** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-Q**

 

**(Mark One)**

 
| **ý**                                         | ** ** | **Quarterly report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**  |
|----------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
| ** **                                         |
| **For the quarterly period ended March 31, 2006.** |
| ** **                                         |
| **OR**                                             |
| ** **                                         |
| **o**                                              | ** ** | **Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |

 

**For the transition period from               to              **

 

**Commission file number 000-51560**

 

**MathStar,Inc.**

(Exactname of registrant 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**

(Formername, 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.  ý  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 “large accelerated filer” in Rule 12b-2 of the ExchangeAct.  (Check one.)

 

| Large Accelerated  Filer | o |   | Accelerated Filer | o |   | Non-Accelerated  Filer | ý |
|--------------------------|---|--------|-------------------|---|--------|------------------------|--------|

 

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

 

Sharesoutstanding of the Registrant’s common stock:

 

| **Class**                      | ** ** | **Outstanding at April 28, 2006** |
|--------------------------------|------------|-------------------------------------------------------|
| Common  stock, $0.01 par value |       | 17,527,649                                            |

 

 

----

 
| ** **                         | ** ** | ** **                                                                                                                                                                         | **Page** |
|------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| PART I  FINANCIAL INFORMATION |       |
|                               |       |
|                               | Item 1.    | Financial Statements (Unaudited)                                                                                                                                                   | 1        |
|                               |       | Condensed Balance Sheets as of December  31, 2005 and March 31, 2006                                                                                                               | 1        |
|                               |       | Condensed Statements of  Operations for the Three Months Ended March 31, 2005 and 2006 and  Cumulative for the period from Inception (April 14, 1997) through March 31,  2006 | 2        |
|                               |       | Condensed Statements of Cash  Flows for the Three Months Ended March 31, 2005 and 2006 and Cumulative for  the period from Inception (April 14, 1997) through March 31, 2006       | 3        |
|                               |       | Notes to Condensed Consolidated  Financial Statements                                                                                                                              | 4        |
|                               |       |                                                                                                                                                                               |     |
|                               | Item 2     | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                                                        | 9        |
|                               | Item 3     | Quantitative and Qualitative  Disclosures about Market Risk                                                                                                                        | 12       |
|                               | Item 4     | Controls and Procedures                                                                                                                                                            | 12       |
|                               |       |                                                                                                                                                                               |     |
| PART II  OTHER INFORMATION    |       |
|                               | Item 1.    | Legal Proceedings                                                                                                                                                                  | 13       |
|                               | Item 1A.   | Risk Factors                                                                                                                                                                       | 13       |
|                               | Item 2.    | Unregisterd Sales of Equity  Securities and Use of Proceeds                                                                                                                        | 14       |
|                               | Item 3.    | Defaults Upon Senior  Securities                                                                                                                                                   | 14       |
|                               | Item 4.    | Submission of Matters to a  Vote of Security Holders                                                                                                                               | 14       |
|                               | Item 5.    | Other Information                                                                                                                                                                  | 14       |
|                               | Item 6.    | Exhibits                                                                                                                                                                           | 14       |
|                               |       |                                                                                                                                                                               |     |
| Signatures                         | 15         |
|                                    |            |                                                                                                                                                                                    |          |  |  |  |

 

----

 

**Part I**

**Financial Information**

 

**Item 1.  FinancialStatements**

 

**MathStar, Inc.**

**(A development stage company)**

**Condensed Balance Sheets**

**(Unaudited)**

 
| ** **                                                                                                                                                            | ** ** | **December 31,  2005**                                   | ** ** | **March 31,  2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                            | ** ** | **(in thousands,  except per share  amounts)** | ** ** |
| **Assets**                                                                                                                                                            |       |                                                          |       |                     |       |
| Current assets                                                                                                                                                        |       |                                                          |       |                     |       |
| Cash and cash equivalents                                                                                                                                             |       | $                                                             | 20,149     |                     | $          | 15,664 |   |
| Accounts receivable                                                                                                                                                   |       | 75                                                            |       | —                   |       |
| Prepaid expenses and other current assets                                                                                                                             |       | 1,480                                                         |       | 1,446                    |       |
| Total current assets                                                                                                                                                  |       | 21,704                                                        |       | 17,110                   |       |
| Property and equipment, net                                                                                                                                           |       | 347                                                           |       | 411                      |       |
| Other assets                                                                                                                                                          |       | 151                                                           |       | 94                       |       |
| Total assets                                                                                                                                                          |       | $                                                             | 22,202     |                     | $          | 17,615 |   |
|                                                                                                                                                                  |       |                                                          |       |                     |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                         |       |                                                          |       |                     |       |
| Current liabilities                                                                                                                                                   |       |                                                          |       |                     |       |
| Accounts payable                                                                                                                                                      |       | $                                                             | 734        |                     | $          | 463 |   |
| Accrued expenses                                                                                                                                                      |       | 1,294                                                         |       | 1,074                    |       |
| Total liabilities                                                                                                                                                     |       | 2,028                                                         |       | 1,537                    |       |
| 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; 17,415 and 17,545 shares issued and outstanding at  December 31, 2005 and March 31, 2006, respectively |       | 175                                                           |       | 176                      |       |
| Additional paid-in capital                                                                                                                                            |       | 105,717                                                       |       | 104,228                  |       |
| Unearned compensation                                                                                                                                                 |       | (2,224                                                        | )          | —                   |       |
| Deficit accumulated during the development  stage                                                                                                                     |       | (83,494                                                       | )          | (88,326                  | )          |
| Total stockholders’ equity (deficit)                                                                                                                             |       | 20,174                                                        |       | 16,078                   |       |
| Total liabilities and stockholders’ equity                                                                                                                       |       | $                                                             | 22,202     |                     | $          | 17,615 |   |
|                                                                                                                                                                       |            |                                                               |            |                          |            |  |  |  |

 

The accompanying notes are an integral part ofthese financial statements.

 

1

----

 

**MathStar, Inc.**

**(A development stage company)**

**Condensed Statements of Operations**

**(Unaudited)**

** **
| ** **                                             | ** ** | **Three Months Ended  March 31,**                      | ** ** | **Cumulative  for the Period  from Inception  (April 14, 1997)  Through  March 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                                              | ** ** | **2006**                                                                                                           | ** ** | **2006** | ** ** |
| ** **                                             | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Revenue                                                |       | $                                                                     | 15         |                                                                                                               | $          | 8 |   | $ | 888 |   |
| Cost of goods sold                                     |       | 7                                                                     |       | 2                                                                                                                  |       | 107 |   |
| Gross margin                                           |       | 8                                                                     |       | 6                                                                                                                  |       | 781 |   |
| Operating expenses:                                    |       |                                                                  |       |                                                                                                               |       |   |   |
| Research and development                               |       | 2,448                                                                 |       | 2,826                                                                                                              |       | 32,820 |   |
| Selling, general and administrative                    |       | 1,147                                                                 |       | 2,202                                                                                                              |       | 21,449 |   |
|                                                   |       | 3,595                                                                 |       | 5,028                                                                                                              |       | 54,269 |   |
| Operating loss                                         |       | (3,587                                                                | )          | (5,022                                                                                                             | )          | (53,488 | ) |
| Interest income                                        |       | 7                                                                     |       | 190                                                                                                                |       | 1,610 |   |
| Interest expense                                       |       | —                                                                |       | —                                                                                                             |       | (4,591 | ) |
| Other income, net                                      |       | —                                                                |       | —                                                                                                             |       | 17 |   |
| Net loss from continuing operations                    |       | (3,580                                                                | )          | (4,832                                                                                                             | )          | (56,452 | ) |
| Loss from discontinued operations                      |       | —                                                                |       | —                                                                                                             |       | (31,874 | ) |
| Net loss                                               |       | $                                                                     | (3,580     | )                                                                                                                  | $          | (4,832 | ) | $ | (88,326 | ) |
|                                                   |       |                                                                  |       |                                                                                                               |       |   |   |
| Basic and diluted net loss per share                   |       | $                                                                     | (0.32      | )                                                                                                                  | $          | (0.28 | ) | — |   |
| Weighted average basic and diluted shares  outstanding |       | 11,155                                                                |       | 16,972                                                                                                             |       | — |   |

 

The accompanying notes are an integral part ofthese financial statements.

 

2

----

 

**MathStar, Inc.**

**(A development stage company)**

**Condensed Statements of CashFlows**

**(Unaudited)**

 
| ** **                                                                                                                        | ** ** | **Three Months Ended  March 31,** | ** **   | **Cumulative  for the Period  from Inception  (April 14, 1997)  Through  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|--------------|--------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                        | ** ** | **2005**                                         | ** **   | **2006**                                                                                                           | ** ** | **2006** | ** ** |
| ** **                                                                                                                        | ** ** | **(in thousands)**                          | ** **   |
| **Cash flows from operating activities**                                                                      | ** ** | ** **                                       | ** **   | ** **                                                                                                         | ** ** | ** ** | ** ** |
| Net loss                                                                                                                     | ** ** | $                                                |  (3,580 | )                                                                                                                  | $          |  (4,832 | ) | $ |  (88,326 | ) |
| Adjustments to reconcile net loss to net cash used in operating activities | ** ** | ** **                                       | ** **   | ** **                                                                                                         | ** ** | ** ** | ** ** |
| Depreciation                                                                                                                      |       | 20                                               |         | 27                                                                                                                 |       | 1,560 |   |
| Amortization of convertible notes discount  - beneficial conversion feature and value of warrants issued with notes               |       | —                                           |         | —                                                                                                             |       | 3,628 |   |
| Amortization of discount on  held-to-maturity securities                                                                          |       | —                                           |         | —                                                                                                             |       | (233 | ) |
| Acquired in-process research and  development                                                                                     |       | —                                           |         | —                                                                                                             |       | 4,300 |   |
| Interest expense settled with common stock                                                                                        |       | —                                           |         | —                                                                                                             |       | 230 |   |
| Stock-based compensation                                                                                                          |       | —                                           |         | 728                                                                                                                |       | 2,968 |   |
| Goodwill impairment                                                                                                               |       | —                                           |         | —                                                                                                             |       | 13,306 |   |
| Change in operating assets and liabilities,  net of effects of acquisition                                                   |       |                                             |         |                                                                                                               |       |   |   |
| Accounts receivable                                                                                                               |       | (15                                              | )            | 75                                                                                                                 |       | 145 |   |
| Prepaid expenses and other assets                                                                                                 |       | (43                                              | )            | 90                                                                                                                 |       | (901 | ) |
| Accounts payable                                                                                                                  |       | 118                                              |         | (271                                                                                                               | )          | 10 |   |
| Accrued expenses                                                                                                                  |       | 109                                              |         | (219                                                                                                               | )          | 847 |   |
| Net cash used in operating activities                                                                                             |       | (3,391                                           | )            | (4,402                                                                                                             | )          | (62,466 | ) |
| **Cash flows from investing activities**                                                                                          |       |                                             |         |                                                                                                               |       |   |   |
| Cash used in acquisition, net of cash  acquired                                                                                   |       | —                                           |         | —                                                                                                             |       | (791 | ) |
| Purchase of property and equipment                                                                                                |       | —                                           |         | (91                                                                                                                | )          | (1,811 | ) |
| Proceeds from sale of discontinued  operations                                                                                    |       | —                                           |         | —                                                                                                             |       | 1,752 |   |
| Purchases of held-to-maturity securities                                                                                          |       | —                                           |         | —                                                                                                             |       | (10,000 | ) |
| Sales of held-to-maturity securities                                                                                              |       | —                                           |         | —                                                                                                             |       | 10,233 |   |
| Net cash used in investing activities                                                                                             |       | —                                           |         | (91                                                                                                                | )          | (617 | ) |
| **Cash flows from financing activities**                                                                                          |       |                                             |         |                                                                                                               |       |   |   |
| Proceeds from issuance of common stock, net  of offering costs                                                                    |       | —                                           |         | —                                                                                                             |       | 66,047 |   |
| Proceeds from issuance of convertible notes                                                                                       |       | —                                           |         | —                                                                                                             |       | 5,500 |   |
| Payments on convertible notes                                                                                                     |       | —                                           |         | —                                                                                                             |       | (300 | ) |
| Proceeds from issuance of warrants to  purchase common stock, net of offering costs                                               |       | —                                           |         | —                                                                                                             |       | 5,304 |   |
| Proceeds from exercise of warrants                                                                                                |       | 108                                              |         | 8                                                                                                                  |       | 2,916 |   |
| Collection of subscription receivable                                                                                             |       | —                                           |         | —                                                                                                             |       | 27 |   |
| Proceeds from exercise of stock options                                                                                           |       | —                                           |         | —                                                                                                             |       | 1 |   |
| Principal payments on notes receivable from  stockholders                                                                         |       | —                                           |         | —                                                                                                             |       | 245 |   |
| Principal payments on notes payable to  stockholders                                                                              |       | —                                           |         | —                                                                                                             |       | (250 | ) |
| Repurchase of common stock                                                                                                        |       | —                                           |         | —                                                                                                             |       | (257 | ) |
| Payments on capital lease obligations                                                                                             |       | —                                           |         | —                                                                                                             |       | (486 | ) |
| Net cash provided by financing activities                                                                                         |       | 108                                              |         | 8                                                                                                                  |       | 78,747 |   |
| Net (decrease) increase in cash and cash  equivalents                                                                             |       | (3,283                                           | )            | (4,485                                                                                                             | )          | 15,664 |   |
| **Cash and cash equivalents**                                                                                                     |       |                                             |         |                                                                                                               |       |   |   |
| Beginning of period                                                                                                               |       | 4,132                                            |         | 20,149                                                                                                             |       | — |   |
| End of period                                                                                                                     |       | $                                                | 849          |                                                                                                               | $          | 15,664 |   | 15,664 |   |
|                                                                                                                              |       |                                             |         |                                                                                                               |       |   |   |
| **Cash paid during period for interest**                                                                                          |       | —                                           |         | —                                                                                                             |       | $ | 26 |   |
| **Significant noncash transactions**                                                                                              |       |                                             |         |                                                                                                               |       |   |   |
| Common stock, options and warrants issued  in connection with Digital Mediacom, Inc. acquisition                                  |       | —                                           |         | —                                                                                                             |       | 18,384 |   |
| Exercise of warrants for subscriptions  receivable                                                                                |       | —                                           |         | —                                                                                                             |       | 27 |   |
| Capital lease obligation incurred for  acquisition of fixed assets                                                                |       | —                                           |         | —                                                                                                             |       | 426 |   |
| Repurchase of common stock with notes  payable                                                                                    |       | —                                           |         | —                                                                                                             |       | 250 |   |
| Prepaid licenses included in accrued  expenses                                                                                    |       | —                                           |         | (232                                                                                                               | )          | 369 |   |
| Conversion of notes payable and $230 of  accrued interest into common stock                                                       |       | —                                           |         | —                                                                                                             |       | 5,430 |   |

 

The accompanying notes are an integral part ofthese financial statements.

 

3

----

 

**MathStar, Inc.**

**(A development stage company)**

**Notes to Financial Statements**

**(in thousands, per share amounts)**

 

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

 

Theaccompanying interim condensed financial statements of MathStar, Inc. (“MathStar”or the “Company”) have been prepared in conformity with United States (U.S.)generally accepted accounting principles, consistent in all material respectswith those applied in the Company’s Annual Report on Form 10-K filed with theSecurities and Exchange Commission (“SEC”) on March 31, 2006. The preparationof financial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates.

 

Theinterim financial information is unaudited, but it reflects all normaladjustments that are, in the opinion of management, necessary to provide a fairstatement of results for the interim periods presented. The interim financialresults are not necessarily indicative of results to be expected in futureinterim or annual periods. The interim financial statements should be read inconjunction with the financial statements in the Company’s Annual Report onForm 10-K filed with the Securities and Exchange Commission on March 31, 2006.

 

TheCompany was incorporated as a Minnesota corporation in April 1997 andreincorporated under Delaware law in June 2005. Since its inception, theCompany has devoted substantially all of its efforts to business planning,research and development, recruitment of management and technical staff,acquiring operating assets and raising capital. The Company has generated onlynominal revenues from the sale of development kits that support customerdevelopment of applications for one of the Company’s products, the sale ofproduct prototypes and contractual research and development services. Accordingly,the Company is considered to be in the development stage as defined by Statementof Financial Accounting Standards (“SFAS”) No. 7, *Accounting and Reporting by Development StageEnterprises*.

 

Theaccompanying financial statements have been prepared on a basis which assumesthat the Company will continue as a going concern and which contemplates therealization of assets and the satisfaction of liabilities and commitments inthe normal course of business. The Company has a limited operating history andhas incurred losses and negative cash flows from operations since inception. TheCompany expects to incur additional losses at least through 2006.

 

InNovember 2005, the Company closed on its initial public offering of 4,000shares of its common stock at $6.00 per share and, in December 2005, theCompany closed on the underwriter’s overallotment option of 600 shares of theCompany’s common stock at $6.00 per share, resulting in net proceeds to theCompany of approximately $24,633.

 

Certainprior year amounts have been reclassified to conform to the current yearpresentation. These changes had no impact on previously reported results ofoperations or shareholders’ equity.

 

**2.****            ****New Accounting Pronouncements**

 

InDecember 2004, the FASB issued SFAS No. 123R, *Share-Based Payment*. SFAS No. 123Rrevised SFAS No. 123 and supersedes Accounting Principles Board OpinionNo. 25, *Accounting for Stock Issued toEmployees* (“APB Opinion No. 25”). The revised statementaddresses the accounting for share-based payment transactions with employeesand other third parties, eliminates the ability to account for share-basedpayments using APB Opinion No. 25 and requires that the compensation costsrelating to such transactions be recognized in the statement of operationsbased upon the grant-date fair value of those instruments. The Company adoptedSFAS No. 123R on January 1, 2006.

 

4

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**3.****            ****Stock-Based Compensation**

 

InJanuary 2002, the Company and its stockholders adopted the 2002 CombinedIncentive and Nonstatutory Stock Option Plan (the “2002 Plan”). InApril 2000, the Company and its stockholders adopted the 2000 CombinedIncentive and Nonstatutory Stock Option Plan (the “2000 Plan”). Under the 2002Plan and the 2000 Plan, 1,000 and 333 shares of the Company’s common stock werereserved for issuance of incentive and nonqualified stock options to directors,officers and employees of and advisers to the Company at exercise prices asdetermined by the Board of Directors on the date of grant, respectively. Theseoptions have exercise prices and vesting terms established by a committee ofthe Board of Directors at the time of each grant. Vesting terms of outstandingoptions are generally four years. In no event are the options exercisable morethan ten years after the date of grant.

 

InOctober 2004, the Company adopted and in June 2005 its stockholdersapproved the 2004 Amended and Restated Long-Term Incentive Plan (the “2004 Plan”).Under the 2004 Plan, 1,334 shares of the Company’s common stock were reservedfor the issuance of restricted stock and incentive and nonqualified stockoptions to directors, officers and employees of and advisors to the Company atexercise prices as determined by the Board of Directors on the date of grants,respectively.

** **

**Stock Options – SFAS 123 R**

 

TheCompany adopted SFAS No. 123R on January 1, 2006. The Company hadhistorically followed the “minimum value” method permitted by SFASNo. 123. The Company elected to use the modified prospective method whichrequires the Company to record compensation expense only for options issuedafter adoption of SFAS No. 123R. As a result of choosing the modifiedprospective method of adoption, there are no cumulative effects on the Company’spreviously reported income from continuing operations, income before incometaxes, net income, cash flow from operations, cash flow from financingactivities or basic and diluted earnings per share. The impact of adopting FAS123R on the results of operations for the three months ended March 31, 2006 wasto record additional expenses of $30, of which $7 was charged to research anddevelopment and $23 was charged to selling, general and administrative expense.This had the effect of increasing net loss per share by $0. Including thecharge for restricted stock and cheap stock, the total stock compensationexpense for the three months ending March 31, 2006 was $728.

 

TheCompany has chosen to use the Black-Scholes option pricing model to determinethe fair value of options. The Black-Scholes model variables are stock pricevolatility, average option life, risk free interest rate and dividend rate. TheCompany has developed an index based on six comparable companies within thesemiconductor industry to use as a volatility index due to the short period oftime it has been public. Average option life has been calculated using the “safeharbor” method prescribed in SEC Staff Accounting Bulletin 107. The Companyanticipates using this average life through 2007 or until if has enough historyto calculate a meaningful life. The Company uses the treasury bill ratecorresponding with the average life. The dividend rate used is zero, as theCompany does not in the near future have any plans to pay dividends. SFASNo. 123R requires the Company to estimate forfeitures in calculating theexpense relating to stock-based compensation as opposed to recognizing theseforfeitures and the corresponding reduction in expense as they occur.

 

Thefollowing table summarizes the weighted average assumptions used by the Companyin the Black-Scholes option pricing model:

 
| ** **                 | ** ** | **Three Months Ended  March 31, 2006** | ** ** |
|----------------------------|------------|------------------------------------------------------------|------------|
|                       |       |                                                       |       |
| Expected option term       |       | 6.25 years                                                 |       |
|                       |       |                                                       |       |
| Expected volatility factor |       | 73.3                                                       | %          |
|                       |       |                                                       |       |
| Expected dividend yield    |       | 0                                                          | %          |
|                       |       |                                                       |       |
| Risk free interest rate    |       | 4.61                                                       | %          |

 

5

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The following table is a summary of optionactivity under the Company’s stock option plans as of March 31, 2006, andchanges during the three months then ended:

 
| **Options**                      | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------|------------|------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at December 31, 2005 |       | 2,037      |       | $                                       | 5.49       |                                                 | 8.03       |                            | $          | 11,176 |   |
| Granted                          |       | 268        |       | 5.33                                    |       | 9.85                                                 |       | 1,430                           |       |
| Exercised                        |       | —     |       |                                    |       |                                                 |       | —                          |       |
| Forfeited or expired             |       | (150       | )          | 7.84                                    |       | 7.73                                                 |       | (1,175                          | )          |
| Outstanding at March 31, 2006    |       | 2,155      |       | $                                       | 5.30       |                                                 | 8.05       |                            | $          | 11,431 |   |
| Exercisable at March 31, 2006    |       | 722        |       | $                                       | 4.96       |                                                 | 5.62       |                            | $          | 3,581 |   |

 

Theweighted-average grant-date fair value of options granted during the threemonths ended March 31, 2006 was $3.67.

 

Thefollowing table is the status of the Company’s unvested shares as of March 31,2006, and changes during the three months then ended:

 

| **Unvested Shares**      | ** ** | **Shares** | ** ** | **Weighted Average  Grant Dated Fair  Value** | ** ** |
|-------------------------------|------------|------------|------------|--------------------------------------------------------------|------------|
| Unvested at December 31, 2005 |       | 1,321      |       | $                                                            | 1.69       |   |
| Granted                       |       | 268        |       | 3.67                                                         |       |
| Vested                        |       | (96        | )          | 0.85                                                         |       |
| Forfeited                     |       | (61        | )          | 0.36                                                         |       |
| Unvested at March 31, 2006    |       | 1,432      |       | $                                                            | 2.24       |   |

 

Asof March 31, 2006, there was $2,476 of total unrecognized compensation costrelated to unvested share-based compensation arrangements granted, includingrestricted stock, under the Company’s stock option plans. That cost is expectedto be recognized over a weighted-average period of 1.73 years. The total fairvalue of shares vested during the three months ended March 31, 2006 was $82.

 

**Stock Options – SFAS 123**

 

Thefollowing table presents the pro forma effect on net loss, for prior periods,if the Company had applied the fair value recognition provisions for SFASNo. 123 (minimum value method) to stock-based employee compensation foroptions issued prior to January 1, 2006:

 

6

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| ** **                                                                                                                 | ** ** | **Three Months Ended  March 31, 2005** | ** ** | **Cumulative  for the Period  from Inception  (April 14, 1997)  Through  March 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|
| Net loss as reported                                                                                                       |       | $                                                          | (3,580     | )                                                                                                                            | $          | (88,326 | ) |
| Add: Total stock-based employee  compensation expense included in net loss, as reported                                    |       | —                                                     |       | 1,571                                                                                                                        |       |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all  employee awards |       | (53                                                        | )          | (2,793                                                                                                                       | )          |
|                                                                                                                       |       |                                                       |       |                                                                                                                         |       |
| Pro forma net loss                                                                                                         |       | $                                                          | (3,633     | )                                                                                                                            | $          | (89,548 | ) |
| Basic and diluted loss per share:                                                                                          |       | 11,157                                                     |       |                                                                                                                         |       |
| As reported                                                                                                                |       | $                                                          | (0.32      | )                                                                                                                            |       |   |
| Pro forma                                                                                                                  |       | $                                                          | (0.33      | )                                                                                                                            |       |   |

 

Forthe purpose of determining fair values using the minimum value method foremployee grants as prescribed by SFAS No. 123, the Company used theBlack-Scholes option pricing model with the following weighted averageassumptions:

 

| ** **                 | ** ** | **Three Months  Ended  March 31, 2005** | ** ** |
|----------------------------|------------|--------------------------------------------------------|------------|
|                       |       |                                                   |       |
| Expected option term       |       | 5 Years                                                |       |
| Expected volatility factor |       | 0                                                      | %          |
| Expected dividend yield    |       | 0                                                      | %          |
| Risk free interest rate    |       | 4.46                                                   | %          |

 

# **RestrictedStock**

 

Asof December 31, 2005 the Company had outstanding 445 shares of restricted stockto certain employees of the Company under its Amended and Restated 2004Long-Term Incentive Plan. The restricted stock terms provided for vesting uponeither a change of control (as defined by the restricted stock agreement) ofthe Company or an initial public offering of the Company’s common stock. However,the restricted stock terms also provide that the Company has the power to delaythe vesting of the restricted stock up to one year after a change in control oran initial public offering of the Company’s common stock. Under theseprovisions, during the three months ended June 30, 2005, the Company’s Board ofDirectors elected to delay vesting of all shares of restricted stock until oneyear after the effectiveness of the Company’s registration statement (whichoccurred on October 26, 2005). In accordance with APB 25, the Company isrecording compensation expense of up to $2,741 related to these restrictedshares over a one-year vesting period of these shares, beginning on theNovember 1, 2005 closing date of the Company’s initial public offering.

 

Duringthe three months ended March 31, 2006, the Company granted 60 shares ofrestricted stock that vests 50% in one year from the date of grant and 50% twoyears from the date of grant. In accordance with SFAS 123R, the Company isrecording compensation expense of up to $342 related to these restricted

 

7

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shares over thevesting period of these shares. During the three months ended March 31, 2006,30 restricted shares were forfeited.

 

Forthe three months ended March 31, 2005 and 2006 the Company recognized $0 and$632 of compensation expense related to restricted stock and $1,079 cumulativefor the period from inception (April 14, 1997) to March 31, 2006. The Companywill recognize approximately $1,753 of compensation expense related tooutstanding restricted shares at March 31, 2006 over the remaining vestingperiods of approximately eight months.

 

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

 

Thefollowing presents prepaid expenses and other current assets:

 
| ** **           | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** |
|----------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **           | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Prepaid license fees |       | $                           | 775        |                     | $          | 582 |   |
| Prepaid insurance    |       | 165                         |       | 107                      |       |
| Prepaid rent         |       | 89                          |       | 101                      |       |
| Other                |       | 451                         |       | 656                      |       |
|                 |       | $                           | 1,480      |                     | $          | 1,446 |   |

 

Thefollowing presents property and equipment, net:

 
| ** **                        | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **                        | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Computer equipment                |       | $                           | 1,003      |                     | $          | 1,003 |   |
| Purchased software                |       | 425                         |       | 452                      |       |
| Furniture and fixtures            |       | 370                         |       | 434                      |       |
|                              |       | $                           | 1,798      |                     | $          | 1,889 |   |
| Less: Accumulated depreciation    |       | (1,451                      | )          | (1,478                   | )          |
| Total property and equipment, net |       | $                           | 347        |                     | $          | 411 |   |

 

Depreciationexpense was $20 and $27 for the three months ended March 31, 2005 and 2006 and$1,560 cumulative for the period from inception (April 14, 1997) to March 31,2006.

 

Thefollowing presents accrued expenses:

 
| ** **                | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** |
|---------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **                | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Accrued rent              |       | $                           | 117        |                     | $          | 107 |   |
| Accrued compensation      |       | 417                         |       | 418                      |       |
| Accrued professional fees |       | 320                         |       | 119                      |       |
| Other                     |       | 440                         |       | 430                      |       |
| Total accrued expenses    |       | $                           | 1,294      |                     | $          | 1,074 |   |

 

8

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**Item 2.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following Management’s Discussion and Analysis ofFinancial Condition and Results of Operations, as well as information containedin the Risk Factors section described below and elsewhere in this report,contains forward-looking statements, which are provided under the “safe harbor”protection of the Private Securities Litigation Reform Act of 1995. Forward-lookingstatements are generally written in the future tense and/or are preceded bywords such as “will,” “may,” “should,” “could,” “expect,” “suggest,” “believe,”“anticipate,” “intend,” “plan,” or other similar words. Forward-lookingstatements include statements regarding the commercial success of our newproducts; the growth prospects of the semiconductor industry and programmablelogic market, including the field programmable object array (“FPOA”) and fieldprogrammable gate array (“FPGA”) product sub-segments; and trends in ourfuture sales, including our opportunities for growth by displacing FPGAs,application-specific integrated circuits (“ASICs”) and other semiconductoralternatives.*

 

*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 may cause actual results to differ materiallyfrom those expressed or implied by the forward-looking statements contained inthis report. These factors include, but are not limited to, those risksdescribed in our Annual Report on Form 10-K filed on March 31, 2006.*

 

**BusinessOverview**

 

Weare a development stage fabless semiconductor company engaged in thedevelopment, marketing and selling of our high-performance, programmableplatform chips and design tools required to program our chips. We havedemonstrated working versions of our first chip and provided an early releaseof our design tools to a limited number of customers. To date, we haverecognized only nominal revenue from research services provided under grantsfrom governmental agencies, engineering services and sales of prototype chipsand our field programmable object array, or FPOA, development kits.

 

Wewere incorporated in April 1997. In August 2001, we acquired DigitalMediaCom, Inc. and began a new and separate operating segment, thephysical media dependent, or PMD, segment. The primary business objective ofthe PMD segment was to develop in-process technology in high-speed serialinterface chips for the 10-gigabit Ethernet market. In August 2002, wedecided to cease operations of the PMD segment because of a severe downturn inthe market for 10-gigabit Ethernet products. On November 15, 2002, we soldor disposed of the assets of our PMD operating segment, including all of thevaluable technology, property and equipment, licensed software and employees,for $1,752,000 in cash and the buyer’s assumption of $187,000 of liabilities. Theresults of operations of the PMD segment are reported as discontinuedoperations in the cumulative period from inception (April 14, 1997) throughMarch 31, 2005.

 

InJanuary 2002, we decided to cease the development of the fixed-functionchips that had been the goal of our research and development efforts until thenand to switch to the development of a family of programmable platform chips. InNovember 2003, we initiated the fabrication of the first version of ourFPOA chip with Taiwan Semiconductor Manufacturing Company, or TSMC, our chipfabrication contractor. In March 2004, TSMC delivered to us the firstworking silicon of that chip. Since that time, we have been principally engagedin further developments of our FPOA products and in marketing and selling ourfirst FPOA to a small number of early customers. Although there can be noassurance, we expect to produce FPOA chips that will be ready for a broadermarket release, and we believe we will begin selling to customers in the thirdquarter of 2006.

 

9

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**Financial Operations Overview**

 

Frominception through March 31, 2006, we had gross revenues of $888,000, aloss from continuing operations of $53,452,000, and a loss from ourdiscontinued PMD operations of $31,874,000.

 

AtDecember 31, 2005, we had federal and state income tax net operating losscarryforwards of approximately $62,554,000. The operating loss carryforwardswill expire in the calendar years from 2014 to 2022. At December 31, 2005,we had federal and state research credit carryforwards of approximately$2,874,000. The research credit carryforwards will expire in the calendar yearsfrom 2014 to 2022. Under the Internal Revenue Code of 1986, the utilization ofthese net operating loss carryforwards may be limited as a result of significantchanges in our ownership.

 

***Research and Development***

 

Researchand development expenses represent costs incurred for designing and engineeringour FPOA chip and developing design tools and applications to enable customersto more easily program our chip. Research and development expenses consistprimarily of salaries and related costs of our engineering organization; feespaid to third party consultants and an allocation of facilities anddepreciation expenses. We expense all research and development costs related tothe development of our FPOA. Development of certain design tools andapplications include the development of software. Such research and developmentexpenses are required to be expensed until the technological feasibility of thesoftware is established. We determine technological feasibility based uponcompletion of a working model of the software. To date, the period betweentechnological feasibility and general release of the software has been short,so virtually all of our software development costs relate to softwaredevelopment during the period before technological feasibility. Accordingly,all such costs have been charged to operations as incurred. We expect to incursignificant additional research and development costs as we develop more chipsusing our FPOA technology.

 

***Recently issued Accounting Pronouncements***

 

SeeNote 2 of Notes to Financial Statements included in Part I, Item 1 of thisQuarterly Report of Form 10-Q.

 

***Selling, General and AdministrativeExpenses***

 

Selling,general and administrative expenses consist primarily of salaries and relatedcosts of our sales and marketing and administrative staff, general corporateactivities and an allocation of facilities and depreciation expenses. Weanticipate that selling, general and administrative costs will increase as aresult of increasing our sales and marketing and administrative staff tosupport sales of FPOA chips in worldwide markets and to support our growth andoperation as a public company.

 

**Results of Operations**

 

***Three MonthsEnded March 31, 2005 and 2006***

 

*Revenue and Cost of Goods Sold.*Forthe three months ended March 31, 2006, we generated revenue of $8,000 comparedto $15,000 for the same period last year. Revenues for the three months endedMarch 31, 2006 were from the sale of FPOA development kits and non-recurringengineering fees. Revenues for the three months ended March 31, 2005 were fromthe sale of FPOA development kits. These product development kits includedsoftware that we licensed from a third party for the development of designtools for our FPOA chips. Costs of goods sold for the three months endedMarch 31, 2005 and 2006 are the cost of the third party software licenses.The cost of producing our development kits are expensed as research and developmentcosts as incurred because we do not anticipate substantial sales of the currentversion of the chip we have produced and because the aggregate cost of thedevelopment kits we expect to sell are immaterial.

 

*Research and Development.*For the three months ended March 31, 2006, research and development expensesincreased $378,000 or 18% to $2,826,000 from $2,448,000 for the three monthsended March 31, 2005. The increase is the result of increased payroll costs($499,000, which includes $37,000 of charges

 

10

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related tocompensation costs related to stock options and restricted stock), increasedoutside engineering and design consultants ($437,000) and increased overheadcosts ($258,000, due to an allocation of certain overhead costs). The increasewas offset by lower engineering materials ($926,000) as we produced a versionof our FPOA in the three months ended March 31, 2005 and did not incur thosecosts for the three months ended March 31, 2006. The increase in payroll costsand the use of outside engineering and design consultants is the result ofincreased staffing and efforts to complete the FPOA chip design and to continuedevelopment of our library of development algorithms for use by our customers.

 

*Selling, General and Administrative*Forthe three months ended March 31, 2006, selling, general and administrativeexpenses increased $1,055,000 or 99% to $2,202,000, compared to $1,147,000 forthe three months ended March 31, 2005. The increase was primarily the result ofincreased salaries ($1,171,000, which includes $691,000 of charges related tocompensation costs related to expensing of stock options and restricted stock),as we hired a chief operating officer, chief financial officer and vicepresidents of marketing and engineering, a controller and other staff in thesecond of 2005. Other expense increases include consulting ($71,000, primarilyrelated to marketing and Sarbanes-Oxley), increased travel expenses ($30,000)and increased insurance expenses ($37,000) due to being a publiccompany. These increases were offset by an allocation in the three monthsended March 31, 2006 of certain overhead costs ($258,000) to research anddevelopment.

 

*Other Income (Expense).*Forthe three months ended March 31, 2006, we had interest income of $190,000compared to interest income of $7,000 for the three months ended March 31,2005. The increase in interest income is the result of higher average cashbalances available to invest, combined with higher interest rates.

 

**Liquidity and Capital Resources**

 

Sinceinception on April 14, 1997, we have funded our cash flow needsprincipally through sales of our common stock, rights to purchase our commonstock and 8% convertible promissory notes. During the period from April 14,1997 to March 31, 2006, we raised net proceeds of $71,351,000 from sales ofcommon stock and common stock warrants and $5,500,000 from sales of 8%convertible promissory notes and common stock warrants. During the three-monthperiod ended March 31, 2006, we raised $8,000 from the exercise of certainwarrants held by investors.

 

Oursales and marketing infrastructure and the administrative support we used tocommercialize our FPOA technology was substantially in place at March 31, 2006.We anticipate that we will commence the production and sale of the new versionof our FPOA chip in the third quarter of 2006, although such production andsale cannot be assured. Going forward, our results of operations will dependupon how long it takes and how successful we are in achieving market acceptanceof our FPOA technology.

 

Ourfuture capital requirements will depend on many factors, including our salesgrowth, market acceptance of our existing and new FPOA chips, the amount andtiming of our research and development expenditures, the timing of ourintroduction of new chips, the expansion of our sales and marketing efforts andworking capital needs. We believe that our cash on hand, combined with ourexisting capital resources, will not be sufficient to meet our capital andoperating needs for the next 12 months. We anticipate seeking additionalfinancing during 2006. Our long-term financing requirements will dependsignificantly on our ability to penetrate the market with our FPOA chiptechnology. If existing cash, cash equivalents and cash generated fromoperations are insufficient to satisfy our liquidity requirements, we may seekto sell additional equity or debt securities or obtain other financing. If weobtain additional funds through the issuance of debt or equity securities,these securities may have rights senior to those associated with our commonstock, and they could contain covenants that would restrict our operations. Ifwe are unable to obtain additional financing or successfully market ourproducts on a timely basis, we would have to slow our product development andmarketing efforts and may be unable to continue our operations.

 

***Net Cash Usedin Operating Activities***

 

Netcash used in operating activities was $3,391,000 and $4,402,000 for the threemonths ended March 31, 2005 and 2006. Net cash used for operating activitiesfor the three months ended March 31,

 

11

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2005 and 2006 was tofund our on-going research and development activities and our selling, generaland administrative costs.

 

***NetCash Provided (Used) by Investing Activities***

 

Netcash used by investing activities for the three months ended March 31, 2006 of$91,000 were for the purchase of property and equipment. We had no investingactivities for the three months ended March 31, 2005.

 

***Net CashProvided by Financing Activities***

 

Netcash provided by financing activities was $108,000 and $8,000 for the threemonths ended March 31, 2005, and 2006. For both periods the cash provided byfinancing activities was proceeds from exercise of warrants.

 

**Off-BalanceSheet Arrangements**

 

Wedo not currently have any relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities, which would have been established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes. In addition, we do not engage in trading activitiesinvolving non-exchange traded contracts. As such, we are not materially exposedto any financing, liquidity, market or credit risk that could arise if we hadengaged in these relationships.

 

**Item 3. Quantitative and Qualitative Disclosures about MarketRisk**

 

Ourexposure to market risk is confined to our cash equivalents. We have investedin high-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 three months. 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.

 

**Item 4. Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

Wemaintain a system of disclosure controls and procedures designed to ensure thatinformation required to be disclosed in our reports filed or submitted underthe Securities Exchange Act of 1934, as amended (“Exchange Act”), is recorded,processed, summarized and reported within the time periods specified in the SECrules and forms. These controls and procedures are also designed to ensurethat such information is accumulated and communicated to the Company’smanagement, including the Chief Executive Officer (CEO) and Chief FinancialOfficer (CFO), as appropriate to allow timely decisions regarding requireddisclosure. Internal controls are procedures designed to provide reasonableassurance that transactions are properly authorized; assets are safeguardedagainst unauthorized or improper use; and transactions are properly recordedand reported, to permit the preparation of our financial statements inconformity with generally accepted accounting principles.

 

Acontrol system, no matter how well designed and operated, can provide onlyreasonable, not absolute, assurance that the control system’s objectives willbe met. Further, the design of a control system must reflect the fact thatthere are resource constraints, and the benefits of controls must be consideredrelative to their costs. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, within the Company have beendetected. These inherent limitations include the realities that judgments indecision-making can be faulty, and that breakdowns can occur because of simpleerrors or mistakes. Controls can also be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe controls. The design of any system of controls is based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions. Over time, controls may become inadequate becauseof changes in conditions or a deterioration in the degree of compliance withits policies

 

12

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or procedures. Becauseof the inherent limitations in a cost-effective control system, misstatementsdue to error or fraud may occur and not be detected. We continuously evaluateour internal controls and make changes to improve them as necessary. Our intentis to maintain our disclosure controls as dynamic systems that change asconditions warrant.

 

Asof the end of the period covered by this report, the Company carried out anevaluation, under the supervision and with the participation of Companymanagement, including its CEO and the CFO, of the effectiveness of the designand operation of the Company’s disclosure controls and procedures as defined inRules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon, and as of thedate of this evaluation, the CEO and the CFO concluded that the Company’sdisclosure controls and procedures were not effective because of the materialweakness described below.

 

*Changesin Internal Control Over Financial Reporting*

 

Asdescribed in our Annual Report on Form 10-K dated March 31, 2006, in connectionwith its audit of our financial statements for the year ended December 31,2005, our independent registered public accounting firm reported twoconditions, which together constitute a material weakness in the internalcontrols over our ability to produce financial statements free from materialmisstatements. A material weakness is a control deficiency, or combination ofcontrol deficiencies, that results in more than a remote likelihood that amaterial misstatement of the annual or interim financial statements will not beprevented or detected. Our independent registered public accounting firmreported to our board of directors that we do not have a sufficient number offinancial personnel with adequate training and experience in accounting orfinancial reporting, and our controls do not ensure that operating expenses andstock compensation transactions are identified and recorded accurately and inthe appropriate accounting period. These two conditions, in combination,constitute a material weakness in our internal controls.

 

Asdescribed in our Annual Report on Form 10-K dated March 31, 2006, our board ofdirectors agrees that the conditions identified by our independent registeredpublic accounting firm constitute a material weakness. The Company hasdeveloped a plan to address this material weakness that includes the additionof our new chief financial officer, controller and staff accountant, as well asthe performance of an assessment of our current accounting and reportingpolicies and procedures, assessment of our financial accounting and reportingstaff requirements, implementation of supervisory reviews by our chieffinancial officer and controller, implementation of new accounting policies andprocedures, and the hiring and training of additional financial accounting andreporting staff. We hired a new chief financial officer in June 2005, a newcontroller in July 2005 and a staff accountant in December 2005. In addition tothis plan, our new chief financial officer and controller are assessing oursystem of internal controls over financial reporting and intend to implementand are implementing controls designed to assure that, among other things,operating expenses and stock compensation transactions are identified andaccurately recorded. The Company will be reviewing and testing the stepsdescribed above throughout fiscal 2006. The Company believes that these stepswill correct the material weakness described above.

 

Thechanges in our internal control over financial reporting during our firstfiscal quarter ended March 31, 2006 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting, are described above.

 

**Part II**

**OtherInformation**

 

**Item 1.   Legal Proceedings**

 

We are currently not a party to any legalproceedings.

 

**Item 1A.   RiskFactors**

 

Thesemiconductor industry is characterized by rapid technological change, intensecompetition and cyclical market patterns which contribute to create factorsthat may affect our future operating result. The risk factors are described inthe section entitled “Risk Factors” beginning on page 16 of our AnnualReport on Form 10-K filed with the Securities and Exchange Commission on March31, 2006. Other information included in this Quarterly Report on Form 10-Qalso should be carefully considered. The risks

 

13

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and uncertaintiesdescribed in our Annual Report are not the only risks the Company faces. Additionalrisks and uncertainties not presently known to the Company or that the Company’smanagement currently deems immaterial also may impair its business operations. Ifany of the risks described were to occur, our business, financial condition,operating results and cash flows could be materially adversely affected.

 

**Item 2. Unregisterd Sales of Equity Securities and Use ofProceeds**

 

(a)From the period beginning February 1, 2006 and ending April 30, 2006, we issuedthe following equity securities in the following transactions, which were notregistered under the Securities Act of 1933 (the “Securities Act”):

 

1.     During the period February1, 2006 through March 31, 2006, the Company granted options to purchase 128,500shares of common stock to nine employees at an exercise price range of $4.65 to$5.33 per share under its Amended and Restated 2004 Long-Term Incentive Plan. Thesegrants were made in reliance on the exemption provided bySection 4(2) of and Rule 506 of Regulation D under theSecurities Act.

 

2.     In March 2006, the Company issued 1,667shares of common stock to two investors, who represented in writing that theywere accredited investors, at a price of $2.25 per share upon the exercise ofwarrants, resulting in gross proceeds of $3,750.75. These sales were made inreliance on the exemption provided by Section 4(2) of andRule 506 of Regulation D under the Securities Act.

 

3.     In April 2006, the Company issued 83,291shares to 28 investors, who represented in writing that they were accreditedinvestors, at a price of $2.25 per share, upon the exercise of warrants,resulting in gross proceeds of $187,404. These sales were made in reliance onthe exemption provided by Section 4(2) of and Rule 506 of Regulation D underthe Securities Act.

 

Thepurchasers of securities described above represented to us in writtensubscription agreements or other written agreements that, among other things,they acquired the securities for their own account and not with a view to anydistribution thereof to the public. The certificates evidencing the securitiesdescribed above bear legends providing that the shares are not to be offered,sold or transferred other than pursuant to an effective registration statementunder the Securities Act or an exemption from such registration requirements.

 

**Item 3.****   ****Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

**Item 5.****   ****Other Information**

 

None.

 

**Item 6.****   ****Exhibits**

 

Theexhibits are described on the Exhibit Index to this Quarterly Report onForm 10-Q.

 

14

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**SIGNATURES**

 

Pursuantto the 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, 2006 | By:            | /s/ James W.  Cruckshank |   |
|               |           | James W. Cruckshank |
|               |           |   |
|               |           | Vice President of  Administration and  Chief Financial Officer |
|               |           |   |
|               |           | (Principal Financial  Officer and Principal  Accounting Officer) |

 

15

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**EXHIBIT INDEX**

 
| **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                 |       | First  Amendment to the Standard Commercial Lease dated as of July 22, 2005 by  and between Parkway Point Joint Venture and MathStar, Inc. (incorporated  by reference to Exhibit 10.11 to the Registration Statement).                                                                                                    |       |     |
|                 |       |                                                                                                                                                                                                                                                                                                                                      |       |     |
| 10.2                 |       | Schedule of  Executive Officer Compensation and Director Compensation for 2005  (incorporated by reference to Exhibit 10.15 to Amendment No. 2 to  the Registration Statement on Form S-1 filed by MathStar, Inc. with the  SEC on September 29, 2005 (File No. 333-127164)).*                                   |       |     |
|                 |       |                                                                                                                                                                                                                                                                                                                                      |       |     |
| 10.3                 |       | Form of  Non-Statutory Stock Option Agreement evidencing options granted and to be  granted to the non-employee directors of MathStar, Inc. as described in  Exhibit 10.2 (filed herewith electronically).*                                                                                                                               |       |     |
|                 |       |                                                                                                                                                                                                                                                                                                                                      |       |     |
| 10.4                 |       | Amendment  No.1 to Strategic Partnership Agreement dated August 11, 2005 by and between  MathStar, Inc. and Valley Technologies, Inc. (incorporated by reference to  Exhibit 10.20 to Amendment No. 1 to the Registration Statement on  Form S-1 filed by MathStar, Inc. with the SEC on September 9,  2005).         |       |     |
|                 |       |                                                                                                                                                                                                                                                                                                                                      |       |     |
| 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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*              Indicatesa management contract or compensatory plan or arrangement.

 

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