to all of our future indebtedness that, by its terms, is subordinated to the Notes. There are no financial covenants in the Notes.
     Interest expense includes the amortization of debt issuance costs. We recorded $449,000 of interest expense on the Notes during each of the three-month periods ended March 31, 2007 and 2006, and $1.3 million during each of the nine-month periods ended March 31, 2007 and 2006.
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8. Share-Based Compensation
     The purpose of our various share-based compensation plans is to attract, motivate, retain, and reward high-quality employees, directors, and consultants by enabling such persons to acquire or increase their proprietary interest in our common stock in order to strengthen the mutuality of interests between such persons and our stockholders and to provide such persons with annual and long-term performance incentives to focus their best efforts in the creation of stockholder value. Consequently, share-based compensatory awards issued subsequent to the initial award to our employees and consultants are determined primarily on individual performance. Our share-based compensation plans with outstanding awards consist of our 1996 Stock Option Plan, our 2000 Nonstatutory Stock Option Plan, our 2001 Incentive Compensation Plan, and our 2001 Employee Stock Purchase Plan.
     Share-based compensation awards available for grant or issuance for each plan as of the beginning of the fiscal year, including changes in the balance of awards available for grant during the nine months ended March 31, 2007, were as follows:
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Awards	 	 	 	 	 	 	 	 	 	 	 	 	 	 	2001	 	
 	 	Available	 	 	1996	 	 	2000	 	 	2001	 	 	Employee	 	
 	 	Under All	 	 	Stock	 	 	Nonstatutory	 	 	Incentive	 	 	Stock	 	
 	 	Share-Based	 	 	Option	 	 	Stock Option	 	 	Compensation	 	 	Purchase	 	
 	 	Award Plans	 	 	Plan	 	 	Plan	 	 	Plan	 	 	Plan	 	
Balance at June 30, 2006	 	 	3,292,246	 	 	 	226,465	 	 	 	37,584	 	 	 	2,414,826	 	 	 	613,371	 	
Additional shares authorized	 	 	1,144,469	 	 	 	—	 	 	 	—	 	 	 	1,144,469	 	 	 	—	 	
Stock options granted	 	 	(866,048	)	 	 	—	 	 	 	—	 	 	 	(866,048	)	 	 	—	 	
Deferred stock units granted	 	 	(168,329	)	 	 	—	 	 	 	—	 	 	 	(168,329	)	 	 	—	 	
Purchases under employee stock purchase plan	 	 	(105,004	)	 	 	—	 	 	 	—	 	 	 	—	 	 	 	(105,004	)	
Forfeited and expired	 	 	245,678	 	 	 	2,926	 	 	 	—	 	 	 	242,752	 	 	 	—	 	
Plan shares expired	 	 	(229,391	)	 	 	(229,391	)	 	 	—	 	 	 	—	 	 	 	—	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Balance at March 31, 2007	 	 	3,313,621	 	 	 	—	 	 	 	37,584	 	 	 	2,767,670	 	 	 	508,367	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
     The 1996 Stock Option Plan (“1996 Plan”) expired in December 2006. Accordingly, plan shares available under the 1996 Plan that had not been granted prior to the expiration of the plan have expired and no new grants can be issued under the 1996 Plan. Option awards that are currently outstanding under the 1996 Plan will remain outstanding unless exercised, forfeited, or cancelled under the terms of the option grant agreements.
     We adopted SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), in fiscal 2006 and applied the provisions of Staff Accounting Bulletin No. 107, “Share-Based Payment,” to our existing share-based compensation plans in accordance with the modified prospective transition method. Previously, we followed Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for employee share-based compensation, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”), and we did not recognize compensation expense for stock option grants to employees and directors with an exercise price equal to the fair market value of the shares at the date of grant. Accordingly, no share-based compensation costs based on grant date fair value were included in our consolidated statements of income for any period prior to fiscal 2006.
     Share-based compensation and the related tax benefit recognized in our consolidated statements of income for the three and nine months ended March 31, 2007 and 2006 were as follows (in thousands):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Nine Months Ended	 	
 	 	March 31,	 	 	March 31,	 	
 	 	2007	 	 	2006	 	 	2007	 	 	2006	 	
Cost of revenue	 	$	160	 	 	$	145	 	 	$	492	 	 	$	525	 	
Research and development	 	 	1,262	 	 	 	1,165	 	 	 	3,736	 	 	 	3,700	 	
Selling, general, and administrative	 	 	1,966	 	 	 	1,967	 	 	 	6,169	 	 	 	5,752	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	3,388	 	 	$	3,277	 	 	$	10,397	 	 	$	9,977	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Income tax benefit recorded on share-based compensation	 	$	896	 	 	$	771	 	 	$	2,775	 	 	$	2,185	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
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     We utilize the Black-Scholes option pricing model to estimate the grant date fair value of certain employee share-based compensatory awards, which requires the input of highly subjective assumptions, including expected volatility and expected life. Historical and implied volatilities were used in estimating the fair value of our share-based awards, while the expected life of our options was estimated to be five years based on historical trends since our initial public offering. Further, as required under SFAS 123R, we now estimate forfeitures for share-based awards that are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation. We charge the estimated fair value to earnings on a straight-line basis over the vesting period of the underlying awards, which is generally four years for our stock option and deferred stock unit awards and up to two years for our employee stock purchase plan. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options having no vesting restrictions and being fully transferable. As our stock option and employee stock purchase plan awards have characteristics that differ significantly from traded options and, as changes in the subjective assumptions can materially affect the estimated value, our estimate of fair value may not accurately represent the value assigned by a third party in an arms’-length transaction. While our estimate of fair value and the associated charge to earnings materially affects our results of operations, it has no impact on our cash position.
     We account for stock options granted to consultants under our share-based compensation plans at fair value determined by using the Black-Scholes option pricing model in accordance with EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or In Conjunction with Selling, Goods or Services.” These awards are subject to periodic revaluation over their vesting term, if any. The assumptions used to value share-based awards to consultants are similar to those used for employees, except that we use the contractual life of the award rather than the expected life.
     In accordance with SFAS 123R, we recognize tax benefit upon expensing certain share-based awards associated with our share-based compensation plans, including nonqualified stock options and deferred stock unit awards, but under current accounting standards we cannot recognize tax benefit concurrent with the recognition of share-based compensation expenses associated with incentive stock options and employee stock purchase plan shares (qualified stock options). For qualified stock options that vested after our adoption of SFAS 123R, we recognize tax benefit only in the period when disqualifying dispositions of the underlying stock occur, which historically has been up to several years after vesting and in a period when our stock price substantially increases. For qualified stock options that vested prior to our adoption of SFAS 123R, the tax benefit is recorded directly to additional paid-in capital. For the nine months ended March 31, 2007, we realized tax benefit from non-qualified stock option exercises and disqualifying dispositions of qualified stock options totaling $9.5 million, of which $440,000 of the tax benefit was recognized as a reduction of the provision for income taxes, $1.2 million reduced deferred tax assets established after our adoption of SFAS 123R, and the remaining $7.8 million of tax benefit was recorded directly to additional paid-in capital.
     We determine excess tax benefit using the long-haul method in which we compare the actual tax benefit associated with the tax deduction from share-based award activity to the hypothetical tax benefit on the grant date fair values of the corresponding share-based awards. Actual tax benefit related to the tax deduction for share-based awards exceeded the hypothetical tax benefit on the grant date fair values of the corresponding share-based awards resulting in excess tax benefit of $7.2 million for the nine months ended March 31, 2007.
     Historically, we have issued new shares in connection with our share-based compensation plans; however, 3.6 million treasury shares were also available for issuance as of March 31, 2007. Any additional shares repurchased under the stock repurchase program would be available for issuance under our share-based compensation plans.
Deferred Stock Units
     Our 2001 Incentive Compensation Plan (“2001 Plan”) provides for the grant of deferred stock unit awards (“DSUs”) to our employees, consultants, and directors. A DSU is a promise to deliver shares of our common stock at a future date in accordance with the terms of the DSU grant agreement. We began granting DSU awards in January 2006.
     DSUs granted under the 2001 Plan generally vest 25% at the end of 12 months from the vesting commencement date and at a rate of approximately 2% each month thereafter until fully vested at the end of 48 months from the vesting commencement date. Delivery of shares under the plan takes place quarterly for all DSUs vested as of the scheduled delivery dates. Until delivery of shares, the grantee has no rights as a stockholder.
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     An election to defer delivery of the underlying shares for unvested DSU awards can be made provided the deferral election is made at least one year before vesting and the deferral period is at least five years from the scheduled delivery date.
     The following table summarizes DSU activity, including DSUs granted, delivered, and forfeited during the nine months ended March 31, 2007, and the balance and aggregate intrinsic value of DSUs as of March 31, 2007. The aggregate intrinsic value is based on the closing price of our common stock on March 30, 2007 of $25.58.
 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Deferred	 	 	Aggregate	 	 	Weighted	 	
 	 	Stock Unit	 	 	Intrinsic	 	 	Average	 	
 	 	Awards	 	 	Value	 	 	Grant Date	 	
 	 	Outstanding	 	 	(thousands)	 	 	Fair Value	 	
Balance at June 30, 2006	 	 	38,280	 	 	 	 	 	 	$	29.68	 	
Granted	 	 	168,329	 	 	 	 	 	 	$	25.19	 	
Delivered	 	 	(6,986	)	 	 	 	 	 	$	30.71	 	
Forfeited	 	 	(8,710	)	 	 	 	 	 	$	24.71	 	
 	 	 	 	 	 	 	 	 	 	 	 	
Balance at March 31, 2007	 	 	190,913	 	 	$	4,884	 	 	$	25.91	 	
 	 	 	 	 	 	 	 	 	 	 	 	
     Unrecognized share-based compensation costs for DSUs granted under the 2001 Plan were approximately $3.8 million as of March 31, 2007, to be recognized over a weighted average period of approximately three years.
Stock Options
     Our share-based compensation plans with outstanding stock option awards include our 1996 Stock Option Plan, our 2000 Nonstatutory Stock Option Plan, and our 2001 Incentive Compensation Plan (“the Plans”). Under the Plans, we may grant employees, consultants, and directors incentive stock options or nonqualified stock options to purchase shares of our common stock at not less than 100% or 85% of the fair market value, respectively, on the date of grant.
     Options issued under the Plans generally vest 25% at the end of 12 months from the vesting commencement date and approximately 2% each month thereafter until fully vested at the end of 48 months from the vesting commencement date. Options not exercised ten years after the date of grant are cancelled.
     The following table summarizes stock option activity and weighted average exercise prices for the nine months ended March 31, 2007, and for options outstanding, options vested and expected to vest, and options exercisable, the weighted average exercise prices, the weighted average remaining contractual life, and the aggregate intrinsic value as of March 31, 2007. The aggregate intrinsic value is based on the closing price of our common stock on March 30, 2007 of $25.58 and excludes the impact of options that were not in-the-money.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Stock	 	 	Weighted	 	 	Remaining	 	 	Aggregate	 	
 	 	Option	 	 	Average	 	 	Contractual	 	 	Intrinsic	 	
 	 	Awards	 	 	Exercise	 	 	Life	 	 	Value	 	
 	 	Outstanding	 	 	Price	 	 	(years)	 	 	(thousands)	 	
Balance at June 30, 2006	 	 	5,808,011	 	 	$	14.55	 	 	 	 	 	 	 	 	 	
Granted	 	 	866,048	 	 	$	23.24	 	 	 	 	 	 	 	 	 	
Exercised	 	 	(1,431,259	)	 	$	8.50	 	 	 	 	 	 	 	 	 	
Forfeited and expired	 	 	(236,968	)	 	$	20.41	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Balance at March 31, 2007	 	 	5,005,832	 	 	$	17.50	 	 	 	7.2	 	 	$	44,172	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Vested and expected to vest	 	 	4,736,606	 	 	$	17.16	 	 	 	7.1	 	 	$	43,312	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Exercisable	 	 	2,707,822	 	 	$	12.96	 	 	 	5.9	 	 	$	35,524	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
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     The following table summarizes cash received and the aggregate intrinsic value for stock options exercised during the nine months ended March 31, 2007 and 2006 (in thousands):
 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended	
 	 	March 31,	
 	 	2007	 	2006	
Cash received	 	$	12,162	 	 	$	4,908	 	
Aggregate intrinsic value	 	$	28,047	 	 	$	13,393	 	
     The grant date fair value of each award granted under the Plans during the nine months ended March 31, 2007 was estimated at the date of grant using the Black-Scholes option pricing model, assuming no expected dividends and the following range of assumptions:
 	 	 	 	 	
Expected volatility	 	 	54.3% - 60.5%	 	
Expected life in years	 	 	5.0	 	
Risk-free interest rate	 	 	4.7% - 5.0%	 	
Grant date fair value per award	 	 	$11.81-$15.93	 	
     The expected volatility is based on a weighting of implied and historical volatility; the expected life is based on historical option exercise trends; and the risk free interest rate is based on U. S. Treasury yields in effect at the time of grant for the expected life of the option.
     Unrecognized share-based compensation costs for stock options granted under the Plans were approximately $27.9 million as of March 31, 2007, to be recognized over a weighted average period of approximately three years.
Employee Stock Purchase Plan
     Our 2001 Employee Stock Purchase Plan (“ESPP”) became effective on January 29, 2002, the effective date of the registration statement for our initial public offering. The ESPP allows employees to designate up to 15% of their base compensation, subject to legal restrictions and limitations, to purchase shares of common stock at 85% of the lesser of the fair market value (“FMV”) at the beginning of the offering period or the exercise date. The offering period extends for up to two years and includes four exercise dates occurring at six month intervals. Under the terms of the plan, if the FMV at an exercise date is less than the FMV at the beginning of the offering period, the current offering period will terminate and a new offering period of up to two years will commence.
     The following table summarizes shares purchased, weighted average purchase price, cash received, and the aggregate intrinsic value for ESPP purchases during the nine months ended March 31, 2007 and 2006 (in thousands, except for shares purchased and weighted average purchase price):
 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended	
 	 	March 31,	
 	 	2007	 	2006	
Shares purchased	 	 	105,004	 	 	 	93,020	 	
Weighted average purchase price	 	$	17.99	 	 	$	17.69	 	
Cash received	 	$	1,888	 	 	$	1,645	 	
Aggregate intrinsic value	 	$	794	 	 	$	488	 	
     In accordance with FASB Technical Bulletin No. 97-1, “Accounting under Statement 123 for Certain Employee Stock Purchase Plans with a Look-Back Option,” the early termination of an offering period followed by the commencement of a new offering period represents a modification to the terms of the related awards. Under the terms of our ESPP, the offering periods that commenced on January 1, 2005 and 2006 were terminated on June 30, 2005 and 2006 and new offering periods commenced on July 1, 2005 and 2006, respectively. The June 30, 2005 modification affected 169 employees, and the June 30, 2006 modification affected 13 employees. Both modifications resulted in
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incremental compensation costs that are being recognized on a straight-line basis over the period from the modification date through June 30, 2007.
     The grant date fair value of each award granted under our ESPP during the nine months ended March 31, 2007 was estimated using the Black-Scholes option pricing model, assuming no expected dividends and the following weighted average assumptions:
 	 	 	 	 	
Expected volatility	 	 	38.1% - 50.2%	 	
Expected life in years	 	 	0.5	 	
Risk-free interest rate	 	 	5.1%	 	
Grant date fair value per award	 	 	$7.93	 	
     The expected volatility is based on either implied volatility or a weighting of implied and historical volatility; the expected life is based on each period that begins with the enrollment date until each purchase date remaining in the offering period at the date of enrollment in the plan; and the risk free interest rate is based on U. S. Treasury yields or yield curve in effect for each expected life.
     Unrecognized share-based compensation costs for awards granted under our ESPP were approximately $287,000 as of March 31, 2007, and will be recognized over the remainder of fiscal 2007.
9. Income Taxes
     We account for income taxes under the asset and liability method in accordance with SFAS No. 109 “Accounting for Income Taxes.” We consider the operating earnings of our foreign subsidiaries to be indefinitely invested outside the United States. Accordingly, no provision has been made for the U.S. federal, state, or foreign taxes that may result from future remittances of undistributed earnings of our foreign subsidiaries. We account for income tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies.” Accordingly, our tax rate may be favorably or unfavorably affected by the release or establishment, respectively, of tax contingency reserves related to tax uncertainties.
     The income tax provision of $2.9 million and $2.1 million for the three months ended March 31, 2007 and 2006, respectively, represented estimated federal, foreign, and state taxes. The effective tax rate for the three months ended March 31, 2007 was 34.1% and diverged from the combined federal and state statutory rate primarily due to the benefit of research tax credits and the impact of tax-exempt interest income, partially offset by the impact of accounting for share-based compensation and foreign withholding taxes. The effective tax rate for the three months ended March 31, 2006 was 56.7% and diverged from the combined federal and state statutory rate primarily as a result of the impact of accounting for share-based compensation and other permanent taxable differences, partially offset by the impact of higher income from foreign operations, the benefit of tax-exempt interest income, and research tax credits.
     The income tax provision of $10.0 million and $9.9 million for the nine months ended March 31, 2007 and 2006, respectively, represented estimated federal, foreign, and state taxes. The effective tax rate for the nine months ended March 31, 2007 was 34.3% and diverged from the combined federal and state statutory rate primarily due to the benefit of research tax credits in general, research tax credits generated from the retroactive extension of the federal research credit signed into law in December 2006, the net release of contingency reserves, and the impact of tax-exempt interest income, partially offset by the impact of accounting for share-based compensation and foreign withholding taxes. The effective tax rate for the nine months ended March 31, 2006 was 45.2% and diverged from the combined federal and state statutory rate primarily as a result of the impact of accounting for share-based compensation and other permanent taxable differences, partially offset by the impact of higher income from foreign operations, the benefit of tax-exempt interest income, and research tax credits.
10. Segment, Customers, and Geographic Information
     We operate in one segment: the development, marketing, and sale of interactive user interface solutions for electronic devices and products. We generate our revenue from two broad product categories: the PC market and digital lifestyle product markets. The PC market accounted for 83% and 90% of net revenue for the three months ended March 31, 2007 and 2006, respectively, and 83% and 84% of net revenue for the nine months ended March 31, 2007 and 2006, respectively.
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     The following is a summary of net revenue from sales to unaffiliated customers within geographic areas based on the customer location (in thousands):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Nine Months Ended	 	 	
 	 	March 31,	 	 	March 31,	 	 	
 	 	2007	 	 	2006	 	 	2007	 	 	2006	 	 	
China	 	$	45,762	 	 	$	30,951	 	 	$	159,791	 	 	$	106,268	 	 	
Taiwan	 	 	13,511	 	 	 	4,124	 	 	 	19,727	 	 	 	18,784	 	 	
Other	 	 	5,036	 	 	 	5,290	 	 	 	15,693	 	 	 	15,593	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	$	64,309	 	 	$	40,365	 	 	$	195,211	 	 	$	140,645	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
     Major customer net revenue data as a percentage of net revenue:
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	Nine Months Ended	
 	 	March 31,	 	March 31,	
 	 	2007	 	2006	 	2007	 	2006	
Customer A	 	 	15	%	 	 	15	%	 	 	15	%	 	 	*	 	
Customer B	 	 	14	%	 	 	*	 	 	 	12	%	 	 	*	 	
Customer C	 	 	10	%	 	 	*	 	 	 	*	 	 	 	*	 	
Customer D	 	 	*	 	 	 	11	%	 	 	11	%	 	 	*	 	
Customer E	 	 	*	 	 	 	*	 	 	 	*	 	 	 	16	%	
     Major customer accounts receivable as a percentage of accounts receivable:
 	 	 	 	 	 	 	 	 	
 	 	As of	 	 	As of	 	
 	 	March 31,	 	 	June 30,	 	
 	 	2007	 	 	2006	 	
Customer A	 	 	19	%	 	 	18	%	
Customer B	 	 	19	%	 	 	*	 	
Customer C	 	 	11	%	 	 	11	%	
Customer D	 	 	*	 	 	 	11	%	

*	 	Less than 10%	
11. Comprehensive Income
     Our comprehensive income consists of net income plus the effect of unrealized gains and losses on our short-term investments due to interest rate fluctuations. The unrealized gains and losses on our short-term investments are considered to be temporary in nature and were not material for either the three or nine-month periods ended March 31, 2007 and 2006. Accordingly, comprehensive income closely approximated net income. We use the United States dollar as the functional currency in accounting for our foreign entities and recognize remeasurement adjustments in our consolidated statement of income.
12. Restructuring Charge
     We incurred a restructuring charge of $915,000 during the second quarter of fiscal 2007 in connection with the closure of our United Kingdom office as part of our strategic efforts to realign our development capabilities to meet the needs of our Asia Pacific customer base. We accounted for our restructuring charge in accordance with SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” Included in the restructuring charge were personnel costs consisting of severance and relocation of $526,000, a lease reserve of $287,000, net of estimated sublease income, and a non-cash impairment of property and equipment of $102,000. Cash payments associated with the restructuring charge aggregated approximately $526,000 during the nine months ended March 31, 2007.
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13. Subsequent Events
     Subsequent to March 31, 2007, our board of directors authorized an additional $80 million for our stock repurchase program, raising the aggregate authorization level to $160 million and extending the period for repurchase to April 2009. The program authorizes us to repurchase our common stock on the open market or in privately negotiated transactions depending upon market conditions and other factors.
     In addition, on April 26, 2007, we made an irrevocable election to cash settle the principal amount of our convertible notes upon conversion of the notes. Our election to cash settle the principal amount of our convertible notes upon conversion will result in us using the “treasury stock” method for calculating diluted shares. Accordingly, we will include on a prospective basis diluted shares underlying the convertible notes in our diluted earnings per share calculation only when the average closing stock price for the period exceeds the conversion price of the notes, which is currently $50.53 per share.
14. Recent Accounting Pronouncements
     In June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109,” (“FIN 48”) that clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109. FIN 48 is designed to reduce the disparity in accounting treatment for uncertain tax positions resulting from diverse interpretations of SFAS 109 among companies. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. FIN 48 is effective beginning in our first quarter of fiscal 2008. We expect the adoption of FIN 48 will result in certain presentation reclassifications on our balance sheet, but we do not expect a material impact on our results of operations or cash flows.
     In September 2006, the Securities and Exchange Commission released Staff Accounting Bulletin No. 108, (“SAB 108”), which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 provides transition guidance for correcting errors and requires registrants to quantify misstatements using both the balance-sheet and income-statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. In the year of adoption only, if the effect is determined to be material, SAB 108 allows registrants to record the effect as a cumulative-effect adjustment to beginning-of-year retained earnings. SAB 108 does not change the requirements within SFAS No. 154, “Accounting Changes and Error Corrections—a replacement of APB No. 20 and FASB Statement No. 3,” for the correction of an error on financial statements. Further, SAB 108 does not change the Staff’s previous guidance in SAB 99 on evaluating the materiality of misstatements. SAB 108 is effective for our fiscal 2007. We do not expect the adoption of SAB 108 to have a material impact on our financial position, results of operations, or cash flows.
     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in U.S. generally accepted accounting principles, and expands disclosure about fair value measurements. SFAS 157 applies under other accounting standards that require or permit fair value measurements. Accordingly, SFAS 157 does not require any new fair value measurement. SFAS 157 is effective beginning in our first quarter of fiscal 2009. We do not expect the adoption of SFAS 157 to have a material impact on our financial position, results of operations, or cash flows.
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&nbsp;    ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements and Factors That May Affect Results
     You should read the following discussion and analysis in conjunction with our condensed consolidated financial statements and notes in Item 1 and with our audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended June 30, 2006.
     In addition to the historical information contained in this report, this report contains forward-looking statements, including those related to market penetration and market share in the notebook and digital lifestyle product markets; competition in the notebook and digital lifestyle product markets; revenue from the notebook and digital lifestyle product markets; growth rates of these markets; average selling prices; product design mix; manufacturing costs; cost-improvement programs; gross margins; customer relationships; research and development expenses; selling, general, and administrative expenses; legal proceedings; and liquidity and anticipated cash requirements. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially.
     We caution that these statements are qualified by various factors that may affect future results, including the following: changes in the market for our products and the success of our customers’ products; our success in moving products from the design phase into the manufacturing phase; changes in the competitive environment; infringement claims; warranty obligations related to product failures; the failure of key technologies to deliver commercially acceptable performance; our dependence on certain key markets; penetration into new markets; the absence of both long-term purchase and supply commitments; and our lengthy development and product acceptance cycles. This report should be read in conjunction with our Annual Report on Form 10-K for the year ended June 30, 2006, including particularly Item 1A Risk Factors.
Overview
     We are a leading worldwide developer and supplier of custom-designed user interface solutions that enable people to interact more easily and intuitively with a wide variety of mobile computing, entertainment, communications, and other electronic devices. From our inception in 1986 through fiscal 1995, we were a development stage company, focused on developing and refining our pattern recognition and capacitive sensing technologies, and generated revenue by providing contract engineering and design services. In fiscal 1996, we began shipping our proprietary TouchPad. We are a leading supplier of interface solutions to the notebook computer market and the hard-disk drive, or HDD, portable digital music player market. In fiscal 2006, we believe we were the market leader in providing interface solutions for notebook computers and HDD portable digital music players. We believe our market share results from the combination of our customer focus, the strength of our intellectual property, and our engineering know-how, which allows us to design products that meet the demanding design specifications of original equipment manufacturers, or OEMs.
     Our manufacturing operations are based on a virtual manufacturing model in which we outsource all of our production requirements, eliminating the need for significant capital expenditures for manufacturing facilities and equipment and allowing us to reduce our investment in inventories. This approach requires us to work closely with our manufacturing subcontractors to ensure adequate production capacity to meet our forecasted production requirements. We provide our manufacturing subcontractors with six-month rolling forecasts and generally issue purchase orders based on our anticipated requirements for the next 90 days. However, we do not have any long-term supply contracts with any of our manufacturing subcontractors. Currently, we use two third-party manufacturers to provide our proprietary capacitive based ASICs, and in certain cases, we rely on a single source or a limited number of suppliers to provide other key components of our products. Our cost of revenue includes all costs associated with the production of our products, including materials, manufacturing, assembly, and test costs paid to third-party manufacturers and related overhead costs associated with our manufacturing operations personnel. Additionally, all warranty costs and any inventory provisions or write-downs are charged to cost of revenue.
     Our gross margin generally reflects the combination of the added value we bring to our customers’ products in meeting their custom design requirements and our ongoing cost-improvement programs. These cost-improvement programs include reducing materials and component costs, assembly and test costs, and implementing design and process improvements. As each product we sell utilizes our capacitive sensing technology in a design that is generally unique or specific to a customer’s application, gross margin varies on a product-by-product basis. Generally, our products, which contain a higher percentage of third-party content, may have lower gross margins. Our newly
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introduced products may have lower gross margins than our more mature products that have realized greater benefits associated with our ongoing cost-improvement programs. As a result, new product introductions may initially negatively impact our gross margins.
     Our research and development expenses include costs for supplies and materials related to product development, as well as the engineering costs incurred to design interface solutions for customers prior to and after the customers’ commitment to incorporate those solutions into their products. These expenses have generally increased, reflecting our continuing commitment to the technological and design innovation required to maintain a leadership position in our existing markets and to adapt our existing technologies or develop new technologies for new markets.
     Selling, general, and administrative expenses include expenses related to sales, marketing, and administrative personnel; internal sales and outside sales representatives’ commissions; market and usability research; outside legal, accounting, and consulting costs; and other marketing and sales activities. These expenses have generally increased, primarily reflecting incremental staffing and related support costs associated with our increased business levels, anticipated growth in our existing markets, and penetration into new markets.
Critical Accounting Policies and Estimates
     The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, cost of revenue, inventories, product warranty, share-based compensation costs, provision for income taxes, income taxes payable, and contingencies. We base our estimates on historical experience, applicable laws and regulations, and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
     The methods, estimates, interpretations, and judgments we use in applying our most critical accounting policies can have a significant impact on the results that we report in our consolidated financial statements. The SEC considers an entity’s most critical accounting policies to be those policies that are both most important to the portrayal of a company’s financial condition and results of operations and those that require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain when estimated. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
     We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred or title has transferred, the price is fixed or determinable, and collection is reasonably assured. We accrue for estimated sales returns and other allowances, based on historical experience, at the time we recognize revenue, which is typically upon shipment. We record contract revenue for research and development as we provide the services under the terms of the contract. We recognize non-refundable contract fees for which no further performance obligations exist and for which there is no continuing involvement by us on the earlier of when the payments are received or when collection is assured.
Inventory
     We state our inventories at the lower of cost or market. We base our assessment of the ultimate realization of inventories on our projections of future demand and market conditions. Sudden declines in demand, rapid product improvements, or technological changes, or any combination of these factors can cause us to have excess or obsolete inventories. On an ongoing basis, we review for estimated obsolete or unmarketable inventories and write down our inventories to their net realizable value based upon our forecasts of future demand and market conditions. If actual market conditions are less favorable than our forecasts, additional inventory reserves may be required. The following factors influence our estimates: changes to or cancellations of customer orders; unexpected decline in demand; rapid product improvements and technological advances; and termination or changes by our OEM customers of any product offerings incorporating our product solutions.
     Periodically, we purchase inventory from our subcontractors when a customer’s delivery schedule is delayed or a customer’s order is cancelled. In those circumstances in which our customer has cancelled its order and we
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purchase inventory from our subcontractors, we consider a write-down to reduce the carrying value of the inventory purchased to its net realizable value. We charge write-downs to reduce the carrying value of obsolete, slow moving, and non-usable inventory to net realizable value to cost of revenue.
Share-Based Compensation Costs
     We account for employee share-based compensation costs in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment” (“SFAS 123R”) and apply the provisions of Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”). We utilize the Black-Scholes option pricing model to estimate the grant date fair value of employee share-based compensatory awards, which requires the input of highly subjective assumptions, including expected volatility and expected life. Historical and implied volatilities were used in estimating the fair value of our share-based awards, while the expected life for our options was estimated to be five years based on historical trends since our initial public offering. Further, as required under SFAS 123R, we now estimate forfeitures for share-based awards that are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation. We charge the estimated fair value to earnings on a straight-line basis over the vesting period of the underlying awards, which is generally four years for our stock option and deferred stock unit awards and up to two years for our employee stock purchase plan.
     The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. As our stock option and employee stock purchase plan awards have characteristics that differ significantly from traded options and as changes in the subjective assumptions can materially affect the estimated value, our estimate of fair value may not accurately represent the value assigned by a third party in an arms’-length transaction. There currently is no market-based mechanism to verify the reliability and accuracy of the estimates derived from the Black-Scholes option pricing model or other allowable valuation models, nor is there a means to compare and adjust the estimates to actual values. While our estimate of fair value and the associated charge to earnings materially affects our results of operations, it has no impact on our cash position.
     The guidance in SFAS 123R and SAB 107 is relatively new and the application of these principles may be subject to further interpretation and guidance. There are significant variations among allowable valuation models, and there is a possibility that we may adopt a different valuation model or refine the inputs and assumptions under our current valuation model in the future resulting in a lack of consistency in future periods. Our current or future valuation model and the inputs and assumptions we make may also lack comparability to other companies that use different models, inputs, or assumptions, and the resulting differences in comparability could be material.
Income Taxes
     We recognize federal, foreign, and state current tax liabilities or assets based on our estimate of taxes payable or refundable in the then current fiscal year for each tax jurisdiction. We also recognize federal, foreign, and state deferred tax liabilities or assets for our estimate of future tax effects attributable to temporary differences and carryforwards and record a valuation allowance to reduce any deferred tax assets by the amount of any tax benefits that, based on available evidence and our judgment, are not expected to be realized. If our assumptions, and consequently our estimates, change in the future, the valuation allowance we have established for our deferred tax assets may be changed, which could impact income tax expense.
     We account for income tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies.” The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of highly complex tax laws. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on our results of operations and financial condition. We believe we have adequately provided for reasonably foreseeable outcomes in connection with the resolution of income tax contingencies. However, our results have in the past, and could in the future, include favorable and unfavorable adjustments to our estimated tax liabilities in the period a determination of such estimated tax liability is made or resolved, upon the filing of an amended return, upon a change in facts, circumstances or interpretation, or upon the expiration of a statute of limitation. Accordingly, our effective tax rate could fluctuate materially from period to period.
     In accordance with SFAS 123R, we recognize tax benefit upon expensing certain share-based awards associated with our share-based compensation plans, including nonqualified stock options and deferred stock unit awards, but under current accounting standards we cannot recognize tax benefit concurrent with the recognition of share-based compensation expenses associated with incentive stock options and employee stock purchase plan shares
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(qualified stock options). For qualified stock options that vested after our adoption of SFAS 123R, we recognize tax benefit only in the period when disqualifying dispositions of the underlying stock occur, which historically has been up to several years after vesting and in a period when our stock price substantially increases. For qualified stock options that vested prior to our adoption of SFAS 123R, the tax benefit is recorded directly to additional paid-in capital. Accordingly, because we cannot recognize the tax benefit for share-based compensation expense associated with qualified stock options until the occurrence of future disqualifying dispositions of the underlying stock and such disqualified dispositions may happen in periods when our stock price substantially increases, and because a portion of that tax benefit may be directly recorded to additional paid-in capital, our future quarterly and annual effective tax rates will be subject to greater volatility and, consequently, our ability to estimate reasonably our future quarterly and annual effective tax rates is greatly diminished.
Results of Operations
Three months ended March 31, 2007 compared with the three months ended March 31, 2006
Net Revenue.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended March 31,	 	
 	 	2007	 	 	2006	 	 	$ Change	 	 	% Change	 	
PC applications	 	$	53,446	 	 	$	36,227	 	 	$	17,219	 	 	 	47.5	%	
% of net revenue	 	 	83.1	%	 	 	89.7	%	 	 	 	 	 	 	 	 	
Digital lifestyle product applications	 	 	10,863	 	 	 	4,138	 	 	 	6,725	 	 	 	162.5	%	
% of net revenue	 	 	16.9	%	 	 	10.3	%	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net revenue	 	$	64,309	 	 	$	40,365	 	 	$	23,944	 	 	 	59.3	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
     We identify the vertical markets that our products serve as the personal computing market (“PC”), from which we generated $53.4 million, or 83.1%, of net revenue during the quarter ended March 31, 2007, and the digital lifestyle product markets, from which we generated $10.9 million, or 16.9%, of net revenue during the quarter ended March 31, 2007. Net revenue was $64.3 million for the three months ended March 31, 2007 compared with $40.4 million for the three months ended March 31, 2006, an increase of $23.9 million, or 59.3%. The increase in net revenue for the three months ended March 31, 2007 was attributable to a $17.2 million, or 47.5%, increase in PC applications net revenue and a $6.7 million, or 162.5%, increase in digital lifestyle product applications net revenue. Our revenue growth was primarily attributable to an approximately 95% increase in unit shipments reflecting the combination of industry growth and market share gains, partially offset by a lower-priced product mix and general competitive pricing pressure.
Gross Margin.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended March 31,	
 	 	2007	 	2006	 	$ Change	 	% Change	
Gross Margin	 	$	25,147	 	 	$	18,108	 	 	$	7,039	 	 	 	38.9	%	
% of net revenue	 	 	39.1	%	 	 	44.9	%	 	 	 	 	 	 	 	 	
     Gross Margin. Gross margin as a percentage of net revenue was 39.1%, or $25.1 million, for the three months ended March 31, 2007 compared with 44.9%, or $18.1 million, for the three months ended March 31, 2006. As each product we sell utilizes our capacitive sensing technology in a design that is generally unique or specific to a customer’s application, gross margin varies on a product-by-product basis, making our cumulative gross margin a blend of our product specific designs and independent of the vertical markets that our products serve. The decline in gross margin as a percentage of net revenue primarily reflected a lower margin product design mix, which included a substantial increase in multimedia-oriented products and general competitive pricing pressure, partially offset by lower manufacturing costs resulting from our continuing design, process-improvement, and cost-reduction programs.
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Operating Expenses.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended March 31,	 	
 	 	2007	 	 	2006	 	 	$ Change	 	 	% Change	 	
Research and development expenses	 	$	9,485	 	 	$	9,106	 	 	$	379	 	 	 	4.2	%	
% of net revenue	 	 	14.8	%	 	 	22.6	%	 	 	 	 	 	 	 	 	
Selling, general, and administrative expenses	 	 	9,339	 	 	 	6,952	 	 	 	2,387	 	 	 	34.3	%	
% of net revenue	 	 	14.5	%	 	 	17.2	%	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating expenses	 	$	18,824	 	 	$	16,058	 	 	$	2,766	 	 	 	17.2	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
% of net revenue	 	 	29.3	%	 	 	39.8	%	 	 	 	 	 	 	 	 	
     Research and Development Expenses. Research and development expenses decreased as a percentage of net revenue to 14.7% from 22.6%, while the cost of research and development activities increased $379,000, or 4.2%, to $9.5 million for the three months ended March 31, 2007 compared with $9.1 million for the three months ended March 31, 2006. The increase in research and development expenses primarily reflected a $661,000 increase in employee compensation costs resulting from additional staffing, increased base compensation related to our annual performance review process, employee benefits costs, variable compensation costs, and recruiting costs, and a $295,000 increase in various general support costs, partially offset by a $577,000 reduction of development project expenses including materials and other related costs. Non-cash share-based compensation costs included in research and development expenses were $1.3 million, or 2.0% of net revenue, and $1.2 million, or 2.9% of net revenue, for the three months ended March 31, 2007 and 2006, respectively.
     Selling, General, and Administrative Expenses. Selling, general, and administrative expenses decreased as a percentage of net revenue to 14.5% from 17.2%, while the cost of selling, general, and administrative activities increased $2.4 million, or 34.3%, to approximately $9.3 million for the three months ended March 31, 2007 compared with approximately $7.0 million for the three months ended March 31, 2006. The increase in selling, general, and administrative expenses primarily reflected a $1.1 million increase in employee compensation costs resulting from additional staffing, increased base compensation related to our annual performance review process, employee benefits costs, variable compensation costs, and recruiting costs, and a $541,000 increase in legal fees, a $398,000 increase in outside consulting and outside service costs, and a $165,000 increase in travel and related costs. The increase in legal fees is primarily related to ongoing patent infringement litigation, which is more fully described in Part II — Other Information — Item 1 Legal Proceedings. Non-cash share-based compensation costs included in selling, general, and administrative expenses were $2.0 million in both the March quarters of fiscal 2007 and 2006, representing 3.1% and 4.9% of net revenue, respectively.
Income from Operations.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended March 31,	
 	 	2007	 	2006	 	$ Change	 	% Change	
Income from operations	 	$	6,323	 	 	$	2,050	 	 	$	4,273	 	 	 	208.4	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
% of net revenue	 	 	9.8	%	 	 	5.1	%	 	 	 	 	 	 	 	 	
     We generated operating income of $6.3 million, or 9.8% of net revenue, for the three months ended March 31, 2007 compared with approximately $2.0 million, or 5.1% of net revenue, for the three months ended March 31, 2006. The increase in operating income primarily reflected the impact of the increase in operating leverage resulting from the 59.3% increase in net revenue, partially offset by a lower gross margin percentage and higher operating expenses.
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Interest Income/(Expense).
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended March 31,	 	
 	 	2007	 	 	2006	 	 	$ Change	 	 	% Change	 	
Interest income	 	$	2,713	 	 	$	2,179	 	 	$	534	 	 	 	24.5	%	
% of net revenue	 	 	4.2	%	 	 	5.4	%	 	 	 	 	 	 	 	 	
Interest expense	 	 	(488	)	 	 	(485	)	 	 	(3	)	 	 	0.6	%	
% of net revenue	 	 	-0.8	%	 	 	-1.2	%	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net interest income	 	$	2,225	 	 	$	1,694	 	 	$	531	 	 	 	31.3	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
% of net revenue	 	 	3.5	%	 	 	4.2	%	 	 	 	 	 	 	 	 	
     Interest Income. Interest income was $2.7 million for the three months ended March 31, 2007 compared with $2.2 million for the three months ended March 31, 2006. The $534,000 increase in interest income resulted from a combination of higher average interest rates and higher average invested cash balances. The increase in average invested cash balances during the past 12 months was primarily attributable to $44.5 million of net cash flows from operations, option exercises, including excess tax benefit thereon, partially offset by $32.3 million of treasury stock purchases under our common stock repurchase program.
     Interest Expense. Interest expense was $488,000 for the three months ended March 31, 2007, essentially unchanged compared with interest expense of $485,000 for the three months ended March 31, 2006. Interest expense primarily reflected the combination of interest expense and amortization of debt issuance costs related to our convertible senior subordinated notes issued in December 2004. The annual debt service cost on the notes is approximately $938,000, which excludes $860,000 of amortization of debt issuance costs.
Provision for Income Taxes.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended March 31,	
 	 	2007	 	2006	 	$ Change	 	% Change	
Income before provision for income taxes	 	$	8,548	 	 	$	3,744	 	 	$	4,804	 	 	 	128.3	%	
Provision for income taxes	 	 	2,913	 	 	 	2,121	 	 	 	792	 	 	 	37.3	%	
% of income before provision for income taxes	 	 	34.1	%	 	 	56.7	%	 	 	 	 	 	 	 	 	
     The provision for income taxes for the three months ended March 31, 2007 was $2.9 million compared with $2.1 million for the three months ended March 31, 2006, reflecting higher pre-tax profit levels, partially offset by a lower effective tax rate. The income tax provision represented estimated federal, foreign, and state taxes for the three months ended March 31, 2007 and 2006. The effective tax rate for the three months ended March 31, 2007 was 34.1% and diverged from the combined federal and state statutory rate primarily due to the benefit of research tax credits and the impact of tax-exempt interest income, partially offset by the impact of accounting for share-based compensation and foreign withholding taxes. The effective tax rate for the three months ended March 31, 2006 was 56.7% and diverged from the combined federal and state statutory rate primarily as a result of the impact of accounting for share-based compensation and other permanent taxable differences, partially offset by the impact of higher income from foreign operations, the benefit of tax-exempt interest income, and research tax credits.
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Nine months ended March 31, 2007 compared with the nine months ended March 31, 2006
Net Revenue.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended March 31,	 	
 	 	2007	 	 	2006	 	 	$ Change	 	 	% Change	 	
PC applications	 	$	162,722	 	 	$	117,890	 	 	$	44,832	 	 	 	38.0	%	
% of net revenue	 	 	83.4	%	 	 	83.8	%	 	 	 	 	 	 	 	 	
Digital lifestyle product applications	 	 	32,489	 	 	 	22,755	 	 	 	9,734	 	 	 	42.8	%	
% of net revenue	 	 	16.6	%	 	 	16.2	%	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net revenue	 	$	195,211	 	 	$	140,645	 	 	$	54,566	 	 	 	38.8	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
     We generated $162.7 million, or 83.4%, of net revenue during the nine months ended March 31, 2007 from the personal computing market (“PC”), and we generated $32.5 million, or 16.6%, of net revenue during the nine months ended March 31, 2007 from the digital lifestyle product markets. Net revenue was $195.2 million for the nine months ended March 31, 2007 compared with $140.6 million for the nine months ended March 31, 2006, an increase of $54.6 million, or 38.8%. The increase in net revenue for the nine months ended March 31, 2007 was attributable to a $44.8 million, or 38.0%, increase in PC applications net revenue and a $9.7 million, or 42.8%, increase in digital lifestyle product applications net revenue. Our revenue growth was primarily attributable to an approximately 72% increase in unit shipments reflecting the combination of industry growth and market share gains, partially offset by a lower-priced product mix and general competitive pricing pressure.
Gross Margin.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended March 31,	
 	 	2007	 	2006	 	$ Change	 	% Change	
Gross Margin	 	$	77,933	 	 	$	63,951	 	 	$	13,982	 	 	 	21.9	%	
% of net revenue	 	 	39.9	%	 	 	45.5	%	 	 	 	 	 	 	 	 	
     Gross Margin. Gross margin as a percentage of net revenue was 39.9%, or $77.9 million, for the nine months ended March 31, 2007 compared with 45.5%, or $64.0 million, for the nine months ended March 31, 2006. As each product we sell utilizes our capacitive sensing technology in a design that is generally unique or specific to a customer’s application, gross margin varies on a product-by-product basis, making our cumulative gross margin a blend of our product specific designs and independent of the vertical markets that our products serve. The decline in gross margin as a percentage of net revenue primarily reflected a lower margin product design mix, which included a substantial increase in multimedia-oriented products and general competitive pricing pressure, partially offset by lower manufacturing costs resulting from our continuing design, process-improvement, and cost-reduction programs.
Operating Expenses.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended March 31,	 	
 	 	2007	 	 	2006	 	 	$ Change	 	 	% Change	 	
Research and development expenses	 	$	28,631	 	 	$	25,740	 	 	$	2,891	 	 	 	11.2	%	
% of net revenue	 	 	14.7	%	 	 	18.3	%	 	 	 	 	 	 	 	 	
Selling, general, and administrative expenses	 	 	26,067	 	 	 	20,593	 	 	 	5,474	 	 	 	26.6	%	
% of net revenue	 	 	13.4	%	 	 	14.6	%	 	 	 	 	 	 	 	 	
Restructuring charge	 	 	915	 	 	 	—	 	 	 	915	 	 	 	—	 	
% of net revenue	 	 	0.5	%	 	 	0.0	%	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating expenses	 	$	55,613	 	 	$	46,333	 	 	$	9,280	 	 	 	20.0	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
% of net revenue	 	 	28.5	%	 	 	32.9	%	 	 	 	 	 	 	 	 	
     Research and Development Expenses. Research and development expenses decreased as a percentage of net revenue to 14.7% from 18.3%, while the cost of research and development activities increased $2.9 million, or 11.2%,
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to $28.6 million for the nine months ended March 31, 2007 compared with $25.7 million for the nine months ended March 31, 2006. The increase in research and development expenses primarily reflected a $1.9 million increase in employee compensation costs resulting from additional staffing, increased base compensation related to our annual performance review process, employee benefits costs, variable compensation costs, and recruiting costs, a $786,000 increase in consulting and outside service costs, and a $952,000 increase in infrastructure and support costs, partially offset by a $790,000 reduction of project materials and related costs. Non-cash share-based compensation costs included in research and development expenses were $3.7 million, or 1.9% of net revenue, and $3.7 million, or 2.6% of net revenue, for the nine months ended March 31, 2007 and 2006, respectively.
     Selling, General, and Administrative Expenses. Selling, general, and administrative expenses decreased as a percentage of net revenue to 13.4% from 14.6%, while the cost of selling, general, and administrative activities increased $5.5 million, or 26.6%, to $26.1 million for the nine months ended March 31, 2007 compared with $20.6 million for the nine months ended March 31, 2006. The increase in selling, general, and administrative expenses primarily reflected a $3.1 million increase in employee compensation and employment related costs resulting from additional staffing, increased base compensation related to our annual performance review process, employee benefits costs, recruiting costs, and variable compensation costs, a $1.5 million increase in legal fees, and a $729,000 increase in consulting and outside service costs. The increase in legal fees is primarily related to ongoing patent infringement litigation, which is more fully described in Part II — Other Information — Item 1 Legal Proceedings. Non-cash share-based compensation costs included in selling, general, and administrative expenses were $6.2 million, or 3.2% of net revenue, and $5.8 million, or 4.1% of net revenue, for the nine months ended March 31, 2007 and 2006, respectively.
     Restructuring Charge. During the nine-month period ended March 31, 2007, we incurred a restructuring charge of $915,000 in connection with the closure of our United Kingdom office as part of our strategic efforts to realign our development capabilities to meet the needs of our Asia Pacific customer base. Included in the restructuring charge were personnel costs consisting of severance and relocation of $526,000, a lease reserve of $287,000, net of estimated sublease income, and a non-cash impairment of property and equipment of $102,000.
Income from Operations.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended March 31,	
 	 	2007	 	2006	 	$ Change	 	% Change	
Income from operations	 	$	22,320	 	 	$	17,618	 	 	$	4,702	 	 	 	26.7	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
% of net revenue	 	 	11.4	%	 	 	12.5	%	 	 	 	 	 	 	 	 	
     We generated operating income of $22.3 million, or 11.4% of net revenue, for the nine months ended March 31, 2007 compared with $17.6 million, or 12.5% of net revenue, for the nine months ended March 31, 2006. The increase in operating income primarily reflected the impact of the increase in operating leverage resulting from the 38.8% increase in net revenue, partially offset by a lower gross margin percentage and higher operating expenses.
Interest Income/(Expense).
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended March 31,	 	
 	 	2007	 	 	2006	 	 	$ Change	 	 	% Change	 	
Interest income	 	$	8,230	 	 	$	5,631	 	 	$	2,599	 	 	 	46.2	%	
% of net revenue	 	 	4.2	%	 	 	4.0	%	 	 	 	 	 	 	 	 	
Interest expense	 	 	(1,463	)	 	 	(1,454	)	 	 	(9	)	 	 	0.6	%	
% of net revenue	 	 	-0.7	%	 	 	-1.0	%	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net interest income	 	$	6,767	 	 	$	4,177	 	 	$	2,590	 	 	 	62.0	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
% of net revenue	 	 	3.5	%	 	 	3.0	%	 	 	 	 	 	 	 	 	
     Interest Income. Interest income was $8.2 million for the nine months ended March 31, 2007 compared with $5.6 million for the nine months ended March 31, 2006. The $2.6 million increase in interest income resulted from a combination of higher average interest rates and higher average invested cash balances. The increase in average invested cash balances during the past 12 months was primarily attributable to $44.5 million of net cash flows from
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operations and option activity, including excess tax benefit thereon, partially offset by $32.3 million of treasury stock purchases under our common stock repurchase program.
     Interest Expense. Interest expense was approximately $1.5 million for the nine months ended March 31, 2007 and 2006. Interest expense primarily reflected the combination of interest expense and amortization of debt issuance costs related to our convertible senior subordinated notes issued in December 2004. The annual debt service cost on the notes is approximately $938,000, which excludes $860,000 of amortization of debt issuance costs.
Provision for Income Taxes.
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Nine Months Ended March 31,	
 	 	2007	 	2006	 	$ Change	 	% Change	
Income before provision for income taxes	 	$	29,087	 	 	$	21,795	 	 	$	7,292	 	 	 	33.5	%	
Provision for income taxes	 	 	9,984	 	 	 	9,857	 	 	 	127	 	 	 	1.3	%	
% of income before provision for income taxes	 	 	34.3	%	 	 	45.2	%	 	 	 	 	 	 	 	 	
     The provision for income taxes for the nine months ended March 31, 2007 was $10.0 million compared with $9.9 million for the nine months ended March 31, 2006, reflecting higher pre-tax profit levels, largely offset by a lower effective tax rate. The income tax provision represented estimated federal, foreign, and state taxes for the nine months ended March 31, 2007 and 2006. The effective tax rate for the nine months ended March 31, 2007 was 34.3% and diverged from the combined federal and state statutory rate primarily due to the benefit of research tax credits in general, research tax credits generated from the retroactive extension of the federal research credit signed into law in December 2006, the net release of contingency reserves, and the impact of tax-exempt interest income, partially offset by the impact of accounting for share-based compensation and foreign withholding taxes. The effective tax rate for the nine months ended March 31, 2006 was 45.2% and diverged from the combined federal and state statutory rate primarily as a result of the impact of accounting for share-based compensation and other permanent taxable differences, partially offset by the impact of higher income from foreign operations, the benefit of tax-exempt interest income, and research tax credits.
     In accordance with SFAS 123R, we recognize tax benefit upon expensing certain share-based awards associated with our share-based compensation plans, including nonqualified stock options and deferred stock unit awards, but under current accounting standards we cannot recognize tax benefit concurrent with the recognition of share-based compensation expenses associated with incentive stock options and employee stock purchase plan shares (qualified stock options). For qualified stock options that vested after our adoption of SFAS 123R, we recognize tax benefit only in the period when disqualifying dispositions of the underlying stock occur, which historically has been up to several years after vesting and in a period when our stock price substantially increases. For qualified stock options that vested prior to our adoption of SFAS 123R, the tax benefit is recorded directly to additional paid-in capital. Tax benefit associated with total share-based compensation was approximately $2.8 million and $2.2 million for the nine months ended March 31, 2007 and 2006, respectively. Excluding the impact of share-based compensation and the related tax benefit, the effective tax rate for the nine months ended March 31, 2007 and 2006 would have been 32.3% and 37.9%, respectively. Because we cannot recognize the tax benefit for share-based compensation expense associated with qualified stock options until the occurrence of future disqualifying dispositions of the underlying stock and such disqualified dispositions may happen in periods when our stock price substantially increases, and because a portion of that tax benefit may be recorded directly to additional paid-in capital, our future quarterly and annual effective tax rates will be subject to greater volatility and, consequently, our ability to reasonably estimate our future quarterly and annual effective tax rates is greatly diminished.
Liquidity and Capital Resources
     Our cash, cash equivalents, and short-term investments of $245.2 million as of March 31, 2007 were essentially unchanged from June 30, 2006. During the nine months ended March 31, 2007, cash, cash equivalents, and short-term investments included the impact of $14.7 million from operating cash flows, $14.0 million from stock option exercises and our employee stock purchase plan activity, and $7.2 million of excess tax benefit from share-based compensation, offset by $32.3 million of cash used for the repurchase of approximately 1.3 million shares of our common stock and $4.0 million used for the purchase of property and equipment.
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     Cash Flows from Operating Activities. Operating activities during the nine months ended March 31, 2007 generated cash of approximately $14.7 million compared with approximately $19.5 million of cash generated during the nine months ended March 31, 2006. For the nine months ended March 31, 2007, net cash provided by operating activities was primarily attributable to net income of $19.1 million plus adjustments for non-cash charges, including share-based compensation costs, depreciation, amortization of debt issuance costs, and the impairment of fixed assets aggregating $12.8 million, partially offset by a $16.7 million net increase in operating assets and liabilities. The increase in operating assets and liabilities was primarily attributable to a $15.1 million increase in accounts receivable, reflecting the substantial increase in our net revenue during the period. For the nine months ended March 31, 2006, the net cash provided by operating activities was primarily attributable to net income of $11.9 million plus adjustments for non-cash charges, including share-based compensation costs, depreciation, and amortization of debt issuance costs totaling $11.8 million, partially offset by a net increase in operating assets and liabilities of $3.1 million and deferred tax, net of realized and excess tax benefit generated from share-based compensation, totaling $1.2 million.
     Cash Flows from Investing Activities. Our investing activities typically relate to purchases of government-backed securities and investment-grade fixed income instruments and purchases of property and equipment. Investing activities during the nine months ended March 31, 2007 generated net cash of $5.1 million compared with net cash used of $26.1 million during the nine months ended March 31, 2006. During the nine months ended March 31, 2007, net cash generated by investing activities consisted of $206.3 million in proceeds from sales and maturities of short-term investments, largely offset by $197.3 million used for the purchase of short-term investments and approximately $4.0 million used for the purchase of property and equipment. During the nine months ended March 31, 2006, net cash used in investing activities consisted of $188.1 million for purchases of short-term investments and $2.4 million for purchases of property and equipment, partially offset by $164.3 million in proceeds from sales and maturities of short-term investments.
     Cash Flows from Financing Activities. Net cash used by financing activities for the nine months ended March 31, 2007 was approximately $11.1 million compared with net cash used in financing activities of $8.3 million for the nine months ended March 31, 2006. Cash used in our financing activities for the nine months ended March 31, 2007 consisted primarily of $32.3 million of cash used for the purchase of 1.3 million shares of treasury stock, partially offset by approximately $14.1 million in proceeds from common stock issued under our stock option plans and employee stock purchase plan and approximately $7.2 million of excess tax benefit from share-based compensation. Our financing activities for the nine months ended March 31, 2006 consisted primarily of $18.8 million of cash used for the purchase of 1.2 million shares of treasury stock, partially offset by approximately $6.6 million in proceeds from common stock issued under our stock option plans and employee stock purchase plan and $4.0 million of excess tax benefit from share-based compensation.
     Common Stock Repurchase Program. In October 2005, our board of directors authorized an additional $40 million for our stock repurchase program, raising the aggregate authorization level to $80 million. The program authorizes us to repurchase our common stock on the open market or in privately negotiated transactions depending upon market conditions and other factors. The number of shares purchased and the timing of purchases is based on the level of our cash balances, general business and market conditions, and other factors, including alternative investment opportunities. Common stock repurchased under this program is held as treasury stock. Aggregate purchases under this program totaled 3,588,100 shares through March 31, 2007 at a cost of $72.3 million, or an average cost of $20.16 per share. Subsequent to March 31, 2007, our board of directors authorized an additional $80 million for our stock repurchase program, bringing the total authorization level to $160 million and extending the period for repurchase to April 2009.
     Convertible Senior Subordinated Notes. During December 2004, we issued $125 million of 0.75% Convertible Senior Subordinated Notes maturing on December 1, 2024 (the “Notes”) in a private offering pursuant to Rule 144A under the Securities Act of 1933, as amended. The Notes bear interest at a rate of 0.75% per annum payable on December 1 and June 1 of each year. We will pay additional contingent interest on the Notes if the average trading price of the Notes is at or above 120% of the principal amount of the Notes for a specified period beginning with the six-month period commencing December 1, 2009. The amount of contingent interest payable on the Notes with respect to a six-month period, for which contingent interest applies, will equal 0.375% per annum of the average trading price of the Notes for a specified five trading-day period preceding such six-month period.
     The Notes are convertible into 2,473,975 shares of our common stock, subject to adjustment in certain events. The denominator of the diluted net income per share calculation includes the weighted average effect of the 2,473,975 shares of common stock issuable upon conversion of the Notes in accordance with SFAS 128 as it applies to the method of settling the principal amount of the notes and Emerging Issues Task Force (“EITF”) Issue No. 04-08 as it
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applies to the market price conversion trigger embedded in the notes. Through November 30, 2009, upon the occurrence of a fundamental change as defined in the indenture governing the Notes, we could potentially be obligated to issue up to 989,587 additional shares, or a total of 3,463,562 shares of common stock. These additional shares, contingently issuable upon a fundamental change, are not included in the calculation of diluted net income per share.
     The Notes may be converted (1) if, during any calendar quarter commencing after December 31, 2004, the last reported sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter is greater than or equal to 120% of the applicable conversion price on such last trading day; (2) on or after January 1, 2020; (3) if we have called the Notes for redemption; or (4) during prescribed periods, upon the occurrence of specified corporate transactions or fundamental changes. On or after December 1, 2009, we may redeem for cash all or a portion of the notes at a redemption price of 100% of the principal amount of the notes plus accrued and unpaid interest, including contingent interest and additional interest, if any. Noteholders have the right to require us to repurchase all or a portion of their notes for cash on December 1, 2009, December 1, 2014, and December 1, 2019 at a price equal to 100% of the principal amount of the Notes to be purchased plus accrued and unpaid interest, including contingent interest and additional interest, if any.
     In April 2007, we made an irrevocable election to cash settle the principal amount of our convertible notes upon conversion of the notes. Our election to cash settle the principal amount of our convertible notes upon conversion will result in us using the “treasury stock” method for calculating diluted shares. Accordingly, we will include on a prospective basis diluted shares underlying the convertible notes in our diluted earnings per share calculation only when the average closing stock price for the period exceeds the conversion price of the notes, which is currently $50.53 per share. As of March 31, 2007, none of the conditions for conversion or redemption of the Notes had occurred.
     The Notes are unsecured senior subordinated obligations and rank junior in right of payment to all of our existing and future senior indebtedness, equal in right of payment with all of our existing and future indebtedness or other obligations that are not, by their terms, either senior or subordinated to the Notes, including trade debt and other general unsecured obligations that do not constitute senior or subordinated indebtedness, and senior in right of payment to all of our future indebtedness that, by its terms, is subordinated to the Notes. There are no financial covenants in the Notes.
     Note Payable to a Related Party. The note payable of $1.5 million to National Semiconductor Corporation (National) due August 2007 represents limited-recourse debt that is secured solely by a portion of our stockholdings in Foveon, Inc., or Foveon, in which National is also an investor. Our decision to make any payment under the limited-recourse note to National will depend on several factors, including current valuations, Foveon’s progress and prospects, and any discounts associated with the note.
     $100 Million Shelf Registration. We have registered an aggregate of $100 million of common stock and preferred stock for issuance in connection with acquisitions, which shares generally will be freely tradeable after their issuance under Rule 145 of the Securities Act unless held by an affiliate of the acquired company, in which case such shares will be subject to the volume and manner of sale restrictions of Rule 144.
     $125 Million Shelf Registration. We have registered an aggregate of $125 million of our 0.75% Convertible Senior Subordinated Notes due 2024 and the common stock issuable upon conversion of the notes. The shares issued upon conversion generally will be freely tradeable after their issuance unless held by an affiliate, in which case such shares will be subject to the volume and manner of sale restrictions of Rule 144.
     Liquidity and Capital Resources. We believe our existing cash, cash equivalents, and short-term investment balances and anticipated cash flows from operating activities will be sufficient to meet our working capital and other cash requirements over the course of at least the next 12 months. Our future capital requirements will depend on many factors, including our business levels, the timing and extent of spending to support product development efforts, costs related to protecting our intellectual property, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access to adequate manufacturing capacity, the continuing market acceptance of our product solutions, our common stock repurchase program, and the amount and timing of our investments in, or acquisitions of, other technologies or companies. Further equity or debt financing may not be available to us on acceptable terms or at all. If sufficient funds are not available or are not available on acceptable terms, our ability to take advantage of unexpected business opportunities or to respond to competitive pressures could be limited or severely constrained.
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Contractual Obligations and Commercial Commitments
     The following table sets forth a summary of our material contractual obligations and commercial commitments as of March 31, 2007 (in millions):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Payments due by period	 	
 	 	 	 	 	 	Less than	 	 	1-3	 	 	3-5	 	 	More than	 	
Contractual Obligations	 	Total	 	 	1 year	 	 	Years	 	 	Years	 	 	5 Years	 	
Convertible senior subordinated notes (1) (2)	 	$	142	 	 	$	1	 	 	$	2	 	 	$	2	 	 	$	137	 	
Note payable (1)	 	 	3	 	 	 	3	 	 	 	—	 	 	 	—	 	 	 	—	 	
Building leases	 	 	2	 	 	 	1	 	 	 	1	 	 	 	—	 	 	 	—	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	147	 	 	$	5	 	 	$	3	 	 	$	2	 	 	$	137	 	

 	 	 	
(1)	 	Represents both principal and interest payable through the maturity date of the underlying contractual obligation.	
 	 	 	
(2)	 	Our convertible senior subordinated notes include a provision allowing the noteholders to require us, at the noteholders’ discretion, to repurchase their notes at a redemption price of 100% of the principal amount of the notes plus accrued and unpaid interest (including contingent interest and additional interest, if any) on December 1, 2009, December 1, 2014, and December 1, 2019 and in the event of a fundamental change as described in the indenture governing the notes. The early repayment of the notes is not reflected in the above schedule, but if all the noteholders elected to exercise their rights to require us to repurchase their notes on December 1, 2009, then our contractual obligations for the one-to-three year period would be increased by $125 million and no amounts would be due in more than three years.	
Recent Accounting Pronouncements
     In June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,” (“FIN 48”) that clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109. FIN 48 is designed to reduce the disparity in accounting treatment for uncertain tax positions resulting from diverse interpretations of SFAS 109 among companies. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. FIN 48 is effective beginning in our first quarter of fiscal 2008. We expect the adoption of FIN 48 will result in certain presentation reclassifications on our balance sheet, but we do not expect a material impact on our results of operations or cash flows.
     In September 2006, the Securities and Exchange Commission released Staff Accounting Bulletin No. 108, (“SAB 108”), which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 provides transition guidance for correcting errors and requires registrants to quantify misstatements using both the balance-sheet and income-statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. In the year of adoption only, if the effect is determined to be material, SAB 108 allows registrants to record the effect as a cumulative-effect adjustment to beginning-of-year retained earnings. SAB 108 does not change the requirements within SFAS No. 154, “Accounting Changes and Error Corrections—a replacement of APB No. 20 and FASB Statement No. 3,” for the correction of an error on financial statements. Further, SAB 108 does not change the Staff’s previous guidance in SAB 99 on evaluating the materiality of misstatements. SAB 108 is effective for our fiscal 2007. We do not expect the adoption of SAB 108 to have a material impact on our financial position, results of operations, or cash flows.
     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value under U.S. generally accepted accounting principles, and expands disclosure about fair value measurements. SFAS 157 applies under other accounting standards that require or permit fair value measurements. Accordingly, SFAS 157 does not require any new fair value measurement. SFAS 157 is effective beginning in our first quarter of fiscal 2009. We do not expect the adoption of SFAS 157 to have a material impact on our financial position, results of operations, or cash flows.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     Our market risk has not changed significantly from the interest rate and foreign currency risks disclosed in Item 7A of our Annual Report on Form 10-K for the fiscal year ended June 30, 2006.
ITEM 4. CONTROLS AND PROCEDURES
     As of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures, which included inquiries made to certain other of our employees. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have each concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and are effective and sufficient to ensure that we record, process, summarize, and report information required to be disclosed by us in our periodic reports filed under the Securities Exchange Act within the time periods specified by the Securities and Exchange Commission’s rules and forms.
     During the fiscal quarter covered by this report, we implemented a new ERP system and in connection therewith adapted certain of our internal controls over financial reporting to utilize our ERP system capabilities. We believe there have not been any changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
     On March 10, 2006, Elantech Devices Corporation filed a Complaint for Patent Infringement against us in the United States District Court for the Northern District of California, San Jose Division, claiming that we infringed Elantech’s U.S. Patent No. 5,825,352 and seeking single and treble damages, attorneys’ fees, and a permanent injunction against us infringing or inducing others to infringe the patent. On April 6, 2006, we filed our Answer to the Complaint and Counterclaims against Elantech, claiming that Elantech has infringed and induced infringement of our U.S. Patent Nos. 5,543,591, 5,880,411, 5,943,052, and 6,380,931 and seeking single and treble damages, attorneys’ fees, and a permanent injunction against infringing or inducing others to infringe.
     Elantech responded to our counterclaim denying liability and counterclaimed seeking an injunction and damages for alleged violations of California law. We subsequently filed a motion to dismiss the Elantech counterclaims that was granted on July 7, 2006 with leave to amend the counterclaims after the adjudication of the patent infringement claims. We intend to vigorously defend our patents and pursue our counterclaims.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
     In April 2007, our board of directors authorized a further expansion of our stock repurchase program for up to an additional $80 million, raising the aggregate authorization level to $160 million and extending the period for repurchase to April 2009. The following sets forth purchases of our common stock under the repurchase program for each fiscal month during the three month period ended March 31, 2007:
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	Total	 	Maximum	
 	 	 	 	 	 	 	 	 	 	Number of	 	Dollar Value	
 	 	 	 	 	 	 	 	 	 	Shares	 	of Shares	
 	 	 	 	 	 	Average	 	Purchased	 	that May	
 	 	Total	 	Price	 	as Part of	 	Yet Be	
 	 	Number	 	Paid	 	Publicly	 	Purchased	
 	 	of Shares	 	per	 	Announced	 	Under the	
Period	 	Purchased	 	Share	 	Program	 	Program	
December 31, 2006 - February 3, 2007	 	 	—	 	 	 	—	 	 	 	2,521,100	 	 	$	35,388,000	 	
February 4, 2007 - March 3, 2007	 	 	1,067,000	 	 	$	25.99	 	 	 	3,588,100	 	 	$	7,653,000	 	
March 4, 2007 - March 31, 2007	 	 	—	 	 	 	—	 	 	 	3,588,100	 	 	$	7,653,000	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	 	1,067,000	 	 	$	25.99	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
ITEM 6. EXHIBITS
 	 	 	 	 	 	 	
 	 	 	31.1	 	 	Certification of Chief Executive Officer	
 	 	 	 	 	 	 	
 	 	 	31.2	 	 	Certification of Chief Financial Officer	
 	 	 	 	 	 	 	
 	 	 	32.1	 	 	Section 1350 Certification of Chief Executive Officer	
 	 	 	 	 	 	 	
 	 	 	32.2	 	 	Section 1350 Certification of Chief Financial Officer	
30

Table of Contents
SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 	 	 	 	 	
 	 	SYNAPTICS INCORPORATED	
 	 	 	 	 	
Date: May 7, 2007	 	By:	 	/s/ Francis F. Lee	
 	 	 	 	 	
 	 	Name:	 	Francis F. Lee	
 	 	Title:	 	President and Chief Executive Officer	
 	 	 	 	 	
 	 	By:	 	/s/ Russell J. Knittel	
 	 	 	 	 	
 	 	Name:	 	Russell J. Knittel	
 	 	Title:	 	Senior Vice President, Chief Financial Officer, and Chief
Administrative Officer	
31

Table of Contents
INDEX TO EXHIBIT
 	 	 	 	 	 	 	
 	 	 	31.1	 	 	Certification of Chief Executive Officer	
 	 	 	 	 	 	 	
 	 	 	31.2	 	 	Certification of Chief Financial Officer	
 	 	 	 	 	 	 	
 	 	 	32.1	 	 	Section 1350 Certification of Chief Executive Officer	
 	 	 	 	 	 	 	
 	 	 	32.2	 	 	Section 1350 Certification of Chief Financial Officer	
32

 
EXHIBIT 31.1
Certification of Chief Executive Officer
     I, Francis F. Lee, certify that:
     1. I have reviewed this Quarterly Report on Form 10-Q of Synaptics Incorporated;
     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 registrant as of, and for, the periods presented in this report;
     4. The registrant’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 registrant 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 registrant, 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 registrant’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 registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
     5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’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 registrant’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 registrant’s internal control over financial reporting.
Date: May 7, 2007
 	 	 	 	 	
 	 	/s/ Francis F. Lee
  Francis F. Lee
Chief Executive Officer	 	 	

 
EXHIBIT 31.2
Certification of Chief Financial Officer
     I, Russell J. Knittel, certify that:
     1. I have reviewed this Quarterly Report on Form 10-Q of Synaptics Incorporated;
     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 registrant as of, and for, the periods presented in this report;
     4. The registrant’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 registrant 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 registrant, 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 registrant’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 registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
     5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’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 registrant’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 registrant’s internal control over financial reporting.
Date: May 7, 2007
 	 	 	 	 	
 	 	/s/ Russell J. Knittel
  Russell J. Knittel
Chief Financial Officer	 	 	

 
EXHIBIT 32.1
Section 1350 Certification of Chief Executive Officer
     In connection with the Quarterly Report on Form 10-Q of Synaptics Incorporated (the “Company”) for the quarterly period ended March 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Francis F. Lee, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1)	 	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and	

(2)	 	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.	

/s/ Francis F. Lee
  Francis F. Lee
Chief Executive Officer	 	 	
May 7, 2007	 	 	

 
EXHIBIT 32.2
Section 1350 Certification of Chief Financial Officer
     In connection with the Quarterly Report on Form 10-Q of Synaptics Incorporated (the “Company”) for the quarterly period ended March 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Russell J. Knittel, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1)	 	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and	

(2)	 	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.	

/s/ Russell J. Knittel
  Russell J. Knittel
Chief Financial Officer	 	 	
May 7, 2007