**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 

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

 

**Forthe quarterly period ended September 30, 2009.**

 

**OR**

 

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

 

**Forthe transition period from              to              **

 

**Commissionfile number 000-51560**

 

**MathStar, Inc.**

(Exact name ofregistrant as specified in its charter)

 

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

 

**(503)726-5500**

(Registrant’stelephone number, including area code)

 

**N/A**

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

 

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

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).  Yes o No o

 

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

 

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

 

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

 

Shares outstandingof the Registrant’s common stock:

 
| **Class**                      | ** ** | **Outstanding at October 31,  2009** |
|--------------------------------|------------|-----------------------------------------------------|
| Common stock,  $0.01 par value |       | 9,181,497                                           |

 

 

 

----

 

Table of Contents

 
| PART I   FINANCIAL INFORMATION | 2                                                                                                         |
|------------------------------------------|-----------------------------------------------------------------------------------------------------------|
|                                     |                                                                                                      |   |
| Item 1.                                  | Consolidated  Financial Statements (Unaudited)                                                            | 2 |
|                                     | Condensed  Balance Sheets as of December 31, 2008 and September 30, 2009                        | 2 |
|                                     | Condensed  Statements of Operations for the Three and Nine Months Ended  September 30, 2008 and 2009 | 3 |
|                                     | Condensed  Statements of Cash Flows for the Nine Months Ended September 30, 2008  and 2009           | 4 |
|                                     | Notes  to Condensed Consolidated Financial Statements                                                     | 5 |
|                                     |                                                                                                      |   |
| Item 2                                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations               | 10 |
| Item 3                                   | Quantitative  and Qualitative Disclosures about Market Risk                                               | 13 |
| Item 4                                   | Controls  and Procedures                                                                                  | 14 |
|                                     |                                                                                                      |   |
| PART II   OTHER INFORMATION    | 14                                                                                                        |
|                                     |                                                                                                      |   |
| Item 1.                                  | Legal  Proceedings                                                                                        | 14 |
| Item 1A.                                 | Risk  Factors                                                                                             | 15 |
| Item 2.                                  | Unregistered  Sales of Equity Securities and Use of Proceeds                                              | 15 |
| Item 3.                                  | Defaults  Upon Senior Securities                                                                          | 16 |
| Item 4.                                  | Submission  of Matters to a Vote of Security Holders                                                      | 16 |
| Item 5.                                  | Other  Information                                                                                        | 16 |
| Item 6.                                  | Exhibits                                                                                                  | 16 |
|                                     |                                                                                                      |   |
| Signatures                               | 17                                                                                                        |

 

1

----

 

**Part I**

**FinancialInformation**

 

**Item1.  Financial Statements**

 

**MathStar, Inc.**

**Condensed Consolidated BalanceSheets**

**(Unaudited)**

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

 
| ** **                                                                                                                                           | ** ** | **December 31,  2008** | ** ** | **September  30,  2009** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------------|------------|
|                                                                                                                                                 |       |                        |       |                               |       |
| **Assets**                                                                                                                                           |       |                        |       |                               |       |
| Current  assets                                                                                                                                      |       |                        |       |                               |       |
| Cash  and cash equivalents                                                                                                                           |       | $                           | 11,767     |                               | $          | 12,918 |   |
| Investments  in marketable securities — short term                                                                                              |       | 2,530                       |       | —                             |       |
| Accounts  receivable                                                                                                                                 |       | 176                         |       | —                             |       |
| Prepaid  expenses and other current assets                                                                                                           |       | 222                         |       | 177                                |       |
| Total  current assets                                                                                                                                |       | 14,695                      |       | 13,095                             |       |
| Property  and equipment, net                                                                                                                         |       | 60                          |       | 54                                 |       |
| Investments  in marketable securities — long term                                                                                               |       | 785                         |       | 799                                |       |
| Put  option                                                                                                                                          |       | 26                          |       | 5                                  |       |
| Other  assets                                                                                                                                        |       | 23                          |       | 18                                 |       |
| Total  assets                                                                                                                                        |       | $                           | 15,589     |                               | $          | 13,971 |   |
|                                                                                                                                                 |       |                        |       |                               |       |
| **Liabilities and Stockholders’ Equity**                                                                                                        |       |                        |       |                               |       |
| Current  liabilities                                                                                                                                 |       |                        |       |                               |       |
| Accounts  payable                                                                                                                                    |       | $                           | 16         |                               | $          | 342 |   |
| Accrued  expenses                                                                                                                                    |       | 519                         |       | 388                                |       |
| Total  current liabilities                                                                                                                           |       | 535                         |       | 730                                |       |
| Other  long term liabilities                                                                                                                         |       | 151                         |       | —                             |       |
| Total  liabilities                                                                                                                                   |       | 686                         |       | 730                                |       |
|                                                                                                                                                 |       |                        |       |                               |       |
| Stockholders’  equity                                                                                                                           |       |                        |       |                               |       |
| Preferred  stock, $0.01 par value; 10,000 shares authorized; no shares issued and outstanding                                                        |       | —                      |       | —                             |       |
| Common  stock, $0.01 par value; 18,000 shares authorized; 9,181 shares issued and  outstanding at December 31, 2008 and September 30, 2009 |       | 92                          |       | 92                                 |       |
| Additional  paid-in capital                                                                                                                          |       | 155,924                     |       | 155,940                            |       |
| Accumulated  deficit                                                                                                                                 |       | (141,113                    | )          | (142,791                           | )          |
| Total  stockholders’ equity                                                                                                                     |       | 14,903                      |       | 13,241                             |       |
|                                                                                                                                                 |       |                        |       |                               |       |
| Total  liabilities and stockholders’ equity                                                                                                     |       | $                           | 15,589     |                               | $          | 13,971 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

2

----

 

**MathStar, Inc.**

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

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

 
| ** **                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                             | ** ** | **2009**                                            | ** ** | **2008** | ** ** | **2009** | ** ** |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Revenue                                                |       | $                                                    | 80         |                                                | $          | — |   | $ | 360 |   | $ | — |   |
| Cost  of sales                                         |       | —                                               |       | —                                              |       | 1,195 |   | — |   |
| Gross  profit (loss)                                   |       | 80                                                   |       | —                                              |       | (835 | ) | — |   |
| Operating  expenses:                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Research  and development                              |       | 165                                                  |       | —                                              |       | 7,259 |   | — |   |
| Selling,  general and administrative                   |       | 666                                                  |       | 742                                                 |       | 4,228 |   | 1,738 |   |
| Restructuring  and impairment charges                  |       | 17                                                   |       | —                                              |       | 2,618 |   | — |   |
|                                                   |       | 848                                                  |       | 742                                                 |       | 14,105 |   | 1,738 |   |
| Operating  loss                                        |       | (768                                                 | )          | (742                                                | )          | (14,940 | ) | (1,738 | ) |
| Interest  income                                       |       | 132                                                  |       | 10                                                  |       | 622 |   | 63 |   |
| Other  income (loss), net                              |       | (25                                                  | )          | —                                              |       | 1 |   | (4 | ) |
| Net  loss                                              |       | $                                                    | (661       | )                                                   | $          | (732 | ) | $ | (14,317 | ) | $ | (1,679 | ) |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Basic  and diluted loss per share                      |       | $                                                    | (0.07      | )                                                   | $          | (0.08 | ) | $ | (1.56 | ) | $ | (0.18 | ) |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted  average basic and diluted shares outstanding |       | 9,181                                                |       | 9,181                                               |       | 9,181 |   | 9,181 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

3

----

 

**MathStar, Inc.**

**Condensed Consolidated Statements ofCash Flows**

**(Unaudited)**

**(inthousands)**

 
| ** **                                                                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2008**                                            | ** ** | **2009** | ** ** |
|                                                                        |       |                                                |       |   |   |
| **Cash flows from operating activities**                                    |       |                                                |       |   |   |
| Net  loss                                                                   |       | $                                                   | (14,317    | ) | $ | (1,679 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities |       |                                                |       |   |   |
| Depreciation  and amortization                                              |       | 155                                                 |       | 7 |   |
| Loss  on asset disposal                                                     |       | 58                                                  |       | — |   |
| Asset  impairment charges                                                   |       | 1,006                                               |       | — |   |
| Amortization  of discount on held-to-maturity securities                    |       | 63                                                  |       | 3 |   |
| Loss  on sale of available-for-sale securities                              |       | 7                                                   |       | — |   |
| Mark  to market, trading securities                                         |       | —                                              |       | (2 | ) |
| Mark  to market, put option                                                 |       | —                                              |       | 9 |   |
| Non-cash  changes in inventory reserves                                     |       | 734                                                 |       | — |   |
| Stock-based  compensation                                                   |       | 3                                                   |       | 18 |   |
| Restructuring  charges                                                      |       | 563                                                 |       | — |   |
| Gain  on sale of marketable securities                                      |       | (42                                                 | )          | — |   |
| Foreign  currency remeasurement                                             |       | (17                                                 | )          | 4 |   |
| Change  in operating assets and liabilities                                 |       |                                                |       |   |   |
| Accounts  receivable                                                        |       | 141                                                 |       | 176 |   |
| Inventory                                                                   |       | (111                                                | )          | — |   |
| Prepaid  expenses and other assets                                          |       | 803                                                 |       | 48 |   |
| Accounts  payable                                                           |       | (904                                                | )          | 326 |   |
| Deferred  revenue                                                           |       | (162                                                | )          | — |   |
| Accrued  expenses                                                           |       | (1,570                                              | )          | (286 | ) |
| Net  cash used in operating activities                                      |       | (13,590                                             | )          | (1,376 | ) |
|                                                                        |       |                                                |       |   |   |
| **Cash flows from investing activities**                                    |       |                                                |       |   |   |
| Purchase  of property and equipment                                         |       | (50                                                 | )          | — |   |
| Proceeds  from sale of equipment                                            |       | 23                                                  |       | — |   |
| Proceeds  from sale of held-to-maturity securities                          |       | 17,158                                              |       | 2,527 |   |
| Proceeds  from sale of available-for-sale securities                        |       | 4,460                                               |       | — |   |
| Purchase  of held-to-maturity securities                                    |       | (2,931                                              | )          | — |   |
| Purchase  of available-for-sale securities                                  |       | (2,685                                              | )          | — |   |
| Restricted  cash                                                            |       | 107                                                 |       | — |   |
| Net  cash provided by investing activities                                  |       | 16,082                                              |       | 2,527 |   |
|                                                                        |       |                                                |       |   |   |
| **Cash flows from financing activities**                                    |       | —                                              |       | — |   |
|                                                                        |       |                                                |       |   |   |
| Effect  of exchange rate changes on cash                                    |       | (7                                                  | )          | — |   |
| Net  (decrease) increase in cash and cash equivalents                       |       | 2,485                                               |       | 1,151 |   |
| **Cash and cash equivalents**                                               |       |                                                |       |   |   |
| Beginning  of period                                                        |       | 4,339                                               |       | 11,767 |   |
| End  of period                                                              |       | $                                                   | 6,824      |   | $ | 12,918 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

4

----

 

**MathStar, Inc.**

**Notes to Condensed ConsolidatedFinancial Statements**

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

 

**1.****                                     ****Basis of Presentationand Going Concern**

 

The accompanying interimcondensed consolidated financial statements of MathStar, Inc. (“MathStar”or the “Company”) have been prepared in conformity with generally acceptedaccounting principles in the United States (U.S. GAAP), consistent in allmaterial respects with those applied in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2008 filed with the Securities andExchange Commission (“SEC”) on March 31, 2009. The year-end condensedconsolidated balance sheet was derived from audited financial statements,but does not include all disclosure required by U.S. GAAP. The preparation offinancial statements in conformity with U.S. GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.During the quarter ended March 31, 2009, MathStar, Inc. closed itstwo wholly-owned subsidiaries, MathStar Holdings B.V. and MathStar Limited.

 

The interim financialinformation is unaudited, but it reflects all normal adjustments that are, inthe opinion of management, necessary to provide a fair statement of results forthe interim periods presented. The interim financial results are notnecessarily indicative of results to be expected in future interim or annualperiods. The interim financial statements should be read in conjunction withthe financial statements in the Company’s Annual Report on Form 10-K filedwith the Securities and Exchange Commission on March 31, 2009.

 

During the three monthsended March 31, 2008, sales did not materialize as expected, and ourdevelopment of the next generation of FPOA chips fell even further behindschedule. As a result, on May 20, 2008, the Board of Directors voted tosuspend research and development activities and ongoing operations whileanalyzing strategic alternatives to protect shareholder value. The Board ofDirectors continues to explore these strategic alternatives, which couldinclude merger, acquisition, increasing operations in another structure orliquidation. MathStar has engaged third party investment banking firms toexplore the sale of intellectual property and patents and potential merger andacquisition alternatives.

 

The accompanyingfinancial statements have been prepared on a basis which assumes that theCompany will continue as a going concern and which contemplates the realizationof assets and the satisfaction of liabilities and commitments in the normalcourse of business.  Although the Companyhas incurred recurring losses and negative cash flows from operations, we havemet all financial obligations with vendors, key suppliers, and strategicpartners, both prior and subsequent to curtailing operations. We have sufficientcash and investments to meet all known obligations as well as projectedexpenditures for the next twelve months at current spending levels. However,because we have not definitively committed to any of the strategic alternativesbeing evaluated, we cannot predict our long-term cash needs or ultimate cashrequirements. The financial statements do not include any adjustments thatmight result from the outcome of this uncertainty.

 

Basic earnings per shareare computed by dividing the net loss available to common shareholders by theweighted average number of shares outstanding during the period. The dilutedearnings per share calculation discloses the impact of all potential dilutivecommon shares outstanding during the period, including stock options andwarrants using the treasury stock method. For the three months and nine monthsended September 30, 2008 and September 30, 2009, options and warrantsto purchase shares of common stock were not included in the computation of netloss per share, as their effect was antidilutive. As of September 30,2009, there were outstanding options and warrants to purchase a total of671,147 shares of common stock.

 

**2.             Restructuring and ImpairmentCharges**

 

During the three monthsended June 30, 2008, the Company announced a curtailment of operations asit evaluated strategic alternatives to preserve shareholder value.  Thisdecision resulted in restructuring and impairment charges of $3,500 in2008.  Management determined that it was highly likely that certainoperational assets would not be used and no alternatives existed. In accordancewith the Financial Accounting Standards Board (“FASB”) Accounting StandardsCodification (“ASC”) 360-10-35, *Impairment or Disposal ofLong-Lived Assets*, these assets were deemed to be impaired andeither held-for-sale or abandoned and written down to their fair marketvalue.  A plan to locate potential buyers was put in place for theirdisposal, and no further depreciation expense will be charged to the Company’soperating activity for these assets. In addition, the Company evaluated assetsthat were not abandoned or held-for-sale and determined that the estimateduseful lives of these assets should be shortened.  As well, in accordancewith ASC 420, *Exit or Disposal CostObligations*, certain one-time charges relating to severance toterminated employees, and fees associated with early contract terminations nolonger used and giving economic benefit to the Company, were 

 

5

----

 

recorded. As theliabilities for these charges were settled, payment was made against theliability, and there will not be any further impact on the Company’s operatingresults.

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

 

Below is the detail ofrestructuring and impairment charges for the nine months ended September 30,2009.

 
| ** **                               | ** ** | **Restructuring  Liability** | ** ** |
|------------------------------------------|------------|------------------------------|------------|
| Liability  as of December 31, 2008  |       | $                            | 4          |   |
|                                     |       |                         |       |
| Additions                                |       | —                       |       |
| Payments                                 |       | (4                           | )          |
| Liability  as of September 30, 2009 |       | $                            | —     |   |

 

Management believes thatno further charges will be incurred for this activity, except for potentialtermination of non-cancellable lease liabilities for the Hillsboro, Oregonfacility, which will depend on the strategic direction chosen by the Company.The amount of the potential lease termination liability will not be known untilthe strategic direction is identified. Total future lease commitments remainingunder this lease were $644 as of September 30, 2009.

 

**3.             New Accounting Pronouncements**

 

EffectiveJuly 1, 2009, the Company adopted the Financial Accounting Standards Board(“FASB”) Accounting Standards Codification (“ASC”) 105-10, *Generally Accepted Accounting Principles — Overall*(“ASC105-10”). ASC 105-10 establishes the *FASBAccounting Standards Codification*(the “Codification”) as the sourceof authoritative accounting principles recognized by the FASB to be applied bynongovernmental entities in the preparation of financial statements inconformity with U.S. GAAP. Rules and interpretive releases of the SECunder authority of federal securities laws are also sources of authoritativeU.S. GAAP for SEC registrants. All guidance contained in the Codificationcarries an equal level of authority. The Codification superseded all existingnon-SEC accounting and reporting standards. All other non-grandfathered,non-SEC accounting literature not included in the Codification isnon-authoritative. The FASB will not issue new standards in the form ofStatements, FASB Staff Positions or Emerging Issues Task Force Abstracts.Instead, it will issue Accounting Standards Updates (“ASUs”). The FASB will notconsider ASUs as authoritative in their own right. ASUs will serve only toupdate the Codification, provide background information about the guidance andprovide the bases for conclusions on the change(s) in the Codification.References made to FASB guidance throughout this document have been updated forthe Codification.

 

In April 2009,the FASB issued updated guidance related to the fair value measurements anddisclosures, which is included in the Codification in ASC 820-10-65, *Determining Fair Value When Volume and Level ofActivity for the Asset or Liability Have Significantly Decreased and IdentifyingTransactions That Are Not Orderly* (“ASC 820-10”). ASC 820-10provides guidance on how to determine the fair value of assets and liabilitieswhen the volume and level of activity for the asset/liability havesignificantly decreased. ASC 820-10 also provides guidance on identifyingcircumstances that indicate a transaction is not orderly. In addition, ASC820-10 requires disclosure in interim and annual periods of the inputs andvaluation techniques used to measure fair value and a discussion of changes invaluation techniques. ASC 820-10 was effective for the Company beginning in thesecond quarter of fiscal year 2009. The adoption of ASC 820-10 did not have amaterial impact on its consolidated financial position, results of operationsor cash flows.

 

In April 2009,the Company adopted FASB ASC 320-10-65, *Investments - Debt andEquity Securities - Overall - Transition and Open Effective Date Information*(“ASC320-10-65”). ASC 320-10-65 amends the requirements for the recognition andmeasurement of other-than-temporary impairments for debt securities bymodifying the pre-existing “intent and ability” indicator. 

 

6

----

 

Under ASC 320-10-65, another-than-temporary impairment is triggered when there is intent to sell thesecurity, it is more likely than not that the security will be required to besold before recovery, or the security is not expected to recover the entireamortized cost basis of the security. Additionally, ASC 320-10-65 changes thepresentation of other-than-temporary impairment in the income statement forthose impairments involving credit losses. The credit loss component will berecognized in earnings, and the remainder of the impairment will be recorded inother comprehensive income. ASC 320-10-65 was effective for the Companybeginning in the second quarter of fiscal year 2009. The adoption of ASC320-10-65 did not have a material impact on its consolidated financialposition, results of operations or cash flows.

 

In April 2009,the Company adopted FASB ASC 825-10-65, *Financial Instruments -Overall - Transition and Open Effective Date Information* (“ASC825-10-65”). ASC 825-10-65amends ASC 825-10 to require disclosures about fair value of financialinstruments in interim financial statements as well as in annual financialstatements and also amends ASC 270-10 to require those disclosures in allinterim financial statements. ASC 825-10-65 does not change the accountingtreatment for these financial instruments and was effective for the Company beginningin the second quarter of fiscal year 2009. For the nine months ended September 30,2009, the change in the fair value of financial instruments was $7,000.

 

In May 2009,the Company adopted 855-10, *Subsequent Events -Overall*(“ASC 855-10”). ASC 855-10 requires management to evaluateevents or transactions that took place after the balance sheet date and priorto release of the financial statements for potential recognition or disclosurein the financial statements.  ASC 855-10is to be applied to all periods following June 15, 2009.  There were no such events or transactionswhich occurred through November 9, 2009, the date these financialstatements were issued.

 

**4.     Selected Balance Sheet Information**

 

**InvestmentSecurities**

 
| ** **                    | ** ** | **December 31,  2008** | ** ** | **September 30,  2009** | ** ** |
|-------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Short-term                    |       |                        |       |                         |       |
| Held-to-maturity              |       |                        |       |                         |       |
| Corporate  bonds and notes    |       | $                           | 2,530      |                         | $          | — |   |
| Total  short-term investments |       | 2,530                       |       | —                       |       |
|                          |       |                        |       |                         |       |
| Long-term                     |       |                        |       |                         |       |
| Trading                       |       |                        |       |                         |       |
| Auction  preferred securities |       | 785                         |       | 799                          |       |
| Total  long-term investments  |       | 785                         |       | 799                          |       |
|                          |       |                        |       |                         |       |
| Total  investments            |       | $                           | 3,315      |                         | $          | 799 |   |

 
| ** **          | ** ** | ** **  | ** ** | **Fair Value Measurement at Reporting Date**           | ** ** |
|---------------------|------------|-------------|------------|---------------------------------------------------------------------------------|------------|
| ** **          | ** ** | ** **  | ** ** | **Quoted Prices  in Active  Markets for  Identical Assets** | ** ** | **Using  Significant  Other  Observable  Inputs** | ** ** | **Significant  Unobservable  Inputs** | ** ** |
| **Description**     | ** ** | **9/30/09** | ** ** | **(Level 1)**                                                              | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Put  option         |       | $           | 5          |                                                                            | —     |   | — |   | $ | 5 |   |
| Trading  securities |       | 799         |       | —                                                                          |       | — |   | 799 |   |
| Total               |       | $           | 804        |                                                                            | —     |   | — |   | $ | 804 |   |

 

The Company has auctionpreferred securities (APS), which are preferred equity instruments in aclosed-end mutual fund that provide liquidity through an auction processconducted by an independent auction agent that resets the applicable dividendrate at pre-determined calendar intervals, generally every 28 days.  Theseinstruments are senior equity securities that have a liquidation preference of$25,000 per share plus the amount of accumulated but unpaid dividends. Upon theliquidation, dissolution or winding up of the fund, APS holders are entitled toreceive their liquidation preference before any distribution or payment is madeto holders of the fund’s common shares. Dividends declared and payable on theAPS have a priority over dividends on the fund’s common shares. Outstanding APSmay be redeemed at the option of the fund upon giving notice to APS holders.

 

The Company generally investedin these securities as part of its overall cash management program. During thefirst quarter of 2008, the Company’s APS failed to auction due to sell ordersexceeding buy orders. The funds associated with failed auctions will 

 

7

----

 

not be accessible until asuccessful auction occurs, the fund redeems outstanding APS or an activesecondary market is created and a buyer is identified outside of the auctionprocess.

 

At September 30,2009, there was insufficient observable APS market information available todetermine the fair value of the Company’s investments in APS. Therefore, theCompany estimated Level 3 fair values for the APS by incorporatingassumptions that market participants would use in their estimates of fairvalue. Despite the failed auctions, the Company’s APS continue to be highlyrated by the rating agencies. Of the original $2,680 in APS purchased, $1,852was redeemed on May 27, 2008 at face value.

 

As further required byASC 820, provided below is a reconciliation of the beginning and endingbalances for each type of security valued using a Level 3 valuation at September  30,2009.

 
| ** **                                                     | ** ** | **Fair  Value Measurement Using Significant  Unobservable Inputs (Level 3)** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **Put  Option**                                                                   | ** ** | **Auction  Preferred  Securities** | ** ** |
| Beginning  balance as of December 31, 2008                |       | $                                                                                 | 26         |   | $ | 785 |   |
| Total  gains (losses) realized/unrealized included in earnings |       | —                                                                            |       | (7 | ) |
| Purchases                                                      |       | —                                                                            |       | — |   |
| Settlements                                                    |       | —                                                                            |       | — |   |
| Issuance  of put option                                        |       | —                                                                            |       | — |   |
| Ending  balance as of March 31, 2009                      |       | $                                                                                 | 26         |   | $ | 778 |   |
| Total  gains (losses) realized/unrealized included in earnings |       | (15                                                                               | )          | 15 |   |
| Purchases                                                      |       | —                                                                            |       | — |   |
| Settlements                                                    |       | —                                                                            |       | — |   |
| Issuance  of put option                                        |       | —                                                                            |       | — |   |
| Ending  balance as of June 30, 2009                       |       | $                                                                                 | 11         |   | $ | 793 |   |
| Total  gains (losses) realized/unrealized included in earnings |       | (6                                                                                | )          | 6 |   |
| Purchases                                                      |       | —                                                                            |       | — |   |
| Settlements                                                    |       | —                                                                            |       | — |   |
| Issuance  of put option                                        |       | —                                                                            |       | — |   |
| Ending  balance as of September 30, 2009                  |       | $                                                                                 | 5          |   | $ | 799 |   |

 

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

 

The Rights represent afirm agreement in accordance with ASC 815, which defines a firm agreement as anagreement with an unrelated party, binding on both parties and usually legallyenforceable, with the following characteristics: a) the agreementspecifies all significant terms, including the quantity to be exchanged, thefixed price, and the timing of the transaction; and b) the agreementincludes a disincentive for nonperformance that is sufficiently large to makeperformance probable. The enforceability of the Rights results in a put optionand should be recognized as a free-standing asset separate from the APS. Uponacceptance of the offer from UBS, we recorded $26 as the fair value of the putoption asset with a corresponding credit to interest income, net. The putoption does not meet the definition of a derivative instrument under ASC 815.Therefore, we have elected to measure the put option at fair value under ASC825, which permits an entity to elect the fair value option for recognizedfinancial assets, in order to match the changes in the fair value of the APS.As a result, gains and losses will be included in earnings in future periods.We expect that future changes in the fair value of the put option willapproximate fair value movements in the related APS; during the quarter ended September 30,2009, the fair value of the put option decreased by $6. Prior to accepting theUBS offer, we recorded our APS as investments available-for-sale. We recordedunrealized gains and losses on our available-for-sale debt securities, net of atax benefit, in accumulated other comprehensive income in the shareholders’equity section of our balance sheets. Such an unrealized loss did not reduce netincome for the applicable accounting period.

 

8

----

 

**Inventory**

 
| ** **                                       | ** ** | **December 31,  2008** | ** ** | **September 30,  2009** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Finished  goods                                  |       | $                           | 446        |                         | $          | 446 |   |
| Less:  reserve for excess and obsolete inventory |       | (446                        | )          | (446                         | )          |
| Total  inventory, net                            |       | $                           | —     |                         | $          | — |   |

 

**Prepaidand Other Current Assets**

 
| ** **                              | ** ** | **December 31,  2008** | ** ** | **September 30,  2009** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Prepaid  insurance                      |       | $                           | 105        |                         | $          | 19 |   |
| Prepaid  rent                           |       | 26                          |       | 27                           |       |
| Interest  receivable                    |       | 61                          |       | —                       |       |
| Taxes  Receivables                      |       | —                      |       | 101                          |       |
| Other                                   |       | 30                          |       | 30                           |       |
| Total  prepaid and other current assets |       | $                           | 222        |                         | $          | 177 |   |

 

**Propertyand Equipment**

 
| ** **                         | ** ** | **December 31,  2008** | ** ** | **September 30,  2009** | ** ** |
|------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Computer  equipment                |       | $                           | 50         |                         | $          | 50 |   |
| Purchased  software                |       | 91                          |       | 91                           |       |
| Furniture  and fixtures            |       | 198                         |       | 198                          |       |
|                               |       | $                           | 339        |                         | $          | 339 |   |
| Less:  Accumulated depreciation    |       | (279                        | )          | (285                         | )          |
| Total  property and equipment, net |       | $                           | 60         |                         | $          | 54 |   |

 

Depreciation expense was$44 and $3 for the three months ended September 30, 2008 and 2009,respectively, and $146 and $7 for the nine months ended September 30, 2008and 2009, respectively.

 

Under ASC 360-10-35, *Impairmentor Disposal of Long-Lived Assets*, assets that are no longer used inoperations and held for sale should be written down to the expected fair marketvalue and depreciation ceased as of the determination date.

 

**OtherAssets**

 
| ** **          | ** ** | **December 31,  2008** | ** ** | **September 30,  2009** | ** ** |
|---------------------|------------|-----------------------------|------------|------------------------------|------------|
| Deposits            |       | $                           | 23         |                         | $          | 18 |   |
| Total  other assets |       | $                           | 23         |                         | $          | 18 |   |

 

**AccruedExpenses**

 
| ** **                     | ** ** | **December 31,  2008** | ** ** | **September 30,  2009** | ** ** |
|--------------------------------|------------|-----------------------------|------------|------------------------------|------------|
|                           |       |                        |       |                         |       |
| Accrued  license contracts     |       | $                           | 302        |                         | $          | 302 |   |
| Accrued  professional fees     |       | 148                         |       | 47                           |       |
| Accrued  rent                  |       | 47                          |       | 39                           |       |
| Accrued  compensation          |       | 9                           |       | —                       |       |
| Accrued  restructuring charges |       | 4                           |       | —                       |       |
| Other                          |       | 9                           |       | —                       |       |
| Total  accrued expenses        |       | $                           | 519        |                         | $          | 388 |   |

 

9

----

 

**SubsequentEvent**

 

The subsequent event testin accordance with ASC 855 was performed as of November 9, 2009. Therewere no transactions or events discovered that required recognition ordisclosure.

 

**5.             Legal Matters**

 

OnOctober 8, 2009, legal counsel for Tiberius Capital II, LLC (“Tiberius”),sent by email to our legal counsel a copy of a Complaint labeled “Draft —Subject to Completion” (the “Tiberius Complaint”).  The Tiberius Complaint names Tiberius,individually and on behalf of all others similarly situated, as plaintiff. Itnames the Company, Feltl and Company, Inc., Sajan, Inc. (“Sajan”),Perkins Capital Management, Inc., Richard C. Perkins, Merrill A. McPeak,Benno G. Sand, John C. Feltl and Joseph P. Sullivan, as defendants(collectively, the “Minnesota Parties”).. Mr. Perkins, McPeak and Mr. Sand (collectively, the “MathStarDirectors”) are members of the Company’s Board of Directors.  The Tiberius Complaint states Tiberius isbringing a class action lawsuit on behalf of a class (the “Class”) consistingof all those who purchased the Company’s securities between May 11, 2009and September 30, 2009.  The captionon the Tiberius Complaint states that it is to be filed in the United StatesDistrict Court for the Southern District of New York.  The Tiberius Complaint alleges (1) violationsof Section 13(d) of the Securities Exchange Act of 1934 (the “ExchangeAct”) and the Rules of the Securities and Exchange Commission (the “SEC”)there under against the Minnesota Parties except Sajan for alleged failure toreport that such Minnesota Parties were acting as a “group” for purposes ofpurchasing the Company’s shares of common stock; (2) breaches of Section 14(a) ofthe Exchange Act and the Rules of the SEC there-under against theMinnesota Parties except Sajan for alleged misstatements in the Company’s proxystatement filed with the SEC on June 17, 2009 (the “Proxy Statement”) andin connection with the Company’s annual meeting of stockholders held on July 10,2009; (3) violations of Section 10(b) of the Exchange Act and Rule 10b-5promulgated by the SEC there-under against the Minnesota Parties except Sajanfor alleged misstatements made in the Proxy Statement and in an alleged fraudon the market by such Minnesota Parties; (4) violation of Section 14of the Exchange Act and Rule 14e-3 promulgated by the SEC there-underagainst the Minnesota Parties except Sajan for actions taken by such MinnesotaParties in connection with an alleged “creeping” tender offer; (5) controlparty liability under Section 20(a) of the Exchange Act against theMathStar Directors for alleged violations of Sections 14(a) and 14(e) ofthe Exchange Act and Rule 10b-5 there-under; (6) breach of fiduciaryduty against the MathStar Directors; and (7) civil conspiracy against theMinnesota Parties.  In the TiberiusComplaint, Tiberius requests that the Court enter a judgment in favor ofTiberius and against the Minnesota Parties declaring that the Company violated “§10b-5,§13d, §14a and §14e” of the Exchange Act and rules promulgatedthere-under, including Regulation FD; enter judgment in favor of Tiberius andthe Class and against the MathStar Directors in the amount of $10,000,000in compensatory and punitive damages; award Tiberius all of its costs incurredin connection with the action, including reasonable attorneys’ fees; and grantsuch other and further relief as the Court deems to be just and equitable.

 

Toour knowledge, the Tiberius Complaint was not filed with a court or served onany of the Minnesota Parties. On October 14, 2009, the Minnesota Partiesfiled a Complaint in the United States District Court for the District ofMinnesota captioned “MathStar, Inc., Feltl and Company, Inc., Sajan, Inc.,Perkins Capital Management, Inc., Richard C. Perkins, Merrill A. McPeak,Benno G. Sand, John C. Feltl and Joseph P. Sullivan, Plaintiffs, v. TiberiusCapital II, LLC, Defendant” (the “Minnesota Complaint”).  In the Minnesota Complaint, the MinnesotaParties state that Tiberius is threatening to bring a class action lawsuitagainst them, as set forth in the Tiberius Complaint.  The Minnesota Complaint also alleges a claimof tortious interference with prospective economic advantage against Tiberiuson behalf of the Company, Sajan and Feltl and Company, Inc. (“F&C”).  The Minnesota Complaint requests judgment infavor of the Minnesota Parties declaring that their actions described in theMinnesota Complaint were lawful; declaring that the Minnesota Parties have notviolated any legal duties to Tiberius; declaring that the proposed TiberiusComplaint is without merit; awarding money damages to the Company, Sajan andF&C in an amount to be determined at trial to compensate such MinnesotaParties for Tiberius’ tortious interference with their economic advantage;awarding the Minnesota Parties their costs, disbursements and reasonableattorneys’ fees; and awarding the Minnesota Parties such other and furtherrelief as the Court deems to be just, proper and equitable.  The Minnesota Complaint was served onTiberius on October 21, 2009.  Todate, neither the Company nor, to the knowledge of the Company, any otherMinnesota Party has received an answer from Tiberius to the MinnesotaComplaint.  Tiberius must answer theMinnesota Complaint or otherwise plead by November 10, 2009, unless thatdate is extended.

 

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

 

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

 

10

----

 

*Manyfactors may cause actual results to differ materially from those expressed orimplied by the forward-looking statements contained in this report. Thesefactors include, but are not limited to, those risks described in our AnnualReport on Form 10-K filed on March 31, 2009.*

 

**BusinessOverview**

 

Until we curtailedoperations in the second quarter of 2008, we were a fabless semiconductorcompany engaged in the development, marketing and selling of ourhigh-performance, programmable platform field programmable object array, orFPOA, chips and design tools required to program our chips. During the threemonths ended March 31, 2008, sales did not materialize as expected, andour development of the next generation of FPOA chips fell behind schedule. As aresult, on May 20, 2008, the Board of Directors voted to suspend researchand development activities and curtail ongoing operations while analyzingstrategic alternatives. The Board of Directors continues to explore thesestrategic alternatives, which could include merging with or acquiring anothercompany, increasing operations in another structure or liquidation. We have engagedthird party investment banking firms to explore the sale of intellectualproperty and patents and potential merger and acquisition alternatives.

 

**RecentlyIssued Accounting Pronouncements**

 

See Note 2 of Notes toFinancial Statements included in Part I, Item 1 of this Quarterly Reporton Form 10-Q.

 

**CriticalAccounting Policies**

 

There were no changes incritical accounting policies in the three months ended September 30, 2009.

 

**Results of Operations**

 

***Three Months Ended September 30, 2008and 2009***

 

*Revenue*. There was no revenue**for the three months ended September 30,2009. For the three months ended September 30, 2008, we generated revenueof $80,000. Revenue for the three months ended September 30, 2008 was fromthe sale of FPOA chips left in our inventory. Future short-term revenue couldbe generated from sales of production chips we have in inventory. Long-termrevenue opportunities will be based on the strategic direction chosen by ourBoard of Directors and the timing for executing the plan.

 

*Costof Sales.* Therewas no cost of sales for the three months ended September 30, 2009 and September 30,2008.  There was no cost of salesassociated with sales in the third quarter of 2008 because all inventory waswritten down to zero in the second quarter of 2008.

 

*Researchand Development.*All research and development activity has been suspended, and no expenses wereincurred during the three months ended September 30, 2009.  Duringthe three months ended September 30, 2008, research and developmentexpenses were essentially terminated, with associated expenses of $165,000 forthe completion of the design documentation phases of current chip development.Those expenses included personnel related expenses of $99,000, contractor andconsulting expenses of $56,000 and other charges of $10,000.

 

*Selling,General and Administrative. *For the three months ended September 30, 2009,selling, general and administrative expenses were $742,000 compared to $666,000for the three months ended September 30, 2008. The $742,000 consisted ofpersonnel expenses of $15,000, outside services, legal and accounting fees of$364,000, facility costs of $80,000, insurance costs of $29,000, and paymentsto investment bankers and consultants associated with the sale of the IP andstrategic opportunities of $254,000.  The $666,000 of expenses for thethree months ended September 30, 2008 included personnel costs of$193,000, outside services and contractors of $202,000, insurance costs of$39,000, depreciation expense of $44,000, building rent and facility costs of$95,000, expenses related to evaluation of strategic directions of $73,000 andother costs of $20,000.  Excludingexpenses associated with investigating strategic alternatives and IP sales, webelieve our expenses are at the lowest sustainable level possible while stillmeeting the requirements of a public company.  Any changes in this levelwill depend on the strategic direction of the Company chosen by our Board ofDirectors and the timing for executing the plan.

 

*Restructuringand Impairment Charges.*For the three months ended September 30, 2009, we did not recordany restructuring and impairment charges. For the three months ended September 30,2008, we recorded restructuring and impairment charges of $17,000. Thesecharges consisted of future rent payments for the Minnesota facility coveredunder a non-cancellable lease agreement which is no longer being utilized.

 

11

----

 

*OtherIncome (Loss).*Forthe three months ended September 30, 2009, other income decreased by$97,000 or 91% to $10,000 compared to $107,000 for the three months ended September 30,2008. The decrease was the result of $108,000 less interest income earned onlower investment balances and a loss on asset sale of $11,000.

 

***Nine Months Ended September 30, 2008 and 2009***

 

*Revenue.*There was no revenue reported for the**ninemonths ended September 30, 2009 compared to $360,000 for the same periodlast year. Revenue for the nine months ended September 30, 2008 was fromthe sale of production FPOA chips of $356,000 and development products of$4,000.

 

*Costof Sales.* Therewas no cost of sales for the nine months ended September 30, 2009. For thenine months ended September 30, 2008, the cost of sales was $1,195,000.Cost of sales for the nine months ended September 30, 2008 includedproduct costs of $36,000, a non-cash charge of $776,000 for excess and obsoleteinventory, scrap costs associated with tool licenses and raw materialwrite-offs of $363,000, and other costs of $20,000.

 

*Researchand Development.*For the nine months ended September 30, 2009, all research and developmentactivities were curtailed and no expenses were incurred. For the nine monthsended September 30, 2008, research and development costs were $7,259,000.The $7,259,000 included employee related expenses of $2,863,000, consulting andcontractor expense of $1,550,000, development tool expense of $614,000, chargesfor application IP development of $515,000 because technological feasibilityhad not been established on the development projects, external developmentcosts associated with the completion of the next generation FPOA of $1,456,000,and other costs of $261,000.

 

*Selling,General and Administrative. *For the nine months ended September 30, 2009,selling, general and administrative expenses were $1,738,000 compared to$4,228,000 for the nine months ended September 30, 2008. The $1,738,000 inexpenses for the nine months ended September  30, 2009 includedemployee related expenses of $252,000, outside services and professional feesof $683,000, facility charges of $240,000, insurance of $85,000, otheroperating expenses of $48,000, and payment related to investment bankingactivities of $430,000.  The $4,228,000 in expenses for the nine monthsended September  30, 2008 included employee related expenses of$2,353,000, outside services and professional fees of $834,000, marketing andadvertising of $110,000, travel expenses of $237,000, facility charges anddepreciation of $288,000, insurance of $116,000, expenses related to evaluatingstrategic alternatives of $7*3*,000 and otheroperating expenses of $217,000. Our selling, general and administrativeinfrastructure is reduced to key individuals necessary to sustain the corporatestructure and activities and plan our strategic direction. Should we choose toincrease operations, there will be significant one-time and recurring expensesrequired to grow our organizational infrastructure.

 

*Restructuringand Impairment Charges*. For the nine months ended September 30,2009, we did not record any restructuring or impairment charges*.*For the nine months ended September 30, 2008, werecorded restructuring and impairment charges of $2,618,000.  See furtherdiscussion of these restructuring charges in Note 2 of the financialstatements.

 

*OtherIncome (Loss).*Forthe nine months ended September 30, 2009, other income decreased by$604,000 or 91% to $59,000 compared to $623,000 for the nine months ended September 30,2008. The decrease was primarily the result of $634,000 less interest incomeand a $30,000 loss on asset sale.

 

**Liquidity and Capital Resources**

 

In response to the Boardof Director’s decision to curtail operations and evaluate our strategicalternatives, staff was reduced to two key individuals in the second quarter of2008, Mr. Douglas M. Pihl, a full-time Chief Executive Officer/ChiefFinancial Officer, and Mr. John M. Jennings, a part-time Chief AccountingOfficer, and support contractors on an as-needed basis to sustain the Company’scorporate structure and activities and plan its strategic direction. As setforth in our Current Report on Form 8-K filed on July 15, 2009, Mr. Pihlresigned as Chief Executive Officer, Chief Financial Officer and a Director on July 14,2009.  On August 5, 2009, theCompany and Mr. Pihl entered into a Severance and Release Agreement (the “Agreement”),the form of which was included as Exhibit A to Exhibit 10.2 of theCompany’s Current Report on Form 8-K filed May 8, 2009.  Pursuant to the Agreement, the Company agreedto make a severance payment of $216,286 to Mr. Pihl. All costs associatedwith the Agreement were paid as of September 30, 2009. As set forth in ourCurrent Report on Form 8-K filed on August 14, 2009, effective as of August 1,2009, the Company engaged Alexander H. Danzberger, Jr. to serve as its ChiefExecutive Officer and Chief Financial Officer.  We havesufficient cash and investments to satisfy all outstanding obligations and toinitiate actions based on the strategic direction when determined by the Boardof Directors.

 

12

----

 

In January 2008, wepurchased $2,680,000 of investments comprised of auction preferred securities(APS). All of our APS are AAA rated by one of the major credit ratingagencies.  Since mid-February 2008, we have experienced failedauctions for our entire APS portfolio, resulting in our inability to sell thesesecurities. A failed auction results in a lack of liquidity in the securitiesbut does not signify a default by the issuer.  Upon an auction failure,the interest rates on the APS do not reset at a market rate but instead resetbased on a formula contained in the APS, which generally is higher than thecurrent market rate. The issuer of the APS redeemed $1,852,000 of the APSon May 27, 2008 and is actively putting a plan in place to redeem theremainder. Our APS were purchased through UBS Financial Services. On August 8,2008, UBS announced that it reached a settlement with the New York AttorneyGeneral, the Massachusetts Securities Division, the Securities and ExchangeCommission and other regulatory agencies to restore liquidity to holders ofAPS.  We do not currently need these funds to satisfy outstandingobligations or meet short-term operating requirements.

 

We classified our APS astrading securities, which has resulted in a $30,000 cumulative adjustment tothe carrying value of our APS to mark them to fair value. If uncertaintiesin the credit and capital markets continue, if the credit worthiness of theissuer deteriorates, if UBS does not comply with the settlement provisions orif we no longer have the ability to hold these investments, we may be requiredto recognize additional impairment charges on our APS holdings or a loss ontheir disposition.

 

Our future capitalrequirements will depend on many factors, including the strategic direction theCompany chooses, the amount of any sales, the type and structure of anystrategic transaction into which we enter, and working capital needs. Webelieve that our cash on hand and our investment securities will be sufficientto meet our current obligations as well as projected expenditures for the nexttwelve months at current spending levels. However, our long-term financing requirementswill depend significantly on the strategic direction we choose to take and thetiming for executing the plan. We cannot quantify our long-term cashrequirements until a strategic alternative is decided. Should cash andinvestments and revenues generated from a strategic alternative not meet ourneeds, we may need to raise funds though the issue of debt or equitysecurities. These securities may have rights senior to those currentlyassociated with our common stock and could contain covenants that wouldrestrict our operations. If we are unable to obtain additional financing, wemay be unable to continue our operations.

 

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

 

Net cash used inoperating activities was $1,376,000 and $13,590,000 for the nine months ended September 30,2009 and 2008, respectively. Net cash used for operating activities for thenine months ended September 30, 2009 was to pay outstanding liabilitiesand ongoing expenses of the company of $1,103,000 and $273,000 in fees andexpenses used in evaluating strategic alternatives.  Net cash used for operating activities forthe nine months ended September 30, 2008 was to fund the completion of thedesign of our next generation of FPOA chip, pay our selling, general andadministrative costs, pay severance payments to employees whose employment wasterminated, and fund contract termination expenses of $13,517,000 and $73,000in fees and expenses related to evaluating strategic alternatives.

 

***Net Cash Provided by Investing Activities***

 

Net cash provided byinvesting activities was $2,527,000 and $16,082,000 for the nine months ended September 30,2009 and 2008, respectively.  Net cash provided by investing activitiesfor the nine months ended September 30, 2009 was from the proceeds fromthe sale of investments.  Net cash provided by investing activities forthe nine months ended September 30, 2008 was from the proceeds from thesale of investments of $16,002,000, the release of $107,000 of restricted cashthat was on deposit to secure company credit cards, $23,000 from the sale ofequipment, and $50,000 used to purchase capital equipment.

 

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

 

There were no financingactivities for the nine months ended September 30, 2009 and 2008.

 

**Off-BalanceSheet Arrangements**

 

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

 

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

 

Our exposure to marketrisk is confined to our cash equivalents and investments. We have invested inhigh-quality financial instruments, primarily money market funds, federalagency notes and asset-backed securities, which we believe are subject tolimited credit risks. Included in our investments are APS. The APS auctionshave historically provided a liquid market for these securities, as investorscould readily sell their investments at auction. With the liquidity issuesexperienced in global credit and capital markets, the

 

13

----

 

APS held by us haveexperienced failed auctions, beginning on February 19, 2008, as the amountof securities submitted for sale exceeded the amount of purchase orders, makingthe liquidity of the APS questionable. Despite the failed auctions, our APScontinue to be highly rated by the rating agencies. We believe we will havefull redemption of all APS at par. If all APS are not redeemed, it could have anegative effect on the liquidity of our funds available for strategicalternatives.

 

**Item4. Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

During the fiscal periodcovered by this report, our management, with the participation of the ChiefExecutive Officer and Chief Financial Officer, completed an evaluation of theeffectiveness of the design and operation of our disclosure controls and procedures,as defined in Rules 13a-15(e) and 15d-15(e) of the SecuritiesExchange Act of 1934 (“Exchange Act”). Based upon this evaluation, our ChiefExecutive Officer and Chief Financial Officer has concluded that, as of the endof the fiscal period covered by this report, our disclosure controls andprocedures were effective to ensure that information required to be disclosedby us in reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified by the rules andforms of the Securities and Exchange Commission and that such information isaccumulated and communicated to management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosures.

 

*Changesin Internal Control Over Financial Reporting*

 

There were no changes inthe Company’s internal control over financial reporting during the mostrecently completed quarter that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.

 

**Part II**

 

**OtherInformation**

 

**Item1.   Legal Proceedings**

 

OnOctober 8, 2009, legal counsel for Tiberius Capital II, LLC (“Tiberius”),sent by email to our legal counsel a copy of a Complaint labeled “Draft –Subject to Completion” (the “Tiberius Complaint”).  The Tiberius Complaint names Tiberius,individually and on behalf of all others similarly situated, as plaintiff. Itnames the Company, Feltl and Company, Inc., Sajan, Inc. (“Sajan”),Perkins Capital Management, Inc., Richard C. Perkins, Merrill A. McPeak,Benno G. Sand, John C. Feltl and Joseph P. Sullivan , as defendants(collectively, the “Minnesota Parties”).. Mr. Perkins, McPeak and Mr. Sand (collectively, the “MathStarDirectors”) are members of the Company’s Board of Directors.  The Tiberius Complaint states Tiberius isbringing a class action lawsuit on behalf of a class (the “Class”) consistingof all those who purchased the Company’s securities between May 11, 2009and September 30, 2009.  The captionon the Tiberius Complaint states that it is to be filed in the United StatesDistrict Court for the Southern District of New York.  The Tiberius Complaint alleges (1) violationsof Section 13(d) of the Securities Exchange Act of 1934 (the “ExchangeAct”) and the Rules of the Securities and Exchange Commission (the “SEC”)there-under against the Minnesota Parties except Sajan for alleged failure toreport that such Minnesota Parties were acting as a “group” for purposes ofpurchasing the Company’s shares of common stock; (2) breaches of Section 14(a) ofthe Exchange Act and the Rules of the SEC thereunder against the MinnesotaParties except Sajan for alleged misstatements in the Company’s proxy statementfiled with the SEC on June 17, 2009 (the “Proxy Statement”) and inconnection with the Company’s annual meeting of stockholders held on July 10,2009; (3) violations of Section 10(b) of the Exchange Act and Rule 10b-5promulgated by the SEC thereunder against the Minnesota Parties except Sajanfor alleged misstatements made in the Proxy Statement and in an alleged fraudon the market by such Minnesota Parties; (4) violation of Section 14of the Exchange Act and Rule 14e-3 promulgated by the SEC thereunder againstthe Minnesota Parties except Sajan for actions taken by such Minnesota Partiesin connection with an alleged “creeping” tender offer; (5) control partyliability under Section 20(a) of the Exchange Act against theMathStar Directors for alleged violations of Sections 14(a) and 14(e) ofthe Exchange Act and Rule 10b-5 thereunder; (6) breach of fiduciaryduty against the MathStar Directors; and (7) civil conspiracy against theMinnesota Parties.  In the TiberiusComplaint, Tiberius requests that the Court enter a judgment in favor ofTiberius and against the Minnesota Parties declaring that the Company violated “§10b-5,§13d, §14a and §14e” of the Exchange Act and rules promulgated thereunder,including Regulation FD; enter judgment in favor of Tiberius and the Class andagainst the MathStar Directors in the amount of $10,000,000 in compensatory andpunitive damages; award Tiberius all of its costs incurred in connection withthe action, including reasonable attorneys’ fees; and grant such other andfurther relief as the Court deems to be just and equitable.

 

Toour knowledge, the Tiberius Complaint was not filed with a court or served onany of the Minnesota Parties.

 

14

----

 

OnOctober 14, 2009, the Minnesota Parties filed a Complaint in the UnitedStates District Court for the District of Minnesota captioned “MathStar, Inc.,Feltl and Company, Inc., Sajan, Inc., Perkins Capital Management, Inc.,Richard C. Perkins, Merrill A. McPeak, Benno G. Sand, John C. Feltl and JosephP. Sullivan, Plaintiffs, v. Tiberius Capital II, LLC, Defendant” (the “MinnesotaComplaint”).  In the Minnesota Complaint,the Minnesota Parties state that Tiberius is threatening to bring a classaction lawsuit against them, as set forth in the Tiberius Complaint.  The Minnesota Complaint also alleges a claimof tortious interference with prospective economic advantage against Tiberiuson behalf of the Company, Sajan and Feltl and Company, Inc. (“F&C”).  The Minnesota Complaint requests judgment infavor of the Minnesota Parties declaring that their actions described in theMinnesota Complaint were lawful; declaring that the Minnesota Parties have notviolated any legal duties to Tiberius; declaring that the proposed TiberiusComplaint is without merit; awarding money damages to the Company, Sajan andF&C in an amount to be determined at trial to compensate such MinnesotaParties for Tiberius’ tortious interference with their economic advantage;awarding the Minnesota Parties their costs, disbursements and reasonableattorneys’ fees; and awarding the Minnesota Parties such other and furtherrelief as the Court deems to be just, proper and equitable.  The Minnesota Complaint was served onTiberius on October 21, 2009.  Todate, neither the Company nor, to the knowledge of the Company, any otherMinnesota Party has received an answer from Tiberius to the MinnesotaComplaint.  Tiberius must answer theMinnesota Complaint or otherwise plead by November 10, 2009, unless thatdate is extended.

 

**Item1A.   Risk Factors**

 

There are many factorsthat may affect our future operating results and financial condition. Some ofthese risk factors are described in the section entitled “Risk Factors”beginning on page 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2008 filed with the SEC on March 31, 2009 (“2008 Form 10-K”).Other information included in this Quarterly Report on Form 10-Q alsoshould be carefully considered. The risks and uncertainties described in our2008 Form 10-K are not the only risks we face. Additional risks anduncertainties not presently known to us or that our management currently deemsimmaterial also may impair our business operations and financial condition. Ifany of the risks described were to occur, our business, financial condition,operating results and cash flows could be materially adversely affected.

 

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

 

None.

 

15

----

 

**Item3.  Defaults Upon Senior Securities**

None

 

**Item4  Submission of Matters to a Vote ofSecurity Holders**

None

 

**Item5.   Other Information**

 

None

 

**Item6.   Exhibits**

 

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

 

16

----

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                         | MathStar, Inc. |
|------------------------------|---------------------|
|                         | (Registrant)        |
|                         |                |   |
|                         |                |   |
| Date: November 9,  2009 | By:                 | /s/ Alexander H.  Danzberger, Jr. |
|                         |                | Alexander H.  Danzberger, Jr. |
|                         |                | Chief Executive Officer  and Chief Financial Officer |

 

17

----

 

**EXHIBITINDEX**

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                    |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.1                  |       | Certificate of  Incorporation of MathStar, Inc. (incorporated by reference to  Exhibit 3.1 to the Registration Statement on Form S-1 filed by  MathStar, Inc. with the Securities and Exchange Commission (“SEC”) on  August 3, 2005 (File No. 333-127164) (the “Registration  Statement”)).                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.2                  |       | By-laws of  MathStar, Inc. (incorporated by reference to Exhibit 3.2 to the  Registration Statement).                                                                                                                                                                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 4.1                  |       | Form of common  stock certificate of MathStar, Inc. (incorporated by reference to  Exhibit 4.1 to the Registration Statement).                                                                                                                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.1                 |       | Severance and Release  Agreement dated August 5, 2009 by and between Douglas M. Pihl and MathStar,  Inc. (incorporated by reference to Exhibit A to Exhibit 10.2 to the Current  Report on Form 8-K dated May 8, 2009 filed by MathStar, Inc. with the SEC).                                                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.2                 |       | Consulting Services  Agreement dated as of August 1, 2009 by and between A. Harris &  Associates LLC and MathStar, Inc. under which Alexander H. Danzberger Jr. is  providing his services to MathStar, Inc. as Chief Executive Officer, Chief  Financial Officer and a Special Advisor (incorporated by reference to Exhibit  10.1 to the Current Report on Form 8-K dated August 14, 2009 filed by  MathStar, Inc. with the SEC). |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 31.1                 |       | Certification of Chief  Executive Officer pursuant to Rules 13a-14(a)/15d-14(a) under the  Securities Exchange Act of 1934 (filed herewith electronically).                                                                                                                                                                                                                                                                   |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 31.2                 |       | Certification of Chief  Financial Officer pursuant to Rules 13a-14(a)/15d-14(a) under the  Securities Exchange Act of 1934 (filed herewith electronically).                                                                                                                                                                                                                                                                   |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 32.1                 |       | Section 1350  Certification of Chief Executive Officer and Chief Financial Officer (filed  herewith electronically).                                                                                                                                                                                                                                                                                                               |

 

18

----