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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the transition period from _________ to ______.

0-21488

CATALYST SEMICONDUCTOR, INC.

(408) 542-1000

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

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12(b)(2) of the Exchange Act). Yes o No x

     The number of shares outstanding of the Registrant’s Common Stock as of November 21, 2003 was 16,545,420 exclusive of 3,044,100 shares of treasury stock.

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CATALYST SEMICONDUCTOR, INC.

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PART I - FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

CATALYST SEMICONDUCTOR, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

See accompanying notes to the unaudited condensed consolidated financial statements.

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CATALYST SEMICONDUCTOR, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

See accompanying notes to the unaudited condensed consolidated financial statements.

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CATALYST SEMICONDUCTOR, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

See accompanying notes to the unaudited condensed consolidated financial statements.

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CATALYST SEMICONDUCTOR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation:

     In the opinion of the management of Catalyst Semiconductor, Inc. (Company), the unaudited condensed consolidated interim financial statements included herein have been prepared on the same basis as the April 30, 2003 audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly state the information set forth herein. The consolidated statements include the accounts of the Company’s wholly owned subsidiaries, Nippon Catalyst KK (NCKK), a sales organization in Japan and Catalyst Semiconductor Romania SRL (CSR), a design center in Europe. All material intercompany balances have been eliminated. The statements have been prepared in accordance with the regulations of the Securities and Exchange Commission (SEC). For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended April 30, 2003. The results of operations for the three month period ended October 31, 2003 are not necessarily indicative of the results to be expected for the entire year ending April 30, 2004 or any other future period. Certain prior period balances have been reclassified to conform to the current period presentation.

     The Company’s business is highly cyclical and has been subject to significant downturns at various times which have been characterized by reduced product demand, production overcapacity and significant erosion of average selling prices.

     The Company’s fiscal year is the 52 or 53-week period ending on the Sunday closest to April 30. In a 52-week year, each fiscal quarter consists of 13 weeks. Fiscal year 2004 will be comprised of 53 weeks with the extra week added to the third quarter making it consist of 14 weeks. For presentation purposes only, the financial statements and notes refer to April 30 as the Company’s year-end and July 31, October 31 and January 31 as the Company’s quarter-ends.

     In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure” which amended SFAS No. 123 (SFAS 123) requiring that disclosures of the pro forma effect use the fair value method of accounting for stock-based employee compensation be displayed more prominently, in a tabular format and on a quarterly basis. The following table illustrates the effect on the Company’s net income and net income per share if compensation costs had been recorded based on the estimated fair value as of the grant date as defined by SFAS 123 for all granted stock-based awards.

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CATALYST SEMICONDUCTOR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 2 – Net Income Per Share:

     Basic net income per share is computed by dividing net income available to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period and excludes the dilutive effect of stock options. Diluted net income per share gives effect to all dilutive potential common shares outstanding during a period. In computing diluted net income per share, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options.

     A reconciliation of the numerators and denominators of the basic and diluted income per share is presented in the following table (in thousands, except per share data):

     Options to purchase 713,000 shares of common stock at a weighted average exercise price of $6.90 during the quarter ended October 31, 2003 and options to purchase 1,245,000 shares of common stock at a weighted average exercise price of $6.22 during the quarter ended October 31, 2002 were not included in the computation of diluted income per share because the inclusion of such options would have been antidilutive.

     Options to purchase 933,000 shares of common stock at a weighted average exercise price of $6.44 during the six months ended October 31, 2003 and options to purchase 1,245,000 shares of common stock at a weighted average exercise price of $6.21 during the six months ended October 31, 2002 were not included in the computation of diluted income per share because the inclusion of such options would have been antidilutive.

Note 3 – Other comprehensive Income:

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

     Accumulated other comprehensive income or expense, as presented on the accompanying condensed consolidated balance sheets, consists of the unrealized gains and loss on the available-for-sale investments.

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CATALYST SEMICONDUCTOR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 4 – Balance Sheet Components (in thousands):

     The financial instruments in short term investments are highly liquid and can be converted to cash and cash equivalents without restriction and, accordingly, are classified as current assets in the balance sheet.

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CATALYST SEMICONDUCTOR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 5 – Income Taxes

     The provision for income taxes was $75,000, or 15% of income before taxes, for the quarter ended October 31, 2003 compared to $501,000, or a 37% of income before taxes, for the quarter ended October 31, 2002. The provision for income taxes was $237,000, or 15% of income before taxes, for the six months ended October 31, 2003 compared to $1,196,000, or a 37% of income before taxes, for the six months ended October 31, 2002. In the quarter ended April 30, 2003, the income tax rate for the 2003 fiscal year was revised to 15%. The provision for income taxes for both the quarter and six months ended October 31, 2003 differed from the statutory rate primarily due to deductions related to net operating losses carried forward and research and development tax credits.

Note 6 – 1998 Special Equity Incentive Plan:

     In December 1998, the Company adopted an additional stock option plan entitled the 1998 Special Equity Incentive Plan (Special Option Plan) for incentive stock options and non-statutory stock options for certain directors, officers and consultants of the Company. A total of 3.5 million shares of common stock have been reserved for issuance under the Special Option Plan. Options granted under the Special Option Plan are for periods not to exceed ten years. Options generally vest over four year periods. During fiscal 1999, options totaling 3.0 million shares were granted under the plan when the market price was $0.125 per share and subsequently approved by the Company’s shareholders when the market price was at $0.33 per share. As a result, an aggregate of $483,000 of compensation expense was recognized over the four year vesting period of the options, $19,000 and $47,000 of which was recognized during the quarter ended and six months ended October 31, 2002, respectively. No compensation expense was recognized during the quarter ended and six months ended October 31, 2003. All compensation expense was recognized by the quarter ended January 31, 2003.

Note 7 – Segment Reporting

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

     Revenues by product group were as follows (in thousands):

     Revenues by destination were as follows (in thousands):

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CATALYST SEMICONDUCTOR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 8 – Commitments and Contingencies

   Purchase Commitments

     The Company had approximately $3.3 million of outstanding manufacturing purchase orders with its foundries at October 31, 2003.

   Contingencies

     On April 17, 2001, Xicor Corporation (Xicor), a competitor in the nonvolatile and mixed signal semiconductor markets, served a complaint against the Company in the United States District Court for the District of Delaware. The complaint alleged that some of the Company’s recently announced digital potentiometer products infringed on a patent that Xicor obtained in 1988. In June 2002, the Company entered into a settlement agreement with Xicor according to which Catalyst has received a license to manufacture the disputed products in exchange for certain royalty payments based upon sales of those products after July 22, 2002. The complaint was dismissed on July 22, 2002. Through October 31, 2003, the royalties paid under this agreement have not been material.

     In 1989, the Company entered into a license agreement with Philips Export B.V. and U.S. Philips Corporation (Philips) to license technology pertinent to their I2C bus technology. Catalyst paid royalties under this license through 1993, at which point the Company believed that the license became fully paid and no further royalties were owed. In May 2001, the Company received a written communication from Philips claiming that royalties under this license were still owing on certain products. In January 2003, Philips again stated that it did not believe that the license was fully paid and that royalties had continued to accrue. The Company does not believe that Philips’ position is meritorious and that, even if a current royalty obligation is demonstrated, it does not extend retroactively back as far as Philips contends. Nonetheless, if Philips’ position is ultimately demonstrated to be correct, Catalyst may owe Philips an amount estimated to range from zero to $3.5 million in back royalty payments and an estimated amount ranging from zero to $1.7 million in interest payments. Moreover, irrespective of the merits of the parties’ positions, the costs and business inconvenience likely to result from the protracted litigation of this dispute are, in themselves, substantial. Accordingly, the Company has established a reserve of $1.0 million against this claim and will accrue a royalty obligation on future revenues of the subject products to the reserve at the rate provided for in the original license agreement through its expiration in August 2004.

     In the normal course of business, the Company receives notification of threats of legal action in relation to claims of patent infringement by the Company. Although no assurances can be given as to the results of such claims, management does not believe that any such results will have a material adverse impact on the Company’s financial condition or results of operations.

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

   Indemnification Obligations

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

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

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CATALYST SEMICONDUCTOR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

incur a loss in any of these matters, such loss should not have a material effect on its business, financial condition, cash flows or results of operations.

   Product Warranties

     Catalyst estimates its product warranty costs based on historical warranty claim experience and applies this estimate to the revenue stream for products under warranty. Included in Catalyst’ sales returns reserves are estimated return exposures associated with product warranties. Estimated future costs for warranties applicable to revenues recognized in the current period are charged to the Company’s cost of goods sold. The warranty reserve is reviewed quarterly to verify that it properly reflects the remaining obligations based on the anticipated expenditures over the balance of the obligation period. Adjustments are made when actual claim experience differs from estimates. Warranty costs were less than $10,000 during the six months ended October 31, 2003.

Note 9 – Related Party Transactions:

     During the fourth quarter of fiscal 2000, the Company began taking delivery of wafers fabricated at X-Fab Texas, Inc. (Xfab), a wholly owned subsidiary of Elex NV, a Belgian holding company (Elex) that owned 4,178,700 shares, or 25%, of the outstanding shares of the Company as of November 21, 2003. Elex initially became a related party in 1998. Mr. Roland Duchâtelet, the Chairman and Chief Executive Officer of Elex, serves as a member of the Company’s Board of Directors. The wafers provided by Xfab includes most of the Company’s mixed signal products and supplements some of the same EEPROM designs fabricated at Oki Semiconductor in Japan, the Company’s principal wafer fab. Other than purchase orders currently open with Xfab, there is no purchasing agreement in place with Xfab. Each purchase order remains open until the wafers are delivered, which is generally within two months of placement of the order, although in the case of one particular wafer design under development, the Company has prepaid a purchase order which calls for a mask set and delivery of a prototype wafer lot at a future time to be determined by future events. During the six months ending October 31, 2003, the Company purchased $1.3 million of wafers from Xfab. As of October 31, 2003, the total amount owed Xfab was $158,000.

     The Company had an informal arrangement from 1995 through January 2003 to obtain engineering services from Lxi Corporation, a California corporation (Lxi), a provider of engineering services through Essex com SRL (Essex), its wholly owned subsidiary in Romania. The number of full-time engineers from Lxi the Company used was dependant upon the scope and number of R&D projects in process at a given time. For example, during the month of January 2003, Essex employed the equivalent of approximately 12 full-time engineers to perform services on the Company’s behalf. These services related to key development projects of Catalyst including development, design, layout and test program development services. In January 2003, the Company established a wholly owned subsidiary in Romania which replaced the services of Lxi as of February 1, 2003. Mr. Radu Vanco, the Company’s former CEO, owned 91% of Lxi at the time of his departure in 2002; Mr. Gelu Voicu and Mr. Thomas Gay owned approximately 3% and 1%, respectively, of Lxi until their shares were sold to Lxi in February 2003 at net book value. Mr. Gay had previously served as the Treasurer of Lxi prior to his joining the Company. Mr. Gay resigned that position immediately prior to joining the Company. Mr. Gay resigned as a director of Lxi in January 2003.

     One director, Mr. Lionel Allan, also served as a consultant to the Company through his consulting company, Allan Advisors, Inc. Under the terms of the consulting agreement, the Company paid consulting fees of $8,333 per month throughout fiscal 2003 and 2002. The consulting agreement was to expire on August 14, 2003. The Company paid the $29,000 balance due under the agreement in April 2003 and cancelled the agreement.

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CATALYST SEMICONDUCTOR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 10 – Recent Accounting Pronouncements:

     In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 was effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. The Company’s adoption of FIN 46 did not have a material impact on the Company’s consolidated financial statements.

     In May 2003, FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of SFAS 150 and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The Company’s adoption of SFAS 150 did not have a material impact on the Company’s consolidated financial statements.

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors that include, but are not limited to, the risks discussed in “Factors Affecting Future Results”. These forward-looking statements include, but are not limited to: the statements relating to future increases in our manufacturing costs, decreases in unit shipments and further downward pricing trends in the second paragraph of “Overview;” the statements relating to the overestimation of future selling prices under “Inventory Reserves;” the statements relating to the higher returns of product if market conditions weaken and the effect on sales if we receive an increased rate of product returns in the second paragraph under “Revenue Recognition;” the statements relating to the benefits of future releases of the valuation allowance and where such releases will be credited in the second paragraph under “Income Tax Valuation Allowances;” and the statements relating to the risks associated with seeking additional financing in the last paragraph of “Liquidity and Capital Resources” among others. These forward-looking statements are based on current expectations and entail various risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties are set forth below under “Certain Risks That may Affect Our Future Results.”

Overview

     Catalyst Semiconductor, Inc. was incorporated on October 8, 1985 and designs, develops and markets nonvolatile memory semiconductor products including Serial and Parallel EEPROMs, Flash memory and Mixed Signal devices. Revenues are derived from sales of semiconductor products designed by us and manufactured by other companies.

     Our business is highly cyclical and has been subject to significant downturns at various times which have been characterized by reduced product demand, production overcapacity and significant erosion of average selling prices. Revenues, gross profits, average selling prices and net income were declining during the second and third quarters of fiscal 2003 due to renewed competitive pressures in the markets for our products. Beginning in the third quarter of fiscal 2003, revenue increased quarter over quarter on a steady trend. During the same period, gross margin and gross profit were variable due to competitive price pressures and were negatively impacted by a royalty expense to Philips Export B.V. and U.S. Philips Corporation (Philips) for the quarter ended October 31, 2003. We could experience future increases in our manufacturing costs, decreases in our unit shipments and further downward trends in our product pricing, all of which are factors that could adversely affect our operating results.

Results of Operations

     Revenues. The company operates in one business segment, the semiconductor manufacturing segment. Sales transactions are denominated in U.S. dollars. Revenues by product group were as follows (in thousands):

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          Total revenues consist of net product sales. A substantial portion of our net product sales are made through independent distributors. Revenues from product sales to original equipment manufacturers and from sales to distributors who have no, or limited, product return rights and no price protection rights, is recognized once the risk of loss and passage of title has transferred to the customer. When distributors have rights to return products or price protection rights, we defer recognition of revenues until the distributor sells the product to the end customer. Total revenues increased $2.2 million, or 16%, to $16.0 million for the quarter ended October 31, 2003 compared to $13.8 million for the quarter ended July 31, 2003. The increase was primarily attributable to increased unit volumes of 21% from the quarter ended July 31, 2003, the majority of the increase attributed to the EEPROM product group. Total revenues increased by $4.0 million, or 33%, to $16.0 million for the quarter ended October 31, 2003 from $12.0 million for the quarter ended October 31, 2002. The increase was primarily attributable to a 102% increase in unit volume at lower average selling prices with a decrease in average cost per unit. For the quarter ended October 31, 2003, EEPROM revenues increased 38% and mixed signal revenues increased 130% while flash memory revenues declined by 9% compared to the quarter ended October 31, 2002.

          Total revenues increased $5.3 million, or 22%, to $29.8 million for the six months ended October 31, 2003 from $24.5 million for the six months ended October 31, 2002. The primary reason for the increase was an 86% increase in unit volume at lower average selling prices with a marked improvement in average cost per unit. Revenues from our EEPROM devices increased $5.6 million, or 27%, to $26.4 million, or 89% of revenues, for the six months ended October 31, 2003 compared to $20.8 million, or 85% of revenues, in the six months ended October 31, 2002. The net increase was primarily attributable to higher volumes shipped into Asia at lower average selling prices. Revenues from our flash memory devices decreased $471,000, or 14%, to $2.9 million, or 10% of revenues, in the six months ended October 31, 2003 compared to $3.4 million, or 14% of revenues, in the six months ended October 31, 2002. The primary reason for the decrease in flash memory revenues was due to lower unit volumes. Revenues from our mixed signal products increased $147,000, or 42%, to $498,000, or 2% of revenues, for the six months ended October 31, 2003, compared to $351,000, or 1% of revenues, in the six months ended October 31, 2002. The primary reason for the increase in mixed signal revenues was higher unit volumes due to an expanding product line. International sales contributed 89% of net revenues in the six months ended October 31, 2003 as compared to 79% in the six months ended October 31, 2002. The increase in the percentage of international revenues during the first six months of fiscal 2004 was primarily attributable to our increased sales in all Asian markets due to increased market demand while demand in the U.S. has weakened. All sales of our products are in U.S. dollars, minimizing the effects of currency fluctuations.

          Gross Profit. Gross profit for the quarter ended October 31, 2003 was $5.0 million, or a gross margin of 31%, compared to gross profit of $5.1 million, or a gross margin of 37%, for the quarter ended July 31, 2003. In the quarter ended October 31, 2003, we recorded a royalty expense of $1.0 million to Philips. Unit volume increased 21% and product unit cost decreased during the quarter ended October 31, 2003. Earlier in the year, inventory pricing was renegotiated with several strategic suppliers. By the end of October 31, 2003, the inventory valued at the old pricing was sold. This improvement in pricing was offset by lower average selling prices due to competition in our Asian markets. Gross profit for the quarter ended October 31, 2003 was $5.0 million, or a gross margin of 31%, compared to gross profit of $5.0 million, or a gross margin of 41%, for the quarter ended October 31, 2002. The decrease in gross margin was primarily attributed to the royalty expense of $1.0 million to Philips and lower average selling prices for the quarter ended October 31, 2003. These declines where offset by an 86% increase in unit volume and significant improvement in product cost per unit. Gross profit decreased $0.3 million, or 3%, to $10.1 million, or a gross margin of 34%, for the six months ended October 31, 2003 compared to a gross profit of $10.4 million, or a gross margin of 42%, for the six months ended October 31, 2002. The decrease in gross profit was primarily attributable to the royalty expense of $1.0 million to Philips and lower average selling prices for the six months ended October 31, 2003. These declines where offset by an 86% increase in unit volume and significant improvement in product cost per unit. It is our policy to fully reserve all inventories that are not expected to be sold in a reasonable period of time following the balance sheet date, generally within the ensuing 12 months. In the six months ended October 31, 2003, inventory reserves decreased $1.4 million as previously reserved inventory continued to be sold to customers while $594,000 of inventory reserves were needed for finished goods inventory that we expect to hold for more than 12 months. The expense of increasing inventory reserves is included in cost of revenues which decreases the gross profit for the period. Once the inventory reserve is established, it can only be released when the inventory is sold or physically scrapped. We pay certain foreign manufacturing expenses in local currency, primarily Baht in Thailand and Yen in Japan. These expenses in foreign currencies are not material to us.

          Research and Development. Research and development (R&D) expenses consist principally of salaries for engineering, technical and support personnel, depreciation of equipment, contract engineering services and the cost of wafers used to evaluate new products and new versions of current products. R&D expenses increased $102,000, or 7%, to $1.7 million, or 10% of revenues, for the quarter ended October 31, 2003 from $1.5 million, or 11% of

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revenues, in the quarter ended July 31, 2003. The increase was primarily attributable to higher personnel related expenses and support costs related to increasing R&D headcount. This increase was offset by lower costs related to patent activity and a decrease in services provided by outside engineering design sources. R&D expenses increased $456,000, or 38%, to $1.7 million, or 10% of revenues, for the quarter ended October 31, 2003 from $1.2 million, or 10% of revenues, in the quarter ended October 31, 2002. The increase was primarily attributable to higher personnel related expenses and support costs related to increasing R&D headcount and an increase in depreciation expense related to purchases of additional equipment. R&D expenses increased $0.7 million, or 29%, to $3.2 million, or 11% of revenues, for the six months ended October 31, 2003 compared to $2.5 million, or 10% of revenues, for the six months ended October 31, 2002. The increase was primarily attributable to higher personnel related expenses, support costs and depreciation expense. As of October 31, 2003, we employed 65 people in research and development activities, compared to 25 employees plus 12 under the arrangement with Lxi Corporation as of October 31, 2002.

          Selling, General and Administrative. Selling, general and administrative (SG&A) expenses consist principally of salaries for sales, marketing and administrative personnel, commissions, promotional activities, professional fees and director and officer (D&O) insurance. SG&A expenses increased $317,000, or 12%, to $2.9 million, or 18% of revenues, for the quarter ended October 31, 2003 compared to $2.6 million, or 19% of revenues, for the quarter ended July 31, 2003. The increase was primarily attributable to an increase in personnel related expenses and travel costs as a result of expanding the sales and marketing group and increasing our domestic and international sales presence. In addition, commission expense increased on higher revenue and we paid a one-time application fee of $100,000 for our NASDAQ National Market listing. SG&A expenses increased $401,000, or 16%, to $2.9 million, or 18% of revenues, for the quarter ended October 31, 2003 from $2.5 million, or 21% of revenues, for the quarter ended October 31, 2002. This increase on a dollar basis was primarily attributable to an increase in personnel related expenses reflecting an increase in headcount, additional commission expense on higher revenue and the one-time NASDAQ application fee. These increases were offset by lower legal expenses related personnel matters and lower outside consulting services related to financial matters. SG&A expenses increased $649,000, or 13%, to $5.5 million, or 19% of revenue, for the six months ended October 31, 2003 compared to $4.9 million, or 20% of revenues, for the six months ended October 31, 2002. The increase was primarily attributable to higher personnel related expenses, additional commission and freight expense on higher revenue, higher insurance premiums, and the one-time NASDAQ application fee. These increases were offset by lower legal expense and lower outside consulting expenses.

          Net Interest Income and Expense. We earned net interest income of $84,000, or 1% of revenues, for the quarter ended October 31, 2003 from $90,000, less than 1% of revenues, in the quarter ended July 31, 2003. Net interest income decreased $4,000 to $84,000, or 1% of revenues, for the quarter ended October 31, 2003 compared to net interest income of $88,000, or 1% of revenues, in the quarter ended October 31, 2002. Net interest income increased $20,000, or 13%, to $174,000, or 1% of revenues, for the six months ended October 31, 2003 compared to $154,000, or 1% of revenues, for the six months ended October 31, 2002.

          Income Tax Provision. The provision for income taxes was $75,000, or 15% of income before taxes, for the quarter ended October 31, 2003 compared to $501,000, or a 37% of income before taxes, for the quarter ended October 31, 2002. The provision for income taxes was $237,000, or 15% of income before taxes, for the six months ended October 31, 2003 compared to $1,196,000, or a 37% of income before taxes, for the six months ended October 31, 2002. In the quarter ended April 30, 2003, the income tax rate for the 2003 fiscal year was revised to 15%. The provision for income taxes for both the quarter and six months ended October 31, 2003 differed from the statutory rate primarily due to deductions related to net operating losses carried forward and research and development tax credits.

Critical Accounting Policies and Estimates

     The preparation of consolidated financial statements in conformity with generally accepted accounting principles (GAAP) in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures. On an on-going basis, we evaluate our estimates, including those related to product shipments, sales returns, bad debts, inventories, income taxes, contingencies and litigation. We base these estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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     Specifically, we believe that the following accounting policies and estimates are most important to the portrayal of our financial condition and results and require management’s most difficult judgments:

          Inventory Reserves.

     We reserve inventory in excess of estimated future demand, generally within the ensuing 12 months. If actual market conditions are less favorable than those projected by management, additional inventory write-downs are also required. Inventory reserves are taken when products in finished goods have been held for more than 12 months. We use the product’s manufacturing date code as the beginning point for the measurement of the 12 months. Additionally, inventory reserves are also taken based upon our estimate of the future selling prices of our inventories. Whenever the estimated future selling price is less than the cost of the inventory, plus the estimated cost to sell any portion of our inventory, a reserve is taken for the amount by which the cost of the inventory plus estimated costs to sell exceeds the estimated future selling price. If we overestimate the future selling prices, we will incur additional losses when the inventory is sold for a lower price or when we establish additional reserves to cover the even lower estimated sales price. Once established, inventory reserves are not released until the associated inventory has been sold or physically scrapped.

          Revenue Recognition.

     For products sold directly to end-users, original equipment manufacturers, or to resellers that do not receive price concessions and do not have rights of return, we recognize revenues once the risk of loss and passage of title has transferred to the customer.

     On our sales to end-users, reserves for sales returns and allowances are estimated based primarily upon historical experience and provided at the time of shipment. If market conditions were to weaken, we may face higher volumes of product returns possibly resulting in an incremental reduction of revenue at the time products are returned. If we were to experience an increased rate of product returns, our sales would be further reduced by the increased reserves taken to cover the increased amount of our products expected to be returned.

     For sales to distributors with agreements allowing for price concessions and product returns, we recognize revenues at the time the distributor sells the product to its end customer. Revenues are not recognized upon shipment since, due to various forms of price concessions; the sales price is not substantially fixed or determinable at that time. Additionally, these distributors have contractual rights to return products, up to a specified amount, for a given period of time. Revenues are recognized when a distributor sells the product to an end-user, at which time the sales price becomes fixed.

     At the time of shipment to distributors, we record a trade receivable for the selling price since there is a legally enforceable right to payment, we relieve inventory for the carrying value of the goods shipped since legal title and risk of loss has passed to the distributor and we record the gross margin in “deferred gross profit on shipments to distributors,” a component of current liabilities on our balance sheet. Deferred margin represents the gross margin on the sale to the distributor; however, the amount of gross margin we recognize in future periods could be less than the deferred margin as a result of price concessions. We do not reduce deferred margin by estimated future price concessions; instead, price concessions are recorded when incurred, which is generally at the time the distributor sells the product to an end-user. The difference between deferred margin and the margin actually recognized has not been material in the past. However, since price concessions are highly dependent upon market conditions, there can be no assurance that the difference will not be material in the future. Price concessions are not granted for amounts in excess of the deferred margin.

          Allowances for Doubtful Accounts.

     We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Bad debt expenses, when incurred, are included in our selling expenses.

          Income Tax Valuation Allowances.

     In years prior to fiscal 2003, we recorded substantial valuation allowances to reduce our deferred tax assets to the amount that was more likely to be realized. As of April 30, 2003, we estimated that amount based on the experience during the year then ended and considered estimated future taxable income in assessing the need for the

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valuation allowance. We determined that the amount of deferred tax assets that we would be able to realize aggregated $1.9 million and the valuation allowance was reduced accordingly which increased income and shareholders’ equity for the fourth quarter and fiscal 2003.

     We had a valuation allowance of $8.6 million as of October 31, 2003, which may be released as we revise our estimate of the likelihood of portions of that amount being realized. The release of up to $4.6 million of that allowance would also benefit our net income and stockholders’ equity if and when it is released. The remaining $4.0 million of valuation allowance would be credited to additional paid-in-capital if and when it is released.

Liquidity and Capital Resources

     Total cash decreased $3.7 million to $4.1 million as of October 31, 2003 from $7.8 million as of April 30, 2003. Net cash provided by operations was $2.8 million for the six months ended October 31, 2003, which was due primarily to net income of $1.3 million, adjusted for depreciation and amortization of $560,000. In the six months ended October 31, 2003, net inventory reserves decreased $771,000 as previously reserved inventory continued to be sold to customers while lower inventory reserves were needed for finished goods inventory that was held for more than 12 months. Gross inventories decreased $3.0 million due to lower pricing on certain inventory purchases and a decrease in the number of units. Deferred distributor profits increased $681,000 due to higher unit volumes in the six months ended October 31, 2003. Such improvements were partially offset by a $3.5 million increase in accounts receivable caused by a 28% higher sales volume and longer payment terms as some customers have transitioned from letters of credit or prepayment to open accounts. We also recorded a royalty expense of $1.0 million to Philips in the six months ended October 31, 2003.

     Net cash provided by operations was $4.0 million for the six months ended October 31, 2002, which was due primarily to net income of $2.0 million, adjusted for depreciation and amortization of $501,000, a decrease in gross accounts receivable of $1.2 million related to increased collections activity, increases in accrued expenses of $1.3 million due to income tax provisions and an increase in other assets of $234,000. Such increases were partially offset by an increase in gross inventories of $136,000 and a decrease in accounts payable of $982,000 due to a decrease in purchase volume activity.

     Our investing activities used $6.9 million during the six months ended October 31, 2003 which was related primarily to the purchase of short term investments for $6.2 million and the acquisition of equipment for our manufacturing and R&D operations of $688,000. Our investing activities used $852,000 during the six months ended October 31, 2002 which was related primarily to the acquisition of equipment for our manufacturing operations and purchases of software to support our development activities.

     Financing activities provided $307,000 during the six months ended October 31, 2003 consisted of $522,000 in proceeds from the sale of common stock through the exercise of stock options less the use of $215,000 for the repurchase of an aggregate of 74,000 shares, an average price per share of $2.91, of our common stock on the open market. Financing activities used $1.4 million during the six months ended October 31, 2002, consisting primarily of $1.6 million utilized for the repurchase of an aggregate of 622,900 shares of our common stock for an average price per share of $2.58 on the open market. Net cash provided by the sale of common stock through the exercise of stock options totaled $195,000 during the six months ended October 31, 2002.

     In September 2001, the Board of Directors authorized a program for the open market repurchase of up to 1.5 million shares of our common stock and in February 2003 increased the authorized limit to a total of 2 million shares. The purpose of this share repurchase program is to reduce the long-term potential dilution in earnings per share that might result from issuances under our stock option plans by taking advantage of opportunities to purchase our common stock while the price is relatively low. We have no immediate plans to reissue the repurchased shares and intend to hold such shares in treasury until suitable opportunities arise. During the six months ended October 31, 2003, we repurchased an aggregate of 74,000 shares at a total cost of $215,000, an average price per share of $2.91. During the six months ended October 31, 2002, we repurchased an aggregate of 622,900 shares at a total cost of $1.6 million.

     As of October 31, 2003, we were indebted to various creditors in the amount of approximately $4.0 million. This amount was comprised of approximately $3.3 million for wafers and inventory processing and approximately $0.7 million for other goods and services.

     We do not have any material contractual obligations or commercial commitments to make any future payments other than with respect to the wafer purchase commitments to foundries and a facilities lease for our principal business office in Sunnyvale which will expire in 2006. The lease agreement allows us to exercise an option to extend the term by an additional five years. Our outstanding purchase commitments with our foundries were

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approximately $3.3 million at October 31, 2003. Further, we do not engage in any off-balance sheet financing arrangements or transactions other than the standard building leases. The following table shows the aggregate future minimum lease payments, by fiscal year, as of October 31, 2003, that we were obligated to pay under the terms of the non-cancelable operating leases we have for our various facilities, principally our headquarters building in Sunnyvale, California (in thousands):

     In light of the current economic and competitive climate, we continue to monitor our liquid resources. We believe our existing cash and cash equivalents and anticipated cash flows from our operating activities will be sufficient to fund our working capital and capital expenditure needs for at least the next 12 months. Additionally, the financial instruments in our short term investments account are highly liquid and can be converted to cash and cash equivalents immediately and, as such, are classified as current assets in the balance sheet. In our competitive industry, we must constantly consider the need to make significant expenditures in connection with our research and development efforts and the marketing of new products. We may use cash to invest in businesses, products and/or technologies which we believe to be strategic. However, we have no present commitments or obligations with respect to any acquisition of other businesses or technology. We have no present intention to seek additional debt or equity financing, but our need to do so is highly dependent upon factors such as the demand for our products and changes in industry and general economic conditions. In the event that we do decide to seek such financing, there can be no assurance that such financing will be available on acceptable terms, if at all, and any additional equity financing could result in incremental dilution to our existing investors.

Effects of Transactions with Related Parties

     During the fourth quarter of fiscal 2000, we began taking delivery of wafers fabricated at X-Fab Texas, Inc. (Xfab), a wholly owned subsidiary of Elex NV, a Belgian holding company (Elex) that owned 4,178,700 shares, or 25%, of the outstanding shares of the Company as of November 21, 2003. Elex initially became a related party in 1998. Mr. Roland Duchâtelet, the Chairman and Chief Executive Officer of Elex, serves as a member of our Board of Directors. The wafers provided by Xfab includes most of our mixed signal products and supplements some of the same EEPROM designs fabricated at Oki Semiconductor in Japan, our principal wafer fab. We believe that the cost of such wafers is no greater than comparable materials available from alternative foundry services. Other than purchase orders currently open with Xfab, there is no purchasing agreement in place with Xfab. Each purchase order remains open until the wafers are delivered, which is generally within two months of placement of the order, although in the case of one particular wafer design under development, we have prepaid a purchase order which calls for a mask set and delivery of a prototype wafer lot at a future time to be determined by future events. The prices of wafers purchased from Xfab are determined by periodic negotiations with the management of Xfab and compared to quotes obtained from other prospective wafer fabricators and pricing surveys published by various industry trade organizations. During the six months ended October 31, 2003, our purchases from Xfab totaled $1.3 million. As of October 31, 2003, the total amount owed Xfab was $158,000.

     We had an informal arrangement from 1995 through January 2003 to obtain engineering services from Lxi Corporation, a California corporation (Lxi), a provider of engineering services through Essex com SRL (Essex), Lxi’s wholly owned subsidiary in Romania. The number of full-time engineers we used was dependent upon the scope and number of research and development projects in process at a given time. For example, during the month of January 2003, Essex employed the equivalent of approximately 12 full-time engineers to perform services on our behalf. These services related to our key development projects including development, design, layout and test program development services. We believe that we received these engineering services from Lxi on terms and at rates that were at least as favorable, if not more favorable, than we could obtain from unaffiliated third parties. Two of our officers, Mr. Gelu Voicu and Mr. Thomas Gay, owned approximately 3% and 1%, respectively, of Lxi until February 2003. Mr. Gay, who had served as a director of Lxi, resigned from that position in January 2003. Mr. Voicu and Mr. Gay received no payments from Lxi during fiscal 2004, 2003 and 2002 other than $40,000 and $12,000, respectively, from the repurchase of their shares at net book value by Lxi in February 2003. Additionally, we believe that our former CEO, Mr. Radu Vanco, continues to own a majority of the outstanding shares of Lxi. In January 2003, we formed a wholly owned subsidiary in Romania, Catalyst Semiconductor Romania SRL (CSR), to

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perform these engineering design services on our behalf and discontinued our use of the engineering services of Lxi in January 2003. As of October 31, 2003, there was no amount owed to Lxi.

     One of our directors, Mr. Lionel Allan, also served as a consultant to us through his consulting company, Allan Advisors, Inc. Under the terms of his consulting agreement, we paid consulting fees of $8,333 per month throughout fiscal 2003 and in April 2003, we terminated the agreement and paid the $29,000 balance due as required by the agreement. The consulting agreement was to expire on August 14, 2003. Mr. Allan no longer provides consulting services to us and we have no continuing obligations to Mr. Allan under the prior agreement.

Recent Accounting Pronouncements

     In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 was effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. Our adoption of FIN 46 did not have a material impact on the Company’s consolidated financial statements.

     In May 2003, FASB issued Statement of Financial Accounting Standards (SFAS) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of SFAS 150 and still existing at the beginning of the interim period of adoption. Restatement is not permitted. Our adoption of SFAS 150 did not have a material impact on the Company’s consolidated financial statements.

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Certain Risks that May Affect Our Future Results

          We desire to take advantage of certain provisions of the Private Securities Litigation Reform Act of 1995, enacted in December 1995 (the “Reform Act”) that provides a “safe harbor” for forward-looking statements made by or on our behalf. We hereby caution stockholders, prospective investors in Catalyst and other readers that the following important factors, among others, in some cases have affected and in the future could affect, our stock price or cause our actual results for the quarter ending January 31, 2004 or the fiscal year ending April 30, 2004 and future fiscal years and quarters to differ materially from those expressed in any forward-looking statements, oral or written, made by or on behalf of us.

Our quarterly operating results may fluctuate due to many factors and are difficult to forecast.

     Our operating results have historically been and in future quarters may be adversely affected or otherwise fluctuate due to factors such as:

	•		fluctuations in customer demand for our products;
	•		volatility in supply and demand affecting semiconductor market prices generally such as the increases in supply of competitive products and significant declines in average selling prices experienced by us in fiscal 2002;
	•		the need to establish additional inventory reserves if our expectations for sales of our inventory fall below the quantities that we have on hand, or the expected selling prices falling below the amounts paid to produce and sell certain parts;
	•		the timing of new product introductions and significant orders of our products;
	•		increased expenses associated with new product introductions, process changes and/or expanding our sales channels;
	•		changes in our product mix;
	•		increases in wafer prices due to increased market demand and other factors;
	•		increases in prices charged by our suppliers due to increased costs, decreased competition and other factors;
	•		gains or losses of significant customers;
	•		foreign currency fluctuations;
	•		fluctuations in manufacturing yields;
	•		charges to bad debt expense caused by accounts receivable that become unlikely to be collected in a reasonable amount of time, if ever; and
	•		general economic conditions.