Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

x    **Quarterlyreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**For thequarterly period ended March 31, 2009.**

 

**OR**

 

o     **Transitionreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**For thetransition period from              to               **

 

**Commissionfile number 000-51560**

 

**MathStar, Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                                  | ** ** | **41-1881957**      |
|---------------------------------------------------------------|------------|---------------------|
| (State or other  jurisdiction of                              |       | (I.R.S. Employer    |
| incorporation or  organization)                               |       | Identification No.) |
|                                                          |       |                |
| **19075 NW  Tanasbourne, Suite 200, Hillsboro,  Oregon** | ** ** | **97124**           |
| (Address of principal  executive offices)                     |       | (Zip  Code)    |

 

**(503)726-5500**

(Registrant’s telephonenumber, including area code)

 

**N/A**

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

 

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

 

Indicate by check mark whether the registranthas submitted electronically and posted on its corporate Web site, if any,every Interactive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).  Yeso No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

| Large accelerated filer o                      |   | Accelerated filer o          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company x |
| (Do not check if a smaller  reporting company) |   |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). x Yes  o No

 

Shares outstanding of theRegistrant’s common stock:

 

| **Class**                      | ** ** | **Outstanding at April 30, 2009** |
|--------------------------------|------------|--------------------------------------------------|
| Common stock, $0.01 par  value |       | 9,181,497                                        |

 

 

 

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Table of Contents

 
| PART I  FINANCIAL INFORMATION | 3                                                                                            |
|-----------------------------------------|----------------------------------------------------------------------------------------------|
|                                    |                                                                                         |   |
| Item 1.                                 | Consolidated Financial Statements  (Unaudited)                                               | 3 |
|                                    | Condensed  Balance Sheets as of December 31, 2008 and March 31, 2009               | 3 |
|                                    | Condensed  Statements of Operations for the Three Months Ended March 31, 2008 and  2009 | 4 |
|                                    | Condensed  Statements of Cash Flows for the Three Months Ended March 31, 2008 and  2009 | 5 |
|                                    | Notes to  Condensed Consolidated Financial Statements                                        | 6 |
|                                    |                                                                                         |   |
| Item 2                                  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations  | 12 |
| Item 3                                  | Quantitative and Qualitative Disclosures  about Market Risk                                  | 14 |
| Item 4                                  | Controls and Procedures                                                                      | 15 |
|                                    |                                                                                         |   |
| PART II   OTHER INFORMATION   | 15                                                                                           |
|                                    |                                                                                         |   |
| Item 1.                                 | Legal Proceedings                                                                            | 15 |
| Item 1A.                                | Risk Factors                                                                                 | 15 |
| Item 2.                                 | Unregistered Sales of Equity Securities and  Use of Proceeds                                 | 15 |
| Item 3.                                 | Defaults Upon Senior Securities                                                              | 15 |
| Item 4.                                 | Submission of Matters to a Vote of Security  Holders                                         | 16 |
| Item 5.                                 | Other Information                                                                            | 16 |
| Item 6.                                 | Exhibits                                                                                     | 16 |
|                                    |                                                                                         |   |
| Signatures                              | 17                                                                                           |

 

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**Part I**

**FinancialInformation**

 

**Item1.  Financial Statements**

 

**MathStar, Inc.**

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

**(inthousands, except per share data)**

 
| ** **                                                                                                                                       | ** ** | **December 31,  2008** | ** ** | **March 31,  2009** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
|                                                                                                                                             |       |                        |       |                     |       |
| **Assets**                                                                                                                                       |       |                        |       |                     |       |
| Current  assets                                                                                                                                  |       |                        |       |                     |       |
| Cash and  cash equivalents                                                                                                                       |       | $                           | 11,767     |                     | $          | 14,004 |   |
| Investments  in marketable securities – short term                                                                                          |       | 2,530                       |       | —                   |       |
| Accounts  receivable                                                                                                                             |       | 176                         |       | —                   |       |
| Prepaid  expenses and other current assets                                                                                                       |       | 222                         |       | 134                      |       |
| Total  current assets                                                                                                                            |       | 14,695                      |       | 14,138                   |       |
| Property  and equipment, net                                                                                                                     |       | 60                          |       | 58                       |       |
| Investments  in marketable securities – long term                                                                                           |       | 785                         |       | 778                      |       |
| Put  option                                                                                                                                      |       | 26                          |       | 26                       |       |
| Other  assets                                                                                                                                    |       | 23                          |       | 21                       |       |
| Total  assets                                                                                                                                    |       | $                           | 15,589     |                     | $          | 15,021 |   |
|                                                                                                                                             |       |                        |       |                     |       |
| **Liabilities and Stockholders’ Equity**                                                                                                    |       |                        |       |                     |       |
| Current  liabilities                                                                                                                             |       |                        |       |                     |       |
| Accounts  payable                                                                                                                                |       | $                           | 16         |                     | $          | 51 |   |
| Accrued  expenses                                                                                                                                |       | 519                         |       | 328                      |       |
| Total  current liabilities                                                                                                                       |       | 535                         |       | 379                      |       |
| Other  long term liabilities                                                                                                                     |       | 151                         |       | 151                      |       |
| Total  liabilities                                                                                                                               |       | 686                         |       | 530                      |       |
|                                                                                                                                             |       |                        |       |                     |       |
| Stockholders’  equity                                                                                                                       |       |                        |       |                     |       |
| Preferred  stock, $0.01 par value; 10,000 shares authorized; no shares issued and  outstanding                                                   |       | —                      |       | —                   |       |
| Common  stock, $0.01 par value; 18,000 shares authorized; 9,181 shares issued and  outstanding at December 31, 2008 and March 31, 2009 |       | 92                          |       | 92                       |       |
| Additional  paid-in capital                                                                                                                      |       | 155,924                     |       | 155,939                  |       |
| Accumulated  deficit                                                                                                                             |       | (141,113                    | )          | (141,540                 | )          |
| Total  stockholders’ equity                                                                                                                 |       | 14,903                      |       | 14,491                   |       |
|                                                                                                                                             |       |                        |       |                     |       |
| Total  liabilities and stockholders’ equity                                                                                                 |       | $                           | 15,589     |                     | $          | 15,021 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

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**MathStar, Inc.**

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

**(inthousands, except per share data)**

 
| ** **                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                         | ** ** | **2009** | ** ** |
| ** **                                             | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Revenue                                                |       | $                                                | 226        |   | $ | — |   |
| Cost of  sales                                         |       | 291                                              |       | — |   |
| Gross  loss                                            |       | (65                                              | )          | — |   |
| Operating  expenses:                                   |       |                                             |       |   |   |
| Research  and development                              |       | 3,552                                            |       | — |   |
| Selling,  general and administrative                   |       | 2,093                                            |       | 458 |   |
| Total  operating expenses                              |       | 5,645                                            |       | 458 |   |
| Operating  loss                                        |       | (5,710                                           | )          | (458 | ) |
| Interest  income                                       |       | 280                                              |       | 35 |   |
| Other  income (expense), net                           |       | 37                                               |       | (4 | ) |
| Net loss                                               |       | $                                                | (5,393     | ) | $ | (427 | ) |
| Basic  and diluted loss per share                      |       | $                                                | (0.59      | ) | $ | (0.05 | ) |
| Weighted  average basic and diluted shares outstanding |       | 9,181                                            |       | 9,181 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

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**MathStar, Inc.**

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

**(inthousands)**

 
| ** **                                                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2008**                                         | ** ** | **2009** | ** ** |
|                                                                        |       |                                             |       |   |   |
| **Cash flows from operating activities**                                    |       |                                             |       |   |   |
| Net loss                                                                    |       | $                                                | (5,393     | ) | $ | (427 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities |       |                                             |       |   |   |
| Depreciation  and amortization                                              |       | 57                                               |       | 2 |   |
| Amortization  of discount on held-to-maturity securities                    |       | 16                                               |       | 3 |   |
| Mark to  market, trading securities                                         |       | —                                           |       | 7 |   |
| Non-cash  changes in inventory reserves                                     |       | 225                                              |       | — |   |
| Stock-based  compensation                                                   |       | 134                                              |       | 15 |   |
| Gain on  sale of marketable securities                                      |       | (42                                              | )          | — |   |
| Foreign  currency remeasurement                                             |       | 3                                                |       | 4 |   |
| Change  in operating assets and liabilities                                 |       |                                             |       |   |   |
| Accounts  receivable                                                        |       | 165                                              |       | 176 |   |
| Inventory                                                                   |       | (485                                             | )          | — |   |
| Prepaid  expenses and other assets                                          |       | 320                                              |       | 90 |   |
| Accounts  payable                                                           |       | (260                                             | )          | 35 |   |
| Deferred  revenue                                                           |       | (129                                             | )          | — |   |
| Accrued  expenses                                                           |       | (60                                              | )          | (195 | ) |
| Net cash  used in operating activities                                      |       | (5,449                                           | )          | (290 | ) |
|                                                                        |       |                                             |       |   |   |
| **Cash flows from investing activities**                                    |       |                                             |       |   |   |
| Purchase  of property and equipment                                         |       | (28                                              | )          | — |   |
| Proceeds  from sale of held-to-maturity securities                          |       | 7,170                                            |       | 2,527 |   |
| Proceeds  from sale of available-for-sale securities                        |       | 2,610                                            |       | — |   |
| Purchase  of held-to-maturity securities                                    |       | (2,931                                           | )          | — |   |
| Purchase  of available-for-sale securities                                  |       | (2,685                                           | )          | — |   |
| Restricted  cash                                                            |       | (2                                               | )          | — |   |
| Net cash  provided by investing activities                                  |       | 4,134                                            |       | 2,527 |   |
|                                                                        |       |                                             |       |   |   |
| **Cash flows from financing activities**                                    |       | —                                           |       | — |   |
| ** **                                                                  |       |                                             |       |   |   |
| Effect  of exchange rate changes on cash                                    |       | (3                                               | )          | — |   |
| Net (decrease)  increase in cash and cash equivalents                       |       | (1,318                                           | )          | 2,237 |   |
| **Cash and cash equivalents**                                               |       |                                             |       |   |   |
| Beginning  of period                                                        |       | 4,339                                            |       | 11,767 |   |
| End of  period                                                              |       | $                                                | 3,021      |   | $ | 14,004 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

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**MathStar, Inc.**

**Notes to Consolidated Financial Statements**

**(inthousands, except per share data)**

 

**1.****                                     ****Basis of Presentation and Going Concern**

 

The accompanying interim condensedconsolidated financial statements of MathStar, Inc. (“MathStar” or the “Company”)have been prepared in conformity with generally accepted accounting principlesin the United States (U.S. GAAP), consistent in all material respects withthose applied in the Company’s Annual Report on Form 10-K filed with theSecurities and Exchange Commission (“SEC”) on March 31, 2009. The year-endcondensed consolidated balance sheet was derived from audited financialstatements, but does not include all disclosure required by U.S. GAAP. Thepreparation of financial statements in conformity with U.S. GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and the disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates. During the quarter ended March 31, 2009, MathStar, Inc.closed its two wholly-owned subsidiaries, MathStar Holdings B.V. and MathStar Limited.

 

The interim financial information isunaudited, but it reflects all normal adjustments that are, in the opinion ofmanagement, necessary to provide a fair statement of results for the interimperiods presented. The interim financial results are not necessarily indicativeof results to be expected in future interim or annual periods. The interimfinancial statements should be read in conjunction with the financialstatements in the Company’s Annual Report on Form 10-K filed with theSecurities and Exchange Commission on March 31, 2009.

 

The accompanying financialstatements have been prepared on a basis which assumes that the Company willcontinue as a going concern and which contemplates the realization of assetsand the satisfaction of liabilities and commitments in the normal course ofbusiness. During the three months ended March 31, 2008, sales did notmaterialize as expected, and our development of the next generation of FPOAchip fell even further behind schedule. As a result, on May 20, 2008, theBoard of Directors voted to suspend research and development activities andongoing operations while analyzing strategic alternatives to protectshareholder value. The Board of Directors continues to explore these strategicalternatives, which could include merger, acquisition, increasing operations inanother structure or liquidation. MathStar has engaged a third partyinvestment banking firm to explore the sale of intellectual property andpatents and potential merger and acquisition alternatives.

 

Theaccompanying financial statements have been prepared assuming the Company willcontinue as a going concern. Although the Company has incurred recurring lossesand negative cash flows from operations, we have met all financial obligationswith vendors, key suppliers, and strategic partners, both prior and subsequentto curtailing operations. We have sufficient cash and investments to meet allknown obligations as well as projected expenditures for the next twelve monthsat current spending levels. However, because we have not committed to any ofthe strategic alternatives being evaluated, we cannot predict our long-termcash needs or ultimate cash requirements. The financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

 

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Basic earnings per shareare computed by dividing the net loss available to common shareholders by theweighted average number of shares outstanding during the period. Dilutedearnings per share gives effect to all potential dilutive common sharesoutstanding during the period, including stock options and warrants using thetreasury stock method. For the three months ended March 31, 2008 and March 31,2009 options and warrants to purchase shares of common stock were not includedin the computation of net loss per share, as their effect was antidilutive.

 

**2.             Restructuring and ImpairmentCharges**

 

During the three months ended June 30,2008, the Company announced a curtailment of operations as it evaluatedstrategic alternatives to preserve shareholder value.  This decisionresulted in restructuring and impairment charges of $3,500 in 2008. Management determined that it was highly likely that certain operational assetswould not be used and no alternatives existed. In accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 144, “*Accounting for the Impairment or Disposal ofLong-Lived Assets*” issued by the Financial Accounting StandardsBoard (“FASB”), these assets were deemed to be impaired and eitherheld-for-sale or abandoned and written down to their fair market value.  Aplan to locate potential buyers was put in place for their disposal, and nofurther depreciation expense will be charged to the Company’s operatingactivity for these assets. In addition, the Company evaluated assets that werenot abandoned or held-for-sale and determined that the estimated useful livesof these assets should be shortened.  Aswell, in accordance with SFAS No. 146 issued by the FASB, “*Accounting for Costs Associated with Exit or DisposalActivities”*, certain one-time charges relating to severance toterminated employees, and fees associated with early contract terminations nolonger used and giving economic benefit to the Company, were recorded. As theliabilities for these charges were settled, payment was made against theliability, and there will not be any further impact on the Company’s operatingresults.

 
| ** **                                                             | ** ** | **Twelve Months  Ended December 31,  2008** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| Inventory abandoned                                                    |       | $                                                | 349        |   |
| Increase in excess and obsolete reserve                                |       | 533                                              |       |
| Charged to cost of sales                                               |       | 882                                              |       |
| Severance                                                              |       | 1,506                                            |       |
| Fair market adjustment of assets  held-for-sale                        |       | 328                                              |       |
| Contract termination                                                   |       | 57                                               |       |
| Assets abandoned                                                       |       | 727                                              |       |
| Charged to operating expenses as  restructuring and impairment charges |       | 2,618                                            |       |
| Total charges for restructuring and  impairment                        |       | $                                                | 3,500      |   |

 

Below is the detail ofrestructuring and impairment charges for the three months ended March 31,2009.

 
| ** **                             | ** ** | **Restructuring  Liability** | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| Liability as of December 31, 2008 |       | $                            | 4          |   |
| Additions                              |       | —                       |       |
| Payments                               |       | (4                           | )          |
| Liability as of March 31, 2009    |       | $                            | —     |   |

 

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Managementbelieves that no further charges will be incurred for this activity, except forpotential termination of non-cancellable lease liabilities for the Hillsboro,Oregon facility, which will depend on the strategic direction chosen by theCompany. The amount of the potential lease termination liability will not beknown until the strategic direction is identified. Total future lease commitmentsremaining under this lease are $806 as of March 31, 2009.

 

**3.****            ****New Accounting Pronouncements**

 

In April 2009, the FASB issued StaffPosition No. 157-4, *“Determining Fair ValueWhen Volume and Level of Activity for the Asset or Liability Have SignificantlyDecreased and Identifying Transactions That Are Not Orderly”* (“FSP157-4”). FSP 157-4 providesguidance on how to determine the fair value of assets and liabilities when the volumeand level of activity for the asset/liability has significantly decreased. FSP157-4 also provides guidance on identifying circumstances that indicate atransaction is not orderly. In addition, FSP 157-4 requires disclosure ininterim and annual periods of the inputs and valuation techniques used tomeasure fair value and a discussion of changes in valuation techniques. FSP157-4 is effective for the Company beginning in the second quarter of fiscalyear 2009. The Company does not expect the adoption of FSP 157-4 to have amaterial impact on its consolidated financial position, results of operationsor cash flows.

 

In April 2009, the FASB issued Staff Position No. 115-2and 124-2, *“Recognition and Presentation ofOther-Than-Temporary Impairment”*(“FSP 115-2/124-2”). FSP115-2/124-2 amends the requirements for the recognition and measurement ofother-than-temporary impairments for debt securities by modifying the pre-existing“intent and ability” indicator. Under FSP 115-2/124-2, on-other-than-temporaryimpairment is triggered when there is an intent to sell the security, it ismore likely than not that the security will be required to be sold beforerecovery, or the security is not expected to recover the entire amortized costbasis of the security. Additionally, FSP 115-2/124-2 changes the presentationof an other-than-temporary impairment in the income statement for thoseimpairments involving credit losses. The credit loss component will berecognized in earnings and the remainder of the impairment will be recorded inother comprehensive income. FSP 115-2/124-2 is effective for the Company beginningin the second quarter of fiscal year 2009. The Company does not expect theadoption of FSP 115-2/124-2 to have a material impact on its consolidatedfinancial position, results of operations or cash flows.

 

In April 2009, the FASB issued Staff Position No. 107-1and APB 28-1, *“Interim Disclosure about Fair Value of Financial Instruments”*(“FSP107-1/APB 28-1”). FSP 107-1/APB 28-1 requires interim disclosures regarding thefair values of financial instruments that are within the scope of FAS 107, *“Disclosures about the Fair Value of FinancialInstruments.”*Additionally, FSP 107-1/APB 28-1 requires disclosureof the methods and significant assumptions used to estimate the fair value offinancial instruments on an interim basis as well as changes of the methods andsignificant assumptions from prior periods. FSP 107-1/APB 28-1 does not changethe accounting treatment for these financial instruments and is effective forthe Company beginning in the second quarter of fiscal year 2009.

 

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**4.****    ****Selected Balance Sheet Information**

 

**InvestmentSecurities**

 
| ** **                   | ** ** | **December 31,  2008** | ** ** | **March 31,  2009** | ** ** |
|------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Short-term                   |       |                        |       |                     |       |
| Held-to-maturity             |       |                        |       |                     |       |
| Corporate bonds and notes    |       | $                           | 2,530      |                     | $          | — |   |
| Total short-term investments |       | 2,530                       |       | —                   |       |
|                         |       |                        |       |                     |       |
| Long-term                    |       |                        |       |                     |       |
| Trading                      |       |                        |       |                     |       |
| Auction preferred securities |       | 785                         |       | 778                      |       |
| Total long-term investments  |       | 785                         |       | 778                      |       |
|                         |       |                        |       |                     |       |
| Total investments            |       | $                           | 3,315      |                     | $          | 778 |   |

 

All held-to-maturity securities withfixed maturity dates matured in the quarter ended March 31, 2009 on theiroriginal scheduled maturity date.

 
| ** **          | ** ** | ** **  | ** ** | **Fair Value Measurement at Reporting Date  Using**    | ** ** |
|---------------------|------------|-------------|------------|---------------------------------------------------------------------------------|------------|
| ** **          | ** ** | ** **  | ** ** | **Quoted Prices  in Active  Markets for  Identical Assets** | ** ** | **Significant  Other  Observable  Inputs** | ** ** | **Significant  Unobservable  Inputs** | ** ** |
| **Description**     | ** ** | **3/31/09** | ** ** | **(Level 1)**                                                              | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Put  option         |       | $           | 26         |                                                                            | —     |   | — |   | $ | 26 |   |
| Trading  securities |       |        | 778        |                                                                            | —     |   | — |   |   | 778 |   |
| Total               |       | $           | 804        |                                                                            | —     |   | — |   | $ | 804 |   |
|                     |            |             |            |                                                                                 |            |  |  |  |  |  |  |  |  |

 

We have auction preferred securities(APS), which are preferred equity instruments in a closed-end mutual fund thatprovide liquidity through an auction process conducted by an independentauction agent that resets the applicable dividend rate at pre-determinedcalendar intervals, generally every 28 days.  These instruments are seniorequity securities that have a liquidation preference of $25,000 per share plusthe amount of accumulated but unpaid dividends. Upon the liquidation,dissolution or winding up of the fund, APS holders are entitled to receivetheir liquidation preference before any distribution or payment is made toholders of the fund’s common shares. Dividends declared and payable on the APShave a priority over dividends on the fund’s common shares. Outstanding APS maybe redeemed at the option of the fund upon giving notice to APS holders.

 

The Company generally invested inthese securities as part of its overall cash management program. During thefirst quarter of 2008, the Company’s APS failed to auction due to sell ordersexceeding buy orders. The funds associated with failed auctions will notbe accessible until a successful auction occurs, the fund redeems outstandingAPS or an active secondary market is created and a buyer is identified outsideof the auction process.

 

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At March 31,2009, there was insufficient observable APS market information available todetermine the fair value of the Company’s investments in APS. Therefore, theCompany estimated Level 3 fair values for these securities byincorporating assumptions that market participants would use in their estimatesof fair value. Despite the failed auctions, the Company’s APS continue to behighly rated by the rating agencies. Of the original $2,680 in APS purchased,$1,852 was redeemed on May 27, 2008 at face value.

 

As further required by SFAS No. 157,provided below is a reconciliation of the beginning and ending balances foreach type of security valued using a Level 3 valuation at March 31, 2009.

 
| ** **                                                     | ** ** | **Fair Value Measurement Using Significant  Unobservable Inputs (Level 3)** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **Put Option**                                                                   | ** ** | **Auction  Preferred  Securities** | ** ** |
| Beginning balance as of December 31,  2008                |       | $                                                                                | 26         |   | $ | 785 |   |
| Total gains (losses) realized/unrealized  included in earnings |       | —                                                                           |       | (7 | ) |
| Purchases                                                      |       | —                                                                           |       | — |   |
| Settlements                                                    |       | —                                                                           |       | — |   |
| Issuance of put option                                         |       | —                                                                           |       | — |   |
| Ending balance as of March 31, 2009                       |       | $                                                                                | 26         |   | $ | 778 |   |

 

On November 14,2008, we accepted an offer from UBS AG (“UBS”), providing us with rightsrelated to our APS (the “Rights”). The Rights permit us to require UBS topurchase our APS at any time during the period from June 30, 2010 until July 2,2012 at par value, which is defined as the price equal to the liquidationpreference of the APS plus accrued but unpaid dividends or interest.Conversely, UBS has the right, in its discretion, to purchase or sell our APSat any time until July 2, 2012 so long as we receive payment at par valueupon any sale or disposition. We expect to sell our APS under the Rights.However, if the Rights are not exercised before July 2, 2012, they willexpire, and UBS will have no further rights or obligation to buy our APS. Solong as we hold our APS, they will continue to accrue interest as determined bythe auction process or the terms of the APS if the auction process fails. UBS’sobligations under the Rights are not secured by its assets and do not requireUBS to obtain any financing to support its performance obligations under theRights. UBS has disclaimed any assurance that it will have sufficient financialresources to satisfy its obligations under the Rights.

 

TheRights represent a firm agreement in accordance with SFAS No. 133, whichdefines a firm agreement as an agreement with an unrelated party, binding onboth parties and usually legally enforceable, with the followingcharacteristics: a) the agreement specifies all significant terms,including the quantity to be exchanged, the fixed price, and the timing of thetransaction; and b) the agreement includes a disincentive fornonperformance that is sufficiently large to make performance probable. Theenforceability of the Rights results in a put option and should be recognizedas a free-standing asset separate from the APS. Upon acceptance of the offerfrom UBS, we recorded $26 as the fair value of the put option asset with acorresponding credit to interest income, net. The put option does not meet thedefinition of a derivative instrument under SFAS No. 133. Therefore, wehave elected to measure the put option at fair value under SFAS No. 159,which permits an entity to elect the fair value option for recognized financialassets, in order to match the changes in the fair value of the APS. As aresult, gains and losses will be included in earnings in future periods. Weexpect that future changes in the fair value of the put option will approximatefair value movements in the related APS; however, during the quarter ended March 31,2009, the fair value of the put option did not materially change. Prior toaccepting the UBS offer, we recorded our APS as investments available-for-sale.We recorded unrealized gains and losses on our available-for-sale debtsecurities, net of a tax benefit, in accumulated other comprehensive income inthe shareholders’ equity section of our balance sheets. Such an unrealized lossdid not reduce net income for the applicable accounting period.

 

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**Inventory**

 
| ** **                                       | ** ** | **December 31,  2008** | ** ** | **March 31,  2009** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Finished  goods                                  |       | $                           | 446        |                     | $          | 446 |   |
| Less:  reserve for excess and obsolete inventory |       | (446                        | )          | (446                     | )          |
| Total  inventory, net                            |       | $                           | —     |                     | $          | — |   |

 

**Prepaid and OtherCurrent Assets**

 
| ** **                              | ** ** | **December 31,  2008** | ** ** | **March 31,  2009** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Interest  receivable                    |       | $                           | 61         |                     | $          | — |   |
| Prepaid  insurance                      |       | 105                         |       | 77                       |       |
| Prepaid  rent                           |       | 26                          |       | 27                       |       |
| Other                                   |       | 30                          |       | 30                       |       |
| Total  prepaid and other current assets |       | $                           | 222        |                     | $          | 134 |   |

 

**Property andEquipment**

 
| ** **                         | ** ** | **December 31,  2008** | ** ** | **March 31,  2009** | ** ** |
|------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Computer  equipment                |       | $                           | 50         |                     | $          | 50 |   |
| Purchased  software                |       | 91                          |       | 91                       |       |
| Furniture  and fixtures            |       | 198                         |       | 198                      |       |
|                               |       | $                           | 339        |                     | $          | 339 |   |
| Less:  Accumulated depreciation    |       | (279                        | )          | (281                     | )          |
| Total  property and equipment, net |       | $                           | 60         |                     | $          | 58 |   |

 

Depreciation expense was $52 and $2for the three months ended March 31, 2008 and 2009, respectively.

 

Under SFAS No. 144, *“Accounting for the Impairment or Disposal of LongLived Assets”,*assets that are no longer used in operations and heldfor sale should be written down to the expected fair market value and depreciationceased as of the determination date.

 

**Other Assets**

 
| ** **          | ** ** | **December 31,  2008** | ** ** | **March 31,  2009** | ** ** |
|---------------------|------------|-----------------------------|------------|--------------------------|------------|
| Deposits            |       | $                           | 23         |                     | $          | 21 |   |
| Total  other assets |       | $                           | 23         |                     | $          | 21 |   |

 

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**Accrued Expenses**

 
| ** **                     | ** ** | **December 31,  2008** | ** ** | **March 31,  2009** | ** ** |
|--------------------------------|------------|-----------------------------|------------|--------------------------|------------|
|                           |       |                        |       |                     |       |
| Accrued  rent                  |       | $                           | 47         |                     | $          | 45 |   |
| Accrued compensation           |       | 9                           |       | —                   |       |
| Accrued  professional fees     |       | 148                         |       | 118                      |       |
| Accrued  license contracts     |       | 302                         |       | 151                      |       |
| Accrued  restructuring charges |       | 4                           |       | —                   |       |
| Other                          |       | 9                           |       | 14                       |       |
| Total  accrued expenses        |       | $                           | 519        |                     | $          | 328 |   |

 

**5.             Subsequent Events**

 

On May 7, 2009, the Company entered into anagreement with its Chief Executive Officer under which the parties amended apreviously existing severance agreement. Under the original agreement, aseverance payment was made to the Chief Executive Officer totaling $216,286 inJuly 2008. Because it was not the Board of Director's intent to pay the ChiefExecutive Officer a severance payment until his employment with the Company wassevered, the Company entered into an amended agreement under which the ChiefExecutive Officer paid back to the Company the severance payment, net ofwithholdings, plus interest, totaling $119,441, which has been received by theCompany.

 

**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

*ThisQuarterly Report on Form 10-Q contains forward-looking statements, whichare being provided under the “safe harbor” protection of the Private SecuritiesLitigation Reform Act of 1995. Forward-looking statements are generally writtenin the future tense and/or are preceded by words such as “will,” “may,” “should,”“could,” “expect,” “suggest,” “believe,” “anticipate,” “intend,” “plan,” orother similar words. Forward-looking statements are not guarantees of futureperformance and involve risks and uncertainties. The forward-looking statementscontained in this report are based on information that is currently availableto us and expectations and assumptions that we deem reasonable at the time thestatements were made. We do not undertake any obligation to update anyforward-looking statements in this report or in any of our othercommunications, except as required by law. All such forward-looking statementsshould be read as of the time the statements were made and with the recognitionthat these forward-looking statements may not be complete or accurate at alater date.*

 

*Many factors maycause actual results to differ materially from those expressed or implied bythe forward-looking statements contained in this report. These factors include,but are not limited to, those risks described in our Annual Report on Form 10-Kfiled on March 31, 2009.*

 

**Business Overview**

 

 Until we curtailed operations in the secondquarter of 2008, we were a fabless semiconductor company engaged in thedevelopment, marketing and selling of our high-performance, programmableplatform field programmable object array, or FPOA chips and design toolsrequired to program our chips. During the three months ended March 31,2008, sales did not materialize as expected, and our development of the nextgeneration of FPOA chips fell behind schedule. As a result, on May 20,2008, the Board of Directors voted to suspend research and developmentactivities and curtail ongoing operations while analyzing strategicalternatives. The Board of Directors continues to explore these strategicalternatives, which could include restarting the company, merging with oracquiring another company, increasing operations in another structure orliquidation. We have engaged a third party investment banking firm to explorethe sale of intellectual property and patents and potential merger andacquisition alternatives.

 

**Recently IssuedAccounting Pronouncements**

 

See Note 2 of Notes to FinancialStatements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

**Critical AccountingPolicies**

 

There were no changes in criticalaccounting policies in the three months ended March 31, 2009.

 

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**Results of Operations**

 

***Three Months Ended March 31, 2008 and 2009***

 

*Revenue*. There was no revenue**for the three months ended March 31, 2009 compared to$226,000 for the same period last year. The revenue for the period ended March 31,2008 consisted of the sale of production FPOA chips.  Future short-term revenue could be generatedfrom sales of production chips we have in inventory. Long-term revenueopportunities will be based on the strategic direction chosen by the Board ofDirectors.

 

*Cost ofSales.* There was no cost of sales for the three months ended March 31,2009 compared to $291,000 for the three months ended March 31, 2008. Costsof sales in the first quarter of 2008 included external chip costs and anoncash charge of $243,000 for excess and obsolete inventory comprisedprimarily of tool licenses that were to expire prior to being sold or renewed.The forecasted demand for tool licenses declined due to the change in ourbusiness strategy to focus on a few customers at a system level.

 

*Researchand Development.* All research and developmentactivity has been suspended, and no expenses were incurred during the threemonths ended March 31, 2009.  Forthe three months ended March 31, 2008, there were research and developmentexpenses of $3,552,000.  Any futureresearch and development costs will depend on the strategic direction of thecompany and the timing for executing the plan.

 

*Selling,General and Administrative. *For the three months ended March 31,2009, selling, general and administrative expenses were $458,000 compared to$2,093,000 for the three months ended March 31, 2008. The $458,000consisted of personnel expenses of $111,000, outside services and contractorsof $33,000, legal and accounting fees of $94,000, facility costs of $79,000,insurance costs of $29,000, payments to investment bankers and consultantsassociated with the sale of the IP and strategic opportunities of $93,000, andother costs of $19,000.  For the threemonths ended March 31, 2008, expenses included personnel costs of$1,436,000, consulting, professional fees and outside services of $240,000,travel of $125,000, facility and depreciation of $80,000, advertising of$39,000, insurance of $39,000 and other expenses of $134,000.  Excluding expenses associated withinvestigating strategic alternatives and IP sales, we believe our expenses areat the lowest sustainable level possible while still meeting the requirementsof a public company.  Any changes in thislevel will depend on the strategic direction of the company chosen by the Boardof Directors.

 

*Restructuringand Impairment Charges.*For the three months ended March 31,2009, we did not record any restructuring and impairment charges. See further discussion of these restructuringand impairment charges in Note 2 of the financial statements.

 

*OtherIncome (Expense).*For the three months ended March 31,2009, other income decreased by $286,000 or 90% to $31,000 compared to $317,000for the three months ended March 31, 2008. The decrease was the result of$245,000 less interest income earned on lower investment balances and acombined loss on foreign currency translation and loss on asset sale of$41,000.

 

**Liquidity and Capital Resources**

 

In response to the Board of Director’sdecision to curtail operations and evaluate our strategic alternatives, staffwas reduced to two key individuals, a full-time Chief Executive Officer / ChiefFinancial Officer and a part-time Chief Accounting Officer, and supportcontractors on an as-needed basis to sustain the Company’s corporate structureand activities and plan its strategic direction. We have sufficient cash andinvestments to satisfy all outstanding obligations and to initiate actionsbased on the strategic direction when determined by the Board of Directors.

 

In January 2008, we purchased$2,680,000 of investments comprised of auction preferred securities (APS). Allof our APS are AAA rated by one of the major credit rating agencies. Since mid-February 2008, we have experienced failed auctions for ourentire APS portfolio, resulting in our inability to sell thesesecurities. A failed auction results in a lack of liquidity in thesecurities but does not signify a default by the issuer.  Upon an auctionfailure, the interest rates on the APS do not reset at a market rate butinstead reset based on a formula contained in the APS, which generally ishigher than the current market rate. The issuer of the APS redeemed $1,852,000of the securities on May 27, 2008 and is actively putting a plan in placeto redeem the remainder. Our APS were purchased through UBS Financial Services.On August 8, 2008, UBS announced that it reached a settlement with the NewYork Attorney General, the Massachusetts Securities Division, the Securitiesand Exchange Commission and other regulatory agencies to restore liquidity toholders of APS.  We do not currently need these funds to satisfyoutstanding obligations or meet short-term operating requirements.

 

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We classified our APS astrading securities, which has resulted in a $50,000 cumulative adjustment tothe carrying value of our APS to mark them to fair value. If uncertaintiesin the credit and capital markets continue, if the credit worthiness of theissuer deteriorates, if UBS does not comply with the settlement provisions orif we no longer have the ability to hold these investments, we may be requiredto recognize additional impairment charges on our APS holdings or a loss ontheir disposition.

 

Ourfuture capital requirements will depend on many factors, including thestrategic direction the company chooses, the amount of any sales, the type andstructure of any strategic transaction into which we enter, and working capitalneeds. We believe that our cash on hand and our investment securities will besufficient to meet our current obligations as well as projected expendituresfor the next twelve months at current spending levels. However, our long-termfinancing requirements will depend significantly on the strategic direction wechoose to take. We cannot quantify our long-term cash requirements until astrategic alternative is decided. Should cash and investments and revenuesgenerated from a strategic alternative not meet our needs, we may need to raisefunds through the issuance of debt or equity securities. These securities mayhave rights senior to those currently associated with our common stock, andthey could contain covenants that would restrict our operations. If we areunable to obtain additional financing, we may be unable to continue ouroperations.

 

***Net Cash Used in Operating Activities***

 

Net cashused in operating activities was $290,000 and $5,449,000 for the three monthsended March 31, 2009 and 2008, respectively. Net cash used for operatingactivities for the three months ended March 31, 2009 was to payoutstanding liabilities and ongoing expenses of the company of $201,000 and$93,000 in investment banking fees used in evaluating strategic alternatives.Net cash used for the three months ended March 31, 2008 was to fund chipdevelopment, fund the promotion of current products and pay general andadministrative costs.

 

***Net Cash Provided (Used) by Investing Activities***

 

Net cashprovided by investing activities was $2,527,000 and $4,134,000 for the threemonths ended March 31, 2009 and 2008, respectively.  Net cash provided by investing activities forthe three months ended March 31, 2009 was from the proceeds from the saleof investments.  Net cash provided byinvesting activities in the three months ended March 31, 2008 was from thesale of securities of $4,164,000 less $28,000 for the purchase of equipment,and $2,000 for the increase of restricted cash.

 

***Net Cash Provided by Financing Activities***

 

There wereno financing activities for the three months ended March 31, 2009 and2008.

 

**Off-Balance Sheet Arrangements**

 

We do nothave any relationships with unconsolidated entities or financial partnerships,such as entities often referred to as structured finance or special purposeentities, which would have been established for the purpose of facilitatingoff-balance sheet arrangements or other contractually narrow or limitedpurposes. In addition, we do not engage in trading activities involvingnon-exchange traded contracts. As such, we are not materially exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin these relationships.

 

**Item 3. Quantitative and QualitativeDisclosures about Market Risk**

 

Our exposureto market risk is confined to our cash equivalents and investments. We haveinvested in high-quality financial instruments, primarily money market funds,federal agency notes and asset-backed securities, which we believe are subjectto limited credit risks. Included in our investments are APS. The APS auctionshave historically provided a liquid market for these securities, as investorscould readily sell their investments at auction. With the liquidity issuesexperienced in global credit and capital markets, the APS held by us haveexperienced 

 

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failedauctions, beginning on February 19, 2008, as the amount of securitiessubmitted for sale exceeded the amount of purchase orders, making the liquidityof the securities questionable. Despite the failed auctions, our APS continueto be highly rated by the rating agencies. We believe we will have fullredemption of all APS at par. If all APS are not redeemed, it could have anegative effect on the liquidity of our funds available for strategicalternatives.

 

**Item 4. Controls and Procedures**

 

*Evaluation of Disclosure Controls andProcedures*

 

During thefiscal period covered by this report, our management, with the participation ofthe Chief Executive Officer and Chief Financial Officer, completed anevaluation of the effectiveness of the design and operation of our disclosurecontrols and procedures, as defined in Rules 13a-15(e) and 15d-15(e) ofthe Securities Exchange Act of 1934 (“Exchange Act”). Based upon thisevaluation, our Chief Executive Officer and Chief Financial Officer hasconcluded that, as of the end of the fiscal period covered by this report, ourdisclosure controls and procedures were effective to ensure that informationrequired to be disclosed by us in reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified by the rules and forms of the Securities and ExchangeCommission and that such information is accumulated and communicated tomanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosures.

 

*Changes in Internal Control Over Financial Reporting*

 

        Therewere no changes in the Company’s internal control over financial reportingduring the most recently completed quarter that have materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**Part II**

 

**Other Information**

 

**Item 1.   Legal Proceedings**

 

We arecurrently not a party to any legal proceedings.

 

**Item 1A.   Risk Factors**

 

There aremany factors that may affect our future operating results and financialcondition. Some of these risk factors are described in the section entitled “RiskFactors” beginning on page 7 of our Annual Report on Form 10-K forthe year ended December 31, 2008 filed with the SEC on March 31, 2009(“2008 Form 10-K”). Other information included in this Quarterly Report onForm 10-Q also should be carefully considered. The risks and uncertaintiesdescribed in our 2008 Form 10-K are not the only risks we face. Additionalrisks and uncertainties not presently known to us or that our managementcurrently deems immaterial also may impair our business operations andfinancial condition. If any of the risks described were to occur, our business,financial condition, operating results and cash flows could be materiallyadversely affected.

 

**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

 

None.

 

**Item 3.   Defaults UponSenior Securities**

 

None.

 

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**Item 4.   Submission ofMatters to a Vote of Security Holders**

 

None

** **

**Item 5.   Other Information**

 

None

 

**Item 6.   Exhibits**

 

The exhibitsare described on the Exhibit Index to this Quarterly Report on Form 10-Q.

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                     | MathStar, Inc. |
|--------------------------|---------------------|
|                     | (Registrant)        |
|                     |                |
|                     |                |
| Date:  May 15, 2009 | By:                 | /s/  Douglas M. Pihl |
|                     |                | Douglas M.  Pihl |
|                     |                | Chief  Executive Officer and Chief  Financial Officer |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                          |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                          |
| 3.1                  |       | Certificate  of Incorporation of MathStar, Inc. (incorporated by reference to  Exhibit 3.1 to the Registration Statement on Form S-1 filed by  MathStar, Inc. with the Securities and Exchange Commission (“SEC”) on  August 3, 2005 (File No. 333-127164) (the “Registration Statement”)). |
|                 |       |                                                                                                                                                                                                                                                                                                                                          |
| 3.2                  |       | By-laws of  MathStar, Inc. (incorporated by reference to Exhibit 3.2 to the  Registration Statement).                                                                                                                                                                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                                                          |
| 4.1                  |       | Form of  common stock certificate of MathStar, Inc. (incorporated by reference to  Exhibit 4.1 to the Registration Statement).                                                                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                                                                          |
| 31.1                 |       | Certification  of Chief Executive Officer pursuant to  Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934  (filed herewith electronically).                                                                                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                                                                          |
| 31.2                 |       | Certification  of Chief Financial Officer pursuant to Rules 13a-14(a)/15d-14(a) under  the Securities Exchange Act of 1934 (filed herewith electronically).                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                          |
| 32.1                 |       | Section 1350  Certification of Chief Executive Officer and Chief Financial Officer (filed  herewith electronically).                                                                                                                                                                                                                     |

 

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