UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number: 0-20784

TRIDENT MICROSYSTEMS, INC.

1090 East Arques Avenue, Sunnyvale, California 94085

(408) 991-8800

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  [X]  No [   ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  [X]  No [   ]

The number of shares of the registrant’s Common Stock, $0.001 par value, outstanding at September 30, 2004 was 22,955,508.

TRIDENT MICROSYSTEMS, INC.

INDEX

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TRIDENT MICROSYSTEMS, INC.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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TRIDENT MICROSYSTEMS, INC.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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TRIDENT MICROSYSTEMS, INC.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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TRIDENT MICROSYSTEMS, INC.

Note 1. The Company

     Trident Microsystems, Inc. and its subsidiaries (collectively the “Company”) designs, develops and markets integrated circuits for videographics, multimedia and digitally processed television products for the consumer television market and the PC market. Our digital media operations are primarily conducted by our majority-owned subsidiary, Trident Technologies, Inc. (“TTI”).

Note 2. Basis of Presentation

     The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts; actual results could differ from those estimates.

     In the opinion of the Company, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the financial position, operating results and cash flows for those periods presented. The condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and are not audited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended June 30, 2004 included in the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission.

     The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for any other period or for the entire fiscal year which ends June 30, 2005.

Note 3. Revenue Recognition

     Revenue from product sales is generally recognized upon shipment when persuasive evidence of an arrangement exists, title and risk of loss pass to the customer, the price is fixed or determinable, shipment is made and collectibility is reasonably assured. Provision is made for expected future sales returns and allowances when revenue is recognized. The Company has no obligation to provide any modification or customization upgrades, enhancements or other post-sale customer support. The Company grants certain distributors limited rights of return and price protection on unsold products. Product revenue on shipments to distributors with such rights is deferred until the products are shipped to end customers by the distributors.

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Note 4. Inventories

     Inventories consisted of the following (in thousands):

Note 5. Net income Per Share

     Basic net income per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income per share is calculated adjusting the net income by the potential minority interests and using the weighted average number of outstanding shares of common stock plus potential common stock shares. The calculation of diluted net income per share excludes potential common stock if the effect is antidilutive. Potential common stock shares consist of common stock options, computed using the treasury stock method based on the average stock price for the period.

Reconciliations of the numerators and denominators of the basic and diluted net income per share calculations are as follows:

Note 6. Stock-based compensation

     Stock-based compensation expense for the three months ended September 30, 2004 represents the intrinsic value of stock options issued by TTI to employees of TTI and certain employees of TMI. The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of APB No. 25, “Accounting for Stock Issued to Employees” and complies with the disclosure provisions of Statements of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” Under APB No. 25, compensation cost is generally recognized based on the difference, if any, between the quoted market price of the Company’s stock on the date of grant and the amount an employee must pay to acquire the stock.

     Had the Company recorded compensation based on the estimated grant date fair value, as defined by SFAS No. 123, for awards granted under its stock option plans and stock purchase plan, the net income and net income per share would have been changed to the pro forma amounts below for the three months ended September 30, 2004 and 2003:

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Note 7. Investment in UMC

     In August 1995, the Company made an investment of $49.3 million in United Integrated Circuits Corporation (“UICC”). On January 3, 2000, United Microelectronics Corporation (“UMC”) acquired UICC and, as a result of this merger, the Company received approximately 46.5 million shares of UMC. Subsequently, UMC announced 20%, 15%, 15%, 4.01% and 8% stock dividends payable to shareholders of record as of May 2000, July 2001, August 2002, July 2003 and August 2004, respectively. As of September 30, 2004, the Company owned approximately 75.1 million shares of UMC, which represents about 0.5% of the outstanding stock of UMC. Shares of the Company’s UMC investment are listed on the Taiwan Stock Exchange. In accordance with SFAS No. 115, as of September 30, 2004, 75.1 million shares are treated as available-for-sale securities and are classified as short-term investments.

     An increase in the market value of UMC’s stock price from July 1, 2003 to June 30, 2004 resulted in an increase in accumulated other comprehensive income of $6.1 million which was recorded as of September 30, 2004 in equity as “accumulated other comprehensive income” in accordance with SFAS No. 130, “Reporting Comprehensive Income”. The $6.1 million was equal to a $8.8 million increase in market value of the Company’s short-term investment in UMC from July 1, 2003 to June 30, 2004, less deferred income taxes of $2.7 million relating to the unrealized gain.

     Due to a decrease in the market value of UMC’s stock price from July 1, 2004 to September 30, 2004, a decrease in accumulated other comprehensive income of $3.9 million was recorded in equity as “accumulated other comprehensive income” in accordance with SFAS No. 130, “Reporting Comprehensive Income”. The $3.9 million is equal to a $6.5 million decrease in market value of the Company’s short-term investment in UMC from July 1, 2004 to September 30, 2004, less deferred income taxes of $2.6 million relating to the unrealized gain.

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Note 8. Gain on investments, net

     During the quarter ended September 30, 2004, the Company recognized a net gain on investments totaling $401,000 as follows:

     During the quarter ended September 30, 2004 the Company sold 330,000 shares of its subsidiary Trident Technology, Inc. (TTI) for cash of $877,000 resulting in a gain of $694,000. The Company’s percentage ownership interest in its TTI subsidiary was approximately 80% as of September 30, 2004.

     During the quarter ended September 30, 2004, the Company received additional cash of $22,000 for an ADSL company which had been previously liquidated.

     In March 2000, the Company invested $550,000 in a private company engaged in broadband server technology. In the quarter ended June 30, 2002, the Company determined that the product outlook and future cash position for this company was unfavorable. Therefore, the Company assessed the estimated fair value of the investment held and concluded that the estimated shortfall was an other-than-temporary impairment. Accordingly, $275,000 of the investment was written off against earnings in accordance with APB No. 18. In the quarter ended September 30, 2004, the Company determined that the product outlook and future cash position for this company had deteriorated further, and the remaining $275,000 investment was written off against earnings in accordance with APB No. 18.

     In January 2004, the Company invested $40,000 in a private company engaged in integrated circuit design. In the quarter ended September 30, 2004, the Company determined that the prospects for recovery of the investment were unfavorable given the deteriorating cash position of the company and the company’s operating losses. Accordingly, all of the investment was written off against earnings in accordance with APB No. 18.

     During the quarter ended September 30, 2003, the Company recognized a net gain on investments totaling $7.2 million as follows:

     On June 12, 2003, the Company announced that it would transfer its Graphics Division in Sunnyvale, California to XGI Technology, Inc. (“XGI”), a newly formed company incorporated in Taiwan, in exchange for stock in XGI. Silicon Integrated Systems Corporation, a company incorporated in Taiwan and unrelated to the Company, also transferred its graphics business to XGI. The transactions were structured to simultaneously close, with the Company receiving cash for the assets of the Graphics Division in one transaction, and simultaneously using the cash to acquire a 30% equity interest in XGI.

     The above transactions closed on July 25, 2003. In addition, on September 30, 2003, the

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Company sold one third of its investment in XGI to a third party for cash of $7.5 million. The above transactions resulted in a gain of approximately $6.6 million being recognized in the third quarter of 2003. Because XGI is a new company that is merging two businesses with an uncertain future and its equity securities are not traded on a quoted exchange, the Company recognized a gain on the above transactions based on the actual cash received and retained by the Company and no value was attributed to the Company’s remaining 20% equity interest in XGI.

     During the quarter ended September 30, 2003, the Company sold approximately 6.8% of its holding in TTI to a venture fund and its affiliates for cash of approximately of $2.8 million which resulted in a gain of approximately $1.0 million. The venture fund is an affiliate of UMC, a key business partner of the Company, and was the largest independent shareholder of TTI.

     In March 2000, the Company invested $287,000 in a private company engaged in software development. In the quarter ended March 31, 2003, the Company determined that revenue growth had not been achieved and the investee company’s financial position had deteriorated significantly. Therefore, the Company assessed the fair value of its investment based on the investee company’s latest financial position and concluded that the impairment was other-than-temporary. Accordingly, $110,000 of the investment was written off against earnings in accordance with APB No. 18. In the quarter ended September 30, 2003, due to further deterioration in the financial position of the investee company, the Company concluded that the remaining investment of $177,000 was impaired and was written off against earnings in accordance with APB No. 18.

     In May 2000, the Company invested $750,000 in a private company engaged in development of an optical applications technology. In June 2001, an additional $509,000 was invested in the company. In the quarter ended December 31, 2002, the Company determined that the fair value of the shares had decreased significantly. Therefore, the Company assessed the fair value of its investment based on the latest financing transaction and concluded that the impairment was other-than-temporary. Accordingly, an amount of the investment of $987,000 was written off against earnings in accordance with APB No. 18. In the quarter ended September 30, 2003, due to further deterioration in the financial position of the investee company, the Company concluded that the remaining investment of $272,000 was impaired and was written off against earnings in accordance with APB No. 18.

Note 9. Comprehensive Income (Loss)

     Under SFAS No. 130, “Reporting Comprehensive Income” any unrealized gains or losses on the short-term investments which are classified as available-for-sale equity securities are to be reported as a separate adjustment to equity. The components of accumulated other comprehensive income (loss) as of September 30, 2004 and June 30, 2004 related to unrealized gain (loss), net of tax, on its investments in UMC.

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Note 10. Segment information and concentration of credit risk.

     Subsequent to the transfer of its graphics division to XGI in July 2003, the Company operates in only one reportable segment: digital media. Accordingly, certain comparative amounts were reclassified to conform with current period presentation.

The following is a summary of the Company’s segment information (in thousands):

As of September 30, 2004, 67.3 million shares and options to purchase 11.9 million options were outstanding for TTI. The options vested over a period of four years from the grant date. During the quarter ended September 30, 2004 the Company sold 330,000 shares of TTI stock for proceeds of $0.9 million and realized a gain on the sale of $0.7 million and certain options granted became vested and were exercised. As a result, the Company held 80% of the outstanding shares of TTI as of September 30, 2004. Further dilution of interest would result upon exercise of stock options by the employees or if the Company determines to sell further interests in TTI in the future.

The following is a summary of the Company’s geographic operations:

Revenues are attributed to countries based on delivery locations. Long-lived assets comprise property and equipment.

Three customers accounted for 37%, 18% and 11% of accounts receivables as of September 30, 2004, respectively.

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Note 11. Contingencies

     On December 14, 1998, NeoMagic Corporation (“NeoMagic”) filed a patent infringement action against the Company in the United States District Court for the District of Delaware, Case No. 98-CV-699. After years of litigation, the Federal Circuit issued a unanimous decision on August 4, 2004 which affirmed summary judgment in the Company’s favor on the remaining claim against the Company. Trident’s counterclaim against NeoMagic for violation of Section 2 of the Sherman Act, attempted monopolization arising out of NeoMagic’s prosecution of the patent infringement action against Trident, remains pending in Delaware federal district court.

     From time to time, the Company may be involved in litigation in the normal course of business. The results of any litigation matters are inherently uncertain. In the event of an adverse decision in the described legal actions or disputes, or any other related litigation with third parties that could arise in the future with respect to patents or other intellectual property rights relevant to the Company’s products, the Company could be required to pay damages and other expenses, to cease the manufacture, use and sale of infringing products, to expend significant resources to develop non-infringing technology or to obtain licenses to the infringing technology. The Company cannot make any assurance that these matters will not materially and adversely affect the Company’s business, financial condition, operating results, or cash flows.

Note 12. Recent Accounting Pronouncements

     In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, which codifies, revises and rescinds certain sections of SAB No. 101, Revenue Recognition in Financial Statements, in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material impact on the Company’s consolidated results of operations, consolidated financial position or consolidated cash flows.

     In April 2004, the Emerging Issues Task Force issued Statement No. 03-06, Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share, (“EITF 03-06”). EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for fiscal periods beginning after March 31, 2004. The Company adopted this EITF during the quarter ended June 30, 2004. The adoption of EITF 03-06 did not have any material impact on the Company’s consolidated financial statements.

     At its November 2003 meeting, the EITF reached a consensus on disclosure guidance previously discussed under EITF 03-01,“The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The consensus provided for certain disclosure requirements that were effective for fiscal years ending after December 15, 2003. At its March 2004 meeting, the EITF reached a consensus on recognition and measurement guidance previously discussed under EITF 03-01. The consensus clarifies the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investments accounted for under the cost method or the equity method. The implementation of the recognition and measurement guidance provisions has been delayed. The disclosure requirement are effective for annual financial statements for fiscal years ending after June 30, 2004. The Company will evaluate the effect of adopting EITF 03-01 on its results of operations when the final guidance is issued.

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Item 2:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)

Special Note Regarding Forward-Looking Statements

     When used in this report the words “expects,” “anticipates,” “estimates” and similar expressions are intended to identify forward-looking statements. Such statements include our expectations and beliefs concerning:

•

our expectations regarding future revenues,

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future prospects for the digital television industry in general,

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our product development plans,

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future gross margin levels and our strategy to maintain and improve gross margins,

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trends in average selling prices,

•

our expectations and plans regarding TTI and our ownership thereof,

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maintenance of majority ownership in our subsidiaries,

•

the sufficiency of our financial resources over the next twelve months,

•

denomination of our international revenues and exposure to interest rate risk,

•

the adequacy of our internal controls over financial reporting,

•

future investments and/or acquisitions.

We are subject to risks and uncertainties, including those set forth below under “Factors That May Affect Our Results” and elsewhere in this report, that could cause actual results to differ materially from those projected. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based.

     The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto.

Overview of Business

     We design, develop and market integrated circuits for digital media applications, such as digital television, liquid crystal display (LCD) television and digital set-top boxes. Our system-on-chip semiconductors provide the “intelligence” for these new types of displays by processing and optimizing video and computer graphic signals to produce high-quality and realistic images. Many of the world’s leading manufacturers of consumer electronics and computer display products utilize our technology to enhance image quality and ease of use of their products. Our goal is to provide the best image quality enhanced digital media integrated circuits at competitive prices to users.

     We sell our products primarily to digital television original equipment manufacturers in China, Korea, Taiwan and Japan. Historically, significant portions of our revenue have been generated by sales to a relatively small number of customers. Our top five customers accounted for 74% of our total revenue for the fiscal quarter ended September 30, 2004. Substantially all of our revenue to date has been denominated in U.S. dollars. Our products are manufactured primarily by United Microelectronics Corporation (UMC), a semiconductor manufacturer located in Taiwan, which also owns a minority interest in our subsidiary TTI.

     Many of our customers sell their end products, digitally enhanced televisions, in Asian and European markets, so the health of these economies and consumer spending trends are indirectly important to our business. For instance, the recent credit tightening in China is something that may indirectly affect our business. While most television purchases are made with cash in China, any resulting slowdown in construction of new homes is thought likely to have somewhat of a dampening affect on the growth of television sales in China. The basis for our comment is anecdotal and cannot be easily quantified. However, this is a situation we continue to monitor.

     We operate primarily through subsidiaries and offices located in California, Taiwan and China. Trident Microsystems, Inc. (TMI), located in Sunnyvale, California, acts as an administrative home office,

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operating through our 80% owned subsidiary, Trident Technology, Inc. (TTI), located in Taipei, Taiwan, TTI’s US Branch located in Sunnyvale, California and our 100% owned subsidiary, Trident Multimedia Technologies (Shanghai) Co., Ltd. (TMT), located in Shanghai, China. Our net income is determined after taking a charge for the share of income relating to the minority interest in TTI. In general our executives are focused on revenue growth and developing new integrated circuits that garners as many high volume future design wins with customers as possible to continue to fuel that revenue growth. Management believes that the Company is operating in what will be a very high growth market over the next 5 years and that success will be measured by companies that seize a “first mover” advantage early in the market’s growth cycle and continue to deliver new innovative products that will hold and grow the Company’s share of the market. Our executives also focus on trends in average selling price erosion as well as gross margin, operating income and cash flow from operations.

     References to “we,” “Trident,” or the “Company” in this report refer to Trident Microsystems, Inc. and its subsidiaries, including TTI which was 83% owned by TMI as of June 30, 2004, and is approximately 80% owned by TMI as of September 30, 2004.

Recent Developments

     Our Board of Directors has authorized management to develop and present a proposal for acquiring the minority interests in our subsidiary TTI. The development of a proposal will require us to address a number of issues and may require negotiation with holders of minority interests. We will need to obtain valuation advice and address structural issues including the most expedient approach to acquiring all or substantially all of the minority interests, and the Board will need to evaluate any proposal and determine whether to proceed with any such proposal. We have not presented a proposal and cannot predict the likelihood or timing of such a transaction. However, we believe that it will be at least several months before any transaction could be proposed reviewed, negotiated and finalized.

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Results of Operations

     The following table sets forth the results of operations expressed as percentages of revenues for the three months ended September 30, 2004 and 2003:

     The following table provides statement of operations data and the percentage change from the prior year (in thousands):

Revenues

     Net sales for the three months ended September 30, 2004 were $16.6 million, an increase of 69% from the $9.8 million reported in the three months ended September 30, 2003. The increase in sales of digitally processed television products in the quarter ended September 30, 2004 was primarily attributed to continued success of our Super Video Processor (SVP) and Motion Video (MV) products in the digital and liquid crystal display television markets. The volume of Digital media units increased by more than 120% from the quarter ended September 30, 2003 to the quarter ended September 30, 2004, however, as is typical with consumer electronics markets, average selling prices decreased by approximately 10% for the same time period. For the December quarter, we expect growth to slow temporarily and revenue

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could be down by as much as 5% - 9% from the September quarter due to a continued soft LCDTV end market and product generation transition from our fourth generation to our fifth generation SVP products at certain customers. We expect growth to resume in the March quarter.

     Sales to customers in Asia, primarily China, Japan and Taiwan accounted for 55%, 27% and 12%, respectively, of our revenues in the three months ended September 30, 2004. Sales to customers in Asia, primarily China, Taiwan and Korea accounted for 62%, 17% and 12%, respectively, of our revenues in the three months ended September 30, 2003. We expect customers in Asia will continue to account for a significant portion of our sales. In the three months ended September 30, 2004, sales to four customers, Skyworth (a television manufacturer located in China), Midoriya (Sony), Hisense (a television manufacturer located in China), and Innotech (Toshiba) accounted for 25%, 17%, 14% and 10% of revenues, respectively. In the three months ended September 30, 2003, sales to three customers, TCL and Skyworth (television manufacturers located in China), and Samsung accounted for 23%, 22% and 15% of revenues, respectively. Approximately 27% of sales in the quarter ended September 30, 2004 were made through distributors.

Gross Profit

     Gross profit increased to $9.2 million for the three months ended September 30, 2004 from $5.0 million for the three months ended September 30, 2003. The increase was due to both increased revenues and increased sales of DPTV products which have higher margins. The gross margin as a percentage of revenues for the three months ended September 30, 2004 increased to 55.3% of revenues from 50.6% for the three months ended September 30, 2003. The increase in gross margin as a percentage of revenues was primarily attributable to higher sales of new DPTV products which have higher sales margins.

     We believe that the prices of high-technology products will decline over time as competition increases and new and more advanced products are introduced. We expect average selling prices of existing products to continue to decline, although the average selling prices of our entire product line may remain constant or increase as a result of introductions of new higher-performance products which may have additional functionality and which are planned to have higher margins. Our strategy is to maintain and improve gross margins by (1) developing new and more advanced products that have higher margins, (2) reducing manufacturing costs by improving production yield and (3) aggressively developing more cost effective products. There is no assurance that we will be able to develop and introduce new products on a timely basis or that we can reduce manufacturing costs.

Research and Development

     Research and development expenses for the three months ended September 30, 2004 increased to $4.7 million from $2.1 million for the three months ended September 30, 2003. As a percentage of revenues, research and development expenses increased to 28.5% for the three months ended September 30, 2004, from 21.2% for the three months ended September 30, 2003. The increase in research and development expenses, both in actual dollars and as a percentage of sales, was primarily the result of increased spending on additional personnel (approximately $1.0 million), facilities (approximately $0.3 million) and tape out related expenditures (approximately $0.3 million) and a reclassification of technical support that was referred to as sales and marketing expense in the previous year of approximately $0.7 million.

     We are currently planning to continue developing the next generation DPTV™ products as well as other advanced products for the digital television market in the U.S., China, Japan, Korea, Taiwan and Europe. However, there can be no assurance that these products will be quickly or widely accepted by consumers in the market place, or that the new products will be developed and shipped in a timely manner.

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Selling, General and Administrative

     Selling, general and administrative expenses decreased to $2.4 million in the three months ended September 30, 2004 from $3.0 million in the three months ended September 30, 2003. As a percentage of revenues selling, general and administrative expenses decreased to 14.2% in the three months ended September 30, 2004 from 30.8% in the three months ended September 30, 2003. The decrease in selling, general and administrative expenditures in actual dollars and as a percentage of revenues was due primarily to a reclassification of technical support to research and development (approximately $0.7 million) and an increase in sales representative commission expense commensurate with the increase in sales volume of $0.5 million offset by a one time reversal of approximately $780,000 in legal fees accrued for the Neomagic litigation which was finally settled in August of 2004. We will continue to monitor and control our selling, general and administrative expenses.

Interest and Other Income and Expense, Net

     Net interest and other income of $99,000 for the quarter ended September 30, 2004 primarily represents interest income of $91,000. Interest income increased to $91,000 in the three months ended September 30, 2004, from $12,000 in the same prior year period. The increase in interest income was primarily the result of higher average cash levels invested during the three months ended September 30, 2004. Net interest and other expense of $128,000 for the quarter ended September 30, 2003 primarily represented expenses relating to our restructuring. The amount of interest income earned by us varies directly with the amount of our cash and cash equivalents and the prevailing interest rates.

Minority Interests in subsidiaries

     Minority interests in subsidiaries increased to $589,000 for the three months ended September 30, 2004 from $96,000 recorded in the three months ended September 30, 2003. The increase in minority interest in the three months ended September 30, 2004 can be primarily attributed to an increase in TTI’s operating income and the dilution of interests in TTI. We currently own approximately 80% of our TTI subsidiary, decreased from 83% as of September 30, 2003.

     Minority interests represents the share of income relating to minority shareholders of our consolidated subsidiaries. The amount of such charges is dependent upon the minority ownership in our subsidiaries, TTI in particular. The percentage held by minority shareholders will increase in the future if employees of TTI exercise options to acquire TTI stock, or if we determine to sell further interests in TTI to outside investors. We are reviewing the possibility of a public offering of TTI stock in Taiwan, or possibly, in the United States. We are also reviewing the possibility of acquiring the minority interests in TTI. No decision has been made to proceed with either an offering or an acquisition. Prior to this time, we have taken steps to ensure that an offering could occur in Taiwan if we decided to proceed. We intend to retain a majority interest in TTI in all cases, but any such offering would increase the minority ownership in TTI and any such acquisition would be intended to reduce the minority ownership to the maximum extent reasonably possible.

Provision for Income Taxes

     Provision for income taxes decreased to $617,000 for the three months ended September 30, 2004 from $2,170,000 recorded for the three months ended September 30, 2003 primarily as a result of our Taiwan operations.

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Investment in UMC and Other Investments

     As of September 30, 2004, the Company owned approximately 75.1 million shares of United Microelectronics Corporation (UMC) which represents about 0.5% of the outstanding stock of UMC. See Part I, Item 1, Notes 7 and 9 above (“Investment in UMC” and “Comprehensive Income (Loss),” respectively) for discussion of this investment and related losses.

During the quarter ended September 30, 2004, we recognized net gain on investments totaling $401,000 as follows:

During the quarter ended September 30, 2003, we recognized net gain on investments totaling $7.2 million as follows:

See Part I, Item 1, Notes 8 and 9 above (“ Gain on investments, net” and “Comprehensive Income (Loss),” respectively) for discussion of these investments and related losses. While we cannot predict the future values of our investments, we do anticipate that our future financial performance will be affected by future fluctuations of such values.

     Under the Investment Company Act of 1940 (the “1940 Act”), a company meeting the definition of an “investment company” is subject to various stringent legal requirements on its operations. A company may become subject to the 1940 Act if, among other reasons, it owns investment securities with a value exceeding 40 percent of the value of its total assets (excluding government securities and cash items) on an unconsolidated basis, unless a particular exemption or safe harbor applies. “Investment securities” do not include interests in majority owned subsidiaries, and we intend to maintain a majority interest in our subsidiaries, including TTI, for the foreseeable future. We do hold other securities, including shares in UMC, and the value of those securities fluctuates significantly. At times, the total value of the investment securities we hold may, and recently has, exceeded 40% of total assets. However, we are, and intend to remain, an operating company. Our efforts are focused almost exclusively on our digital media business and we intend to continue to conduct business as an operating company, and to take such actions as are necessary to ensure we are not, and are not regulated as, an investment company.

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Liquidity and Capital Resources

     As of September 30, 2004, our principal sources of liquidity included cash and cash equivalents of $35.4 million, which increased from $32.5 million at June 30, 2004. During the three months ended September 30, 2004, $2.3 million of cash was provided by operations, compared to the three months ended September 30, 2003, during which $3.7 million of cash was provided by operations. Cash provided by operations in the three months ended September 30, 2004 was primarily due to increased operating income and accounts payable of $865,000, offset by increases in prepaid expenses and other assets of $859,000. Cash provided by operations in the three months ended September 30, 2003 was primarily due to operating income, a decrease in accounts receivable of $3,743,000 and an increase in income taxes payable $2,170,000.

     Prepaid expenses increased $859,000 during the three months ended September 30, 2004 primarily due to the prepayment of software license fees. Accounts payable increased $865,000 during the three months ended September 30, 2004 due primarily to increased research and development expenditures.

     During the three months ended September 30, 2004, $355,000 was provided by investing activities of which $877,000 was primarily provided by the proceeds from the sale of TTI stock, $690,000 was provided by the exercise of TTI employee stock options and $22,000 of cash provided by the sale of a long-term investment, offset by $982,000 of cash used primarily in the purchase of engineering software licenses fees and $252,000 of cash used in the purchase of property plant and equipment. During the three months ended September 30, 2003, $11.3 million of net cash was provided by investing activities of which $11.6 million was primarily the net proceeds of $8.4 million from the transfer of our Graphics Division to XGI and the sale of one-third of our interest in XGI, the sale of approximately 6.8% equity interest in our TTI subsidiary of $2.8 million, and $400,000 from the liquidation of a short-term investment.

     During the three months ended September 30, 2004, $246,000 of net cash was provided by financing activities which relates to the exercise of employee stock options in TMI. During the three months ended September 30, 2003, $2.1 million of net cash was provided by financing activities which was the result of the exercising of employee stock options.

     While we are an operating company not in the business of investing, reinvesting, owning, holding or trading in securities, we do intend to monitor the advisability of disposing of our UMC stock and intend to sell all or part of the stock when it is in the best interests of our stockholders to do so.

     We believe our current resources are sufficient to meet our needs for at least the next twelve months. We regularly consider transactions to finance our activities, including debt and equity offerings and new credit facilities or other financing transactions. We believe our current reserves are adequate.

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Contractual Obligations

     As of September 30, 2004, our principal commitments consisted of obligations outstanding under non-cancelable operating leases and unconditional purchase order commitments for wafers and chipsets. Our operating lease commitments include the lease of our headquarters in Sunnyvale, California and leases for four premises in China and two premises in Taiwan. Our lease agreements expire at various dates through 2008 and require payment of property taxes, insurance, maintenance and utilities. The following table summarizes our contractual obligations and commitments as of September 30, 2004 (in millions):

     We believe our current resources are sufficient to meet our needs for at least the next twelve months. However, we regularly consider transactions to finance our activities, including debt and equity offerings and new credit facilities or other financing transactions. On a longer term basis the Company is focused on managing for positive and growing cash flow from operations. The business is largely engineering focused and as such, does not require long term capital commitments other than for office and lab space. Additional liquidity will be provided from the eventual disposition of the UMC stock which the Company intends to eventually sell and reinvest into more traditional liquid short term secure fixed income type instruments. The Company also believes that as long as it continues to grow and prosper that additional funds could also be raised in the future through an equity offering. This is dependent on the Company’s future performance as well as the availability of favorable capital markets which is difficult to predict or for see in the longer term.

Off-Balance Sheet Arrangements

     We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.

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Factors That May Affect Our Results

While we recognized operating income in the quarter ended September 30, 2004, we have incurred operating losses in recent history.

     We recognized income from operations of $2.1 million in the quarter ended September 30, 2004. However, we did incur losses for several quarters prior to our reorganization completed in August 2003.

     Our reorganization was intended to reduce our operating expenses and position the Company in a market in which we may be profitable. We are trying to expedite new digital media product launchings and to control operating expenses to achieve sustained profitability. However, there is no guarantee that our efforts will be successful. Sales and marketing, product development and general and administrative expenses may increase as a result of shifts in the market place, our efforts in developing and marketing new products, and our need to respond to these shifts, which could result in the need to generate significantly higher revenue to achieve and sustain profitability.

Our success depends upon the digital television market and we must continue to develop new products and to enhance our existing products.

     The digitally processed television industry is characterized by rapidly changing technology, frequent new product introductions, and changes in customer requirements. Our future success depends on our ability to anticipate market needs and develop products that address those needs. As a result, our products could quickly become obsolete if we fail to predict market needs accurately or develop new products or product enhancements in a timely manner. The long term success in the digitally processed television business will depend on the introduction of successive generations of products in time to meet the design cycles as well as the specifications of television original equipment manufacturers. Our failure to predict market needs accurately or to develop new products or product enhancements in a timely manner will harm market acceptance and sales of our products. If the development or enhancement of these products or any other future products takes longer than we anticipate, or if we are unable to introduce these products to market, our sales will not increase. Even if we are able to develop and commercially introduce these new products, the new products may not achieve widespread market acceptance necessary to provide an adequate return on our investment.

We have had fluctuations in quarterly results in the past and may continue to do so in the future.

     Our quarterly revenue and operating results have varied in the past and may fluctuate in the future due to a number of factors including:

•		uncertain demand in new markets in which we have limited experience;
•		fluctuations in demand for our products, including seasonality;
•		unexpected product returns or the cancellation or rescheduling of significant orders;
•		our ability to develop, introduce, ship and support new products and product enhancements and to manage product transitions;
•		new product introductions by our competitors;
•		seasonality, particularly in the third quarter of each fiscal year, due to the extended holidays surrounding the Chinese New Year;
•		our ability to achieve required cost reductions;
•		our ability to attain and maintain production volumes and quality levels for our products;
•		delayed new product introductions;
•		unfavorable responses to new products;
•		adverse economic conditions, particularly in Asia; and
•		the mix of products sold and the mix of distribution channels through which they are sold.

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     The quarterly results of TMI also depend in part on the charges we incur as a result of the minority ownership of TTI. The minority ownership will increase in the future as a result of the exercise of TTI options by employees or if we determine to sell further interests in TTI.

Dilution of shareholders’ interest may occur.

     As part of our business strategy, we review acquisition and strategic investment prospects that would complement our current product offerings, augment our market coverage or enhance our technical capabilities, or that may otherwise offer growth opportunities. We consider from time to time investment opportunities in new businesses, and we expect to make investments in and may acquire businesses, products or technologies in the future. In the event of any future acquisitions, we could issue equity securities, which would dilute current stockholders’ percentage ownership.

     We have considered the possibility of a public offering of TTI stock in Taiwan. We are also considering the acquisition of the minority interests in TTI. A decision has not been made as to either transaction at this time. A public offering would increase the minority ownership in TTI, and result in larger charges, as a percentage of operating income, for minority interest in subsidiaries. An acquisition of the minority interests would probably occur through the issuance of additional TMI shares and possibly some cash. A proposal is being developed by management for such a transaction and it is anticipated that such a transaction would be accretive to Company shareholders, however we cannot assure that such a transaction will occur or that it will be accretive.

     On November 5, 2003, the Company announced that its Board of Directors had approved a three-for-two stock split of the Company’s outstanding shares of common stock to be effected in the form of a 50 percent stock dividend. The stock split entitled each stockholder of record at the close of business on November 26, 2003 to receive one additional share for every two outstanding shares of common stock held on the record date. The additional shares resulting from the stock split were distributed on December 12, 2003. On March 17, 2004, a Special Meeting of Stockholders was held and approval was given to increase the number of authorized shares of common stock from 30,000,000 to 60,000,000. All share numbers in this document reflect the capital structure as of the end of the fiscal quarter and are therefore on a post-split basis.

     These actions could affect our operating results and/or the price of our common stock. Acquisitions and investment activities also entail numerous risks, including: difficulties in the assimilation of acquired operations, technologies or products; unanticipated costs associated with the acquisition or investment transaction; adverse effects on existing business relationships with suppliers and customers; risk associated with entering markets in which we have no or limited prior experience; and potential loss of key employees of acquired organizations.

     We cannot assure that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future, and our failure to do so could harm our business, operating results and financial condition.

We currently rely on certain international customers for a substantial portion of our revenue.

     As a result of our focus on Digital Media products, we expect to be primarily dependent on international sales and operations, particularly in Taiwan, Japan, Korea and China, which are expected to constitute a significant portion of our sales in the future. There are a number of risks arising from our international business, which could adversely affect future results, including:

•		exchange rate variations
•		potential adverse tax consequences; and
•		unexpected changes in regulatory requirements.

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     Our international sales currently are U.S. dollar-denominated. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets.

Intense competition exists in the market for digital media products.

     We plan to continue developing the next generation DPTV™, HiDTV™ as well as other advanced products for digital TV and digital STB for the digital television market in the U.S., China, Japan, Korea, Taiwan and Europe. We believe the market for digital television will be competitive, and will require substantial research and development, technical support, sales and other expenditures to stay competitive in this market. In the digital television market our principal competitors are Toshiba, Philips Electronics, Micronas AG, Pixelworks, Inc., Genesis Microchip, Inc. ATI Technologies Inc., Zoran Corporation, ST Microelectronics, and Media Tek, Ltd. Certain of our current competitors and many potential competitors have significantly greater technical, manufacturing, financial and marketing resources than we have. Therefore, we expect to devote significant resources to the DPTV™ and HiDTV™ market even though competitors are substantially more experienced than we are in this market.

We are vulnerable to undetected product problems.

     Although we establish and implement test specifications, impose quality standards upon our suppliers and perform separate application-based compatibility and system testing, our products may contain undetected defects, which may or may not be material, and which may or may not have a feasible solution. Although we have experienced such errors in the past, significant errors have generally been detected relatively early in a product’s life cycle and therefore that costs associated with such errors have been immaterial. We cannot ensure that such errors will not be found from time to time in new or enhanced products after commencement of commercial shipments. These problems may materially adversely affect our business by causing us to incur significant warranty and repair costs, diverting the attention of our engineering personnel from our product development efforts and causing significant customer relations problems.

Our reliance upon independent foundries could make it difficult to obtain products and affect our sales.

     If the demand for our products grows, we will need to increase our material purchases, contract manufacturing capacity and internal test and quality functions. Any disruptions in product flow could limit our revenue, adversely affect our competitive position and reputation and result in additional costs or cancellation of orders under agreements with our customers.

     We currently rely on one third-party foundry to manufacture our products either in finished form or wafer form. Generally, foundries are not obligated to manufacture our products on a long-term fixed price base. If we encounter shortages and delays in obtaining components, our ability to meet customer orders would be materially adversely affected.

The market price of our common stock has been, and may continue to be volatile.

     The market price of our common stock has been, and may continue to be volatile. Factors such as new product announcements by us or our competitors, quarterly fluctuations in our operating results and unfavorable conditions in the digital television market may have a significant impact on the market price of our common stock. These conditions, as well as factors that generally affect the market for stocks and stocks in high-technology companies in particular, could cause the price of our stock to fluctuate from time to time.

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Our success depends to a significant degree on the continued employment of key personnel.

     Our success depends to a significant degree upon the continued contributions of the principal members of our technical sales, marketing, engineering and management personnel, many of whom perform important management functions and would be difficult to replace. We particularly depend upon the continued services of our executive officers, particularly Frank Lin, our President and Chief Executive Officer, Dr. Jung-Herng Chang, President of TTI, John Edmunds, Chief Financial Officer and Peter Jen, Senior Vice President, Asia Operations and Chief Accounting Officer and other key engineering, sales, marketing, finance, manufacturing and support personnel. In addition, we depend upon the continued services of key management personnel at our overseas subsidiaries. Our officers and key employees are not bound by employment agreements for any specific term, and may terminate their employment at any time. In order to continue to expand our product offerings both in the U.S. and abroad, we must hire and retain a number of research and development personnel. Hiring technical sales personnel in our industry is very competitive due to the limited number of people available with the necessary technical skills and understanding of our technologies. Our ability to continue to attract and retain highly skilled personnel will be a critical factor in determining whether we will be successful in the future. Competition for highly skilled personnel is intense, particularly in Northern California. If we are not successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs, our business may be harmed.

Our success depends in part on our ability to protect our intellectual property rights, which may be difficult.

     The digital media market is a highly competitive industry in which we, and most other participants, rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and licensing arrangements to establish and protect proprietary rights. The competitive nature of our industry, rapidly changing technology, frequent new product introductions, changes in customer requirements and evolving industry standards heighten the importance of protecting proprietary technology rights. Since the United States Patent and Trademark Office keeps patent applications confidential until a patent is issued, our pending patent applications may attempt to protect proprietary technology claimed in a third party patent application. Our existing and future patents may not be sufficiently broad to protect our proprietary technologies as policing unauthorized use of our products is difficult and we cannot be certain that the steps we have taken will prevent the misappropriation or unauthorized use of our technologies, particularly in foreign countries where the laws may not protect our proprietary rights as fully as U.S. law. Our competitors may independently develop similar technology, duplicate our products or design around any of our patents or other intellectual property. If we are unable to adequately protect our proprietary technology rights, others may be able to use our proprietary technology without having to compensate us, which could reduce our revenues and negatively impact our ability to compete effectively. We have in the past, and may in the future, file lawsuits to enforce our intellectual property rights or to determine the validity or scope of the proprietary rights of others. As a result of any such litigation or resulting counterclaims, we could lose our proprietary rights and incur substantial unexpected operating costs. Any action we take to protect our intellectual property rights could be costly and could absorb significant management time and attention. In addition, failure to adequately protect our trademark rights could impair our brand identity and our ability to compete effectively.

We have been involved in intellectual property infringement claims, and may be involved in others in the future, which can be costly.

     Our industry is very competitive and is characterized by frequent litigation alleging infringement of intellectual property rights. Numerous patents in our industry have already been issued and as the market further develops and additional intellectual property protection is obtained by participants in our

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industry, litigation is likely to become more frequent. From time to time, third parties have asserted and are likely in the future to assert patent, copyright, trademark and other intellectual property rights to technologies or rights that are important to our business. Historically we have been involved in such disputes. See Part II, Item 1 (“Legal Proceedings”). In addition, we have and may in the future enter into agreements to indemnify our customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. Litigation or other disputes or negotiations arising from claims asserting that our products infringe or may infringe the proprietary rights of third parties, whether with or without merit, has been and may in the future be, time-consuming, resulting in significant expenses and diverting the efforts of our technical and management personnel. We do not have insurance against our alleged or actual infringement of intellectual property of others. These claims, if resolved adversely to us, could cause us to stop selling our products which incorporate the challenged intellectual property and could also result in product shipment delays or require us to redesign or modify our products or to enter into licensing agreements. These licensing agreements, if required, would increase our product costs and may not be available on terms acceptable to us, if at all. If there is a successful claim of infringement or we fail to develop non-infringing technology or license the proprietary rights on a timely and reasonable basis, our business could be harmed.

Natural disasters could limit our ability to supply products.

     Our primary suppliers are located in California and Taiwan, both active earthquake fault zones. These regions have experienced large earthquakes in the past and may experience them in the future. A large earthquake in any of these areas could disrupt our manufacturing operations for an extended period of time, which would limit our ability to supply our products to our customers in sufficient quantities on a timely basis, harming our customer relationships.

Future terrorist attacks may affect our business.

     We cannot guarantee that our business will be unaffected by terrorist attacks in the future. The impact and future effects of terrorism are currently uncertain, and we are unable to predict the future impact that terrorist attacks may have on our business and operations, the international markets in which we operate and the global economy in general.

Changes in our business organization will affect our operations.

     As a result of our reorganization and as we go forward into fiscal year 2005, our principle design, development and marketing effort will focus primarily on our Digital Media products. These products are now our only product line and our success in the near term depends upon the growth of the market for these products and our success in this market. Our success in the longer term will also depend on our ability to develop and introduce other digital media products. Through our TTI subsidiary, we plan to continue developing the next generation DPTV™ and HDTV, as well as other advanced products for digital TV and digital STB for the digital television market in the U.S., China, Japan, Korea, Taiwan and Europe. While we anticipate this market to generate an increasing percentage of our revenues, we have limited experience with digital video television. There can be no guarantee that our digital media products will be accepted by the market or increase our revenues or profitability.

The performance of our investment in UMC is uncertain.

     We hold a substantial investment in UMC as well as a few smaller investments in other companies. The values of these investments are subject to market price volatility. We have in the past incurred losses on our investments. In the future, we could further lose a portion of, or our entire investment, in these companies.

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Changes in stock option accounting rules may adversely impact our reported operating results prepared in accordance with generally accepted accounting principles, our stock price and our competitiveness in the employee marketplace.

     Technology companies like ours have a history of using broad based employee stock option programs to hire, incentivize and retain our workforce in a competitive marketplace. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) allows companies the choice of either using a fair value method of accounting for options, which would result in expense recognition for all options granted, or using an intrinsic value method, as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), with a pro forma disclosure of the impact on net income (loss) of using the fair value option expense recognition method. We have elected to apply APB 25 and accordingly we generally do not recognize any expense with respect to employee stock options as long as such options are granted at exercise prices equal to the fair value of our common stock on the date of grant.

     During March 2004 the FASB issued a proposed Statement, “Share-Based Payment, an amendment of FASB Statements No. 123 and 95”. The proposed statement eliminates the treatment for share-based transactions using APB 25 and generally would require share-based payments to employees be accounted for using a fair-value-based method and recognized as expenses in our statements of operations. The proposed standard would require the modified prospective method be used, which would require that the fair value of new awards granted from the beginning of the year of adoption plus unvested awards at the date of adoption be expensed over the vesting term. In addition, the proposed statement encourages companies to use the “binomial” approach to value stock options, as opposed to the Black-Scholes option pricing model that we currently use for the fair value of our options under SFAS 123 disclosure provisions.

     The effective date the proposed standard is recommending is for fiscal years beginning after June 15, 2005. Should this proposed statement be finalized, it will have a significant impact on our consolidated statement of operations as we will be required to expense the fair value of our stock options rather than disclosing the impact on our consolidated result of operations within our footnotes in accordance with the disclosure provisions of SFAS 123 (see Note 6 of the notes to unaudited condensed consolidated financial statements). This will result in lower reported earnings per share which could negatively impact our future stock price. In addition, should the proposal be finalized, this could impact our ability to utilize broad based employee stock plans to reward employees and could result in a competitive disadvantage to us in the employee marketplace.

We are exposed to increased costs and risks associated with complying with increasing and new regulation of corporate governance and disclosure standards.

     We are spending an increasing amount of management time and external resources to comply with changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules. In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and evaluation of our internal control systems, and attestations of the effectiveness of these systems by our independent registered public accounting firm. We are currently documenting our internal control systems and procedures and considering improvements that may be necessary in order for us to comply with the requirements of Section 404 by the end of fiscal 2005. This process may require us to hire additional personnel and outside advisory services and has resulted in additional accounting and legal expenses. In addition, the evaluation and attestation processes required by Section 404 are new and neither companies nor auditing firms have significant experiences in testing or complying with these requirements. Accordingly, we may encounter problems or delays in completing the review and evaluation, the implementation of improvements and the receipt of a positive attestation by our

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independent registered public accounting firm. While we believe that we currently have adequate internal controls over financial reporting, in the event that our chief executive officer, chief financial officer or independent registered public accounting firm determine that our controls over financial reporting are not effective as defined under Section 404, investor perceptions of our company may be adversely affected and could cause a decline in the market price of our stock.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest rate risk

     We currently maintain our cash equivalents primarily in money market funds and highly liquid marketable securities. We do not have any derivative financial instruments. As of September 30, 2004, approximately $35.4 million of our investments matured in less than three months. We will continue to invest a significant portion of our existing cash equivalents in interest bearing, investment grade securities, with maturities of less than twelve months. We do not believe that our investments, in the aggregate, have significant exposure to interest rate risk.

Exchange rate risk

     We currently have operations in the United States, Taiwan and China. The functional currency of all our operations is the U.S. dollar. Though some expenses are incurred in local currencies by our Taiwan and China operations, substantially all of our transactions are made in U.S. dollars, hence, we have minimal exposure to foreign currency rate fluctuations relating to our transactions.

     While we expect our international revenues to continue to be denominated predominately in U.S. dollars, an increasing portion of our international revenues may be denominated in foreign currencies in the future. In addition, we plan to continue to expand our overseas operations. As a result, our operating results may become subject to significant fluctuations based upon changes in exchange rates of certain currencies in relation to the U.S. dollar. We will analyze our exposure to currency fluctuations and may engage in financial hedging techniques in the future to attempt to minimize the effect of these potential fluctuations; however, exchange rate fluctuations may adversely affect our financial results in the future.

Investment risk

     We are exposed to market risk as it relates to changes in the market value of our investments in public companies. We invest in equity instruments of public companies for business and strategic purposes and we have classified these securities as available-for-sale. These available-for-sale equity investments, primarily in technology companies, are subject to significant fluctuations in fair market value due to the volatility of the stock market and the industries in which these companies participate. As of September 30, 2004, we had available-for-sale equity investments with a fair market value of $45.3 million all relating to shares of UMC. Our objective in managing our exposure to stock market fluctuations is to minimize the impact of stock market declines to our earnings and cash flows. There are, however, a number of factors beyond our control. Continued market volatility, as well as mergers and acquisitions, have the potential to have a material impact on our results of operations in future periods.

     We are also exposed to changes in the value of our investments in non-public companies, including start-up companies. These long-term equity investments in technology companies are subject to significant fluctuations in fair value due to the volatility of the industries in which these companies participate and other factors. For the three months ended September 30, 2004, we recognized an impairment loss of approximately $315,000 on our investments in private companies that we concluded was other-than-temporary. As of September 30, 2004, the balance of our long-term equity investments in non-public companies was approximately $2.4 million.

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Item 4: Controls and Procedures

(a)

Evaluation of Disclosure Controls and Procedures

          Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

(b)

Changes in Internal Control Over Financial Reporting

          There was no change in our internal control over financial reporting during the quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II: Other Information

Item 1: Legal Proceedings

     On December 14, 1998, NeoMagic Corporation (“NeoMagic”) filed a patent infringement action against the Company in the United States District Court for the District of Delaware, Case No. 98-CV-699. After years of litigation, the Federal Circuit issued a unanimous decision on August 4, 2004 which affirmed summary judgment in the Company’s favor on the remaining claim against the Company. Trident’s counterclaim against NeoMagic for violation of Section 2 of the Sherman Act, attempted monopolization arising out of NeoMagic’s prosecution of the patent infringement action against Trident, remains pending in Delaware federal district court.

     From time to time, the Company may be involved in litigation tin the normal course of business. The results of any litigation matters are inherently uncertain. In the event of an adverse decision in the described legal actions or disputes, or any other related litigation with third parties that could arise in the future with respect to patents or other intellectual property rights relevant to the Company’s products, the Company could be required to pay damages and other expenses, to cease the manufacture, use and sale of infringing products, to expend significant resources to develop non-infringing technology or to obtain licenses to the infringing technology. The Company cannot make any assurance that these matters will not materially and adversely affect the Company’s business, financial condition, operating results, or cash flows.

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds

     Not applicable

Item 3: Defaults upon Senior Securities

     Not applicable

Item 4: Submission of Matters to a Vote of Security Holders

     Not applicable

Item 5: Other Information

     Not applicable

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Item 6: Exhibits

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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 November 9, 2004, on its behalf by the undersigned thereunto duly authorized.

Trident Microsystems, Inc.

/s/ Frank C. Lin

/s/ John S. Edmunds

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Index to Exhibits