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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, DC 20549

 


 

FORM 10-Q

 

(Mark one)

 

ý

 

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

 

For the quarterly period ended March 31, 2004

 

OR

 

o

 

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

 

For the transition period from            to           

 

 

Commission file number 000-32929

 


 

Monolithic System Technology, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

77-0291941

(State or other jurisdiction
of Incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

1020 Stewart Drive
Sunnyvale, California, 94085

(Address of principal executive office and zip code)

 

(408) 731-1800

(Registrant’s telephone number, including area code)

 


 

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

YES ý  NO o

 

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

YES ý  NO o

 

As of May 3, 2004, 31,131,238 shares of the Registrant’s common stock, $0.01 par value, were outstanding.

 

 



 

MONOLITHIC SYSTEM TECHNOLOGY, INC.

 

FORM 10-Q
March 31, 2004

 

INDEX

 

PART I—FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements:

 

 

 

 

a.

Condensed Consolidated Balance Sheets as of March 31, 2004 (Unaudited) and December 31, 2003

 

 

 

 

 

 

b.

Condensed Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003 (Unaudited)

 

 

 

 

 

 

c.

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003 (Unaudited)

 

 

 

 

 

 

d.

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

Item 3.

Qualitative and Quantitative Disclosure About Market Risk

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

PART II—OTHER INFORMATION

 

 

 

Item 1.

Legal Proceedings

 

 

 

 

Item 2.

Changes In Securities and Use of Proceeds

 

 

 

 

Item 5.

Other Information

 

 

 

 

Item 6.

Exhibits and Reports on Form 8-K

 

 

 

 

 

Signatures

 

 

2



 

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

MONOLITHIC SYSTEM TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

 

 

 

March 31,
2004

 

December 31,
2003

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

28,177

 

$

22,033

 

Short-term investments

 

14,626

 

19,332

 

Accounts receivable, net

 

609

 

1,027

 

Unbilled contract receivables

 

2,152

 

1,106

 

Inventories, net

 

437

 

474

 

Prepaid expenses and other current assets

 

2,700

 

3,822

 

Total current assets

 

48,701

 

47,794

 

Long-term investments

 

46,320

 

44,462

 

Property and equipment, net

 

1,545

 

1,796

 

Goodwill

 

12,326

 

12,326

 

Other assets

 

513

 

514

 

Total assets

 

$

109,405

 

$

106,892

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

114

 

$

116

 

Accrued expenses and other liabilities

 

3,171

 

2,733

 

Deferred revenue

 

208

 

506

 

Current portion of capital lease obligations

 

11

 

13

 

Total current liabilities

 

3,504

 

3,368

 

Long-term portion of capital lease obligations

 

11

 

13

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.01 par value; 20,000 shares authorized; none issued and outstanding at March 31, 2004 and December 31, 2003

 

 

 

Common stock, $0.01 par value; 120,000 shares authorized; 31,063 shares and 30,724 shares issued and outstanding at March 31, 2004 and December 31, 2003

 

311

 

307

 

Additional paid-in capital

 

101,908

 

99,719

 

Deferred stock-based compensation

 

(39

)

(626

)

Accumulated other comprehensive income

 

176

 

56

 

Retained earnings

 

3,534

 

4,055

 

Total stockholders’ equity

 

105,890

 

103,511

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

109,405

 

$

106,892

 

 

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

 

3



 

MONOLITHIC SYSTEM TECHNOLOGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 

 

 

Three Months Ended
March 31,

 

 

 

2004

 

2003

 

Net revenue:

 

 

 

 

 

Product

 

$

162

 

$

544

 

Licensing

 

2,988

 

4,513

 

Royalty

 

1,353

 

2,856

 

 

 

4,503

 

7,913

 

 

 

 

 

 

 

Cost of net revenue:

 

 

 

 

 

Product

 

150

 

407

 

Licensing

 

375

 

615

 

 

 

525

 

1,022

 

Gross profit

 

3,978

 

6,891

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Research and development

 

2,206

 

2,245

 

Selling, general and administrative

 

2,758

 

1,670

 

Stock-based compensation expense

 

26

 

126

 

Total operating expenses

 

4,990

 

4,041

 

Income (loss) from operations

 

(1,012

)

2,850

 

Interest and other income

 

361

 

490

 

Income (loss) before income taxes

 

(651

)

3,340

 

Benefit (provision) for income taxes

 

130

 

(668

)

 

 

 

 

 

 

Net income (loss)

 

$

(521

)

$

2,672

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

Basic

 

$

(0.02

)

$

0.09

 

Diluted

 

$

(0.02

)

$

0.09

 

 

 

 

 

 

 

Shares used in computing net income (loss) per share:

 

 

 

 

 

Basic

 

30,845

 

30,302

 

Diluted

 

30,845

 

30,539

 

Allocation of stock-based compensation to operating expenses:

 

 

 

 

 

Research and development

 

$

19

 

$

52

 

Selling, general and administrative

 

7

 

74

 

 

 

 

 

 

 

 

 

$

26

 

$

126

 

 

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

 

4



 

MONOLITHIC SYSTEM TECHNOLOGY, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(Unaudited)

 

(In thousands)

 

 

 

Three Months Ended
March 31,

 

 

 

2004

 

2003

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

(521

)

$

2,672

 

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

450

 

541

 

Amortization of deferred stock-based compensation

 

26

 

126

 

Changes in current assets and liabilities:

 

 

 

 

 

Accounts receivable

 

418

 

(1,205

)

Unbilled contract receivable

 

(1,046

)

(244

)

Inventories

 

37

 

145

 

Prepaid expenses and other assets

 

1,122

 

666

 

Deferred revenue

 

(298

)

(1,107

)

Accounts payable

 

(2

)

148

 

Accrued liabilities

 

439

 

250

 

Net cash provided by operating activities

 

625

 

1,992

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of property and equipment

 

(199

)

(245

)

Purchase of available-for-sale investments

 

(81,373

)

(37,163

)

Proceeds from maturity of short-term investments

 

86,079

 

41,626

 

Purchase of long-term investments

 

(1,858

)

(5,620

)

Net cash provided by (used in) investing activities

 

2,649

 

(1,402

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Payment of capital lease obligations

 

(4

)

(57

)

Proceeds from issuance of common stock

 

2,874

 

412

 

Net cash provided by financing activities

 

2,870

 

355

 

Net increase in cash and cash equivalents

 

6,144

 

945

 

Cash and cash equivalents at beginning of period

 

22,033

 

26,321

 

Cash and cash equivalents at end of period

 

$

28,177

 

$

27,266

 

 

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

 

5



 

MONOLITHIC SYSTEM TECHNOLOGY, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(Unaudited)

 

Note 1. Background and Basis of Presentation

 

The Company

 

Monolithic System Technology, Inc. (the “Company” or “MoSys”) was incorporated in California on September 16, 1991 to design, develop and market high performance semiconductor memory products and technologies used by the semiconductor industry and electronic product manufacturers. On September 12, 2000, the shareholders approved the Company’s reincorporation in Delaware.

 

The Company has developed an innovative embedded-memory technology, called 1T-SRAM, which the Company licenses worldwide on a non-exclusive basis to semiconductor companies and electronic products manufacturers. Through 1998, the Company focused primarily on the sale of stand-alone memory products. In the fourth quarter of 1998, the Company changed the emphasis of its business model to focus primarily on the licensing of its 1T-SRAM technology.

 

The accompanying condensed consolidated financial statements of the Company have been prepared without audit in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted in accordance with these rules and regulations. The information in this report should be read in conjunction with the Company’s financial statements and notes thereto included in its most recent annual report on Form 10-K filed with the Securities and Exchange Commission.

 

In the opinion of management, the accompanying unaudited condensed financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to summarize fairly the Company’s financial position, results of operations and cash flows for the interim periods presented. The operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004 or for any other future period.

 

Basis of Presentation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. The Company reports financial results on a calendar fiscal year.

 

Use of estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

 

Revenue Recognition

 

Licensing

 

Licensing revenue consists of fees paid for engineering development and engineering support services. All contracts we have entered into to date require that the Company develop a design that meets a licensee’s specifications. For contracts involving design specifications that the Company has not previously met, the Company defers the recognition of revenue until the design meets the contractual design specifications and expenses the cost of revenue as incurred. When the Company has experience in meeting design specifications but does not have significant experience to reasonably estimate the cost of services to meet a design specification, the Company defers both the recognition of revenue and the cost. For these arrangements, the Company recognizes revenue using the completed contract method. However, if the Company has significant experience in meeting the design specification involved in the contract and the cost of services under the contract can be reasonably estimated, then the Company recognizes revenue over the period in which the contract services are performed. For these arrangements, the Company recognizes revenue using the percentage of completion method. Labor costs for the development of the licensee’s design are estimated at the beginning of the contract. As these

 

6



 

costs are incurred, they are used as a measure of progress towards completion. The Company has the ability to reasonably estimate labor cost on a contract-by-contract basis based on its experience in developing prior licensees’ designs.

 

Under our support and maintenance arrangements, we provide unspecified upgrades, design rule changes and technical support. No other upgrades, products or other post-contract support are provided. These arrangements are renewable annually by the customer. Support and maintenance revenue is recognized at its fair value ratably over the period during which the obligation exists, typically 12 months. The fair value of any support and maintenance obligation is established based on the specified renewal rate for such support and maintenance. When we provide a combination of products and services to customers, in addition to the considerations noted above, we evaluate the arrangements under EITF 00-21, Revenue Arrangements with Multiple Deliverables, which is effective for transactions entered into after June 30, 2003. EITF 00-21 addresses certain aspects of accounting for arrangements under which we will perform multiple revenue generating activities. Application of EITF 00-21 did not have a material effect on our consolidated financial position or results of operations.

 

From time to time, a licensee may cancel a project during the development phase. The cancellation is not within the Company’s control and is often caused by changes in market conditions or the licensee’s business. Generally, the Company’s contracts allow it to retain all payments that the Company has received or is entitled to collect for items and services provided before the cancellation occurs. The Company will consider a project to have been canceled even in the absence of specific notice from its licensee if there has been no activity under the contract for a significant period, and the Company believes that completion of the contract is unlikely. In this event, the Company recognizes revenue in the amount of cash received, if it has performed a sufficient portion of the development services.  In the first three months of 2004, the Company recognized no licensing revenue from cancelled projects compared to $350,000 in the same period in 2003.

 

Product

 

Revenue from product sales is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed or determinable, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations.  For each of the periods presented, there were no formal acceptance provisions with our end customers.

 

Royalty

 

Licensing contracts provide also for royalty payments at a stated rate and require licensees to report the manufacture or sale of products that include the Company’s 1T-SRAM technologies after the end of the quarter in which the sale or manufacture occurs. The Company recognizes royalties in the quarter in which the Company receives the licensee’s report.

 

Inventory

 

We state inventories at the lower of cost or market, determined using the first-in, first-out method. Our policy is to write down our inventory for estimated obsolescence or unmarketable inventory to the extent the cost exceeds the estimated market value. We base the estimate on our assumptions about historical and forecasted sales and market conditions. If actual market conditions are less favorable than those assumed in our estimates, additional inventory write-downs might be required. Our policy is to reflect any revaluation of inventory in reported income for the period in which the facts giving rise to the inventory revaluation become known.

 

Goodwill

 

We review goodwill, recorded from the acquisition of ATMOS Corp. on August 2002, for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable in accordance with the Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.”  The provisions of SFAS No. 142 require that a two-step impairment test be performed on goodwill.  In the first step, we compare the fair value of each reporting unit to its carrying value.  Using the guidance in SFAS No. 142, we consider there to be only one reporting unit at the entity level.  For step one, we determine the fair value of our reporting unit using the market approach.  Under the market approach, we estimate the fair value based on the market value of the reporting unit at the entity level.  If the fair value of the reporting unit exceeds the carrying value of net assets to the reporting unit, goodwill is not impaired and we are not required to perform further testing.  If the carrying value of the net assets to the reporting unit exceeds the fair value of the reporting unit, we must perform the second step in order to determine the implied fair value of the reporting unit’s goodwill and compare it to the carrying value of the reporting unit’s goodwill.  If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we must record an impairment loss equal to the difference.  In addition, every quarter we assess whether there are indicators of potential impairment.  As of March 31, 2004, we found no indications of potential impairment.

 

7



 

Foreign Currency Translation

 

The Company has foreign offices located in Canada, Korea, Japan and France, which are operated by subsidiaries of the Company.  The functional currency of the Company’s foreign entities is the U.S. dollar. Accordingly, the financial statements of these entities, which are maintained in the local currency, are remeasured into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52, “Foreign Currency Translation.” Exchange gains or losses from remeasurement of monetary assets and liabilities that are not denominated in U.S. dollar were not material for any period presented and are included in the consolidated income statements.

 

Cash Equivalents, Short-term and Long-term Investments

 

The Company accounts for investments in accordance with Statement of Financial Accounting Standards No. 115 “Accounting for Certain Investments in Debt and Equity Securities”. Management determines the appropriate classification of debt securities at the time of purchase. The Company’s short-term and long-term investments are carried at fair value, based on quoted market prices, with the unrealized holding gains and losses reported in stockholders’ equity. Realized gains and losses and declines in the value judged to be other-than-temporary are included in interest income. The cost of securities sold is based on the specific identification method.

 

The Company invests its excess cash in money market accounts and debt instruments and considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Investments with original maturities greater than three months and remaining maturities less than one year are classified as short-term investments. Investments with remaining maturities greater than one year are classified as long-term investments.

 

Property and equipment

 

Property and equipment are stated at cost. Depreciation is generally computed using the straight-line method over the estimated useful lives of the assets, generally three years.

 

Valuation of long-lived assets

 

Long-lived assets, such as property, plant and equipment, are evaluated for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset (if any) are less than the carrying value of the asset. When impairment is identified, the carrying amount of the asset is reduced to its estimated fair value.

 

Cost of revenue

 

Product

 

Cost of product revenue consists primarily of costs associated with the manufacture, assembly and testing of our memory chip products by independent, third-party contractors.

 

Licensing

 

Cost of licensing revenue consists primarily of engineering costs directly related to engineering development projects specified in agreements we have with licensees of our 1T-SRAM technologies. These projects typically include customization of 1T-SRAM circuitry to enable embedding our memory on a licensee’s integrated circuit and may include engineering support to assist in the commencement of production of a licensee’s products. We recognize costs of licensing revenue in the following manner:

 

                  If licensing revenue is recognized using the percentage of completion method, the associated cost of licensing revenue is recognized in the period in which we incur the engineering expense.

 

                  If licensing revenue is recognized using the completed contract method, and to the extent that the amount of engineering cost does not exceed the amount of the related licensing revenue, this cost is deferred on a contract-by-contract basis from the time we have established technological feasibility of the product to be developed under the license. Technological feasibility is established when we have completed all activities necessary to demonstrate that the licensee’s product can be produced to meet the performance specifications when incorporating our technology. Deferred costs are charged to cost of licensing revenue when the related revenue is recognized.

 

8



 

                  For contracts entered into prior to establishing technological feasibility, we do not defer related development costs, but rather expense them in the period in which they are incurred. Consequently, upon completion of these contracts, we recognize the related revenues without any corresponding costs.

 

Royalty

 

There are no reported costs associated with royalty revenue.

 

Shipping and handling

 

Costs related to shipping and handling have been included in costs of sales for all periods presented. These costs are not material.

 

Advertising

 

Advertising costs are expensed as incurred and are not material.

 

Unbilled contract receivable

 

Under the percentage of completion method, if the amount of revenue recognized exceeds the amount of billings to a customer; the excess amount is carried as an unbilled contract receivable. We recorded $2.2 million and $1.1 million of unbilled contract receivable as of March 31, 2004 and December 31, 2003, respectively.

 

Research and development

 

We generally record engineering cost as research and development expense in the period incurred.

 

Stock-based compensation

 

The Company accounts for stock-based compensation arrangements in accordance with the provisions of APB No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees” and complies with the disclosure provisions of Statement of Financial Accounting Standard No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation.” Under APB No. 25, compensation cost is, in general, recognized based on the excess, if any, of the fair market value of the Company’s stock on the date of grant over the amount an employee must pay to acquire the stock. Equity instruments issued to non-employees are accounted for in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force 96-18. Deferred stock-based compensation is being amortized using the graded vesting method in accordance with Financial Accounting Standards Board Interpretation No. 28 (“FIN No. 28”) over the vesting period of each respective option, which is generally four years. Under the graded vesting method, each option grant is separated into portions based on its vesting terms, which results in acceleration of amortization expense for the overall award compared to the straight line method.

 

SFAS No. 123 pro forma disclosures

 

Had compensation cost for the Company’s option plans been determined based on the fair value at the grant dates, as prescribed in SFAS 123, the Company’s net income (loss) would have been as follows (in thousands, except per share amounts):

 

 

 

Three months ended March 31,

 

 

 

2004

 

2003

 

 

 

 

 

 

 

Net income (loss):

 

 

 

 

 

As reported

 

$

(521

)

$

2,672

 

Stock-based compensation expense to the income statement

 

23

 

78

 

Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects

 

(1,076

)

(1,015

)

Pro forma

 

$

(1,574

)

$

1,735

 

 

 

 

 

 

 

Earnings (losses) per share:

 

 

 

 

 

Basic—as reported

 

$

(0.02

)

$

0.09

 

Basic—pro forma

 

$

(0.05

)

$

0.06

 

Diluted—as reported

 

$

(0.02

)

$

0.09

 

Diluted—pro forma

 

$

(0.05

)

$

0.06

 

 

9



 

The fair value of each grant is estimated on the date of grant using the Black-Scholes method with the following assumptions used for grants during the applicable periods:

 

 

 

Three months ended March 31,

 

Employee stock options

 

2004

 

2003

 

Expected life (in years)

 

5.0

 

5.0

 

Risk-free interest rate

 

3.2

%

2.5%-3.0

%

Volatility

 

0.8

 

0.8

 

Dividend yield

 

0

%

0

%

 

Employee stock purchase plan shares

 

2004

 

2003

 

Expected life (in years)

 

1.0

 

1.0

 

Risk-free interest rate

 

1.3

%

1.4

%

Volatility

 

0.7

 

0.8

 

Dividend yield

 

0

%

0

%

 

The Company selected the Black-Scholes option valuation model, which is one of the permitted methods to estimate the fair market value of options under SFAS No. 123. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimated, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of employee stock options.  The weighted average fair value of options granted for the quarter ended March 31, 2004 and 2003 was $5.15 and $4.95 respectively. The weighted average estimated fair value of shares granted under the employee stock purchase plan for the quarter ended March 31, 2004 and 2003 was $3.21 and $4.67 respectively.

 

Net income (loss) per share

 

Basic net income (loss) per share is computed by dividing net income (loss) for the period by the weighted-average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and potential common equivalent shares outstanding during the period. Potential common shares are composed of incremental shares of common stock issuable upon the exercise of stock options and warrants and common stock issuable upon conversion of redeemable convertible preferred stock.

 

For the three months ended March 31, 2004, outstanding employee stock options of 806,000 shares were not included in the calculation of diluted net income (loss) per share as they were anti-dilutive.

 

 

 

Three Months Ended
March 31,

 

 

 

2004

 

2003

 

Numerator:

 

 

 

 

 

Net income (loss)

 

$

(521

)

$

2,672

 

Denominator:

 

 

 

 

 

Shares used in computing net income (loss) per share:

 

 

 

 

 

Basic

 

30,845

 

30,302

 

Employee stock options and unvested common stock outstanding

 

 

237

 

Diluted

 

30,845

 

30,539

 

Net income (loss) per share:

 

 

 

 

 

Basic

 

$

(0.02

)

$

0.09

 

Diluted

 

$

(0.02

)

$

0.09

 

 

10



 

Income taxes

 

The Company accounts for deferred income taxes under the liability approach whereby the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities are recognized as deferred tax assets and liabilities. A valuation allowance is established for any deferred tax assets for which realization is uncertain.

 

Comprehensive income

 

Statement of Financial Accounting Standards No. 130 “Reporting Comprehensive Income” (“SFAS No. 130”) requires the Company to display comprehensive income and its components as part of the financial statements. The Company’s only component of comprehensive income is unrealized gains and losses on available for sale securities. Accumulated other comprehensive income, as of March 31, 2004 and December 31, 2003 was $176,000 and $56,000, respectively.

 

The changes in other comprehensive income (loss), net of taxes, were as follows, for the quarter ended March 31, 2004 and 2003 (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

2004

 

2003

 

Net income (loss)

 

$

(521

)

$

2,672

 

Net unrealized gain on available-for-sale securities:

 

 

 

 

 

Change in net unrealized gains

 

120

 

7

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

(401

)

$

2,679

 

 

Segment reporting

 

Financial Accounting Standards Board Statement No. 131, “Disclosure about Segments of an Enterprise and Related Information” (“SFAS No. 131”) requires that companies report separately in the financial statements certain financial and descriptive information about operating segments profit or loss, certain specific revenue and expense items and segment assets. The Company operates in one segment, using one measurement of profitability for its business. The Company has sales outside the United States that are described in Note 10. The majority of long-lived assets are maintained in the United States.

 

Note 2. Inventories

 

Inventories consist of the following (in thousands):

 

 

 

March 31,
2004

 

December 31,
2003

 

 

 

 

 

 

 

Work-in-process

 

$

 

$

195

 

Finished goods

 

437

 

279

 

 

 

$

437

 

$

474

 

 

Note 3. Guarantees

 

Product Warranties:

 

The Company generally offers a 90-day warranty for its memory chip products. The Company provides reserves for the estimated costs of product warranties at the time revenue is recognized. The Company estimates the costs of its warranty obligations based on its historical experience of replacement costs incurred for the last 90 days in correcting product failures.  The Company has not experienced any material issues regarding warranty.  The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. Accordingly, the Company assessed the level of warranty reserve as of March 31,

 

11



 

2004 and determined that no warranty reserve was necessary.  The Company does not have any other guarantees as of March 31, 2004.

 

From time to time, the Company enters into contracts with licensees of its 1T-SRAM technologies in which the Company provides some indemnification to the licensee in the event of claims of patent or other intellectual property infringement resulting from the licensee’s use of the licensed technology.  Such provisions are customary in the semiconductor industry and do not reflect an assessment by the Company of the likelihood of a claim.  The Company has not recorded a liability for potential obligations under these indemnification provisions and would not record such a liability unless the Company believed that the likelihood of a material obligation was probable and estimateable.  See Note 5, “Contingencies.”

 

Note 4. Segment Information

 

The Company operates in a single industry segment, supplying semiconductor memories to the electronics industry. The Company sells its products and technology to customers in the Far East, North America and Europe. Net revenue by geographic area was (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2004

 

2003

 

 

 

 

 

 

 

United States

 

$

1,275

 

$

2,122

 

Japan

 

2,622

 

3,955

 

Taiwan

 

539

 

1,780

 

Other Asian Countries

 

9

 

 

Europe

 

58

 

56

 

Total

 

$

4,503

 

$

7,913

 

 

One customer accounted for a significant percentage of our total revenue. For the quarter ended March 31, 2004, Fujitsu represented 40% of total revenue. In the first quarter of 2003, three customers, NEC, UMC and Sony, represented 28%, 20% and 13% of our total revenue, respectively.

 

Note 5. Contingencies

 

From time to time, the Company may be subject to legal proceedings and claims in the ordinary course of business.  These claims, even if not meritorious, could result in the expenditure of significant financial and other resources.  On March 31, 2004, UniRAM Technology, Inc. filed a complaint against the Company in the United States District Court for the Northern District of California, alleging trade secret misappropriation and patent infringement.  UniRAM’s complaint asserts that it provided trade secret information to Taiwan Semiconductor Manufacturing Corporation (TSMC) in 1996-97 and speculated that the Company improperly obtained unspecified trade secrets of UniRAM from TSMC in an unknown manner.  Subsequent to March 31, 2004, UniRAM has amended its complaint twice to add TSMC as a defendant and additional allegations to the suit, and to drop all infringement claims for one of the two patents identified in the initial complaint.  The Company believes that UniRAM’s complaint lacks merit and intends to vigorously defend itself.

 

Note 6. Capital lease obligations

 

The Company assumed capital lease obligations through the acquisition of ATMOS. Equipment under capital lease arrangements included in property and equipment aggregated approximately $176,000 at March 31, 2004. Related accumulated depreciation was approximately $172,000 at March 31, 2004.

 

Future minimum lease payments under capital leases as of March 31, 2004 are as follows (in thousands):

 

Remainder of 2004

 

$

9

 

2005

 

15

 

 

 

 

 

Total minimum payments

 

24

 

Less amount representing interest

 

2

 

 

 

22

 

Less current portion

 

11

 

Long term portion

 

$

11

 

 

12



 

Note 7. Provision for Income Taxes

 

The Company’s effective tax rate is based on the estimated annual effective tax rate in accordance with Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes”. A benefit for income taxes of  $130,000 was recorded in the first quarter of 2004 and provisions for income taxes of  $668,000 was recorded in the same quarter of 2003.  Effective tax rate was 20% in the first quarter of 2004 and 2003.

 

Note 8. Subsequent Events

 

Synopsys Transaction

 

On February 23, 2004, Synopsys, Inc., or Synopsys, Mountain Acquisition Sub, Inc., a wholly owned subsidiary of Synopsys, or, Acquisition Sub, and the Company, entered into a definitive agreement and plan of merger and reorganization, or reorganization agreement, which contemplated the acquisition by Synopsys, through Acquisition Sub, of all of the Company’s outstanding common stock in a two-step transaction comprised of a combination cash and stock exchange offer for all of the issued and outstanding shares of the Company’s common stock for consideration valued at an aggregate of $13.50 per share, followed by its merger with Acquisition Sub.  In the offer, each share of its common stock validly tendered (and not withdrawn) would be converted into a combination of $6.75 in cash and a fraction of a share of Synopsys common stock having a value of $6.75 based on a formula set forth in the reorganization agreement.  Synopsys had the right, at any time through the date two business days prior to the expiration date of the offer (as it may be extended from time to time), to convert the offer into an all-cash tender offer, in which case each share of the Company’s common stock would be converted into $13.50 in cash.

 

On March 22, 2004, Synopsys elected, in accordance with the terms of the reorganization agreement, to change the transaction from an exchange offer (which would have involved both cash and stock consideration) to an all-cash tender offer at a purchase price of $13.50 per share of the Company’s common stock, net to the seller, without interest.  That offer expired at 12:00 midnight, New York City time, on Friday, April 16, 2004.

 

The acceptance for payment of shares of the Company’s common stock in the Synopsys tender offer was subject to the conditions set forth in the reorganization agreement, including the tender of a number of shares of its common stock equal to or greater than 50% of the sum of the aggregate number of shares of common stock then outstanding, plus the aggregate number of shares of common stock issuable upon the exercise of all vested options, warrants or other rights to acquire common stock then outstanding, receipt of regulatory approvals and other conditions set forth in the reorganization agreement.

 

Concurrently with the execution of the reorganization agreement, Fu-Chieh Hsu, Wingyu Leung, Carl Berg, who are members of the Company’s board of directors, and Clyde J. Berg, Trustee of the 1981 Kara Ann Berg Trust, who together represent approximately 29% of the Company’s outstanding stock, entered into a separate stockholder agreement with Synopsys.  Each of them agreed to tender (and not to withdraw his tender) of the shares of common stock that he beneficially owns into the offer. The stockholder agreements automatically terminated upon consummation of the merger, upon any amendment to the reorganization agreement without the Company’s consent that decreases the per share merger consideration or upon termination of the reorganization agreement in accordance with its terms.

 

By its term, the reorganization agreement may be terminated by—

 

                                          mutual consent of Synopsys and the Company;

 

                                          either Synopsys or the Company if a court or governmental body issues an order permanently enjoining or making illegal the merger;

 

                                          either Synopsys or the Company if the offer expires without Synopsys having accepted any shares of its common stock or if the offer shall not have been accepted by July 31, 2004;

 

                                          Synopsys if the Company’s board retracts its recommendation of the transaction;

 

13



 

                                          the Company to accept an unsolicited, bona fide written offer by a third party to purchase all of the outstanding shares of its common stock, after the board of directors determines, consistent with its obligations under the reorganization agreement and its fiduciary duties, that such third party offer is more favorable to its stockholders than the Synopsys offer, after providing Synopsys with an opportunity to amend the offer or enter into an alternative transaction with the Issuer and then after paying a termination fee to Synopsys of $10 million;

 

                                          Synopsys if the Company’s representations and warranties are materially inaccurate, such that there has been a material adverse effect on the Issuer, or any of the Company’s covenants shall have been materially breached, after it has had an opportunity to cure such breach or inaccuracy, and upon certain conditions, after paying the Company a termination fee of $10 million;

 

                                          the Company if any of Synopsys’ representations and warranties are materially inaccurate or if its covenants are materially breached, which causes a material adverse effect on Synopsys’ ability to consummate the merger, and after Synopsys has had an opportunity to cure such breach or inaccuracy; or

 

                                          Synopsys if a material adverse effect shall have occurred or is reasonably likely to occur with respect to the Company, and upon certain conditions, after paying the Company a termination fee of $10 million.

 

On April 16, 2004, 27,568,891 shares representing 89% of the outstanding shares of the Company’s common stock had been tendered pursuant to the offer by Synopsys.   After the expiration of the offer, Synopsys delivered a notice of termination of the reorganization agreement without accepting any of the tendered shares and tendered cashiers’ checks totaling $10 million in connection with its claim of termination pursuant to Section 8.3(d) of the reorganization agreement.  Synopsys also asserted alternative grounds for termination that it claimed would not require payment of $10 million.  The Company believes that all conditions of the terms of the offer were satisfied prior to expiration of the offer and does not believe that Synopsys had the right to terminate the reorganization agreement. The Company has not cashed the Synopsys checks in light of its view that Synopsys was not entitled to terminate the reorganization agreement.

 

With the greater engineering, sales and financial resources possessed by Synopsys, and its substantial distribution channels, the Company believes it will be able to more rapidly proliferate its1T-SRAM technologies, increase the volume of its licensing activities, increase the number of design projects that it can manage, innovate more quickly, penetrate more accounts and substantially increase revenue from its intellectual property licensing activities.

 

On April 23, 2004, the Company filed a complaint in the Delaware Court of Chancery.  The complaint alleges that defendants, Synopsys, Inc., and its subsidiary Mountain Acquisition Sub, Inc., breached the reorganization agreement when defendants terminated the reorganization agreement on April 16, 2004.  The complaint seeks specific performance under the reorganization agreement or, in the alternative, monetary damages.  The parties have stipulated to expedited proceedings.  Trial of the Company’s claim for specific performance is scheduled to commence on July 6, 2004; further proceedings on its claims for damages are deferred pending the outcome of that trial.

 

Stock Repurchase Plan

 

On April 19, 2004, the Company announced that its board of directors authorized the Company to purchase up to $25 million of its common stock over the next year.  The share repurchases may be made, from time to time in the open market subject to market conditions and other factors, such as the Company’s belief that the repurchase will be beneficial to shareholders.  These repurchases may be commenced or suspended at any time or from time to time without prior notice.

 

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

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying condensed consolidated financial statements and notes included in this report. This 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 include, without limitation, statements about the market for our technology, our strategy, competition, expected financial performance, all information disclosed under Item 3 of this Part I., and other aspects of our business identified in the Company’s most recent annual report on Form 10-K filed with the Securities and Exchange Commission and in other reports that we file from time to time with the Securities and Exchange Commission. Any statements about our business, financial results, financial condition and operations contained in this Form 10-Q that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “expects,” “intends,” “projects,” or similar

 

14



 

expressions are intended to identify forward-looking statements. Our actual results could differ materially from those expressed or implied by these forward-looking statements as a result of various factors, including the risk factors described in Risk Factors and elsewhere in this report. We undertake no obligation to update publicly any forward-looking statements for any reason, except as required by law, even as new information becomes available or events occur in the future.

 

MoSys® and 1T-SRAM® are our trademarks. Product names, trade names and trademarks of other companies are also referred to in this report.

 

Overview

 

We design, develop, license and market memory technologies used by the semiconductor industry and electronic product manufacturers. We have developed a patented semiconductor memory technology, called 1T-SRAM, that offers a combination of high density, low power consumption and high speed at performance and cost levels that other available memory technologies do not match. We license this technology to companies that incorporate, or embed, memory on complex integrated circuits, such as SoCs. We also sell memory chips based on our 1T-SRAM technologies.

 

Using elements of our existing memory technology as a foundation, we completed development of our first memory chips incorporating our 1T-SRAM technologies in the fourth quarter of 1998. We signed our first license agreement related to our 1T-SRAM technologies at the end of the fourth quarter of 1998 and recognized licensing revenue from our 1T-SRAM technologies for the first time in the first quarter of 2000. In 2001 and 2002, we introduced improved and enhanced versions of our technology, 1T-SRAM-R, 1T-STRAM-M, and 1T-SRAM-Q.

 

We generate most of our revenue from the licensing of our intellectual property which consist of both licensing revenues and royalty. Our licensing revenue consists of fees paid for engineering development and engineering support services. Royalty revenues are earned under each of our licensing agreements when our licensees manufacture or sell products that incorporate any of our 1T-SRAM technologies and report the results to us.

 

As of March 31, 2004, we had signed license agreements related to our 1T-SRAM technologies with 43 companies, 11 of which have paid us royalties to date. Generally, we expect our total sales cycle, or the period from our initial discussion with a prospective licensee to our receipt of royalties from the licensee’s use of our 1T-SRAM technologies, to run from 18 to 24 months after the commencement of the project.

 

Effective August 30, 2002, we purchased 100% of the outstanding stock of ATMOS Corporation, a semiconductor memory company focused on creating high-density, compiler-generated embedded memory solutions for SoC applications. The total purchase price for the acquisition was approximately $12.4 million.

 

Sources of Revenue

 

We generate three types of revenue: licensing, royalties and product sales. Prior to 2001, we derived almost all our revenue from the sale of memory chips. Since the beginning of 2001, product revenue as a percentage of our total revenue has declined significantly, while licensing and royalty revenues have grown substantially as a percentage of total revenue. In the third quarter of 2001, for the first time, combined license and royalty revenue exceeded product revenue. We expect this trend to continue for the foreseeable future and anticipate further declines in product revenue in 2004.

 

Licensing.   Our license agreements involve long sales cycles, which makes it difficult to predict when the agreements will be signed and when, if ever, we will recognize revenues under the agreements. In addition, our licensing revenues fluctuate from period to period, and, it is difficult for us to predict the timing and magnitude of such revenue from quarter-to-quarter. Moreover, we believe that the amount of licensing revenues for any period is not necessarily indicative of results in any future period. Our future revenue results are subject to a number of factors, particularly those described in “Risk Factors”, below.

 

Our licensing revenue consists of fees for providing circuit design, layout and design verification and granting a license to a customer that is embedding our memory technology into its product. For some customers, we also provide engineering support services to assist in the commencement of production of products utilizing the licensed 1T-SRAM technologies. License fees generally range from one hundred thousand dollars to several million dollars per contract, depending on the scope and complexity of the development project, the licensee’s rights and the royalties expected to be received under the agreement. The licensee generally pays the license fees in installments at the beginning of the license term and upon the attainment of specified milestones. All license agreements entered into to date require us to meet performance specifications. For agreements involving performance specifications that we have not met and for which we lack the historical experience to reasonably estimate the costs, we defer recognition of revenue until the licensee manufactures products that meet the contract performance specifications and recognize revenue under the completed contract accounting method. Fees collected prior to revenue recognition are recorded as deferred contract revenue. However, if the agreement involves performance specifications that we have significant experience in meeting and the cost of contract completion can

 

15



 

be reasonably estimated, we recognize revenue over the period in which the contract services are performed under the percentage of completion accounting method. We use our labor costs incurred to measure progress towards completion. If the amount of revenue recognized under the percentage of completion method exceeds the amount of billings to a customer, then under the percentage of completion accounting method, we account for the excess amount as an unbilled contract receivable. Our total unbilled contract receivable was $2,152,000and $937,000 as of March 31, 2004 and 2003, respectively.

 

From time to time, a licensee may cancel a project during the development phase. Such a cancellation is not within our control and is often caused by changes in market conditions or the licensee’s business. Cancellations of this nature are an aspect of our licensing business, and most of our newer contracts allow us to retain all payments that we have received or are entitled to collect for items and services provided before the cancellation occurs. We will consider a project to have been canceled even in the absence of specific notice from our licensee, if there has been no activity under the contract for a significant period, and we believe that completion of the contract is unlikely. In this event, we recognize revenue in the amount of cash received, if we have performed a sufficient portion of the development services.  If a cancelled contract had been entered into before the establishment of technological feasibility, the costs associated with the contract would have been expensed prior to the recognition of revenue. In that case, there would be no costs associated with that revenue recognition, and gross margin would increase for the corresponding period. For the three months ended March 31, 2004, we recognized no licensing revenue from cancelled projects compared to $350,000 in the corresponding period of 2003

 

Royalties.   Each license agreement provides for royalty payments at a stated rate. We negotiate royalty rates by taking into account such factors as the amount of license fees to be paid, the anticipated volume of the licensee’s sales of products utilizing our technologies and the cost savings to be achieved by the licensee through the use of our technology. Our license agreements require the licensee to report the manufacture or sale of products that include our technology after the end of the quarter in which the sale or manufacture occurs. We recognize royalties from reports provided by the licensee that are received in the quarter immediately following the quarter during which the licensee has sold or manufactured products containing our technology.

 

As with our licensing revenues, the timing and level of royalties are difficult to predict.  They depend on the licensee’s ability to market, produce and sell products incorporating our technology. Many of the products of our licensees that are currently subject to licenses from us are consumer products, such as electronic game consoles, for which demand can be seasonal and generally highest in the fourth quarter.  We would report royalties from products sold in the fourth quarter in the first quarter of the following year. If a licensee holds excess inventory of products using our licensed technology, we are unlikely to report additional royalty revenue attributable to that product until the quarter after the licensee restarts production. For a discussion of factors that could contribute to the fluctuation of our revenues, see “Risk Factors—Our lengthy licensing cycle and our licensees’ lengthy development cycles will make the operating results of our licensing business difficult to predict, and Anything that negatively affects the business of our licensees could negatively impact our revenue.”

 

Product sales.   Product sales are typically on a purchase-order basis, with shipment of product occurring from one to six months later. Allowances for sales returns or warranty liabilities are recorded based upon historical experiences and any specific known pending customer returns. Our products are manufactured, assembled and tested prior to shipment by independent, third-party contractors. We contract for manufacturing services on a purchase-order basis and have no long-term commitments for the supply of any of our memory chip products.

 

Our memory chips are subject to competitive pricing pressure that might result in fluctuating gross profits, which we have experienced in the past. Prior to 1999, we sold most of our memory chips to the personal computer market, which is seasonal, and experienced the strongest demand for these products in the fourth quarter each year. From late 1998 to date, our memory chip sales have consisted primarily of 1T-SRAM chips sold to customers in the communications equipment business, and we have not seen the effect of seasonal demand in the market.

 

The semiconductor industry has experienced a difficult economic environment and downturn during the past several years. Most of our memory chip sales are made to communications equipment manufacturers, which also have experienced a sharp economic downturn since 2001. Our product revenues for the first quarter of 2004 were only 30% of our product revenues for the same quarter in 2003. As a result of these downturns and our continued focus on our high margin intellectual property licensing business as the major source of our revenue, we expect continued decline in product revenue in 2004.

 

Critical Accounting Policies

 

Use of estimates.  Our discussion and analysis of our financial condition and results of operation are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis we make these estimates based on our historical experience and on assumptions that we consider reasonable under the circumstances. Actual results may differ from these estimates, and reported results could differ under different assumptions or conditions.

 

16



 

We believe that the following accounting policies are affected by estimates and judgments in the following manner:

 

Revenue.

 

Licensing.  If a licensing contract involves performance specifications that we have significant experience in meeting and the cost of contract completion can be reasonably estimated, we recognize the revenue over the period in which the contract services are performed using the percentage of completion method.  The percentage of completion method includes judgmental elements, such as determining that we have the experience to meet the design specifications and estimation of the total contract costs.  We follow this method because we can obtain reasonably dependable estimates of the costs to perform the contracted services.  Labor costs for the development of the licensee’s design are estimated at the beginning of the contract.  As these costs are incurred, they are used as a measure of progress towards completion.  We have the ability to reasonably estimate labor cost on a contract to contract basis from our experience in developing prior licensee’s designs.  During the contract performance period we review estimates of cost to complete the contracts as the contract progresses to completion and will revise our estimates of revenue and gross profit under the contract if we revise the estimations of the cost to complete.  Our policy is to reflect any revision in the contract gross profit estimate in reported income in the period in which the facts giving rise to the revision become known.  For contracts involving design specifications that we have not met previously, we defer the recognition of revenue until the design meets the contractual design specifications and expenses the cost of services as incurred.  When we have experience in meeting design specifications but do not have significant experience to reasonably estimate the cost of services to meet a design specification, we defer both the recognition of revenue and the cost.  For these arrangements, we recognize revenue using the completed contract method.  Under the completed contract method, we recognize revenue when we have knowledge that the customer has successfully verified our design.

 

Under our support and maintenance arrangements, we provide unspecified upgrades, design rule changes and technical support.  No other upgrades, products or other post-contract support are provided.  These arrangements are renewable annually by the customer.  Support and maintenance revenue is recognized at its fair value ratably over the period during which the obligation exists, typically 12 months.  The fair value of any support and maintenance obligation is established based on the specified renewal rate for such support and maintenance.  When we provide a combination of products and services to customers, in addition to the considerations noted above, we evaluate the arrangements under EITF 00-21, Revenue Arrangements with Multiple Deliverables, which is effective for transactions entered into after June 30, 2003.  EITF 00-21 addresses certain aspects of accounting for arrangements under which we will perform multiple revenue generating activities.  Application of EITF 00-21 did not have a material effect on our consolidated financial position or results of operations.

 

Product.  Revenue from product sales is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed or determinable, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations.  For each of the periods presented, there were no formal acceptance provisions with our end customers.

 

Royalty.  Licensing contracts provide also for royalty payments at a stated rate and require licensees to report the manufacture or sale of products that include our 1T-SRAM technologies after the end of the quarter in which the sale or manufacture occurs.  We recognize royalties in the quarter in which we receive the licensee’s report.

 

Inventory.  We state inventories at the lower of cost or market, determined using the first-in, first-out method. Our policy is to write down our inventory for estimated obsolescence or unmarketable inventory to the extent the cost exceeds the estimated market value. We estimate fair market value based on our historical sales for the last six months and current market conditions. If actual market conditions are less favorable than those assumed in our estimates, additional inventory write-downs may be required. Our policy is to reflect any write-down of inventory in reported income for the period in which the facts giving rise to the inventory write-down become known. If previously reserved inventory is sold, the reserve is reversed.

 

Goodwill.  We review goodwill, recorded from the acquisition of ATMOS Corp. on August 2002, for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable in accordance with the Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.”  The provisions of SFAS No. 142 require that a two-step impairment test be performed on goodwill.  In the first step, we compare the fair value of each reporting unit to its carrying value.  Using the guidance in SFAS No. 142, we consider there to be only one reporting unit at the entity level.  For step one, we determine the fair value of our reporting unit using the market approach.  Under the market approach, we estimate the fair value based on the market value of the reporting unit at the entity level.  If the fair value of the reporting unit exceeds the carrying value of net assets assigned to the reporting unit, goodwill is not impaired and we are not required to perform further testing.  If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, we must perform the second step in order to determine the implied fair value of the reporting unit’s goodwill and compare it to the carrying value of the reporting unit’s goodwill.  If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we must record an impairment loss equal to the difference.  As of March 31, 2004, we found no indications of potential impairment.

 

17



 

Tax valuation allowance.  When we prepare our consolidated financial statements, we estimate our income tax liability for each of the various jurisdictions where we conduct business. This requires us to estimate our actual current tax exposure and to assess temporary differences that result from differing treatment of certain items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which we show on our consolidated balance sheet under the category of other current assets. The net deferred tax assets are reduced by a valuation allowance if, based upon weighted available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. When we establish a valuation allowance or increase this allowance in an accounting period, we must record a tax expense in our consolidated statement of income unless the increase is attributable to stock- based compensation deductions, which has been recorded directly to equity. We must make significant judgments to determine our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance to be recorded against our net deferred tax asset. As of December 31, 2003, we had a valuation allowance of approximately $8.2 million of which approximately $6.2 million was attributable to Canadian net operating losses and $670,000 was attributable to stock option deductions.

 

Results of Operations

 

Three Months Ended March 31, 2004 and 2003

 

Revenue.  Total revenue decreased to $4.5 million for the three months ended March 31, 2004 from $7.9 million for the three months ended March 31, 2003. Licensing revenue decreased to $3.0 million in the first quarter of 2004 from $4.5 million in the same period of 2003 as revenue recognized from new projects did not offset a decline in revenue from existing projects. Licensing revenue represented 66% of total revenue in the first quarter of 2004, compared to 57% in the same period in 2003. Royalty revenue decreased to $1.4 million in the first quarter of 2004 from $2.9 million in the same period of 2003, and represented 30% of total revenue in the first quarter of 2004, compared to 36% for the same period in 2003. In the first three months of 2004, royalties earned from the production of Gamecube chips incorporating our 1T-SRAM technology represented 6% of total revenue, a significant decrease from 25% of our total revenue from the same period in 2003, as Nintendo had reduced its purchases of chips incorporating our licensed technology for its Gamecube consoles in 2003 from much higher levels in 2002.

 

In the three months ended March 31, 2004, product revenue decreased to $162,000 from $544,000 in the same period of 2003. Product revenue represented 4% of total revenue in the first quarter of 2004, compared to 7% in the same period in 2003. We attribute the product revenue decrease primarily to the economic downturn in the communications equipment industry, which is the primary market for our memory chips.  We expect continued decline in product revenue in 2004 due to our focus on the licensing of our intellectual property as the major source of our revenue, which typically produces higher gross margins than can be achieved from product revenue.

 

A small number of customers continue to account for a significant percentage of our total revenue. For the first quarter ended March 31, 2004, Fujitsu represented 40% of total revenue. For the three months ended March 31, 2003, our three largest customers, NEC, UMC and Sony represented 28%, 20% and 13% of total revenue, respectively. For information regarding revenues recorded by us in three months ended March 31, 2004 and 2003 from customers residing in the United States or residing in a foreign country, please refer to note 5, “Segment Information,” of Notes to Consolidated Financial Statements. All of our sales are denominated in U.S. dollars. For a discussion of certain risks related to our revenue concentration, please see “Risk Factors—We expect our revenue to be highly concentrated”.

 

Gross Profit.  Gross profit decreased to $4.0 million in the three months ended March 31, 2004 from $6.9 million in the same period of 2003 due to the decrease in royalty, licensing and product revenue. Gross profit as a percentage of total revenue increased slightly, however, to 88% in the first quarter of 2004 from 87% in the corresponding period of 2003 primarily due to a decline in product revenue, which has much higher associated costs compared to our other sources of revenue.

 

Product gross margin as a percentage of product revenue decreased to 7% in the first quarter of 2004 compared to 25% in the same quarter of 2003. This decline occurred because our fixed manufacturing overhead costs were spread over a reduced number of units of product shipped in the first three months of 2004 compared to the same period of 2003.

 

Research and Development.  Research and development expense was $2.2 million in the first quarter of 2004 and 2003.  We anticipate the same level of research and development expenses for the foreseeable future.

 

Selling, General and Administrative.  Selling, general and administrative expenses increased to $2.8 million in the first quarter of 2004 from $1.7 million in the same period of 2003 due primarily to costs associated with the planned acquisition of the Company by Synopsys of $888,000 and increased professional fees.

 

Interest and Other Income.  Interest and other income decreased to $361,000 in the first quarter of 2004 from $490,000 in the same period of 2003 because of lower interest rates on our cash equivalents and investments.  Additionally, in the first quarter of 2003, other income included Canadian research and development incentives received.

 

18



 

Provision for Income Taxes.  The Company’s effective tax rate is based on the estimated annual effective tax rate in accordance with Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes”. A benefit for income taxes of  $130,000 was recorded in the first quarter of 2004 and provisions for income taxes of  $668,000 were recorded in the same quarter of 2003.  The effective tax rate was 20% in the first quarter of 2004 and 2003.  In 2004, we anticipate that our effective income tax rate will be less than the federal statutory tax rate.

 

Liquidity and Capital Resources

 

Cash Flows

 

As of March 31, 2004, we had cash and cash equivalents of $28.2 million, short-term investments of $14.6 million and long-term investments of $46.3 million resulting in a total balance of cash, equivalents, and long and short term investments of $89.1 million. As of the same date, we had total working capital of $45.2 million. Our primary capital requirements are to fund working capital needs. We believe that our current focus on licensing and royalty revenues and reduced levels of memory chip sales has lessened the volatility of our business and generally has enabled us to steadily improve our cash position.

 

Net cash provided by operating activities was $625,000 for the three months ended March 31, 2004 compared to $2.0 million for the same period of 2003.  Net cash provided by operating activities for the first quarter of 2004 resulted primarily from an increase in unbilled contract receivables due to higher revenue recognized in excess of billings and lower prepaid expenses and other assets mainly due to the receipt of a tax refund.  For the first three months of 2003, net cash provided by operating activities resulted primarily from net income of $2.7 million, which was reduced by higher accounts receivables due to an increase in accounts receivables from our licensees and lower deferred revenue.

 

Net cash provided by investing activities was approximately $2.6 million in the first quarter in 2004 and net cash used in investing activities was approximately $1.5 million in the first quarter in 2003. Net cash provided by investing activities for the first three months of 2004 consisted primarily of investment transactions of short-term and long-term marketable securities of $2.8 million, net of proceeds from disposition and purchases of investment securities.  For the first three months ended March 31, 2003, net cash used in investing activities for the first three months of 2003 consisted primarily of purchases of short-term and long-term marketable securities of $1.2 million, net of proceeds from disposition of investment securities.

 

Net cash provided by financing activities was $2.9 million and $412,000 for the first three months ended 2004 and 2003, respectively. Net cash provided by financing activities for the first three months of 2004 and 2003 primarily consisted of proceeds received from the exercise of employee options to purchase common stock.

 

Our future liquidity and capital requirements are expected to vary from quarter to quarter, depending on numerous factors, including—

 

                                          level and timing of licensing, royalty and product revenues;

 

                                          cost, timing and success of technology development efforts;

 

                                          market acceptance of our existing and future technologies and products;

 

                                          competing technological and market developments;

 

                                          cost of maintaining and enforcing patent claims and intellectual property rights;

 

                                          variations in manufacturing yields, materials costs and other manufacturing risks;

 

                                          costs of acquiring other businesses and integrating the acquired operations;

 

                                          profitability of our business; and

 

                                          litigation expenses.

 

We expect that existing short-term and long-term investments along with our existing capital and cash generated from operations, if any, will be sufficient to meet our capital requirements for the foreseeable future. We expect that a licensing business such as ours generally will require less cash to support operations after multiple licensees begin to ship products and pay royalties.

 

19



 

However, we cannot be certain that we will not require additional financing at some point in time. Should our cash resources prove inadequate, we might need to raise additional funding through public or private financing. There can be no assurance that such additional funding will be available to us on favorable terms, if at all. The failure to raise capital when needed could have a material, adverse effect on our business and financial condition.

 

Synopsys Transaction

 

On February 23, 2004, Synopsys, Inc., or Synopsys, Mountain Acquisition Sub, Inc., a wholly owned subsidiary of Synopsys, or, Acquisition Sub, and we, entered into a definitive agreement and plan of merger and reorganization, or reorganization agreement, which contemplated the acquisition by Synopsys, through Acquisition Sub, of all of our outstanding common stock in a two-step transaction comprised of a combination cash and stock exchange offer for all of the issued and outstanding shares of our common stock for consideration valued at an aggregate of $13.50 per share, followed by our merger with Acquisition Sub.  In the offer, each share of our common stock validly tendered (and not withdrawn) would be converted into a combination of $6.75 in cash and a fraction of a share of Synopsys common stock having a value of $6.75 based on a formula set forth in the reorganization agreement.  Synopsys had the right, at any time through the date two business days prior to the expiration date of the offer (as it may be extended from time to time), to convert the offer into an all-cash tender offer, in which case each share of our common stock would be converted into $13.50 in cash.

 

On March 22, 2004, Synopsys elected, in accordance with the terms of the reorganization agreement, to change the transaction from an exchange offer (which would have involved both cash and stock consideration) to an all-cash tender offer at a purchase price of $13.50 per share of our common stock, net to the seller, without interest.  That offer expired at 12:00 midnight, New York City time, on Friday, April 16, 2004.

 

The acceptance for payment of shares of our common stock in the Synopsys tender offer was subject to the conditions set forth in the reorganization agreement, including the tender of a number of shares of our common stock equal to greater than 50% of the sum of the aggregate number of shares of our common stock then outstanding, plus the aggregate number of shares of our common stock issuable upon the exercise of all vested options, warrants or other rights to acquire common stock of our then outstanding, receipt of regulatory approvals and other conditions set forth in the reorganization agreement.

 

Concurrently with the execution of the reorganization agreement, Fu-Chieh Hsu, Wingyu Leung, Carl Berg, who are members of our board of directors, and Clyde J. Berg, Trustee of the 1981 Kara Ann Berg Trust, who together represent approximately 29% of our outstanding stock, entered into a separate stockholder agreement with Synopsys.  Each of them agreed to tender (and not to withdraw his tender) the shares of common stock that he beneficially owns into the offer. The stockholder agreements automatically terminated upon consummation of the merger, upon any amendment to the reorganization agreement without our consent that decreases the per share merger consideration or upon termination of the reorganization agreement in accordance with its terms.

 

By its term, the reorganization agreement may be terminated by—

 

                                          mutual consent of Synopsys and us;

 

                                          either Synopsys or us if a court or governmental body issues an order permanently enjoining or making illegal the merger;

 

                                          either Synopsys or us if the offer expires without Synopsys having accepted any shares of our common stock or if the offer shall not have been accepted by July 31, 2004;

 

                                          Synopsys if our board retracts its recommendation of the transaction;

 

                                          us to accept an unsolicited, bona fide written offer by a third party to purchase all of the outstanding shares of our common stock, after the board of directors determines, consistent with its obligations under the reorganization agreement and its fiduciary duties, that such third party offer is more favorable to our stockholders than the Synopsys offer, after providing Synopsys with an opportunity to amend the offer or enter into an alternative transaction with the Issuer and then after paying a termination fee to Synopsys of $10 million;

 

                                          Synopsys if our representations and warranties are materially inaccurate, such that there has been a material adverse effect on the Issuer, or any of our covenants shall have been materially breached, after we have had an opportunity to cure such breach or inaccuracy, and upon certain conditions, after paying us a termination fee of $10 million;

 

20



 

                                          us if any of Synopsys’ representations and warranties are materially inaccurate or if its covenants are materially breached, which causes a material adverse effect on Synopsys’ ability to consummate the merger, and after Synopsys has had an opportunity to cure such breach or inaccuracy; or

 

                                          Synopsys if a material adverse effect shall have occurred or is reasonably likely to occur with respect to us, and upon certain conditions, after paying us a termination fee of $10 million.

 

On April 16, 2004, 27,568,891 shares representing 89% of the outstanding shares of our common stock had been tendered pursuant to the offer by Synopsys.  After the expiration of the offer, Synopsys delivered a notice of termination of the reorganization agreement without accepting any of the tendered shares and tendered cashiers’ checks totaling $10 million in connection with its claim of termination pursuant to Section 8.3(d) of the reorganization agreement.  Synopsys’ letter also asserted alternative grounds for termination that it claimed would not require payment of $10 million.  We believe that all conditions set forth in Item 13 of the terms of the offer were satisfied prior to expiration of the offer and do not believe that Synopsys had the right to terminate the reorganization agreement.  We have not cashed the Synopsys checks in light of our view that Synopsys was not entitled to terminate the reorganization agreement.

 

We and our board of directors continue to believe that the combination with Synopsys will significantly enhance our ability to realize our strategic goals.  With the greater engineering, sales and financial resources possessed by Synopsys, and its substantial distribution channels, we believe we will be able to more rapidly proliferate our 1T-SRAM technologies, increase the volume of our licensing activities, increase the number of design projects that we can manage, innovate more quickly, penetrate more accounts and substantially increase revenue from our intellectual property licensing activities.

 

Therefore, on April 23, 2004, we filed a complaint in the Delaware Court of Chancery.  The complaint alleges that defendants Synopsys, Inc., and its subsidiary Mountain Acquisition Sub, Inc., breached the reorganization agreement when defendants terminated the reorganization agreement on April 16, 2004.  The complaint seeks specific performance under the reorganization agreement or, in the alternative, monetary damages.  The parties have stipulated to expedited proceedings.  Trial of our claim for specific performance is scheduled to commence on July 6, 2004; further proceedings on our claims for damages are deferred pending the outcome of that trial.

 

Lease Commitments and Off Balance Sheet Financing

 

The following table identifies our contractual obligations as of March 31, 2004 that will impact our liquidity and cash flow in future periods:

 

 

 

Payment Due by Period

 

 

 

Total

 

Less than 1
year

 

1-3 years

 

4-5 years

 

Over 5 years

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Lease Obligations

 

$

2,672

 

$

1,331

 

$

937

 

$

404

 

$

 

Capital Lease Obligations

 

24

 

12

 

12

 

 

 

 

We did not have any unconditional purchase obligations as of March 31, 2004.

 

RISK FACTORS

 

If any of the following risks actually occur, our business, results of operations and financial condition could suffer significantly.

 

Our success depends upon the semiconductor market’s acceptance of our 1T-SRAM technologies.

 

The future prospects of our business depend on the acceptance by our target markets of our 1T-SRAM technologies for embedded memory applications and any future technology we might develop. Our technology is intended to allow our licensees to develop embedded memory integrated circuits to replace other embedded memory technology with different cost and performance parameters. Our 1T-SRAM technologies utilize fundamentally different internal circuitry that is not widely known in the semiconductor industry. Therefore, one of our principal challenges, which we might fail to meet, is to convince a substantial percentage of SOC designers to adopt our technology instead of other memory solutions, which have proven effective in their products.

 

An important part of our strategy to gain market acceptance is to penetrate new markets by targeting market leaders as

 

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licensees of our technology. This strategy is designed to encourage other participants in those markets to follow these leaders in adopting our technology. Should a high-profile industry participant adopt our technology for one or more of its products but fail to achieve success with those products, other industry participants’ perception of our technology could be harmed. Any such event could reduce the number of future licenses of our technology. Likewise, were a market leader to adopt and achieve success with a competing technology, our reputation and licensing program could be harmed.

 

Our embedded memory technology might not integrate as well as anticipated with other semiconductor functions in all intended applications, which would slow or prevent adoption of our technology and reduce our revenue. Detailed aspects of our technology could cause unforeseen problems in the efficient integration of our technology with other functions of particular integrated circuits. Any significant compatibility problems with our technology could reduce the attractiveness of our solution, impede its acceptance in the industry and result in a decrease in demand for our technology.

 

Our lengthy licensing cycle and our licensees’ lengthy product development cycles make the operating results of our licensing business difficult to predict.

 

We anticipate difficulty in accurately predicting the timing and amounts of revenue generated from licensing our 1T-SRAM technologies. The establishment of a business relationship with a potential licensee is a lengthy process, generally taking from three to nine months, and sometimes longer. Following the establishment of the relationship, the negotiation of licensing terms can be time-consuming, and a potential licensee may require an extended evaluation and testing period.

 

Once a license agreement has been executed, the timing and amount of licensing and royalty revenue from our licensing business will remain difficult to predict. The completion of the licensees’ development projects and the commencement of production will be subject to the licensees’ efforts, development risks and other factors outside our control. Our royalty revenue may depend on such factors as success of the licensees’ project, the licensees’ production and shipment volumes, the timing of product shipments and when the licensees report to us the manufacture or sale of products that include our 1T-SRAM technologies. All of these factors will prevent us from making predictions of revenue with any certainty and could cause us to experience substantial period-to-period fluctuations in operating results.

 

None of our licensees are under any obligation to incorporate our technology in any present or future product or to pursue the manufacture or sale of any product incorporating our technology. A licensee’s decision to complete a project or manufacture a product is subject to changing economic, marketing or strategic factors. The long development cycle of our licensees’ products increases the risk that these factors will cause the licensee to change its plans. In the past, some of our licensees have discontinued development of products incorporating our technology. These customers’ decisions were based on factors unrelated to our technology, but, as a result, it is unlikely that we will receive royalties in connection with those products. We expect that occasionally our licensees will discontinue a product line or cancel a product introduction, which could adversely affect our future operating results and business.

 

If the market for system-on-a-chip integrated circuits does not expand, our business may suffer.

 

Our ability to achieve sustained revenue growth and profitability in the future will depend on the continued development of the market for SoC integrated circuits. SoC integrated circuits are characterized by rapid technological change and competition from an increasing number of alternate design strategies such as combining multiple integrated circuits to create a system-on-a-package. We cannot be certain that the market for SoC integrated circuits will continue to develop or grow at a rate sufficient to support our business.  If the market fails to grow or develops slower than expected, our business may suffer.

 

The semiconductor industry is cyclical in nature and subject to periodic downturns, which can negatively affect our revenue.

 

The semiconductor industry is cyclical and has experienced a pronounced downturn over the past few years.  To respond to this downturn, many semiconductor manufacturers and their customers have slowed their research and development activities, canceled or delayed new product developments, reduced their workforces and inventories and taken a cautious approach to acquiring new equipment and technologies.  As a result, our business has been adversely affected in 2003 and first three months of 2004, and we believe that a continued downturn could negatively impact our future revenue and profitability.  In the future, the cyclical nature of the semiconductor industry may cause our operating results to fluctuate significantly from year-to-year, which also may tend to increase the volatility of the price of our common stock.

 

We might be unable to deliver our customized memory technology in the time frame demanded by our licensees, which could damage our reputation, harm our ability to attract future licensees and impact operating results.

 

The majority of our licenses require us to customize our 1T-SRAM technologies within a certain delivery timetable. Not all of the factors relating to this customization are within our control. There might be factors outside our control that could influence our ability to meet the time requirements under these licenses in addition to design or development problems that we fail to solve in a timely manner. Any failure to meet the time requirements could delay the receipt of payment from our licensee, damage our

 

22



 

reputation in the industry, harm our ability to attract new licensees and negatively impact our operating results.

 

Our business model relies on royalties as a key component in the licensing of our technologies, and if we fail to realize expected royalties our operating results will suffer.

 

We believe that our long-term success is substantially dependent on the receipt of future royalties.  Royalty payments owed to us are calculated based on factors such as our licensees’ selling prices, wafer production, and other variables as provided in each license agreement.  The amount of royalties we will receive depends on the licensees’ business success, production volumes and other factors beyond our control.  This exposes our business model to risks that we cannot minimize directly and may result in significant fluctuations in our royalty revenue and operating results from quarter-to-quarter.  We recognize royalty revenue in the quarter in which we receive a royalty report from our licensee.  As a result, our recognition of royalty revenue typically lags behind the quarter in which the related integrated circuit is manufactured or sold by our licensee by at least one quarter. We cannot be certain that our business strategy will be successful in expanding the number of licensees, nor can we be certain that we will receive significant royalty revenue in the future.

 

We expect our revenue to be highly concentrated among a small number of licensees and customers, and our results of operations could be harmed if we lose and fail to replace this revenue.

 

Our royalty revenue has been highly concentrated among a few licensees, and we expect this trend to continue for the foreseeable future. In particular, a substantial portion of our licensing and royalty revenue in 2003, 2002 and 2001 has come from the licenses for integrated circuits used by Nintendo in its GAMECUBE®. Gamecube-related revenue represented 7% and 28% of total revenue in the first quarter ended March 31, 2004 and 2003, respectively. Gamecube-related revenue represented 13% and 44%of total revenue in 2003 and 2002, respectively.  Moreover, Nintendo faces intense competitive pressure in the video game market, which is characterized by extreme volatility, costly new product introductions and rapidly shifting consumer preferences. Nintendo has publicly announced that sales of Gamecube units to date have been significantly less than its expectations when it launched this video game console.   We cannot assure you that Nintendo’s sales of product incorporating our technology will increase beyond prior or current levels.

 

Furthermore, our overall revenue has been highly concentrated, with a few customers accounting for a significant percentage of our total revenue. For the first quarter ended March 31, 2004, Fujitsu represented 40% of total revenue. We expect that a relatively small number of licensees will continue to account for a substantial portion of our revenue for the foreseeable future.

 

As a result of this revenue concentration, our results of operations could be impaired by the decision of a single key licensee or customer to cease using our technology or products or by a decline in the number of products that incorporate our technology that are sold by a single licensee or customer or by a small group of licensees or customers.

 

Our revenue concentration may also pose credit risks, which could negatively affect our cash flow and financial condition.

 

We might also face credit risks associated with the concentration of our revenue among a small number of licensees and customers. As of March 31, 2004, five customers represented 82% of total trade receivables. Our failure to collect receivables from any customer that represents a large percentage of receivables on a timely basis, or at all, could adversely affect our cash flow or results of operations and might cause our stock price to fall.

 

Anything that negatively affects the businesses of our licensees could negatively impact our revenue.

 

The timing and level of our royalties depend on our licensees’ ability to market, produce and ship products incorporating our technology. Because we expect licensing and royalty revenue to be the largest source of our future revenue, anything that negatively affects a significant licensee or group of licensees could negatively affect our results of operations and financial condition. Many issues beyond our control influence the success of our licensees, including, for example, the highly competitive environment in which they operate, the strength of the markets for their products, their engineering capabilities and their financial and other resources.

 

Likewise, we have no control over the product development, pricing and marketing strategies of our licensees, which directly affect sales of their products and the corresponding royalties payable to us. A decline in sales of our licensees’ royalty-generating products for any reason would reduce our royalty revenue. In addition, seasonal and other fluctuations in demand for our licensees’ products could cause our operating results to fluctuate, which could cause our stock price to fall.

 

23



 

Our embedded memory technology is new and the occurrence of manufacturing difficulties or low production yields could hinder market acceptance of our technology and reduce future revenue.

 

Complex technology like ours may contain errors or defects when first incorporated into customer products. For example, semiconductor manufacturing yield could be adversely affected by difficulties in adapting our 1T-SRAM technologies to our licensees’ product design or to the manufacturing process technology of a particular foundry or semiconductor manufacturer. Any decrease in manufacturing yields of integrated circuits utilizing our technology could impede the acceptance of our technology in the industry. The discovery of defects or problems regarding the reliability, quality or compatibility of our technology could require significant expenditures and resources to fix, significantly delay or hinder market acceptance of our technology, reduce anticipated revenues and damage our reputation.

 

Our failure to continue to enhance our technology or develop new technology on a timely basis could diminish our ability to attract and retain licensees and product customers.

 

The existing and potential markets for memory products and technology are characterized by ever increasing performance requirements, evolving industry standards, rapid technological change and product obsolescence. These characteristics lead to frequent new product and technology introductions and enhancements, shorter product life cycles and changes in consumer demands. In order to attain and maintain a significant position in the market, we will need to continue to enhance our technology in anticipation of these market trends.

 

In addition, the semiconductor industry might adopt or develop a completely different approach to utilizing memory for many applications, which could render our existing technology unmarketable or obsolete. We might not be able to successfully develop new technology, or adapt our existing technology, to comply with these innovative standards.

 

Our future performance depends on a number of factors, including our ability to—

 

                                          identify target markets and relevant emerging technological trends, including new standards and protocols;

 

                                          develop and maintain competitive technology by improving performance and adding innovative features that differentiate our technology from alternative technologies;

 

                                          enable the incorporation of enhanced technology in our licensees’ and customers’ products on a timely basis and at competitive prices; and

 

                                          respond effectively to new technological developments or new product introductions by others.

 

Since its introduction in 1998, we have introduced enhancements to our 1T-SRAM technology designed to meet market requirements. However, we cannot assure you that the design and introduction schedules of any additions and enhancements to our existing and future technology will be met, that this technology will achieve market acceptance or that we will be able to license this technology on terms that are favorable to us. Our failure to develop future technology that achieves market acceptance could harm our competitive position and impede our future growth.

 

We may incur substantial litigation expense, which would adversely affect our profitability.

 

On March 31, 2004, UniRAM Technology, Inc. filed a complaint against us in the United States District Court for the Northern District of California, alleging trade secret misappropriation and patent infringement.  UniRAM’s complaint asserts that it provided trade secret information to Taiwan Semiconductor Manufacturing Corporation (TSMC) in 1996-97 and speculated that we improperly obtained unspecified trade secrets of UniRAM from TSMC in an unknown manner.  Subsequent to March 31, 2004, UniRAM has amended its complaint twice to add TSMC as a defendant and additional allegations to the suit, and to drop all infringement claims for one of the two patents identified in the initial complaint.  We believe that UniRAM’s complaint lacks merit and intend to vigorously defend against it.

 

On April 23, 2004, we filed a complaint in the Delaware Court of Chancery alleging that defendants Synopsys, Inc. and its subsidiary Mountain Acquisition Sub, Inc. breached the Agreement and Plan of Merger and Reorganization dated February 23, 2004, or the reorganization agreement, under which they agreed to acquire all of our common stock by improperly terminating that agreement without accepting all shares tendered in response to their tender offer on April 16, 2004.  The complaint seeks specific performance under the reorganization agreement or, in the alternative, monetary damages.  The parties have stipulated to expedited proceedings.  Trial of our claim for specific performance is scheduled to commence on July 6, 2004; further proceedings on our claims for damages are deferred pending the outcome of that trial.  If we do not obtain a judgment for specific performance in this suit, we expect to continue to litigate to obtain a judgment for damages against the defendants.

 

24



 

We expect to incur substantial expenses litigating both matters during the second and third quarters of 2004, at least, and potentially for the foreseeable future.  In addition, if we do not prevail in these lawsuits we may be required to pay substantial damages (in the UniRAM) case, and/or the attorneys’ fees and expenses of the other parties, as well as our own.  Any such damages and/or expenses could adversely affect our results of operation and cause net losses for the periods in which we record them.

 

Our quarterly revenues may fluctuate significantly and as a result we cannot provide assurance of our future profitability.

 

Our quarterly revenues have fluctuated in the past, and may in the future as a result of many factors, some of which are beyond our control.  These factors would include the following:

 

                  the length of our sales cycle;

 

                  deferred spending decisions by customers;

 

                  the cyclical nature of the semiconductor industry and the general economic environment;

 

                  the timing and completion of milestones under license agreements;

 

                  changes in the demand for integrated circuits that incorporate our technology; and

 

                  the amount of litigation expenses that we may incur.

 

We believe that period-to-period comparisons of our revenues and operating results are not necessarily meaningful and these comparisons are not indicators of future performance.  We intend to continue our investment in research and development as well as in the marketing and licensing of our technology in an effort to maximize future results.  If revenue falls below our expectations in any quarter and we are not able to adjust spending in a timely manner, we may incur an operating loss.  As a result, we cannot assure you that we will be profitable on a quarterly or annual basis in the future.

 

We rely on semiconductor foundries to assist us in attracting potential licensees, and a loss or failure of these relationships could inhibit our growth and reduce our revenue.

 

Part of our marketing strategy relies upon our relationships and agreements with semiconductor foundries. These foundries have existing relationships, and continually seek new relationships, with companies in the markets we target, and have agreed to utilize these relationships to introduce our technology to potential licensees. If we fail to maintain our current relationships with these foundries, we might fail to achieve anticipated growth.

 

Royalty amounts owed to us might be difficult to verify, and we might find it difficult, expensive and time-consuming to enforce our license agreements.

 

The standard terms of our license agreements require our licensees to document the manufacture and sale of products that incorporate our technology and report this data to us after the end of each quarter. Though our standard license terms give us the right to audit the books and records of any licensee to attempt to verify the information provided to us in these reports, an audit of a licensee’s records can be expensive and time consuming, and potentially detrimental to the business relationship. A failure to fully enforce the royalty provisions of our license agreements could cause our revenue to decrease and impede our ability to maintain profitability.

 

We might not be able to protect and enforce our intellectual property rights, which could impair our ability to compete and reduce the value of our technology.

 

Our technology is complex and is intended for use in complicated integrated circuits. A very large number of new and existing products utilize embedded memory, and a large number of companies manufacture and market these products. Because of these factors, policing the unauthorized use of our intellectual property is difficult and expensive. We cannot be certain that we will be able to detect unauthorized use of our technology or prevent other parties from designing and marketing unauthorized products based on our technology. Although we are not aware of any past or present infringement of our patents, copyrights or trademarks, or any violation of our trade secrets, confidentiality procedures or licensing agreements, we cannot assure you that the steps taken by us to protect our proprietary information will be adequate to prevent misappropriation of our technology. Our inability to protect adequately our intellectual property would reduce significantly the barriers of entry for directly competing technologies and could reduce the value of our technology. Furthermore, we might initiate claims or litigation against third parties for infringement of our proprietary

 

25



 

rights or to establish the validity of our proprietary rights. Litigation by us could result in significant expense and divert the efforts of our technical and management personnel, whether or not such litigation results in a determination favorable to us.

 

Our existing patents might not provide us with sufficient protection of our intellectual property, and our patent applications might not result in the issuance of patents, either of which could reduce the value of our core technology and harm our business.

 

We rely on a combination of patents, trademarks, copyrights, trade secret laws and confidentiality procedures to protect our intellectual property rights. As of March 31, 2004, we held 66 patents in the United States, which expire at various times from 2011 to 2023, and 35 corresponding foreign patents. In addition, as of March 31, 2004, we had 12 patent applications pending in the United States and 24 pending foreign applications, and had received notice of allowance of six patent applications pending in the United States. We cannot be sure that any patents will issue from any of our pending applications or that any claims allowed from pending applications will be of sufficient scope or strength, or issued in all countries where our products can be sold, to provide meaningful protection or any commercial advantage to us. Also, competitors might be able to design around our patents. Failure of our patents or patent applications to provide meaningful protection might allow others to utilize our technology without any compensation to us and impair our ability to increase our licensing revenue.

 

Any claim that our products or technology infringe third-party intellectual property rights could increase our costs of operation and distract management and could result in expensive settlement costs or the discontinuance of our technology licensing or product offerings.

 

The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights or positions, which has resulted in often protracted and expensive litigation. For example, on March 31, 2004, we were sued by UniRAM Technology, Inc. in United States District Court for the Northern District of California based on claims of patent infringement and misappropriation of trade secrets that were allegedly disclosed by UniRAM to TSMC, which allegedly improperly provided them to us.  Additionally, our licensees or we might, from time to time, receive notice of claims that we have infringed patents or other intellectual property rights owned by others. Litigation against us, including the UniRAM suit, could result in significant expense and divert the efforts of our technical and management personnel, whether or not the litigation results in a determination adverse to us. Although we believe that UniRAM’s claims lack merit and we intend to rigorously defend against them, in the event of an adverse result in any such litigation, we could be required to pay damages in an amount we cannot presently predict, cease the licensing of certain technology and expend resources to develop non-infringing technology or obtain licenses for the infringing technology. We cannot assure you that we would be successful in such development or that such licenses would be available on reasonable terms, or at all.

 

The discovery of defects in our technology could expose us to liability for damages.

 

The discovery of a defect in our 1T-SRAM technology could lead our licensees to seek damages from us. Our standard license terms include provisions waiving implied warranties regarding our technology and limiting our liability to our licensees. We also maintain insurance coverage that is intended to protect us against potential liability for defects in our technology. We cannot be certain, however, that the waivers or limitations of liability contained in our license contracts will be enforceable, that insurance coverage will continue to be available on reasonable terms or in amounts sufficient to cover one or more large claims or that our insurer will not disclaim coverage as to any future claim. The successful assertion of one or more large claims that exceed available insurance coverage or changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could cause our expenses to rise significantly and consequently harm our profitability.

 

Our failure to compete effectively in the market for embedded memory technology could reduce our revenue.

 

There exists significant competition in the market for embedded memory technologies. Our licensees and prospective licensees can meet their need for embedded memory by using traditional memory solutions with different cost and performance parameters, which they may internally develop or acquire from third party vendors. If alternative technologies are developed that provide comparable system performance at lower cost than our 1T-SRAM technologies or do not require the payment of comparable royalties, or if the industry generally demonstrates a preference for applications for which our 1T-SRAM technologies do not offer significant advantages, our ability to realize revenue from our 1T-SRAM technologies could be impaired.

 

We might be challenged by competitive developers of alternative technologies who are more established, benefit from greater market recognition and have substantially greater financial, development, manufacturing and marketing resources than we have. These advantages might permit these developers to respond more quickly to new or emerging technologies and changes in licensee requirements. We cannot assure you that future competition will not have a material adverse effect on the adoption of our technology and our market penetration.

 

Our failure to manage the growth of our business could reduce our potential revenue and threaten our future profitability.

 

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The size of our company has increased substantially over the past three years, as we grew from 43 employees in January 2001 to 92 employees in March 2004. The efficient management of our planned expansion of the development, licensing and marketing of our technology, including through the acquisition of other companies will require us to continue to—

 

                                          implement and manage new marketing channels to penetrate different and broader markets for our 1T-SRAM technologies;

 

                                          manage an increasing number of complex relationships with licensees and co-marketers and their customers and other third parties;

 

                                          improve our operating systems, procedures and financial controls on a timely basis;

 

                                          hire additional key management and technical personnel; and

 

                                          expand, train and manage our workforce and, in particular, our development, sales, marketing and support organizations.

 

We cannot assure you that we will adequately manage our growth or meet the foregoing objectives. A failure to do so could jeopardize our future revenues and cause our stock price to fall.

 

Any acquisitions we make could disrupt our business and harm our financial condition.

 

As part of our growth strategy, we might consider opportunities to acquire other businesses or technologies that would complement our current offerings, expand the breadth of our markets or enhance our technical capabilities. ATMOS Corporation is our only acquisition to date. Acquisitions present a number of potential challenges that could, if not overcome, disrupt our business operations, increase our operating costs and reduce the value to us of the acquired company, including—

 

                                          integration of the acquired employees, operations, technologies and products with our existing business and products;

 

                                          focusing management’s time and attention on our core business;

 

                                          retention of business relationships with suppliers and customers of the acquired company;

 

                                          entering markets in which we lack prior experience;

 

                                          retention of key employees of the acquired company; and

 

                                          amortization of intangible assets, write-offs, stock-based compensation and other charges relating to the acquired business and our acquisition costs.

 

If we fail to retain key personnel, our business and growth could be negatively affected.

 

Our business has been dependent to a significant degree upon the services of a small number of executive officers and technical employees, including Dr. Fu-Chieh Hsu, our Chairman of the Board, President and Chief Executive Officer, and Dr. Wingyu Leung, our Executive Vice President and Chief Technical Officer. The loss of their services could negatively impact our technology development efforts and our ability to perform our existing agreements and obtain new customers. We generally have not entered into employment or non-competition agreements with any of our employees and do not maintain key-man life insurance on the lives of any of our key personnel.

 

Our failure to successfully address the potential difficulties associated with our international operations could increase our costs of operation and negatively impact our revenue.

 

We are subject to many difficulties posed by doing business internationally, including—

 

                                          foreign currency exchange fluctuations;

 

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                                          unanticipated changes in local regulation;

 

                                          potentially adverse tax consequences, such as withholding taxes;

 

                                          difficulties regarding timing and availability of export and import licenses;

 

                                          political and economic instability; and

 

                                          reduced or limited protection of our intellectual property.

 

Because we anticipate that licenses to companies that operate primarily outside the United States will account for a substantial portion of our licensing revenue in future periods, the occurrence of any of these circumstances could significantly increase our costs of operation, delay the timing of our revenue and harm our profitability.

 

Provisions of our certificate of incorporation and bylaws or Delaware law might delay or prevent a change of control transaction and depress the market price of our stock.

 

Various provisions of our certificate of incorporation and bylaws might have the effect of making it more difficult for a third party to acquire, or discouraging a third party from attempting to acquire, control of our company. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. Certain of these provisions eliminate cumulative voting in the election of directors, limit the right of stockholders to call special meetings and establish specific procedures for director nominations by stockholders and the submission of other proposals for consideration at stockholder meetings.

 

We are also subject to provisions of Delaware law which could delay or make more difficult a merger, tender offer or proxy contest involving our company. In particular, Section 203 of the Delaware General Corporation Law prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless specific conditions are met. Any of these provisions could have the effect of delaying, deferring or preventing a change in control, including without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of our common stock.

 

Our board of directors may issue up to 20,000,000 shares of preferred stock without stockholder approval on such terms as the board might determine. The rights of the holders of common stock will be subject to, and might be adversely affected by, the rights of the holders of any preferred stock that might be issued in the future.

 

Our stockholder rights plan could prevent stockholders from receiving a premium over the market price for their shares from a potential acquiror.

 

We have adopted a stockholder rights plan, which entitles our stockholders to rights to acquire additional shares of our common stock generally when a third party acquires 15% of our common stock or commences or announces its intent to commence a tender offer for at least 15% of our common stock. This plan could delay, deter or prevent an investor from acquiring us in a transaction that could otherwise result in stockholders receiving a premium over the market price for their shares of common stock.

 

A limited number of stockholders have the ability to influence the outcome of director elections and other matters requiring stockholder approval.

 

Our executive officers, directors and their affiliates or non-affiliate related entities, in the aggregate, beneficially own approximately 29% of our common stock. These stockholders acting together have the ability to exert substantial influence over all matters requiring the approval of our stockholders, including the election and removal of directors and any proposed acquisition, consolidation or sale of all or substantially all of our assets. In addition, they could dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding an acquisition, consolidation, takeover or other business combination, which might otherwise involve the payment of a premium for your shares of our common stock.

 

Potential volatility of the price of our common stock could negatively affect your investment.

 

We cannot assure you that there will continue to be an active trading market for our common stock. Recently, the stock market, as well as our common stock, has experienced significant price and volume fluctuations. Market prices of securities of technology companies have been highly volatile and frequently reach levels that bear no relationship to the operating performance of such companies. These market prices generally are not sustainable and are subject to wide variations. If our common stock trades to unsustainably high levels, it is likely that the market price of our common stock will thereafter experience a material decline.

 

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In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We could be the target of similar litigation in the future. Securities litigation could cause us to incur substantial costs, divert management’s attention and resources, harm our reputation in the industry and the securities markets and reduce our profitability.

 

The price of our stock could decrease as a result of shares being sold in the market by directors, officers and other significant stockholders.

 

Sales of a substantial number of shares of common stock in the public market could adversely affect the market price of the common stock prevailing from time to time. The number of shares of our common stock available for sale in the public market is limited by restrictions under the Securities Act of 1933, as amended, or the Securities Act, but taking into account sales of stock made in accordance with the provisions of Rules 144(k), 144 and 701, substantially all the shares of common stock currently outstanding are eligible for sale in the public market.

 

Risks Relating to the Synopsys Transaction and Litigation

 

If the offer and merger by Synopsys are not completed our stock price may decline, we will have incurred significant costs, we may be liable for fees and our business may be harmed.

 

We have sued Synopsys, Inc. and its wholly owned subsidiary, Mountain Acquisition Sub, Inc. in Delaware Chancery Court seeking an order of specific performance to complete the acquisition of our common stock through acceptance by Synopsys and/or Mountain Acquisition Subs, Inc. of shares tendered in response to the defendants $13.50 per share all cash tender offer dated March 22, 2004. Subsequent to the announcement of Synopsys’s attempted termination of the reorganization agreement, our stock price declined substantially. If we do not obtain a judgment of specific performance, and the offer and merger are not completed, we may be subject to a number of substantial risks, including the following:

 

                  The price of our common stock may decline further, including to the extent the current price of our common stock reflects the price of the offer or the prospect that we may prevail in our suit for specific performance;

 

                  We will be required to pay significant costs related to the offer and the merger, including legal, accounting and financial advisory fees, although we may be entitled to receive $10 million from Synopsys upon termination of the reorganization agreement under certain circumstances; and

 

                  Our reputation and relationships with our customers, suppliers, distributors, licensors and employees may be harmed.

 

Our business and prospects may have been adversely impacted by the offer and merger

 

The negotiation and announcement of the offer and merger, the attempted termination of the reorganization agreement by Synopsys, and the uncertainty regarding our business pending the completion of the offer and merger, may have a number of negative affects on our business, including the following:

 

                  Our management will have been diverted from day-to-day business operations, possibly leading to a loss of revenues and market position;

 

                  Our current and potential customers may have delayed or cancelled purchasing decisions in response to the offer and its termination resulting in a material decline in our revenues;

 

                  Our business partners, including suppliers, distributors and licensors, may have adversely changed or terminated their relationships with us in response to the offer and its termination and

 

                  Our employees may experience uncertainty about their future role with us, harming our ability to attract and retain key management, sales and technical personnel.

 

ITEM 3. Qualitative and Quantitative Disclosure about Market Risk

 

Our investment portfolio consists of money market funds, corporate-backed debt obligations and mortgage-backed government obligations generally due within one year. Our primary objective with this investment portfolio is to invest available cash while preserving principal and meeting liquidity needs. In accordance with our investment policy, we place investments with high

 

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credit quality issuers and limit the amount of credit exposure to any one issuer. These securities, which approximated $84.2 million as of March 31, 2004, and earn an average interest rate of approximately 1.65%, are subject to interest rate risks. However, based on the investment portfolio contents and our ability to hold these investments until maturity, we believe that if a significant change in interest rates were to occur, it would not have a material effect on our financial condition.

 

ITEM 4. Controls and Procedures

 

(a)                                  Evaluation of disclosure controls and procedures

 

Under the supervision and with the participation of our management, including our principle executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the year covered by this report.  Based on this evaluation, our principal executive officer and principal financial officer concluded as of March 31, 2004 that our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our reports filed with the Securities and Exchange Commission (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to MoSys’ management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

(b)                                 Changes in internal controls

 

There have been no significant changes in the Company’s internal controls or in other factors, which could significantly affect internal controls subsequent to the date the Company carried out its evaluation.

 

PART II—OTHER INFORMATION

 

ITEM 1.    Legal Proceedings

 

Descriptions of our pending litigation with UniRAM Technology, Inc. and Synopsys, Inc. are contained in Part I, Item 1, Financial Statements – Notes to Condensed Consolidated Financial Statements — “Note 5.  Contingencies.” and “Note 8.  Subsequent Events,” and Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations –”Liquidity and Capital Resources” and “— Risk Factors — We may incur substantial litigation expense, which would adversely affect our profitability.”

 

ITEM 2.    Changes in Securities and Use of Proceeds

 

The Securities and Exchange Commission declared the Company’s first registration statement, filed on Form S-1 under the Securities Act of 1933 (File No. 333-43122) relating to the Company’s initial public offering of its common stock, effective on June 27, 2001. The Company realized approximately $51.5 million after offering expenses. To date, the Company has not used any of the net proceeds of the offering.

 

ITEM 5.    Other Information

 

On April 17, 2004, Wei Yen submitted his resignation from our board of directors.  In his letter of resignation, Dr. Yen explained that he spends more than half of his time on business in Asia and as a result did not believe he was able to dedicate sufficient time to serving as a director of our company in the future.  He had remained on the board during the pendency of the Synopsys acquisition and was to resign upon its completion. Previously, we had one vacancy on our board of directors that we refrained from filling due to the pendency of our acquisition by Synopsys.  Currently, there are two vacancies on our board of directors for which we are actively seeking qualified individuals who will be “independent” within the meaning of the Nasdaq National Market continued listing requirements.

 

ITEM 6.   Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits

 

31.1                           Rule 13a-14 certification

31.2                           Rule 13a-14 certification

32                                    Section 1350 certification

 

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(b)                                 Reports on Form 8-K

 

On January 28, 2004, the Company filed a report on Form 8-K regarding the Company’s results of operations and financial condition for the forth quarter of 2004.

 

On April 20, 2004, we filed a report on Form 8-K regarding, (1) the failure by Synopsys, Inc. to accept shares of our common stock tendered pursuant to its tender offer and its action to terminate the Agreement and Plan of Merger and Reorganization dated February 23, 2004; and (2) the adoption of a share repurchase program by our board of directors.

 

 

Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated: May 10, 2004

 

 

 

/s/ Mark Voll

 

Vice President, Finance and Administration

 

Chief Financial Officer and Secretary

 

(Duly Authorized and Principal Accounting Officer)

 

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