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** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 
| **x** | ** ** | **Quarterly report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|------------|--------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended June 30, 2008.**

 

**OR**

 
| o | ** ** | **Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|---|------------|---------------------------------------------------------------------------------------------------------|

 

**For the transition period from              to                **

 

**Commission file number 000-51560**

 

**MathStar, Inc.**

(Exact name of registrant as specified in its charter)

 

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

 

**(503) 726-5500**

(Registrant’s telephone number, including area code)

 

**N/A**

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

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  x  Yes    o  No

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  o  Yes    x  No

 

Shares outstanding of the Registrant’s common stock:

 
| **Class**                     | ** ** | **Outstanding at June 30,  2008** |
|-------------------------------|------------|--------------------------------------------------|
| Common stock, $0.01 par value |       | 9,181,497                                        |

 

 

 

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| PART I  FINANCIAL INFORMATION |                                                                                               | 1      |
|-----------------------------------------|----------------------------------------------------------------------------------------------------|--------|
|                                    |                                                                                               |   |   |
| Item 1.                                 | Consolidated Financial Statements (Unaudited)                                                      |   | 1 |
|                                    | Condensed Balance Sheets as of December 31, 2007 and  June 30, 2008                      |   | 1 |
|                                    | Condensed Statements of Operations for the  Three and Six Months Ended June 30, 2007 and 2008 |   | 2 |
|                                    | Condensed Statements of Cash Flows for the  Six Months Ended June 30, 2007 and 2008           |   | 3 |
|                                    | Notes to Condensed Consolidated Financial  Statements                                              |   | 4 |
|                                    |                                                                                               |   |   |
| Item 2                                  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations        |   | 10 |
| Item  3                                 | Quantitative  and Qualitative Disclosures about Market Risk                                        |   | 15 |
| Item  4                                 | Controls  and Procedures                                                                           |   | 15 |
|                                    |                                                                                               |   |   |
| PART II   OTHER INFORMATION   |                                                                                               | 15     |
| Item 1.                                 | Legal Proceedings                                                                                  |   | 15 |
| Item 1A.                                | Risk Factors                                                                                       |   | 15 |
| Item 2.                                 | Unregistered Sales of Equity Securities and  Use of Proceeds                                       |   | 17 |
| Item 3.                                 | Defaults Upon Senior Securities                                                                    |   | 17 |
| Item 4.                                 | Submission of Matters to a Vote of Security  Holders                                               |   | 17 |
| Item 5.                                 | Other Information                                                                                  |   | 18 |
| Item 6.                                 | Exhibits                                                                                           |   | 18 |
|                                    |                                                                                               |   |   |
| Signatures                              |                                                                                               |   | 19 |

 

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**Part I**

**Financial Information**

 

**Item 1.  Financial Statements**

 

**MathStar, Inc.**

**CondensedConsolidated Balance Sheets**

**(Unaudited)**

**(in thousands, except per share data)**

 
| ** **                                                                                                                                      | ** ** | **December 31,  2007** | ** ** | **June 30,  2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
|                                                                                                                                            |       |                        |       |                    |       |
| **Assets**                                                                                                                                      |       |                        |       |                    |       |
| Current assets                                                                                                                                  |       |                        |       |                    |       |
| Cash and cash equivalents                                                                                                                       |       | $                           | 4,339      |                    | $          | 4,182 |   |
| Restricted cash                                                                                                                                 |       | 107                         |       | 109                     |       |
| Investments in marketable securities –  short term                                                                                         |       | 22,200                      |       | 12,873                  |       |
| Accounts receivable                                                                                                                             |       | 271                         |       | 57                      |       |
| Inventory                                                                                                                                       |       | 623                         |       | —                  |       |
| Prepaid expenses and other current assets                                                                                                       |       | 1,326                       |       | 319                     |       |
| Total current assets                                                                                                                            |       | 28,866                      |       | 17,540                  |       |
| Property and equipment, net                                                                                                                     |       | 557                         |       | 132                     |       |
| Investments in marketable securities – long  term                                                                                          |       | 2,599                       |       | —                  |       |
| Other assets                                                                                                                                    |       | 435                         |       | 27                      |       |
| Total assets                                                                                                                                    |       | $                           | 32,457     |                    | $          | 17,699 |   |
|                                                                                                                                            |       |                        |       |                    |       |
| **Liabilities and Stockholders’ Equity**                                                                                                   |       |                        |       |                    |       |
| Current liabilities                                                                                                                             |       |                        |       |                    |       |
| Accounts payable                                                                                                                                |       | $                           | 930        |                    | $          | 238 |   |
| Deferred revenue                                                                                                                                |       | 162                         |       | —                  |       |
| Accrued expenses                                                                                                                                |       | 1,416                       |       | 1,348                   |       |
| Total current liabilities                                                                                                                       |       | 2,508                       |       | 1,586                   |       |
| Other long term liabilities                                                                                                                     |       | 453                         |       | 302                     |       |
| Total liabilities                                                                                                                               |       | 2,961                       |       | 1,888                   |       |
|                                                                                                                                            |       |                        |       |                    |       |
| 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,  2007 and June 30, 2008 |       | 459                         |       | 92                      |       |
| Additional paid-in capital                                                                                                                      |       | 155,539                     |       | 155,897                 |       |
| Accumulated deficit                                                                                                                             |       | (126,502                    | )          | (140,158                | )          |
| Accumulated other comprehensive loss                                                                                                            |       | —                      |       | (20                     | )          |
| Total stockholders’ equity                                                                                                                 |       | 29,496                      |       | 15,811                  |       |
|                                                                                                                                            |       |                        |       |                    |       |
| Total liabilities and stockholders’ equity                                                                                                 |       | $                           | 32,457     |                    | $          | 17,699 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**MathStar, Inc.**

**CondensedConsolidated Statements of Operations**

**(Unaudited)**

**(in thousands, except per share data)**

 
| ** **                                                   | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended   June 30,** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                   | ** ** | **2007**                                              | ** ** | **2008**                                            | ** ** | **2007** | ** ** | **2008** | ** ** |
|                                                         |       |                                                  |       |                                                |       |   |   |   |   |
| Revenue                                                      |       | $                                                     | 120        |                                                | $          | 54 |   | $ | 212 |   | $ | 280 |   |
| Cost of sales                                                |       | 54                                                    |       | 904                                                 |       | 123 |   | 1,195 |   |
| Gross profit (loss)                                          |       | 66                                                    |       | (850                                                | )          | 89 |   | (915 | ) |
| Operating expenses:                                          |       |                                                  |       |                                                |       |   |   |   |   |
| Research and development                                     |       | 2,607                                                 |       | 3,542                                               |       | 5,732 |   | 7,094 |   |
| Selling, general and administrative                          |       | 2,107                                                 |       | 1,469                                               |       | 4,569 |   | 3,562 |   |
|                                                         |       |                                                  |       |                                                |       |   |   |   |   |
| Restructuring and impairment charges                         |       | —                                                |       | 2,601                                               |       | — |   | 2,601 |   |
|                                                         |       | 4,714                                                 |       | 7,612                                               |       | 10,301 |   | 13,257 |   |
| Operating loss                                               |       | (4,648                                                | )          | (8,462                                              | )          | (10,212 | ) | (14,172 | ) |
| Interest income                                              |       | 107                                                   |       | 210                                                 |       | 226 |   | 490 |   |
| Other income, net                                            |       | (14                                                   | )          | (11                                                 | )          | (16 | ) | 26 |   |
| Net loss                                                     |       | $                                                     | (4,555     | )                                                   | $          | (8,263 | ) | $ | (10,002 | ) | $ | (13,656 | ) |
|                                                         |       |                                                  |       |                                                |       |   |   |   |   |
| Basic and diluted loss per share from  continuing operations |       | $                                                     | (0.94      | )                                                   | $          | (0.90 | ) | $ | (2.22 | ) | $ | (1.49 | ) |
|                                                         |       |                                                  |       |                                                |       |   |   |   |   |
| Weighted average basic and diluted shares  outstanding       |       | 4,827                                                 |       | 9,181                                               |       | 4,505 |   | 9,181 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**MathStar, Inc.**

**CondensedConsolidated Statements of Cash Flows**

**(Unaudited)**

**(in thousands)**

 
| ** **                                                                  | ** ** | **Six Months Ended   June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2007**                                            | ** ** | **2008** | ** ** |
|                                                                        |       |                                                |       |   |   |
| **Cash flows from operating activities**                                    |       |                                                |       |   |   |
| Net loss                                                                    |       | $                                                   | (10,002    | ) | $ | (13,656 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities |       |                                                |       |   |   |
| Depreciation and amortization                                               |       | 82                                                  |       | 111 |   |
| Loss on asset disposal                                                      |       | 4                                                   |       | 48 |   |
| Asset impairment charges                                                    |       |                                                |       | 1,006 |   |
| Amortization of discount on  held-to-maturity securities                    |       |                                                |       | 39 |   |
| Loss on sale of available-for-sale  securities                              |       |                                                |       | 7 |   |
| Non-cash changes in inventory                                               |       |                                                |       | 734 |   |
| Stock-based compensation                                                    |       | (51                                                 | )          | (9 | ) |
| Restructuring charges                                                       |       |                                                |       | 563 |   |
| Gain on sale of marketable securities                                       |       |                                                |       | (42 | ) |
| Foreign currency remeasurement                                              |       | 7                                                   |       | 7 |   |
| Change in operating assets and liabilities                                  |       |                                                |       |   |   |
| Accounts receivable                                                         |       | (117                                                | )          | 214 |   |
| Inventory                                                                   |       | (126                                                | )          | (111 | ) |
| Prepaid expenses and other assets                                           |       | 575                                                 |       | 703 |   |
| Accounts payable                                                            |       | (798                                                | )          | (692 | ) |
| Deferred revenue                                                            |       | 139                                                 |       | (162 | ) |
| Accrued expenses                                                            |       | (207                                                | )          | (785 | ) |
| Net cash used in operating activities                                       |       | (10,494                                             | )          | (12,025 | ) |
|                                                                        |       |                                                |       |   |   |
| ** Cash  flows from investing activities**                             |       |                                                |       |   |   |
| Purchase of property and equipment                                          |       | (58                                                 | )          | (50 | ) |
| Proceeds from sale of equipment                                             |       |                                                |       | 21 |   |
| Purchase of capitalized application  software                               |       | (269                                                | )          |   |   |
| Proceeds from sale of held-to-maturity  securities                          |       |                                                |       | 13,058 |   |
| 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                                                             |       | (2                                                  | )          | (2 | ) |
| Net cash used in investing activities                                       |       | (329                                                | )          | 11,871 |   |
|                                                                        |       |                                                |       |   |   |
| ** Cash  flows from financing activities**                             |       |                                                |       |   |   |
| Proceeds from issuance of common stock, net  of offering costs              |       | 36,485                                              |       |   |   |
| Proceeds from exercise of warrants, net of  costs                           |       | 21                                                  |       | — |   |
| Proceeds from exercise of stock options                                     |       | 9                                                   |       | — |   |
| Net cash provided by financing activities                                   |       | 36,515                                              |       | — |   |
| Effect of exchange rate changes on cash                                     |       |                                                |       | (3 | ) |
| Net decrease in cash and cash equivalents                                   |       | 25,692                                              |       | (157 | ) |
| **Cash and cash equivalents**                                               |       |                                                |       |   |   |
| Beginning of period                                                         |       | 12,891                                              |       | 4,339 |   |
| End of period                                                               |       | $                                                   | 38,583     |   | $ | 4,182 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**MathStar, Inc.**

**Notes toConsolidated Financial Statements**

**(in thousands, except per share data)**

 

**1.            Basisof Presentation**

** **

Theaccompanying interim condensed consolidated financial statements of MathStar, Inc.(“MathStar” or the “Company”) have been prepared in conformity with UnitedStates generally accepted accounting principles (U.S. GAAP), consistent in allmaterial respects with those applied in the Company’s Annual Report on Form 10-Kfiled with the Securities and Exchange Commission (“SEC”) on March 14,2008. The year-end condensed consolidated balance sheet was derived fromaudited financial statements, but does not include all disclosure required by U.S.GAAP. The preparation of financial statements in conformity with U.S. GAAPrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and the disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

 

Theinterim financial information is unaudited, but it reflects all normaladjustments that are, in the opinion of management, necessary to provide a fairstatement of results for the interim periods presented. The interim financialresults are not necessarily indicative of results to be expected in futureinterim or annual periods. The interim financial statements should be read inconjunction with the financial statements in the Company’s Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on March 14, 2008.

 

Theaccompanying financial statements have been prepared on a basis which assumesthat the Company will continue as a going concern and which contemplates therealization of assets and the satisfaction of liabilities and commitments inthe normal course of business. During the three months ended March 31, 2008, salesdid not materialize as expected, and development of the next generation of FPOAfell even further behind schedule. As a result, on May 20, 2008, the Boardof Directors voted to curtail research and development activities and ongoingoperations while analyzing strategic alternatives to protect the value to the stockholders.Alternatives could include merger, acquisition, increasing operations inanother structure or liquidation.

 

TheCompany’s stockholders approved a one-for-five reverse stock split, effectiveMay 23, 2008. The accompanying financial statements and related notes giveretrospective effect to this split on recorded share amounts and earnings pershare information.

 

**2.            Restructuring andImpairment Charges**

** **

Duringthe three months ended June 30, 2008, the Company announced a curtailmentof operations as it evaluated strategic alternatives to preserve shareholdervalue.  This decision resulted inrestructuring and impairment charges of $3,483. Management determined that it was highly likely that certain operationalassets would not be used and no alternatives existed. In accordance with Statement of Financial Accounting Standards(“SFAS”) No. 144, “*Accounting for theImpairment or Disposal of Long-Lived Assets*” issued by the FinancialAccounting Standards Board (“FASB”), these assets were deemed to be impairedand either held-for-sale or abandoned and written down to their fair marketvalue.  A plan to locate potential buyerswas put in place for their disposal, and no further depreciation expense will becharged to the Company’s operating activity. In addition, the Company evaluatedassets that were not abandoned or held-for-sale and determinedthat the estimated useful lives of these assets should be shortened.Accordingly, higher depreciation expense has been incurred during the period. As well, in accordancewith SFAS Statement No. 146 issued by the Financial Accounting StandardsBoard (“FASB”), “*Accountingfor Costs Associated with Exit or Disposal Activities”*, certain one-time chargesrelating to severance to terminated employees, and fees associated with earlycontract terminations no longer used and giving economic benefit to theCompany, were recorded. As the liabilities for these charges are settled,payment will be made against the liability, and there will not be any furtherimpact on the Company’s operating results.

 

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Managementbelieves that no further charges will be incurred for this activity, except forpotential termination of non-cancelable lease liabilities for the Hillsboro andMinnesota facilities, which will depend on the strategic direction chosen bythe Company. The amount of the potential lease termination liability will notbe known until the strategic direction is identified. Below is the detail ofrestructuring and impairment charges.

 
| ** **                                                             | ** ** | **Three Months  Ended June 30,  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                                                   |       | 40                                                    |       |
| Assets abandoned                                                       |       | 727                                                   |       |
| Charged to operating expenses as  restructuring and impairment charges |       | 2,601                                                 |       |
|                                                                   |       |                                                  |       |
| Total charges for restructuring and  impairment                        |       | $                                                     | 3,483      |   |

 

Severanceexpense of $1,506 impacted approximately 75 employees, which accounted for amajority of the Company’s workforce.  Thefollowing is a rollforward of severance liabilities recorded during the quarterended June 30, 2008.

 
| ** **                          | ** ** | **Severance** | ** ** |
|-------------------------------------|------------|---------------|------------|
| Liability as of March 31, 2008 |       | $             | —     |   |
| Additions                           |       |          | 1,506      |   |
| Payments                            |       | 943           |       |
| Liability as of June 30, 2008  |       | $             | 563        |   |

 

**3.            NewAccounting Pronouncements**

 

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (SFAS No. 157), which defines fair value, establishes aframework for measuring fair value in generally accepted accounting principlesand expands disclosures about fair value measurements. SFAS No. 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. In February 2008, theFASB issued FSP FAS 157-2 “Partial Deferral of the Effective Date of Statement157” (FSP 157-2). FSP 157-2 delays the effective date of SFAS No. 157 fornon-financial assets and liabilities that are not measured or disclosed on arecurring basis to fiscal years

 

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beginningafter November 15, 2008. The adoption of this accounting pronouncement didnot have a material effect on the Company’s consolidated financial statementsfor financial assets and liabilities and any other assets and liabilitiescarried at fair value although we expanded the disclosure requirements tocomply with SFAS No. 157.  The Company is currently in theprocess of evaluating the impact of adopting this pronouncement for othernon-financial assets or liabilities.

 

SFASNo. 157 defines fair value as the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date (exit price). SFAS No. 157 classifiesthe inputs used to measure fair value into the following hierarchy:

 
| Level  1 |   | Unadjusted  quoted prices in active markets for identical assets or liabilities                                                                                                                                                                                                |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                                                                                                                                           |
| Level  2 |   | Unadjusted  quoted prices in active markets for similar assets or liabilities, or  unadjusted quoted prices for identical or similar assets or liabilities in  markets that are not active, or inputs other than quoted prices that are  observable for the asset or liability |
|     |   |                                                                                                                                                                                                                                                                           |
| Level  3 |   | Unobservable  inputs for the asset or liability                                                                                                                                                                                                                                |

 

Weendeavor to utilize the best available information in measuring fair value.Financial assets and liabilities are classified in their entirety based on thelowest level of input that is significant to the fair value measurement.

 

InFebruary 2007, the FASB issued SFAS No. 159, “The fair value optionfor Financial Assets and Liabilities—including Amendment*of FAS No. 115”.*SFAS No. 159gives companies the option of recording certain financial assets andliabilities at fair value. SFAS No. 159 was effective for the Companycommencing January 1, 2008. The Company’s adoption of SFAS No. 159did not have an impact on the financial statements, as the Company did notelect to record eligible items at fair value.

 

InDecember 2007, the FASB issued SFAS No. 141 (revised 2007), “BusinessCombinations” and SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements”.  These standards aim to improve, simplify andconverge internationally the accounting for business combinations and thereporting of noncontrolling interests in consolidated financialstatements.  The provisions of SFAS No. 141(R) and SFAS No. 160apply to business combinations for which the acquisition date is on or afterthe beginning of the first annual reporting period beginning on or after December 31,2008.  The Company does not expect the provisions of SFAS No. 141(R) andSFAS No. 160 will have an effect on its consolidated financial positionand results of operations.

 

**4.      StockBased Compensation**

** **

MathStar has issued options as a means to incentpotential employees to join and retain certain existing employees.  The Company accounts for options grantedunder SFAS No. 123R (revised 2004), “*Share-Based Payment*,”utilizing the Black-Scholes pricing model. The table below discloses option activity during the first six months of2008 and the total options outstanding as of June 30, 2008, as adjustedfor the one-for-five reverse stock split effective on May 23, 2008.

 
| ** **                            | ** ** | ** **     | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **     | ** ** |
|---------------------------------------|------------|----------------|------------|---------------|------------|-----------------|------------|----------------|------------|
| ** **                            | ** ** | ** **     | ** ** | ** **    | ** ** | **Average**     | ** ** | **Aggregate**  | ** ** |
| ** **                            | ** ** | ** **     | ** ** | **Weighted-** | ** ** | **Remaining**   | ** ** | **Intrinsic**  | ** ** |
| ** **                            | ** ** | **Shares**     | ** ** | **Average**   | ** ** | **Contractual** | ** ** | **Value**      | ** ** |
| ** **                            | ** ** | **(in**        | ** ** | **Exercise**  | ** ** | **Term**        | ** ** | **(in**        | ** ** |
| **Options**                           | ** ** | **thousands)** | ** ** | **Price**     | ** ** | **(in years)**  | ** ** | **thousands)** | ** ** |
| Outstanding at December 31, 2007 |       | 670            |       | $             | 18.15      |            | 8.01       |           | $          | 0 |   |
| Granted                               |       | 26             |       | 2.58          |       |            |       |           |       |
| Exercised                             |       | —         |       | —        |       |            |       |           |       |
| Forfeited or expired                  |       | (569           | )          | 16.55         |       | 8.01            |       |           |       |
| Outstanding at June 30, 2008     |       | 127            |       | $             | 22.01      |            | 6.26       |           | $          |   |   |
|                                  |       |           |       |          |       |            |       |           |       |
| Exercisable at June 30, 2008     |       | 86             |       | $             | 25.12      |            | 5.24       |           | $          | 0 |   |
|                                       |            |                |            |               |            |                 |            |                |            |  |  |  |

 

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For the first six months of 2008, the Companyrecorded non-cash income of ($9) primarily resulting from the revised estimateof the expected forfeiture rate of unvested stock options resulting from therestructuring during the second quarter of 2008. The forfeiture rate wasincreased to reflect the termination of employees whose options will likelyexpire without being exercised due to their price and period available forexercise.  In the first six months of2007, the Company had $328 in non-cash stock-based compensation expense.

 

**5.    SelectedBalance Sheet Information**

 

**Restricted Cash**

 

TheCompany has pledged collateral to secure the balances on Company issued creditcards. The Company cannot use the restricted cash in the normal course ofbusiness until the credit cards are cancelled or the bank releases the funds.The credit cards are issued to certain Company employees for the purpose oftravel and Company related purchases. The amount pledged as collateral amountedto $109 on June 30, 2008 compared to $107 on December 31, 2007.

 

**Investment Securities**

 
| ** **                        | ** ** | **December 31,  2007** | ** ** | **June 30,  2008** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Short-term                        |       |                        |       |                    | ** ** |
| Available-for-sale                |       | $                           | 2,605      |                    | $          |   |
| Municipal securities              |       |                        |       |                    |       |
| Auction preferred securities      |       |                        |       | 808                     |       |
| Held-to-maturity                  |       |                        |       |                    |       |
| Government securities             |       | 19,595                      |       | 9,518                   |       |
| Corporate bonds and notes         |       |                        |       | 2,547                   |       |
| Total short term investments      |       | 22,200                      |       | 12,873                  |       |
|                              |       |                        |       |                    |       |
| Long-term – held-to-maturity |       | 2,599                       |       |                    |       |
| Corporate bonds and notes         |       |                        |       |                    |       |
|                              |       |                        |       |                    |       |
| Total investments                 |       | $                           | 24,799     |                    | $          | 12,873 |   |
|                                   |            |                             |            |                         |            |  |  |

 

Investmentsclassified as held-to-maturity have timed maturities to meet forecasted cashneeds, which range from July 2008 to February 2009 and are reportedat amortized cost, as the Company has the ability and intent to hold these securitiesto maturity. Investments with maturities beyond one year are classified aslong-term investment securities.

 

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| ** **                    | ** ** | ** **  | ** ** | **Fair Value Measurement at Reporting Date   Using**          | ** ** |
|-------------------------------|------------|-------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                    | ** ** | ** **  | ** ** | **Quoted Prices  in Active   Markets for   Identical Assets** | ** ** | **Significant   Other   Observable   Inputs** | ** ** | **Significant   Unobservable   Inputs** | ** ** |
| **Description**               | ** ** | **6/30/08** | ** ** | **(Level 1)**                                                                          | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
|                          |       |        |       |                                                                                        |       |   |   |   |   |
| Available-for-sale securities |       | $           | 808        |                                                                                        | —     |   | — |   | $ | 808 |   |
| Total                         |       | $           | 808        |                                                                                        | —     |   | — |   | $ | 808 |   |

 

Wehave auction preferred securities (APS), which are preferred equity instrumentsin a closed-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.

 

TheCompany generally invests in these securities as part of its overall cashmanagement program. During the first quarter of 2008, the Company’s APS failedto auction due to sell orders exceeding buy orders. The funds associatedwith failed auctions will not be accessible until a successful auction occurs,the fund redeems outstanding APS or an active secondary market is created and abuyer is identified outside of the auction process.

 

AtJune 30, 2008, there was insufficient observable APS market informationavailable to determine the fair value of the Company’s investments in APS.Therefore, the Company estimated Level 3 fair values for these securities byincorporating assumptions that market participants would use in their estimatesof fair value. Despite the failed auctions, the Company’s APS continue to behighly rated by the rating agencies.  Ofthe original $2,680 in APS purchased, $1,850 was redeemed on May 27, 2008at face value, with the remaining amount expected to be redeemed in theupcoming quarter.  Based upon thisanalysis, the Company adjusted the June 30, 2008 carrying value of thesesecurities downward to fair value by the amount of $20. The entire adjustmentamount, which resulted from the limited liquidity of those investments, wasconsidered temporary and was recorded in other comprehensive income. The APSunderlying this temporary adjustment amount was classified as current as of June 30,2008 due to the anticipated redemption. These funds are not required to meetthe Company’s current operating activities or to satisfy its outstanding liabilities.

 

Asfurther required by SFAS No. 157, provided below is a reconciliation ofthe beginning and ending balances for each type of security valued using aLevel 3 valuation at June 30, 2008.

 
| ** **                                                                                     | ** ** | **Fair Value Measurement Using Significant  Unobservable Inputs (Level 3)** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **Action  Preferred   securities**                                                                        | ** ** |
| Beginning balance as of March 31, 2008                                                    |       | $                                                                                                              | 2,592      |   |
| Total gains or losses realized/unrealized included  in earnings included in comprehensive loss |       | 73                                                                                                             |       |
| Purchases, issuance and settlements                                                            |       | (1,857                                                                                                         | )          |
| Ending Balance as of June 30, 2008                                                        |       | $                                                                                                              | 808        |   |

 

**Inventory**

 
| ** **                                       | ** ** | **December 31,  2007** | ** ** | **June 30,  2008** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Raw materials and sub assemblies                 |       | $                           | 113        |                    | $          | 0 |   |
| Finished goods                                   |       | 717                         |       | 588                     |       |
|                                             |       | $                           | 830        |                    | $          | 588 |   |
| Less: reserve for excess and obsolete  inventory |       | (207                        | )          | (588                    | )          |
| Total inventory, net                             |       | $                           | 623        |                    | $          | 0 |   |

 

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**Prepaid and Other Current Assets**

 
| ** **                             | ** ** | **December 31,   2007** | ** ** | **June 30,   2008** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|
| Design licenses (short term)           |       | $                                 | 729        |                          | $          |   |
| Interest receivable                    |       | 307                               |       | 189                           |       |
| Prepaid insurance                      |       | 189                               |       | 64                            |       |
| Prepaid rent                           |       | 33                                |       | 28                            |       |
| Other                                  |       | 68                                |       | 38                            |       |
| Total prepaid and other current assets |       | $                                 | 1,326      |                          | $          | 319 |   |
|                                        |            |                                   |            |                               |            |  |  |

** **

**Property and Equipment**

 
| ** **                        | ** ** | **December 31,   2007** | ** ** | **June 30,   2008** | ** ** |
|-----------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|
| Computer equipment                |       | $                                 | 144        |                          | $          | 51 |   |
| Purchased software                |       | 533                               |       | 91                            |       |
| Equipment                         |       | 207                               |       | 24                            |       |
| Furniture and fixtures            |       | 387                               |       | 197                           |       |
|                              |       | $                                 | 1,271      |                          | $          | 363 |   |
|                              |       |                              |       |                          |       |
| Less: Accumulated depreciation    |       | (714                              | )          | (231                          | )          |
| Total property and equipment, net |       | $                                 | 557        |                          | $          | 132 |   |

 

Depreciationexpense was $39 and $50 for the three months ended June 30, 2007 and 2008,respectively, and $80 and $102 for the six months ended June 30, 2007 and2008, respectively.

 

Under SFAS No. 144, *“Accounting for the Impairment or Disposal of Long Lived Assets”,*assetsthat are no longer used in operations and held for sale should be written downto the expected fair market value and depreciation ceased as of thedetermination date. In June 2008, the Company recorded a noncash charge of$328 to adjust the book value to fair value of nonoperational assets held forsale. The depreciation of assets remaining in service was accelerated and theassets will be fully depreciated in October 2008.

 

**Other Assets**

 
| ** **                                                                                                                        | ** ** | **December 31,   2007** | ** ** | **June 30,   2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|
| Deposits                                                                                                                          |       | $                                 | 36         |                          | $          | 27 |   |
| Design licenses (long-term)                                                                                                       |       | 347                               |       |                          |       |
| Capitalized IP, net of accumulated  amortization of $12 and $0 as of December 31, 2007 and June 30,  2008, respectively |       | 52                                |       |                          |       |
| Total other assets                                                                                                                |       | $                                 | 435        |                          | $          | 27 |   |

 

Amortizationexpense associated with capitalized application software was $2 and $4 for thethree months ended June 30, 2007 and 2008, respectively, and $2 and $9 forthe six months ended June 30, 2007 and 2008, respectively.

 

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**Accrued Expenses**

 
| ** **                    | ** ** | **December 31,   2007** | ** ** | **June 30,   2008** | ** ** |
|-------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|
|                          |       |                              |       |                          |       |
| Accrued rent                  |       | $                                 | 48         |                          | $          | 49 |   |
| Accrued compensation          |       | 702                               |       | 100                           |       |
| Accrued professional fees     |       | 161                               |       | 202                           |       |
| Accrued license contracts     |       | 389                               |       | 366                           |       |
| Accrued restructuring charges |       |                              |       | 563                           |       |
| Other                         |       | 116                               |       | 68                            |       |
| Total accrued expenses        |       | $                                 | 1,416      |                          | $          | 1,348 |   |

 

**Comprehensive Income**

 
| ** **                               | ** ** | **Six Months Ended**          | ** ** |
|------------------------------------------|------------|-------------------------------|------------|
| ** **                               | ** ** | **June 30,   2007** | ** ** | **June 30,   2008** | ** ** |
| Net loss                                 |       | $                             | (10,002    | ) | $ | (13,656 | ) |
| Unrealized loss on marketable securities |       | —                        |       | (20 | ) |
| Comprehensive loss                       |       | $                             | (10,002    | ) | $ | (13,676 | ) |

 

**Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*This Quarterly Report on Form 10-Q containsforward-looking statements, which are being provided under the “safe harbor”protection of the Private Securities Litigation Reform Act of 1995.Forward-looking statements are generally written in the future tense and/or arepreceded by words such as “will,” “may,” “should,” “could,” “expect,” “suggest,”“believe,” “anticipate,” “intend,” “plan,” or other similar words.Forward-looking statements include statements regarding the commercial successof our new products; the growth prospects of the semiconductor industry andprogrammable logic market, including the field programmable object array (“FPOA”)and field programmable gate array (“FPGA”) product sub-segments;and trends in our future sales, including our opportunities for growth bydisplacing FPGAs, application-specific integrated circuits (“ASICs”) and othersemiconductor alternatives.*

 

*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 other communications,except as required by law. All such forward-looking statements should be readas of the time the statements were made and with the recognition that theseforward-looking statements may not be complete or accurate at a later date.*

 

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*Many factors may cause actual results to differ materiallyfrom those expressed or implied by the forward-looking statements contained inthis report. These factors include, but are not limited to, those risksdescribed in our Annual Report on Form 10-K filed on March 14, 2008,as updated in our Quarterly Report on Form 10-Q filed on May 12, 2008and in this Quarterly Report.*

 

**Business Overview**

 

Duringthe three months ended June 30, 2008, sales of our field programmable objectarray, or FPOA did not materialize as expected, and development of the nextgeneration of FPOA fell even further behind schedule. As a result, on May 20,2008 the Board of Directors voted to suspend research and developmentactivities and ongoing operations while analyzing strategic alternatives toprotect the remaining value to the stockholders. Alternatives could includemerger, acquisition, increasing operations in another structure or liquidation.

 

**Recently Issued Accounting Pronouncements**

 

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

 

**Critical Accounting Policies**

 

Therewere no changes in critical accounting policies in the three months ended June 30,2008.

 

**Results of Operations**

 

***Three MonthsEnded June 30, 2007 and 2008***

 

*Revenue.*For the three months ended June 30, 2008, we generated revenue of$54,000 compared to $120,000 for the same period last year. Revenue for thethree months ended June 30, 2008 was from the sale of production FPOAchips of $50,000 and the sale of evaluation products of $4,000. Revenue for thethree months ended June 30, 2007 was from the sale of sample FPOA chips of$7,000, development systems of $32,000, and licensed software and NRE fees of$81,000.

 

*Cost of Sales.* Cost of sales for the three months ended June 30,2008 and 2007 were $904,000 and $54,000, respectively. Costs of sales in thesecond quarter of 2008 include external chip costs of $5,000, costs fordevelopment products of $2,000, a non-cash charge of $533,000 for excess andobsolete inventory comprised primarily of current generation chips held ininventory, $353,000 for scrapping tool licenses and raw material, and othercharges of $11,000. The cost of sales for the three months ended June 30,2007 was made up of production costs of development systems of $6,000, externalcosts of engineering services of $30,000, and other costs of $18,000.  Inventory on hand exceeds current salesforecasts, and with our uncertain strategic direction, the excess and obsoletereserve was increased and charged to cost of sales, reducing the inventory tozero.

* *

*Gross Margin.*Gross margin for the three months ended June 30,2008 was (1,574%) compared to 55% for the three months ended June 30,2007. The $897,000 non-cash excess and obsolete and scrap charges had a(1,661%) impact on the gross margin percentage for the three months ended June 30,2008.

 

*Research and Development.* For the three months ended June 30,2008, research and development expenses increased $935,000 or 36% to $3,542,000from $2,607,000 for the three months ended June 30, 2007. The increase isthe result of $1,158,000  in higherengineering services and material to complete design services of the nextgeneration chip, development tool expense of $49,000 and charges forapplication IP development of $238,000 because technological feasibility hadnot been established on the

 

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developmentprojects.  The increase was offset by lower employee related expenses of$293,000 due to terminating the employment of 25 employees while we evaluateour strategic options; consulting and contractor fees of $77,000; building rentof $62,000 resulting from the downsizing of our Minneapolis facility; and$78,000 in other related charges. Research and development expenses and the mixof those expenses are heavily dependent on where we are in the developmentcycle of new technology. The three months ended June 30, 2008 was a periodduring which final design was being completed just prior to tape-out and washeavily dependent on design tools and outside engineering service contracts. Incontrast, the three months ended June 30, 2007 was a period of internaldesign work, which is very labor intensive. Should we choose to restartdevelopment activity, employee related expenses will drastically increase as wereestablish the research and development team.

 

*Selling, General and Administrative. *For the three months ended June 30,2008, selling, general and administrative expenses decreased $638,000 or 30% to$1,469,000, compared to $2,107,000 for the three months ended June 30,2007. The decrease was primarily the result of reduced employee relatedexpenses of $480,000, travel expenses of $66,000, computer expenses of $15,000,advertising and trade show costs of $9,000, and infrastructure and other chargesof $68,000.  Our selling, general and administrative infrastructure isreduced to key individuals necessary to sustain the corporate structure andactivities and plan our strategic direction. Should we choose to increaseoperations, there will be significant one-time and recurring expenses requiredto grow our organizational infrastructure.

* *

*Restructuring and Impairment Charges:*For the threemonths ended June 30, 2008, we recorded restructuring and impairmentcharges of $2,601,000. These charges consisted of severance payments of$1,506,000, contract termination charges of $40,000, $727,000 for abandonedassets no longer of value, and $328,000 for the write-down of assets availablefor sale to their estimated fair value.

 

Severanceexpense of $1,506,000 impacted approximately 75 employees, which accounted fora majority of the Company’s workforce. The following is a rollforward of severance liabilities recorded duringthe quarter ended June 30, 2008.

 
| ** **                          | ** ** | **Severance** | ** ** |
|-------------------------------------|------------|---------------|------------|
| Liability as of March 31, 2008 |       | $             | —     |   |
| Additions                           |       |          | 1,506,000  |   |
| Payments                            |       | 943,000       |       |
| Liability as of June 30, 2008  |       | $             | 563,000    |   |

 

The remaining severance payments are expected to bepaid during the quarterending September 30, 2008 and relateto the remaining employees retained to assist in the completion of thestrategic alternatives currently being evaluated.  There were no restructuring charges for thethree months ended June 30, 2007.

 

*Other Income (Expense).*For the three months ended June 30,2008, other income increased by $106,000 or 114% to $199,000 compared to$93,000 for the three months ended June 30, 2007. The increase wasprimarily the result of $103,000 in additional interest income on higherinvestment balances.

 

***Six Months Ended June 30,2007 and 2008***

 

*Revenue.*For the six months ended June 30, 2008, we generated revenue of$280,000 compared to $212,000 for the same period last year. Revenue for thesix months ended June 30, 2008 was from the sale of production FPOA chipsof $276,000 and development products of $4,000. Revenue for the six monthsended June 30, 2007 was from the sale of production FPOA chips of $16,000,development products of $108,000, and software license fees and engineeringservices of $88,000.

 

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*Cost of Sales.* Costof sales for the six months ended June 30, 2008 and 2007 were $1,195,000and $123,000, respectively. Cost of sales for the six months ended June 30,2008 include product costs of $36,000, a non-cash charge of $776,000 for excessand obsolete inventory, scrap costs associated with tool licenses and rawmaterial write-offs of $363,000, and other costs of $20,000.  Costs of sales for the six months ended June 30,2007 was from manufacturing costs of the chips of $1,000, development productsof $56,000, the cost of the third party software licenses and subcontracted NREservices of $30,000, and other costs of sales of $36,000.  We have current products for sale and areactively marketing them. However, inventory exceeds current sales forecasts,and with uncertain strategic direction, the excess and obsolete reserve wasincreased and charged to cost of sales.

 

*Gross Margin.*Gross margin for the six months ended June 30,2008 was (327%) compared to 42% for the six months ended June 30, 2007.The $776,000 non-cash excess and obsolete charge had a (277%) impact on thegross margin percentage for the six months ended June 30, 2008.

 

*Research and Development.* For the six months ended June 30, 2008,research and development expenses increased $1,362,000 or 24% to $7,094,000from $5,732,000 for the six months ended June 30, 2007. The increase isthe result of employee related expenses of $28,000, consulting and contractorexpense of $77,000, development tool expense of $168,000, charges forapplication IP development of $515,000 because technological feasibility hadnot been established on the development projects, and external developmentcosts associated with the completion of the next generation FPOA of$1,029,000.  The increase was offset by lower building rent of $279,000resulting from the downsizing of our Minneapolis facility and $176,000 invalidation and other related charges. Research and development expenses and themix of those expenses are heavily dependent on where we are in the developmentcycle of new technology. The six months ended June 30, 2008 was a periodwhere final design was completed, which is very labor and design tool dependentand external development costs. In contrast, the six months ended June 30,2007 was a period following tape-out of the current production chip andrequired more validation related expenses.

 

*Selling, General and Administrative. *For the six months ended June 30, 2008,selling, general and administrative expenses decreased $1,007,000 or 22% to$3,562,000, compared to $4,569,000 for the six months ended June 30, 2007.The decrease was primarily the result of reduced  employee related expenses of $499,000,recruiting fees of $119,000, advertising costs of $59,000, consulting andoutside services of $68,000, travel expenses of $75,000, insurance costs of$25,000, and infrastructure and other charges of $162,000.  Our selling,general and administrative infrastructure is reduced to key individualsnecessary to sustain the corporate structure and activities and plan ourstrategic direction. Should we choose to increase operations, there will besignificant one-time and recurring expenses required to grow our organizationalinfrastructure.

 

*Restructuring and Impairment Charges:*For the six monthsended June 30, 2008, we recorded restructuring and impairment charges of$2,601,000.  See further discussion ofthese restructuring charges above in the results of operations for the threemonths ended June 30, 2007 and 2008.

 

*Other Income (Expense).*For the six months ended June 30, 2008,other income increased by $306,000 or 146% to $516,000 compared to $210,000 forthe six months ended June 30, 2007. The increase was the result of$264,000 in additional interest income on higher investment balances, $40,000in a gain resulting from the sale and reinvestment of investments held, and$2,000 gain on foreign currency translation.

 

**Liquidity and Capital Resources**

 

Inresponse to the Board of Director’s decision to curtail operations and evaluateour strategic alternatives, staff was reduced to 10 key individuals needed tosustain the corporate structure and activities and plan our strategicdirection. We have sufficient cash and investments to satisfy all outstandingobligations and to initiate actions based on the strategic direction when determinedby the Board of Directors.

 

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InJanuary 2008, we purchased $2.6 million of investments comprised ofauction preferred securities (APS). All of our APS are AAA rated by one of themajor credit rating agencies.  Since mid-February 2008, we have experiencefailed auctions for our entire APS portfolio, resulting in our inability tosell these securities. A failed auction results in a lack of liquidity inthe securities but does not signify a default by the issuer.  Upon anauction failure, the interest rates on the APS do not reset at a market ratebut instead reset based on a formula contained in the APS, which generally ishigher than the current market rate. The issuer of the APS redeemed $1.85million of the securities on May 27, 2008 and is actively putting a planin place to redeem the remainder. We anticipate further redemption by September 30,2008 of our remaining $808,000 of APS.  We do not currently need these funds to satisfy outstanding obligationsor meet short-term operating requirements.

 

Weclassified our APS as available-for-sale, which resulted in the $20,000adjustment to the carrying value of our APS to mark them to fair value, whichwas recorded in other comprehensive loss. If uncertainties in the creditand capital markets continue, if the credit worthiness of the issuancedeteriorates, or if we no longer have the ability to hold these investments, wemay be required to recognize impairment charges or additional losses on our APSor a loss on their disposition.

 

***Net Cash Used inOperating Activities***

 

Netcash used in operating activities was $12,025,000 and $10,494,000 for the sixmonths ended June 30, 2008 and 2007, respectively. Net cash used foroperating activities for the six months ended June 30, 2008 was to fundthe completion of the design of our next generation of FPOA chip, pay ourselling, general and administrative costs, pay severance payments to employeeswhose employment was terminated, and fund contract termination expenses. Netcash used for the six months ended June 30, 2007 was to fund our on-goingresearch and development activities and our selling, general and administrativecosts.

 

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

 

Netcash provided by investing activities for the six months ended June 30,2008 was $11,871,000. Cash used in investing activities for the six monthsended June 30, 2007 was $329,000 for the purchase of capital equipment.Net cash provided by investing activities for the six months ended June 30,2008 was from the proceeds from the sale of investments of $11,902,000, $21,000from the sale of equipment, $50,000 used to purchase capital equipment and$2,000 in the increase of restricted cash. Net cash used in the six monthsended June 30, 2007 was for the purchase of $269,000 in capitalized intellectualproperty, $58,000 for the purchase of equipment, and $2,000 in the increase ofrestricted cash.

 

***Net Cash Providedby Financing Activities***

 

Netcash provided by financing activities was $36,515,000 for the six months ended June 30,2007. For the six months ended June 30, 2007, the cash provided byfinancing activities was from proceeds from the exercise of options andwarrants of $30,000 and $36,485,000 from the issuance of common stock net ofoffering costs. There were no financing activities for the six months ended June 30,2008.

 

**Off-Balance Sheet Arrangements**

 

Wedo not have any relationships with unconsolidated entities or financialpartnerships, such as entities often referred to as structured finance orspecial purpose entities, which would have been established for the purpose offacilitating off-balance sheet arrangements or other contractually narrow orlimited purposes. In addition, we do not engage in trading activities involvingnon-exchange traded contracts. As such, we are not materially exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin these relationships.

 

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**Item 3. Quantitative andQualitative Disclosures about Market Risk**

 

Ourexposure to market risk is confined to our cash equivalents and investments. Wehave invested in high-quality financial instruments, primarily money marketfunds, federal agency notes and asset-backed securities, which we believe aresubject to limited credit risks. Our investments are matched to forecasted cashneeds such that investments will not be sold prior to maturity and expose us tolosses due to interest rate changes.  Included in our investments are APS.These auctions have historically provided a liquid market for these securities,as investors could readily sell their investments at auction. With theliquidity issues experienced in global credit and capital markets, the APS heldby us have experienced failed auctions, beginning on February 19, 2008, asthe amount of securities submitted for sale has exceeded the amount of purchaseorders, making the liquidity of the securities questionable. Despite the failedauctions, our APS continue to be highly rated by the rating agencies. Webelieve we will have full redemption of all APS at par. If all APS are notredeemed, it could have a negative effect on the liquidity of our fundsavailable for strategic alternatives.

 

**Item 4. Controls andProcedures**

 

*Evaluation of Disclosure Controlsand Procedures*

 

Duringthe fiscal period covered by this report, our management, with theparticipation of the Chief Executive Officer and Chief Financial Officer,completed an evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934 (“Exchange Act”). Basedupon this evaluation, our Chief Executive Officer and Chief Financial Officerhave concluded that, as of the end of the fiscal period covered by this report,our disclosure controls and procedures were effective to ensure thatinformation required to be disclosed by us in reports that we file or submitunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified by the rules and forms of the Securities andExchange Commission and that such information is accumulated and communicatedto management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate, to allow timely decisions regarding requireddisclosures.

 

*Changes in Internal Control OverFinancial Reporting*

 

Therewere no changes in our internal control over financial reporting during thefiscal quarter covered by this report that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting. Sufficient accounting and finance staff was retained to insurecontinued control over financial reporting.

 

**Part II**

**Other Information**

 

**Item 1.   Legal Proceedings**

 

Weare currently not a party to any legal proceedings.

 

**Item 1A.   Risk Factors**

 

There are manyfactors that may affect our future operating results and financial condition.Some of these risk factors are described in the section entitled “Risk Factors”beginning on page 4 of our Annual Report on Form 10-K filed with theSecurities and Exchange Commission (SEC) on March 14, 2008 (“2007 Form 10-K”),as updated in the section entitled “Risk Factors” on page 13 of ourQuarterly Report on Form 10-Q for the quarter ended March 31, 2008filed with the SEC on May 12, 2008 (“2008 First Quarter Form 10-Q”).Other information included in this Quarterly Report on Form 10-Q alsoshould be carefully considered. The risks and uncertainties described in our2007 Form 10-K, our 2008 First Quarter Form 10-Q and this QuarterlyReport are not the only risks we face. Additional risks and uncertainties notpresently known to us or that our management currently deems immaterial alsomay impair our business operations and financial condition. If any of the risksdescribed were to occur, our business, financial condition, operating resultsand cash flows could be materially adversely affected.

 

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Thefollowing updates the section entitled “Risk Factors” included in our 2007 Form 10-K,as updated in our 2008 First Quarter Form 10-Q:

 

**As of June 30, 2008, we had $828,000 invested in auctionpreferred securities (APS).  Since mid-February 2008, the auctionsfor these APS have been failing, which adversely affects their liquidity. If we must record impairment charges on the recorded value of these APS,recognize additional losses, or recognize a loss on the disposition of our APS,our financial condition would be adversely affected.**

 

InJanuary 2008, we purchased $2.6 million of investments comprised ofAPS.  All of our APS are AAA rated by oneof the major credit rating agencies. Since mid-February 2008, we have experienced failed auctions forour entire APS portfolio, resulting in our inability to sell thesesecurities.  A failed auction results ina lack of liquidity in the securities but does not signify a default by theissuer.  Upon an auction failure, theinterest rates on the APS do not reset at a market rate but instead reset basedon a formula contained in the APS, which generally is higher than the currentmarket rate.  The issuer of the APSredeemed $1.85 million of the securities on May 27, 2008 at face value andis actively putting a plan in place to redeem the remainder.  We anticipate redemption by September 30,2008.  We do not need these funds tosatisfy outstanding obligations or meet short-term operating requirements.

 

Weclassified our APS as available-for-sale, which resulted in a $20,000adjustment to the carrying value of our APS to mark them to fair value, whichwas recorded in other comprehensive loss. If uncertainties in the credit and capital markets continue, if thecredit worthiness of the issuance deteriorates, or if we no longer have theability to hold these investments, we may be required to recognize impairmentcharges or additional losses on our APS or a loss on their disposition.

 

**We are currently considering variousstrategic alternatives and may not be able to complete one we may decide topursue, which failure could result in increased expenses and/or a delay infinally completing the selecting strategy, or pursuing and completing anotheralternative.**

 

OnMay 20, 2008, the Board of Directors voted to curtail research anddevelopment activities and ongoing operations while analyzing alternatives toprotect the value to the stockholders. Alternatives could include merger,acquisition, increasing operations in another structure or liquidation. Wemay select a strategic alternative that we may not be able to complete forvarious reasons, including a decision of our principal stockholders not to approvesuch alternative, our inability to obtain regulatory approval, actions of othercompanies or possible litigation involving the selected alternative or othermatters. The inability to complete a selected alternative may adversely affectus or limit other strategic alternatives still available to us, including byadversely affecting our financial results or our ability to liquidate, ordeterring other companies from entering into a merger or acquisition with us.

 

**Our common stock is at potentialrisk for delisting from The NASDAQ Global Market.  If it is delisted, our stock price and theliquidity of our common stock may be impacted.**

 

OnJuly 25, 2008, we received a letter from The NASDAQ Stock Market (“NASDAQ”)indicating that the NASDAQ Staff lacks assurance that we have a sustainableon-going business and therefore MathStar may be deemed to be a “public shell.”  In the determination of NASDAQ, this couldraise potential public interest concerns under Marketplace Rule 4300.  Marketplace Rule 4300 provides NASDAQwith discretionary authority to apply more stringent criteria for continuedlisting and terminate the inclusion of particular securities based on any eventthat occurs that makes inclusion of the securities in NASDAQ inadvisable orunwarranted, even though the securities meet all enumerated criteria forcontinued inclusion in NASDAQ, or because NASDAQ deems it necessary to protectinvestors and the public interest.

 

Atthis time, NASDAQ has not made a finding that MathStar is a “public shell” andthus should be delisted from The NASDAQ Global Market but has only requestedinformation from MathStar. As requested by NASDAQ, we provided NASDAQ with theinformation on August 8, 2008.

 

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Ifwe receive a notification from NASDAQ that our common stock will be delistedfrom The NASDAQ Global Market under Marketplace Rule 4300 because MathStaris a public shell, it is our present intent to request an appeal of thatdetermination or relief from that determination until we can complete a mergeror other similar transaction.

 

Ifwe receive a notification from NASDAQ that our common stock will be delistedfrom The NASDAQ Global Market and our appeal of that determination is notsuccessful or NASDAQ does not grant us relief from that determination and ourcommon stock is delisted, our stock price and the liquidity of our common stockwould be adversely impacted as a result.

 

**Item 2. Unregistered Sales of Equity Securities andUse of Proceeds**

 

None.

 

**Item 3.    Defaults Upon SeniorSecurities**

 

None.

 

**Item 4.   Submission of Matters to aVote of Security Holders**

 

On May 22,2008, at our Annual Meeting of Stockholders, the stockholders voted on threeproposals.  The vote on each of those proposals is described below.

 

*Proposal No. 1*

 

Thefollowing incumbent directors were re-elected to our Board of Directors by thefollowing votes:

 
| **Nominee**              | ** ** | **For**    | ** ** | **Withheld/Against** | ** ** | **Broker Non-Votes** | ** ** |
|--------------------------|------------|------------|------------|----------------------|------------|---------------------------|------------|
|                     |       |       |       |                 |       |                      |       |
| Douglas M. Pihl          |       | 39,616,061 |       | 884,326              |       | —                    |       |
| Benno G. Sand            |       | 39,799,700 |       | 700,687              |       | —                    |       |
| Merrill A. McPeak        |       | 39,660,202 |       | 840,185              |       | —                    |       |
| Morris Goodwin, Jr. |       | 39,889,852 |       | 610,535              |       | —                    |       |
| Michael O. Maerz         |       | 39,881,352 |       | 619,035              |       | —                    |       |

 

*Proposal No. 2*

 

Thestockholders approved amending the MathStar, Inc. 2004 Amended andRestated Long-Term Incentive Plan as described in the proxy statement for theAnnual Meeting by the following vote:

 
| **For**    | ** ** | **Against** | ** ** | **Withheld** | ** ** | **Broker Non-Votes** | ** ** |
|------------|------------|-------------|------------|--------------|------------|---------------------------|------------|
|       |       |        |       |         |       |                      |       |
| 12,625,600 |       | 4,023,792   |       | 159,136      |       | 22,730,328                |       |

 

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*Proposal No. 3*

 

Thestockholders approved an amendment to our Certificate of Incorporation toaccomplish a one-for-five reverse stock split of shares of our common stock bythe following vote:

 
| **For**    | ** ** | **Against** | ** ** | **Withheld** | ** ** | **Broker Non-Votes** | ** ** |
|------------|------------|-------------|------------|--------------|------------|---------------------------|------------|
|       |       |        |       |         |       |                      |       |
| 36,475,654 |       | 3,865,597   |       | 159,156      |       | —                    |       |

 

*Proposal No. 4*

 

Thestockholders ratified the selection of PricewaterhouseCoopers LLP as ourindependent registered public accounting firm by the following vote:

 
| **For**    | ** ** | **Against** | ** ** | **Withheld** | ** ** | **Broker Non-Votes** | ** ** |
|------------|------------|-------------|------------|--------------|------------|---------------------------|------------|
|       |       |        |       |         |       |                      |       |
| 40,049,540 |       | 358,624     |       | 92,223       |       | —                    |       |

 

None.

 

**Item 5.    Other Information**

 

 Aswe announced in our Current Report on Form 8-K filed on May 27, 2008with the Securities and Exchange Commission, on May 20, 2008, we committedto a plan to discontinue our field programmable object array (FPOA) chipdevelopment and our board-level systems development businesses and to curtailour operations.  As a result of thisplan, we may become or may be considered to be an investment company under theInvestment Company Act of 1940 (the “1940 Act”).  We believe that if MathStar is an investmentcompany, it is a transient investment company meeting the exception fromregistration provided by Rule 3b-2 under the 1940 Act.  We are not, and do not intend to, primarilyengage in the business of investing, reinvesting, owning, holding or trading insecurities.

 

**Item 6.    Exhibits**

 

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

 

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**SIGNATURES**

 

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

 
|                        | MathStar, Inc. |
|-----------------------------|---------------------|
|                        | (Registrant)        |
|                        |                |   |
|                        |                |   |
| Date:  August 11, 2008 | By:                 | /s/  Douglas M. Pihl |
|                        |                | Douglas  M. Pihl |
|                        |                | Chief  Executive Officer and Chief   Financial Officer |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                           |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                                                                                                                                                                     |
| 3.1                  |       | Certificate  of Incorporation of MathStar, Inc. (incorporated by reference to  Exhibit 3.1 to the Registration Statement on Form S-1 filed by  MathStar, Inc. with the Securities and Exchange Commission (“SEC”) on  August 3, 2005 (File No. 333-127164) (the “Registration  Statement”)). |
|                 |       |                                                                                                                                                                                                                                                                                                                                           |
| 3.2                  |       | By-laws  of MathStar, Inc. (incorporated by reference to Exhibit 3.2 to the  Registration Statement).                                                                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                           |
| 4.1                  |       | Form of  common stock certificate of MathStar, Inc. (incorporated by reference to  Exhibit 4.1 to the Registration Statement).                                                                                                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                           |
| 31.1                 |       | Certification  of Chief Executive Officer pursuant to  Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934  (filed herewith electronically).                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                           |
| 31.2                 |       | Certification  of Chief Financial Officer pursuant to  Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934  (filed herewith electronically).                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                           |
| 32.1                 |       | Section 1350  Certification of Chief Executive Officer (filed herewith electronically).                                                                                                                                                                                                                                                   |
|                 |       |                                                                                                                                                                                                                                                                                                                                           |
| 32.2                 |       | Section 1350  Certification of Chief Financial Officer (filed herewith electronically).                                                                                                                                                                                                                                                   |

 

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