TRIPATH TECHNOLOGY INC - 10-Q Quarterly Report

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

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

55,345,746 shares of the Registrant’s common stock were outstanding as of May 2, 2005.

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

The unaudited condensed interim consolidated financial statements included herein have been prepared by Tripath Technology Inc. (the “Company”) in accordance with accounting principles generally accepted in the United States of America and reflect all adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary to state fairly the Company’s financial position, results of operations and cash flows for the periods presented. These interim financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Transition Report on Form 10-K/T as restated (refer to Note 16) for the transition period ended September 30, 2004. The results of operations for the three months ended March 31, 2005 are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year.

On November 14, 2004, Tripath’s Board of Directors approved a change in the Company’s fiscal year end from December 31 to September 30, effective as of September 30, 2004.

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

The unaudited condensed interim consolidated financial statements include the accounts of the Company and its wholly-owned Japanese subsidiary, which was incorporated in January 2001. All significant intercompany balances and transactions have been eliminated in consolidation. The U.S. dollar is the functional currency for the Company’s Japanese wholly-owned subsidiary. Assets and liabilities that are not denominated in the functional currency are remeasured into U.S. dollars and the resulting gains or losses are included in “Interest and other income, net.” Such gains or losses have not been material for any period presented.

The Company’s consolidated financial statements have been prepared on the basis of a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred substantial losses and has experienced negative cash flow since inception and has an accumulated deficit of $195.9 million at March 31, 2005.

Beginning in August 2001, the Company instituted programs to reduce expenses including reducing headcount from 144 employees at the end of July 2001 to 63 employees at the end of March 2005 and reducing employees’ salaries by 10%. In September 2002 the Company relocated its headquarters which reduced rent expense and canceled its D&O policy which reduced insurance expense. These actions resulted in significant cost savings in 2003. The Company reduced its cash used in operating activities from approximately $13.0 million in 2002 to approximately $4.1 million in 2003. However, for the nine months ended September 30, 2004, cash used in operating activities increased to $9.1 million. For the six months ended March 31, 2005, cash used in operating activities was $6.0 million.

During 2004, warrants were exercised which resulted in the Company receiving proceeds totaling approximately $2.3 million. In addition, in August 2004 we raised $5.0 million through financing and in March 2005 we raised $4.0 million through a private placement. At March 31, 2005, the Company had working capital of $6.5 million, including cash of $5.1 million.

The Company is aware that its existing working capital at March 31, 2005 may not be sufficient to meet its operating, working capital, investing and financing requirements for the next twelve months. The Company has not made any adjustment to its consolidated financial statements as a result of the potential outcome of the uncertainty described above.

The Company will need to raise additional funds to finance its activities through public or private equity or debt financings, the formation of strategic partnerships or alliances with other companies or through bank borrowings with existing or new banks. The Company may not be able to obtain additional funds on terms that would be favorable to the Company and its stockholders, or at all. In such instance, the Company will take measures to reduce its operating expenses, such as reducing headcount or canceling selected research and development projects. Without sufficient capital to fund its operations, the Company will no longer be able to continue as a going concern. The Company believes, based on its current cash balance as well as its ability to implement the aforementioned measures, if needed, that the Company will have liquidity sufficient to meet its operating, working capital and financing needs for the next twelve months and perhaps beyond. The Company’s long-term prospects are dependent upon obtaining sufficient financing as needed to fund current working capital needs and future growth, and ultimately on achieving profitability.

The Company recognizes revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition”. The Company recognizes revenue when all of the following criteria are met: 1) there is persuasive evidence that an arrangement exists, 2) delivery of goods has occurred, 3) the sales price is fixed or determinable, and 4) collectibility is reasonably assured. The following policies apply to the Company’s major categories of revenue transactions.

Sales to OEM Customers: Under the Company’s standard terms and conditions of sale, title and risk of loss transfer to the customer at the time product is shipped to the customer, FOB shipping point, and revenue is recognized accordingly. The Company accrues the estimated cost of post-sale obligations, including basic product warranties or returns, based on historical experience. The Company has experienced minimal warranty or other returns to date.

Sales to Distributors: Sales to distributors are made under arrangements allowing limited rights of return, generally under product warranty provisions, stock rotation rights and price protection on products unsold by the distributor. In addition, the distributor may request special pricing and allowances which may be granted subject to the company’s approval. As a result of these return rights and potential pricing adjustments, the Company generally defers recognition of revenue until such time that the distributor sells product to its customer based upon receipt of point-of-sale reports from the distributor.

Basic net loss per share is computed by dividing the net loss attributable to common stockholders for the period by the weighted average number of common stock outstanding during the period. Diluted net loss per share is computed based on the weighted average number of common stock and dilutive potential common stock outstanding. The calculation of diluted net loss per share excludes potential common stock if the effect is anti-dilutive. Potential common stock consists of incremental common stock issuable upon the exercise of stock options and common stock issuable upon the exercise of common stock warrants.

Total potential common stock of 11,392,000 and 8,912,000 shares were not included in the diluted net loss per share calculation for the periods ended March 31, 2005 and 2004, respectively, because to do so would be anti-dilutive.

The following table sets forth the computation of basic and diluted net loss per share for the periods presented (in thousands, except per share amounts):

The Company recognized deferred stock-based compensation in connection with certain employee stock option grants and the issuance of restricted stock. The deferred stock-based compensation related to the employee stock option grants is being amortized over the vesting periods of the related options, generally four years, using an accelerated basis while the deferred stock-based compensation related to the issuance of restricted stock is being amortized over two years on a straight line basis. The fair value per share used to calculate deferred stock-based compensation was derived by reference to the share quoted price. Future compensation charges are subject to reduction for any employee who terminates employment prior to such employee’s option vesting date.

The Company has granted options to purchase shares of common stock to consultants in exchange for services. The Company determined the value of the options granted to consultants based on the Black-Scholes option pricing model.

The following table sets forth, for each of the periods presented, the deferred stock-based compensation recorded and the amortization of deferred stock-based compensation (in thousands):

Unamortized deferred stock-based compensation at March 31, 2005 and September 30, 2004 was $14,000 and $95,000 respectively.

The Company accounts for its stock-based compensation plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. No stock-based employee compensation cost is reflected in net income for the periods ended March 31, 2005 and 2004, as all options granted under those plans had an exercise price that was at least equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net loss and loss per share as if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation” to stock-based employee compensation.

The Company considers all highly liquid investments with a maturity of three months or less from the date of purchase to be cash equivalents. Cash and cash equivalents consist of cash on deposit with banks and money market funds, the fair value of which approximates cost.

The Company has entered into a Security Agreement to provide collateral for an outstanding standby letter of credit which totaled approximately $160,000 at March 31, 2005. The collateral is considered restricted cash.

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and short-term investments. Substantially all of the Company’s cash and cash equivalents are invested in highly-liquid money market funds with major financial institutions. The Company sells its products through distributors and directly to original equipment manufacturers. The Company performs periodic credit evaluations of its customers and maintains an allowance for potential credit losses, as considered necessary by management. Credit losses to date have been consistent with management’s estimates. During the quarters ended March 31, 2005 and 2004, the Company had minimal bad debts write-offs.

The following table summarizes sales to end customers comprising 10% or more of the Company’s total revenue for the periods indicated:

The Company’s accounts receivable were concentrated with five customers at March 31, 2005 representing 24%, 14%, 11%, 9%, and 9% of aggregate gross receivables and with four customers at September 30, 2004 representing 46%, 16%, 9% and 9% of aggregate gross receivables.

Inventories are stated at the lower of cost or market. This policy requires the Company to make estimates regarding the market value of the Company’s inventory, including an assessment of excess or obsolete inventory. The Company determines excess and obsolete inventory based on an estimate of the future demand and estimated selling prices for the Company’s products within a specified time horizon, generally 12 months. The estimates the Company uses for expected demand are also used for near-term capacity planning and inventory purchasing and are consistent with the Company’s revenue forecasts. Actual demand and market conditions may be different from those projected by the Company’s management. If the Company’s unit demand forecast is less than the Company’s current inventory levels and purchase commitments, during the specified time horizon, or if the estimated selling price is less than the Company’s inventory value, the Company will be required to take additional excess inventory charges or write-downs to the net realizable value which will decrease the Company’s gross margin and net operating results in the future. During the quarter ended March 31, 2002, the Company recorded a provision for slow moving, excess, and obsolete inventory of approximately $5.0 million related to excess inventory for the Company’s TA2022 product as a result of a decrease in forecasted sales for this product. In fiscal 2004, the Company increased the inventory reserves by an additional $4.3 million from $4.9 million to $9.2 million to account for slow moving, excess, and obsolete inventory. The additional inventory charge related to slow-moving and excess inventory for our TA1101B, TA3020, TA2041, TA2022 and leaded TA2024 products, the TK2350, TK2051, TK2150, TK2050 and TK2052 chipsets, and Kauai 2BB and U461 die based on a decline in forecasted sales for these parts. During the quarter ended March 31, 2005, the Company released a net amount of approximately $1.5 million of inventory reserves for products sold that were previously reserved for.

On March 3, 2005, the Company completed a private placement which resulted in gross proceeds of $4.4 million. In connection with this private placement the Company sold 4,833,335 shares of common stock at a price of $0.90 per share and issued warrants to purchase up to 966,667 shares of common stock. The warrants have a term of 3.5 years and an exercise price equal to $1.25. Since the warrants are subject to certain registration rights, the Company recorded a warrant liability, totaling $967,000, in accordance with EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”. The registration rights provide for the Company to file with the Securities and Exchange Commission a Registration

Statement covering the resale of all of the securities issued in connection with the private placement. The Company is subject to certain penalties if the Registration Statement is not declared effective by the stipulated deadline. The Company valued the warrants using the Black-Scholes option pricing model, applying a life of 3.5 years, a risk free interest rate of 4.02%, an expected dividend yield of 0%, a volatility of 154% and a deemed fair value of common stock of $1.17 which was the closing price of the Company’s common stock on March 3, 2005. In accordance with SFAS 133 “Accounting for Derivative Instruments and Hedging Activities”, the Company revalued the warrants as of March 31, 2005 using the Black-Scholes option pricing model. Assumptions regarding the life, the expected dividend yield and volatility were left unchanged but the Company did apply a risk free interest rate of 4.18% and a deemed fair value of common stock of $0.89, which was the closing price of the Company’s common stock on March 31, 2005. The difference of $252,000 between the fair value of the warrants as of March 31, 2005 and the original valuation of $967,000 as of March 3, 2005 has been recorded as a gain on revaluation of warrant liability. Upon the registration statement covering the shares underlying the warrants being declared effective, the fair value of the warrants on that date will be reclassified to equity.

In March 2005 the Company completed a private placement of common stock and common stock purchase warrants with certain institutional investors. The Company agreed to sell an aggregate of approximately 4,833,335 shares of common stock at $0.90 per share. The investors will also receive warrants to purchase an aggregate of approximately 966,667 shares of the Company’s common stock at an exercise price of $1.25 per share.

On March 2, 2005 the Company entered into a Severance Agreement and Release (the “Agreement”) with its former Chief Financial Officer. Pursuant to the Agreement, the vesting of the former Chief Financial Officer’s stock options was accelerated so that options to purchase 75,000 shares of the Company’s common stock became fully vested and exercisable. Such options have an exercise price of $1.85 per share and are exercisable at any time up to September 15, 2005. The Company has recorded compensation expense totaling $19,000 related to the acceleration of the vesting of these options.

The Company has determined that it has one reportable business segment: the design, license and marketing of integrated circuits.

The following is a geographic breakdown of the Company’s sales by shipping destination for the following periods (in thousands):

Approximately 96% of the Company’s total revenue for the three months ended March 31, 2005 was derived from sales to end customers based outside the United States. The same percentage of the Company’s total revenue for the three months ended March 31, 2004 was derived from sales to end customers based outside the United States.

Lease commitments: The Company leases office space and equipment under non-cancelable operating leases. The Company also has a capital lease for research and development related software and a capital lease for manufacturing test equipment.

The Company’s total commitments on its operating and capital leases and inventory purchases as of March 31, 2005, were as follows (in thousands):

Contingencies: From time to time, in the normal course of business, various claims could be made against the Company. At March 31, 2005, there were no pending claims the outcome of which is expected to result in a material adverse effect on the financial position or results of operations of the Company.

In November 2002, the FASB issued FIN No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others—an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34.” The following is a summary of the Company’s agreements that the Company has determined are within the scope of FIN 45.

The Company provides a limited warranty for up to one year for any defective products. During the quarter ended March 31, 2005 and for the transition period ended September 30, 2004, warranty expense was insignificant. The Company has a reserve for warranty costs of $30,000, which has not changed in the past quarter.

In March 2004, the Company entered into a Security Agreement to provide collateral for outstanding standby letters of credit which totaled $0.7 million at December 31, 2004. In March 2005, one of these standby letters of credit expired. The remaining outstanding standby letter of credit totals approximately $0.2 million.

Pursuant to its bylaws, the Company has agreed to indemnify its officers and directors for certain events or occurrences arising as a result of the officer or director serving in such capacity. The term of the indemnification

period is for the officer’s or director’s lifetime. The Company is likely to incur costs in connection with these indemnification agreements as a result of the recent litigation. However, the Company has no liabilities recorded for these agreements as of March 31, 2005 as the Company is unable to estimate these liabilities at this time. During the quarter ended December 31, 2004 the Company obtained a new Directors and Officers (“D&O”) Liability Insurance policy. However, this new D&O policy does not cover the lawsuits described in Note 15 although the claims involved in these lawsuits may be covered by the aforementioned indemnification agreements.

The Company enters into indemnification provisions under (i) its agreements with other companies in its ordinary course of business, typically with business partners, contractors and customers, its sublandlord and (ii) its agreements with investors. Under these provisions the Company has agreed to generally indemnify and hold harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities or, in some cases, as a result of the indemnified party’s activities under the agreement. These indemnification provisions often include indemnifications relating to representations made by the Company with regard to intellectual property rights. These indemnification provisions generally survive termination of the underlying agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. To date, the Company has not incurred any costs in connection with these indemnification agreements. Accordingly, the Company has no liabilities recorded for these agreements as of March 31, 2005.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs—an amendment of ARB No. 43, Chapter 4.” (“SFAS 151”). SFAS 151 amends ARB 43, Chapter 4 to clarify that “abnormal” amounts of idle freight, handling costs and spoilage should be recognized as current period charges. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not anticipate that the adoption of this standard will have a material impact on the Company’s consolidated financial statements.

In December 2004, the FASB issued SFAS No. 152 “Accounting for Real Estate Time-Sharing Transactions—an amendment of FASB statements No. 66 and 67” (“SFAS 152”). SFAS 152 amends SFAS 66 and 67 to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2, Accounting for Real Estate Time-Sharing Transactions. SFAS 152 is effective for financial statement for fiscal years beginning after June 15, 2005. The Company does not anticipate that the adoption of this standard will have a material impact on the Company’s consolidated financial statements.

In December 2004, the FASB issued SFAS No. 153 “Exchanges of Non-monetary Assets—an amendment of APB opinion No. 29” (“SFAS 153”). SFAS 153 clarifies that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged, with a general exception for exchanges that have no commercial substance. SFAS 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not anticipate that the adoption of this standard will have a material impact on the Company’s consolidated financial statements.

April 14, 2005, the SEC announced the adoption of a new rule that amended the compliance dates for SFAS 123 (R). Under the new rule, companies are allowed to implement SFAS 123 (R) at the beginning of the next fiscal year, instead of the next reporting period, that begins after June 15, 2005. The Company is required to comply with SFAS 123 (R) beginning with the Company’s fiscal quarter ending December 31, 2005. SFAS 123 (R) provides transition alternatives for public companies to restate prior interim periods or prior years. The Company is still evaluating the transition provisions allowed by SFAS 123 (R).

In March 2005, the SEC released SEC Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”). SAB 107 provides the SEC staff’s position regarding the application of SFAS 123(R) and certain SEC rules and regulations, and also provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. The Company is currently reviewing the effect, if any, that the application of SAB 107 will have on the Company’s financial position and results of operations.

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”), which clarifies the term “conditional asset retirement obligations” as used in SFAS No. 143, “Accounting for Asset Retirement Obligations.” The Company does not anticipate that the application of FIN 47 will have a material impact on the Company’s financial position and results of operations.

The Company is a party to lawsuits in the normal course of its business. Litigation in general, and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict. An unfavorable resolution of one or more of these lawsuits would materially adversely affect its business, results of operations, or financial condition. In addition, given the Company’s financial condition and that the Company does not have insurance to offset the cost of litigation, the costs of defending one or more of these lawsuits will likely adversely affect the Company’s financial condition. The Company cannot estimate the loss or range of loss that may be reasonably possible for any of the contingencies described and accordingly has not recorded any associated liabilities in its consolidated balance sheets. The Company accrues legal costs when incurred.

On or about November 9, 2004, the U.S. Securities and Exchange Commission (the “SEC”) requested that the Company voluntarily produce documents responsive to certain document requests in the investigation entitled In the Matter of Tripath Technology, Inc. On or about January 25, 2004, February 14, 2005, and February 16, 2005, the SEC made additional documents requests. On or about March 30, 2005, the SEC issued a subpoena to the Company seeking additional documents. The Company has produced documents and is continuing to produce documents in response to the SEC’s voluntary requests as well as the subpoena. The Company has cooperated with the SEC in its review of these matters.

On or about February 24, 2005, the SEC, pursuant to Section 20(a) of the Securities Act and Section 21(a) of the Exchange Act, issued a formal order of private investigation to determine whether there have been any violations of Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-13, 13a-14, 13b2-1 and 13b2-2 thereunder.

its officers and/or directors violated Sections 10(b) and 20(a) of the Exchange Act. Plaintiffs purport to represent a putative class of shareholders who purchased or otherwise acquired Tripath securities between January 29, 2004 and October 22, 2004. The complaints contain varying allegations, including that the Company and the individual defendants made materially false and misleading statements with respect to its financial results and with respect to the Company’s business, prospects and operations in its filings with the SEC, press releases and other disclosures. The complaints seek unspecified compensatory damages, attorneys’ fees, expert witness fees, costs and such other relief as may be awarded by the Court.

On December 22, 2004, the Court entered a stipulation and order consolidating all of these complaints and ordering that the defendants need not respond to any of these complaints until after plaintiffs file a consolidated complaint. The Court further ordered plaintiffs to file a consolidated complaint within sixty (60) days after the Court entered an order adjudicating the pending motions for the appointment of lead plaintiff.

On January 4, 2005, plaintiffs filed motions for the appointment of lead plaintiff. The Court, by Order dated January 28, 2005, appointed Robert Poteet as the sole lead plaintiff and approved Milberg Weiss Bershad & Schulman LLP as lead counsel. On March 10, 2005, the Court granted the parties’ stipulated request to extend lead plaintiff’s time for filing the consolidated complaint from March 29, 2005 to May 31, 2005. By order dated May 16, 2005, the Court extended lead plaintiffs’ time for filing the consolidated complaint from May 31, 2005 to June 28, 2005.

On December 7, 2004, plaintiff Mildred Lyon filed a purported derivative action in Santa Clara Superior Court against the Company and certain of its officers and/or directors. This complaint appears to be based upon the same facts and circumstances as the federal class actions and makes the following claims: violation of Section 25402 of the California Corporations Code, breach of fiduciary duty and misappropriation of information, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment. On this basis, the complaint seeks unspecified compensatory damages, treble damages under Section 25502.5(a) of the California Corporations Code, extraordinary equitable and/or injunctive relief, restitution and disgorgement, attorneys’ fees, expert witness fees, costs, and such other relief as may be ordered by the Court.

On December 27, 2004, the Court entered a stipulation and order extending the time for the Company to respond to the complaint to February 23, 2005. On February 16, 2005, the Court entered an order further extending the time for the Company to respond to the complaint to March 25, 2005. On March 10, the Court ordered that the individual defendants shall have through and including April 25, 2005 to file any motions to quash and/or dismiss for lack of personal jurisdiction, and that all defendants shall have thirty (30) days from the date the court issues a ruling on any motions to quash and/or dismiss for lack of personal jurisdiction to respond to the complaint, or in the event that no such motions are brought, extended the time for all defendants to respond to the complaint to April 25, 2005.

On March 30, 2005, the Court rescheduled the Case Management Conference to July 12, 2005. On April 4, 2005, the Court ordered that all deadlines shall be stayed for Defendants filing any motions to quash and/or dismiss for lack of personal jurisdictions, or otherwise respond to the Complaint, until such date as the parties mutually designate to the Court for the Court’s approval. The parties currently are engaged in settlement discussions.

As previously disclosed in the Company’s current report on Form 8-K dated October 18, 2004 and filed on October 22, 2004, in October 2004, the Company’s former independent registered public accountants, BDO Seidman LLP (“BDO”), provided the Company’s Audit Committee with a letter citing what BDO asserted are two “material weaknesses” over the Company’s internal financial controls: one regarding the lack of effectiveness of the Company’s Audit Committee and the other regarding the lack of controls in place to estimate distributor returns in accordance with SFAS No. 48. Following discussions with employees of the Company, representatives of BDO further orally advised the Company that BDO had concerns regarding the appropriate accounting for approximately $1.3 million of product that, upon the Company’s inquiries, one of the Company’s distributors, Macnica (the “Distributor”), reported had been returned to the Distributor by the Distributor’s customers (the “Product Return”). In response to both the letter and the verbal comments, the Audit Committee instructed the Company’s Chief Financial Officer to investigate this matter and report the findings to the Audit Committee. As a result of the litigation matters referenced above, the Company retained outside litigation counsel to represent the Company in responding to the aforementioned complaints. In addition, the Audit Committee and the Chief Financial Officer directed litigation counsel to further conduct an internal investigation into the verbal concerns raised by BDO regarding the Product Return. Separately, the Audit Committee, with the assistance of the Company’s Chief Financial Officer investigated BDO’s assertion regarding the lack of controls in place to estimate distributor returns.

The Audit Committee received an initial report from the Company’s litigation counsel on findings of the internal investigation on January 21, 2005 and requested additional investigation by litigation counsel. On January 25, 2005, litigation counsel made a supplemental report on the findings of the internal investigation to date. Following the presentation of such report, including discussion of the findings of the forensic accountant hired by the litigation counsel with the approval of the Audit Committee, the Audit Committee concluded that the Company’s Country Manager for the Japan Sales Office (who is no longer employed with the Company) agreed in an arrangement outside the formal paperwork of the transactions underlying the Product Return that the Distributor could return the products back to the Company at the Distributor’s discretion.

The Audit Committee investigation and discussion included a review of the Company’s compliance with Securities and Exchange Commission Staff Accounting Bulletin No. 104 “Revenue Recognition in Financial Statements (“SAB 104”) as applied to the circumstances surrounding the Product Return. Under SAB 104, a requirement for revenue recognition is that all of the following criteria must be met: (1) there is persuasive evidence that an arrangement exists, (2) delivery of goods has occurred, (3) the sales price is fixed or determinable, and (4) collectibility is reasonably assured. In addition, pursuant to the Company’s revenue recognition policy, for sales to distributors, the Company defers recognition of revenue until such time that the distributor sells products to its customers based upon receipt of point-of-sales reports from the Distributor. The internal investigation revealed that approximately $1.4 million of a sale of the Company’s product to the Distributor did not meet the foregoing criteria because a former employee of the Company had agreed that the Distributor could return the product at the Distributor’s discretion, which forms the basis of the Restatement. This former employee had on this occasion agreed to a term of sale that was outside of the Company’s standard practices and was not referenced in the documentation related to the sale submitted to the Company’s finance department. Given the discovery of this arrangement for the Distributor to return the product, the Audit Committee concluded on January 25, 2005 that the Company should restate certain financial information that was previously reported in the Company’s Form 10-Q for the quarter ended June 30, 2004 filed with the Securities and Exchange Commission on August 6, 2004 (the “Restatement”). For more information regarding the Restatement, please see Note 9 to the Company’s consolidated financial statements, “Supplementary Financial Information” in the Company’s Transitional Report on Form 10-K/T filed with the Securities and Exchange Commission on February 3, 2005. In addition, the Audit Committee approved certain changes to the

Company’s internal controls over financial reporting as an additional remedial action in response to the report of the litigation counsel and its forensic accountant and to the report by the Company’s Chief Financial Officer. For more information regarding these changes, please see Item 9A, “Controls and Procedures.”

As originally described in the Company’s Current Report on Form 8-K dated October 18, 2004 and filed with the Securities and Exchange Commission on October 22, 2004 (the “Prior 8-K”), the Company’s Audit Committee initiated an internal investigation regarding certain purported product returns (the “Product Returns”) to one of the Company’s distributors, Macnica Japan (“Macnica”), by its customers. The Audit Committee investigation and discussion included a review of the Company’s compliance with Securities and Exchange Commission Staff Accounting Bulletin No. 104 “Revenue Recognition in Financial Statements” (“SAB 104”) as applied to the circumstances surrounding the Product Returns. Under SAB 104, a requirement for revenue recognition is that all of the following criteria must be met: (1) there is persuasive evidence that an arrangement exists, (2) delivery of goods has occurred, (3) the sales price is fixed or determinable, and (4) collectibility is reasonably assured. In addition to SAB 104, the Company’s revenue recognition policy, for sales to distributors, requires that the Company defer recognition of revenue until such time that the distributor sells products to its customers based upon receipt of point-of-sales reports from the distributor. As of the Audit Committee’s determination on January 25, 2005, the internal investigation revealed that approximately $1.4 million of a sale of the Company’s product to Macnica did not meet the foregoing criteria because the Company’s Country Manager for the Japan Sales Office (who is no longer employed by the Company) had agreed that Macnica could return the product to the Company at Macnica’s discretion. The Audit Committee determined that this former employee had agreed to a term of sale that was outside of the Company’s standard practices and was not referenced in the documentation related to the sale submitted to the Company’s finance department. Given the discovery of this arrangement for Macnica to return the product, the Company’s Audit Committee concluded that the Company should restate certain financial information that was previously reported in the Company’s Form 10-Q for the quarter ended June 30, 2004, filed with the Securities and Exchange Commission on August 6, 2004 (the “June 2004 Form 10-Q”) to properly reflect its revenue and related financial information for the referenced periods (the “Initial Restatement”). Accordingly, the Company advised in the Prior 8-K that the Consolidated Statement of Operations for the three months and six months ended June 30, 2004 and the Consolidated Balance Sheet as of June 30, 2004 included in the June 2004 Form 10-Q should no longer be relied upon. The financial impact of the Initial Restatement was reflected in the Company’s Transitional Report on Form 10-K/T for the transition period ended September 30, 2004 filed with the Securities and Exchange Commission on February 3, 2005 (the “Transitional Report”). For more information regarding the Initial Restatement, please see Note 9 of the Notes to the Company’s Consolidated Financial Statements, “Supplementary Financial Information” in the Company’s Transitional Report.

The Audit Committee directed that the internal investigation continue following reporting of the Initial Restatement. As a result of this further investigation, on May 5, 2005 the Audit Committee determined that additional sale transactions with Macnica, as well as with an additional distributor of the Company, Uniquest, did not meet the Company’s revenue recognition criteria and the requirements of SAB 104. In certain circumstances, the same former employee of the Company had agreed that Macnica could return the referenced product at Macnica’s discretion. This former employee had on these occasions agreed to a term of sale that was outside of the Company’s standard practices and was not referenced in the documentation related to the sale submitted to the Company’s finance department. In addition, the Audit Committee determined that, in certain other circumstances, Macnica had shipped product not to end customers but to other distributors and the Company had relied on point-of-sales reports submitted to the Company by Macnica that indicated the referenced product had been shipped to an end customer of Macnica when such product had only been shipped to other distributors. Recognition of revenue on

sales between distributors instead of to the end customers is not permitted under the Company’s revenue recognition policies. Further, the Audit Committee determined that certain sales transactions with Uniquest did not meet the Company’s revenue recognition criteria and the requirements of SAB 104 because in certain circumstances, employees of Uniquest had incorrectly reported to the Company the date of shipments to end customers.

As a result, the Audit Committee concluded on May 5, 2005 that the Company should restate certain financial information (the “Additional Restatement”) that was previously reported in the Company’s Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2004, June 30, 2004 and December 31, 2004 as well as certain financial information for the quarter and transitional period ended September 30, 2004 and that was previously reported in the Company’s Transitional Report on Form 10-K/T.

The Company, in consultation with its former independent public accountants, has determined that any adjustments to periods prior to 2003, are immaterial and will not require a restatement. The Company’s assessment of materiality was based on a review of both qualitative and quantitative factors in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 99 “Materiality”. The Company further anticipates that there will be no change to the previously reported net loss per share for any of the periods prior to 2003. The Company is in consultation with its current independent public accountants and the determination as to whether any adjustments to the Company’s 2003 financial statements are material or not is still pending.

The following table provides a reconciliation of amounts previously reported in the Company’s Form 10-Q for the quarter ended March 31, 2004 with amounts previously adjusted for the restatement as a result of the Audit Committee’s investigation.

The following table provides a reconciliation of amounts previously reported in the Company’s Transitional Report on Form 10-K/T for the nine months ended September 30, 2004 with amounts previously adjusted for the restatement as a result of the Audit Committee’s Investigation.

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

This report contains forward looking statements (as such term is defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) and information relating to us that are based on the beliefs of our management as well as assumptions made by and information currently available to our management. In addition, when used in this report, the words “likely,” “will,” “suggests,” “target,” “may,” “would,” “could,” “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “predict,” and similar expressions and their variants, as they relate to us or our management, may identify forward looking statements. Such statements reflect our judgment as of the date of this quarterly report on Form 10-Q with respect to future events, the outcome of which are subject to certain known and unknown risks and uncertainties, including the factors discussed under the caption “Risk Factors,” and those discussed elsewhere in this quarterly report on Form 10-Q, which may have a significant impact on our business, operating results or financial condition. Investors are cautioned that these forward looking statements are inherently uncertain. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein. Although we believe that the expectations reflected in these forward looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward looking statements included in this report are based on information available to us as of the date of this report. We undertake no obligation to update or revise any forward looking statements, whether as a result of new information, future events or otherwise, unless we are required to do so by law.

The following discussion and analysis should be read in connection with the condensed consolidated financial statements and the notes thereto included in Item 1 in this quarterly report and our transition report on Form 10-K/T for the transition period ended September 30, 2004.

As originally described in our Current Report on Form 8-K dated October 18, 2004 and filed with the Securities and Exchange Commission on October 22, 2004 (the “Prior 8-K”), our Audit Committee initiated an internal investigation regarding certain purported product returns (the “Product Returns”) to one of our distributors, Macnica Japan (“Macnica”), by its customers. The Audit Committee investigation and discussion included a review of our compliance with Securities and Exchange Commission Staff Accounting Bulletin No. 104 “Revenue Recognition in Financial Statements” (“SAB 104”) as applied to the circumstances surrounding the Product Returns. Under SAB 104, a requirement for revenue recognition is that all of the following criteria must be met: (1) there is persuasive evidence that an arrangement exists, (2) delivery of goods has occurred, (3) the sales price is fixed or determinable, and (4) collectibility is reasonably assured. In addition to SAB 104, our revenue recognition policy, for sales to distributors, requires that we defer recognition of revenue until such time that the distributor sells products to its customers based upon receipt of point-of-sales reports from the distributor. As of the Audit Committee’s determination on January 25, 2005, the internal investigation revealed that approximately $1.4 million of a sale of our product to Macnica did not meet the foregoing criteria because our Country Manager for the Japan Sales Office (who is no longer employed by us) had agreed that Macnica could return the product to us at Macnica’s discretion. The Audit Committee determined that this former employee had agreed to a term of sale that was outside of our standard practices and was not referenced in the documentation related to the sale submitted to our finance department. Given the discovery of this arrangement for Macnica to return the product, our Audit Committee concluded that we should restate certain financial information that was previously reported in our Form 10-Q for the quarter ended June 30, 2004, filed with the Securities and Exchange Commission on August 6, 2004 (the “June 2004 Form 10-Q”) to properly reflect our revenue and related financial information for the referenced periods (the “Initial Restatement”). Accordingly, we advised in the Prior 8-K that the Consolidated Statement of Operations for the three months and six months ended June 30, 2004 and the Consolidated Balance Sheet as of June 30, 2004 included in the June 2004 Form 10-Q should no longer be relied upon. The financial impact of the Initial Restatement was reflected in our Transitional Report on Form 10-K/T for the transition period ended September 30, 2004 filed with the Securities and Exchange Commission on February 3, 2005 (the “Transitional Report”). For more information regarding the

Initial Restatement, please see Note 9 of the Notes to our Consolidated Financial Statements, “Supplementary Financial Information” in our Transitional Report.

The Audit Committee directed that the internal investigation continue following reporting of the Initial Restatement. As a result of this further investigation, on May 5, 2005 the Audit Committee determined that additional sale transactions with Macnica, as well as with an additional distributor of the Company, Uniquest, did not meet the our revenue recognition criteria and the requirements of SAB 104. In certain circumstances, the same former employee of the Company had agreed that Macnica could return the referenced product at Macnica’s discretion. This former employee had on these occasions agreed to a term of sale that was outside of our standard practices and was not referenced in the documentation related to the sale submitted to our finance department. In addition, the Audit Committee determined that, in certain other circumstances, Macnica had shipped product not to end customers but to other distributors and we had relied on point-of-sales reports submitted to us by Macnica that indicated the referenced product had been shipped to an end customer of Macnica when such product had only been shipped to other distributors. Recognition of revenue on sales between distributors instead of to the end customers is not permitted under our revenue recognition policies. Further, the Audit Committee determined that certain sales transactions with Uniquest did not meet our revenue recognition criteria and the requirements of SAB 104 because in certain circumstances, employees of Uniquest had incorrectly reported to us the date of shipments to end customers.

As a result, the Audit Committee concluded on May 5, 2005 that we should restate certain financial information (the “Additional Restatement”) that was previously reported in our Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2004, June 30, 2004 and December 31, 2004 as well as certain financial information for the quarter and transitional period ended September 30, 2004 and that was previously reported in our Transitional Report on Form 10-K/T.

We, in consultation with our former independent public accountants, have determined that any adjustments to periods prior to 2003 are immaterial and will not require a restatement. Our assessment of materiality was based on a review of both qualitative and quantitative factors in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 99 “Materiality.” We further anticipate that there will be no change to the previously reported net loss per share for any of the periods prior to 2003. We are in consultation with our current independent public accountants and the determination as to whether any adjustments to the Company’s 2003 financial statements are material or not is still pending.

Use of Estimates: Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to product returns, warranty obligations, bad debts, inventory direct costing and valuation, accruals, valuation of stock options and warrants, income taxes (including the valuation allowance for deferred taxes) and restructuring costs. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from the other sources. Actual results may materially differ from these estimates under different assumptions or conditions. Material differences may occur in our results of operations for any period if we made different judgments or utilized different estimates.

Revenue Recognition: We recognize revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition in Financial Statements”. We recognize revenue when all of the following criteria are met: 1) there is persuasive evidence that an arrangement exists, 2) delivery of goods has occurred, 3) the sales price is fixed or determinable, and 4) collectibility is reasonably assured. The following policies apply to our major categories of revenue transactions. Sales to OEM Customers:

Under our standard terms and conditions of sale, title and risk of loss transfer to the customer at the time product is delivered to the customer, FOB shipping point, and revenue is recognized accordingly. We accrue the estimated cost of post-sale obligations, including product warranties or returns, based on historical experience. We have experienced minimal warranty or other returns to date. Sales to Distributors: Sales to distributors are made under arrangements allowing limited rights of return, generally under product warranty provisions, stock rotation rights and price protection on products unsold by the distributor. In addition, the distributor may request special pricing and allowances which may be granted subject to our approval. As a result of these return rights and potential pricing adjustments, we generally defer recognition of revenue until such time that the distributor sells product to its customer based upon receipt of point-of-sale reports from the distributor.

Allowance for Doubtful Accounts: We provide an allowance for doubtful accounts to ensure trade receivables are not overstated due to uncollectibility. The collectibility of our receivables is evaluated based on a variety of factors, including the length of time receivables are past due, indication of the customer’s willingness to pay, significant one-time events and historical experience. An additional reserve for individual accounts is recorded when we become aware of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings or substantial deterioration in the customer’s operating results or financial position. If circumstances related to our customers change, estimates of the recoverability of receivables would be further adjusted.

Inventories: Inventories are stated at the lower of cost or market. This policy requires us to make estimates regarding the market value of our inventory, including an assessment of excess or obsolete inventory. We determine excess and obsolete inventory based on an estimate of the future demand and estimated selling prices for our products within a specified time horizon, generally 12 months. The estimates we use for expected demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. Actual demand and market conditions may be different from those projected by our management. If our unit demand forecast is less than our current inventory levels and purchase commitments, during the specified time horizon, or if the estimated selling price is less than our inventory value, we will be required to take additional excess inventory charges or write-downs to the net realizable value which will decrease our gross margin and net operating results in the future. During the quarter ended March 31, 2002, we recorded a provision for excess inventory of approximately $5.0 million related to excess inventory for our TA2022 product as a result of a decrease in forecasted sales for this product. In 2004, we increased the inventory reserves by an additional $4.3 million, from $4.9 million to $9.2 million, to account for slow moving, excess, and obsolete inventory. During the quarter ended March 31, 2005, we released a net amount of approximately $1.5 million of inventory reserves, which reduced inventory reserves at March 31, 2005 to $7.7 million.

Revenue. Revenue for the three months ended March 31, 2005 was $ 2.7 million, a decrease of $0.6 million or 18% from revenues of $3.3 million for the three months ended March 31, 2004. The decrease in revenue resulted primarily from a decrease in sales of our TA2020 product of approximately $0.8 million. Of the $2.7 million revenue for the quarter ended March 31, 2005, approximately $1.0 million was from revenue recognized from the deferral of approximately $1.4 million from the transaction which resulted in the restatement of our financial results for the quarter ended June 30, 2004. Excluding the restatement related revenues, net revenue for the quarter ended March 31, 2005 was approximately $1.7 million, a decrease of $1.6 million or 48% from revenues of $3.3 million for the quarter ended March 31, 2004.

Sales to Sharp, Kyoshin Technosonic Co., Ltd., (KTS), and Beko accounted for approximately 20%, 13% and 10%, respectively, of revenue in the three months ended March 31, 2005 and 0%, 40%, and 0%, respectively, in the corresponding prior year quarter. Sales to our five largest customers represented approximately 59% of revenue in the three months ended March 31, 2005 and 71% of revenue in the three months ended March 31, 2004.

Gross Profit. Gross profit for the three months ended March 31, 2005 was $1.7 million or 64%, compared with a gross profit of $0.9 million or 27% for the three months ended March 31, 2004. The increase in the gross profit for the three months ended March 31, 2005 reflects the net release of approximately $1.5 million of inventory reserves during the quarter ended March 31, 2005 for products sold which had been previously reserved for.

Research and Development. Research and development expenses for the three months ended March 31, 2005 were $2.0 million, an increase of $0.3 million from $1.7 million for the three months ended March 31, 2004. The increase in R&D expenses was primarily due to an increase in headcount and related personnel costs of approximately $0.1 million, an increase in legal fees of approximately $0.1 million coupled with a lower overhead allocation of approximately $0.1 million. We anticipate that our R&D expenses will continue to increase during fiscal 2005.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three months ended March 31, 2005 were $1.8 million, an increase of approximately $0.5 million from $1.3 million for the three months ended March 31, 2004. This increase in selling, general and administrative expenses was primarily due to higher litigation costs of approximately $0.4 million and higher accounting fees of approximately $0.1 million. We anticipate that our S,G&A expenses will continue to increase during fiscal 2005, including expenses for legal and financial compliance costs related to the Sarbanes-Oxley Act of 2002, ongoing litigation costs and increased insurance costs related to obtaining a new Directors and Officers liability insurance policy.

Gain on revaluation of warrant liability. The gain on revaluation of warrant liability represents the difference between the fair value of the warrants on the closing date, March 3, 2005, of the private placement in connection with which those warrants were issued and the fair value of those same warrants on March 31, 2005.

Gain on revaluation of warrant liability was $0.3 million for the three months ended March 31, 2005 compared to $0.0 for the three months ended March 31, 2004 since no warrants were issued during that period.

Revenue. Revenue for the six months ended March 31, 2005 was $4.4 million, decrease of $3.0 million or 41% from revenues of $7.4 million for the six months ended March 31, 2004. The decrease in revenue resulted primarily from decrease in unit sales of our TA2020 TA2024 and TA1101B products of approximately $1.7 million, $0.7 million and $0.6 million, respectively. Of the $4.4 million revenue for the six months ended March 31, 2005, approximately $1.0 million was from revenue recognized from the deferral of approximately $1.4 million from the transaction which resulted in the restatement of our financial results for the quarter ended June 30, 2004. Excluding the restatement related revenues, net revenue for the six months ended March 31, 2005 was approximately $3.4 million, a decrease of $4.0 million or 54% from revenues of $7.4 million for the six months ended March 31, 2004.

Sales to Sharp and KTS accounted for approximately 17% and 10%, respectively, of revenue in the six months ended March 31, 2005 and 0% and 7%, respectively, in the corresponding six month period. Sales to our five largest customers represented approximately 48% of revenue in the six months ended March 31, 2005 and 71% of revenue in the six months ended March 31, 2004.

Gross Profit. Gross profit for the six months ended March 31, 2005 was $2.2 million or 50%, compared with a gross profit of $2.3 million or 31% for the six months ended March 31, 2004. The higher gross margin is primarily attributable to a net release of approximately $1.5 million in inventory reserves during the period ended March 31, 2005 for products sold which had been previously reserved for.

Research and Development. Research and development expenses for the six months ended March 31, 2005 were $3.9 million, an increase of $0.5 million from $3.4 million for the six months ended March 31, 2004. The increase in R&D expenses was primarily due to an increase in headcount and related personnel costs of approximately $0.3 million, higher legal fees of approximately $0.1 million and higher project related expenses of approximately $0.1 million. We anticipate that our R&D expenses will continue to increase during fiscal 2005.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for the six months ended March 31, 2005 were $3.2 million, an increase of approximately $0.8 million from $2.4 million for the six months ended March 31, 2004. This increase in selling, general and administrative expenses was primarily due to higher litigation costs of approximately $0.7 million. We anticipate that our S,G&A expenses will continue to increase during fiscal 2005, including expenses for legal and financial compliance costs related to the Sarbanes-Oxley Act of 2002, ongoing litigation costs and increased insurance costs related to obtaining a new Directors and Officers liability insurance policy.

Gain on revaluation of warrant liability. The gain on revaluation of warrant liability represents the difference between the fair value of the warrants on the closing date, March 3, 2005, of the private placement in connection with which those warrants were issued and the fair value of those same warrants on March 31, 2005. Gain on revaluation of warrant liability was $0.3 million for the six months ended March 31, 2005 compared to $0.0 for the six months ended March 31, 2004 since no warrants were issued during that period.

Since our inception, we have financed our operations through the private sale of our equity securities, primarily the sale of preferred stock, through our initial public offering on August 1, 2000, through a private placement in January 2002 and a financing in August 2004. The January 2002 private placement included warrants whereas no warrants were issued in connection with the August 2004 financing. Net proceeds to us as a result of our initial public offering, our 2002 private placement, our 2004 financing, and 2005 private placement were approximately $45.4 million, $19.9 million, $5.0 million, and $4.0 million respectively. In addition, we received $5.4 million from the exercise of warrants issued in connection with the 2002 private placement.

Net cash used in operating activities increased to $6.1 million for the six months ended March 31, 2005 from $3.4 million for the six months ended March 31, 2004. The increase was mainly due to an increase in net loss and a decrease in inventories and accounts payable.

Cash used in investing activities was $0.02 million for the six months ended March 31, 2005 compared to $0.5 million for the six months ended March 31, 2004. The decrease was due to a decrease in purchases of property and equipment.

Cash provided by financing activities was $3.8 million for the six months ended March 31, 2005 compared to $4.0 million for the six months ended March 31, 2004. The positive cash flow from financing activities in 2004 was mostly due to the proceeds received of approximately $2.3 million from the exercise of warrants. In 2005, we raised a net amount of $4.0 million from a private placement.

In August 2004, we completed a financing in which we raised gross proceeds of $5.0 million through financing of 2,500,000 shares of common stock at a price of $2.00 per share.

In March 2005, we completed a private placement which resulted in gross proceeds of $4.4 million. In connection with this private placement we sold 4,833,335 shares of common stock at a price of $0.90 per share and issued warrants to purchase up to 966,667 shares of common stock.

Our total commitments on our operating and capital leases and inventory purchases as of March 31, 2005, were as follows (in thousands):

We expect our future liquidity and capital requirements will fluctuate depending on numerous factors including: market acceptance and demand for current and future products, the timing of new product introductions and enhancements to existing products, the success of on-going efforts to reduce our manufacturing costs as well as operating expenses and need for working capital for such items as inventory and accounts receivable.

We have incurred substantial losses and have experienced negative cash flow since inception and have an accumulated deficit of $195.9 million at March 31, 2005. Beginning in August 2001, we instituted programs to reduce expenses including reducing headcount from 144 employees at the end of July 2001 to 56 employees at the end of December 2003 and reducing employees salaries by 10%. In September 2002 we relocated our headquarters which reduced rent expense and canceled our Directors and Officers Liability Insurance policy which reduced insurance expense. These actions resulted in significant cost savings in 2003. We reduced our cash used in operating activities from approximately $13.0 million in 2002 to approximately $4.1 million in 2003. However, for the nine month transition period ended September 30, 2004, cash used in operating activities increased to $9.1 million and for the three months ended March 31, 2005, cash used in operating activities was $2.8 million.

We, as well as certain of our directors and current and former officers have been named as defendants in certain legal proceedings described in this Form 10-Q (see Part II Item 1 “Legal Proceedings”). We do not have third party insurance coverage for either the costs of defending these legal proceedings, including the costs of possible indemnification claims by the individual named defendants, or any potential settlement payments. The costs of defending or settling these legal proceedings will likely be significant. At this time we are not able to accurately estimate the costs of the defense or of a potential settlement, as the defendants were just served during the quarter ended March 31, 2005, but we believe that these costs will have a material adverse effect on our cash balances and will be another factor requiring the Company to raise additional funds.

During fiscal 2004, warrants were exercised which resulted in us receiving proceeds totaling approximately $2.3 million. In addition, in August 2004 we raised $5.0 million through a financing and in March 2005 we completed a private placement of common stock and common stock purchase warrants that resulted in gross proceeds of approximately $4.4 million. At March 31, 2005, we had working capital of $6.5 million, including unrestricted cash of $4.9 million.

We will need to raise additional funds to finance our activities through public or private equity or debt financings, the formation of strategic partnerships or alliances with other companies or through bank borrowings with existing or new banks. We may not be able to obtain additional funds on terms that would be favorable to our stockholders and us, or at all. In such instance, we will take measures to reduce our operating expenses, such

as reducing headcount or canceling selected research and development projects. Without sufficient capital to fund our operations, we will no longer be able to continue as a going concern. We believe, based on our current cash balance as well as our ability to implement the aforementioned measures, if needed, that we will have liquidity sufficient to meet our operating, working capital and financing needs for the next twelve months and perhaps beyond. Our long-term prospects are dependent upon obtaining sufficient financing as needed to fund current working capital needs and future growth, and ultimately on achieving profitability.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs—an amendment of ARB No. 43, Chapter 4.” (“SFAS 151”). SFAS 151 amends ARB 43, Chapter 4 to clarify that “abnormal” amounts of idle freight, handling costs and spoilage should be recognized as current period charges. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not anticipate that the adoption of this standard will have a material impact on our consolidated financial statements.

In December 2004, the FASB issued SFAS No. 152 “Accounting for Real Estate Time-Sharing Transactions—an amendment of FASB statements No. 66 and 67” (“SFAS 152”). SFAS 152 amends SFAS 66 and 67 to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2, Accounting for Real Estate Time-Sharing Transactions. SFAS 152 is effective for financial statement for fiscal years beginning after June 15, 2005. We do not anticipate that the adoption of this standard will have a material impact on our consolidated financial statements.

In December 2004, the FASB issued SFAS No. 153 “Exchanges of Non-monetary Assets—an amendment of APB opinion No. 29” (“SFAS 153”). SFAS 153 clarifies that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged, with a general exception for exchanges that have no commercial substance. SFAS 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not anticipate that the adoption of this standard will have a material impact on our consolidated financial statements.

In December 2004, the FASB revised SFAS No. 123 (SFAS 123 (R)”). SFAS 123 (R), “Share-Based Payment”, requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Pro forma disclosure is no longer an alternative to financial statement recognition. SFAS 123 (R) is effective for periods beginning after June 15, 2005. On April 14, 2005, the SEC announced the adoption of a new rule that amended the compliance dates for SFAS 123 (R). Under the new rule, companies are allowed to implement SFAS 123 (R) at the beginning of the next fiscal year, instead of the next reporting period, that begins after June 15, 2005. We are required to comply with SFAS 123 (R) beginning with our fiscal quarter ending December 31, 2005. SFAS 123 (R) provides transition alternatives for public companies to restate prior interim periods or prior years. We are still evaluating the transition provisions allowed by SFAS 123 (R).

In March 2005, the SEC released SEC Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”). SAB 107 provides the SEC staff’s position regarding the application of SFAS 123(R) and certain SEC rules and regulations, and also provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. We are currently reviewing the effect, if any, that the application of SAB 107 will have on our financial position and results of operations.

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”), which clarifies the term “conditional asset retirement obligations” as used in SFAS No. 143, “Accounting for Asset Retirement Obligations.” We do not anticipate that the application of FIN 47 will have a material impact on our financial position and results of operations.

Set forth below and elsewhere in this quarterly report and in the other documents we file with the Securities and Exchange Commission are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward looking statements contained in this quarterly report. Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this quarterly report and our other public filings.

We need to raise additional capital to continue to grow our business, which may not be available to us.

We incurred net losses of approximately $1.8 million for the three months ended March 31, 2005, $11.6 million for the nine months ended September 30, 2004 and $7.2 million for the twelve months ended December 31, 2003. Because we have had losses, we have funded our operating activities to date from the sale of securities, including our most recent financings in March 2005, August 2004 and January 2002 as well as from the proceeds from the related exercise of warrants issued in connection with the 2002 financing. However, to grow our business significantly and to fund additional losses, we will need additional capital. We cannot be certain that any such financing will be available on acceptable terms, or at all. Moreover, additional equity financing, if available, would likely be dilutive to the holders of our common stock, and debt financing, if available, would likely involve restrictive covenants. In addition, pursuant to the terms of the March 2005 private transaction under which we sold shares offered to the selling stockholders, we are prohibited from issuing additional securities until 60 days after the registration statement is declared effective, except pursuant to employee stock benefit plans, upon exercise or conversion of outstanding securities and pursuant to acquisitions or other strategic transactions that are not primarily for the purpose of raising additional capital. We can provide no assurance as to when this registration statement will be declared effective. We are also subject to certain cash penalties payable to the selling stockholders under certain circumstances relating to the timely filing, effectiveness and maintenance of effectiveness of the registration statement. If we cannot raise sufficient additional capital, it would adversely affect our ability to achieve our business objectives and to continue as a going concern.

On April 25, 2005, we received a deficiency notice from the Nasdaq Stock Market, or Nasdaq, for failing to maintain the Nasdaq National Market’s minimum $50 million market value of listed securities requirement for continued listing. We have a grace period of 30 calendar days, or until May 25, 2005, to cure the deficiency by meeting the $50 million minimum market value of listed securities for 10 consecutive days or such longer period of time as may be required by Nasdaq, at its discretion. Based upon 55,349,746 shares outstanding as of April 20, 2005, our stock price would have to equal or exceed approximately $0.91 for a minimum of ten consecutive days. There can be no assurance that we will regain or maintain compliance with the minimum market value of listed securities requirement. If we fail to meet the minimum market value of listed securities for a minimum of 10 consecutive days during the grace period our common stock may be delisted from the Nasdaq National Market.

In addition, on April 26, 2005, we received a deficiency notice from Nasdaq for failing to maintain the Nasdaq National Market’s minimum $1.00 bid price requirement for continued listing. We have a grace period of 180 calendar days, or until October 24, 2005, to cure the deficiency by meeting the minimum $1.00 bid price for 10 consecutive trading days or such longer period of time as may be required by Nasdaq, at its discretion. There can be no assurance that we will regain or maintain compliance with the minimum bid price. If we fail to meet the minimum bid price for 10 consecutive days during the grace period our common stock may be delisted from the Nasdaq National Market.

Even if we are able to comply with the continued listing requirements referred to in the Nasdaq’s April 25, 2005 letter by May 25, 2005 or in the Nasdaq’s April 26, 2005 letter by October 24, 2005, there is no assurance that in the future we will continue to satisfy the Nasdaq listing requirements, with the result that our common

stock may be delisted from The Nasdaq National Market. Should our common stock be delisted from The NASDAQ National Market, it would likely be traded on The Nasdaq Small Cap Market, and if delisted from The Nasdaq Small Cap Market, would likely be traded on the Over the Counter (OTC) Bulletin Board of the National Association of Securities Dealers, Inc. If our common stock is delisted from the Nasdaq National Market or The Nasdaq Small Cap Market, it would likely be more difficult to trade in or obtain accurate quotations as to the market price of our common stock. Delisting of our common stock could materially adversely affect the market price, the market liquidity of our common stock and our ability to raise necessary capital and could otherwise have an adverse impact on our business, financial condition and results of operations.

As of March 31, 2005, we had an accumulated deficit of $195.9 million. We incurred net losses of approximately $2.0 million for the three months ended March 31, 2005, $11.6 million for the nine months ended September 30, 2004 and $7.2 million for the twelve months ended December 31, 2003. We may continue to incur net losses and these losses may be substantial. Furthermore, we may continue to generate significant negative cash flow in the future. We will need to generate substantially higher revenue to achieve and sustain profitability and positive cash flow. Our ability to generate future revenue and achieve profitability will depend on a number of factors, many of which are described throughout this section. If we are unable to achieve or maintain profitability, we will be unable to build a sustainable business. In this event, our share price and the value of your investment would likely decline and we might be unable to continue as a going concern.

Our quarterly operating results are likely to fluctuate significantly and may fail to meet the expectations of securities analysts and investors, which may cause our share price to decline.

Our quarterly operating results have fluctuated significantly in the past and are likely to continue to do so in the future. The many factors that could cause our quarterly results to fluctuate include, in part:

A large portion of our operating expenses, including salaries, rent and capital lease expenses, are fixed. If we experience a shortfall in revenues relative to our expenses, we may be unable to reduce our expenses quickly enough to offset the reduction in revenues during that accounting period, which would adversely affect our operating results. Fluctuations in our operating results may also result in fluctuations in our common stock price. If the market price of our stock is adversely affected, we may experience difficulty in raising capital or making acquisitions. In addition, we may become the object of securities class action litigation, which occurred in late 2004. As a result, we do not believe that period-to-period comparisons of our revenues and operating results are necessarily meaningful. One should not rely on the results of any one quarter as an indication of future performance.

The stock prices for many technology companies have recently experienced large fluctuations, which may or may not be directly related to the operating performance of the specific companies. For example, during the

calendar year 2004, our common stock had closing sales prices on Nasdaq as low as $0.77 and as high as $8.20 per share. Broad market fluctuations as well as general economic conditions may cause our stock price to decline. We believe that fluctuations of our stock price may continue to be caused by a variety of factors, including:

Our product shipment patterns make it difficult to predict our quarterly revenues.

As is common in our industry, we frequently ship more products in the third month of each quarter than in either of the first two months, and shipments in the third month are higher at the end of that month than at the beginning. We believe this pattern is likely to continue. The concentration of sales in the last month of the quarter may cause our quarterly results of operations to be more difficult to predict. Moreover, if sufficient business does not materialize or a disruption in our production or shipping occurs near the end of a quarter, our revenues for that quarter could be materially affected.

Our customers may cancel or defer product orders, which could result in excess inventory.

Our sales are generally made pursuant to individual purchase orders that may be canceled or deferred by customers on short notice without significant penalty. Thus, orders in backlog may not result in future revenue. In the past, we have had cancellations and deferrals by customers. Any cancellation or deferral of product orders could result in us holding excess inventory, or result in obsolete inventory over time, which could seriously harm our profit margins and restrict our ability to fund our operations. For example, during the quarter ended September 30, 2004, we recorded a provision for slow moving, excess and obsolete inventory of approximately $4.3 million. Our inventory and purchase commitments are based on expected demand and not necessarily built for firm purchase commitments for our customers. Because of the required delivery lead time, we need to carry a high level of inventory in comparison to past sales. We recognize revenue upon shipment of products to the end customer and, in the case of distributor sales, based upon receipt of point-of-sales report from the distributor. Although we have not experienced customer refusals to accept shipped products or material difficulties in collecting accounts receivable, such refusals or collection difficulties are possible and could result in significant charges against income, which could seriously harm our revenues and our cash flow.

We rely on a small number of customers and sales by distributors for most of our revenue and a decrease in revenue from these customers could seriously harm our business.

A relatively small number of customers have accounted for most of our revenues to date. Any reduction or delay in sales of our products to one or more of these key customers could seriously reduce our sales volume and revenue and adversely affect our operating results. Our top five end customers accounted for 55% of revenue in

the three month period ended March 31, 2005, 59% of revenue in the transition period ended September 30, 2004 and 68% of revenue in 2003. Our primary customers in the three months ended March 31, 2005 were Sharp, Kyoshin Technosonic Co., Ltd. (“KTS”) and Beko representing 20%, 13% and 10% respectively of our revenue. Our primary end customers in the transition period ended September 30, 2004 were Alcatel, KTS and JVC representing 15%, 11% and 9% of revenue, respectively. In 2003, our primary end customers were KTS, Samsung and Apple representing 24%, 18% and 15% of revenue, respectively. We expect that we will continue to rely on the success of our largest customers and on our success in selling our existing and future products to those customers in significant quantities. In addition, approximately 62% and 69% of our revenue in the three month period ended March 31, 2005 and transition period ended September 30, 2004, respectively, was from our largest distributor, Macnica. We cannot be sure that we will retain our largest customers (whether from inside sales or through our distributors) or that we will be able to obtain additional key customers or replace key customers we may lose or who may reduce their purchases.

We currently rely on sales of one product for a significant portion of our revenue, and the failure of this product to be successful in the future could substantially reduce our sales.

We currently rely on sales of our TA2024 digital audio amplifier product to generate a significant portion of our revenue. Sales of this product amounted to 61% of our revenue for the three months ended March 31, 2005, 34% of our revenue for the nine months ended September 30, 2004, and 39% of our revenue for the twelve months ended December 31, 2003. We have developed additional products and plan to introduce more products in the future, but there can be no assurance that these products will be commercially successful. Consequently, if our existing products are not successful, our sales could decline substantially.

Our lengthy sales cycle makes it difficult for us to predict if or when a sale will be made, to forecast our revenue and to budget expenses, which may cause fluctuations in our quarterly results.

Because of our lengthy sales cycles, we may continue to experience a delay between incurring expenses for research and development, sales and marketing and general and administrative efforts, as well as incurring investments in inventory, and the generation of revenue, if any, from such expenditures. In addition, the delays inherent in such a lengthy sales cycle raise additional risks of customer decisions to cancel or change product plans, which could result in our loss of anticipated sales. Our new products are generally incorporated into our customers’ products or systems at the design stage. To try and have our products selected for design into new products of current and potential customers, commonly referred to as design wins, often requires significant expenditures by us without any assurance of success. Once we have achieved a design win, our sales cycle will start with the test and evaluation of our products by the potential customer and design of the customer’s equipment to incorporate our products. Generally, different parts have to be redesigned to incorporate our devices successfully into our customers’ products.

The sales cycle for the test and evaluation of our products can range from a minimum of three to six months, and it can take a minimum of an additional six to nine months before a customer commences volume production of equipment that incorporates our products. Achieving a design win provides no assurance that such customer will ultimately ship products incorporating our products or that such products will be commercially successful. Our revenue or prospective revenue would be reduced if a significant customer curtails, reduces or delays orders during our sales cycle, or chooses not to release products incorporating our products.

Our ability to achieve revenue growth will be harmed if we are unable to persuade electronic systems manufacturers to adopt our new amplifier technology.

We face difficulties in persuading manufacturers to adopt our products using our new amplifier technology. Traditional amplifiers use design approaches developed in the 1930s. These approaches are still used in most amplifiers and engineers are familiar with these design approaches. To adopt our products, manufacturers and engineers must understand and accept our new technology. To take advantage of our products, manufacturers must redesign their systems, particularly components such as the power supply and heat sinks. Manufacturers

must work with their suppliers to obtain modified components and they often must complete lengthy evaluation and testing. In addition, our amplifiers are often more expensive as components than traditional amplifiers. For these reasons, prospective customers may be reluctant to adopt our technology.

We currently depend on consumer electronics markets that are typically characterized by aggressive pricing, frequent new product introductions and intense competition.

A substantial portion of our current revenue is generated from sales of products that address the consumer electronics markets, including home theater, computer audio, flat panel TV, gaming, professional amplifiers, set-top box, AV receivers and the automotive audio markets. These markets are characterized by frequent new product introductions, declining prices and intense competition. Pricing in these markets is aggressive, and we expect pricing pressure to continue. In the computer audio segment, our success depends on consumer awareness and acceptance of existing and new products by our customers and consumers, in particular, the elimination of externally-powered speakers. In the automotive audio segment, we face pressure from our customers to deliver increasingly higher-powered solutions under significant engineering limitations due to the size constraints in car dashboards. In addition, our ability to obtain prices higher than the prices of traditional amplifiers will depend on our ability to educate manufacturers and their customers about the benefits of our products. Failure of our customers and consumers to accept our existing or new products will seriously harm our operating results.

The cyclical nature of the semiconductor industry could create fluctuations in our operating results.

The semiconductor industry has historically been cyclical and characterized by wide fluctuations in product supply and demand. From time to time, the industry has also experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles and declines in general economic conditions. Industry downturns have been characterized by diminished product demand, production overcapacity and accelerated decline in average selling prices, and in some cases have lasted for more than a year. In addition, we may determine to lower our prices of our products to increase or maintain market share, which would likely harm our operating results. The semiconductor industry also periodically experiences increased demand and production capacity constraints. As a result, we have experienced and may experience in the future substantial period-to-period fluctuations in our results of operations due to general semiconductor industry conditions, overall economic conditions or other factors, many of which are outside our control. Due to these risks, you should not rely on period-to-period comparisons to predict our future performance.

We may experience difficulties in the introduction of new or enhanced products, including but not limited to the new “Godzilla” architecture products, that could result in significant, unexpected expenses or delay their launch, which would harm our business.

Our failure or our customers’ failure to develop and introduce new products successfully and in a timely manner would seriously harm our ability to generate revenues. Consequently, our success depends on our ability to develop new products for existing and new markets, introduce such products in a timely and cost-effective manner and to achieve design wins. The development of these new devices is highly complex, and from time to time we have experienced delays in completing the development and introduction of new products. The successful introduction of a new product may currently take up to 18 months. Successful product development and introduction depends on a number of factors, including:

We cannot guarantee success with regard to these factors. We introduced our lower cost “Godzilla” architecture products in January 2004 and began sampling them in certain customers’ products in mid-2004. However, we have not received design-wins for these products to date.

We depend on three outside foundries for our semiconductor device manufacturing requirements.

We do not own or operate a fabrication facility, and substantially all of our semiconductor device requirements are currently supplied by three outside foundries, United Microelectronics Corporation, in Taiwan, STMicroelectronics Group in Europe and Renesas Technology (Mitsubishi Electric) in Japan. Although we primarily utilize these three outside foundries, most of our components are not manufactured at these foundries at the same time. As a result, each foundry is a sole source for certain products.

There are significant risks associated with our reliance on outside foundries, including:

In addition, the manufacture of integrated circuits is a highly complex and technologically demanding process. Although we work closely with our foundries to minimize the likelihood of reduced manufacturing yields, our foundries have from time to time experienced lower than anticipated manufacturing yields, particularly in connection with the introduction of new products and the installation and start-up of new process technologies.

We provide our foundries with continuous forecasts of our production requirements; however, the ability of each foundry to provide us with semiconductor devices is limited by the foundry’s available capacity. In many cases, we place our orders on a purchase order basis, and foundries may allocate capacity to the production of other companies’ products while reducing the deliveries to us on short notice. In particular, foundry customers that are larger and better financed than us or that have long-term agreements with our foundries may cause such foundries to reallocate capacity in a manner adverse to us. While capacity at our foundries has been available during the last several years, the cyclical nature of the semiconductor industry could result in capacity limitations in a cyclical upturn or otherwise.

If we use a new foundry, several months would be typically required to complete the qualification process before we can begin shipping products from the new foundry. In the event any of our current foundries suffers any damage or destruction to their respective facilities, or in the event of any other disruption of foundry capacity, we may not be able to qualify alternative manufacturing sources for existing or new products in a timely manner. Even our current outside foundries would need to have certain manufacturing processes qualified in the event of disruption at another foundry, which we may not be able to accomplish in a timely enough manner to prevent an interruption in supply of the affected products.

If we encounter shortages or delays in obtaining semiconductor devices for our products in sufficient quantities when required, delivery of our products could be delayed, resulting in customer dissatisfaction and decreased revenues.

We depend on third-party subcontractors for most of our semiconductor assembly and testing requirements and any unexpected interruption in their services could cause us to miss scheduled shipments to customers and to lose revenues.

Semiconductor assembly and testing are complex processes, which involve significant technological expertise and specialized equipment. As a result of our reliance on third-party subcontractors for assembly and testing of our products, we cannot directly control product delivery schedules, which has in the past, and could in

the future, result in product shortages or quality assurance problems that could increase the costs of manufacture, assembly or testing of our products. Almost all of our products are assembled and tested by one of five subcontractors: ASE in Korea, Malaysia and Taiwan, Hon Hai (formerly AMBIT Microsystems Corporation) in China, Lingsen in Taiwan, STMicroelectronics Group in Malaysia, and ST Assembly Test Services Ltd. in Singapore. We do not have long-term agreements with any of these suppliers and retain their services on a per order basis. The availability of assembly and testing services from these subcontractors could be adversely affected in the event a subcontractor suffers any damage or destruction to their respective facilities, or in the event of any other disruption of assembly and testing capacity. Due to the amount of time normally required to qualify assemblers and testers, if we are required to find alternative manufacturing assemblers or testers of our components, shipments could be delayed. Any problems associated with the delivery, quality or cost of our products could seriously harm our business.

Failure to transition our products to more effective and/or increasingly smaller semiconductor chip sizes and packaging could cause us to lose our competitive advantage and reduce our gross margins.

We evaluate the benefits, on a product-by-product basis, of migrating to smaller semiconductor process technologies in order to reduce costs and have commenced migration of some products to smaller semiconductor processes. We believe that the transition of our products to increasingly smaller semiconductor processes will be important for us to reduce manufacturing costs and to remain competitive. Moreover, we are dependent on our relationships with our foundries to migrate to smaller semiconductor processes successfully. We cannot be sure that our future process migrations will be achieved without difficulties, delays or increased expenses. Our gross margins would be seriously harmed if any such transition is substantially delayed or inefficiently implemented.

Our international operations subject us to risks inherent in doing business on an international level that could harm our operating results.

We currently obtain almost all of our manufacturing, assembly and test services from suppliers located outside the United States and may expand our manufacturing activities abroad. Approximately 96% and 94%, respectively, of our total revenue for the three months ended March 31, 2005 and for the nine months ended September 30, 2004, was derived from sales to end customers based outside the United States. In 2003, 88% of our total revenue was derived from sales to end customers based outside of the United States. In addition, we often ship products to our domestic customers’ international manufacturing divisions and subcontractors.

Accordingly, we are subject to risks inherent in international operations, which include:

All of our international sales to date have been denominated in U.S. dollars. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. Conversely, a decrease in the value of the U.S. dollar relative to foreign currencies would increase the cost of our overseas manufacturing, which would reduce our gross margins.

If we are not successful in developing and marketing new and enhanced products for the DSL high speed communications markets that keep pace with technology and our customers’ needs, our operating results will suffer.

The market for our DSL products is new and emerging, and is characterized by rapid technological advances, intense competition and a relatively small number of potential customers. This will likely result in price erosion on existing products and pressure for cost-reduced future versions. Implementation of our products requires manufacturers to accept our technology and redesign their products. If potential customers do not accept our technology or experience problems implementing our devices in their products, our products could be rendered obsolete and our business would be harmed. If we are unsuccessful in introducing future products with enhanced performance, our ability to achieve revenue growth will be seriously harmed.

We may experience difficulties in the development and introduction of a new amplifier product for use in the cellular phone market, which could result in significant expenses or delay in its launch.

We are currently developing an amplifier product for use in the cellular phone market. This product is still in research and development and we currently have no design wins or customers for this product. We may not introduce our amplifier product for the cellular phone market on time, and this product may never achieve market acceptance. Furthermore, competition in this market is likely to result in price reductions, shorter product life cycles, reduced gross margins and longer sales cycles compared with what we have experienced to date with our other products.

Intense competition in the semiconductor industry and in the consumer electronics and communications markets could prevent us from achieving or sustaining profitability.

The semiconductor industry and the consumer audio and communications markets are highly competitive. We compete with a number of major domestic and international suppliers of semiconductors in the consumer electronics and communications markets. We also may face competition from suppliers of products based on new or emerging technologies. Many of our competitors operate their own fabrication facilities and have longer operating histories and presence in key markets, greater name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than us. As a result, such competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the promotion and sale of their products than us. Current and potential competitors have established or may establish financial or strategic relationships among themselves or with existing or potential customers, resellers or other third parties. Accordingly, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. In addition, existing or new competitors may in the future develop technologies that more effectively address the transmission of digital information through existing analog infrastructures at a lower cost or develop new technologies that may render our technology obsolete. There can be no assurance that we will be able to compete successfully in the future against our existing or potential competitors, or that our business will not be harmed by increased competition.

Our products are complex and may have errors and defects that are detected only after deployment in customers’ products, which may harm our business.

Products such as those that we offer may contain errors and defects when first introduced or as new versions are released. We have in the past experienced such errors and defects, in particular in the development stage of a new product. Delivery of products with production defects or reliability, quality or compatibility problems could significantly delay or hinder market acceptance of such products, which could damage our reputation and seriously harm our ability to retain our existing customers and to attract new customers and therefore impact our revenues. Moreover, such errors and defects could cause problems, interruptions, delays or a cessation of sales to our customers. Alleviating such problems may require substantial redesign, manufacturing and testing which would result in significant expenditures of capital and resources. Despite testing conducted by us, our suppliers

and our customers, we cannot be sure that errors and defects will not be found in new products after commencement of commercial production. Such errors and defects could result in additional development costs, loss of, or delays in, market acceptance, diversion of technical and other resources from our other development efforts, product repair or replacement costs, claims by our customers or others against us or the loss of credibility with our current and prospective customers. Any such event could result in the delay or loss of market acceptance of our products and would likely harm our business.

We do not have third party insurance coverage to offset the cost of defending the pending securities class action and derivative litigation and, therefore, defending the litigation matters set forth in this quarterly report on Form 10-Q will likely materially and adversely affect our financial condition.

Our financial condition will likely be materially adversely affected by the pendency of the litigation referenced in this Quarterly Report on Form 10-Q because we do not have third-party insurance coverage for either the costs of defending these lawsuits, including the costs of possible indemnification claims by the individual named defendants, or settling such litigation. We believe that the cost of defending or settling such litigation will have a material adverse effect on our cash balances and will be another factor requiring us to raise additional funds. In addition, these matters will require devotion of significant management resources which may also adversely affect our business operations.

If we are unable to retain key personnel, we may not be able to operate our business successfully.

We may not be successful in retaining executive officers and other key management and technical personnel. A high level of technical expertise is required to support the implementation of our technology in our existing and new customers’ products. In addition, the loss of the management and technical expertise of Dr. Adya S. Tripathi, our founder, president and chief executive officer, could seriously harm us. We do not have any employment contracts with our employees.

Our intellectual property and proprietary rights may be insufficient to protect our competitive position.

Our business depends, in part, on our ability to protect our intellectual property. We rely primarily on patent, copyright, trademark and trade secret laws to protect our proprietary technologies. We cannot be sure that such measures will provide meaningful protection for our proprietary technologies and processes. As of March 31, 2005, we had 38 issued United States patents, and 8 additional United States patent applications which are pending. In addition, we had 17 international patents issued and an additional 24 international patents pending. We cannot be sure that any patent will issue as a result of these applications or future applications or, if issued, that any claims allowed will be sufficient to protect our technology. In addition, we cannot be sure that any existing or future patents will not be challenged, invalidated or circumvented, or that any right granted thereunder would provide us meaningful protection. The failure of any patents to provide protection to our technology would make it easier for our competitors to offer similar products. In connection with our participation in the development of various industry standards, we may be required to agree to license certain of our patents to other parties, including our competitors, that develop products based upon the adopted standards.

We also rely on copyright, trademark and trade secret laws in the United States and other countries to protect our propriety rights. As discussed above, we have several international issued and pending patents in certain foreign countries. However the laws of some foreign countries in which we do business may not protect our copyrights, trademarks and trade secrets to the same extent as the laws of the United States. We also generally enter into confidentiality agreements with our employees and strategic partners, and generally control access to and distribution of our documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our products, services or technology without authorization, develop similar technology independently or design around our patents. In addition, effective copyright, trademark and trade secret protection may be unavailable or limited in certain foreign countries. Some of our customers have entered into agreements with us pursuant to which such customers have the right to use our proprietary technology in the event we default in our contractual obligations, including product supply obligations, and fail to cure the default within a specified period of time.

We may be subject to intellectual property rights disputes that could divert management’s attention and could be costly.

The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights. From time to time, we may receive in the future notices of claims of infringement, misappropriation or misuse of other parties’ proprietary rights. We cannot be sure that we will prevail in these actions, or that other actions alleging infringement by us of third-party patents, misappropriation or misuse by us of third-party trade secrets or the invalidity of one or more patents held by us will not be asserted or prosecuted against us, or that any assertions of infringement, misappropriation or misuse or prosecutions seeking to establish the invalidity of our patents will not seriously harm our business. For example, in a patent or trade secret action, an injunction could be issued against us requiring that we withdraw particular products from the market or necessitating that specific products offered for sale or under development be redesigned. We have also entered into certain indemnification obligations in favor of our customers and strategic partners that could be triggered upon an allegation or finding of our infringement, misappropriation or misuse of other parties’ proprietary rights. Irrespective of the validity or successful assertion of such claims, we would likely incur significant costs and diversion of our management and personnel resources with respect to the defense of such claims, which could also seriously harm our business. If any claims or actions are asserted against us, we may seek to obtain a license under a third party’s intellectual property rights. We cannot be sure that under such circumstances a license would be available on commercially reasonable terms, if at all. Moreover, we often incorporate the intellectual property of our strategic customers into our designs, and we have certain obligations with respect to the non-use and non-disclosure of such intellectual property.

We cannot be sure that the steps taken by us to prevent our, or our customers’, misappropriation or infringement of intellectual property will be successful.

The facilities of several of our key manufacturers and the majority of our customers, are located in geographic regions with increased risks of natural disasters.

Several key manufacturers and a majority of customers are located in the Pacific Rim region. The risk of earthquakes in this region, particularly in Taiwan, is significant due to the proximity of major earthquake fault lines. Earthquakes, fire, flooding and other natural disasters in the Pacific Rim region likely would result in the disruption of our foundry partners’ assembly and testing capacity and the ability of our customers to purchase our products. Labor strikes or political unrest in these regions would likely also disrupt operations of our foundries and customers. Any disruption resulting from such events could cause significant delays in shipments of our products until we are able to shift our manufacturing, assembly and testing from the affected contractor to another third party vendor. We cannot be sure that such alternative capacity could be obtained on favorable terms, if at all. Moreover, any such disruptions could also cause significant decreases in our sales to these customers until our customers resume normal purchasing volumes.

Changes in accounting rules for stock-based compensation may adversely affect our operating results, our stock price and our competitiveness in the employee marketplace.

We have a history of using employee stock options and other stock-based compensation to hire, motivate and retain our workforce. In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment,” to measure compensation costs for all stock-based compensation (including stock options and our employee stock purchase plan) at fair value and to recognize these costs as expenses in our statements of operations. We are required to comply with SFAS 123 (R) beginning with our fiscal quarter ending December 31, 2005. The recognition of these expenses in our statements of operations will result in lower earnings per share, which could negatively impact our future stock price. In addition, if we reduced or alter our use of stock-based compensation to minimize the recognition of these expenses, our ability to recruit, motivate and retain employees may be impaired, which could put us at a competitive disadvantage in the employee marketplace.

Our independent registered public accounting firm may decline to attest on the adequacy of our internal controls over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002.

The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report of management on internal controls over financial reporting in their annual reports on Form 10-K that contain an assessment by management of the effectiveness of the company’s internal controls over financial reporting. In addition, the company’s independent registered public accounting firm must attest to and report on management’s assessment of the effectiveness of the internal controls over financial reporting. We are required to comply with Section 404 reporting beginning with our fiscal year ending September 30, 2005. Although we intend to diligently and vigorously review our internal controls over financial reporting in order to ensure compliance with the Section 404 requirements on an annual basis, if our independent registered public accounting firm is not satisfied with our internal controls over financial reporting or the level at which these controls are documented, designed, operated or reviewed, or if the independent registered public accounting firm interprets the requirements, rules and/or regulations differently from us, then they may decline to attest to management’s assessment or may issue a report that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our consolidated financial statements, which ultimately could negatively impact our stock price.

Terrorist attacks and threats, and government responses thereto, may negatively impact all aspects of our operations, revenues, costs and stock price.

The threat of terrorist attacks involving the United States, the instability in the Middle East, a decline in consumer confidence and continued economic weakness and geo-political instability have had a substantial adverse effect on the economy. If consumer confidence does not recover, our revenues may be adversely affected for fiscal 2005 and beyond. Moreover, any further terrorist attacks involving the U.S., or any additional U.S. military actions overseas may disrupt our operations or those of our customers and suppliers. These events have had and may continue to have an adverse impact on the U.S. and world economy in general and consumer confidence and spending in particular, which could harm our sales. Any of these events could increase volatility in the U.S. and world financial markets which could harm our stock price and may limit the capital resources available to us and our customers or suppliers. This could have a significant impact on our operating results, revenues and costs and may result in increased volatility in the market price of our common stock.

We are subject to anti-takeover provisions that could delay or prevent an unfriendly acquisition of our company.

Provisions of our restated certificate of incorporation, equity incentive plans, bylaws and Delaware law may discourage transactions involving an unfriendly change in corporate control. In addition to the foregoing, the stockholdings of our officers, directors and persons or entities that may be deemed affiliates and the ability of our board of directors to issue preferred stock without further stockholder approval could have the effect of delaying, deferring or preventing a third party from acquiring us and may adversely affect the voting and other rights of holders of our common stock.

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk of loss. Some of the securities that we may acquire in the future may be subject to market risk for changes in interest rates. To mitigate this risk, we plan to maintain a portfolio of cash equivalents and short-term investments in a variety of securities, which may include commercial paper, money market funds, government and non-government debt securities. We manage the sensitivity of our results of operations to these risks by maintaining a conservative portfolio, which is comprised solely of highly-rated, short-term investments. We do not hold or issue derivative, derivative commodity instruments or other financial instruments for trading purposes. Currently we are exposed to minimal market risks. Due to the short-term and liquid nature of our portfolio, if interest rates were to fluctuate by 10% from rates at March 31, 2005 and September 30, 2004, our financial position and results of operations would not be materially affected.

We have evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as of the end of the period covered by this Quarterly Report. The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO) and has allowed us to make conclusions, as set forth below, regarding the state of our disclosure controls and procedures.

Attached as exhibits to this Quarterly Report are certifications of the CEO and the CFO, which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes the information concerning the controls evaluation referred to in the certifications, and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.

Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Our disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including the CEO and CFO, to allow timely decisions regarding required disclosure. Our disclosure controls include components of our internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles in the U.S. To the extent that components of our internal control over financial reporting are included within our disclosure controls, they are included in the scope of our quarterly controls evaluation.

Management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system will be attained. Furthermore, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, no evaluation of controls can provide absolute assurance that all misstatements due to error or fraud, if any, may occur and not be detected on a timely basis. These inherent limitations include the possibility that judgments in decision-making can be faulty and that breakdowns can occur because of errors or mistakes. Our disclosure controls and procedures can also be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Furthermore, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

The evaluation of our disclosure controls and procedures included a review of the controls’ objectives and design, the Company’s implementation of the controls and the effect of the controls on the information generated for use in this Quarterly Report. During the evaluation of our controls and procedures, we looked to identify data errors, control problems or acts of fraud and confirm that appropriate corrective action (including process improvements) was being undertaken. This evaluation is performed on a quarterly basis so that the conclusions

of management, including the CEO and CFO, concerning the effectiveness of the disclosure controls and procedures can be reported in our Quarterly Reports on Form 10-Q and to supplement our disclosures made in our Transitional Report on Form 10-K/T. The overall goal of the evaluation activity is to monitor our disclosure controls and procedures, and to modify them as necessary. We intend to maintain our disclosure controls and procedures as a dynamic system that changes as conditions warrant.

We also considered whether our evaluation identified any “significant deficiencies” or “material weaknesses” in our internal control over financial reporting, and whether we identified any acts of fraud involving personnel with a significant role in our internal control over financial reporting. Emphasis was placed on this information as it was important both for the controls evaluation and because Item 5 in the certifications of the CEO and CFO requires that they disclose that information to our Board of Director’s Audit Committee and to our independent auditors. In the professional auditing literature, “significant deficiencies” are defined as a control deficiency, or combination of deficiencies, that adversely affects our ability to initiate, authorize, record, process or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of our financial statements that is more than inconsequential will not be prevented or detected. Auditing literature defines “material weakness” as a “significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.”

As previously disclosed in our current report on Form 8-K dated October 18, 2004 and filed on October 22, 2004, in October 2004, our former independent registered public accountants, BDO Seidman LLP (“BDO”) provided our Audit Committee with a letter citing what BDO asserted are two “material weaknesses” over our internal financial controls: one regarding the lack of effectiveness of our Audit Committee and the other regarding the lack of controls in place to estimate distributor returns in accordance with SFAS No. 48. In response to this letter, we added an additional independent member to its Board of Directors and Audit Committee who the Board of Directors determined was an Audit Committee Financial Expert, as such term is defined under rules promulgated by the Securities and Exchange Commission. We believe that there is no material weakness regarding the effectiveness of its Audit Committee following the appointment of such new member. In addition, the Audit Committee instructed our Chief Financial Officer to conduct an internal investigation as to the verbal concerns raised by BDO regarding the appropriate accounting for approximately $1.4 million of product that, upon our inquiries, one of our distributors (the “Distributor”) reported had been returned to the Distributor by the Distributor’s customers. As a result of the internal investigation concerning the circumstances surrounding and the appropriate accounting for approximately $1.4 million of product that, upon our inquiries, the Distributor reported had been returned to the Distributor by the Distributor’s customers, on January 25, 2005, the Audit Committee determined that we should restate certain financial information previously reported in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004.

Following the end of the period covered by this Quarterly Report on Form 10-Q, we determined that certain changes were warranted in our internal control over financial reporting regarding the review of sales orders. As a result, we have implemented a requirement that our sales personnel, including those managing our distributor relationships, certify in writing to our finance department that all arrangements relating to sales transactions are contained in the operative sales agreement or related purchase order provided to our finance department. In addition, the point-of-sale reports from our distributors, which are used as part of our revenue recognition policies and indicate shipment by the distributor of our products, include attestation that there are no arrangements related to rights of return, pricing, discounting, or other marketing concessions that are not contained in the operative sales agreement or related purchase order for the sale transaction and that there is a corresponding valid purchase order from the end customer for the sale of the product that is the subject of the point-of-sale report. Going forward, before sales from distributors are recognized, the distributor will certify to us that the final sales agreement and/or invoice include all of the terms related to the sale and return of our products and that copies of such agreements and/or invoices are delivered to us at the same time as the order confirmation.

Based upon the evaluation of the effectiveness of our disclosure controls and procedures, our CEO and CFO have concluded that as of the end of the period covered by this Quarterly Report, our disclosure controls and procedures were effective to provide reasonable assurance that material information required to be included in our Exchange Act reports, including this Quarterly Report on Form 10-Q is made known to management, including the CEO and CFO, on a timely basis. There were no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2005, that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We are a party to lawsuits in the normal course of our business. Litigation in general, and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict. An unfavorable resolution of one or more of these lawsuits would materially adversely affect our business, results of operations, or financial condition. In addition, given our financial condition and that we do not have insurance to offset the cost of litigation, the costs of defending one or more of these lawsuits will likely adversely affect our financial condition. We cannot estimate the loss or range of loss that may be reasonably possible for any of the contingencies described and accordingly have not recorded any associated liabilities in our consolidated balance sheets. We accrue legal costs when incurred.

On or about November 9, 2004, the U.S. Securities and Exchange Commission ( the “SEC”) requested that we voluntarily produce documents responsive to certain document requests in the investigation entitled In the Matter of Tripath Technology, Inc. On or about January 25, 2004, February 14, 2005, and February 16, 2005, the SEC made additional documents requests. On or about March 30, 2005, the SEC issued a subpoena to us seeking additional documents. We have produced documents and are continuing to produce documents in response to the SEC’s voluntary requests as well as the subpoena. We have cooperated with the SEC in its review of these matters.

Beginning on November 4, 2004, plaintiffs filed four separate complaints purporting to be class actions in the United States District Court for the Northern District of California alleging that we and certain of our officers and/or directors violated Sections 10(b) and 20(a) of the Exchange Act. Plaintiffs purport to represent a putative class of shareholders who purchased or otherwise acquired Tripath securities between January 29, 2004 and October 22, 2004. The complaints contain varying allegations, including that we and the individual defendants made materially false and misleading statements with respect to our financial results and with respect to our business, prospects and operations in the our filings with the SEC, press releases and other disclosures. The complaints seek unspecified compensatory damages, attorneys’ fees, expert witness fees, costs and such other relief as may be awarded by the Court.

On January 4, 2005, plaintiffs filed motions for the appointment of lead plaintiff. The Court, by Order dated January 28, 2005, appointed Robert Poteet as the sole lead plaintiff and approved Milberg Weiss Bershad & Schulman LLP as lead counsel. On March 10, 2005, the Court granted the parties’ stipulated request to extend lead plaintiff’s time for filing the consolidated complaint from March 29, 2005 to May 31, 2005. By order dated May 16, 2005, the Court further extended lead plaintiff’s time for filing the consolidated complaint from May 31, 2005 to June 28, 2005.

On December 7, 2004, plaintiff Mildred Lyon filed a purported derivative action in Santa Clara Superior Court against us and certain of our officers and/or directors. This complaint appears to be based upon the same facts and circumstances as the federal class actions and makes the following claims: violation of Section 25402 of the California Corporations Code, breach of fiduciary duty and misappropriation of information, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment. On this basis, the complaint seeks unspecified compensatory damages, treble damages under Section 25502.5(a) of the California Corporations Code, extraordinary equitable and/or injunctive relief, restitution and disgorgement, attorneys’ fees, expert witness fees, costs, and such other relief as may be ordered by the Court.

On December 27, 2004, the Court entered a stipulation and order extending the time for us to respond to the complaint to February 23, 2005. On February 16, 2005, the Court entered an order further extending the time for us to respond to the complaint to March 25, 2005. On March 10, the court ordered that the individual defendants shall have through and including April 25, 2005 to file any motions to quash and/or dismiss for lack of personal jurisdiction, and that all defendants shall have thirty (30) days from the date the court issues a ruling on any motions to quash and/or dismiss for lack of personal jurisdiction to respond to the complaint, or in the event that no such motions are brought, extended the time for all defendants to respond to the complaint to April 25, 2005.

As previously disclosed in our current report on Form 8-K dated October 18, 2004 and filed on October 22, 2004, in October 2004, our former independent registered public accountants, BDO Seidman LLP, or BDO, provided our audit committee with a letter citing what BDO asserted are two “material weaknesses” over our internal financial controls: one regarding the lack of effectiveness of our audit committee and the other regarding the lack of controls in place to estimate distributor returns in accordance with SFAS No. 48. Following discussions with our employees, representatives of BDO further orally advised us that BDO had concerns regarding the appropriate accounting for approximately $1.3 million of product that, upon our inquiries, one of our distributors, Macnica, or the Distributor, reported had been returned to the Distributor by the Distributor’s customers, or the Product Return. In response to both the letter and the verbal comments, the audit committee instructed our then-chief financial officer to investigate this matter and report the findings to the audit committee. As a result of the litigation matters referenced above, we retained outside litigation counsel to represent us in responding to the aforementioned complaints. In addition, the audit committee and the then-chief financial officer directed litigation counsel to further conduct an internal investigation into the verbal concerns raised by BDO regarding the Product Return. Separately, the audit committee, with the assistance of our then-chief financial officer investigated BDO’s assertion regarding the lack of controls in place to estimate distributor returns.

The audit committee received an initial report from our litigation counsel on findings of the internal investigation on January 21, 2005 and requested additional investigation by litigation counsel. On January 25, 2005, litigation counsel made a supplemental report on the findings of the internal investigation to date. Following the presentation of such report, including discussion of the findings of the forensic accountant hired by the litigation counsel with the approval of the audit committee, the audit committee concluded that our Country Manager for the Japan Sales Office (who is no longer employed with us) agreed in an arrangement outside the formal paperwork of the transactions underlying the Product Return that the Distributor could return the products back to us at the Distributor’s discretion.

The audit committee investigation and discussion included a review of our compliance with Securities and Exchange Commission Staff Accounting Bulletin No. 104 “Revenue Recognition in Financial Statements, or SAB 104, as applied to the circumstances surrounding the Product Return. Under SAB 104, a requirement for revenue recognition is that all of the following criteria must be met: (1) there is persuasive evidence that an arrangement exists, (2) delivery of goods has occurred, (3) the sales price is fixed or determinable, and (4) collectibility is reasonably assured. In addition, pursuant to our revenue recognition policy, for sales to distributors, we defer recognition of revenue until such time that the distributor sells products to its customers based upon receipt of point-of-sales reports from the distributor. The internal investigation revealed that approximately $1.4 million of a sale of our product to the Distributor did not meet the foregoing criteria because our former employee had agreed that the Distributor could return the product at the Distributor’s discretion, which forms the basis of the Restatement. This former employee had on this occasion agreed to a term of sale that was outside of our standard practices and was not referenced in the documentation related to the sale submitted to our finance department. Given the discovery of this arrangement for the Distributor to return the product, the audit committee concluded on January 25, 2005 that we should restate certain financial information that was previously reported in our Form 10-Q for the quarter ended June 30, 2004 filed with the Securities and Exchange Commission on August 6, 2004. For more information regarding the Restatement, please see Note 9 to our consolidated financial statements included elsewhere in this prospectus. In addition, the audit committee approved certain changes to our internal controls over financial reporting as an additional remedial action in response to the report of our litigation counsel and our forensic accountant and to the report by our Chief Financial Officer.

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


TRIPATH TECHNOLOGY INC.

Date: May 17, 2005

By:		/s/ JEFFREY L. GARON
		Jeffrey L. Garon Vice President Finance and Chief Financial Officer (Principal Financial and Accounting Officer)



PART I.	Financial Information	3

	Item 1. Financial Statements	3

	Condensed Consolidated Balance Sheets as of March 31, 2005 (unaudited) and September 30, 2004	3

	Condensed Consolidated Statements of Operations for the three months and six months ended March 31, 2005 and 2004 (unaudited)	4

	Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2005 and 2004 (unaudited)	5

	Notes to Condensed Interim Consolidated Financial Statements	6

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

	Risk Factors	28

	Item 3. Quantitative and Qualitative Disclosures about Market Risk	38

	Item 4. Controls and Procedures	39

PART II.	Other Information	42

	Item 1. Legal Proceedings	42

	Item 6. Exhibits	44

	Signatures	45

	Exhibit Index	46


	March 31, 2005 (Unaudited)			September 30, 2004 Restated (Audited)
ASSETS
Current assets:
Cash, cash equivalents and restricted cash	$	5,091		$	7,339
Accounts receivable, net		346			1,019
Inventories, net		3,520			3,939
Prepaid expenses and other current assets		947			212

Total current assets		9,904			12,509

Property and equipment, net		1,232			1,674
Other assets		126			123

Total assets	$	11,262		$	14,306

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	990		$	2,908
Current portion of capital lease obligations		336			664
Current portion of deferred rent		285			266
Accrued expenses		656			764
Deferred distributor revenue		1,183			1,075
Warrant liability		715			—

Total current liabilities		4,165			5,677

Long term liabilities		386			571

Commitments and contingencies (see Note 12)

Stockholders’ equity:
Common stock, $0.001 par value, 100,000,000 shares authorized; 55,343,896 and 50,043,158 shares issued and outstanding at March 31, 2005 (unaudited) and September 30, 2004, respectively		55			49
Additional paid-in capital		202,555			199,333
Deferred stock-based compensation		(14	)		(95	)
Accumulated deficit		(195,885	)		(191,229	)

Total stockholders’ equity		6,711			8,058

Total liabilities and stockholders’ equity	$	11,262		$	14,306


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004 Restated			2005			2004
Revenue	$	2,728		$	3,273		$	4,401		$	7,399
Cost of revenue		990			2,373			2,217			5,142

Gross profit		1,738			900			2,184			2,257

Operating expenses:
Research and development		1,962			1,718			3,863			3,387
Selling, general and administrative		1,790			1,269			3,218			2,351

Total operating expenses		3,752			2,987			7,081			5,738

Loss from operations		(2,014	)		(2,087	)		(4,897	)		(3,481	)
Gain on revaluation of warrant liability		252			—			252			—
Interest and other income (expense), net		(16	)		8			(11	)		16

Net loss	$	(1,778	)	$	(2,079	)	$	(4,656	)	$	(3,465	)


Basic and diluted net loss per share	$	(0.03	)	$	(0.05	)	$	(0.09	)	$	(0.07	)

Weighted average number of common shares used in computing basic and diluted net loss per share		51,950			45,266			51,923			46,845


	Six Months Ended March 31,
	2005			2004
Cash flows from operating activities:
Net loss	$	(4,656	)	$	(3,465	)
Adjustments to reconcile net loss to net cash used in operating activities:
Gain on revaluation of warrant liability		(252	)		—
Depreciation and amortization		463			560
Deferred Rent		(128	)		104
Allowance for doubtful accounts		(50	)		—
Provision for slow moving, excess and obsolete inventory		(1,467	)		243
Stock-based compensation		81			87
Changes in assets and liabilities:
Accounts receivable, net		723			(758	)
Inventories, net		1,886			(3,822	)
Prepaid expenses and other assets		(738	)		(102	)
Accounts payable		(1,918	)		2,232
Accrued expenses		(108	)		248
Deferred distributor revenue		108			1,267

Net cash used in operating activities		(6,056	)		(3,406	)

Cash flows from investing activities:
Purchase of property and equipment		(21	)		(519	)

Net cash used in investing activities		(21	)		(519	)

Cash flows from financing activities:

Net proceeds from issuance of common stock		4,195			4,270
Principal payments on capital lease obligations		(366	)		(250	)

Net cash provided by financing activities		3,829			4,020

Net increase (decrease) in cash and cash equivalents		(2,248	)		95
Cash, cash equivalents, and restricted cash, beginning of period		7,339			9,088

Cash, cash equivalents, and restricted cash, end of period	$	5,091		$	9,183

Non-cash financing activity:
Property and equipment acquired by capital lease	$	—		$	317


	Three months ended March 31,						Six months ended March 31,
	2005			2004 Restated			2005			2004
Numerator:
Net loss	$	(1,778	)	$	(2,079	)	$	(4,656	)	$	(3,465	)

Denominator:
Weighted average common stock		51,950			45,266			51,923			46,845

Net loss per share:
Basic and diluted	$	(0.03	)	$	(0.05	)	$	(0.09	)	$	(0.07	)


	Three months ended March 31,						Six months ended March 31,
	2005			2004 Restated			2005			2004
Net loss applicable to common stockholders, as reported	$	(1,778	)	$	(2,079	)	$	(4,656	)	$	(3,465	)
Total stock-based employee compensation expense included in the net loss, determined under the recognition and measurement principles of APB Opinion No. 25, net of related tax effects		40			42			81			87
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(329	)		(708	)		(1,364	)		(1,187	)

Pro forma net loss applicable to common stockholders	$	(2,067	)	$	(2,745	)	$	(5,939	)	$	(4,565	)

Loss per share:
Basic and diluted—as reported	$	(0.03	)	$	(0.05	)	$	(0.09	)	$	(0.07	)

Basic and diluted—pro forma	$	(0.04	)	$	(0.05	)	$	(0.11	)	$	(0.10	)


	% of Revenue for the Three Months Ended March 31,				% of Revenue for the Six Months Ended March 31,
	2005		2004		2005		2004
Customer A	20	%	—		17	%	—
Customer B	13	%	40	%	10	%	33	%
Customer C	10	%	—		—		—
Customer D	—		13	%	—		21	%


	March 31, 2005			September 30, 2004 Restated
Raw materials	$	7,515		$	6,668
Work-in-process		128			847
Finished goods		2,638			4,938
Inventory held by distributors		970			685
Less: reserve for slow-moving, excess and obsolete inventory		(7,731	)		(9,199	)

Total	$	3,520		$	3,939


Year ending September 30,	Operating Leases		Capital Leases			Inventory Purchase Commitments
2005	$	554	$	315		$	766
2006		1,036		86			—
2007		537		21			—

Total minimum lease payments	$	2,127		422		$	766

Less: amount representing interest				(24	)

Present value of minimum lease payments				398
Less: current portion of capital lease obligations				(336	)

Long-term capital lease obligations			$	62


	Three Months Ended March 31, 2004									Three Months Ended December 31, 2003			Six Months Ended March 31, 2004
	Previously Reported (1)			Restatement Adjustment			Restated Total			Three Months Ended December 31, 2003			Six Months Ended March 31, 2004
Revenue	$	4,166		$	(893	)(2)	$	3,273		$	4,126		$	7,399
Cost of revenue		2,972			(599	)(3)		2,373			2,769			5,142

Gross profit (loss)		1,194			(294	)		900			1,357			2,257

Operating expenses:
Research and development		1,718			—			1,718			1,669			3,387
Selling, general and administrative		1,269			—			1,269			1,082			2,351

Total operating expenses		2,987			—			2,987			2,751			5,738

Loss from operations		(1,793	)					(2,087	)		(1,394	)		(3,481	)
Interest and other income (expense), net		8			—			8			8			16

Net loss	$	(1,785	)	$	(294	)	$	(2,079	)	$	(1,386	)	$	(3,465	)

Basic and diluted net loss per share	$	(0.04	)				$	(0.05	)	$	(0.03	)	$	(0.07	)

Number of shares used to compute basic and diluted net loss per share		45,266						45,266			43,853			46,845


	March 31, 2004
	Previously Reported (1)			Restatement Adjustment			Restated Total
ASSETS
Current assets:
Cash, cash equivalents and restricted cash	$	9,183		$	—		$	9,183
Accounts receivable, net		2,692			—			2,692
Inventories, net		7,016			599	(3)		7,615
Prepaid expenses and other current assets		257			—			257

Total current assets		19,148			599			19,747
Property and equipment, net		1,949			—			1,949
Other assets		83			—			83

Total assets	$	21,180		$	599		$	21,779

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,742		$	—		$	4,742
Current portion of capital lease obligations		477			—			477
Current portion of deferred rent		140			—			140
Accrued expenses		922			—			922
Deferred distributor revenue		1,112			893	(2)		2,005

Total current liabilities		7,393			893			8,286

Long term liabilities:		1,011			—			1,011

Stockholders’ equity:
Common stock		47			—			47
Additional paid-in capital		194,254			—			194,254
Deferred stock-based compensation		(176	)		—			(176	)
Accumulated deficit		(181,349	)		(294	)		(181,643	)

Total stockholders’ equity		12,776			(294	)		12,482

Total liabilities and stockholders’ equity	$	21,180		$	599		$	21,779


	September 30, 2004
	Previously Reported (1)			Restatement Adjustment			Restated Total
ASSETS
Current assets:
Cash, cash equivalents and restricted cash	$	7,339		$	—		$	7,339
Accounts receivable, net		1,019			—			1,019
Inventories, net		3,780			159	(3)		3,939
Prepaid expenses and other current assets		212			—			212

Total current assets		12,350			159			12,509
Property and equipment, net		1,674			—			1,674
Other assets		123			—			123

Total assets	$	14,147		$	159		$	14,306

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,908		$	—		$	2,908
Current portion of capital lease obligations		664			—			664
Current portion of deferred rent		266			—			266
Accrued expenses		764			—			764
Deferred distributor revenue		823			252	(2)		1,075

Total current liabilities		5,425			252			5,677

Long term liabilities:		471			—			571

Stockholders’ equity:
Common stock		49			—			49
Additional paid-in capital		199,333			—			199,333
Deferred stock-based compensation		(95	)		—			(95	)
Accumulated deficit		(191,136	)		(93	)		(191,229	)

Total stockholders’ equity		8,151			(93	)		8,058

Total liabilities and stockholders’ equity	$	14,147		$	159		$	14,306


Year ending September 30,	Operating Leases		Capital Leases			Inventory Purchase Commitments		Totals
2005	$	554	$	315		$	766	$	1,635
2006		1,036		86			—		1,122
2007		537		21			—		558
2008		—		—			—

Total minimum lease payments	$	2,127		422		$	766	$	3,315

Less: amount representing interest				(24	)

Present value of minimum lease payments				398
Less: current portion of capital lease obligations				(336	)

Long-term capital lease obligations			$	62


Exhibit No.		Description
10.1		Letter dated as of February 15, 2005, from Tripath Technology Inc. to Mr. Jeffrey L. Garon offering him the position of Chief Financial Officer.

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification by Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


	Three Months Ended March 31,				Six Months Ended March 31,
	2005		2004		2005		2004
Europe	$	508	$	340	$	758	$	555
Korea		62		0		275		1,311
United States		121		529		320		753
Japan		1,544		2,126		2,326		4,037
Taiwan		131		98		159		505
China		338		141		527		191
Rest of World		24		39		36		47

	$	2,728	$	3,273	$	4,401	$	7,399