10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006.

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 000-23084

Integrated Silicon Solution, Inc.

(Exact name of registrant as specified in its charter)

Delaware	77-0199971
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1940 Zanker Road, San Jose, California	95112
(Address of principal executive offices)	(Zip Code)

(408) 969-6600

(Registrant’s telephone number, including area code)

2231 Lawson Lane, Santa Clara, California 95054

(Former name, former address, and former fiscal year if changed since last report)

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  ¨    No  x

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

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of outstanding shares of the registrant’s Common Stock as of April 30, 2007 was 37,611,822.

TABLE OF CONTENTS

Explanatory Note		1
PART I	Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Statements of Operations Three and nine months ended June 30, 2006 and 2005 (Unaudited)	2
	Condensed Consolidated Balance Sheets June 30, 2006 and September 30, 2005 (Unaudited)	3
	Condensed Consolidated Statements of Cash Flows Nine months ended June 30, 2006 and 2005 (Unaudited)	4
	Notes to Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44
Item 4.	Controls and Procedures	45
PART II	Other Information
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	48
Item 6.	Exhibits	59
Signatures		60

References in this Report on Form 10-Q to “we,” “us,” “our” and “ISSI” mean Integrated Silicon Solution, Inc. and all entities controlled by Integrated Silicon Solution, Inc.

EXPLANATORY NOTE

In this Form 10-Q, Integrated Silicon Solution, Inc. (“ISSI,” “we,” “us” or “our”) is restating its condensed consolidated balance sheet as of September 30, 2005, the related consolidated statements of operations for the three and nine months ended June 30, 2005, and the related consolidated statement of cash flows for the nine months ended June 30, 2005 as a result of an independent stock option investigation commenced by the Special Committee of the Board of Directors. This restatement is more fully described in Note 2 “Restatement of Condensed Consolidated Financial Statements” to Consolidated Financial Statements and in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

In our Form 10-K for the year ended September 30, 2006 to be filed with the Securities and Exchange Commission (the “2006 Form 10-K”), we are restating our consolidated balance sheet as of September 30, 2005, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the fiscal years ended September 30, 2005 and September 30, 2004. In addition, we are restating our unaudited quarterly financial information for all interim periods of fiscal year 2005 and the interim periods ended December 31, 2005 and March 31, 2006.

Financial information included in our reports on Form 10-K, Form 10-Q and Form 8-K filed by us prior to May 9, 2006, and the related opinions of our independent registered public accounting firm and all earnings press releases and similar communications issued by us prior to May 9, 2006 should not be relied upon and are superseded in their entirety by this report and other reports on Form 10-K and Form 8-K filed by us with the Securities and Exchange Commission (SEC) on and after May 9, 2006.

1

Item 1. Financial Statements

Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share data)

	Three Months Ended June 30,						Nine Months Ended June 30,
	2006			2005			2006			2005
				As restated (1)						As restated (1)
Net sales (See Note 17)	$	53,249		$	53,722		$	157,587		$	119,971
Cost of sales (See Note 17)		48,911			46,428			140,219			113,935
Gross profit		4,338			7,294			17,368			6,036
Operating expenses:
Research and development		5,459			5,277			16,574			15,536
Selling, general and administrative		6,509			6,211			20,360			16,318
Acquired in-process technology charge		—			1,480			499			1,915
Total operating expenses		11,968			12,968			37,433			33,769
Operating loss		(7,630	)		(5,674	)		(20,065	)		(27,733	)
Interest and other income (expense), net		696			917			3,441			2,343
Gain on sale of investments		267			500			2,454			3,405
Loss before income taxes, minority interest and equity in net loss of affiliated companies		(6,667	)		(4,257	)		(14,170	)		(21,985	)
Provision for income taxes		51			9			164			26
Loss before minority interest and equity in net loss of affiliated companies		(6,718	)		(4,266	)		(14,334	)		(22,011	)
Minority interest in net loss of consolidated subsidiary		39			445			689			631
Equity in net loss of affiliated companies		(233	)		(1,134	)		(709	)		(11,776	)
Net loss	$	(6,912	)	$	(4,955	)	$	(14,354	)	$	(33,156	)
Basic and diluted net loss per share	$	(0.18	)	$	(0.13	)	$	(0.38	)	$	(0.91	)
Shares used in per share calculation		37,488			36,830			37,367			36,538

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” in Notes to Condensed Consolidated Financial Statements.

See accompanying notes to condensed consolidated financial statements.

2

Integrated Silicon Solution, Inc.

Condensed Consolidated Balance Sheets

(In thousands)

	June 30, 2006			September 30, 2005
	(unaudited)			As restated (1)
ASSETS
Current assets:
Cash and cash equivalents	$	37,529		$	27,484
Restricted cash		—			301
Short-term investments		79,639			96,427
Accounts receivable, net		27,822			28,255
Accounts receivable from related parties (See Note 17) 423		253
Inventories		54,170			60,468
Other current assets		4,354			3,594
Total current assets		203,937			216,782
Investments		—			9,182
Property, equipment, and leasehold improvements, net 22,887		23,636
Goodwill		25,338			20,232
Purchased intangible assets, net		5,876			6,142
Other assets		5,981			8,142
Total assets	$	264,019		$	284,116
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Short-term debt and notes	$	8,797		$	6,628
Accounts payable		29,234			29,612
Accounts payable to related parties (See Note 17)		4,247			6,093
Accrued compensation and benefits		3,187			2,509
Accrued expenses		9,931			8,029
Total current liabilities		55,396			52,871
Other long-term liabilities		2,105			1,793
Total liabilities		57,501			54,664
Commitments and contingencies
Minority interest		694			6,566
Stockholders’ equity:
Common stock		4			4
Additional paid-in capital		377,511			376,477
Accumulated deficit		(178,141	)		(163,787	)
Unearned compensation		—			(3,917	)
Accumulated comprehensive income		6,450			14,109
Total stockholders’ equity		205,824			222,886
Total liabilities and stockholders’ equity	$	264,019		$	284,116

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” in Notes to Condensed Consolidated Financial Statements.

See accompanying notes to condensed consolidated financial statements.

3

Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

	Nine Months Ended June 30,
	2006			2005
				As restated (1)
Cash flows from operating activities
Net loss	$	(14,354	)	$	(33,156	)
Depreciation and amortization		2,775			2,455
Stock-based compensation		3,582			1,518
Amortization of intangible assets		1,270			301
Acquired in-process technology charge		499			1,915
Gain on sale of shares of Semiconductor Manufacturing International Corp. (SMIC)		—			(2,905	)
Gain on sale of shares of Signia Technologies Inc. (Signia)		(2,187	)		—
Gain on sale of shares of E-CMOS Corporation (E-CMOS)		(267	)		—
Gain on sale of shares of NexFlash equity securities		—			(482	)
Gain on sale of other investment		—			(18	)
Loss on embedded derivative		—			21
Gain on disposal of asset		(541	)		(281	)
Net foreign currency transaction (gains) losses		(339	)		13
Equity in net loss of affiliated companies		709			11,776
Minority interest in net loss of consolidated subsidiary		(689	)		(631	)
Net effect of changes in current and other assets and liabilities		6,740			16,814
Cash used in operating activities		(2,802	)		(2,660	)
Cash flows from investing activities
Acquisition of property, equipment and leasehold improvements		(1,316	)		(975	)
Proceeds from the sale of assets		1,144			502
Proceeds from sale of SMIC equity securities		—			5,627
Proceeds from sale of Signia equity securities		4,620			—
Proceeds from sale of E-CMOS equity securities		1,454			—
Proceeds from the sale of NexFlash stock		—			2,225
Cash impact of deconsolidation of Signia		(149	)		—
Investment in Signia, net of cash and cash equivalents		—			(6,827	)
Investment in Integrated Circuit Solution, Inc. (ICSI)		(13,860	)		(23,194	)
Investment in NexFlash		—			(452	)
Purchases of available-for-sale securities		(55,650	)		(92,850	)
Sales of available-for-sale securities		72,701			160,146
Cash provided by investing activities		8,944			44,202
Cash flows from financing activities
Proceeds from issuance of common stock		1,367			2,248
Principal payments of short-term lines of credit		(53,783	)		(1,806	)
Proceeds from borrowings under short-term lines of credit		55,743			632
Payment of convertible debentures		—			(14,982	)
Decrease in restricted cash		150			1,189
Cash provided by (used in) financing activities		3,477			(12,719	)
Effect of exchange rate changes on cash and cash equivalents 426		148
Net increase in cash and cash equivalents		10,045			28,971
Cash and cash equivalents at beginning of period		27,484			17,015
Cash and cash equivalents at end of period	$	37,529		$	45,986

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” in Notes to Condensed Consolidated Financial Statements.

See accompanying notes to condensed consolidated financial statements.

4

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Integrated Silicon Solution, Inc. (the “Company”) and its consolidated majority owned subsidiaries, after elimination of all significant intercompany accounts and transactions and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (which are of a normal, recurring nature) considered necessary for fair presentation have been included.

Operating results for the three and nine months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending September 30, 2006 or for any other period. The financial statements included herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2005.

2. Restatement of Condensed Consolidated Financial Statements

Restatement of Previously Issued Financial Statements

In this Form 10-Q, the Company is restating its condensed consolidated balance sheet as of September 30, 2005, the related consolidated statements of operations for the three and nine months ended June 30, 2005, and the related consolidated statement of cash flows for the nine months ended June 30, 2005 as a result of an independent stock option investigation commenced by the Special Committee of the Board of Directors.

The Special Committee Investigation

On July 18, 2006 and July 26, 2006, two purported shareholder derivative actions were filed against certain of the Company’s current and former directors and officers alleging that the Company’s historical stock option granting practices from 1995 through 2002 violated federal and state law. In response to these lawsuits, management conducted a preliminary review of the Company’s historical stock option granting practices.

On August 8, 2006, based on this review, the Board of Directors established the Special Committee, composed of two independent directors, to review the Company’s historical stock option practices and related accounting. The Special Committee was charged with reviewing management’s practices related to all stock option grants made by the Company during the review period, and examining the conduct of its current and former directors, officers, and employees involved in the option grant process.

The Board of Directors, with the concurrence of the Special Committee, determined that, pursuant to the requirements of APB 25, the actual measurement dates for financial accounting purposes of certain stock options granted primarily during fiscal years 1997-2005 differed from the recorded grant dates of such awards, and that revised measurement dates for financial accounting purposes would apply to the affected awards, which would result in additional and material non-cash stock-based compensation expense.

5

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The Special Committee’s Review Process

The Special Committee reviewed the facts and circumstances surrounding all stock option grants made during the period from January 1, 1997 through July 2006 (“the “Review Period”) as well as grants dated October 13, 1995 and November 8, 1996, which were identified in the derivative complaints, for a total of 104 grant dates. The Special Committee held sixteen meetings and interviewed 20 individuals, including current and former employees of ISSI, officers and directors, and outside counsel. In addition, the Company evaluated all grants in 1995 and 1996 since the date of the Company’s initial public offering and concluded that any possible additional errors arising from grants made during this time would not be material to the financial statements included in this Form 10-Q.

The Special Committee also reviewed the facts and circumstances surrounding the potential backdating of cash and cash-less exercises of options. The Company considered whether the cash-less exercises or cash exercises had any accounting consequences such as potential compensation charges and additional income tax deductions. For cash-less exercises, the exercise process utilized a third party broker so there was little chance for exercise date manipulation. For cash exercises, the Special Committee determined that the existing evidence and information available are inconclusive. Had there been backdating of cash exercises, the potential maximum exposure of the compensation charge representing tax benefits forgone by the Company using fixed plan accounting, together with any underreported taxes would not be material for any fiscal period.

Findings of the Special Committee’s Review

From the beginning of the Review Period through December 2005, the Company did not consistently follow its option grant procedures. Of the 104 grants under review, the Special Committee was unable to find sufficient contemporaneous documentation to support the original measurement date for 73 grant dates. The Special Committee did find documentation to support the original measurement date for the remaining 31 grant dates, and because the accounting treatment for these grants is correct, they are not included in the accounting adjustment.

The 73 grant dates for which there was insufficient evidence to support the original grant date were further placed into one of three sub-categories:

• Backdated. There are eight grant dates for which there is conclusive evidence that the original measurement date was selected retroactively. On these eight grant dates, the Company granted options for approximately 3.0 million shares. The associated compensation charge through Fiscal Year 2005 is approximately $12.7 million.

• Appears Misdated. There are 55 grant dates which resemble Backdated grants in that they were made on dates when the stock price was comparatively low, the grants were added to the Company’s Equity Edge database (i.e., the software system the Company used to record stock option data) a significant amount of time after the purported date of grant, and meta-data from documents such as minutes or resolutions indicates that these documents were created after the purported grant date. These grant dates differ from Backdated grants in that there is no email or testimonial evidence to directly support the inference that the grant dates were selected retroactively. On these 55 grant dates, the Company granted options for approximately 10.9 million shares. The associated compensation charge is approximately $16.5 million through Fiscal Year 2005.

• Appears Misdated/No Accounting Impact. There are ten grant dates that follow the same pattern as the Appears Misdated grants, but because the stock price on the revised measurement date is lower than the stock price on the original measurement date, the Company will not recognize compensation expense on these misdated grants. On these ten grant dates, the Company granted options for approximately 2.3 million shares.

After consideration of the accounting literature and recent guidance from the SEC staff, the Company has organized the grants during the relevant period into categories based on grant type and the process by which the grant was finalized. The Company analyzed the evidence from the Special Committee’s investigation related to each category including, but not limited to, physical documents, electronic documents, underlying electronic data about documents, and witness interviews.

6

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Based on the relevant facts and circumstances, the Company applied the then appropriate accounting standards to determine, for every grant within each category, the proper measurement date. If the measurement date was not the originally assigned grant date, accounting adjustments were made as required, resulting in stock-based compensation expense and related tax effects.

The following summarizes the Company’s findings by type of grant:

Board of Director Grants. Outside directors receive option grants automatically pursuant to the Director Plan, which provides that the first grant occurs on the date a person becomes a director. Grants recur automatically on the date each director is re-elected by shareholders. Grants were made to outside directors on 15 dates in the Review Period. The Company discovered one discrepancy and recorded $2,350 in stock compensation charges.

Officer Grants. Awards of option grants to executive officers (as defined in Section 16 of the Securities Exchange Act of 1934) were made either by the Board of Directors as a whole, or by the Compensation Committee of the Board, which was comprised of non-management directors. Grants to executive officers were memorialized and approved in minutes of Board meetings or in documents signed by our Compensation Committee. The Compensation Committee determined a specific number of stock options and salary compensation to officers, but delegated in a de facto manner its authority to select the grant dates and exercise prices to the former Chief Financial Officer, Gary L. Fischer, including at times when he was not a member of the Board of Directors. The Compensation Committee thereafter authorized the grants, without knowledge of how Mr. Fischer selected the grant dates or prices. The Company has concluded that the authorization by the Compensation Committee was perfunctory and therefore could not be relied upon to determine the grant date. Grants to executive officers were made on 21 dates and include approximately 2.4 million shares. Four grants were categorized as Backdated, seven grants were categorized as Appears Misdated, and ten of these grant dates were categorized as Correct. The ten grants categorized as correct had original measurement dates that were deemed appropriate based upon various contemporaneous documentation that indicated that the exercise price and the number of options granted to individual recipients were known with finality at the original measurement dates. The associated compensation charge is approximately $3.4 million through Fiscal Year 2005.

Non-executive Employee Grants (New Hire, Follow-on, and Bonus). Option grants awarded to employees who were not then executive officers (as defined in Section 16 of the Securities Exchange Act of 1934) were memorialized and approved in documents signed by the Stock Option Committee, pursuant to authority delegated by the Board of Directors. The Stock Option Committee was made up of the Chief Executive Officer and a non-management director. The Special Committee concluded that the Stock Option Committee delegated in a de facto manner its authority to select the grant dates and exercise prices to the former Chief Financial Officer, Gary L. Fischer, including at times when he was not a member of the Board of Directors. The quantity of shares granted were typically based on salary range guidelines set by the Company and approved by the Stock Option Committee. The Stock Option Committee thereafter authorized the grants, without knowledge of how Mr. Fischer had selected the grant dates or prices. The Company has concluded that the authorization by the Stock Option Committee was perfunctory and therefore could not be relied upon to determine the grant date. Grants to non-executive employees were made on 76 dates during the Review Period, and totaled approximately 13.6 million shares. Grants on six dates were categorized as Backdated and 52 grant dates were categorized as Appears Misdated, representing approximately 10.2 million shares. The associated compensation charge is approximately $21.5 million through Fiscal Year 2005. In addition, ten grants were categorized as Appears Misdated/No Accounting Impact and eight grants were categorized as Correct, representing approximately 3.4 million shares. The eight grants categorized as correct had original measurement dates that were deemed appropriate based upon various contemporaneous documentation that indicated that the exercise price and the number of options granted to individual recipients were known with finality at the original measurement dates.

Salary Reduction Grants. The Company granted options to officers and employees in connection with five salary reduction programs. Three of these grant dates were categorized as Backdated (representing 535,716 shares) and two grant dates were categorized as Appears Misdated (representing 254,965 shares). These totals exclude any grants to officers, as they were previously included in the Officer Grant totals. The associated compensation charge is approximately $2.2 million through Fiscal Year 2005.

Stock Option Re-pricing Grants. The Company granted options to officers and employees four times in connection with stock option re-pricing programs. On October 13, 1995, the Company granted 699,000 options (excluding options to

7

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

officers); this grant was categorized as Correct. On December 6, 1996 the Company granted 75,000 options to officers and on December 27, 1996 the Company granted 847,000 options to employees; both of these grants, which were outside of the Review Period, have been determined to be Correct by the Company. On December 2, 1998, the Company granted 1,622,418 options (excluding options to officers); this grant was categorized as Appears Misdated (the appropriate measurement date was determined to be December 11, 1998). These re-pricing grants predated the adoption of FIN 44 and the Company applied EITF Issue No. 87-33, Stock Compensation Issues Related to Market Decline (EITF Issue No. 87-33). The associated fixed compensation charge is approximately $2.1 million through Fiscal Year 2005. During the investigation, the Company identified that 232,050 options granted, all to non-officers, in the December 1998 re-pricing, represented options re-priced a third time and are being considered variable awards under EITF 87-33. The Company has recorded the related charges of approximately $2.3 million over the Review Period as part of this restatement.

Consultant Grants. During the Review Period, the Company made one grant to a consultant that was not properly recorded. A total of 25,000 shares were granted on March 23, 1998 which was the date of the consulting contract. Compensation expense of $74,000 was recorded during the year ended September 30,1998 as per FASB’s Emerging Issues Task Force “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” (EITF 96-18).

Modification of Grants. There were 20 option grants which were modified between the periods of 1997 to 2003 to have the exercise period extended. Under Financial Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, the Company has recorded additional compensation expense for the modification of these option grants. The additional compensation charge for the affected options, calculated as the difference between the intrinsic value on the award date and the intrinsic value on the modification date, amounted to $440,000.

Consideration for Revised Measurement Dates

The Company identified two types of fact patterns regarding the available evidence regarding grants made during the Review Period. In Fact Pattern One, the Company found documentation to identify a specific date on which the grantees, the number of shares, and the prices of the options were known and support the original measurement date. Grants falling within this first fact pattern are primarily grants to directors and officers. Options granted from February 2006 onward also fall within this category, because at that time, the Company instituted new procedures for granting stock options. These procedures require contemporaneous documentation of the date of grant. The 31 grants in this category did not require revised measurement dates.

In Fact Pattern Two, for most grants in the Review Period, it is not possible to ascertain with certainty from the available evidence when the list of grantees was final. For these 73 grants, there was insufficient contemporaneous evidence related to the Original Measurement Date. For four grants in this category, contemporaneous evidence exists to support a revised measurement date

Based on the evidence, the Company has concluded that it should consider all available evidence to determine the earliest date that the terms of options to individual recipients were known with finality for all grants which fall into the categories Backdated, Appears Misdated and Appears Misdated/No Accounting Impact (other than for FAS 123 Pro Forma purposes), for purposes of selecting the Revised Measurement Dates. For the vast majority of grants, the Company has concluded, based on all available evidence, that the Equity Edge Record Added Date is the earliest date when the terms of options to individual recipients were known with finality and therefore that is the Revised Measurement Date. Alternative measurement dates were used when other documentary evidence exists to support such dates such as dated Unanimous Written Consents, or in the case of a grant to a new director, the date of commencement of service. Alternative methods for determining revised measurement dates were used on four grants as the documentary evidence for the grants either identified with certainty the date the terms of the option to individual recipients were known with finality or supported, when uncertainty remains, a date earlier than the Equity Edge entry date.

The Equity Edge Record Added date represents a contemporaneous, fixed, identifiable date in the option grant process, which evidences that the Company had incurred a legal obligation to the employee-recipient and that the criteria listed in Paragraph 10(b) of APB 25 were met. There is significant evidence that the terms of the grants were final by the

8

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

time they were entered into Equity Edge. Furthermore, based on the lack of verifiable contemporaneous documentation, the Equity Edge Record Added date represents the earliest determinable date as of which the criteria listed in Paragraph 10(b) of APB 25 were met, as both the exercise price and the number of options granted to each individual were known on that date. Based on the apparent practice utilized by Mr. Fischer to grant stock awards using hindsight, the Company believes that the APB 25 criteria were not met at the earlier stated grant date, and it is likely that the exercise price was not established until a point close to the Equity Edge Entry Date.

Financial Impact of the Adjustments to the Measurement Dates

Based on the results of the equity award review, the Company concluded that, pursuant to APB 25, and related interpretations, the accounting measurement dates for most of the stock option grants awarded between 1995 through 2005, covering options to purchase 19.3 million shares of our common stock, differed from the measurement dates previously used for such awards. As a result, revised measurement dates were applied to the affected option grants and the Company recorded a total of $29.2 million in additional non-cash stock-based compensation expense for the years 1997 through 2005. Of the $29.2 million, $25.6 million utilized the equity edge entry dates. This amount is net of forfeitures related to employee terminations. The additional stock-based compensation expense is being amortized over the service period relating to each option which is typically four years.

Stock Option grants that were intended to qualify as Incentive Stock Options (“ISOs”) under the Internal Revenue Code but were granted “in-the-money” as described above would not receive the favorable tax treatment under the ISOs. As such, the employer and employee portions of certain payroll tax amounts were not appropriately withheld when the options were exercised. Had the Company recorded these expenses as they occurred, then the Company would have recognized an additional tax expense of $368,000 over the period. The Company intends to enter into settlement discussions with the Internal Revenue Service in June 2007 regarding this matter for those tax years which are still open with the IRS: 2004, 2005, and 2006. Based on the Company’s assessment, the payroll tax and withholding liability is approximately $13,000 for those periods. The Company intends to pay the amounts including the amounts on behalf of the employees. The Company is recording charges for each year in which the payroll tax should have been assessed, and then reversing that charge in the fiscal year when the statute of limitations expires. These charges have been recorded in the financial statements as compensation cost.

In the Company’s restatements for fiscal years 1997 to 2003 and 2005, no adjustments were made to the originally reported income tax provision or benefit resulting from the additional stock-based compensation expenses. No tax benefits were recorded for additional stock-based compensation for these years since such amounts were offset by valuation allowances which would not be realized given the existence of operating losses and lack of earnings history. In the Company’s restatement for fiscal year 2004, a $52,000 reduction to the amount of originally reported tax provision was recorded to reflect the tax benefits that the additional stock-based compensation had to the federal alternative minimum tax expense.

9

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The impact of the restatement is summarized as follows:

(in thousands)	1997		1998		1999		2000		2001			2002			2003			2004			2005			Total
Revised measurement dates	$	117	$	815	$	2,084	$	5,318	$	6,489		$	5,055		$	4,117		$	3,210		$	1,959		$	29,164
Variable accounting treatment					$	1,120	$	1,349	$	(98	)	$	(82	)	$	95								$	2,384
Stock grants to consultant			$	74																				$	74
Modification of stock option exercise period at termination			$	1	$	2						$	421		$	16								$	440
Total stock-based compensation restatement	$	117	$	890	$	3,206	$	6,667	$	6,391		$	5,394		$	4,228		$	3,210		$	1,959		$	32,062
Payroll tax charge			$	1	$	38	$	237	$	50		$	24		$	5		$	9		$	4		$	368
Reverse when tax period closes												$	(1	)	$	(38	)	$	(237	)	$	(50	)	$	(326	)
Net payroll tax impact	$	0	$	1	$	38	$	237	$	50		$	23		$	(33	)	$	(228	)	$	(46	)	$	42
Decrease in income tax provision																		$	(52	)				$	(52	)
Total restatement	$	117	$	891	$	3,244	$	6,904	$	6,441		$	5,417		$	4,195		$	2,930		$	1,913		$	32,052
Cumulative increase in accumulated deficit at September 30, 2003															$	27,209
Cumulative increase in accumulated deficit at September 30, 2005																					$	32,052

10

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The following tables present the effects of the stock-based compensation and related tax adjustments made to the Company’s previously reported consolidated statements of operations.

	Three Months Ended June 30, 2005									Nine Months Ended June 30, 2005
	As reported			Adjustments			As restated			As reported			Adjustments			As restated
	(In thousands, except per share data)
Net sales	$	53,722		$	—		$	53,722		$	119,971		$	—		$	119,971
Cost of sales		46,422			6			46,428			113,921			14			113,935
Gross profit		7,300			(6	)		7,294			6,050			(14	)		6,036
Operating expenses
Research and development		5,063			214			5,277			14,789			747			15,536
Selling, general and administrative		6,059			152			6,211			15,668			650			16,318
Acquired in-process technology		1,480			—			1,480			1,915			—			1,915
Total operating expenses		12,602			366			12,968			32,372			1,397			33,769
Operating loss		(5,302	)		(372	)		(5,674	)		(26,322	)		(1,411	)		(27,733	)
Interest and other income (expense), net		917			—			917			2,343			—			2,343
Gain on sales of investments, net		500			—			500			3,405			—			3,405
Loss before income taxes, minority interest and equity in net loss of affiliated Companies		(3,885	)		(372	)		(4,257	)		(20,574	)		(1,411	)		(6,941	)
Provision for income taxes		9			—			9			26			—			(294	)
Loss before minority interest and equity in net loss of affiliated companies		(3,894	)		(372	)		(4,266	)		(20,600	)		(1,411	)		(22,011	)
Minority interest in net loss of consolidated subsidiary		445			—			445			631			—			631
Equity in net loss of affiliated companies		(1,134	)		—			(1,134	)		(11,776	)		—			(11,776	)
Net loss	$	(4,583	)	$	(372	)	$	(4,955	)	$	(31,745	)	$	(1,411	)	$	(33,156	)
Basic and diluted net loss per share	$	(0.12	)	$	(0.01	)	$	(0.13	)	$	(0.87	)	$	(0.04	)	$	(0.91	)

11

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The following table presents the effects of the stock-based compensation and related tax adjustments made to the Company’s previously reported consolidated balance sheet as of September 30, 2005.

	September 30, 2005
	As reported			Adjustments			As restated
	(in thousands, except par value)
ASSETS
Current assets:
Cash and cash equivalents	$	27,484		$	—		$	27,484
Restricted cash		301			—			301
Short-term investments		96,427			—			96,427
Accounts receivable, net		28,255			—			28,255
Accounts receivable from related parties		253			—			253
Inventories		60,468			—			60,468
Other current assets		3,594			—			3,594
Total current assets		216,782			—			216,782
Investments		9,182			—			9,182
Property, equipment and leasehold improvements, net		23,636			—			23,636
Goodwill		20,232			—			20,232
Purchased intangible assets, net		6,142			—			6,142
Other assets		8,142			—			8,142
Total assets	$	284,116		$	—		$	284,116
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Short-term debt and notes	$	6,628		$	—		$	6,628
Accounts payable		29,612			—			29,612
Accounts payable to related parties		6,093			—			6,093
Accrued compensation and benefits		2,467			42			2,509
Accrued expenses		8,029			—			8,029
Total current liabilities		52,829			42			52,871
Other long-term liabilities		1,793			—			1,793
Total liabilities		54,622			—			54,664
Commitments and contingencies
Minority interest		6,566			—			6,566
Stockholders’ equity:
Common stock		4			—			4
Additional paid-in capital		340,567			35,910			376,477
Accumulated deficit		(131,735	)		(32,052	)		(163,787	)
Accumulated comprehensive income		14,109			—			14,109
Unearned compensation		(17	)		(3,900	)		(3,917	)
Total stockholders’ equity		222,928			(42	)		222,886
Total liabilities and stockholders’ equity	$	284,116		$	—		$	284,116

12

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The following tables present the effects of the stock-based compensation and related tax adjustments made to the Company’s previously reported consolidated statements of cash flows.

	Nine Months Ended June 30, 2005
	As reported			Adjustments			As restated
	(in thousands)
Cash flows from operating activities:
Net loss	$	(31,745	)	$	(1,411	)	$	(33,156	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation		61			1,457			1,518
Depreciation and amortization		2,455			—			2,455
Amortization of intangibles		301			—			301
Acquired in-process technology charge		1,915			—			1,915
Gain on sale of shares of SMIC		(2,905	)		—			(2,905	)
Gain on sale of shares of NexFlash stock		(482	)		—			(482	)
Gain on sale of other investment		(18	)		—			(18	)
Loss on embedded derivative		21			—			21
Gain on disposal of assets		(281	)		—			(281	)
Net foreign currency transaction losses		13			—			13
Equity in net loss of affiliated companies		11,776			—			11,776
Minority interest in net loss of consolidated subsidiary		(631	)		—			(631	)
Net effect of changes in current and other assets and liabilities		16,860			(46	)		16,814
Net cash used in operating activities		(2,660	)		—			(2,660	)
Cash flows from investing activities:
Acquisition of property, equipment, and leasehold improvements		(975	)		—			(975	)
Proceeds from sale of fixed assets		502			—			502
Purchases of available-for-sale securities		(92,850	)		—			(92,850	)
Sales of available-for-sale securities		160,146			—			160,146
Investment in Signia, net of cash and cash equivalents		(6,827	)		—			(6,827	)
Investment in ICSI, net of cash and cash equivalents		(23,194	)		—			(23,194	)
Investment in NexFlash		(452	)		—			(452	)
Proceeds from sale of NexFlash stock		2,225			—			2,225
Proceeds from sale of SMIC equity securities		5,627			—			5,627
Net cash provided by investing activities		44,202			—			44,202
Cash flows from financing activities:
Proceeds from issuance of stock through compensation plans		2,248			—			2,248
Proceeds from borrowing under short-term lines of credit		632			—			632
Principal payments of short-term lines of credit		(1,806	)		—			(1,806	)
Payment of convertible debentures		(14,982	)		—			(14,982	)
Decrease in restricted cash		1,189			—			1,189
Net cash used in financing activities		(12,719	)		—			(12,719	)
Effect of exchange rate changes on cash and cash equivalents		148			—			148
Net increase in cash and cash equivalents		28,971			—			28,971
Cash and cash equivalents at beginning of year		17,015			—			17,015
Cash and cash equivalents at end of year	$	45,986		$	—		$	45,986

13

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The following table presents the effects of the stock-based compensation and related tax adjustments made to the Company’s previously reported pro forma disclosures under FAS123.

	Three Months Ended June 30, 2005									Nine Months Ended June 30, 2005
	As reported			Adjustments			As restated			As reported			Adjustments			As restated
	(In thousands, except per share data)
Net loss — as reported	$	(4,583	)	$	(372	)	$	(4,955	)	$	(31,745	)	$	(1,411	)	$	(33,156	)
Intrinsic value method expense included in reported net loss, net of tax		16			418			434			61			1,457			1,518
Fair value expense, net of tax		(756	)		(594	)		(1,350	)		(2,551	)		(2,102	)		(4,643	)
Net loss — pro forma	$	(5,323	)	$	(548	)	$	(5,871	)	$	(34,235	)	$	(2,056	)	$	(36,291	)
Basic and diluted net loss per share — as reported	$	(0.12	)	$	(0.01	)	$	(0.13	)	$	(0.87	)	$	(0.04	)	$	(0.91	)
Basic and diluted net loss per share — pro forma	$	(0.14	)	$	(0.02	)	$	(0.16	)	$	(0.94	)	$	(0.05	)	$	(0.99	)

3. Reclassifications

Certain reclassifications have been made to prior period balances in order to conform to the current period’s presentation. In particular, accounts receivable, net has been increased by $1.0 million and accrued liabilities has been increased by $1.0 million as of September 30, 2005 and property, equipment and leasehold improvements has been increased by $1.9 million and other assets has been decreased by $1.9 million.

4. Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and such differences, may be material to the financial statements.

5. Impact of Recently Issued Accounting Standards

In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections” (SFAS 154) which replaces Accounting Principles Board Opinion (APB) No. 20 “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements—An Amendment of APB Opinion No. 28.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2007. The Company does not expect the adoption of SFAS 154 will have a material impact on its consolidated results of operations and financial position.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” The interpretation contains a two step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The provisions are effective for the Company beginning in the first quarter of fiscal 2008. The Company is currently evaluating the impact this statement will have on its consolidated financial statements.

14

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 gives guidance on how errors, built up over time in the balance sheet, should be considered from a materiality perspective and corrected. SAB 108 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 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. The Company is currently evaluating the impact that the provisions will have on the Company’s consolidated balance sheet and statement of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157) which establishes a framework for measuring fair value and enhance disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The measurement and disclosure requirements are effective for the Company beginning in the first quarter of fiscal 2009. The Company is currently evaluating whether SFAS No. 157 will result in a change to its fair value measurements.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of FASB Statements No. 87, 88, 106, and 132R” (SFAS No. 158). SFAS No. 158 requires that the funded status of defined benefit postretirement plans be recognized on the Company’s balance sheet, and changes in the funded status be reflected in comprehensive income, effective fiscal years ending after December 15, 2006. SFAS No. 158 also requires the measurement date of the plan’s funded status to be the same as the Company’s fiscal year-end. This requirement is not required until fiscal 2008. The Company is currently evaluating the impact that the provisions will have on the Company’s consolidated balance sheet and statement of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS No. 159) which permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS 159 is effective for the Company beginning in the first quarter of fiscal 2009, although earlier adoption is permitted. The Company is currently evaluating the impact SFAS No. 159 will have on its consolidated financial statements.

6. Stock-based Compensation

The Company has stock option plans under which options to purchase shares of the Company’s common stock may be granted to employees and directors. At June 30, 2006, the total number of shares subject to options outstanding under all plans was 5,979,000. At June 30, 2006, 2,809,000 shares were available for grant under all plans. Options generally vest ratably over a four-year period with a 6-month or 1-year cliff vest and then vesting ratably over the remaining period. Options granted prior to September 30, 2005 expire ten years after the date of grant; options granted after October 1, 2005 expire seven years after the date of the grant.

As approved by the Board of Directors, effective February 1, 2006, future offering periods under the Company’s employee stock purchase plan (ESPP) will have a duration of six months and the purchase price will be equal to 85% of the fair value of the Company’s common stock on the purchase date. Previously, the Company’s ESPP permitted eligible employees to purchase common stock through payroll deductions at a price equal to 85% of the lesser of the fair value of the Company’s common stock as of the first day of the 24-month offering period or the last day of each six-month purchase period. The offering periods under the ESPP commence on approximately February 1 and August 1 of each year. At June 30, 2006, 1,177,000 shares were available for issuance under the ESPP.

Adoption of SFAS 123R

Beginning in fiscal 2006, the Company accounts for stock-based compensation arrangements in accordance with the provisions of SFAS No. 123(R) “Share-Based Payment” (SFAS 123R). Under SFAS 123R, compensation cost is calculated

15

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

by the Company on the date of grant using the fair value of the option as determined using the Black-Scholes method. The compensation cost is then amortized ratably over the vesting period of the individual option grants. The Black-Scholes valuation calculation requires the Company to estimate key assumptions such as expected term, volatility and interest rates to determine the fair value of the stock options. The estimate of these key assumptions is based on the Company’s historical stock price volatility, employees’ historical exercise patterns and judgment regarding market factors and trends. SFAS 123R also requires that forfeitures be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company estimates forfeitures based on its historical forfeiture rates as it believes these rates to be the most indicative of the Company’s expected forfeiture rate.

The Company adopted the fair value recognition provisions of SFAS 123R using the modified prospective transition method. Under the modified prospective transition method, prior periods are not restated for the effect of adopting SFAS 123R. Commencing with the first quarter of fiscal 2006, compensation cost includes all share-based awards granted prior to, but not yet vested as of October 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and compensation for all share-based awards granted subsequent to October 1, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.

As a result of adopting SFAS 123R on October 1, 2005, the Company recorded stock-based compensation expense of $0.9 million and $3.6 million, in the three and nine month periods ended June 30, 2006, respectively. The impact of adopting SFAS 123R resulted in an increase to the Company’s net loss per share of $0.02 and $0.10 for the three and nine months ended June 30, 2006, respectively. As of June 30, 2006, there was approximately $10.7 million of total unrecognized stock-based compensation expense net of estimated forfeitures of $2.1 million related to share-based payments awards under the Company’s stock option plans that will be recognized over a weighted-average period of approximately 2.8 years. Future stock option grants will add to this total whereas quarterly amortization and the vesting of the existing stock option grants will reduce this total. The Company will also record compensation expense for its ESPP for the difference between the purchase price and the fair market value on the day of purchase.

Prior to the adoption of SFAS 123R, the Company presented all tax benefits resulting from the exercise of stock options as operating cash flows in its Statement of Cash Flows. SFAS 123R requires that these cash flows be classified as financing cash flows. As the Company has a valuation allowance for all of its deferred tax assets, a tax benefit associated with stock option exercises has not been recognized.

During the three and nine months ended June 30, 2006, options to purchase 56,000 shares and 196,000 shares, respectively, were exercised at an aggregate intrinsic value of $178,000 and $559,000, respectively, determined as of the date of option exercise.

Prior to Adoption of SFAS 123R

Prior to October 1, 2005, the Company accounted for stock options under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), and related Interpretations, as permitted by SFAS Statement No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). The Company provided the disclosures required under SFAS 123 as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosures.” The Company generally did not recognize stock-based compensation expense in its statement of operations for periods prior to the adoption of SFAS 123R except when options were granted at an exercise price lower than the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net loss and net loss per share as if the Company had applied the fair value recognition provisions of SFAS 123R to options granted under the Company’s stock-based compensation plans prior to its adoption of SFAS 123R. For purposes of this pro forma disclosure, the value of the options was estimated using a Black-Scholes option-pricing formula and amortized on a straight-line basis over the respective vesting periods. Disclosures for the three and nine month periods ended June 30, 2006 are not presented because stock-based payments were accounted for under SFAS 123R’s fair-value method during this period and included in the determination of net loss.

16

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

	Three Months Ended June 30, 2005			Nine Months Ended June 30, 2005
	(As restated)			(As restated)
	(In thousands)
Net loss – as reported	$	(4,955	)	$	(33,156	)
Intrinsic value method expense included in reported net loss, net of tax		434			1,518
Fair value method expense, net of tax		(1,350	)		(4,643	)
Net loss – pro forma	$	(5,871	)	$	(36,291	)
Basic and diluted net loss per share – as reported	$	(0.13	)	$	(0.91	)
Basic and diluted net loss per share – pro forma	$	(0.16	)	$	(0.99	)

Valuation Assumptions

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions:

	Three Months Ended June 30,				Nine Months Ended June 30,
	2006		2005		2006		2005
Expected term in years	4.54		2.75		4.53		2.75
Estimated volatility	67	%	69	%	69	%	73	%
Risk-free interest rate	4.96	%	3.72	%	4.50	%	3.45	%
Dividend yield	0.00	%	0.00	%	0.00	%	0.00	%

The Company utilizes the simplified calculation of expected life under the provisions of the SEC’s Staff Accounting Bulletin 107, as the Company shortened the contractual life of employee stock options from ten years to seven years. Estimated volatilities are based on historical stock price volatilities of the period immediately preceding the option grant that is equal in length to the option’s expected term. The Company believes that historical volatility is the best estimate of future volatility. The Company bases the risk-free interest rate on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term. The Company has never paid dividends and does not anticipate doing so over the expected life of the options and therefore used 0% for dividend yield. The weighted-average grant date fair value of options granted during the three and nine months ended June 30, 2006 was $3.61 and $3.70, respectively. The weighted-average grant date fair value of options granted during the three and nine months ended June 30, 2005 was $2.91 and $3.35, respectively. The estimated fair value of the employee stock options is amortized to expense ratably over the vesting period of the individual option grants.

7. Concentrations of Credit Risk

In the three and nine months ended June 30, 2006 and June 30, 2005, no single customer accounted for over 10% of net sales.

17

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

8. Inventories

The following is a summary of inventories by major category:

	June 30, 2006		September 30, 2005
	(In thousands)
Purchased components	$	8,925	$	10,760
Work-in-process		21,169		16,005
Finished goods		24,076		33,703
	$	54,170	$	60,468

During the three months and nine months ended June 30, 2006, the Company recorded inventory write-downs of $4.9 million and $14.3 million, respectively. During the three and nine months ended June 30, 2005, the Company recorded inventory write-downs of $0 and $10.9 million, respectively. The inventory write-downs were predominately for lower of cost or market and excess and obsolescence on certain products.

9. Investments

Investments consisted of the following:

June 30, 2006	Amortized Cost		Gross Unrealized Gains		Fair Value
	(In thousands)
Certificates of deposit	$	2,007	$	—	$	2,007
Municipal notes and bonds		40,150		—		40,150
SMIC common stock		30,346		7,136		37,482
Total	$	72,503	$	7,136	$	79,639
September 30, 2005	Amortized Cost		Gross Unrealized Gains		Fair Value
	(In thousands)
Certificates of deposit	$	3,525	$	—	$	3,525
Municipal notes and bonds		55,200		—		55,200
Publicly traded equity securities		483		—		483
SMIC common stock—saleable within 12 months		24,341		12,878		37,219
SMIC common stock—saleable in more than 12 months		6,005		3,177		9,182
Total	$	89,554	$	16,055	$	105,609
Reported as:
Short-term investments					$	96,427
Investments						9,182
Total					$	105,609

18

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

As of June 30, 2006, approximately $15.2 million of the Company’s SMIC common stock is subject to lock-up provisions which will expire by February 2007. All debt securities held at June 30, 2006 are due in less than one year. Certificates of deposit are in foreign institutions.

10. Other Assets

Other assets consisted of the following:

	June 30, 2006		September 30, 2005
	(In thousands)
Private equity method investment	$	1,037	$	1,561
Cost method equity investments		2,464		3,149
Restricted assets		933		914
Other		1,547		2,518
	$	5,981	$	8,142

The Company sold its investment in E-CMOS in April 2006 for approximately $1.5 million which resulted in a pre-tax gain of $0.3 million.

The Company sold approximately 77% of its investment in Signia in February 2006 for approximately $4.6 million which resulted in a pre-tax gain of $2.2 million. As a result of the sale of the Signia shares, the Company reduced its ownership percentage to approximately 16%, or approximately $0.7 million, and effective March 2006 accounts for its investment in Signia on the cost basis. In prior periods, Signia’s financial position and results of operation were consolidated with the Company’s financial statements. The deconsolidation of Signia did not have a material impact on the Company’s balance sheet and will not have a material effect on the Company’s revenues or results of operations.

The Company has various deposits including deposits with suppliers for purchase guarantees and for customs clearance. These deposits are included in restricted assets.

11. Comprehensive Income (Loss)

Comprehensive income (loss) includes the Company’s net loss as well as other comprehensive income (loss). The Company’s other comprehensive income (loss) consists of changes in cumulative translation adjustment and unrealized gains and losses on investments.

Comprehensive income (loss), net of taxes, was as follows:

	Three Months Ended June 30,						Nine Months Ended June 30,
	2006			2005			2006			2005
				As restated						As restated
				(In thousands)
Net loss	$	(6,912	)	$	(4,955	)	$	(14,354	)	$	(33,156	)
Other comprehensive income (loss), net of tax:
Change in cumulative translation adjustment		79			4,535			1,260			504
Change in unrealized gains/(losses) on investments		(1,741	)		3,053			(8,919	)		4,598
Comprehensive income (loss)	$	(8,574	)	$	2,633		$	(22,013	)	$	(28,054	)

19

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The components of accumulated other comprehensive income, net of tax, were as follows:

	June 30, 2006			September 30, 2005
	(In thousands)
Accumulated foreign currency translation adjustments	$	(686	)	$	(1,946	)
Accumulated net unrealized gain on SMIC		7,136			16,055
Total accumulated other comprehensive income	$	6,450		$	14,109

12. Borrowings

Short term debt and notes were as follows:

	June 30, 2006				September 30, 2005
	Amount Outstanding		Weighted Average Interest Rate		Amount Outstanding		Weighted Average Interest Rate
	(In thousands)				(In thousands)
Working capital loans	$	8,797	2.44	%	$	4,821	2.08	%
Commercial paper		—				1,807	2.17	%
Total short-term debt and notes	$	8,797			$	6,628

There were no assets pledged as collateral for short-term debt or notes. The Company has guaranteed the borrowings of Integrated Circuit Solution, Inc. (ICSI) under a line of credit with a bank in Taiwan for a maximum amount of approximately $4.9 million through January 2007. As of June 30, 2006, $3.1 million was outstanding under this line of credit.

13. Income Taxes

The income tax provision for the three months and nine months ended June 30, 2006 consists primarily of foreign withholding taxes of $51,000 and $164,000, respectively. The income tax provision for the three months and nine months ended June 30, 2005 consists of foreign withholding taxes of $9,000 and $26,000, respectively.

14. Net Loss Per Share

The diluted earnings per share calculations for the three months and nine months ended June 30, 2006 do not include approximately 362,000 and 426,000 potential common shares from outstanding stock options because their inclusion would be anti-dilutive. For the three months and nine months ended June 30, 2006, an additional 5,105,000 and 5,019,000 stock options were excluded from diluted earnings per share by the application of the treasury stock method. For the three months and nine months ended June 30, 2005, approximately 597,000 and 751,000 potential common shares from outstanding stock options were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive. For the three months and nine months ended June 30, 2005, an additional 3,036,000 and 3,098,000 stock options were excluded from diluted earnings per share by the application of the treasury stock method.

20

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

15. Commitments and Contingencies

Legal Proceedings

The Company is subject to various legal proceedings and claims as discussed below. In addition, In the ordinary course of our business, the Company has been involved in a limited number of legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. Although the outcome of these actions is not presently determinable, we believe that the ultimate resolution of these matters will not harm our business and will not have a material adverse effect on our financial position, cash flows or results of operations. Litigation relating to the semiconductor industry is not uncommon, and we are, and from time to time have been, subject to such litigation. No assurances can be given with respect to the extent or outcome of any such litigation in the future.

Shareholder Derivative Actions

On July 18, 2006 and July 26, 2006, two purported shareholder derivative actions were filed against certain current and former directors and officers of ISSI in the United States District Court for the Northern District of California, entitled (1) Rick Tope v. Jimmy S.M. Lee, et al., Case No. C06-04387, and (2) Murray Donnelly v. Jimmy S.M. Lee, et al., Case No. C06-04545. The complaints purport to assert claims against the individual defendants on behalf of ISSI for breach of fiduciary duty, violations of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 promulgated thereunder, unjust enrichment, and restitution based upon our alleged stock option grant practices from 1995 through 2002. The Company is named solely as a nominal defendant. The complaints seek damages in an unspecified amount against the individual defendants, disgorgement of stock options or proceeds, equitable relief, attorney’s fees, and other unspecified relief. Pursuant to the parties’ stipulation, the Court consolidated the two derivative actions on August 22, 2006, under the caption In re Integrated Silicon Solution, Inc. Shareholder Derivative Litigation, Master File No. C-06-04387 RMW.

Plaintiffs filed a consolidated shareholder derivative complaint on November 27, 2006, based upon the same underlying facts and circumstances alleged in the prior complaints. In addition to the claims asserted and the relief sought in the original complaints, the consolidated complaint purports to assert claims against the individual defendants for aiding and abetting and violating Sections 14(a) and 20(a) of the Exchange Act and seeks an accounting. The Company is again named solely as a nominal defendant.

On October 31, 2006, another purported shareholder derivative action was filed against certain current and former directors and officers of ISSI in the Superior Court of California for the County of Santa Clara, entitled Alex Chuzhoy v. Jimmy S.M. Lee, et al., Case No. 1:06-CV-074031. The complaint purports to assert claims against the individual defendants on behalf of ISSI for insider trading in violation of California Corporations Code Sections 25402 / 25502.5, breach of fiduciary duty including in connection with the alleged insider selling and misappropriation, abuse of control, gross mismanagement, constructive fraud, corporate waste, unjust enrichment, and rescission, based upon the Company’s alleged stock option grant practices from 1995 through 2002. The Company is named solely as a nominal defendant. The complaint seeks damages in an unspecified amount against the individual defendants, an accounting, certain corporate governance changes, a constructive trust over the defendants’ stock options or proceeds, punitive damages, attorney’s fees, and other unspecified relief.

Plaintiffs in the state and federal derivative complaints will amend their complaints after the Company concludes its financial restatement. Defendants intend to move to dismiss both the state and federal complaints.

Nasdaq Delisting

On August 17, 2006, the Company received a letter from The NASDAQ Stock Market indicating that the Company was not in compliance with the NASDAQ requirements for continued listing set forth in NASDAQ Marketplace Rule 4310(c)(14), and faces a possible delisting. On December 7, 2006, following a hearing before the Nasdaq Listing Qualifications Panel (“Panel”), the Panel notified the Company that it would remain listed on Nasdaq subject to the filing by February 13, 2007 of all required restatements and delinquent periodic reports, communication with the Panel about the results of the independent committee’s investigation, and compliance with all other requirements for continued listing on the

21

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Nasdaq Stock Market. The Company also received letters from The NASDAQ Stock Market indicating that as a result of its failure to timely file its Form 10-K for the fiscal year ended September 30, 2006, and its Form 10-Q’s for the quarters ended December 31, 2006 and March 31, 2007, it was not in compliance with the NASDAQ requirements for continued listing set forth in NASDAQ Marketplace Rule 4310(c)(14).

On January 19, 2007, the Nasdaq Listing and Hearing Review Council (“Listing Council”) notified the Company that, pursuant to its discretionary authority, it had called for review the December 7, 2006 decision of the Panel and stayed any determinations to suspend the Company’s securities from trading pending further action by the Listing Council. On May 9, 2007, the Company was advised by the Listing Council that it would remain listed on NASDAQ if it concludes its restatement and files its delinquent required SEC filings by June 5, 2007.

SRAM Antitrust Litigation

Thirty-two purported class action lawsuits were filed against the Company and other SRAM suppliers in various U.S. federal courts alleging violations of the Sherman Act, violations of state unfair competition laws, and unjust enrichment relating to the sale and pricing of SRAM products. The U.S. lawsuits have been consolidated in a single federal court for coordinated pre-trail proceedings. The U.S. complaints seek treble damages for the alleged damages sustained by purported class members, in addition to restitution, costs and attorneys’ fees, as well as an injunction against the allegedly unlawful conduct. Two purported class action lawsuits were filed against us and other SRAM suppliers in two Canadian courts alleging violation of the Canadian Competition Act and unlawful conduct at common law. The Canadian complaints seek compensatory and punitive damages, in addition to declaratory relief, restitution, and costs. The Company is committed to defending itself against these claims and has instructed its counsel to contest these actions vigorously. Given the preliminary stage of these proceedings and the inherent uncertainty in litigation, the Company is unable to predict the outcome of these suits. The final resolution of these alleged violations of federal or state antitrust laws could have a material adverse effect on the Company’s business, results of operations, or financial condition.

SRAM Antitrust Civil Investigative Demand

In May 2007, the Company received a civil investigative demand (“CID”) from the Attorney General of the State of Florida. The CID is issued pursuant to the Florida Antitrust Act in the course of an official investigation to determine whether there is, has been, or may be a violation of state or federal antitrust laws. Although not alleging any wrongdoing, the CID seeks documents and data relating to the Company’s business. The Company intends to cooperate fully with the Attorney General of Florida in this investigation. Because the investigation is at an early stage, the Company cannot predict the outcome of the investigation and its effect, if any, on its business.

Commitments to Wafer Fabrication Facilities and Contract Manufacturers

The Company issues purchase orders for wafers to various wafer foundries. These purchase orders are generally considered to be cancelable. However, to the degree that the wafers have entered into work-in-process, as a matter of practice, it becomes increasingly difficult to cancel the purchase order. As of June 30, 2006, the Company had approximately $15.4 million of purchase orders for which the related wafers had been entered into wafer work-in-process (i.e., manufacturing had begun).

22

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

16. Geographic and Segment Information

The Company has one operating segment, which is to design, develop, and market high-performance SRAM, DRAM, and other memory and non-memory semiconductor products. The following table summarizes the Company’s operations in different geographic areas:

	Three Months Ended June 30,				Nine Months Ended June 30,
	2006		2005		2006		2005
	(In thousands)
Net sales
United States	$	6,408	$	6,031	$	26,249	$	18,259
China		1,285		6,218		10,164		18,726
Hong Kong		12,561		11,633		29,856		23,071
Japan		5,017		—		15,699		—
Taiwan		15,463		17,071		43,208		30,123
Other Asia Pacific countries		6,581		8,839		17,173		16,325
Europe		5,852		3,781		14,764		11,750
Other		82		149		474		1,717
Total net sales	$	53,249	$	53,722	$	157,587	$	119,971

	June 30, 2006		September 30, 2005
	(In thousands)
Long-lived assets
United States	$	1,465	$	2,057
Hong Kong		87		34
China		899		1,360
Taiwan		20,436		20,185
	$	22,887	$	23,636

17. Related Party Transactions

Prior to May 2005 when the Company gained control and began consolidating the results of ICSI, ICSI was a related party. For the seven months ended April 30, 2005, purchases of goods and services by the Company from ICSI were approximately $1,056,000. The Company also paid ICSI for certain product development costs, license fees and royalties. For the seven months ended April 30, 2005, these charges totaled approximately $169,000.

The Company purchases goods from SMIC in which the Company has less than a 2% ownership interest. Lip-Bu Tan, a director of the Company, has been a director of SMIC since January 2002. For the nine months ended June 30, 2006 and June 30, 2005, purchases of goods from SMIC were approximately $15,013,000 and $43,324,000, respectively. Accounts payable to SMIC was approximately $4,247,000 and $6,093,000 at June 30, 2006 and September 30, 2005, respectively.

The Company sells semiconductor products to Key Stream Corp. (KSC) in which the Company has approximately a 22% equity interest. Kong-Yeu Han, a director of the Company, is a director of KSC.

The Company sells memory products to Flextronics. Lip-Bu Tan, a director of the Company, has been a director of Flextronics since April 3, 2003. The Company had been doing business with Flextronics prior to Mr. Tan joining the board of directors of Flextronics.

23

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The Company provided manufacturing support services to Signia. In February 2006, the Company sold approximately 77% of its shares in Signia, thereby reducing its ownership percentage to approximately 16%. Effective March 1, 2006, the Company resumed accounting for Signia on the cost basis. During the period from December 1, 2004 through February 28, 2006, the Company’s financial results reflect accounting for Signia on a consolidated basis. The Company’s financial results through the period ended November 30, 2004 reflect accounting for Signia on the cost basis. At June 30, 2006, the Company had approximately a 16% ownership interest in Signia. The Company’s Chairman and CEO, Jimmy S.M. Lee, is a director of Signia. For the two months ended November 30, 2004, the Company provided services of approximately $382,000 to Signia.

Accounts receivable from related parties consisted of the following:

	June 30, 2006		September 30, 2005
	(In thousands)
Flextronics	$	268	$	253
KSC		155		—
Total	$	423	$	253

The following table shows net sales to related parties:

	Nine months ended June 30,
	2006		2005
	(In thousands)
Net sales to related parties
Flextronics	$	492	$	2,962
ICSI (1)		—		3,185
Others		108		115
Total	$	600	$	6,262

(1) Sales to ICSI after May 1, 2005 are eliminated in consolidation.

18. Acquisition of ICSI

On January 25, 2005, the Company announced its intent to acquire the remaining 71% of ICSI that the Company did not then own. On May 1, 2005, ISSI assumed control of ICSI and in accordance with generally accepted accounting principles began consolidating the financial results of ICSI with its own results. In the nine months ended September 30, 2005, the Company purchased additional shares of ICSI for approximately $52.5 million, increasing its ownership percentage to approximately 83%. In the nine months ended June 30, 2006, the Company purchased additional shares of ICSI for approximately $13.9 million, increasing its percentage ownership to approximately 97%.

The Company’s decision to acquire ICSI was driven by several considerations including the opportunity to enhance sales, the ability to reduce the combined company’s operating expenses, obtain stronger purchasing power, expand sales channels, and enhance opportunities to develop non-memory product lines.

The Company is accounting for the acquisition of ICSI as a step acquisition. The allocation of the purchase price of ICSI includes both tangible assets and acquired intangible assets including both developed technology and in-process research and development (IPR&D). The excess of the purchase price over the fair value allocated to the net assets is goodwill. The Company currently does not expect to receive a tax benefit for goodwill. The amounts allocated to IPR&D have been expensed as it was deemed to have no future alternative value.

24

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The purchase price allocation is as follows:

	September 30, 2005			Fiscal 2006 Additions		June 30, 2006
	(In thousands)
Net tangible assets	$	40,124		$	1,097	$	41,221
Intangible assets:
In-process research and development		2,470			499		2,969
Purchased intangible assets		5,583			1,438		7,021
Goodwill		19,112			6,226		25,338
Minority interest		(6,245	)		4,600		(1,645	)
Total estimated purchase price allocation	$	61,044		$	13,860	$	74,904

The developed technology is being amortized over lives ranging from approximately three to six years and the other amortizable intangible assets are being amortized over lives ranging from six months to five years.

Pro forma Financial Information

The pro forma financial information presented below is presented as if the acquisition of ICSI had occurred at the beginning of fiscal 2005. The pro forma statements of operations for the three and nine months ended June 30, 2006 and 2005 (restated) include the historical results of the Company and ICSI plus the effect of recurring amortization of the related intangible assets. Such pro forma results do not purport to be indicative of what would have occurred had the acquisition been made as of those dates or the results which may occur in the future. The pro forma financial results are as follows:

	Three Months Ended June 30,						Nine Months Ended June 30,
	2006			2005			2006			2005
	(In thousands)
Net sales	$	53,249		$	58,636		$	157,587		$	173,061
Minority interest in net loss of consolidated subsidiary	$	41		$	176		$	453		$	900
Net loss	$	(7,047	)	$	(5,434	)	$	(13,932	)	$	(43,571	)
Basic and diluted net loss per share	$	(0.19	)	$	(0.15	)	$	(0.37	)	$	(1.19	)
Shares used in per share calculation		37,488			36,830			37,367			36,538

25

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

We have made forward-looking statements in this report that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of our operations. Also, when we use words such as “believes,” “expects,” “anticipates” or similar expressions, we are making forward-looking statements. You should note that an investment in our securities involves certain risks and uncertainties that could affect our future financial results. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in “Risk Factors” and elsewhere in this report.

We believe it is important to communicate our expectations to our investors. However, there may be events in the future that we are not able to predict accurately or over which we have no control. The risks described in “Risk Factors” included in this report, as well as any other cautionary language in this report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements.

All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth in this report. Except as required by federal securities laws, we are under no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise.

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

Background

On January 25, 2005, we announced our intention to acquire ICSI. ICSI was a public company in Taiwan and traded on the Gre Tai Securities Market (OTC). ICSI is a fabless semiconductor company whose principal products are DRAM and controller chips. Prior to this transaction, we owned approximately 29% of ICSI. In the nine months ended September 30, 2005, we purchased additional shares of ICSI in the open market for approximately $52.5 million increasing our ownership percentage to approximately 83% at September 30, 2005. In the nine months ended June 30, 2006, we purchased additional shares of ICSI for approximately $13.9 million increasing our ownership percentage to approximately 97% at June 30, 2006.

Our financial results for fiscal 2006 and for fiscal 2005 beginning May 1, 2005 reflect accounting for ICSI on a consolidated basis. On May 1, 2005, we assumed effective control of ICSI and in accordance with generally accepted accounting principles we began consolidating the financial results of ICSI with our results as of such date. Our financial results for fiscal 2005 through the period ended April 30, 2005 reflect accounting for ICSI on the equity basis and include our percentage share of the results of ICSI’s operations.

In February 2006, we sold approximately 77% of our shares in Signia Technologies Inc. (Signia), a developer of wireless semiconductors, thereby reducing our ownership percentage to approximately 16%. Effective March 1, 2006, we resumed accounting for Signia on the cost basis. During the period from December 1, 2004 through February 28, 2006, our financial results reflect accounting for Signia on a consolidated basis. Our financial results through the period ended November 30, 2004 reflect accounting for Signia on the cost basis.

Our financial results for fiscal 2006 and for fiscal 2005 beginning May 1, 2005 reflect accounting for Key Stream Corp. (KSC), a semiconductor company, on the equity basis. At June 30, 2006, we owned approximately 22% of KSC.

Overview

We are a fabless semiconductor company that designs and markets high performance integrated circuits for the following key markets: (i) digital consumer electronics, (ii) networking, (iii) mobile communications and (iv) automotive electronics. Our primary products are high speed and low power SRAM and low and medium density DRAM. We also design and market EEPROMs, SmartCards, and controller chips for card reader-writers. We were founded in October 1988 and initially focused on high performance, low cost SRAM for PC cache memory applications. In 1997, we introduced our first low and medium density DRAM products. Prior to fiscal 2003, our SRAM product family generated a majority of our

26

revenue. However, in 2001, the high-end networking and telecom markets slowed and this adversely impacted our SRAM revenue. During this period, we increased our focus on the digital consumer electronics, mobile communications and automotive electronics markets. As a result of our success in the digital consumer electronics market, sales of our low and medium density DRAM products have increased significantly and have represented a majority of our net sales in each year since fiscal 2003.

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

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

The average selling prices of our SRAM and DRAM products are very sensitive to supply and demand conditions in our target markets and have generally declined over time. While the average selling prices for certain of our products increased during the first three quarters of fiscal 2004, the average selling prices for our products declined significantly in the fourth quarter of fiscal 2004. We experienced declines in the average selling prices for certain of our products in fiscal 2005 and the first nine months of fiscal 2006. We expect average selling prices for our products to decline in the future, principally due to increased market competition and an increased supply of competitive products in the market. Any future decreases in our average selling prices would have an adverse impact on our revenue growth rate, gross margins and operating margins. Our ability to maintain or increase revenues will be highly dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in quantities sufficient to compensate for the anticipated declines in average selling prices of existing products. Declining average selling prices will adversely affect our gross margins unless we are able to offset such declines with commensurate reductions in per unit costs or changes in product mix in favor of higher margin products.

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

We market and sell our products in Asia, the U.S. and Europe and other locations through our direct sales force, distributors and sales representatives. The percentage of our sales shipped outside the U.S. was approximately 83% and 85% in the first nine months of fiscal 2006 and fiscal 2005, respectively. We measure sales location by the shipping destination, even if the customer is headquartered in the U.S. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. The percentages of our sales by region are set forth in the following table:

	Nine Months Ended June 30,
	2006		2005
Asia	74	%	74	%
Europe	9		10
U.S.	17		15
Other	—		1
Total	100	%	100	%

27

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

Since a significant portion of our revenue is from the digital consumer electronics market, our business may be subject to seasonality, with increased revenues in the third and fourth calendar quarters of each year, when customers place orders to meet year-end holiday demand. However, broad fluctuations in our overall business in the past several years makes it difficult for us to assess the impact of seasonal factors on our business.

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

Restatement of Previously Issued Financial Statements

The information below has been adjusted to reflect the restatement of our financial results which is more fully described in the “Explanatory Note” immediately preceding Part 1, Item 1 and in Note 2 “Restatement of Condensed Consolidated Financial Statements” to Condensed Consolidated Financial Statements of this Form 10-Q.

In this Form 10-Q, we are restating our condensed consolidated balance sheet as of September 30, 2005, the related consolidated statements of operations for the three and nine months ended June 30, 2005, and the related consolidated statement of cash flows for the nine months ended June 30, 2005 as a result of an independent stock option investigation commenced by the Special Committee of our Board of Directors. This restatement is also described in Note 2 “Restatement of Condensed Consolidated Financial Statements” to our Condensed Consolidated Financial Statements. In our Form 10-K for the year ended September 30, 2006 to be filed with the Securities and Exchange Commission (the “2006 Form 10-K”), we are restating our consolidated balance sheet as of September 30, 2005, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the fiscal years ended September 30, 2005 and September 30, 2004. In addition, we are restating our unaudited quarterly financial information for all interim periods of fiscal year 2005 and the interim periods ended December 31, 2005 and March 31, 2006.

Financial information included in our reports on Form 10-K, Form 10-Q and Form 8-K filed by us prior to May 9, 2006, and the related opinions of our independent registered public accounting firm and all earnings press releases and similar communications issued by us prior to May 9, 2006 should not be relied upon and are superseded in their entirety by this report and other reports on Form 10-Q and Form 8-K filed by us with the SEC on and after May 9, 2006.

The Special Committee Investigation

On July 18, 2006 and July 26, 2006, two purported shareholder derivative actions were filed against certain of our current and former directors and officers alleging that our historical stock option granting practices from 1995 through 2002 violated federal and state law. In response to these lawsuits, management conducted a preliminary review of our historical stock option granting practices.

On August 8, 2006, based on this review, our Board of Directors established a special committee (the “Special Committee”), composed of two independent directors, to review our historical stock option practices and related accounting. We advised our independent registered public accounting firm, Ernst & Young LLP (“E&Y”), of the formation of the Special Committee and the review to be conducted by such committee. Shortly thereafter, the Special Committee retained Latham

28

and Watkins LLP as independent legal counsel and LECG as forensic accounting experts to conduct a full investigation of our past stock option granting practices. The Special Committee was charged with reviewing our practices related to all stock option grants made by us during the review period, and examining the conduct of our current and former directors, officers, and employees involved in the option grant process.

On August 9, 2006, we publicly announced the Special Committee’s investigation, and also filed a Form 12b-25 with the SEC stating that our June 30, 2006 Form 10-Q could not be filed until the investigation had been completed. On October 24, 2006, we filed a Form 8-K stating that our Board of Directors, with the concurrence of the Special Committee, had determined that, pursuant to the requirements of APB 25, the actual measurement dates for financial accounting purposes of certain stock options granted primarily during fiscal years 1997-2005 differed from the recorded grant dates of such awards, and that revised measurement dates for financial accounting purposes would apply to the affected awards, which would result in additional and material non-cash stock-based compensation expense. We further disclosed that, on October 19, 2006, our Board of Directors, with the concurrence of the Special Committee, determined that we should restate our financial statements for various periods since our initial public offering in February 1995. Accordingly, we stated that our financial statements and the related reports of our independent registered public accounting firm, E&Y, and all related earnings press releases and communications relating to periods after our initial public offering (“IPO”) in February 1995, should not be relied upon.

The Special Committee’s Review Process

The Special Committee reviewed the facts and circumstances surrounding all stock option grants made during the period from January 1, 1997 through July 2006 (“the “Review Period”) as well as grants dated October 13, 1995 and November 8, 1996, which were identified in the derivative complaints, for a total of 104 grant dates. The Special Committee held sixteen meetings and interviewed 20 individuals, including current and former employees of ISSI, our officers and directors, and outside counsel. The Special Committee reviewed over 390,000 electronic documents and 25 boxes of hard copy documents relating to stock option grants. Collectively, the Special Committee and its advisors expended over 5,600 hours in the course of this investigation. The Special Committee’s investigation was conducted with the full support of current management and the Board. In addition, the Company evaluated all grants in 1995 and 1996 since the date of the Company’s initial public offering and concluded that any possible additional errors arising from grants made during this time would not be material to the financial statements included in this Form
10-Q.

The Special Committee also reviewed the facts and circumstances surrounding the potential backdating of cash and cash-less exercises of options. We considered whether the cash-less exercises or cash exercises had any accounting consequences such as potential compensation charges and additional income tax deductions. For cash-less exercises, the exercise process utilized a third party broker so there was little chance for exercise date manipulation. For cash exercises, the Special Committee determined that the existing evidence and information available are inconclusive. Had there been backdating of cash exercises, the potential maximum exposure of the compensation charge representing tax benefits forgone by the Company using fixed plan accounting, together with any underreported taxes would not be material for any fiscal period.

Findings of the Special Committee’s Review

From the beginning of the Review Period through December 2005, we did not consistently follow our option grant procedures. Of the 104 grants under review, the Special Committee was unable to find sufficient contemporaneous documentation to support the original measurement date for 73 grant dates. The Special Committee did find documentation to support the original measurement date for the remaining 31 grant dates, and because the accounting treatment for these grants is correct, they are not included in the accounting adjustment.

The 73 grant dates for which there was insufficient evidence to support the original grant date were further placed into one of three sub-categories:

• Backdated. There are eight grant dates for which there is conclusive evidence that the original measurement date was selected retroactively. On these eight grant dates, we granted options for approximately 3.0 million shares. The associated compensation charge through fiscal year 2005 is approximately $12.7 million.

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• Appears Misdated. There are 55 grant dates which resemble Backdated grants in that they were made on dates when the stock price was comparatively low, the grants were added to our Equity Edge database (i.e., the software system we used to record stock option data) a significant amount of time after the purported date of grant, and meta-data from documents such as minutes or resolutions indicates that these documents were created after the purported grant date. These grant dates differ from Backdated grants in that there is no email or testimonial evidence to directly support the inference that the grant dates were selected retroactively. On these 55 grant dates, we granted options for approximately 10.9 million shares. The associated compensation charge is approximately $16.5 million through fiscal year 2005.

• Appears Misdated/No Accounting Impact. There are ten grant dates that follow the same pattern as the Appears Misdated grants, but because the stock price on the revised measurement date is lower than the stock price on the original measurement date, we will not recognize compensation expense on these misdated grants. On these ten grant dates, we granted options for approximately 2.3 million shares.

After consideration of the accounting literature and recent guidance from the SEC staff, we have organized the grants during the relevant period into categories based on grant type and the process by which the grant was finalized. We analyzed the evidence from the Special Committee’s investigation related to each category including, but not limited to, physical documents, electronic documents, underlying electronic data about documents, and witness interviews. Based on the relevant facts and circumstances, we applied the then appropriate accounting standards to determine, for every grant within each category, the proper measurement date. If the measurement date was not the originally assigned grant date, accounting adjustments were made as required, resulting in stock-based compensation expense and related tax effects.

The following summarizes our findings by type of grant:

Board of Director Grants. Outside directors receive option grants automatically pursuant to the Director Plan, which provides that the first grant occurs on the date a person becomes a director. Grants recur automatically on the date each director is re-elected by shareholders. Grants were made to outside directors on 15 dates in the Review Period. We discovered one discrepancy and recorded $2,350 in stock compensation charges.

Officer Grants. Awards of option grants to executive officers (as defined in Section 16 of the Securities Exchange Act of 1934) were made either by the Board of Directors as a whole, or by the Compensation Committee of the Board, which was comprised of non-management directors. Grants to executive officers were memorialized and approved in minutes of Board meetings or in documents signed by our Compensation Committee. The Compensation Committee determined a specific number of stock options and salary compensation to officers, but delegated in a de facto manner its authority to select the grant dates and exercise prices to our former Chief Financial Officer, Gary L. Fischer, including at times when he was not a member of the Board of Directors. The Compensation Committee thereafter authorized the grants, without knowledge of how Mr. Fischer selected the grant dates or prices. We have concluded that the authorization by the Compensation Committee was perfunctory and therefore could not be relied upon to determine the grant date. Grants to executive officers were made on 21 dates and include approximately 2.4 million shares. Four grants were categorized as Backdated, seven grants were categorized as Appears Misdated, and ten of these grant dates were categorized as Correct. The ten grants categorized as correct had original measurement dates that were deemed appropriate based upon various contemporaneous documentation that indicated that the exercise price and the number of options granted to individual recipients were known with finality at the original measurement dates. The associated compensation charge is approximately $3.4 million through fiscal year 2005.

Non-executive Employee Grants (New Hire, Follow-on, and Bonus). Option grants awarded to employees who were not then executive officers (as defined in Section 16 of the Securities Exchange Act of 1934) were memorialized and approved in documents signed by our Stock Option Committee, pursuant to authority delegated by the Board of Directors. The Stock Option Committee was made up of our Chief Executive Officer and a non-management director. The Special Committee concluded that the Stock Option Committee delegated in a de facto manner its authority to select the grant dates and exercise prices to our former Chief Financial Officer, Gary L. Fischer, including at times when he was not a member of the Board of Directors. The quantity of shares granted were typically based on salary range guidelines set by us and approved by the Stock Option Committee. The Stock Option Committee thereafter authorized the grants, without knowledge of how Mr. Fischer had selected the grant dates or prices. We have concluded that the authorization by the Stock Option Committee was perfunctory and therefore could not be relied upon to determine the grant date. Grants to non-executive employees were

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made on 76 dates during the Review Period, and totaled approximately 13.6 million shares. Grants on six dates were categorized as Backdated and 52 grant dates were categorized as Appears Misdated, representing approximately 10.2 million shares. The associated compensation charge is approximately $21.5 million through fiscal year 2005. In addition, ten grants were categorized as Appears Misdated/No Accounting Impact and eight grants were categorized as Correct, representing approximately 3.4 million shares. The eight grants categorized as correct had original measurement dates that were deemed appropriate based upon various contemporaneous documentation that indicated that the exercise price and the number of options granted to individual recipients were known with finality at the original measurement dates.

Salary Reduction Grants. We granted options to officers and employees in connection with five salary reduction programs. Three of these grant dates were categorized as Backdated (representing 535,716 shares) and two grant dates were categorized as Appears Misdated (representing 254,965 shares). These totals exclude any grants to officers, as they were previously included in the Officer Grant totals. The associated compensation charge is approximately $2.2 million through fiscal year 2005.

Stock Option Re-pricing Grants. We granted options to officers and employees four times in connection with stock option re-pricing programs. On October 13, 1995, we granted 699,000 options (excluding options to officers); this grant was categorized as Correct. On December 6, 1996 we granted 75,000 options to officers and on December 27, 1996 we granted 847,000 options to employees; both of these grants, which were outside of the Review Period, have been determined to be Correct by us. On December 2, 1998, we granted 1,622,418 options (excluding options to officers); this grant was categorized as Appears Misdated (the appropriate measurement date was determined to be December 11, 1998). These re-pricing grants predated the adoption of FIN 44 and we applied EITF Issue No. 87-33, Stock Compensation Issues Related to Market Decline (EITF Issue No. 87-33). The associated fixed compensation charge is approximately $2.1 million through fiscal year 2005. During the investigation we identified that 232,050 options granted, all to non-officers, in the December 1998 re-pricing represented options re-priced a third time and are being considered variable awards under EITF 87-33. We have recorded the related charges of approximately $2.3 million over the Review Period as part of this restatement.

Consultant Grants. During the Review Period, we made one grant to a consultant that was not properly recorded. A total of 25,000 shares were granted on March 23, 1998 which was the date of the consulting contract. Compensation expense of $74,000 was recorded as per FASB’s Emerging Issues Task Force “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” (EITF 96-18).

Modification of Grants. There were 20 option grants which were modified between the periods of 1997 to 2003 to have the exercise period extended. Under FIN 44 Compensation, we have recorded additional compensation expense for the modification of these option grants. The additional compensation charge for the affected options, calculated as the difference between the intrinsic value on the award date and the intrinsic value on the modification date, amounted to $440,000.

Consideration for Revised Measurement Dates

We have identified two types of fact patterns regarding the available evidence regarding grants made during the Review Period. In Fact Pattern One, we found documentation to identify a specific date on which the grantees, the number of shares, and the prices of the options were known and support the original measurement date. Grants falling within this first fact pattern are primarily grants to directors and officers. Options granted from February 2006 onward also fall within this category, because at that time, we instituted new procedures for granting stock options. These procedures require contemporaneous documentation of the date of grant. The 31 grants in this category did not require revised measurement dates.

In Fact Pattern Two, for most grants in the Review Period, it is not possible to ascertain with certainty from the available evidence when the list of grantees was final. For these 73 grants, there was insufficient contemporaneous evidence related to the Original Measurement Date. For four grants in this category, contemporaneous evidence exists to support a revised measurement date

Based on the evidence, we have concluded that we should consider all available evidence to determine the earliest date that the terms of options to individual recipients were known with finality for all grants which fall into the categories Backdated, Appears Misdated and Appears Misdated/No Accounting Impact (other than for FAS 123 Pro Forma purposes), for purposes of selecting the Revised Measurement Dates. For the vast majority of grants, we have concluded, based on all

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available evidence, that the Equity Edge Record Added Date is the earliest date when the terms of options to individual recipients were known with finality and therefore that is the Revised Measurement Date. Alternative measurement dates were used when other documentary evidence exists to support such dates such as dated Unanimous Written Consents, or in the case of a grant to a new director, the date of commencement of service. Alternative methods for determining revised measurement dates were used on four grants as the documentary evidence for the grants either identified with certainty the date the terms of the option to individual recipients were known with finality or supported, when uncertainty remains, a date earlier than the Equity Edge entry date.

The Equity Edge Record Added date represents a contemporaneous, fixed, identifiable date in the option grant process, which evidences that we had incurred a legal obligation to the employee-recipient and that the criteria listed in Paragraph 10(b) of APB 25 were met. There is significant evidence that the terms of the grants were final by the time they were entered into Equity Edge. Furthermore, based on the lack of verifiable contemporaneous documentation, the Equity Edge Record Added date represents the earliest determinable date as of which the criteria listed in Paragraph 10(b) of APB 25 were met, as both the exercise price and the number of options granted to each individual were known on that date. Based on the apparent practice utilized by Mr. Fischer to grant stock awards using hindsight, we believe that the APB 25 criteria were not met at the earlier stated grant date, and it is likely that the exercise price was not established until a point close to the Equity Edge Entry Date.

Findings of the Special Committee Concerning Conduct of Individuals

On December 12, 2006, the Special Committee presented the findings of its investigation to, and recommended certain remedial measures for adoption by, the Board of Directors. The Board of Directors accepted all of the findings of the Special Committee and all of the proposed remedial measures. As a result of the Special Committee’s investigation, as well as our internal review of our historical financial statements, we have determined the following:

• Prior to the improvements to our internal control systems beginning in March 2006 made by our new CFO, we did not maintain adequate controls and procedures for granting, accounting for, and reporting stock option grants. Our stock option plans require that grants to officers be approved by the Compensation Committee and grants to other employees be approved by our Stock Option Committee. As a matter of practice, however, grant dates and the corresponding exercise prices were selected without a formal delegation of authority by our former Chief Financial Officer, Gary L. Fischer, including at times when he was not a director of ISSI. In addition, Mr. Fischer was never a member of either the Stock Option or Compensation Committees. Documents authorizing the grants on the dates selected by Mr. Fischer were subsequently prepared at Mr. Fischer’s direction and presented to the Compensation and Stock Option Committee members for signature.

Based on the totality of the information available to it, the Special Committee found that certain individuals were responsible for the lack of effective controls and the inappropriate grant practices. Specifically:

• The Special Committee found that Mr. Fischer appears to have selected a number of grant dates with the benefit of hindsight in order to obtain favorable exercise prices. Mr. Fischer benefited personally from certain of these grants. Mr. Fischer paid cash to exercise certain stock options, but paid $23,632 less than he should have paid due to improper measurement dates associated with stock options. Mr. Fischer also realized gains from the cashless exercise of options through an independent broker, and same-day sale of our Common Stock, of which $360,344 represented gains derived from improper measurement dates associated with stock options. In addition, following the conclusion of the Special Committee’s investigation in December 2006, we terminated the consulting agreement we had entered into with Mr. Fischer in December 2005. Mr. Fischer voluntarily agreed in December 2006 to amend and increase the exercise prices of certain option grants with improper measurement dates that otherwise would have been subject to Section 409A of the Internal Revenue Code.

• Chairman and Chief Executive Officer Jimmy Lee was involved in the process of granting options to employees who were not Section 16 Officers through his membership on the Stock Option Committee. The Stock Option Committee delegated in a de facto manner the task of selecting grant dates to Mr. Fischer without knowledge of how Mr. Fischer selected such dates. As a member of the Stock Option Committee, Mr. Lee signed documents that were drafted at Mr. Fischer’s direction authorizing those grants. The Special Committee concluded, however, that Mr. Lee relied on

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Mr. Fischer and did not understand the accounting requirements or legal implications of our stock option granting practices. Mr. Lee was forthcoming and cooperated fully with the investigation. As recommended by the Special Committee, as described below, we have admonished Mr. Lee for failing to establish a proper control environment and informally delegating authority to Mr. Fischer, Mr. Lee has voluntarily agreed to give up any economic benefit he received from the improper measurement dates, and the Compensation Committee or the Board is now responsible for granting non-executive stock options. Mr. Lee benefited personally from certain grants with improper measurement dates, specifically, he paid cash to exercise stock options but paid $257,329 less than he should have paid if the exercise prices had been established based on the stock price on the Revised Measurement Date. Mr. Lee has voluntarily agreed to repay this amount to us. In addition, Mr. Lee held vested in-the-money stock options, of which $7,200 represented holding gains associated with improper measurement dates based on the closing price of our Common Stock on March 21, 2007. Mr. Lee voluntarily agreed to amend and increase the exercise prices of all of his vested and unvested stock options, including options that otherwise would have been subject to Section 409A of the Internal Revenue Code, which will eliminate any potential future gains he would have received as a result of the improper measurement dates. .

• Two of our current directors, Lip-Bu Tan and Hide Tanigami, were involved in the stock option granting process. Mr. Tan and Mr. Tanigami were members of the Compensation Committee. In addition, Mr. Tan along with Mr. Lee served on the Stock Option Committee. The Compensation and Stock Option Committee members delegated in a de facto manner the task of selecting grant dates to Mr. Fischer, without knowledge of how Mr. Fischer selected grant dates, and signed documents that were drafted at Mr. Fischer’s direction authorizing those grants. The Special Committee concluded, however, that Mr. Tan and Mr. Tanigami relied upon Mr. Fischer and did not understand the accounting requirements or legal implications of our stock option granting practices. Both Mr. Tan and Mr. Tanigami were forthcoming and cooperated fully with the investigation. As recommended by the Special Committee, Mr. Tan and Mr. Tanigami no longer serve on the committees responsible for granting stock options. In addition, Mr. Tanigami holds one option grant that is presently out-of-the-money that he voluntarily agreed to reprice to the adjusted exercise price to eliminate a potential gain of $2,350 due to the improper measurement date.

• Two current non-officer employees and one former non-officer employee were involved in executing the paperwork required as part of the stock option granting process without knowledge of how Mr. Fischer selected grant dates. As recommended by the Special Committee, the current employees were admonished and they will receive additional training. In addition, they voluntarily agreed to reprice certain out-of-the-money options to the new higher measurement price which are not subject to Section 409A of the Internal Revenue Code to eliminate any potential gain due to improper measurement dates.

Financial Impact of the Adjustments to the Measurement Dates

Based on the results of the equity award review, the Audit Committee concluded that, pursuant to APB 25, and related interpretations, the accounting measurement dates for most of the stock option grants awarded between 1995 through 2005, covering options to purchase 19.3 million shares of our common stock, differed from the measurement dates previously used for such awards. As a result, revised measurement dates were applied to the affected option grants and we have recorded a total of $29.2 million in additional non-cash stock-based compensation expense for the years 1997 through 2005. Of the $29.2 million, $25.6 million utilized the equity edge entry dates. This amount is net of forfeitures related to employee terminations. The additional stock-based compensation expense is being amortized over the service period relating to each option which is typically four years.

Stock Option grants that were intended to qualify as Incentive Stock Options (“ISOs”) under the Internal Revenue Code but were granted “in-the-money” as described above would not receive the favorable tax treatment under the ISOs. As such, the employer and employee portions of certain payroll tax amounts were not appropriately withheld when the options were exercised. Had we recorded these expenses as they occurred, then we would have recognized an additional tax expense of $368,000 over the period. We intend to enter into settlement discussions with the Internal Revenue Service in June 2007 regarding this matter for those tax years which are still open with the IRS: 2004, 2005, and 2006. Based on our assessment, the payroll tax and withholding liability is approximately $13,000 for those periods. We intend to pay the amounts including the amounts on behalf of the employees. We are recording charges for each year in which the payroll tax should have been assessed, and then reversing that charge in the fiscal year when the statute of limitations expires. These charges have been recorded in the financial statements as compensation cost.

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In our restatements for fiscal years 1997 to 2003 and 2005, no adjustments were made to the originally reported income tax provision or benefit resulting from the additional stock-based compensation expenses. No tax benefits were recorded for additional stock-based compensation for these years since such amounts were offset by valuation allowances which would not be realized given the existence of operating losses and lack of earnings history. In our restatement for fiscal year 2004, a $52,000 reduction to the amount of originally reported tax provision was recorded to reflect the tax benefits that the additional stock-based compensation had to the federal alternative minimum tax expense.

The impact of the restatement is summarized as follows:

(in thousands)	1997		1998		1999		2000		2001			2002			2003			2004			2005			Total
Revised measurement dates	$	117	$	815	$	2,084	$	5,318	$	6,489		$	5,055		$	4,117		$	3,210		$	1,959		$	29,164
Variable accounting treatment					$	1,120	$	1,349	$	(98	)	$	(82	)	$	95								$	2,384
Stock grants to consultant			$	74																				$	74
Modification of stock option exercise period at termination			$	1	$	2						$	421		$	16								$	440
Total stock-based compensation restatement	$	117	$	890	$	3,206	$	6,667	$	6,391		$	5,394		$	4,228		$	3,210		$	1,959		$	32,062
Payroll tax charge			$	1	$	38	$	237	$	50		$	24		$	5		$	9		$	4		$	368
Reverse when tax period closes												$	(1	)	$	(38	)	$	(237	)	$	(50	)	$	(326	)
Net payroll tax impact	$	0	$	1	$	38	$	237	$	50		$	23		$	(33	)	$	(228	)	$	(46	)	$	42
Decrease in income tax provision																		$	(52	)				$	(52	)
Total restatement	$	117	$	891	$	3,244	$	6,904	$	6,441		$	5,417		$	4,195		$	2,930		$	1,913		$	32,052
Cumulative increase in accumulated deficit at September 30, 2003															$	27,209
Cumulative increase in accumulated deficit at September 30, 2005																					$	32,052

In addition to the compensation expense increase, the FAS 123 pro forma stock option expense as reported in the notes to our consolidated financial statements will also be revised accordingly. For fiscal years 2004 and 2005, the additional FAS 123 stock option expense is approximately $0.1 million as per the table below:

FAS 123 Stock Option Expense by Fiscal Year [2]

(in thousands)

Fiscal Year	Originally Reported (net of tax)		Revised
2004	$	5,083	$	5,338
2005	$	4,462	$	4,276
Total	$	9,545	$	9,614

[2] Based on revised measurement dates. Includes cancellations and repricing.

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Judgment

In light of the significant judgment used in establishing revised measurement date, alternate approaches to those used by us could have resulted in different compensation expense charges then those recorded by us in the restatement. We prepared a sensitivity analysis to determine the possible maximum compensation expense charge that could occur if an alternative methodology to determine the revised measurement date were chosen. We only provided a maximum range to this sensitivity analysis as in most situations the original prices were near or at the lowest in the period, and if a lower price were to be determined to be the revised measurement date, then there would be no resulting compensation charges. Also, we considered other possible alternative grant dates for determining a sensitivity analysis based on all available data but were unable to find any such data or evidence that would provide a reasonable alternative. The sensitivity analysis is formulated to provide the reader of the financial statements with the potential impact of a change in measurement dates on the recognized compensation expense.

We applied an expense sensitivity methodology to examine the largest possible variations in stock-based compensation expense with a range of possible approval dates for each grant event. We developed this range using the original grant date as the earliest date and the revised measurement date as the end date. Our approach resulted in a broad range of dates which in some situations would produce an alternate measurement date before the terms of a grant would be met under APB25. However, based on all available evidence, such as unanimous written consents, email dates, and Board of Director or committee meeting dates, we were unable to identify dates that would provide a more reasonable range of dates for this sensitivity analysis. While we believe the evidence and methodology used to determine the revised measurement dates to be the best available, we also believe that illustrating the difference in stock-based compensation expense using the highest price provides the reader of financial statements possible insight into the potential fluctuations in stock-based compensation expense if alternate dates had been chosen by the Company.

After developing the range for the grant dates, we selected the high closing price of our stock within the range for each grant event and calculated the difference in stock-based compensation expense for the high stock price within the range. We compared this aggregated amount to the stock-based compensation that we selected through our evaluation. Had we used the highest closing price of our stock within the range, our total restated stock-based compensation adjustment relating to the revision in measurement dates would have been increased by approximately $13.7 million. Since we do not have evidence that the grant dates and exercise prices were selected on the date when our stock price was at it highest during each period, we concluded that the use of the “highest closing price” when measuring compensation expense would not have been consistent with the requirements of ABP 25 which looks to the “first” date on which the amounts, individuals and price were known.

The results of the sensitivity analysis are summarized by grant type as follows:

(in $M)	Sensitivity Analysis By Type of Grant
	Compensation Charge Using Revised Measurement Dates		Increase to Compensation Charge If Using the Highest Price [1]
Backdated	$	12.6	$	4.4
Appears Misdated	$	16.6	$	7.8
Appears Misdated/No Impact	$	0	$	1.4
Correct	$	0	$	0
Total Compensation Charge	$	29.2	$	13.7

[1] Note: Assumes the maximum stock price between the original measurement and the revised measurement dates

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Critical Accounting Policies

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

Our critical accounting policies which are impacted by our estimates are: (i) the valuation of our inventory, which impacts cost of goods sold and gross profit; (ii) the valuation of our allowance for sales returns and allowances, which impacts net sales; (iii) the valuation of our allowance for doubtful accounts, which impacts general and administrative expense; (iv) accounting for acquisitions and goodwill, which impacts other expense when we record impairments; (v) the valuation of our non-marketable equity securities, which impacts other expense when we record impairments and (vi) accounting for stock-based compensation which impacts costs of goods sold, research and development expense and selling, general and administrative expense. Each of these policies is described in more detail below. We also have other key accounting policies that may not require us to make estimates and judgments that are as subjective or difficult. For instance, our policies with regard to revenue recognition, including the deferral of revenues on sales to distributors with sales price rebates and product return privileges. These policies are described in the notes to our financial statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2005.

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

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

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

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Accounting for acquisitions and goodwill. We account for acquisitions using the purchase accounting method in accordance with SFAS 142, “Goodwill and Other Intangible Assets.” Under this method, the total consideration paid, excluding, if any, the contingent consideration that has not been earned, is allocated over the fair value of the net assets acquired, including in-process research and development, with any excess allocated to goodwill. Goodwill is defined as the excess of the purchase price over the fair value allocated to the net assets. Our judgments as to fair value of the assets will, therefore, affect the amount of goodwill that we record. We engage a qualified third party valuation firm that specializes in the valuation of tangible and intangible assets to advise us in the valuation analysis. The valuation firm will deliver a written analysis of the values assessed. For tangible assets acquired in any acquisition, such as plant and equipment, the useful lives are estimated by considering comparable lives of similar assets, past history, the intended use of the assets and their condition. In estimating the useful life of the acquired intangible assets with definite lives, we and our valuation firm consider the industry environment and unique factors relating to each product relative to our business strategy and the likelihood of technological obsolescence. Acquired intangible assets primarily include core and current technology, customer relationships and customer contracts. We are currently amortizing our acquired intangible assets with definite lives over periods generally ranging from six months to six years.

We perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. In response to changes in industry and market conditions, we could be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of goodwill. In fiscal 2005, we recorded charges for impairment of goodwill in the amount of $4.4 million.

Valuation of non-marketable securities. Our ability to recover our strategic investments in equity securities that are non-marketable and to earn a return on these investments is largely dependent on financial market conditions and the occurrence of liquidity events, such as initial public offerings, mergers or acquisitions, and private equity transactions. The timing of when any of these events may occur is uncertain and very difficult to predict. In addition, under our accounting policy, we are required to periodically review all of our investments for impairment. In the case of non-marketable equity securities, this requires significant judgment on our part, including an assessment of the investees’ financial condition, the existence of subsequent rounds of financing and the impact of any relevant equity preferences, as well as the investees’ historical results of operations and projected results and cash flows. If the actual outcomes for the investees’ are significantly different from their forecasts, the carrying value of our non-marketable equity securities may be above fair value, and we may incur additional charges in future periods, which will decrease our profitability. In fiscal 2005, we recorded approximately $0.3 million impairment losses related to two of our non-marketable equity securities. At June 30, 2006, our strategic investments in non-marketable securities totaled $3.5 million.

Accounting for stock-based compensation. Effective October 1, 2005, we adopted the fair value recognition provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R), using the modified prospective transition method and therefore have not restated results for prior periods. Under this transition method, stock-based compensation expense in fiscal 2006 included stock-based compensation expense for all share-based payment awards granted prior to, but not yet vested as of October 1, 2005, based on the grant-date fair value estimated in accordance with the original provision of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Stock-based compensation expense for all share-based payment awards granted after October 1, 2005 is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. We recognize these compensation costs on a straight-line basis over the requisite service period of the option, which is generally the option vesting term of four years. Prior to the adoption of SFAS 123R, we recognized stock-based compensation expense in accordance with Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). Under APB 25, when the exercise price of our employee stock options was equal to the market price of the underlying stock on the date of the grant, no compensation expense was recognized. In March 2005, the Securities and Exchange Commission (the SEC) issued Staff Accounting Bulletin No. 107 (SAB 107) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. We have applied the provisions of SAB 107 in its adoption of SFAS 123R.

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Impact of Recently Issued Accounting Standards

In May 2005, the Financial Accounting Standards Board (FASB) FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (SFAS 154) which replaces APB Opinion No. 20 “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements—An Amendment of APB Opinion No. 28.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by us in the first quarter of fiscal 2007. We do not expect that the adoption of SFAS 154 will have a material impact on our consolidated results of operations and financial position.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” The interpretation contains a two step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The provisions are effective us beginning in the first quarter of fiscal 2008. We are currently evaluating the impact this statement will have on our consolidated financial statements.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 gives guidance on how errors, built up over time in the balance sheet, should be considered from a materiality perspective and corrected. SAB 108 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 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. We are currently evaluating the impact that the provisions will have on our consolidated balance sheet and statement of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157) which establishes a framework for measuring fair value and enhance disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The measurement and disclosure requirements are effective for us beginning in the first quarter of fiscal 2009. We are currently evaluating whether SFAS No. 157 will result in a change to our fair value measurements.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of FASB Statements No. 87, 88, 106, and 132R” (SFAS No. 158). SFAS No. 158 requires that the funded status of defined benefit postretirement plans be recognized on our balance sheet, and changes in the funded status be reflected in comprehensive income, effective fiscal years ending after December 15, 2006. SFAS No. 158 also requires the measurement date of the plan’s funded status to be the same as our fiscal year-end. This requirement is not required until fiscal 2008. We are currently evaluating the impact that the provisions will have on our consolidated balance sheet and statement of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS No. 159) which permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS 159 is effective for us beginning in the first quarter of fiscal 2009, although earlier adoption is permitted. We are currently evaluating the impact SFAS No. 159 will have on our consolidated financial statements.

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Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005 (restated)

Net sales. Net sales consist principally of total product sales less estimated sales returns. Net sales decreased by 1% to $53.2 million in the three months ended June 30, 2006 from $53.7 million in the three months ended June 30, 2005. The decrease in net sales of $0.5 million can principally be attributed to a shift in product mix from DRAM to SRAM products in the three months ended June 30, 2006 compared to the three months ended June 30, 2005. The overall increase in SRAM revenue is attributable to an increase in unit sales which more than offset a decline in average selling prices. The increase in SRAM revenue more than compensated for the decrease in DRAM revenue which was a result of decreasing average selling prices in conjunction with a decrease in unit sales during the three months ended June 30, 2006 compared to the three months ended June 30, 2005. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for certain products. There can be no assurance that any future price declines will be offset by higher volumes or by higher prices on newer products.

Gross profit. Cost of sales includes die cost from the wafers acquired from foundries, subcontracted package, assembly and test costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit decreased by $3.0 million to $4.3 million in the three months ended June 30, 2006 from $7.3 million in the three months ended June 30, 2005. Our gross margin decreased to 8.1% in the three months ended June 30, 2006 from 13.6% in the three months ended June 30, 2005. Our gross profit for the three months ended June 30, 2006 included inventory write-downs of $4.9 million while our gross profit for the three months ended June 30, 2005 did not contain any inventory write-downs. The inventory write-downs were for excess and obsolescence issues and lower of cost or market accounting on certain of our products. Excluding the inventory write-downs in the three months ended June 30, 2006, the increase in gross profit in the three months ended June 30, 2006 compared to the June 2005 period can be attributed to increased unit shipments of SRAM products which more than offset declines in average selling prices for such products. The gross profit for our DRAM products was relatively unchanged in the three months ended June 30, 2006 compared to the three months ended June 30, 2005. The decrease in our gross margin in the June 2006 quarter as compared to the June 2005 quarter can be primarily attributed to the inventory write-downs in the June 2006 quarter. In addition, declines in the average selling prices of our SRAM products more than offset declines in the cost of our SRAM products in three months ended June 30, 2006 compared to three months ended June 30, 2005 resulting in a decline in our SRAM gross margin. However, declines in the cost of our DRAM products more than offset declines in the average selling prices of our DRAM products in three months ended June 30, 2006 compared to the three months ended June 30, 2005. This contributed to an increase in our DRAM gross margin. We believe that the average selling prices of our products will decline over time and, unless we are able to reduce our cost per unit to the extent necessary to offset such declines, the decline in average selling prices will result in a material decline in our gross margin. In addition, product costs could increase if our suppliers raise prices, which could result in a material decline in our gross margin. In the past, foundries have raised wafer prices when demand for end products increases. Although we have product cost reduction programs in place that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. We do not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our products or the level of service provided by us.

Research and development. Research and development expenses increased by 3% to $5.5 million in the three months ended June 30, 2006 compared to $5.3 million in the three months ended June 30, 2005. As a percentage of net sales, research and development expenses increased to 10.1% in the three months ended June 30, 2006 from 9.8% in the three months ended June 30, 2005. The three months ended June 30, 2006 includes stock-based compensation expense under SFAS 123R of approximately $0.4 million and the three months ended June 30, 2005 includes stock-based compensation of approximately $0.2 million. From the June 2005 period to the June 2006 period, research and development expenses also increased due to our consolidation of ICSI but such increase was offset by a decrease in research and development expenses in the U.S. and for Bluetooth and Flash controller development projects which we exited in the March 2006 quarter. The three months ended June 30, 2006, included $0.5 million attributable to SRAM mask works acquired in an asset purchase from Alliance Semiconductor (Alliance). Our research and development expenses could increase in absolute dollars in future periods due to increased costs associated with the development of new products.

Selling, general and administrative. Selling, general and administrative expenses increased by 5% to $6.5 million in the three months ended June 30, 2006 from $6.2 million in the three months ended June 30, 2005. As a percentage of net sales, selling, general and administrative expenses increased to 11.9% in the three months ended June 30, 2006 from 11.6% in

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the three months ended June 30, 2005. The three months ended June 30, 2006 includes stock-based compensation expense under SFAS 123R of approximately $0.5 million and the three months ended June 30, 2005 includes stock-based compensation of approximately $0.2 million. From the June 2005 period to the June 2006 period, selling, general and administrative expenses also increased due to our consolidation of ICSI but such increase was offset by a decrease in selling, general and administrative expenses for the Bluetooth and Flash controller markets. Complying with the internal control requirements under Section 404 of the Sarbanes-Oxley Act of 2002 which apply to our operations at ICSI beginning in fiscal 2006, has had and will continue to result in increased internal efforts, significantly higher fees from our independent accounting firm and significantly higher fees from third party contractors. As a result, our selling, general and administrative expenses may increase in absolute dollars in future quarters, although such expenses may fluctuate as a percentage of net sales.

Acquired in-process technology charge. The $1.5 million allocated to in-process technology charge (IPR&D) in the three months ending June 30, 2005 related to our acquisition of ICSI in May 2005.

Interest and other income (expense), net. Interest and other income (expense), net was $0.7 million in the three months ended June 30, 2006 compared to $0.9 million in the three months ended June 30, 2005. These amounts were comprised primarily of interest income. In addition, in the three months ended June 30, 2005, we recorded a gain of approximately $0.2 million from the sale of fixed assets.

Gain on sale of investments. The gain on the sale of investments was $0.3 million in the three months ended June 30, 2006 compared to $0.5 million in the three months ended June 30, 2005. In the three months ended June 30, 2006, we sold our investment in E-CMOS for approximately $1.5 million which resulted in a pre-tax gain of $0.3 million. In the three months ended June 30, 2005, we sold our equity interest in NexFlash for approximately $2.2 million which resulted in a pre-tax gain of $0.5 million.

Provision for income taxes. The provision for income taxes for the three month period ended June 30, 2006 of $51,000 consists primarily of foreign withholding taxes and taxes in foreign jurisdictions. The provision for income taxes for the three month period ended June 30, 2005 of $9,000 consists of foreign withholding taxes.

Minority interest in net loss of consolidated subsidiaries. The minority interest in net loss of consolidated subsidiaries was $38,000 in the three months ended June 30, 2006 compared to $445,000 in the three months ended June 30, 2005. The minority interest in net loss of consolidated subsidiaries for the three months ended June 30, 2006 represents the minority shareholders’ proportionate share of the net loss of ICSI for the quarter. The minority interest in net loss of consolidated subsidiaries for the three months ended June 30, 2005 includes the minority shareholders’ proportionate share of the net loss of ICSI for the two months ended June 30, 2005. On May 1, 2005, ISSI assumed effective control of ICSI and in accordance with generally accepted accounting principles we began consolidating the financial results of ICSI with our own results as of such date. In addition, the three months ended June 30, 2005 includes the minority shareholders’ proportionate share of the net loss of Signia. Effective March 2006, we account for Signia on the cost basis.

Equity in net loss of affiliated companies. Equity in net loss of affiliated companies was $0.2 million in the three months ended June 30, 2006 compared to a $1.1 million loss in the three months ended June 30, 2005. In the three months ended June 30, 2006, we recorded a loss of approximately $0.2 million related to our equity interest in KSC. The $1.1 million loss in the three months ended June 30, 2005 primarily reflects our equity interest in ICSI’s financial results for Apri1 2005. Effective May 1, 2005, we began consolidating the financial results of ICSI with our results in accordance with generally accepted accounting principles.

Nine Months Ended June 30, 2006 Compared to Nine Months Ended June 30, 2005 (restated)

Net Sales. Net sales increased by 31% to $157.6 million in the nine months ended June 30, 2006 from $120.0 million in the nine months ended June 30, 2005. The increase in net sales of $37.6 million can principally be attributed to our acquisition of a controlling interest in and the resulting consolidation of ICSI’s results of operations beginning in May 2005. An increase in unit shipments of our DRAM products in the nine months ended June 30, 2006 compared to the nine months ended June 30, 2005 more than offset a decline in average selling prices resulting in an overall increase in DRAM revenue. In addition, an increase in unit shipments of our SRAM products in the nine months ended June 30, 2006 compared to the nine months ended June 30, 2005 more than offset a decrease in average selling prices resulting in an overall increase in SRAM revenue.

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Gross profit. Gross profit increased by $11.4 million to $17.4 million in the nine months ended June 30, 2006 from $6.0 million in the nine months ended June 30, 2005. Our gross margin increased to 11.0% in the nine months ended June 30, 2006 from 5.0% in the nine months ended June 30, 2005. Our gross profit for the nine months ended June 30, 2006 included inventory write-downs of $14.3 million while our gross profit for the nine months ended June 30, 2005 included inventory write-downs of $10.9 million. The inventory write-downs were for excess and obsolescence issues and lower of cost or market accounting on certain of our products. The increase in gross profit in the nine months ended June 30, 2006 can be attributed to increased unit shipments of DRAM and SRAM products due to our acquisition of ICSI which more than offset declines in average selling prices for such products. Also, we recognized $2.3 million of gross profit on inventory sold during the nine months ended June 30, 2006 that had been previously written-off. The increase in the gross margin in the nine months ended June 30, 2006 compared to the nine months ended June 30, 2005 can be primarily attributed to declines in the cost of our DRAM products which more than offset declines in the average selling prices of our DRAM products. This contributed to an increase in our DRAM gross margin. However, declines in the average selling prices of our SRAM products more than offset declines in the cost of our SRAM products in the nine months ended June 30, 2006 compared to nine months ended June 30, 2005 resulting in a decline in our SRAM gross margin.

Research and development. Research and development expenses increased by 7% to $16.6 million in the nine months ended June 30, 2006 from $15.5 million in the nine months ended June 30, 2005. As a percentage of net sales, research and development expenses decreased to 10.4% in the nine months ended June 30, 2006 from 12.9% in the nine months ended June 30, 2005. The nine months ended June 30, 2006 includes stock-based compensation expense under SFAS 123R of approximately $1.6 million and the nine months ended June 30, 2005 includes stock-based compensation of approximately $0.8 million. From the nine months ended June 30, 2005 to the nine months ended June 30, 2006, research and development expenses also increased due to our consolidation of ICSI but such increase was offset by a decrease in research and development expenses in the U.S. and for Bluetooth and Flash controller development projects which we exited in the March 2006 quarter. The nine months ended June 30, 2006 included $0.5 million attributable to SRAM mask works acquired in an asset purchase from Alliance. Our research and development expenses could increase in absolute dollars in future periods due to increased costs associated with the development of new products.

Selling, general and administrative. Selling, general and administrative expenses increased by 25% to $20.4 million in the nine months ended June 30, 2006 from $16.3 million in the nine months ended June 30, 2005. As a percentage of net sales, selling, general and administrative expenses decreased to 12.8% in the nine months ended June 30, 2006 from 13.6% in the nine months ended June 30, 2005. The nine months ended June 30, 2006 includes stock-based compensation expense under SFAS 123R of approximately $1.9 million and the nine months ended June 30, 2005 includes stock-based compensation of approximately $0.7 million. The nine months ended June 30, 2005 included a $1.1 million write-off of excess facility space in our Santa Clara headquarters. Excluding the impact of SFAS 123R in the nine months ended June 30, 2006 and the $1.1 million write-off in the nine months ended June 30, 2005, the increase in selling, general and administrative expenses was primarily attributable to our consolidation of ICSI.

Acquired in-process technology charge. In the nine months ended June 30, 2006, we incurred a $0.5 million acquired in-process technology charge (IPR&D) in connection with our purchase of additional shares of ICSI. The valuation and purchase allocation is preliminary and is subject to further adjustment. The $0.5 million allocated to IPR&D was expensed in the nine months ending June 30, 2006 as it was deemed to have no future alternative use. The $1.9 million allocated to IPR&D in the nine months ending June 30, 2005 related to our acquisition of ICSI shares in the June 2005 quarter and Signia in December 2004.

Interest and other income (expense), net. Interest and other income (expense), net was $3.4 million in the nine months ended June 30, 2006 compared to $2.3 million in the nine months ended June 30, 2005. The $3.4 million of interest and other income (expense), net in the nine months ended June 30, 2006 is comprised primarily of interest income of $2.0 million, $0.5 million from the sale of assets from our Bluetooth business in the March 2006 quarter and $0.3 million in foreign currency exchange gains. The $2.3 million of interest and other income (expense) in the nine months ended June 30, 2005 was comprised primarily of interest income. In addition, in the nine months ended June 30, 2005, we recorded a gain of approximately $0.5 million from the sale of fixed assets.

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Gain on sale of investments. The gain on the sale of investments was $2.5 million in the nine months ended June 30, 2006 compared to $3.4 million in the nine months ended June 30, 2005. In the nine months ended June 30, 2006, we sold our investment in E-CMOS for approximately $1.5 million which resulted in a pre-tax gain of $0.3 million. In addition, we sold approximately 77% of our investment in Signia for approximately $4.6 million which resulted in a pre-tax gain of $2.2 million. As a result of the sale of the Signia shares, we reduced our ownership percentage to approximately 16% and effective March 2006 account for Signia on the cost basis. The deconsolidation of Signia did not have a material impact on our balance sheet and will not have a material effect on our revenue or earnings per share. In the nine months ended June 30, 2005, we sold shares of SMIC for approximately $5.6 million which resulted in a pre-tax gain of $2.9 million. In addition, we sold our investment in NexFlash for approximately $2.2 million which resulted in a pre-tax gain of $0.5 million.

Provision for income taxes. The provision for income taxes for the nine month period ended June 30, 2006 of $164,000 consists primarily of foreign withholding taxes and taxes in foreign jurisdictions. The provision for income taxes for the nine month period ended June 30, 2005 of $26,000 consists solely of foreign withholding taxes.

Minority interest in net loss of consolidated subsidiaries. The minority interest in net loss of consolidated subsidiaries was $0.7 million in the nine months ended June 30, 2006 compared to $0.6 million in the nine months ended June 30, 2005. The minority interest in net loss of consolidated subsidiaries for the nine months ended June 30, 2006 represents the minority shareholders’ proportionate share of the net loss of ICSI for such period and the minority shareholders’ proportionate share of the net loss of Signia for the five months ended February 28, 2006. Effective March 2006, we account for Signia on the cost basis. The minority interest in net loss of consolidated subsidiaries for the nine months ended June 30, 2005 represents the minority shareholders’ proportionate share of the net loss of Signia for the seven months ended June 30, 2005 and the minority shareholders’ proportionate share of the net loss of ICSI for the two months ended June 30, 2005.

Equity in net loss of affiliated companies. Equity in net loss of affiliated companies was $0.7 million in the nine months ended June 30, 2006 compared to a $11.8 million loss in the nine months ended June 30, 2005. In the nine months ended June 30, 2006, we recorded a loss of approximately $0.7 million related to our equity interest in KSC. In the nine months ended June 30, 2005, we recorded a loss of approximately $11.8 million related primarily to our equity interest in ICSI prior to our consolidation of ICSI’s financial results effective May 1, 2005.

Liquidity and Capital Resources

As of June 30, 2006, our principal sources of liquidity included cash, cash equivalents and short-term investments of approximately $117.2 million. During the nine months ended June 30, 2006, operating activities used cash of approximately $2.8 million compared to $2.7 million used in the nine months ended June 30, 2005. The cash used by operations was primarily due to our net loss of $14.4 million adjusted for non-cash items of $4.8 million (gain on the sale of Signia shares of $(2.2) million, gain on the sale of assets of $(0.5) million, gain on the sale of E-CMOS of $(0.3) million, stock-based compensation expense of $3.6 million, equity in net loss of affiliated companies of $0.7 million, depreciation and amortization of $2.8 million, amortization of intangibles of $1.3 million, acquired in-process technology charge of $0.5 million and other non-cash items of $(1.0) million) and decreases in accounts payable of $2.9 million. This was partially offset by decreases in inventories of $6.3 million, decreases in accounts receivable of $0.3 million, and increases in accrued expenses of $2.7 million and other liabilities of $0.3 million.

In the nine months ended June 30, 2006, we generated $8.9 million from investing activities compared to $44.2 million generated in the nine months ended June 30, 2005. The cash generated from investing activities in the nine months ended June 30, 2006 primarily resulted from net sales of available-for-sale securities of $17.0 million. In addition, during the nine months ended June 30, 2006, we generated $1.5 million from the sale of our investment in E-CMOS resulting in a pre-tax gain of approximately $0.3 million, $4.6 million from the sale of Signia shares resulting in a pre-tax gain of approximately $2.2 million (which was offset by $0.1 million from the deconsolidation of Signia) and $1.1 million from the sale of Bluetooth and other assets. We used approximately $13.9 million in the nine months ended June 30, 2006 for the purchase of additional shares of ICSI. The cash generated from investing activities in the nine months ended June 30, 2005 primarily resulted from net sales of available-for-sale securities of $67.3 million. In addition, in the nine months ended June 30, 2005, we generated approximately $5.6 million from the sale of additional shares of SMIC, resulting in a pre-tax gain of approximately $2.9 million. In addition, in the nine months ended June 30, 2005, we generated approximately $2.2 million from the sale of shares of NexFlash (which included the $0.5 million of NexFlash shares purchased in the March 2005 quarter) resulting in a pre-tax gain of approximately $0.5 million and approximately $0.5 million from the sale of fixed assets.

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We used approximately $6.8 million for our additional investment in Signia and approximately $23.2 million for our additional investment in ICSI which was comprised of cash used for the purchase of ICSI shares of $31.6 million less cash acquired as a result of our consolidation of ICSI of $8.4 million.

In the nine months ended June 30, 2006, we made capital expenditures of approximately $1.3 million for test equipment and engineering tools. We expect to spend approximately $1.0 million to $3.0 million to purchase capital equipment during the next twelve months, principally for the purchase of design and engineering tools, additional test equipment, and computer software and hardware. We expect to fund our capital expenditures from our existing cash and cash equivalent balances.

We generated $3.5 million from financing activities during the nine months ended June 30, 2006 compared to $12.7 million used in the nine months ended June 30, 2005. In the nine months ended June 30, 2006, we used $53.8 million for the repayment of short-term borrowings. Our sources of financing for the nine months ended June 30, 2006 were borrowings of $55.7 million under ICSI lines of credit, proceeds from the issuance of common stock of $1.4 million from stock option exercises and sales under our employee stock purchase plan and a decrease in restricted cash of $0.2 million. In the nine months ended June 30, 2005, we used $15.0 million to pay convertible debentures and $1.8 million to repay short-term debt acquired in the consolidation of ICSI. The sources of financing for the nine months ended June 30, 2005 were proceeds from the issuance of common stock of $2.2 million from stock option exercises and sales under our employee stock purchase plan and a decrease in restricted cash of $1.2 million and borrowings of $0.6 million under ICSI lines of credit.

We have $21.1 million available through a number of short-term lines of credit with various financial institutions in Taiwan. These lines of credit expire at various times through April 2007. As of June 30, 2006, we had outstanding borrowings of approximately $8.8 million under these short-term lines of credit. We guaranteed the borrowings of ICSI under a line of credit with a bank in Taiwan for a maximum amount of approximately $4.9 million through January 2007. As of June 30, 2006, $3.1 million was outstanding under this line of credit. Our unused short-term lines of credit and unused lines of credit for short-term notes amounted to approximately $10.8 million and $1.5 million, respectively, at June 30, 2006.

Our headquarters are located in a leased site in San Jose, California. Outside of the U.S., we have operations in leased sites in China and Hong Kong. In addition to these sites, we lease sales offices in the U.S., Europe and Asia. These leases expire at various dates through 2009. In Taiwan, we own and occupy the ICSI building. The land upon which the ICSI building is situated is leased under an operating lease that expires in March 2016. Our outstanding commitments under these leases were approximately $3.6 million at June 30, 2006.

We generally warrant our products against defects in materials and workmanship for a period of 12 months. Liability for a stated warranty period is usually limited to the replacement of defective items or return of amounts paid. Warranty expense has historically been immaterial to our financial statements.

We believe our existing funds will satisfy our anticipated working capital and other cash requirements through at least the next 12 months. We may, from time to time, take actions to further increase our cash position through equity or debt financings, sales of shares of investments, bank borrowings, or the disposition of certain assets. From time to time, we may also commit to acquisitions or equity investments, including strategic investments in wafer fabrication foundries or assembly and test subcontractors. To the extent we enter into such transactions, we may need to seek additional equity or debt financing to fund such activities. There can be no assurance that any such additional financing could be obtained on terms acceptable to us, if at all.

Off-Balance Sheet Arrangements

As of June 30, 2006, we did not have any off-balance sheet arrangements as defined in Item 303 (a)(4)(ii) of SEC Regulation
S-K.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our financial market risk includes foreign currency transactions, exposure to changes in interest rates on our fixed rate debt, our investments in marketable equity securities and our investments in private companies.

We anticipate that international sales will continue to account for a significant portion of our consolidated revenue. Our international sales are largely denominated in U.S. dollars and therefore are not subject to material foreign currency exchange risk. However, we have operations in China, Europe, Taiwan, Hong Kong, India, Japan and Korea where expenses are denominated in each country’s local currency and are subject to foreign currency exchange risk. In the nine months ended June 30, 2006, we recorded exchange gains of approximately $0.3 million. However, in the quarter ended September 30, 2005, we recorded exchange losses of approximately $0.9 million. Prior to this we had not experienced any significant negative impact on our operations as a result of fluctuations in foreign currency exchange rates. We do not currently engage in any hedging activities.

We had cash, cash equivalents and short-term investments of $79.7 million at June 30, 2006 excluding $37.5 million of SMIC stock included in short-term investments. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without increasing risk. We invest primarily in high-quality, short-term debt instruments such as municipal auction rate certificates and instruments issued by high quality financial institutions and companies, including money market instruments. A hypothetical one percentage point decrease in interest rates would result in approximately a $0.8 million decrease in our interest income. As our portfolio consists mainly of short-term investments whose interest rates reset, a hypothetical one percentage point change in interest rates would not have a material affect on the value of our investments.

We own ordinary shares in SMIC which has been a publicly traded company since March 2004. SMIC’s ordinary shares are traded on the Hong Kong Stock Exchange and SMIC American Depository Receipts (“ADR”) are traded on the New York Stock Exchange. Each SMIC ADR represents fifty (50) ordinary shares. We use the weighted-average cost method to determine the cost basis of shares of SMIC. In fiscal 2005, we sold shares of SMIC and recorded gross proceeds of approximately $8.7 million and a pre-tax gain of approximately $4.4 million. Since SMIC’s IPO, we account for our shares in SMIC under the provisions of FASB 115 and mark the shares to the market value with the offset recorded in accumulated other comprehensive income. The cost basis of our shares in SMIC is approximately $30.3 million and the market value at June 30, 2006 was approximately $37.5 million. The market value of SMIC shares is subject to fluctuations and our carrying value will be subject to adjustments to reflect changes in SMIC’s market value in future periods. In the event the market value of our SMIC shares declines below our cost basis, and the decline is other-than-temporary, we may be required to recognize a loss on our investment through operating results. Our shares in SMIC are subject to certain lockup restrictions and therefore are not freely tradable. These lockup restrictions generally lapse at the rate of 15% of our pre-offering shares every 180 days following SMIC’s IPO in March 2004. Thus, all of our shares in SMIC have been freely tradable only since February 2007. Through June 30, 2006, these lockup restrictions impacted our ability to sell the locked up portion of our SMIC shares.

We have investments in equity securities of privately held companies of approximately $3.5 million at June 30, 2006. These investments are generally in companies in the semiconductor industry. These investments are included in other assets and are accounted for using the equity or cost method. For investments in which no public market exists, our policy is to review the operating performance, recent financing transactions and cash flow forecasts for such companies in assessing whether our investments in these companies are impaired below our cost basis. Impairment losses on equity investments are recorded when events and circumstances indicate that such assets are impaired and the decline in value is other than temporary. In this regard, we recorded approximately $0.3 million impairment losses on two equity investments in fiscal 2005.

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Item 4. Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer, based on the evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that, as of June 30, 2006, our disclosure controls and procedures were effective to ensure that the information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. During the three months ended June 30, 2006, there was no change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting except that certain of the remedial actions described below had been implemented or were in the process of being implemented during such period.

Stock Option Grant Practices and Restatement

As discussed in Note 2 “Restatement of Consolidated Financial Statements” to Condensed Consolidated Financial Statements and in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operation.” of this Form 10-Q, during fiscal year 2006, an independent investigation related to our historical stock option granting practices was carried out by a Special Committee of our Board of Directors. As a result of the investigation, we reached the conclusion that incorrect measurement dates were used for financial accounting purposes for certain stock option grants made in prior periods. Therefore, we have recorded additional non-cash stock-based compensation expense with regard to past stock option grants. In our 2006 Form 10-K, we are restating our consolidated balance sheet as of September 30, 2005, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the fiscal years ended September 30, 2005 and September 30, 2004. We are also restating the unaudited quarterly financial information for all interim periods of fiscal year 2005 and the interim periods ended December 31, 2005 and March 31, 2006 in our 2006 Form 10-K for the year ended September 30, 2006.

Remedial Measures

As a result of this investigation, we identified a material weakness in our internal control over financial reporting related to our stock option granting practices and the related accounting in periods ending prior to March 31, 2006.

Before March 2006, we did not have sufficient safeguards in place to monitor our control practices regarding stock option pricing and related financial reporting, the result of which is discussed in Item 1, Note 2 and Item 2 of this report. Beginning in March 2006, we standardized and formalized the procedure for granting awards of stock options to employees and to executive officers. In addition, management, along with our Board of Directors, has implemented or is in the process of implementing the following internal control systems and procedures, which were recommended by the Special Committee:

1. Limit authority to approve grants and any amendments to outstanding grants to members of the Board of Directors or the Compensation Committee (i.e., eliminate the Stock Option Committee).

2. Establish fixed dates, in advance, on which all equity grants are to be made. Avoid dates near earnings announcements and off-cycle exception grants. For new hires, grants must be made following their actual commencement of employment.

3. Grant only at in person or telephonic meetings of the Board or Compensation Committee that occur before the predetermined grant dates and not through unanimous written consent actions. The Compensation Committee should meet monthly or every other month.

4. Complete all grant documentation before the predetermined grant dates and circulate information to those approving the grants prior to the meeting. If there are any changes to the grants resulting from the meeting, the changes will be documented.

5. Provide for participation by legal personnel (external counsel) in Board and Compensation Committee meetings and timely and accurately communicate Board and Compensation actions to responsible human resources, finance, and stock administration personnel.

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6. Ensure the completion and execution of Board and Compensation Committee minutes promptly after meetings, and approve them at the following Board or Compensation Committee meeting, as applicable.

7. Establish controls to prohibit any revisions to lists of approved grants or modification of equity grants, whether direct or indirect (i.e., through adoption of separate individual agreements which impact outstanding grants), including termination arrangements providing for accelerated vesting or extended vesting or exercising of options, without prior review by representatives of human resources, finance and legal and approval by the Board or Compensation Committee.

8. Timely communicate material terms of grants to recipients following their effective date of grant.

9. Maintain all documentation related to equity grant approval centrally (e.g., Compensation Committee minutes). One person should be responsible for entering stock option grants into the equity tracking software program, and a second person should review the input in a timely manner to guard against errors. Grants should be entered into the system shortly after they are made, rather than at end of each quarter. Grant lists should be marked to indicate the dates on which they become final, and the stock administrator should indicate the date on which grant lists and other relevant documents are received, so as to provide an appropriate audit trail.

10. Establish written policies and procedures for equity grants, vesting, exercises, sales and recordkeeping consistent with the above that have been approved jointly by representatives from finance and human resources (including stock administration personnel) and discussed with the Compensation Committee.

11. Monitor any guidance regarding equity grant procedures from the SEC and the public accounting community, to make sure procedures are in compliance.

12. Implement annual formal review of stock option documentation, including plan documents, agreements, and approving resolutions, to ensure compliance and understanding of material terms by representatives of finance, human resources and stock administration personnel. Any proposed amendments to plan documents should be reviewed by finance, human resources and stock administration personnel before approval by Board.

13. Establish regular training programs for stock administration, human resources, and finance personnel, covering the equity grant process and proper accounting. Provide for active involvement of external legal counsel or other appropriate experts in training and review of the equity grant process.

14. Establish and proactively monitor internal controls regarding the equity grant process, including the IT processes involved in grant procedures. Ensure that full audit functionality of equity tracking software is understood and employed and kept up to date.

15. Establish and proactively monitor internal controls regarding cash exercises of stock options to ensure that such exercises and payments therefore are fully and accurately documented, all necessary approvals are obtained and documented, and such exercises are accurately and timely entered into the Equity Edge tracking software system.

16. Ensure that our disclosure controls adequately address the processes for making, recording, disclosing and accounting for equity grants and exercises of such grants.

We believe that the changes made in March 2006 remediated the past material weakness in our internal control over financial reporting related to our stock option granting practices and the related accounting, and reduced to remote the likelihood that any incorrect measurement dates or any material error in accounting for stock options could have occurred during fiscal year 2006 and not been detected as part of our financial reporting close process.

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Part II. OTHER INFORMATION

Item 1. Legal Proceedings

We are subject to various legal proceedings and claims as discussed below. In addition, in the ordinary course of our business, we have been involved in a limited number of legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. Although the outcome of these actions is not presently determinable, we believe that the ultimate resolution of these matters will not harm our business and will not have a material adverse effect on our financial position, cash flows or results of operations. Litigation relating to the semiconductor industry is not uncommon, and we are, and from time to time have been, subject to such litigation. No assurances can be given with respect to the extent or outcome of any such litigation in the future.

Shareholder Derivative Actions

On July 18, 2006 and July 26, 2006, two purported shareholder derivative actions were filed against certain current and former directors and officers of ISSI in the United States District Court for the Northern District of California, entitled (1) Rick Tope v. Jimmy S.M. Lee, et al., Case No. C06-04387, and (2) Murray Donnelly v. Jimmy S.M. Lee, et al., Case No. C06-04545. The complaints purport to assert claims against the individual defendants on behalf of ISSI for breach of fiduciary duty, violations of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 promulgated thereunder, unjust enrichment, and restitution based upon our alleged stock option grant practices from 1995 through 2002. We are named solely as a nominal defendant. The complaints seek damages in an unspecified amount against the individual defendants, disgorgement of stock options or proceeds, equitable relief, attorney’s fees, and other unspecified relief. Pursuant to the parties’ stipulation, the Court consolidated the two derivative actions on August 22, 2006, under the caption In re Integrated Silicon Solution, Inc. Shareholder Derivative Litigation, Master File No. C-06-04387 RMW. Plaintiffs filed a consolidated shareholder derivative complaint on November 27, 2006, based upon the same underlying facts and circumstances alleged in the prior complaints. In addition to the claims asserted and the relief sought in the original complaints, the consolidated complaint purports to assert claims against the individual defendants for aiding and abetting and violating Sections 14(a) and 20(a) of the Exchange Act and seeks an accounting. We are again named solely as a nominal defendant.

On October 31, 2006, another purported shareholder derivative action was filed against certain current and former directors and officers of ISSI in the Superior Court of California for the County of Santa Clara, entitled Alex Chuzhoy v. Jimmy S.M. Lee, et al., Case No. 1:06-CV-074031. The complaint purports to assert claims against the individual defendants on behalf of ISSI for insider trading in violation of California Corporations Code Sections 25402 / 25502.5, breach of fiduciary duty including in connection with the alleged insider selling and misappropriation, abuse of control, gross mismanagement, constructive fraud, corporate waste, unjust enrichment, and rescission, based upon our alleged stock option grant practices from 1995 through 2002. We are named solely as a nominal defendant. The complaint seeks damages in an unspecified amount against the individual defendants, an accounting, certain corporate governance changes, a constructive trust over the defendants’ stock options or proceeds, punitive damages, attorney’s fees, and other unspecified relief.

Plaintiffs in the state and federal derivative complaints will amend their complaints after we conclude our financial restatement. Defendants intend to move to dismiss both the state and federal complaints.

Nasdaq Delisting

On August 17, 2006, we received a letter from The NASDAQ Stock Market indicating that we were not in compliance with the NASDAQ requirements for continued listing set forth in NASDAQ Marketplace Rule 4310(c)(14), and faces a possible delisting. On December 7, 2006, following a hearing before the Nasdaq Listing Qualifications Panel (“Panel”), the Panel notified us that we would remain listed on Nasdaq subject to the filing by February 13, 2007 of all required restatements and delinquent periodic reports, communication with the Panel about the results of the independent committee’s investigation, and compliance with all other requirements for continued listing on the Nasdaq Stock Market. We also received a letters from The NASDAQ Stock Market indicating that as a result of our failure to timely file our Form 10-K for the fiscal year ended September 30, 2006 and our Form 10-Q’s for the quarters ended December 31, 2006 and March 31, 2007, we were not in compliance with the NASDAQ requirements for continued listing set forth in NASDAQ Marketplace Rule 4310(c)(14).

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On January 19, 2007, the Nasdaq Listing and Hearing Review Council (“Listing Council”) notified us that, pursuant to its discretionary authority, it had called for review the December 7, 2006 decision of the Panel and stayed any determinations to suspend our securities from trading pending further action by the Listing Council. On May 9, 2007, we were advised by the Listing Council that we would remain listed on NASDAQ if we conclude our restatement and file our delinquent required SEC filings by June 5, 2007.

SRAM Antitrust Litigation

Thirty-two purported class action lawsuits were filed against us and other SRAM suppliers in various U.S. federal courts alleging violations of the Sherman Act, violations of state unfair competition laws, and unjust enrichment relating to the sale and pricing of SRAM products. The U.S. lawsuits have been consolidated in a single federal court for coordinated pre-trial proceedings. The U.S. complaints seek treble damages for the alleged damages sustained by purported class members, in addition to restitution, costs and attorneys’ fees, as well as an injunction against the allegedly unlawful conduct. Two purported class action lawsuits were filed against us and other SRAM suppliers in two Canadian courts alleging violation of the Canadian Competition Act and unlawful conduct at common law. The Canadian complaints seek compensatory and punitive damages, in addition to declaratory relief, restitution, and costs. We are committed to defending ourself against these claims and have instructed our counsel to contest these actions vigorously. Given the preliminary stage of these proceedings and the inherent uncertainty in litigation, we are unable to predict the outcome of these suits. The final resolution of these alleged violations of federal or state antitrust laws could have a material adverse effect on our business, results of operations, or financial condition.

SRAM Antitrust Civil Investigative Demand

In May 2007, we received a civil investigative demand (“CID”) from the Attorney General of the State of Florida. The CID is issued pursuant to the Florida Antitrust Act in the course of an official investigation to determine whether there is, has been, or may be a violation of state or federal antitrust laws. Although not alleging any wrongdoing, the CID seeks documents and data relating to our business. We intend to cooperate fully with the Attorney General of Florida in this investigation. Because the investigation is at an early stage, we cannot predict the outcome of the investigation and its effect, if any, on our business.

Item 1A. Risk Factors

We have been named as a party to several lawsuits related to our historical stock option practices and related accounting, we may be named in additional litigation in the future and we are the subject of a formal SEC investigation, all of which could result in an unfavorable outcome and have a material adverse effect on our business, financial condition, results of operations, cash flows and the trading price for our securities.

Several lawsuits have been filed against certain of our current directors and officers and our former directors and officers relating to our historical stock option practices and related accounting; we are named as nominal defendant in such matters. We are also subject to a formal SEC investigation with respect to such matters. See “Item 1—Legal Proceedings” for a more detailed description of these proceedings. We may become the subject of additional private or government actions regarding these matters in the future. These actions are in the preliminary stages, and their ultimate outcome could have a material adverse effect on our business, financial condition, results of operations, cash flows and the trading price for our securities. Litigation may be time-consuming, expensive and disruptive to our normal business operations, and the outcome of litigation is difficult to predict. The defense of these lawsuits has resulted and will continue to result in significant legal and accounting expenditures and the continued diversion of our management’s time and attention from the operation of our business. All or a portion of any amount we may be required to pay to satisfy a judgment or settlement of any or all of these claims may not be covered by insurance.

We have entered into indemnification agreements with each of our present and former directors and officers. Under those agreements, we are required to indemnify each such director or officer against expenses, including attorneys’ fees, judgments, fines and settlements, paid by such individual in connection with the pending litigation subject to applicable Delaware law.

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If we do not maintain compliance with the listing requirements of the NASDAQ Global Market, our common stock could be delisted, which could, among other things, reduce the price of our common stock and the levels of liquidity available to our stockholders.

In connection with the restatement of our financial statements, we were delinquent in filing certain of our periodic reports with the SEC, and consequently we were not in compliance with the listing requirements under the NASDAQ Global Market’s Marketplace Rules. Upon the filing of this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K for the year ended September 30, 2006 and our Quarterly Reports on Form 10-Q for the periods ended December 31, 2006 and March 31, 2007, we believe that we will be in compliance with the NASDAQ listing standards. However, our securities could be delisted in the future if we do not maintain compliance with applicable listing requirements. If our securities are delisted from the NASDAQ Global Market, they would subsequently be transferred to the National Quotation Service Bureau, or “Pink Sheets.” The trading of our common stock on the Pink Sheets may reduce the price of our common stock and the levels of liquidity available to our stockholders. If we are delisted in the future from the NASDAQ Global Market and transferred to the Pink Sheets, there may also be other negative implications, including the potential loss of confidence by suppliers, customers and employees and the loss of institutional investor interest in our company.

We have incurred significant losses in certain recent periods, and there can be no assurance that we will be able to achieve or sustain profitability in the future.

We incurred losses of $14.4 million in the first nine months of fiscal 2006, which included inventory write-downs of $14.3 million. We incurred losses of $39.8 million in fiscal 2005, which included inventory write-downs of $13.9 million, charges of $11.7 million related to our equity interest in ICSI, charges on impairment of goodwill and investments of $4.7 million and charges for in-process R&D of $2.8 million. Though we were profitable in the first three quarters of fiscal 2004, we incurred a loss in the fourth quarter of fiscal 2004, which included an inventory write-down of $12.1 million. There is no assurance that we will achieve or maintain profitability in subsequent quarters. Our ability to achieve and maintain profitability on a quarterly or fiscal year basis in the future will depend on a variety of factors, including the need for future inventory write-downs, our ability to increase net sales, maintain or expand gross margins, introduce new products on a timely basis, secure sufficient wafer fabrication capacity and control operating expenses, including stock-based compensation as required by SFAS 123R. Adverse developments with respect to these or other factors could result in quarterly or annual operating losses in the future.

Our operating results are expected to continue to fluctuate and may not meet our financial guidance or published analyst forecasts. This may cause the price of our common stock to decline significantly.

Our future quarterly and annual operating results are subject to fluctuations due to a wide variety of factors, including:

• the cyclicality of the semiconductor industry;

• declines in average selling prices of our products;

• inventory write-downs for lower of cost or market or excess and obsolete;

• excess inventory levels at our customers;

• decreases in the demand for our products;

• oversupply of memory products in the market;

• our ability to control or reduce our operating expenses;

• shortages in foundry, assembly or test capacity;

• disruption in the supply of wafers, assembly or test services;

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• changes in our product mix which could reduce our gross margins;

• cancellation of existing orders or the failure to secure new orders;

• a failure to introduce new products and to implement technologies on a timely basis;

• market acceptance of ours and our customers’ products;

• economic slowness and low end-user demand;

• a failure to anticipate changing customer product requirements;

• fluctuations in manufacturing yields at our suppliers;

• fluctuations in product quality resulting in rework, replacement, or loss due to damages;

• a failure to deliver products to customers on a timely basis;

• the timing of significant orders;

• increased expenses associated with new product introductions, masks or process changes;

• the ability of customers to make payments to us;

• the outcome of any pending or future litigation; and

• the commencement of any future litigation or antidumping proceedings.

Our sales depend on DRAM and SRAM products and reduced demand for these products or a decline in average selling prices could harm our business.

In the nine months ended June 30, 2006 and in fiscal 2005, approximately 92% and 88%, respectively, of our net sales were derived from the sale of DRAM and SRAM products, which are subject to unit volume fluctuations and declines in average selling prices that could harm our business. For example, we experienced a sequential decline in revenue from $61.5 million in our September 2005 quarter to $51.1 million in our December 2005 quarter. This decline in revenue was primarily the result of a decrease in unit shipments and the average selling prices of our DRAM products. In the December 2005 quarter, we turned down some orders for DRAM products that had unfavorable margins as a result of the decrease in the average selling prices in the market. We may not be able to offset any future price declines for our products by higher volumes or by higher prices on newer products. Historically, average selling prices for semiconductor memory products have declined, and we expect that average selling prices for our products will decline in the future. Our ability to maintain or increase revenues will depend upon our ability to increase unit sales volume of existing products and introduce and sell new products that compensate for the anticipated declines in the average selling prices of our existing products.

We are subject to pending legal proceedings related to the SRAM market.

We have been named as a defendant in a number of civil antirust complaints filed against semiconductor companies on behalf of purported classes of direct and indirect purchasers of SRAM products throughout the United States. The complaints allege that the defendants conspired to raise the price of SRAM in violation of Section 1 of the Sherman Act, the California Cartwright Act, and several other State antitrust, unfair competition and consumer protection statutes. We believe that we have meritorious defenses to the allegations in the complaints, and we intend to defend these lawsuits vigorously. However, the litigation is in the preliminary stage and we cannot predict its outcome. Multidistrict antitrust litigation is particularly complex and can extend for a protracted time, which can substantially increase the cost of such litigation. The defense of these lawsuits is also expected to divert the efforts and attention of some of our key management and technical personnel. As a result, our defense of this litigation, regardless of its eventual outcome, will likely be costly and time consuming. Should the outcome of the litigation be adverse to us, we could be required to pay significant monetary damages, which could adversely affect our business, financial condition, operating results and cash flows.

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Any future downturn in the markets we serve would harm our business and financial results.

Substantially all of our products are incorporated into products for the digital consumer electronics, networking, mobile communications and automotive electronics markets. Historically, these markets have experienced cyclical depressed business conditions, often in connection with, or in anticipation of, a decline in general economic conditions or due to adverse supply and demand conditions in such markets. Industry downturns have resulted in reduced demand and declining average selling prices for our products which adversely affected our business. We expect that our industry will remain cyclical, and we are unable to predict when any upturn or downturn will occur or how long it will last.

Shifts in industry-wide capacity may cause our results to fluctuate. These shifts may occur quickly with little or no advance notice. Such shifts have historically resulted in significant inventory write-downs.

The semiconductor industry is highly cyclical and is subject to significant downturns resulting from excess capacity, overproduction, reduced demand or technological obsolescence. Shifts in industry-wide capacity from shortages to oversupply or from oversupply to shortages may result in significant fluctuations in our quarterly or annual operating results. These shifts in industry conditions can occur quickly with little or no advance notice to us. Adverse changes in industry conditions are likely to result in a decline in average selling prices and the stated value of inventory. In the first nine months of fiscal 2006, in fiscal 2005 and in fiscal 2004, we recorded inventory write-downs of $14.3 million, $13.9 million and $17.3 million, respectively. The inventory write-downs related to valuing our inventory at the lower-of-cost-or-market, and adjusting our inventory valuation for certain excess and obsolete products.

We write down to zero dollars the carrying value of inventory on hand in excess of six months’ historical sales volumes to cover estimated excess and obsolete exposures, unless adjustments are made based on management’s judgments for newer products, end of life products, planned inventory increases or strategic customer supply. In making such judgments to write down inventory, management takes into account the product life cycles which can range from six to 30 months, the stage in the life cycle of the product, the impact of competitors’ announcements and product introductions on our products.

We believe that six months is an appropriate period because it is difficult to accurately forecast for a specific product beyond this time frame due to the potential introduction of products by competitors, technology obsolescence or fluctuations in demand. Future additional inventory write-downs may occur due to lower of cost or market accounting, excess inventory or inventory obsolescence.

Our transition to lead-free parts may result in excess inventory of products packaged using traditional methods.

Customers are requiring that we offer our products in lead-free packages. Governmental regulations in certain countries and customers’ intention to produce products that are less harmful to the environment has resulted in a requirement from many of our customers to purchase integrated circuits that do not contain lead. We have responded by offering our products in lead-free versions. While the lead-free versions of our products are expected to be more friendly to the environment, the ultimate impact is uncertain. The transition to lead-free products may produce sudden changes in demand depending on the packaging method used, which may result in excess inventory of products packaged using traditional methods. This may have an adverse effect on our results of operations. In addition, the quality, cost and manufacturing yields of the lead-free parts may be less favorable to us than the products packaged using more traditional materials which may result in higher product costs.

If we are unable to obtain an adequate supply of wafers, our business will be harmed.

If we are unable to obtain an adequate supply of wafers from our current suppliers or any alternative sources in a timely manner, our business will be harmed. Our principal manufacturing relationships are with Powerchip Semiconductor, SMIC, Taiwan Semiconductor Manufacturing Corporation (TSMC) and Chartered Semiconductor Manufacturing. Each of our wafer foundries also supplies wafers to other semiconductor companies, including certain of our competitors or for their own account. Although we are allocated specific wafer capacity from our suppliers, we may not be able to obtain such capacity in periods of tight supply. If any of our suppliers experience manufacturing failures or yield shortfalls, choose to prioritize capacity for other uses, or reduce or eliminate deliveries to us, we may not be able to obtain enough wafers to meet the market demand for our products which would adversely affect our revenues. Once a product is in production at a particular foundry, it is time consuming and costly to have such product manufactured at a different foundry. In addition, we may not be able to qualify additional manufacturing sources for existing or new products in a timely manner and we cannot be certain that other manufacturing sources would be able to deliver an adequate supply of wafers to us or at the same cost.

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Our gross margins may decline even in periods of increasing revenue.

Our gross margin is affected by a variety of factors, including our mix of products sold, average selling prices for our products and cost of wafers. Even when our revenues are increasing, our gross margin may be adversely affected if such increased revenue is from products with lower margins or declining average selling prices. During periods of strong demand, wafer capacity is likely to be in short supply and we will likely have to pay higher prices for wafers, which would adversely affect our gross margin unless we are able to increase our product prices to offset such costs. To maintain our gross margins when average selling prices are declining, we must introduce new products with higher margins or reduce our cost per unit. There can be no assurance that we will be able to increase unit sales volumes, introduce and sell new products or reduce our cost per unit.

We may encounter difficulties in effectively integrating newly acquired businesses.

From time to time, we intend to acquire other companies or assets that we believe to be complementary to our business. Acquisitions may result in use of our cash resources, potentially dilutive issuances of equity securities, incurrence of debt and contingent liabilities, amortization expenses related to intangible assets, and the possible impairment of goodwill, which could harm our profitability. In addition, acquisitions involve numerous risks, including:

• higher than estimated acquisition expenses;

• difficulties in successfully assimilating the operations, technologies and personnel of the acquired company;

• difficulties in continuing to develop the new technologies and deliver products to market on time;

• diversion of management’s attention from other business concerns;

• risks of entering markets in which we have no, or limited, direct prior experience;

• the risk that the markets for acquired products do not develop as expected; and

• the potential loss of key employees and customers as a result of the acquisition.

In this regard, in February 2006, we sold our shares of Signia as we decided to exit the Bluetooth market and focus on our core product strategy. We sold approximately 77% of our investment in Signia for approximately $4.6 million which resulted in a pre-tax gain of $2.2 million. As a result of the sale of the Signia shares, we reduced our ownership percentage to approximately 16% and effective March 2006 account for Signia on the cost basis. For the period ending September 30, 2005, we incurred an impairment charge of $4.4 million related to the goodwill acquired with Signia. There is no assurance that any future acquisitions will contribute positively to our business or operating results.

We rely on third-party contractors to assemble and test our products and our failure to successfully manage our relationships with these contractors could damage our relationships with our customers, decrease our sales and limit our growth.

We rely on third-party contractors located in Asia to assemble and test our products. There are significant risks associated with our reliance on these third-party contractors, including:

• reduced control over product quality;

• potential price increases;

• reduced control over delivery schedules;

• possible capacity shortages;

• their inability to increase production and achieve acceptable yields on a timely basis;

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• absence of long-term agreements;

• limited warranties on products supplied to us; and

• general risks related to conducting business internationally.

If any of these risks are realized, our business and results of operations could be adversely affected until our subcontractor is able to remedy the problem or until we are able to secure an alternative subcontractor.

The loss of a significant customer or a reduction in orders from one or more large customers could adversely affect our operating results.

As sales to our customers are executed pursuant to purchase orders and no purchasing contracts typically exist, our customers can cease doing business with us at any time. We may not be able to retain our key customers, such customers may cancel or reschedule orders, and in the event of canceled orders, such orders may not be replaced by other sales. In addition, sales to any particular customer may fluctuate significantly from quarter to quarter, and such fluctuating sales could harm our business and financial results.

We have significant international sales and operations and risks related to our international activities could harm our operating results.

In the nine months ended June 30, 2006, approximately 17% of our net sales was attributable to customers located in the U.S., 9% was attributable to customers located in Europe and 74% was attributable to customers located in Asia. In fiscal 2005, approximately 15% of our net sales was attributable to customers in the U.S., 9% was attributable to customers in Europe and 75% was attributable to customers in Asia. We anticipate that sales to international sites will continue to represent a significant percentage of our net sales. In addition, all of our wafer foundries and assembly and test subcontractors are in Taiwan, China and Singapore and a substantial majority of our employees are located outside of the U.S. In particular, a devaluation of the New Taiwan dollar or Chinese Renminbi could substantially increase the cost of our operations in Taiwan or China.

We are subject to the risks of conducting business internationally, including:

• global economic conditions, particularly in Taiwan and China;

• duties, tariffs and other trade barriers and restrictions;

• foreign currency fluctuations;

• changes in trade policy and regulatory requirements;

• transportation delays;

• the burdens of complying with foreign laws;

• imposition of foreign currency controls;

• language barriers;

• difficulties in hiring and retaining experienced engineers in countries such as China and Taiwan;

• difficulties in collecting foreign accounts receivable;

• political instability, including any changes in relations between China and Taiwan; and

• earthquakes, diseases (SARS/ avian flu) and other natural disasters.

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Strong competition in the semiconductor memory market may harm our business.

The semiconductor memory market is intensely competitive and has been characterized by an oversupply of product, price erosion, rapid technological change, short product life cycles, cyclical market patterns, and heightened foreign and domestic competition. Many of our competitors offer broader product lines and have greater financial, technical, marketing, distribution and other resources than us. In particular, a competitor with a materially smaller die size and lower cost could dramatically gain market share in a short period of time. We may not be able to compete successfully against any of these competitors. Our ability to compete successfully in the memory market depends on factors both within and outside of our control, including:

• the pricing of our products;

• the supply and cost of wafers;

• product design, functionality, performance and reliability;

• successful and timely product development;

• the performance of our competitors and their pricing policies;

• wafer manufacturing over or under capacity;

• real or perceived imbalances in supply and demand for our products;

• the rate at which OEM customers incorporate our products into their systems;

• the success of our customers’ products and end-user demand;

• access to advanced process technologies at competitive prices;

• achievement of acceptable yields of functional die;

• the capacity of our third-party contractors to assemble and test our products;

• the gain or loss of significant customers;

• the nature of our competitors; and

• general economic conditions.

In addition, we are vulnerable to technology advances utilized by competitors to manufacture higher performance or lower cost products. We may not be able to compete successfully in the future as to any of these factors. Our failure to compete successfully in these or other areas could harm our business and financial results.

Our revenues and business would be harmed if we are not able to successfully develop, introduce and sell new products and develop and implement new manufacturing technologies in a timely manner. Our research and development expenses could increase and our business could be harmed if the implementation of these new manufacturing technologies is unsuccessful.

We operate in highly competitive, quickly changing markets which are characterized by rapid obsolescence of existing products. As a result, our future success depends on our ability to develop and introduce new products that our customers choose to buy in significant quantities. If we fail to introduce new products in a timely manner or if our customers’ products do not achieve commercial success, our business and results of operations could be seriously harmed. The design and introduction of new products is challenging as such products typically incorporate more functions and operate at faster speeds than prior products. Increasing complexity generally requires smaller features on a chip. This makes developing new generations of products substantially more difficult than prior generations. The cost to develop products utilizing these new technologies is expensive and requires significant research and development spending and, as a result, our research and

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development expenses could increase in the future. Further, new products may not work properly in our customers’ applications. If we are unable to design, introduce, market and sell new products successfully, our business and financial results would be seriously harmed.

Our products are complex and could contain defects, which could reduce sales of those products or result in claims against us.

We develop complex and evolving products. Despite testing by us and our customers, errors may be found in existing or new products. This could result in a delay in recognition or loss of revenues, loss of market share or failure to achieve market acceptance. The occurrence of defects could also cause us to incur significant warranty, support and repair costs, could divert the attention of our engineering personnel from our product development efforts, and could harm our relationships with our customers. The occurrence of these problems could result in the delay or loss of market acceptance of our products and would likely harm our business. Defects, integration issues or other performance problems in our products could result in financial or other damages to our customers. Our customers could also seek and obtain damages from us for their losses. From time to time, we have been involved in disputes regarding product warranty issues. Although we seek to limit our liability, a product liability claim brought against us, even if unsuccessful, would likely be time consuming and could be costly to defend.

Potential intellectual property claims and litigation could subject us to significant liability for damages and could invalidate our proprietary rights.

In the semiconductor industry, it is not unusual for companies to receive notices alleging infringement of patents or other intellectual property rights. We have been, and from time-to-time expect to be, notified of claims that we may be infringing patents, maskwork rights or copyrights owned by third-parties. If it appears necessary or desirable, we may seek licenses under patents that we are alleged to be infringing. However, licenses may not be offered and the terms of any offered licenses may not be acceptable to us.

The failure to obtain a license under a key patent or intellectual property right from a third party for technology used by us could cause us to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could harm our business. Furthermore, we may become involved in protracted litigation regarding the alleged infringement by us of third-party intellectual property rights or litigation to assert and protect our patents or other intellectual property rights. Any litigation relating to patent infringement or other intellectual property matters could result in substantial cost and diversion of our resources, which could harm our business.

We may be unable to effectively protect our intellectual property, which would negatively impact our ability to compete.

We believe that the protection of our intellectual proprietary rights will continue to be important to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and business partners, and control access to and distribution of our documentation and other proprietary information. Despite these efforts, unauthorized parties may attempt to copy or otherwise obtain and use our proprietary technology. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as do the laws of the U.S. Many U.S. companies have encountered substantial infringement problems in foreign countries, including countries in which we design and sell our products. We cannot be certain that patents will be issued as a result of our pending applications nor can we be certain that any issued patents would protect or benefit us or give us adequate protection from competing products. For example, issued patents may be circumvented or challenged and declared invalid or unenforceable. We also cannot be certain that others will not develop our unpatented proprietary technology or effective competing technologies on their own.

We have acquired equity positions for strategic reasons in other companies which may significantly decrease in value.

Over the last several years, we have acquired equity positions for strategic reasons in other technology companies and we may make similar equity purchases in the future. At June 30, 2006, our strategic investments in non-marketable securities totaled $3.5 million. These equity investments may not increase in value and there is the possibility that they could decrease in value over time, even to the point of becoming completely worthless. These equity securities are evaluated for impairment on a recurring basis and any reductions in the carrying value would lower our profitability.

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In this regard, we recorded approximately $0.3 million in impairment losses on two of our equity positions in fiscal 2005. In addition, we own shares in SMIC with a cost basis of approximately $30.3 million and a market value at June 30, 2006 of approximately $37.5 million. The market value of SMIC shares is subject to fluctuation and our carrying value will be subject to adjustments to reflect the current market value. Our shares in SMIC are subject to certain lockup restrictions and therefore all of such shares are not freely tradable. These lockup restrictions generally lapse at the rate of 15% of our pre-offering shares every 180 days following SMIC’s IPO which occurred in March 2004. Thus, all of our shares in SMIC have been freely tradable only since February 2007. Through June 30, 2006, these lockup restrictions impacted our ability to sell the locked up portion of our SMIC shares.

Changes in securities laws and regulations are increasing our costs.

The Sarbanes-Oxley Act of 2002 that became law in July 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq Stock Market, have required changes to some of our accounting and corporate governance practices, including the report on our internal controls as required by Section 404 of the Sarbanes-Oxley Act of 2002. These rules and regulations have increased our accounting, legal and other costs, and have made some activities more difficult, time consuming and/or costly. In particular, complying with the internal control requirements of Sarbanes-Oxley Section 404 has resulted in increased internal efforts, significantly higher fees from our independent accounting firm and significantly higher fees from third party contractors. We also expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These rules and regulations could also make it more difficult for us to attract and retain qualified executive officers and qualified members of our board of directors, particularly to serve on our audit committee.

We may experience difficulties and increased expenses in complying with Sarbanes-Oxley Section 404.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our Annual Report on Form 10-K for our fiscal year ending September 30, 2005, we are required to furnish a report by our management on our internal control over financial reporting. Such report contains among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment includes disclosure of any material weaknesses in our internal control over financial reporting identified by management and also contains a statement that our auditors have issued an attestation report on management’s assessment of such internal controls. Public Company Oversight Board Auditing Standard No. 2 provides the professional standards and related performance guidance for auditors to attest to, and report on, management’s assessment of the effectiveness of internal control over financial reporting under Section 404.

We concluded that our internal control over financial reporting was effective and our auditors concurred with such assessment at September 30, 2005. Our internal control analysis for fiscal 2005 was not required to cover ICSI. However, ICSI will be covered by our internal control analysis for fiscal 2006. A key element of Section 404 compliance involves an analysis of management information systems (MIS). We are in the process of implementing a new worldwide MIS system and we are continuing to use our current systems. Although we are working to improve such system, there are some Section 404 challenges with the current systems at ICSI and there can be no assurance that such system issues will not result in a significant deficiency or material weakness under applicable accounting standards. If in the future we are unable to assert that our internal control over financial reporting is effective (or if our auditors are unable to attest that our management’s report is fairly stated or they are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our stock price.

Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States.

We prepare our financial statements in conformity with accounting principles generally accepted in the U.S. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in these policies or interpretations could have a significant effect on our reported

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financial results, and could affect the reporting of transactions completed before the announcement of a change. For example, beginning in the first quarter of fiscal 2006, with the adoption of SFAS 123R, we now record a charge to earnings for employee stock option grants for all stock options unvested at and granted after October 1, 2005. This accounting pronouncement has and is expected to continue to negatively impact our financial results. Technology companies generally, and our company specifically, rely on stock options as a major component of our employee compensation packages. Because we are required to expense options, we may be less likely to sustain profitability or we may have to decrease or eliminate option grants. Decreasing or eliminating option grants may negatively impact our ability to attract and retain qualified employees.

We depend on our ability to attract and retain our key technical and management personnel.

Our success depends upon the continued service of our key technical and management personnel. Several of our important manufacturing and other subcontractor relationships are based on personal relationships between our senior executive officers and such parties. In particular, our Chairman and Chief Executive Officer has long-term relationships with our key foundries. If we were to lose the services of any key executives, it may negatively impact the related business relationships since we have no long-term contractual agreements with such parties. Our success also depends on our ability to continue to attract, retain and motivate qualified technical personnel, particularly experienced circuit designers and process engineers. The competition for such employees is intense. We have no employment contracts or key person life insurance policies with or for any of our employees. The loss of the service of one or more of our key personnel could harm our business.

Our stock price is expected to continue to be volatile.

The trading price of our common stock has been and is expected to be subject to wide fluctuations in response to:

• quarter-to-quarter variations in our operating results;

• general conditions or cyclicality in the semiconductor industry or the end markets that we serve;

• new or revised earnings estimates or guidance by us or industry analysts;

• comments or recommendations issued by analysts who follow us, our competitors or the semiconductor industry;

• aggregate valuations and movement of stocks in the broader semiconductor industry;

• announcements of new products, strategic relationships or acquisitions by us or our competitors;

• increases or decreases in available wafer capacity;

• governmental regulations, trade laws and import duties;

• announcements related to future or existing litigation involving us or any of our competitors;

• announcements of technological innovations by us or our competitors;

• additions or departures of senior management; and

• other events or factors, many of which are beyond our control.

In addition, stock markets have experienced extreme price and trading volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.

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Foundry capacity can be limited, and we may be required to enter into costly arrangements to secure foundry capacity.

If we are not able to obtain additional foundry capacity as required, our relationships with our customers would be harmed and our future sales would be adversely impacted. In order to secure foundry capacity, we have entered into in the past, and may enter into in the future, various arrangements with suppliers, which could include:

• purchases of equity or debt securities in foundries;

• joint ventures;

• process development relationships with foundries;

• contracts that commit us to purchase specified quantities of wafers over extended periods;

• increased price for wafers;

• option payments or other prepayments to foundries; and

• nonrefundable deposits with, or loans to, foundries in exchange for capacity commitments.

We may not be able to make any such arrangements in a timely fashion or at all, and such arrangements, if any, may not be on terms favorable to us. Once we make commitments to secure foundry capacity, we may incur significant financial penalties if we subsequently determine that we are not able to utilize all of that capacity. Such penalties may be substantial and could harm our financial results.

Our foundries may experience lower than expected yields which could adversely affect our business.

The manufacture of integrated circuits is a highly complex and technically demanding process. Production yields and device reliability can be affected by a large number of factors. As is typical in the semiconductor industry, our outside foundries have from time to time experienced lower than anticipated manufacturing yields and device reliability problems, particularly in connection with the introduction of new products and changes in such foundry’s processing steps. There can be no assurance that our foundries will not experience lower than expected manufacturing yields or device reliability problems in the future, which could materially and adversely affect our business and operating results.

Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses.

Our worldwide operations could be subject to natural disasters and other business disruptions, which could seriously harm our revenue and financial condition and increase our costs and expenses. Our corporate headquarters, and a portion of our research and development activities, are located in California, and other critical business operations and many of our suppliers are located in Asia, near major earthquake faults. The ultimate impact on us, our significant suppliers and our general infrastructure of being located near major earthquake faults is unknown, but our revenue, profitability and financial condition could suffer in the event of a major earthquake or other natural disaster. Losses and interruptions could also be caused by earthquakes, power shortages, telecommunications failures, water shortages, tsunamis, floods, typhoons, fires, extreme weather conditions, medical epidemics and other natural or manmade disasters.

Terrorist attacks, threats of further attacks, acts of war and threats of war may negatively impact all aspects of our operations, revenues, costs and stock price.

Terrorist acts, conflicts or wars, as well as future events occurring in response or connection to them, including future terrorist attacks against U.S. targets, rumors or threats of war, actual conflicts involving the U.S. or its allies (such as the war in Iraq), conflict between China and Taiwan, or trade disruptions impacting our domestic or foreign suppliers or our customers, may impact our operations and may, among other things, cause delays or losses in the delivery of wafers or other products to us and decreased sales of our products. More generally, these events have affected, and are expected to continue to affect, the general economy and customer demand for products sold by our customers. Any of these occurrences could have a significant impact on our operating results, revenues and costs, which in turn may result in increased volatility in our common stock price and a decline in the price of our common stock.

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Item 6. Exhibits

(a) The following exhibits are filed as a part of this report.

Exhibit 31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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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.

	Integrated Silicon Solution, Inc.
	(Registrant)
Dated: May 29, 2007	/s/ Scott D. Howarth
	Scott D. Howarth
	Chief Financial Officer
	(Principal Financial and
	Accounting Officer)

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EX-31.1

Exhibit 31.1

CERTIFICATION

I, Jimmy S.M. Lee, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Integrated Silicon Solution, Inc.;

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 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 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 29, 2007

/s/ Jimmy S.M. Lee

Jimmy S.M. Lee

Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Scott D. Howarth, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Integrated Silicon Solution, Inc.;

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 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 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 29, 2007

/s/ Scott D. Howarth

Scott D. Howarth

Chief Financial Officer

EX-32

Exhibit 32

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Jimmy S.M. Lee, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Integrated Silicon Solution, Inc. on Form 10-Q for the quarterly period ended June 30, 2006 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of Integrated Silicon Solution, Inc.

By:	/s/ Jimmy S.M. Lee
	Jimmy S.M. Lee
	Chairman of the Board and Chief Executive Officer
	May 29, 2007

I, Scott D. Howarth, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Integrated Silicon Solution, Inc. on Form 10-Q for the quarterly period ended June 30, 2006 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of Integrated Silicon Solution, Inc.

By:	/s/ Scott D. Howarth
	Scott D. Howarth
	Chief Financial Officer
	May 29, 2007