**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM10-Q**

**(MarkOne)**
| **x**                                              | **Quarterly report pursuant to Section 13 or 15(d)  of the Securities Exchange**  |
|----------------------------------------------------|-----------------------------------------------------------------------------------|
| **Act of 1934**                                    |
| ** **                                         |
| **For the  quarterly period ended June 30, 2007.** |
| ** **                                         |
| **OR**                                             |
| ** **                                         |
| **o**                                              | **Transition report pursuant to Section 13 or  15(d) of the Securities Exchange** |
| **Act of 1934**                                    |
|                                                    |                                                                                   |  |

 

**For the transition period from                to             **

**Commissionfile number 000-51560**

**MathStar,Inc.**

(Exact name ofregistrant as specified 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’stelephone number, including area code)

**N/A**

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

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  x  Yes    o  No

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of “accelerated filer” and “largeaccelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one.)
|  | Large Accelerated Filer  o | Accelerated Filer  x | Non-Accelerated Filer  o |
|--|--------------------------------------|--------------------------------|------------------------------------|

 

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

Shares outstandingof the Registrant’s common stock:
| Class                          | ** ** | **Outstanding at July 31, 2007** |
|--------------------------------|------------|--------------------------------------------|
| Common stock,  $0.01 par value |       | 45,906,890                                 |

 

 

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| PART I  FINANCIAL  INFORMATION | 1         |
|-------------------------------------|-----------|
|                                |      |   |
|                                | Item 1.   | Financial Statements  (Unaudited) | 1 |
|                                |      | Condensed Balance Sheets  as of December 31, 2006 and June 30, 2007 | 1 |
|                                |      | Condensed  Statements of Operations for the Three and Six Months Ended June 30,  2006 and 2007 | 2 |
|                                |      | Condensed  Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2007 | 3 |
|                                |      | Notes to Condensed  Consolidated Financial Statements | 4 |
|                                |      |   |   |
|                                | Item 2    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 8 |
|                                | Item 3    | Quantitative  and Qualitative Disclosures about Market Risk | 12 |
|                                | Item 4    | Controls and  Procedures | 12 |
|                                |      |   |
| PART II   OTHER INFORMATION    | 12        |
|                                | Item 1.   | Legal Proceedings | 12 |
|                                | Item  1A. | Risk  Factors | 12 |
|                                | Item 2.   | Unregistered  Sales of Equity Securities and Use of Proceeds | 13 |
|                                | Item 3.   | Defaults Upon  Senior Securities | 13 |
|                                | Item 4.   | Submission of Matters  to a Vote of Security Holders | 14 |
|                                | Item 5.   | Other Information | 13 |
|                                | Item  6.  | Exhibits | 14 |
|                                |      |   |   |
| Signatures                          |      | 14 |

 

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**Part I**

**Financial Information**

**Item1.  Financial Statements**

**MathStar, Inc.**

**Condensed Balance Sheets**

**(Unaudited)**
| ** **                                                                                                                                                           | ** ** | **December 31,  2006** | ** ** | **June 30,  2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **(In Thousands,)**    | ** ** |
| **Assets**                                                                                                                                                           |       |                        |       |                    |       |
| Current assets                                                                                                                                                       |       |                        |       |                    |       |
| Cash and cash  equivalents                                                                                                                                           |       | $                           | 12,891     |                    | $          | 38,583 |   |
| Restricted cash                                                                                                                                                      |       | 103                         |       | 105                     |       |
| Accounts  receivable                                                                                                                                                 |       | 14                          |       | 131                     |       |
| Inventory                                                                                                                                                            |       | 610                         |       | 736                     |       |
| Prepaid expenses  and other current assets                                                                                                                           |       | 1,231                       |       | 750                     |       |
| Total current  assets                                                                                                                                                |       | 14,849                      |       | 40,305                  |       |
| Property and equipment,  net                                                                                                                                         |       | 487                         |       | 461                     |       |
| Other assets                                                                                                                                                         |       | 278                         |       | 444                     |       |
| Total assets                                                                                                                                                         |       | $                           | 15,614     |                    | $          | 41,210 |   |
|                                                                                                                                                                 |       |                        |       |                    |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                       |       |                        |       |                    |       |
| Current liabilities                                                                                                                                                  |       |                        |       |                    |       |
| Accounts payable                                                                                                                                                     |       | $                           | 1,791      |                    | $          | 993 |   |
| Deferred revenue                                                                                                                                                     |       | —                      |       | 139                     |       |
| Accrued expenses                                                                                                                                                     |       | 1,206                       |       | 999                     |       |
| Total  liabilities                                                                                                                                                   |       | 2,997                       |       | 2,131                   |       |
| Commitments and  contingencies                                                                                                                                       |       |                        |       |                    |       |
| Stockholders’ equity                                                                                                                                            |       |                        |       |                    |       |
| Preferred stock,  $0.01 par value; 10,000 shares authorized; no shares issued and outstanding                                                                        |       | —                      |       | —                  |       |
| Common stock,  $0.01 par value; 90,000 shares authorized; 20,922 and 45,907 shares issued  and outstanding at December 31, 2006 and June 30, 2007, respectively |       | 209                         |       | 459                     |       |
| Additional  paid-in capital                                                                                                                                          |       | 118,545                     |       | 154,759                 |       |
| Accumulated  deficit                                                                                                                                                 |       | (106,137                    | )          | (116,139                | )          |
| Total  stockholders’ equity                                                                                                                                     |       | 12,617                      |       | 39,079                  |       |
| Total liabilities and  stockholders’ equity                                                                                                                     |       | $                           | 15,614     |                    | $          | 41,210 |   |

 

The accompanying notes are an integral part of these financialstatements.

1

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**MathStar, Inc.**

**Condensed Statements of Operations**

**(Unaudited)**

**(inthousands except for per share amounts)**
| ** **                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                        | ** ** | **2007**                                      | ** ** | **2006** | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                |       | $                                               | 10         |                                          | $          | 120 |   | $ | 18 |   | $ | 212 |   |
| Cost of goods  sold                                    |       | 5                                               |       | 54                                            |       | 6 |   | 123 |   |
| Gross margin                                           |       | 5                                               |       | 66                                            |       | 12 |   | 89 |   |
| Operating  expenses:                                   |       |                                            |       |                                          |       |   |   |   |   |
| Research and development                               |       | 3,200                                           |       | 2,607                                         |       | 6,026 |   | 5,732 |   |
| Selling, general and administrative                    |       | 2,348                                           |       | 2,107                                         |       | 4,551 |   | 4,569 |   |
|                                                   |       | 5,548                                           |       | 4,714                                         |       | 10,577 |   | 10,301 |   |
| Operating loss                                         |       | (5,543                                          | )          | (4,648                                        | )          | (10,565 | ) | (10,212 | ) |
| Interest income                                        |       | 160                                             |       | 107                                           |       | 350 |   | 226 |   |
| Other income  /(loss), net                             |       | —                                          |       | (14                                           | )          | — |   | (16 | ) |
| Net loss                                               |       | $                                               | (5,383     | )                                             | $          | (4,555 | ) | $ | (10,215 | ) | $ | (10,002 | ) |
|                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Basic and  diluted net loss per share                  |       | $                                               | (0.31      | )                                             | $          | (0.19 | ) | $ | (0.60 | ) | $ | (0.44 | ) |
| Weighted average basic  and diluted shares outstanding |       | 17,104                                          |       | 24,135                                        |       | 17,037 |   | 22,525 |   |

 

The accompanying notes are an integral part of these financialstatements.

2

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**MathStar, Inc.**

**Condensed Statements of Cash Flows**

**(Unaudited)**

**(inthousands)**
| ** **                                                                  | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                  | ** ** | **June 30,**              | ** ** |
| ** **                                                                  | ** ** | **2006**                       | ** ** | **2007** | ** ** |
| ** **                                                                  | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities**                                   |       |                           |       |   |   |
| Net loss                                                                    |       | $                              | (10,215    | ) | $ | (10,002 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities |       |                           |       |   |   |
| Depreciation and amortization                                               |       | 61                             |       | 82 |   |
| Loss on asset disposal                                                      |       |                           |       | 4 |   |
| Foreign currency                                                            |       |                           |       | 7 |   |
| Stock-based  compensation                                                   |       | 1,477                          |       | (51 | ) |
| Change in  operating assets and liabilities                                 |       |                           |       |   |   |
| Accounts receivable                                                         |       | 65                             |       | (117 | ) |
| Inventory                                                                   |       | (74                            | )          | (126 | ) |
| Prepaid expenses and other assets                                           |       | 292                            |       | 575 |   |
| Accounts payable                                                            |       | 39                             |       | (798 | ) |
| Deferred revenue                                                            |       |                           |       | 139 |   |
| Accrued expenses                                                            |       | (251                           | )          | (207 | ) |
| Net cash used in operating activities                                       |       | (8,606                         | )          | (10,494 | ) |
| ** **                                                                  |       |                           |       |   |   |
| **Cash  flows from investing activities**                                   |       |                           |       |   |   |
| Purchase of  property and equipment                                         |       | (209                           | )          | (58 | ) |
| Purchase of  capitalized application software                               |       |                           |       | (269 | ) |
| Restricted cash                                                             |       |                           |       | (2 | ) |
| Net cash used in investing activities                                       |       | (209                           | )          | (329 | ) |
| ** **                                                                  |       |                           |       |   |   |
| **Cash  flows from financing activities**                                   |       |                           |       |   |   |
| Proceeds from  issuance of common stock, net of offering costs              |       |                           |       | 36,485 |   |
| Proceeds from  exercise of warrants                                         |       | 417                            |       | 21 |   |
| Proceeds from  exercise of stock options                                    |       | 27                             |       | 9 |   |
| Net cash provided by financing activities                                   |       | 444                            |       | 36,515 |   |
| Net (decrease) increase in cash and cash equivalents                        |       | (8,371                         | )          | 25,692 |   |
|                                                                        |       |                           |       |   |   |
| **Cash  and cash equivalents**                                              |       |                           |       |   |   |
| Beginning of  period                                                        |       | 20,149                         |       | 12,891 |   |
| End of period                                                               |       | $                              | 11,778     |   | $ | 38,583 |   |

 

The accompanying notes are an integral part of these financialstatements.

3

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**MathStar, Inc.**

**Notes to Financial Statements**

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

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

The accompanyinginterim condensed financial statements of MathStar, Inc. (“MathStar” or the “Company”)have been prepared in conformity with United States (U.S.) generally acceptedaccounting principles, consistent in all material respects with those appliedto the financial statements in the Company’s Annual Report on Form 10-K filedwith the Securities and Exchange Commission (“SEC”) on March 14, 2007. Theyear-end condensed balance sheet was  derived from audited financialstatements, but does not include all disclosure required by accountingprinciples generally accepted in the United States of America (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 andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

The interimfinancial information is unaudited, but it reflects all normal adjustments thatare, in the opinion of management, necessary to provide a fair statement ofresults for the interim periods presented. The interim financial results arenot necessarily indicative of results to be expected in future interim orannual periods. The interim financial statements should be read in conjunctionwith the financial statements in the Company’s Annual Report on Form 10-K filedwith the Securities and Exchange Commission on March 14, 2007.

In prior filings,MathStar reported as a “development stage company” as prescribed in Statementof Financial Accounting Standards (“SFAS”) No.7, *Accounting and Reporting by Development Stage Enterprises.*Duringthat time, MathStar’s major emphasis was on planning, research and development,recruitment and development of a management and technical staff, and raisingcapital. These development stage activities were completed as of December 31,2006. MathStar has its management team and organizational structure in placewith its primary focus on the sale and commercialization of its currentproduct. MathStar has production products placed within its distributionchannel and has sold production chips and development systems to end customers.As such, MathStar is no longer a development stage company and will not reportas such.

The accompanyingfinancial statements have been prepared on a basis which assumes that theCompany will continue as a going concern and which contemplates the realizationof assets and the satisfaction of liabilities and commitments in the normalcourse of business. The Company has a limited operating history and hasincurred losses and negative cash flows from operations since inception, whichraise concerns about the Company’s ability to continue as a going concern.Although the Company successfully completed a $40,000 follow-on offering duringthe quarter ended June 30, 2007, it expects to incur additional losses whilethe Company continues to develop its sales. Given the lack of operatingprofitability, the Company will continue to disclose a substantial doubt aboutits ability to continue as a going concern.

**2.****             New AccountingPronouncements**

The Company adopted the provisions of the FinancialAccounting Standards Board (“FASB”) Interpretation No. 48, *Accounting for Uncertainty in Income Taxes*,on January 1, 2007.  This adoption did not have a material effect on theCompany’s consolidated financial position or results of operations.  As ofJune 30, 2007, the Company had $38,304 of deferred tax assets; however,valuation allowances have been established to fully offset these deferred taxassets due to the uncertainty about the Company’s ability to generate thefuture taxable income necessary to realize these deferred tax assets,particularly in light of the Company’s recent history of significant operatinglosses.

4

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InFebruary 2007, the FASB issued SFAS No. 159, “*The Fair Value Option for Financial Assets and Liabilities—includingAmendment of FAS No. 115”.*SFAS No. 159 gives companiesthe option of recording certain financial assets and liabilities at fair value.SFAS No. 159 is effective for the Company in the first quarter of 2008.The Company is still evaluating the potential impact of the standard.

InSeptember 2006, the FASB issued SFAS No. 157, “*Fair Value Measurements*” (“SFAS No. 157”).SFAS No. 157 defines fair value, establishes a framework for measuring fairvalue in U.S. GAAP, and expands disclosures about fair value measurements. SFASNo. 157 is effective for financial statements issued for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years. TheCompany will be required to adopt SFAS No. 157 in the first quarter of 2008.Management is currently evaluating the requirements of SFAS No. 157 and has notyet determined the impact on the Company’s consolidated financial statements.

**3.****             Stock-BasedCompensation**

MathStar continuesto issue options as a means to incent potential employees to join and retaincertain existing employees.  The Companyaccounts for options granted under SFAS No. 123R (revised 2004), “*Share-Based Payment*,” utilizing the Black-Sholes pricingmodel.  The table below discloses optionsgranted to new and existing employees and the total options outstanding as ofJune 30, 2007.
| **Options**                           | ** ** | **Shares  (in  thousands)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (as of  6/30/07)** | ** ** | **Aggregate  Intrinsic  Value  (in  thousands)** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|-----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| Outstanding at  March 31, 2007        |       | 2,130                       |       | $                                       | 5.45       |                                                                        | 7.47       |                                             | $          | 32 |   |
| Granted – New  Employees         |       | 87                          |       | 2.33                                    |       | 9.83                                                                        |       |                                             |       |
| Granted –  Replenishment Options |       | 630                         |       | 1.69                                    |       | 9.88                                                                        |       |                                             |       |
| Exercised                             |       | —                      |       | —                                  |       | —                                                                      |       |                                             |       |
| Forfeited or  expired                 |       | (166                        | )          | 5.60                                    |       | 8.51                                                                        |       |                                             |       |
| Outstanding at  June 30, 2007         |       | 2,681                       |       | $                                       | 4.47       |                                                                        | 5.28       |                                             | $          | 12 |   |
|                                  |       |                        |       |                                    |       |                                                                        |       |                                             |       |
| Exercisable at June 30,  2007         |       | 989                         |       | $                                       | 5.56       |                                                                        | 5.80       |                                             | $          | 11 |   |

 
| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Six Months  Ended**  | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| **2007 Stock Based Compensation Expense** | ** ** | **March 31, 2007**     | ** ** | **June 30, 2007** | ** ** | **June 30, 2007** | ** ** |
| Employee stock based  compensation                            |       | $                                | 215        |                        | $          | 113 |   | $ | 328 |   |
| Nonemployee adjustments                                       |       | (208                             | )          | (171                        | )          | (379 | ) |
| Net stock based compensation                                  |       | $                                | 7          |                        | $          | (58 | ) | $ | (51 | ) |

 

For the first sixmonths of 2007, the Company had $328 in non-cash stock based compensationexpense. As required, the Company revalued non-employee awards based on themarket value of the stock at the end of each quarter, which resulted inyear-to-date recapturing of previous year’s expenses of $379.

5

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**4.****             Selected BalanceSheet Information**

**Restricted Cash**

The Company has pledged $105 as collateral to secure the balances onCompany-issued credit cards. The Company cannot use the restricted cash in thenormal course of business until the credit cards are cancelled or the bankreleases the funds. The credit cards are issued to certain Company employeesfor the purpose of Company-related travel and purchases.

**Inventory**
|                                                  | ** ** | **December 31,  2006** | ** ** | **June 30,  2007** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Raw materials                                    |       | $                           | 49         |                    | $          | 57 |   |
| Sub-assembly                                     |       | —                      |       | 36                      |       |
| Finished goods                                   |       | 662                         |       | 760                     |       |
|                                             |       | $                           | 711        |                    | $          | 853 |   |
| Less: reserve  for excess and obsolete inventory |       | (101                        | )          | (117                    | )          |
| Total inventory, net                             |       | $                           | 610        |                    | $          | 736 |   |

 

The increase inthe valuation reserve was charged to cost of sales.

**Prepaidand Other Current Assets**
|                                         | ** ** | **December 31,  2006** | ** ** | **June 30,  2007** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| EDA licenses                            |       | $                           | 695        |                    | $          | 499 |   |
| Prepaid  insurance                      |       | 239                         |       | 82                      |       |
| Prepaid rent                            |       | 111                         |       | 35                      |       |
| Other                                   |       | 186                         |       | 134                     |       |
| Total prepaid and other  current assets |       | $                           | 1,231      |                    | $          | 750 |   |

 

**Propertyand Equipment**
|                                    | ** ** | **December 31,  2006** | ** ** | **June 30,  2007** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Construction in  progress          |       | $                           | —     |                    | $          | 12 |   |
| Computer  equipment                |       | $                           | 1,003      |                    | $          | 144 |   |
| Purchased  software                |       | 533                         |       | 533                     |       |
| Equipment                          |       | 106                         |       | 106                     |       |
| Furniture and  fixtures            |       | 365                         |       | 291                     |       |
|                               |       | $                           | 2,007      |                    | $          | 1,086 |   |
| Less:  Accumulated depreciation    |       | (1,520                      | )          | (625                    | )          |
| Total property and  equipment, net |       | $                           | 487        |                    | $          | 461 |   |

 

6

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Depreciation expense was $34 and $39 for the three months ended June30, 2006 and 2007, respectively, and $60 and $80 for the six months ended June30, 2006 and 2007, respectively.  Thereduction in gross property and equipment and accumulated depreciation is dueto disposal of excess and idle assets from the previous Minneapolislocation.  The disposal resulted in anoncash charge of $4 to operating results.

**OtherAssets**
|                                   | ** ** | **December 31,  2006** | ** ** | **June 30,  2007** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-------------------------|------------|
|                              |       |                        |       |                    |       |
| Capitalized application  software |       | $                           | 134        |                    | $          | 401 |   |
| Other                             |       | 144                         |       | 43                      |       |
|                              |       | $                           | 278        |                    | $          | 444 |   |

 

Amortization expense associated with capitalized software was $0 and $2for the three months ended June 30, 2006 and 2007, respectively, and $0 and $2for the six months ended June 30, 2006 and 2007, respectively.

**AccruedExpenses**
|                            | ** ** | **December 31,  2006** | ** ** | **June 30,  2007** | ** ** |
|----------------------------|------------|-----------------------------|------------|-------------------------|------------|
|                       |       |                        |       |                    |       |
| Accrued rent               |       | $                           | 77         |                    | $          | 46 |   |
| Accrued  compensation      |       | 480                         |       | 483                     |       |
| Accrued  professional fees |       | 226                         |       | 133                     |       |
| Other                      |       | 423                         |       | 337                     |       |
| Total accrued expenses     |       | $                           | 1,206      |                    | $          | 999 |   |

 

**Stockholders’Equity**

During the quarter ended June 30, 2007, the Company completed aregistered follow-on offering of 25,000 shares of its common stock at a priceto the public of $1.60 per share, netting $36,485 in cash after commissions andoffering costs.

7

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**Item2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

*ThisQuarterly Report on Form 10-Q contains forward-looking statements, which arebeing provided under the “safe harbor” protection of the Private Securities LitigationReform Act of 1995. Forward-looking statements are generally written in thefuture 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 include statements regardingthe commercial success of our new products; the growth prospects of thesemiconductor industry and programmable logic market, including the fieldprogrammable object array (“FPOA”) and field programmable gate array (“FPGA”)product sub-segments; and trends in our future sales, including ouropportunities for growth by displacing FPGAs, application-specific integratedcircuits (“ASICs”) and other semiconductor alternatives.*

*Forward-lookingstatements are not guarantees of future performance and involve risks anduncertainties. The forward-looking statements contained in this report arebased on information that is currently available to us and expectations andassumptions that we deem reasonable at the time the statements were made. We donot undertake any obligation to update any forward-looking statements in thisreport or in any of our other communications, except as required by law. Allsuch forward-looking statements should be read as of the time the statementswere made and with the recognition that these forward-looking statements maynot be complete or accurate at a later date.*

*Manyfactors may cause actual results to differ materially from those expressed orimplied by the forward-looking statements contained in this report. Thesefactors include, but are not limited to, those risks described in our AnnualReport on Form 10-K filed on March 14, 2007.*

**BusinessOverview**

We are a fablesssemiconductor company engaged in the development, marketing and selling of ourhigh-performance, programmable platform chips and design tools required toprogram our chips. We have established a sales network and distributionchannel, sold and shipped a limited quantity of our first production fieldprogrammable object array, or FPOA, chip, and provided a second release of ourdesign tools to customers.  Current activities are focused on the sale ofcurrent products and developing enhanced and follow-on products.

Our sales cyclebegins when a prospective customer decides to introduce a new product or changeor upgrade an existing product.  Generally, the prospective customer willsurvey new and existing technology to determine if there are technologicaladvances that it needs need to integrate into its product lines. At this point,if there appears to be a fit, the prospective customer will engage with us todetermine if our FPOA can solve its product needs.  Typically, one of ourFAEs (Field Application Engineers) will work with the prospective customer’sengineers to create an application assessment that documents the advantages ofusing a FPOA in the customer’s product.  At this point, the prospectivecustomer will make a technology decision.  If the decision is to use anFPOA, the customer will buy an FPOA evaluation system and FPOA Design Softwaretools license from us to develop a prototype of its application on ourFPOA.  Once the customer has developed and tested its FPOA design, thecustomer will develop prototypes of its new product.  The customer willthen sell prototypes or limited production versions of its new product to itscustomers.  Assuming the customer achieves market acceptance, it will rampits design in production and start purchasing production quantities of FPOAs.Our sales cycle can be as short as six months and as long as 18 months, exceptin the case of the military/aerospace markets, in which the development cyclecan be three to five years.

Our productionFPOA is currently in inventory and for sale at our warehouse, a worldwideelectronics component distributor and an e-commerce distributor.  Ourrevenue for the first half of 2007 was primarily from sales of productionchips, evaluation systems, tools, nonrecurring engineering fees (NRE) andapplication licenses which are the key components of the beginning of the salescycle.  As more of our customers move their products into production, moreof our revenues will be from the sale of FPOAs.

8

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**FinancialOperations Overview**

***Revenue and Costs***

The Companyrecognizes revenue for products when persuasive evidence of an arrangementexists, delivery has occurred, the sales price is fixed or determinable,collection is reasonably assured and there are no post-delivery obligations.Costs associated with product revenue consist of the manufacturing costs of theevaluation units and chips, subcontracted expenses associated with NRE revenueand software license fees and recorded in cost of sales.  Revenue andcosts associated with sales to distributors are deferred until MathStarreceives notice from the distributor that the product has been sold to an enduser.  The amount reflected on MathStar’s balance sheet is the net marginfrom the deferred revenue and associated costs. Revenue and costs for chipsheld at distributors are deferred because of the distributor’s ability toreturn unsold chips for refund or credit.

***Research and Development***

Research anddevelopment expenses represent costs incurred for designing and engineering ourFPOA chips and developing design tools and applications to enable customers tomore easily program our chip. Research and development expenses consistprimarily of salaries and related costs of our engineering organization; feespaid to third party consultants associated with chip development; an allocationof facilities; and depreciation expenses. We expense all research anddevelopment costs related to the development of our FPOA chips. Development ofcertain design tools and applications include the development of software. Suchresearch and development expenses are required to be expensed until thetechnological feasibility of the software is established. We determinetechnological feasibility based upon completion of a working model of thesoftware. To date, the period between technological feasibility and generalrelease of the software has been short, so virtually all of our softwaredevelopment costs relate to software development during the period beforetechnological feasibility. Accordingly, all such costs have been charged tooperations as incurred. We expect to incur significant additional research anddevelopment costs as we develop more chips using our FPOA technology.

***Selling, General and Administrative Expenses***

Selling, generaland administrative expenses consist primarily of salaries and related costs ofour sales and marketing and administrative staff, commissions paid to directsales staff and manufacturing representatives, general corporate activities andan allocation of facilities and depreciation expenses. We anticipate that ourselling, general and administrative costs will increase as a result ofincreasing our sales and marketing and administrative staff andcommissions to support sales of FPOA chips in worldwide markets and to supportour growth and operation as a public company.

**RecentlyIssued Accounting Pronouncements**

See Note 2 ofNotes to Financial Statements included in Part I, Item 1 of this QuarterlyReport on Form 10-Q.

**CriticalAccounting Policies**

The Company hasupdated the disclosure related to critical accounting policies since its AnnualReport on Form 10-K for the year ended December 31, 2006 to include capitalizedapplication software.

**Capitalizationof application software**

The Company isdeveloping certain applications of known algorithms for use on its FPOAchips.  The accounting for developmentcosts of these applications is covered under SFAS No. 86, “*Research and Development Costs of Computer Software”.*Judgment is required in determining when technological feasibilityis established. Because these are established algorithms, we definetechnological feasability of an application development project to be the pointat which a feasability assessment is complete and a detailed technical designdocument is established. All costs incurred prior to establishing technologicalfeasibility are expensed when incurred. Costs after that date are capitalizedthen amortized on a straight-line basis over the useful life of theapplications.

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**Results of Operations**

***Three Months Ended June 30, 2006 and 2007***

*Revenueand Cost of Goods Sold.*For the three months ended June 30,2007, we generated revenue of $120,000 compared to $10,000 for the same periodlast year. Revenue for the three months ended June 30, 2007 was from the saleof production FPOA chips, development systems, licensed software and non-recurringengineering, or NRE, fees. Revenue for the three months ended June 30, 2006 wasfrom the sale of FPOA development boards and NRE. Costs of goods sold for thethree months ended June 30, 2007 and 2006 were $54,000 and $5,000,respectively. Costs of goods sold in the second quarter of 2007 includeexternal chip and evaluation system manufacturing costs, subcontracted servicesassociated with NRE revenue and the cost of third party softwarelicenses.  Costs of goods sold for the second quarter of 2006 consist ofthe cost of third party software licenses.

*Researchand Development.* For the three months ended June 30, 2007,research and development expenses decreased $593,000 or 19% to $2,607,000 from$3,200,000 for the three months ended June 30, 2006. The decrease was theresult of reductions in contracted services ($102,000), design tools($160,000), engineering material ($309,000), building rent ($112,000) andtravel and other costs ($70,000). These decreases were partially offset by theincrease in employee related expenses ($160,000).  Research and development spending willcontinue to fluctuate based on the timing in the chip design cycle andapplication development projects.

*Selling,General and Administrative. *For the three months endedJune 30, 2007, selling, general and administrative expenses decreased $241,000or 10% to $2,107,000, compared to $2,348,000 for the three months ended June30, 2006. The decrease was the result of lower employee related expenses($347,000, which was the result of a $490,000 increase in recurring expensesless the elimination of restricted stock charges of $651,000, $79,000 in recapturednoncash expenses due to the resignation of the Vice President of Sales and anaccrued bonus adjustment of $107,000). The decrease was partially offset byincreases in travel ($36,000), building rent ($14,000), commissions ($12,000)and other infrastructure costs ($44,000). Future selling, general andadministrative expense increases will be primarily in sales and commissionexpenses as revenues grow.

*OtherIncome (Expense).*For the three months ended June 30, 2007,we had interest income of $107,000 compared to interest income of $160,000 forthe three months ended June 30, 2006. The decrease in interest income is the resultof lower average cash balances available to invest.

***Six Months EndedJune 30, 2006 and 2007***

*Revenue and Cost of GoodsSold. *Forthe six months ended June 30, 2007, we generated revenue of $212,000 comparedto $18,000 for the six months ended June 30, 2006.  Revenue for the sixmonths ended June 30, 2007 was from the sale of production FPOA chips, softwarelicense fees and NRE, and revenue for the six months ended June 30, 2006 wasfrom the sale of FPOA development kits. These product development kitsincluded software that we licensed from a third party for the development ofdesign tools for our FPOA chips. Costs of goods sold for the six months endedJune 30, 2007 and 2006 were $123,000 and $6,000, respectively. Costs of goodssold for the six months ended June 30, 2007 were from manufacturing costsof the chips and evaluation systems, the cost of the third party softwarelicenses and subcontracted NRE services. Costs of goods sold for the six monthsended June 30, 2006 were for third party software licenses.

*Research and Development.*  For the six months ended June 30,2007, we incurred research and development costs of $5,732,000, a decrease of$294,000 or 5% below research and development costs for the six months endedJune 30, 2006 of $6,026,000.  The decrease was the result of lowercontractor and outside service expense ($243,000), design tool licenses($236,000), building rent ($95,000) and recruiting and other expenses($60,000).  These were offset by higheremployee related expenses ($340,000). Research and development expenses willfluctuate depending on the development cycle of future chips and applicationprojects.

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*Selling, General and Administrative.*  For the six months ended June 30,2007, selling, general and administrative costs increased $18,000 or 0.4% to$4,569,000 from $4,551,000 for the six months ended June 30, 2006.  Thisincrease was a result of an increase in travel ($88,000), advertising andpromotions ($44,000), product samples and development systems ($70,000), and recruitingof sales personnel ($120,000) that focused on the commercialization of ourproducts.  Other expense increasesinclude legal and auditing ($86,000), insurance ($13,000), taxes and fees($33,000), consultants and outside services ($38,000), rent ($42,000), andother infrastructure costs, including the one-time expense to downsize theMinneapolis office ($30,000). These were offset by a decrease that wasprimarily due to the reduction of employee related expenses ($546,000, of which$455,000 was an increase in recurring cash expenses less the reduction of$1,001,000 in non-cash compensation charges due to restricted stock awardsexpensed in 2006).  Growth in spendingwill continue to be directed towards sales and product promoting activities.

*Other Income (Expense). *For the six months ended June 30,2007 and June 30, 2006, we had interest income of $226,000 and $350,000,respectively.

**Liquidity and Capital Resources**

In June 2007,MathStar completed a registered follow-on public offering of 25,000,000 sharesof its common stock at a price to the public of $1.60 per share, netting$36,485,000 in cash after commissions and offering costs. We believe that ourcash on hand and cash resulting from the sale of product and services will besufficient to fund operations and meet our capital needs and do not anticipateneeding to raise additional funds. However, our future capital requirementswill depend on many factors, including our sales growth, further marketacceptance of our existing and new FPOA chips, the amount and timing of ourresearch and development expenditures, the timing of our introduction of newchips, the expansion of our sales and marketing efforts and working capitalneeds.

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

Net cash used inoperating activities was $10,494,000 and $8,606,000 for the six months endedJune 30, 2007 and 2006, respectively. Net cash used in operating activities wasto fund further chip development, promotion of current products and general andadministrative costs.

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

Net cash used byinvesting activities for the six months ended June 30, 2007 was $329,000.Investing activities for the three months ended June 30, 2006 was $209,000.Investing activities in both quarters were for the purchase of property andequipment.

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

Net cash providedby financing activities was $36,515,000 and $444,000 for the six months endedJune 30, 2007 and 2006, respectively. For the six month period ended June 30,2007, cash was provided from a registered follow-on public offering($36,485,000) and exercising warrants ($21,000) and stock options ($9,000). Forthe six month period ended June 30, 2006, cash provided by financing activitieswas from exercising warrants ($417,000) and stock options ($27,000).

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**Off-BalanceSheet Arrangements**

We do not have anyrelationships with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance or special purpose entities,which would have been established for the purpose of facilitating off-balancesheet arrangements or other contractually narrow or limited purposes. Inaddition, we do not engage in trading activities involving non-exchange tradedcontracts. As such, we are not materially exposed to any financing, liquidity,market or credit risk that could arise if we had engaged in theserelationships.

**Item3. Quantitative and Qualitative Disclosures about Market Risk**

Our exposure tomarket risk is confined to our cash equivalents. We have invested inhigh-quality financial instruments, primarily money market funds, federalagency notes and asset-backed securities, which we believe are subject tolimited credit risks. The effective duration of the portfolio is less thanthree months, and no individual investment has an effective duration in excessof one year. We currently do not hedge interest rate exposure. Due to theshort-term nature of our investments, we do not believe we have any materialexposure to interest rate risk arising from our investments.

**Item4. Controls and Procedures**

*Evaluation of Disclosure Controlsand Procedures*

During the fiscal period covered by this report, the Company’smanagement, with the participation of the Chief Executive Officer and Chief FinancialOfficer, completed an evaluation of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures, as defined inRules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (“ExchangeAct”). Based upon this evaluation, the Company’s Chief Executive Officer andChief Financial Officer have concluded that, as of the end of the fiscal periodcovered by this report, the Company’s disclosure controls and procedures wereeffective to ensure that information required to be disclosed by the Company inreports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified by the rules andforms of the Securities and Exchange Commission and that such information isaccumulated and communicated to management, including the Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosures.

*Changesin Internal Control over Financial Reporting*

There were nochanges in the Company’s internal control over financial reporting during thefiscal quarter covered by this report that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

**Part II**

**Other Information**

**Item1.   Legal Proceedings**

We are currentlynot a party to any legal proceedings.

**Item1A.   Risk Factors**

The semiconductorindustry is characterized by rapid technological change, intense competitionand cyclical market patterns which contribute to create factors that may affectour future operating results. The risk factors are described in the sectionentitled “Risk Factors” beginning on page 4 of our Annual Report on Form10-K filed with the Securities and Exchange Commission on March 14, 2007. Otherinformation included in this Quarterly Report on Form 10-Q also should becarefully considered. The risks and uncertainties described in our AnnualReport are not the only risks the Company faces. Additional risks

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and uncertainties notpresently known to the Company or that the Company’s management currently deemsimmaterial also may impair its business operations. If any of the risksdescribed were to occur, our business, financial condition, operating resultsand cash flows could be materially adversely affected.

**Item2. Unregistered Sales of Equity Securities and Use of Proceeds**

None.

**Item3.    Defaults Upon Senior Securities**

None.

**Item4.    Submission of Matters to a Vote of Security Holders.**

On May 17, 2007, at our Annual Meeting ofStockholders, the stockholders voted on three proposals.  The vote on eachof those proposals is summarized below.

*ProposalNo. 1*

The followingincumbent directors were re-elected to our Board of Directors by the followingvote:
| Nominee              | ** ** | **For**    | ** ** | **Withheld/Against** | ** ** | **Broker Non-Votes** | ** ** |
|----------------------|------------|------------|------------|----------------------|------------|---------------------------|------------|
|                 |       |       |       |                 |       |                      |       |
| Douglas M. Pihl      |       | 17,073,357 |       | 88,472               |       | —                    |       |
| Benno G. Sand        |       | 17,064,457 |       | 97,372               |       | —                    |       |
| Merrill A.  McPeak   |       | 17,065,357 |       | 96,472               |       | —                    |       |
| Morris Goodwin,  Jr. |       | 17,065,357 |       | 96,472               |       | —                    |       |
| Michael O. Maerz     |       | 17,068,357 |       | 93,472               |       | —                    |       |

 

*ProposalNo. 2*

The stockholdersapproved amending the MathStar, Inc. Amended and Restated 2004 Long-TermIncentive Plan as described in the proxy statement for the Annual Meeting bythe following vote:
| For       | ** ** | **Against** | ** ** | **Withheld** | ** ** | **Broker Non-Votes** | ** ** |
|-----------|------------|-------------|------------|--------------|------------|---------------------------|------------|
|      |       |        |       |         |       |                      |       |
| 7,650,627 |       | 749,686     |       | 283,550      |       | 8,477,966                 |       |

 

*ProposalNo. 3*

The stockholdersratified the selection of PricewaterhouseCoopers LLP as our independentregistered public accounting firm by the following vote:
| For        | ** ** | **Against** | ** ** | **Withheld** | ** ** | **Broker Non-Votes** | ** ** |
|------------|------------|-------------|------------|--------------|------------|---------------------------|------------|
|       |       |        |       |         |       |                      |       |
| 17,105,595 |       | 38,694      |       | 17,540       |       | —                    |       |

 

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**Item5.    Other Information**

None.

**Item6.    Exhibits**

The exhibits aredescribed on the Exhibit Index to this Quarterly Report on Form 10-Q.

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                       | MathStar, Inc. |
|-----------------------|----------------|
|                  | (Registrant)   |
|                  |           |
|                  |           |
| Date: August 9,  2007 | By:            | /s/ James W. Cruckshank |   |
|                  |           | James W. Cruckshank |
|                  |           | Vice President of Administration and Chief Financial  Officer |
|                  |           | (Principal Financial Officer and Principal  Accounting Officer) |

 

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**EXHIBITINDEX**
| Exhibit No. | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                     | ** ** | **Page**   |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **       | ** ** | ** **                                                                                                                                                                                                                                                                                                                               | ** ** | ** ** |
| 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).                                                                                                                                                                                                 |       |       |
|             |       |                                                                                                                                                                                                                                                                                                                                     |       |       |
| 10.1             |       | MathStar, Inc. Amended and Restated 2004 Long-Term Incentive  Plan (incorporated by reference to Exhibit 10.1 to the Current Report on Form  8-K filed by MathStar, Inc. with the SEC on May 17, 2007).                                                                                                                                  |       |       |
|             |       |                                                                                                                                                                                                                                                                                                                                     |       |       |
| 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 (filed herewith electronically).                                                                                                                                                                                                                                                  |       |       |
|             |       |                                                                                                                                                                                                                                                                                                                                     |       |       |
| 32.2             |       | Section 1350 Certification of Chief Financial  Officer (filed herewith electronically).                                                                                                                                                                                                                                                  |       |       |

 

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