** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

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**FORM 10-K/A**

**(Amendment No. 1)**

**(Mark One)**
| x | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |
|---|------------|-----------------------------------------------------------------------------------------------------|------------|

 

**For the fiscal year ended December 31, 2005**

**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

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**MathStar, Inc.**

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

 

**(503)726-5500**

(Registrant’stelephone number, including area code)

**5900Green Oak Drive, Minnetonka, Minnesota 55343**

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

Securities registered pursuant toSection 12(b) of the Act:

| Title of each class | ** ** | **Name of each exchange on which registered** | ** ** |
|------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| **Not applicable.**                | ** ** | **Not applicable.**                                                         | ** ** |

 

Securitiesregistered pursuant to Section 12(g) of the Act:   Common stock, $0.01 per share par value

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act.   Yes o   No x

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Exchange Act.   Yes o   No x

Indicateby check mark whether the registrant (1) has filed all reports required tobe 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.   Yes x   No o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.   x

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).   Yes o   No x

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

Statethe aggregate market value of the voting and non-voting common equity held bynon-affiliates computed by reference to the price at which the common equitywas last sold, or the average bid and asked price of such common equity, as ofthe last business day of the registrant’s most recently completed second fiscalquarter.

Notapplicable. The registrant’s common equity was not publicly traded on TheNasdaq National Market on June 30, 2005, which was the last day of theregistrant’s most recently completed second fiscal quarter. The registrant’scommon equity began trading on The Nasdaq National Market on October 27,2005.

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.

| Class                                    | ** ** | **Outstanding at March 17, 2006** | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|
| Common Stock, $0.01 par  value per share |       | 17,447,691 shares                      |       |

 

 

 

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** **

**Explanatory Note**

This Amendment No. 1on Form 10-K/A (the “Amendment”) to the Annual Report on Form 10-K for the yearended December 31, 2005, which was originally filed with the Securities andExchange Commission on March 31, 2006 (the “Original Filing”), is being filedsolely for the purpose of replacing the previous dual date of the report ofPricewaterhouseCoopers LLP, the independentregistered public accounting firm of MathStar, Inc., with a single date.

As a result of thisAmendment, the certifications pursuant to Section 302 of the Sarbanes-Oxley Actof 2002 (Rules 13a-14 and 15d-14 under the Securities Exchange Actof 1934) have become re-executed and re-filed with this Amendment.

This Amendment doesnot otherwise modify or update disclosures in, or exhibits to, the OriginalFiling, except for the addition of a consent from PricewaterhouseCoopers LLP,our independent registered public accounting firm.

2

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**MathStar,Inc.**

**Form10-K/A**

**(AmendmentNo. 1)**

** **
|                                                      | ** ** | **Page** | ** ** |
|------------------------------------------------------|------------|----------|------------|
| Part II                                              |       | 4        |       |
| Item 8. Financial Statements  and Supplementary Data |       | 4        |       |
| Part IV                                              |       | 25       |       |
| Item 15.  Exhibits and Financial Satement Schedules  |       | 25       |       |
| Signatures                                           |       | 26       |       |

** **

** **

3

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** **

**PART II**

**Item8. Financial Statements and Supplementary Data**

Unauditedquarterly financial data for each of the eight quarters in the two-year periodended December 31, 2005 is as follows (the numbers in the table may not addup due to rounding):
| ** **                                            | ** ** | **Three Months Ended**                                      | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **March 31**                                                     | ** ** | **June 30** | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** |
| ** **                                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **2004**                                              |       |                                                                  |       |   |   |   |   |   |   |
| Net revenue                                           |       | $                                                                     | —     |   | $ | — |   | $ | 100 |   | $ | 30 |   |
| Cost of sales                                         |       | —                                                                |       | — |   | 45 |   | 8 |   |
| Gross profit                                          |       | —                                                                |       | — |   | 55 |   | 22 |   |
| Operating expenses:                                   |       |                                                                  |       |   |   |   |   |   |   |
| Research and  development                             |       | 1,280                                                                 |       | 880 |   | 1,342 |   | 1,690 |   |
| Selling, general  and administrative                  |       | 836                                                                   |       | 987 |   | 973 |   | 895 |   |
| Total operating  expenses                             |       | 2,116                                                                 |       | 1,867 |   | 2,315 |   | 2,585 |   |
| Loss from operations                                  |       | (2,116                                                                | )          | (1,867 | ) | (2,260 | ) | (2,563 | ) |
| Other income (expense)                                |       | 14                                                                    |       | 19 |   | 14 |   | 10 |   |
| Net loss                                              |       | $                                                                     | (2,102     | ) | $ | (1,848 | ) | $ | (2,246 | ) | $ | (2,553 | ) |
| Basic and diluted net  loss per share                 |       | $                                                                     | (0.25      | ) | $ | (0.20 | ) | $ | (0.24 | ) | $ | (0.26 | ) |
| Weighted average number  of common shares outstanding |       | 8,333                                                                 |       | 9,101 |   | 9,468 |   | 9,925 |   |
| **2005**                                              |       |                                                                  |       |   |   |   |   |   |   |
| Net revenue                                           |       | $                                                                     | 15         |   | $ | 25 |   | $ | 15 |   | $ | 79 |   |
| Cost of sales                                         |       | 7                                                                     |       | 8 |   | — |   | 37 |   |
| Gross profit                                          |       | 8                                                                     |       | 17 |   | 15 |   | 42 |   |
| Operating expenses:                                   |       |                                                                  |       |   |   |   |   |   |   |
| Research and  development                             |       | 2,572                                                                 |       | 2,006 |   | 1,806 |   | 2,350 |   |
| Selling, general and administrative                   |       | 1,023                                                                 |       | 1,435 |   | 1,519 |   | 2,081 |   |
| Total operating expenses                              |       | 3,595                                                                 |       | 3,441 |   | 3,325 |   | 4,431 |   |
| Loss from operations                                  |       | (3,587                                                                | )          | (3,424 | ) | (3,310 | ) | (4,389 | ) |
| Other income (expense)                                |       | 7                                                                     |       | (476 | ) | (893 | ) | (2,863 | ) |
| Net loss                                              |       | $                                                                     | (3,580     | ) | $ | (3,900 | ) | $ | (4,203 | ) | $ | (7,252 | ) |
| Basic and diluted net  loss per share                 |       | $                                                                     | (0.32      | ) | $ | (0.35 | ) | $ | (0.37 | ) | $ | (0.49 | ) |
| Weighted average number of common shares outstanding  |       | 11,155                                                                |       | 11,192 |   | 11,233 |   | 14,870 |   |

 

4

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**Reportof Independent Registered Public Accounting Firm**

To the Board of Directors and Stockholdersof MathStar, Inc.

In our opinion, the accompanying balance sheets andthe related statements of operations, changes in stockholders’ equity and cashflows present fairly, in all material respects, the financial position ofMathStar, Inc. (a development stage company) (the “Company”) atDecember 31, 2004 and 2005, and the results of its operations and its cashflows for each of the three years in the period ended December 31, 2005,and cumulatively for the period from April 14, 1997 (date of inception) toDecember 31, 2005, in conformity with accounting principles generallyaccepted in the United States of America. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits. We conducted ouraudits of these statements in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

The accompanying financial statements have beenprepared assuming that the Company will continue as a going concern. Asdiscussed in Note 1 to the financial statements, the Company has incurredrecurring losses and negative cash flows from operations and will requireadditional funding to continue its operations. These matters raise substantialdoubt about the Company’s ability to continue as a going concern. Management’splans in regard to these matters are also described in Note 1. The financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

/s/ PricewaterhouseCoopers LLPMinneapolis, MinnesotaMarch 30, 2006

5

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**MathStar, Inc.(A development stage company)**

**BalanceSheets**
| ** **                                                                                                                                                  | ** ** | **December 31,**                                                   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                  | ** ** | **2004**                                                                | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                  | ** ** | **(in thousands, except   per share amounts)** | ** ** |
| **Assets**                                                                                                                                                  | ** ** | ** **                                                              | ** ** | ** ** | ** ** |
| Current assets                                                                                                                                              | ** ** | ** **                                                              | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                                                                                                                   |       | $                                                                       | 4,132      |   | $ | 20,149 |   |
| Accounts receivable                                                                                                                                         |       | 29                                                                      |       | 75 |   |
| Prepaid expenses and other current assets                                                                                                                   |       | 230                                                                     |       | 1,480 |   |
| Total current assets                                                                                                                                        |       | 4,391                                                                   |       | 21,704 |   |
|                                                                                                                                                        |       |                                                                    |       |   |   |
| Property and  equipment, net                                                                                                                                |       | 109                                                                     |       | 347 |   |
| Other assets                                                                                                                                                |       | 4                                                                       |       | 151 |   |
| Total assets                                                                                                                                                |       | $                                                                       | 4,504      |   | $ | 22,202 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                              |       |                                                                    |       |   |   |
| Current  liabilities                                                                                                                                        |       |                                                                    |       |   |   |
| Accounts payable                                                                                                                                            |       | $                                                                       | 251        |   | $ | 734 |   |
| Accrued expenses                                                                                                                                            |       | 236                                                                     |       | 1,294 |   |
| Total liabilities                                                                                                                                           |       | 487                                                                     |       | 2,028 |   |
|                                                                                                                                                        |       |                                                                    |       |   |   |
| Commitments and  contingencies (Note 10)                                                                                                                    |       |                                                                    |       |   |   |
|                                                                                                                                                        |       |                                                                    |       |   |   |
| Stockholders’  equity                                                                                                                                  |       |                                                                    |       |   |   |
| Preferred stock, $0.01 par value; 10,000 shares  authorized; no shares issued and outstanding                                                               |       | —                                                                  |       | — |   |
| Common stock, $0.01 par value; 90,000 shares  authorized; 11,140 and 17,415 shares issued and outstanding at  December 31, 2004 and 2005, respectively |       | 111                                                                     |       | 175 |   |
| Additional paid-in capital                                                                                                                                  |       | 68,465                                                                  |       | 105,717 |   |
| Unearned compensation                                                                                                                                       |       | —                                                                  |       | (2,224 | ) |
| Deficit accumulated during the development stage                                                                                                            |       | (64,559                                                                 | )          | (83,494 | ) |
| Total stockholders’ equity                                                                                                                             |       | 4,017                                                                   |       | 20,174 |   |
| Total  liabilities and stockholders’ equity                                                                                                            |       | $                                                                       | 4,504      |   | $ | 22,202 |   |

 

The accompanying notesare an integral part of these financial statements.

6

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**MathStar, Inc.(A development stage company)**

**Statementsof Operations**
| ** **                                                     | ** ** | **Year Ended  December 31,**                                | ** ** | **Cumulative  for the Period  from Inception  (April 14, 1997)  Through  December 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **2003**                                                              | ** ** | **2004**                                                                                                              | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **                                                     | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Revenue                                                        |       | $                                                                     | 50         |                                                                                                                  | $          | 130 |   | $ | 134 |   | $ | 880 |   |
| Cost of sales                                                  |       | —                                                                |       | 53                                                                                                                    |       | 52 |   | 105 |   |
| Gross margin                                                   |       | 50                                                                    |       | 77                                                                                                                    |       | 82 |   | 775 |   |
| Operating  expenses                                            |       |                                                                  |       |                                                                                                                  |       |   |   |   |   |
| Research and development                                       |       | 7,903                                                                 |       | 5,192                                                                                                                 |       | 8,734 |   | 29,967 |   |
| Selling, general and administrative                            |       | 3,221                                                                 |       | 3,691                                                                                                                 |       | 6,058 |   | 19,274 |   |
|                                                           |       | 11,124                                                                |       | 8,883                                                                                                                 |       | 14,792 |   | 49,241 |   |
| Operating loss                                                 |       | (11,074                                                               | )          | (8,806                                                                                                                | )          | (14,710 | ) | (48,466 | ) |
| Interest income                                                |       | 47                                                                    |       | 57                                                                                                                    |       | 170 |   | 1,420 |   |
| Interest expense                                               |       | —                                                                |       | —                                                                                                                |       | (4,395 | ) | (4,591 | ) |
| Other income,  net                                             |       | —                                                                |       | —                                                                                                                |       | — |   | 17 |   |
| Net loss from  continuing operations                           |       | (11,027                                                               | )          | (8,749                                                                                                                | )          | (18,935 | ) | (51,620 | ) |
| Loss from  discontinued operations (Note 4)                    |       | —                                                                |       | —                                                                                                                |       | — |   | (31,874 | ) |
| Net loss                                                       |       | $                                                                     | (11,027    | )                                                                                                                     | $          | (8,749 | ) | $ | (18,935 | ) | $ | (83,494 | ) |
| Basic and  diluted loss per share from continuing operations   |       | $                                                                     | (1.56      | )                                                                                                                     | $          | (0.95 | ) | $ | (1.56 | ) |   |   |
| Basic and  diluted loss per share from discontinued operations |       | $                                                                     | —     |                                                                                                                  | $          | — |   | $ | — |   |   |   |
| Basic and  diluted loss per share                              |       | $                                                                     | (1.56      | )                                                                                                                     | $          | (0.95 | ) | $ | (1.56 | ) |   |   |
| Weighted average basic  and diluted shares outstanding         |       | 7,048                                                                 |       | 9,209                                                                                                                 |       | 12,121 |   |   |   |

 

The accompanying notes are an integral part of thesefinancial statements.

7

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**MathStar, Inc.(A development stage company)**

**Statementsof Changes in Stockholders’ EquityCumulative for the Period from Inception (April 14, 1997) ThroughDecember 31, 2005**

 
| ** **                                                                                           | ** ** | ** **                                                            | ** ** | **Price**      | ** ** | **Common  Stock** | ** ** | **Additional** | ** ** | ** **           | ** ** | ** **            | ** ** | **Deficit  Accumulated  During the** | ** ** | ** **             | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------|------------|-------------------|------------|----------------|------------|----------------------|------------|-----------------------|------------|-------------------------------------------|------------|------------------------|------------|
| ** **                                                                                           | ** ** | **Date**                                                              | ** ** | **Per  Share** | ** ** | **Shares**        | ** ** | **Par  Value** | ** ** | **Paid-in  Capital** | ** ** | **Notes  Receivable** | ** ** | **Unearned  Compensation**                | ** ** | **Development  Stage** | ** ** | **Total** | ** ** |
| ** **                                                                                           | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Issuance of  common stock to founders for cash and notes receivable                                  |       | January 1998                                                     |       | $              | 0.045      |              | 667        |           | $          | 7                    |       | $                     | 23         |                                      | $          | (15                    | )          |   |   |   |   | $ | 15 |   |
| Net income                                                                                           |       |                                                                  |       |           |       |              |       |           |       |                 |       |                  |       |                                      |       | $                      | 7          |   | 7 |   |
| **Balances  at December 31, 1998**                                                              |       |                                                                  |       |           |       | 667               |       | 7              |       | 23                   |       | (15                   | )          | —                                    |       | 7                      |       | 22 |   |
| Payments on notes  receivable                                                                        |       |                                                                  |       |           |       |              |       |           |       |                 |       | 15                    |       |                                      |       |                   |       | 15 |   |
| Net loss                                                                                             |       |                                                                  |       |           |       |              |       |           |       |                 |       |                  |       |                                      |       | (15                    | )          | (15 | ) |
| **Balances  at December 31, 1999**                                                              |       |                                                                  |       |           |       | 667               |       | 7              |       | 23                   |       | —                |       | —                                    |       | (8                     | )          | 22 |   |
| Issuance of  common stock for notes receivable                                                       |       | April 2000                                                       |       | $              | .11        |              | 2,100      |           | 21         |                 | 209        |                  | (230       | )                                         |       |                   |       |   | — |   |
| Issuance of  common stock for cash                                                                   |       | June 2000                                                        |       | $              | 5.25       |              | 140        |           | 1          |                 | 735        |                  |       |                                      |       |                   |       |   | 736 |   |
| Payments on notes  receivable                                                                        |       |                                                                  |       |           |       |              |       |           |       |                 |       | 230                   |       |                                      |       |                   |       | 230 |   |
| Issuance of common  stock for cash, net of offering costs of $1,908                             |       | July -  November 2000                                       |       | $              | 8.25       |              | 2,235      |           | 23         |                 | 16,511     |                  |       |                                      |       |                   |       |   | 16,534 |   |
| Net loss                                                                                             |       |                                                                  |       |           |       |              |       |           |       |                 |       |                  |       |                                      |       | (1,437                 | )          | (1,437 | ) |
| **Balances  at December 31, 2000**                                                              |       |                                                                  |       |           |       | 5,142             |       | 52             |       | 17,478               |       | —                |       | —                                    |       | (1,445                 | )          | 16,085 |   |
| Issuance of common  stock in connection with the acquisition of Digital Mediacom, Inc.          |       | August 2001                                                      |       | $              | 8.25       |              | 1,603      |           | 16         |                 | 13,210     |                  |       |                                      |       |                   |       |   | 13,226 |   |
| Issuance of  options and warrants in connection with the acquisition of Digital  Mediacom, Inc. |       |                                                                  |       |           |       |              |       |           |       | 5,158                |       |                  |       |                                      |       |                   |       | 5,158 |   |
| Stock-based  employee compensation                                                                   |       |                                                                  |       |           |       |              |       |           |       | 148                  |       |                  |       |                                      |       |                   |       | 148 |   |
| Stock-based  nonemployee compensation                                                                |       |                                                                  |       |           |       |              |       |           |       | 116                  |       |                  |       |                                      |       |                   |       | 116 |   |
| Repurchase of  common stock                                                                          |       |                                                                  |       |           |       | (667              | )          | (7             | )          | (243                 | )          |                  |       |                                      |       |                   |       | (250 | ) |
| Net loss                                                                                             |       |                                                                  |       |           |       |              |       |           |       |                 |       |                  |       |                                      |       | (13,629                | )          | (13,629 | ) |
| **Balances  at December 31, 2001**                                                              |       |                                                                  |       |           |       | 6,078             |       | 61             |       | 35,867               |       | —                |       | —                                    |       | (15,074                | )          | 20,854 |   |
| Issuance of  common stock for cash, net of offering costs of $1,645                             |       | April -  August 2002                                        |       | $              | 10.50      |              | 1,458      |           | 14         |                 | 13,644     |                  |       |                                      |       |                   |       |   | 13,658 |   |
| Exercise of stock  options                                                                           |       |                                                                  |       |           |       | 9                 |       |           |       | 47                   |       |                  |       |                                      |       |                   |       | 47 |   |
| Stock-based  employee compensation                                                                   |       |                                                                  |       |           |       |              |       |           |       | 528                  |       |                  |       |                                      |       |                   |       | 528 |   |
| Repurchase of  common stock                                                                          |       |                                                                  |       |           |       | (500              | )          | (5             | )          | (252                 | )          |                  |       |                                      |       |                   |       | (257 | ) |
| Net loss                                                                                             |       |                                                                  |       |           |       |              |       |           |       |                 |       |                  |       |                                      |       | (29,709                | )          | (29,709 | ) |
| **Balances  at December 31, 2002**                                                              |       |                                                                  |       |           |       | 7,045             |       | 70             |       | 49,834               |       | —                |       | —                                    |       | (44,783                | )          | 5,121 |   |
| Issuance of  warrants to purchase common stock for cash, net of offering costs of $697               |       | April -  August 2003                                        |       |           |       |              |       |           |       | 5,304                |       |                  |       |                                      |       |                   |       | 5,304 |   |
| Issuance of  common stock for cash, net of offering costs of $316                               |       | December 2003                                                    |       | $              | 4.80       |              | 585        |           | 6          |                 | 2,487      |                  |       |                                      |       |                   |       |   | 2,493 |   |
| Exercise of  warrants for subscription receivable                                                    |       |                                                                  |       |           |       | 18                |       |           |       | 27                   |       |                  |       |                                      |       |                   |       | 27 |   |
| Stock-based  employee compensation                                                                   |       |                                                                  |       |           |       |              |       |           |       | 148                  |       |                  |       |                                      |       |                   |       | 148 |   |
| Stock-based  nonemployee compensation—options                                                   |       |                                                                  |       |           |       |              |       |           |       | 26                   |       |                  |       |                                      |       |                   |       | 26 |   |
| Net loss                                                                                             |       |                                                                  |       |           |       |              |       |           |       |                 |       |                  |       |                                      |       | (11,027                | )          | (11,027 | ) |
| **Balances at December 31,  2003**                                                              |       |                                                                  |       |           |       | 7,648             |       | 76             |       | 57,826               |       | —                |       | —                                    |       | (55,810                | )          | 2,092 |   |
|                                                                                                      |            |                                                                       |            |                |            |                   |            |                |            |                      |            |                       |            |                                           |            |                        |            |  |  |  |  |  |  |  |  |

 

8

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**MathStar, Inc.(A development stage company)**

**Statements of Changes inStockholders’ Equity (Continued)Cumulative for the Period from Inception (April 14, 1997) ThroughDecember 31, 2005**

 
| ** **                                                                    | ** ** | ** **                                                            | ** ** | **Price**      | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **           | ** ** | ** **            | ** ** | **Deficit  Accumulated  During the** | ** ** | ** **             | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------|------------|-----------------------|------------|----------------|------------|----------------------|------------|-----------------------|------------|-------------------------------------------|------------|------------------------|------------|
| ** **                                                                    | ** ** | **Date**                                                              | ** ** | **Per  Share** | ** ** | **Shares**            | ** ** | **Par  Value** | ** ** | **Paid-in  Capital** | ** ** | **Notes  Receivable** | ** ** | **Unearned  Compensation**                | ** ** | **Development  Stage** | ** ** | **Total** | ** ** |
| ** **                                                                    | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Balances  at December 31, 2003**                                       |       |                                                                  |       |           |       | 7,648                 |       | 76             |       | 57,826               |       | —                |       | —                                    |       | (55,810                | )          | 2,092 |   |
| Issuance of  common stock for cash, net of offering costs of $970        |       | January -  August 2004                                      |       | $              | 4.80       |                  | 1,864      |           | 19         |                 | 7,959      |                  |       |                                      |       |                   |       |   | 7,978 |   |
| Exercise of  warrants for cash, net of warrant call costs of $279             |       |                                                                  |       |           |       | 1,627                 |       | 16             |       | 2,629                |       |                  |       |                                      |       |                   |       | 2,645 |   |
| Exercise of stock  options                                                    |       |                                                                  |       |           |       | 1                     |       |           |       | 1                    |       |                  |       |                                      |       |                   |       | 1 |   |
| Vesting of  warrants issued to nonemployees                                   |       |                                                                  |       |           |       |                  |       |           |       | 50                   |       |                  |       |                                      |       |                   |       | 50 |   |
| Net loss                                                                      |       |                                                                  |       |           |       |                  |       |           |       |                 |       |                  |       |                                      |       | (8,749                 | )          | (8,749 | ) |
| **Balances  at December 31, 2004**                                       |       |                                                                  |       |           |       | 11,140                |       | 111            |       | 68,465               |       | —                |       | —                                    |       | (64,559                | )          | 4,017 |   |
| Exercise of warrants for cash                                                 |       |                                                                  |       |           |       | 101                   |       | 2              |       | 233                  |       | —                |       |                                      |       | —                 |       | 235 |   |
| Warrants issued  in connection with convertible bridge notes                  |       |                                                                  |       |           |       | —                |       | —         |       | 1,126                |       | —                |       |                                      |       | —                 |       | 1,126 |   |
| Discount on  convertible bridge notes—beneficial conversion rate         |       |                                                                  |       |           |       | —                |       | —         |       | 2,502                |       | —                |       |                                      |       | —                 |       | 2,502 |   |
| Vesting of  warrants issued to nonemployees                                   |       |                                                                  |       |           |       | —                |       | —         |       | 515                  |       | —                |       |                                      |       | —                 |       | 515 |   |
| Issuance of  common stock in public offering, net of offering costs of $2,967 |       | Oct./Dec. 2005                                                   |       | $              | 6.00       |                  | 4,600      |           | 46         |                 | 24,587     |                  | —     |                                      |       |                   | —     |   | 24,633 |   |
| Restricted common  stock issued to employees                                  |       |                                                                  |       |           |       | 457                   |       | 5              |       | 2,736                |       |                  |       | (2,741                                    | )          | —                 |       | — |   |
| Forfeitures of  restricted stock                                              |       |                                                                  |       |           |       | (11                   | )          | —         |       | (70                  | )          |                  |       | 70                                        |       | —                 |       | — |   |
| Bridge note  conversion                                                       |       | Dec. 2005                                                        |       | $              | 4.80       |                  | 1,128      |           | 11         |                 | 5,419      |                  |       |                                      | —     |                   | —     |   | 5,430 |   |
| Stock-based  employee compensation—restricted stock                      |       |                                                                  |       |           |       | —                |       | —         |       |                 |       |                  |       | 447                                       |       | —                 |       | 447 |   |
| Stock-based  employee compensation—options                               |       |                                                                  |       |           |       | —                |       | —         |       | 204                  |       |                  |       | —                                    |       | —                 |       | 204 |   |
| Net loss                                                                      |       |                                                                  |       |           |       | —                |       | —         |       | —               |       |                  |       | —                                    |       | (18,935                | )          | (18,935 | ) |
| **Balances at December 31,  2005**                                       |       |                                                                  |       |           |       | 17,415                |       | $              | 175        |                 | $          | 105,717               |       | —                                    |       | $                      | (2,224     | ) | $ | (83,494 | ) | $ | 20,174 |   |
|                                                                               |            |                                                                       |            |                |            |                       |            |                |            |                      |            |                       |            |                                           |            |                        |            |  |  |  |  |  |  |  |  |

 

The accompanying notesare an integral part of these financial statements.

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**MathStar, Inc.(A development stage company)**

**Statements of CashFlows**
| ** **                                                                                                           | ** ** | **Year Ended  December 31,** | ** ** | **Cumulative  for the Period  from Inception  (April 14, 1997)  Through  December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2003**                               | ** ** | **2004**                                                                                                              | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **                                                                                                           | ** ** | **(In thousands)**                | ** ** |
| **Cash  flows from operating activities**                                                                            | ** ** | ** **                             | ** ** | ** **                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                                                             |       | $                                      | (11,027    | )                                                                                                                     | $          | (8,749 | ) | $ | (18,935 | ) | $ | (83,494 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities                                          | ** ** | ** **                             | ** ** | ** **                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Depreciation                                                                                                         |       | 358                                    |       | 183                                                                                                                   |       | 74 |   | 1,533 |   |
| Amortization of beneficial conversion feature  convertible notes and value of warrants issued with convertible notes |       | —                                 |       | —                                                                                                                |       | 3,628 |   | 3,628 |   |
| Interest expense settled with common stock                                                                           |       | —                                 |       | —                                                                                                                |       | 230 |   | 230 |   |
| Amortization of discount on held-to-maturity  securities                                                             |       | —                                 |       | —                                                                                                                |       | — |   | (233 | ) |
| Acquired in-process research and development                                                                         |       | —                                 |       | —                                                                                                                |       | — |   | 4,300 |   |
| Stock-based compensation                                                                                             |       | 175                                    |       | 50                                                                                                                    |       | 1,166 |   | 2,241 |   |
| Goodwill impairment                                                                                                  |       | —                                 |       | —                                                                                                                |       | — |   | 13,306 |   |
| Change in operating assets and liabilities, net of  effects of acquisition                                      |       |                                   |       |                                                                                                                  |       |   |   |   |   |
| Accounts receivable                                                                                                  |       | —                                 |       | (29                                                                                                                   | )          | (46 | ) | 70 |   |
| Prepaid expenses and other assets                                                                                    |       | 302                                    |       | (101                                                                                                                  | )          | (896 | ) | (991 | ) |
| Accounts payable                                                                                                     |       | 68                                     |       | (188                                                                                                                  | )          | 178 |   | 281 |   |
| Accrued expenses                                                                                                     |       | 513                                    |       | (477                                                                                                                  | )          | 862 |   | 1,076 |   |
| Net cash used in operating activities                                                                                |       | (9,611                                 | )          | (9,311                                                                                                                | )          | (13,740 | ) | (58,064 | ) |
| **Cash  flows from investing activities**                                                                            | ** ** | ** **                             | ** ** | ** **                                                                                                            | ** ** | ** ** |   |   |   |
| Cash used in  acquisition, net of cash acquired                                                                      |       | —                                 |       | —                                                                                                                |       | — |   | (791 | ) |
| Purchase of  property and equipment                                                                                  |       | —                                 |       | (13                                                                                                                   | )          | (312 | ) | (1,720 | ) |
| Proceeds from  sale of discontinued operations                                                                       |       | —                                 |       | —                                                                                                                |       | — |   | 1,752 |   |
| Purchases of  held-to-maturity securities                                                                            |       | —                                 |       | —                                                                                                                |       | — |   | (10,000 | ) |
| Sales of  held-to-maturity securities                                                                                |       | —                                 |       | —                                                                                                                |       | — |   | 10,233 |   |
| Net cash used in investing activities                                                                                |       | —                                 |       | (13                                                                                                                   | )          | (312 | ) | (526 | ) |
| **Cash  flows from financing activities**                                                                            | ** ** | ** **                             | ** ** | ** **                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  issuance of common stock, net of offering costs                                                       |       | 2,493                                  |       | 7,978                                                                                                                 |       | 24,633 |   | 66,047 |   |
| Proceeds from  issuance of convertible notes                                                                         |       | —                                 |       | —                                                                                                                |       | 5,500 |   | 5,500 |   |
| Payments on  convertible notes                                                                                       |       | —                                 |       | —                                                                                                                |       | (300 | ) | (300 | ) |
| Proceeds from  issuance of warrants to purchase common stock, net of offering costs                                  |       | 5,304                                  |       | —                                                                                                                |       | — |   | 5,304 |   |
| Proceeds from  exercise of warrants, net of costs                                                                    |       | —                                 |       | 2,645                                                                                                                 |       | 235 |   | 2,908 |   |
| Collection of  subscription receivable                                                                               |       | —                                 |       | 27                                                                                                                    |       | — |   | 27 |   |
| Proceeds from  exercise of stock options                                                                             |       | —                                 |       | 1                                                                                                                     |       | — |   | 1 |   |
| Principal  payments on notes receivable from stockholders                                                            |       | —                                 |       | —                                                                                                                |       | — |   | 245 |   |
| Principal  payments on notes payable to stockholders                                                                 |       | (125                                   | )          | —                                                                                                                |       | — |   | (250 | ) |
| Repurchase of  common stock                                                                                          |       | —                                 |       | —                                                                                                                |       | — |   | (257 | ) |
| Payments on  capital lease obligations                                                                               |       | (29                                    | )          | —                                                                                                                |       | — |   | (486 | ) |
| Net cash provided by financing activities                                                                            |       | 7,643                                  |       | 10,651                                                                                                                |       | 30,068 |   | 78,739 |   |
| Net (decrease) increase in cash and cash equivalents                                                                 |       | (1,968                                 | )          | 1,327                                                                                                                 |       | 16,017 |   | 20,149 |   |
| **Cash  and cash equivalents**                                                                                       | ** ** | ** **                             | ** ** | ** **                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Beginning of  period                                                                                                 |       | 4,773                                  |       | 2,805                                                                                                                 |       | 4,132 |   | — |   |
| End of period                                                                                                        |       | $                                      | 2,805      |                                                                                                                  | $          | 4,132 |   | $ | 20,149 |   | $ | 20,149 |   |
| **Cash  paid during period for interest**                                                                            |       |                                   |       |                                                                                                                  |       |   |   | 26 |   |
| **Significant  noncash transactions**                                                                                |       |                                   |       |                                                                                                                  |       |   |   |   |   |
| Common stock,  options and warrants issued in connection with Digital Mediacom, Inc.  acquisition               |       | $                                      | —     |                                                                                                                  | $          | — |   | $ | — |   | $ | 18,384 |   |
| Exercise of  warrants for subscription receivable                                                                    |       | 27                                     |       | —                                                                                                                |       | — |   | 27 |   |
| Capital lease  obligation incurred for acquisition of fixed assets                                                   |       | —                                 |       | —                                                                                                                |       | — |   | 426 |   |
| Repurchase of  common stock with notes payable                                                                       |       | —                                 |       | —                                                                                                                |       | — |   | 250 |   |
| Prepaid licenses  included in accrued expenses                                                                       |       | —                                 |       | —                                                                                                                |       | 601 |   | 601 |   |
| Conversion of notes  payable and $230 of accrued interest into common stock                                          |       | —                                 |       | —                                                                                                                |       | 5,430 |   | 5,430 |   |

 

The accompanying notesare an integral part of these financial statements.

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** **

**MathStar, Inc.(A development stage company)**

**Notes to FinancialStatements (Continued)(in thousands, except per share amounts)**

**1.**   Nature of the Business and GoingConcern

MathStar, Inc. (the “Company”) was incorporatedas a Minnesota corporation in April 1997 and reincorporated under Delawarelaw during 2005. The Company is a fabless semiconductor company addressing thereconfigurable logic markets with a new class of platform chips designed to behigh performance, reconfigurable integrated circuits based on the Company’sproprietary silicon object technology. Since its inception, the Company hasdevoted substantially all of its efforts to business planning, research anddevelopment, recruitment of management and technical staff, acquiring operatingassets and raising capital. The Company has generated only nominal revenuesfrom the sale of development kits that support customer development ofapplications for one of the Company’s products, the sale of product prototypesand contractual research and development services. Accordingly, the Company isconsidered to be in the development stage as defined by Statement of FinancialAccounting Standards (“SFAS”) No. 7, *Accountingand Reporting by Development Stage Enterprises*.

In November 2005, the Company closed on itsinitial public offering of 4,000 shares of its common stock at $6.00 per shareand in December 2005 the Company closed on the underwriter’s overallotmentoption of 600 shares of the Company’s common stock at $6.00 per share,resulting in net proceeds to the Company of $24,633.

The accompanying financial statements have beenprepared on a basis which assumes that the Company will continue as a goingconcern and which contemplates the realization of assets and the satisfactionof liabilities and commitments in the normal course of business. The Companyhas a limited operating history and has incurred losses and negative cash flowsfrom operations since inception. The Company expects to incur additional lossesand will require additional funding to continue its operations. Thesecircumstances raise substantial doubt about the Company’s ability to continueas a going concern. Management intends to seek additional equity financingduring 2006. However, there can be no assurance that such additional funding willbe available on terms acceptable to the Company or at all.

**2.**   Summary of Significant AccountingPolicies

**Use of Estimates**

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires 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.

**Cash and CashEquivalents**

The Company considers all highly liquid investmentswith an original maturity of three months or less at the date of purchase to becash equivalents.

**Fair Value ofFinancial Instruments**

The carrying amounts of the Company’s financialinstruments, which include cash equivalents, accounts receivable, accountspayable and other accrued expenses, approximate their fair values due to theirshort maturities and/or market-consistent interest rates.

**Property andEquipment**

Property and equipment are recorded at cost anddepreciated over their estimated useful lives, generally three to five years,using the straight-line method. Upon retirement or sale, the cost of assetsdisposed of and the related 

11

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accumulated depreciationare removed from the accounts, and any resulting gain or loss is included inoperating results. Repairs and maintenance costs are expensed as incurred.

**Patents**

The Company has filed applications for patents withthe U.S. Patent and Trademark Office. The legal fees and application costsassociated with obtaining patents from the U.S. Patent and Trademark Officesare expensed as incurred.

**Long-Lived Assets**

The recoverability of long-lived assets is assessedperiodically or whenever adverse events or changes in circumstances or businessclimate indicate that the expected cash flows previously anticipated warrant areassessment. When such reassessments indicate the potential of impairment, allbusiness factors are considered and, if the carrying value of such assets isnot likely to be recovered from future undiscounted operating cash flows, theywill be written down for financial reporting purposes. See Note 4 regardingassessment of the carrying value of goodwill.

**Research andDevelopment**

Research and development expenses represent costsincurred for designing and engineering of the Company’s products, including thecosts of developing design tools and applications to enable customers to more easilyutilize the Company’s products. The Company expenses all research anddevelopment costs related to development of its products. Development ofcertain tools and applications include the development of software. Suchresearch and development expenses are required to be expensed until the pointthat technological feasibility of the software is established. The Companydetermines technological feasibility based upon completion of a working modelof the software. To date, the period between technological feasibility andgeneral release of the software has been short, such that virtually all of theCompany’s software development costs relate to software development during theperiod prior to technological feasibility. Accordingly, all such costs havebeen charged to operations as incurred.

**RevenueRecognition**

Revenue prior to 2003 resulted from contractualresearch and development services and was recognized as the services wereperformed. Customer payments received in advance of providing services wererecorded as customer deposits. Costs related to these revenues consistedprimarily of salary and related benefits of certain employees and were includedin operating expenses.

Revenue after 2002 resulted from the sale of prototypeproducts and the sale of product development kits. The Company recognizesrevenue for these products when persuasive evidence of an arrangement exists,delivery has occurred, the sales price is fixed or determinable, collectibility is reasonably assuredand there are no post-delivery obligations. During 2004 and 2005, marketingsupport was paid to a customer of the Company. Such payments are reported as areduction of revenue in accordance with Emerging Issues Task Force Issue 01-09,*Accounting for Consideration Given by aVendor to a Customer (Including a Reseller of the Vendor’s Products)*.

During 2005, revenue also resulted from contractualresearch and development services that was recognized as the services wereperformed. Costs related to these revenues consisted primarily of salary andrelated benefits of certain employees and were included in cost of sales.

**Stock-BasedCompensation**

In accordance with SFAS No. 123, *Accounting for Stock-Based Compensation*,the Company has elected to account for stock-based compensation to employees usingthe intrinsic value method prescribed in Accounting 

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Principles Board OpinionNo. 25, *Accounting for Stock Issued toEmployees*, and related interpretations. Accordingly, compensationcost for stock options granted to employees is measured as the excess, if any,of the fair value of the Company’s stock at the date of the grant over theamount an employee must pay to acquire the stock. The Company accounts forstock-based compensation to nonemployees using the fair value method prescribedby SFAS No. 123. Compensation cost for stock options granted tononemployees is measured based on the fair value of the option at the date ofgrant with the unvested portion revalued at each balance sheet date.Compensation costs, if any, are amortized over the underlying option vestingterms.

The followingtable presents the pro forma effect on net loss if the Company had applied thefair value recognition provisions for SFAS No. 123 to stock-based employeecompensation:
| ** **                                                                                                                 | ** ** | ** **                                 | ** ** | ** **            | ** ** | ** ** | ** ** | **Cumulative**                 | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------|------------|------------|------------|--------------------------------|------------|
| ** **                                                                                                                 | ** ** | ** **                                 | ** ** | ** **            | ** ** | ** ** | ** ** | **for the Period**   | ** ** |
| ** **                                                                                                                 | ** ** | ** **                                 | ** ** | ** **            | ** ** | ** ** | ** ** | **from Inception**        | ** ** |
| ** **                                                                                                                 | ** ** | ** **                                 | ** ** | ** **            | ** ** | ** ** | ** ** | **(April 14, 1997)** | ** ** |
| ** **                                                                                                                 | ** ** | ** **                                 | ** ** | ** **            | ** ** | ** ** | ** ** | **Through**                    | ** ** |
| ** **                                                                                                                 | ** ** | **Year Ended December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                 | ** ** | **2003**                                   | ** ** | **2004**              | ** ** | **2005**   | ** ** | **2005**                       | ** ** |
| Net loss as  reported                                                                                                      |       | $                                          | (11,027    | )                     | $          | (8,749     | )          | $                              | (18,935    | ) | $ | (83,494 | ) |
| Add: Total  stock-based employee compensation expense included in net loss, as reported                                    |       | 148                                        |       | —                |       | 651        |       | 1,475                          |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all employee awards |       | (369                                       | )          | (174                  | )          | (912       | )          | (2,697                         | )          |
| Pro forma net  loss                                                                                                        |       | $                                          | (11,248    | )                     | $          | (8,923     | )          | $                              | (19,196    | ) | $ | (85,163 | ) |
| Basic and  diluted loss per share:                                                                                         |       |                                       |       |                  |       |       |       |                           |       |
| As reported                                                                                                                |       | $                                          | (1.56      | )                     | $          | (0.95      | )          | $                              | (1.56      | ) |   |   |
| Pro forma                                                                                                                  |       | $                                          | (1.60      | )                     | $          | (0.97      | )          | $                              | (1.58      | ) |   |   |

 

**Advertising Costs**

Advertising costs are charged to operations asincurred. Advertising costs were $4, $3 and $14 for the years endedDecember 31, 2003, 2004 and 2005, respectively, and $137 cumulative forthe period from inception (April 14, 1997) through December 31, 2005.

**Income Taxes**

The Company accounts for income taxes in accordancewith SFAS No. 109, *Accounting forIncome Taxes*. The asset and liability approach of SFAS No. 109requires the recognition of deferred tax assets and liabilities for the taxconsequences of temporary differences between the tax bases of assets andliabilities and their carrying amounts for financial reporting purposes usingenacted tax rates in effect for the years in which the differences are expectedto reverse. Valuation allowances are provided if, based upon the weight ofavailable evidence, it is more likely than not that some or all of the deferredtax assets will not be realized.

**Concentration ofCredit Risk**

Financial instruments, which potentially subject theCompany to concentrations of credit risk, consist primarily of cash and cashequivalents. The Company places its cash and cash equivalents primarily inchecking and money market accounts with one financial institution thatmanagement considers creditworthy. However, the Federal Deposit InsuranceCorporation does not insure most of these accounts.

13

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**Comprehensive Loss**

Comprehensive loss, as defined in SFAS No. 130, *Reporting Comprehensive Income*, includesall changes in equity during a period from nonowner sources. The Company hasnot had any changes in stockholders’ equity from nonowner sources other than anet loss.

**Earnings Per Share**

Basic earnings per share are computed by dividing thenet loss available to common stockholders by the weighted average number ofcommon shares outstanding during the period. Diluted earnings per share giveseffect to all dilutive potential common shares outstanding during the period,including stock options, warrants and convertible notes payable, using thetreasury stock method. Options and warrants to purchase 3,672, 2,611 and 4,021shares of common stock were outstanding at December 31, 2003, 2004 and2005, respectively, but were not included in the computation of net loss pershare as their effect was anti-dilutive. Common shares issuable upon exerciseof the convertible notes payable and related accrued interest and shares of theCompany’s contingently issuable restricted stock also were not included in thecomputation of net loss per share as their effect was anti-dilutive (see Note6).

**New AccountingPronouncements**

In December 2004, the FASB issued SFASNo. 123R, *Share-Based Payment*.SFAS No. 123R revised SFAS No. 123 and supersedes AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees*(“APB Opinion No. 25”). Therevised statement addresses the accounting for share-based payment transactionswith employees and other third parties, eliminates the ability to account forshare-based payments using APB Opinion No. 25 and requires that thecompensation costs relating to such transactions be recognized in the statementof operations based upon the grant-date fair value of those instruments. Therevised statement is effective for the Company in the first quarter of 2006which begins on January 1, 2006. The Company expects that adoption of SFASNo. 123R will result in significant charges to operations beginning in2006.

Under SFAS No. 123R, the Company must determinethe appropriate fair value model to be used for valuing share-based payments,the amortization method for compensation costs and the transition method to beused at the date of adoption. The transition methods include prospective andretroactive adoption alternatives. The Company will adopt SFAS No. 123Rusing the prospective method. Because the Company has historically followed the“minimum value” method permitted by SFAS No. 123, the prospective methodwill require the Company to record compensation expense only for options issuedafter the closing of the Company’s initial public offering inNovember 2005.

In May 2005, the Financial Accounting StandardsBoard issued SFAS No. 154, *Accounting Changesand Error Corrections*. This new standard replaces AccountingPrincipals Board Opinion (“APB”) No. 20, *AccountingChanges*, and SFAS No. 3, *ReportingAccounting Changes in Interim Financial Statements*. This statementchanges the requirements for the accounting for and reporting of a change inaccounting principle and applies to all voluntary changes in accountingprinciple. It also applies to changes required by an accounting pronouncementin the unusual instance that the pronouncement does not include specifictransition provisions. When a pronouncement includes specific transitionprovisions, those provisions should be followed. APB No. 20 required thatmost voluntary changes in accounting principle be recognized by including innet income of the period of the change the cumulative effect of changing to thenew accounting principle. This statement requires retrospective application toprior period financial statements of changes in accounting principle, unless itis impracticable to determine either the period-specific effects or thecumulative effect of the change. The provisions of SFAS No. 154 areeffective for fiscal years beginning after December 15, 2005. As such, theCompany is required to adopt SFAS No. 154 by January 1, 2006. TheCompany does not expect the adoption of this statement to have an impact on itsfinancial statements.

14

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**3.**   Selected Balance Sheet Information

The followingpresents prepaid expenses and other current assets:

|                       | ** ** | **December 31,** | ** ** |
|-----------------------|------------|-----------------------|------------|
| ** **            | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Prepaid license  fees |       | $                     | 108        |   | $ | 775 |   |
| Prepaid  insurance    |       | 25                    |       | 165 |   |
| Prepaid rent          |       | —                |       | 89 |   |
| Other                 |       | 97                    |       | 451 |   |
|                  |       | $                     | 230        |   | $ | 1,480 |   |

 

The followingpresents property and equipment, net:

|                                    | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Computer  equipment                |       | $                     | 896        |   | $ | 1,003 |   |
| Purchased  software                |       | 425                   |       | 425 |   |
| Furniture and  fixtures            |       | 165                   |       | 370 |   |
|                               |       | $                     | 1,486      |   | $ | 1,798 |   |
| Less:  Accumulated depreciation    |       | (1,377                | )          | (1,451 | ) |
| Total property and  equipment, net |       | $                     | 109        |   | $ | 347 |   |

 

Depreciation expense was $358, $183 and $74 for theyears ended December 31, 2003, 2004 and 2005 and $1,533 cumulative for theperiod from inception (April 14, 1997) through December 31, 2005.

The followingpresents accrued expenses:

|                            | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Accrued rent               |       | $                     | 146        |   | $ | 117 |   |
| Accrued  compensation      |       | 90                    |       | 417 |   |
| Accrued  professional fees |       | —                |       | 320 |   |
| Other                      |       | —                |       | 440 |   |
| Total accrued expenses     |       | $                     | 236        |   | $ | 1,294 |   |

 

**4.   Acquisitionand Disposition of Digital Mediacom, Inc.**

**Acquisition**

On August 31, 2001, the Company completed itsacquisition of Digital Mediacom, Inc. (“DMC”), a provider of design andengineering services and a developer of physical media device technology. Inconnection with the merger transaction, the Company acquired all outstandingshares of DMC common stock in exchange for cash of $950 and 1,603 shares of theCompany’s common stock. In addition, options and warrants to purchase shares ofDMC common stock outstanding immediately prior to the consummation of themerger were assumed by the Company and converted into options and warrants topurchase 781 shares of the Company’s common stock. The total purchase price,including the fair value of converted options and warrants and directacquisition costs, was $19,402. The purchase price was allocated to the assetsacquired and liabilities assumed based upon their fair values. The mostsignificant asset was $4,300 of acquired, in process research and development(see discussion below). The excess of the purchase price over the fair value ofthe net assets acquired of $14,589 was recorded as goodwill.

15

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**In-ProcessResearch and Development**

At the time of acquisition, DMC had certain in processdevelopment projects. Management estimated that $4,300 of the purchase pricerepresented the fair value of purchased in process research and developmentrelating to these development projects which had not yet reached technologicalfeasibility and had no alternative future uses. The Company estimated the fairvalue of the in-process research and development using an income approach,which estimates fair value by discounting the cash flows expected to arise fromthe development of the in-process projects and future sale of the resultingproducts.

**GoodwillImpairment and Discontinued Operations**

In August 2002, due to events and changes incircumstances which included a severe downturn in the market for the acquiredin process development projects, management and the Board of Directorscommitted to a plan to sell the physical media device (“PMD”) operating segmentwhich was comprised of the acquired DMC operations. Accordingly, the Companytested the PMD assets for impairment in accordance with SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*, and SFAS No. 142, *Goodwill and Other Intangible Assets*, and recorded a $13,306goodwill impairment charge.

On November 15, 2002, the Company closed on thesale of its PMD operating segment for $1,752 in cash. In connection with thesale, the buyer assumed $187 in liabilities, and the Company sold or disposedof all of the valuable technology, property and equipment, licensed softwareand employees. There was no gain or loss on the sale because the assets of thePMD operating segment were written down to their estimated net realizable valuein August 2002.

The operatingresults from the discontinued PMD operating segment included in theaccompanying financial statements were as follows:

|                                                | ** ** | **Cumulative for  the Period from  August 31,  2001 Through  December 31,  2002** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| Operating  expenses                            |       | $                                                                                                               | 14,268     |   |
| Purchased  in-process research and development |       | 4,300                                                                                                           |       |
| Goodwill  impairment                           |       | 13,306                                                                                                          |       |
| Loss from discontinued  operations             |       | $                                                                                                               | 31,874     |   |

 

**5.**   Note Payable to Stockholder

On January 16, 2002, the Company agreed topurchase 500 shares of the Company’s common stock from a stockholder inexchange for a note payable of $250. The note bore interest at 5% and was duein four equal installments through 2002. At December 31, 2002, theremaining balance due was $125. During 2003, the Company repaid the outstandingbalance of this note payable.

**6.**   Stockholders’ Equity

**Authorized Shares**

The Company’s authorized capital consists of 100,000shares of capital stock, of which 90,000 shares have been designated as commonstock ($0.01 per share par value), and 10,000 shares have been designated aspreferred stock ($0.01 per share par value). In addition, 3,411 of the 90,000shares of common stock have been reserved for issuance under the Company’sStock Option and Restricted Stock Plans. Each share of common stock entitlesthe holder to one vote.

16

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**Stock Split**

The Company’s Board of Directors and stockholdersdeclared a three-for-one reverse stock split, effective June 10, 2005. Theaccompanying financial statements and related notes give retroactive effect tothis reverse stock split.

**Warrants**

In connection with its initial public offering, theCompany issued warrants to purchase 400 common shares to the selling agent atan exercise price of $7.20 per share expiring in October 2010.

In connection with the convertible notes issued inApril 2005 (see”Convertible Notes” below), the Company issued warrants topurchase 367 common shares at an exercise price of $4.80 per share.

In March 2005, the Company granted fully vestedwarrants to purchase 33 common shares at an exercise price of $6.00 per shareto a consultant of the Company. In August 2005, the Company grantedwarrants to purchase 80 common shares at an exercise price of $6.30 per shareto a consultant of the Company. These warrants vest ratably over three yearsbeginning retroactively to October 2004. Total stock compensation expenserelated to these warrants during the year ended December 31, 2005 was $247.The fair value of the warrants was measured as they were earned using theBlack-Scholes option pricing model and the following assumptions atDecember 31, 2005:  term—10 years;volatility—73.8%; risk-free interest rate—4.35%; and expected dividend yield ofzero.

In connection with the issuance of  common stock by the Company fromJanuary 2004 to August 2004, the Company issued warrants to theselling agent to purchase 244 shares of common stock at an exercise price of$4.80. 200 of the warrants expire on March 24, 2009, and the remaining 44warrants expire on August 15, 2009.

In October and December 2004, the Companygranted warrants to purchase 253 shares of the Company’s common stock at aprice of $6.00 per share to consultants of the Company. Of these warrants,warrants to purchase 170 shares vest over three years and have a ten-year term.The remaining warrants to purchase 83 shares vest based on design wins and havea five-year term. Total stock-based compensation expense related to thesewarrants during the years ended December 31, 2004 and 2005 and cumulativefor the period from inception (April 14, 1997) through December 31,2005 was $50, $515 and $565, respectively. Unvested stock-based compensationrelated to these warrants at December 31, 2005 was $840. The fair value ofthese warrants was measured as they were earned using the Black-Scholes optionpricing model and the following assumptions at December 31, 2005: term—10years; volatility—68%; risk-free interest rate—4.47%; and expected dividend yieldof zero.

In the period between April 1, 2003 andJuly 31, 2003, the Company received proceeds of $5,304 net of $697 ofoffering costs, in exchange for 2,000 three-year warrants to purchase shares ofthe Company’s common stock. These warrants, which expire if not exercised threeyears after issuance, consisted of 1,000 Part A Warrants with an exerciseprice of $1.50 and 1,000 Part B Warrants with an exercise price of $2.25.

The warrants areredeemable at the Company’s option upon at least 30 days’ notice at a redemptionprice of $0.01 per warrant under any of the following circumstances:

·       Part Aand B Warrants are redeemable by the Company when any one of the followingtransactions closes: i) the sale, lease, exchange or other transfer,directly or indirectly, of all or substantially all of the assets of theCompany, ii) the approval by the Company’s stockholders of any plan or proposalfor the liquidation or dissolution of the Company, iii) any person or entitybecomes the beneficial owner, directly or indirectly, of more than 50% ofcombined voting power of the outstanding securities of the Company, or iv) amerger or consolidation to which the Company’s stockholders represent less than50% of the surviving company’s combined voting power of outstanding securities.

·       Part AWarrants were redeemable by the Company when the Company gave notice that ithad fabricated and successfully tested and demonstrated the functionality ofits Field Programmable Object Array chip (the 

17

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             “Chip”) and also received commitments fromat least two customers that will use the Chip in at least one of each customer’sdesign programs.

·       Part BWarrants are redeemable by the Company when the Company gives notice that ithas i) closed on a strategic investment from a company with significantfinancial resources (as defined) that is a participant in the semiconductorindustry or a related industry, or ii) recognized total aggregate cumulativerevenue from the sale or license of its silicon object chips of at least$2,500.

During 2004, the Company gave notice that it hadachieved the milestones required to permit the Company to redeem thePart A warrants. In December 2004, the Company called for redemptionof all Part A warrants. Proceeds from the exercise of Part A warrantsto purchase 981 shares and Part B warrants to purchase 646 shares, whoseholders voluntarily elected to exercise, were $2,645 net of offering costs of$279. The remaining Part A warrants to purchase 19 shares were exercisedin December 2003 and January 2005.

In connection with the sale of warrants to purchaseshares of the Company’s common stock from April to July 2003, theCompany issued warrants to the selling agent to purchase 200 shares of theCompany’s common stock at an exercise price of $4.89. Of these warrants, warrantsto purchase 183 shares expire on June 29, 2008, and the remaining warrantsto purchase 17 shares expire on July 7, 2008.

In connection with the issuance of common stock by theCompany from April 2002 to August 2002, the Company issued warrantsto the selling agent to purchase 146 shares of common stock at an exerciseprice of $10.50. The warrants expire on July 18, 2007.

In connection with the acquisition of DMC inAugust 2001, warrants to purchase shares of DMC common stock wereconverted to warrants to purchase 37 shares of the Company’s common stock at anexercise price of $7.76. Of these warrants, warrants to purchase 34 sharesexpired on various dates through December 31, 2005, and the remainingwarrants to purchase 3 shares expire on various dates through March 2006.

In connection with the issuance of common stock by theCompany in July and November 2000, the Company issued warrants to theselling agent to purchase 224 shares of common stock at an exercise price of$8.25. All of these warrants had expired as of December 31, 2005.

During December 2003, warrants to purchase 18shares were exercised in exchange for a subscription receivable for $27. Thesubscription receivable was paid in January 2004.

18

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The followingtable summarizes warrant activity:
| ** **                                               | ** ** | **Warrants  Outstanding** | ** ** | **Price Range  Per Share** | ** **    |
|----------------------------------------------------------|------------|---------------------------|------------|--------------------------------------|---------------|
| Warrants  outstanding at beginning of period (inception) |       |                      |       |                                 |          |
| Warrants issued in 2000                                  |       | 224                       |       | $                                    | 8.25          |   |
| Outstanding at December 31, 2000                    |       | 224                       |       | $                                    | 8.25          |   |
| Warrants issued                                          |       | 36                        |       | $                                    | 7.77          |   |
| Outstanding at December 31, 2001                    |       | 260                       |       | $                                    | 7.77 - $8.25  |   |
| Warrants issued                                          |       | 146                       |       | $                                    | 10.50         |   |
| Outstanding at December 31, 2002                    |       | 406                       |       | $                                    | 7.77 - $10.50 |   |
| Warrants sold                                            |       | 2,000                     |       | $                                    | 1.50 - $2.25  |   |
| Warrants issued                                          |       | 200                       |       | $                                    | 4.89          |   |
| Warrants  exercised                                      |       | (18                       | )          | $                                    | 1.50          |   |
| Outstanding at December 31, 2003                    |       | 2,588                     |       | $                                    | 1.50 - $10.50 |   |
| Warrants issued                                          |       | 497                       |       | $                                    | 4.80 - $6.00  |   |
| Warrants  exercised                                      |       | (1,627                    | )          | $                                    | 1.50 - $2.25  |   |
| Outstanding at December 31, 2004                    |       | 1,458                     |       | $                                    | 1.50 - $10.50 |   |
| Warrants issued                                          |       | 880                       |       | $                                    | 4.80 - $7.20  |   |
| Warrants  exercised                                      |       | (101                      | )          | $                                    | 1.50 - $2.25  |   |
| Warrants expired                                         |       | (253                      | )          | $                                    | 7.77 - $8.25  |   |
| Outstanding at  December 31, 2005                   |       | 1,984                     |       | $                                    | 1.50 - $10.50 |   |

 

**Notes Receivable**

In 1998 and 2000, the Company issued stock to certainstockholders totaling $15 and $230, respectively, under subscription agreementsin exchange for notes receivable with no stated interest rate. In 1999 and2000, the note holders repaid $15 and $230, respectively.

**Restricted Stock**

In 2004 and 2005, the Company issued 84 and 408 sharesof restricted common stock to certain employees of the Company. These shareswere granted effective upon the closing of the Company’s initial publicoffering and will vest on October 26, 2006 so long as the holders are thenemployees of the Company. The Company is recognizing compensation expense equalto the grant date fair value of the common shares ($2,741) pro rata over theone-year vesting period. During 2005, the Company recognized $447 ofcompensation expense related to these restricted shares, net of the reversal of$70 compensation expense recorded for 47 restricted shares cancelledbefore vesting. The remaining estimated compensation expense of $2,224 will berecognized over the remaining vesting period.

**Convertible Notes**

In April 2005, the Company issued 8% convertiblenotes totaling $5,500. The notes, which were due on April 28, 2006, boreinterest at the rate of 8% per year and were convertible into shares of theCompany’s common stock at a price per share equal to 80% of the issuance priceof the Company’s stock in an initial public offering, if any. If an initialpublic offering did not occur on or before April 28, 2006 or any extendedmaturity date of the notes, 

19

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the notes would have beenconvertible into shares of the Company’s common stock at a price of $4.80 pershare. The Company could have elected to extend the maturity of the notes forup to six months if an initial public offering had not closed on or beforeApril 28, 2006. However, the notes were payable in full 30 days after theclosing date an initial public offering.

In connection with the issuance of the convertiblenotes, the Company issued to the note holders warrants to purchase up to 367shares of the Company’s common stock. The warrants, which have a five-yearterm, are exercisable at a price per share equal to 80% of the issuance priceof the Company’s stock in an initial public offering ($4.80). If an initialpublic offering had not occurred on or before April 28, 2006 or anyextended maturity date of the notes, the warrants would have become exercisableat a price of $4.80 per share.

The allocated fair value of the warrants of $1,126 andthe value attributable to the beneficial price for conversion of the notes of$2,502 was accounted for as a discount on the convertible notes. The Companywas amortizing this discount to interest expense over the original term of thenotes. However, following completion of the Company’s initial public offeringduring the fourth quarter of 2005, the note holders elected to convert $5,430of the notes and accrued interest into 1,128 shares of common stock, and theremaining $330 of notes and accrued interest was repaid on December 1,2005 in accordance with the terms of the notes. The remaining unamortizeddiscount on these notes was charged to interest expense during the quarterended December 31, 2005. Interest expense recorded during the year endedDecember 31, 2005 related to amortization of the discount was $3,628.

The fair value of the warrants was determined usingthe Black-Scholes option pricing model and the following assumptions at thedate of issuance:  term—five years; volatility—68%; risk-freeinterest rate—3.79%; and expected dividend yield of zero. The value of theconversion feature was determined using the most beneficial conversion price ofthe notes at the time of issuance ($4.80 per share) and taking into account theadditional discount attributable to the allocated value of the warrants. Thisapproach resulted in a per share conversion price for accounting purposes ofapproximately $3.81. When compared to the estimated fair value of the Company’scommon stock at the time of the issuance of the notes ($6.00 per share), thisaccounting conversion price provides approximately a $2.19 conversion benefitto the note holders for each of the 1,146 shares into which the notes wereconvertible.

**7.**   Stock Option Plan

In January 2002, the Company and its stockholdersadopted the 2002 Combined Incentive and Nonstatutory Stock Option Plan (the “2002Plan”). In April 2000, the Company and its stockholders adopted the 2000Combined Incentive and Nonstatutory Stock Option Plan (the “2000 Plan”). Underthe 2002 Plan and the 2000 Plan, 1,000 and 333 shares of the Company’s commonstock were reserved for issuance of incentive and nonqualified stock options todirectors, officers and employees of and advisers to the Company at exerciseprices as determined by the Board of Directors on the date of grant,respectively. These options have exercise prices and vesting terms establishedby a committee of the Board of Directors at the time of each grant. Vestingterms of outstanding options are generally four years. In no event are theoptions exercisable more than ten years after the date of grant.

In October 2004, the Company adopted and inJune 2005 its stockholders approved the 2004 Amended and RestatedLong-Term Incentive Plan (the “2004 Plan”). Under the 2004 Plan, 1,334 sharesof the Company’s common stock were reserved for the issuance of restrictedstock and incentive and nonqualified stock options to directors, officers andemployees of and advisors to the Company at exercise prices as determined bythe Board of Directors on the date of grants, respectively.

20

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In connection with the acquisition of DMC (Note 4),the Company assumed DMC’s stock option plan. 744 shares of the Company’s commonstock have been reserved for issuance under the assumed plan and the relatedoptions are included in the following table, which summarizes stock option planactivity:
| ** **                                      | ** ** | **Shares  Available  for Grant** | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|
| Outstanding at  beginning of period (inception) |       |                                  |       |                        |       |                                    |       |
| Shares reserved                                 |       | 333                                   |       | —                      |       |                                    |       |
| Options granted  in 2000                        |       | (187                                  | )          | 187                         |       | $                                       | 6.80       |   |
| Outstanding at December 31, 2000           |       | 146                                   |       | 187                         |       | $                                       | 6.80       |   |
| Shares reserved for DMC assumed options         |       | 744                                   |       | —                      |       |                                    |       |
| Options assumed  from DMC acquisition           |       | (744                                  | )          | 744                         |       | $                                       | 1.54       |   |
| Options granted                                 |       | (95                                   | )          | 95                          |       | $                                       | 8.25       |   |
| Options  cancelled                              |       | 5                                     |       | (5                          | )          | $                                       | 8.25       |   |
| Outstanding at December 31, 2001           |       | 56                                    |       | 1,021                       |       | $                                       | 3.10       |   |
| Shares reserved                                 |       | 1,000                                 |       | —                      |       |                                    |       |
| Options granted                                 |       | (796                                  | )          | 796                         |       | $                                       | 7.98       |   |
| Options  cancelled                              |       | 358                                   |       | (712                        | )          | $                                       | 4.76       |   |
| Options exercised                               |       | —                                |       | (12                         | )          | $                                       | 7.01       |   |
| Outstanding at December 31, 2002           |       | 618                                   |       | 1,093                       |       | $                                       | 5.50       |   |
| Options granted                                 |       | (174                                  | )          | 174                         |       | $                                       | 4.89       |   |
| Options  cancelled                              |       | 130                                   |       | (183                        | )          | $                                       | 6.38       |   |
| Outstanding at December 31, 2003           |       | 574                                   |       | 1,084                       |       | $                                       | 5.26       |   |
| Shares reserved                                 |       | 334                                   |       | —                      |       |                                    |       |
| Options granted                                 |       | (276                                  | )          | 276                         |       | $                                       | 4.80       |   |
| Options  cancelled                              |       | 128                                   |       | (206                        | )          | $                                       | 4.63       |   |
| Options  exercised                              |       | —                                |       | (1                          | )          | $                                       | 0.87       |   |
| Restricted stock  issued                        |       | (84                                   | )          | —                      |       |                                    |       |
| Outstanding at December 31, 2004           |       | 676                                   |       | 1,153                       |       | $                                       | 5.79       |   |
| Shares reserved                                 |       | 1,000                                 |       | —                      |       |                                    |       |
| Options granted                                 |       | (1,203                                | )          | 1,203                       |       | $                                       | 5.75       |   |
| Options  cancelled                              |       | 319                                   |       | (319                        | )          | $                                       | 6.84       |   |
| Restricted stock  issued                        |       | (408                                  | )          | —                      |       |                                    |       |
| Restricted stock  cancelled                     |       | 47                                    |       | —                      |       |                                    |       |
| Outstanding at  December 31, 2005          |       | 431                                   |       | 2,037                       |       | $                                       | 5.60       |   |

 

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The followingtable summarizes information about stock options outstanding atDecember 31, 2005:

|                          | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **               | ** ** | ** **                   | ** ** | **Weighted-**                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **                   | ** ** | **Average**                  | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **               | ** ** | ** **                   | ** ** | **Remaining**                | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**        | ** ** | **Number**                   | ** ** | **Contractual**              | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Exercise Prices** | ** ** | **Outstanding**              | ** ** | **Life**                     | ** ** | **Price** | ** ** | **Outstanding** | ** ** | **Price** | ** ** |
| $  0.87        |       | 118                          |       | 1.35                         |       | $ | 0.87 |   | 118 |   | $ | 0.87 |   |
| $  3.45-$4.89  |       | 993                          |       | 7.47                         |       | $ | 4.72 |   | 321 |   | $ | 4.53 |   |
| $  5.25        |       | 38                           |       | 4.24                         |       | $ | 5.25 |   | 38 |   | $ | 5.25 |   |
| $  5.85-$6.30  |       | 656                          |       | 9.61                         |       | $ | 6.24 |   | 67 |   | $ | 6.30 |   |
| $  8.25        |       | 136                          |       | 4.97                         |       | $ | 8.25 |   | 136 |   | $ | 8.25 |   |
| $10.50                   |       | 96                           |       | 5.88                         |       | $ | 10.50 |   | 79 |   | $ | 10.50 |   |
|                     |       | 2,037                        |       |                         |       |   |   | 758 |   |   |   |

 

Stock options outstanding at December 31, 2005,include 56 options that were granted to nonemployees and 1,981 options thatwere granted to employees. During the year ended December 31, 2003, andcumulative for the period from inception (April 14, 1997) throughDecember 31, 2005, total stock-based compensation expense related tooptions issued to nonemployees measured using the fair value method asprescribed by SFAS No. 123, was $26 and $142, respectively. Totalstock-based compensation expense related to options issued to employees,including options assumed in connection with the acquisition of DMC, measuredusing the intrinsic value method, as prescribed by APB Opinion No. 25, was$148, $204 and $1,028 for the years ended December 31, 2003 and 2005 andcumulative for the period from inception (April 14, 1997) throughDecember 31, 2005. Compensation expense related to employee stock optionsthat will be amortized into future operating expenses was $932 atDecember 31, 2005.

Theweighted-average fair value of employee options on the date of grant orassumption was as follows:

|                                                                                                  | ** ** | ** **            | ** ** | ** **            | ** ** | ** ** | ** ** | **Cumulative**                 | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|--------------------------------|------------|
| ** **                                                                                       | ** ** | ** **            | ** ** | ** **            | ** ** | ** ** | ** ** | **for the Period**   | ** ** |
| ** **                                                                                       | ** ** | ** **            | ** ** | ** **            | ** ** | ** ** | ** ** | **from Inception**        | ** ** |
| ** **                                                                                       | ** ** | ** **            | ** ** | ** **            | ** ** | ** ** | ** ** | **(April 14, 1997)** | ** ** |
| ** **                                                                                       | ** ** | **Year Ended**   | ** ** | **Through**           | ** ** |
| ** **                                                                                       | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                       | ** ** | **2003**              | ** ** | **2004**              | ** ** | **2005**   | ** ** | **2005**                       | ** ** |
| For options  granted with exercise prices above the fair value of common stock              |       | —                |       | —                |       | —     |       | $                              | 0.01       |   |
| For options  granted with exercise prices at the fair value of common  stock |       | $                     | 0.69       |                  | $          | 0.77       |       | $                              | 3.73       |   | $ | 1.74 |   |
| For options granted or  assumed with exercise prices below the fair value of common stock        |       | —                |       | —                |       | 1.50       |       | $                              | 4.03       |   |
|                                                                                                  |            |                       |            |                       |            |            |            |                                |            |  |  |  |  |

 

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For the purpose ofdetermining fair values using the minimum value method for employee grants andthe fair value method for nonemployee grants as prescribed by SFASNo. 123, the Company used the Black-Scholes option pricing model with thefollowing weighted average assumptions:

|                                                                            | ** ** | **Year Ended**   | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                 | ** ** | **December 31,** | ** ** |
| ** **                                                                 | ** ** | **2003**              | ** ** | **2004** | ** ** | **2005** | ** ** |
| Expected option  term—employee                                        |       | 5 years               |       | 5 years |   | 5 years |   |
| Expected option  term—nonemployee                                     |       | 4 years               |       | N/A |   | N/A |   |
| Expected  volatility factor—employee (before initial public offering) |       | 0                     | %          | 0 | % | 0 | % |
| Expected  volatility factor—employee (after initial public offering)  |       | N/A                   |       | N/A |   | 73.8 | % |
| Expected  volatility factor—nonemployee                               |       | 81.60                 |       | N/A |   | N/A |   |
| Expected  dividend yield                                                   |       | 0                     | %          | 0 | % | 0 | % |
| Risk free  interest rate—employee                                     |       | 3.01                  | %          | 3.51 | % | 4.35 | % |
| Risk free interest  rate—nonemployee                                  |       | 4.53                  | %          | N/A |   | N/A |   |

 

**8.**   Income Taxes

The components ofdeferred income taxes are as follows:

|                                                    | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Net operating  loss carryforwards                  |       | $                     | 19,447     |   | $ | 25,461 |   |
| Research and  experimentation credit carryforwards |       | 2,503                 |       | 2,669 |   |
| Accrued expenses  and stock options                |       | 257                   |       | 822 |   |
| Total deferred tax assets                          |       | 22,207                |       | 28,952 |   |
| Valuation  allowance                               |       | (22,207               | )          | (28,952 | ) |
| Net deferred tax asset                             |       | $                     | —     |   | $ | — |   |

 

The Company has established valuation allowances tofully offset its deferred tax assets due to uncertainty about the Company’sability to generate the future taxable income necessary to realize thesedeferred tax assets, particularly in light of the Company’s recent history ofsignificant operating losses. The valuation allowance increases by $6,745 in2005. Future utilization of available net operating loss carryforwards may belimited under Internal Revenue Code Section 382 as a result of significantchanges in ownership. These limitations could result in expiration of these netoperating loss carryforwards before they are utilized.

For the years ended December 31, 2004 and 2005,and cumulative for the period from inception (April 14, 1997) throughDecember 31, 2005, the Company has generated federal net operating losscarryforwards of approximately $8,650, $13,937 and $62,554, respectively.

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The Company’sfederal net operating loss carryforwards and state net operating losscarryforwards expire in various calendar years from 2014 through 2025.Available research and development credit carryforwards at December 31,2005, include federal and state amounts of $2,287 and $587, respectively, withexpiration dates in calendar years 2015 through 2025.

The Company’seffective income tax rate differs from the U.S. Federal income tax rate asshown below:

|                                                               | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Tax expense  (benefit) at the federal statutory rate          |       | (35.00                | )%         | (35.00 | )% |
| State income tax  (benefit), net of federal income tax effect |       | (5.00                 | )%         | (5.70 | )% |
| Permanent  differences                                        |       | —                |       | 7.84 | % |
| Other                                                         |       | (4.83                 | )%         | (2.78 | )% |
| Increase in  valuation allowance                              |       | 44.83                 | %          | 35.62 | % |
| Effective tax rate                                            |       | 0.00                  | %          | 0.00 | % |

 

**9.**   401(k) Savings Plan

During 2000, the Company established a definedcontribution savings plan under Section 401(k) of the InternalRevenue Code. This plan covers substantially all employees who meet minimum ageand service requirements and allows participants to defer a portion of theirannual compensation on a pre-tax basis. The Company may make contributions tothe plan at the discretion of the Board of Directors. The Company has made nocontributions to the plan.

**10.**   Commitments

**Operating Leases**

The Company leases its office and research facilitiesand certain office equipment under noncancellable operating leases. Total rentexpense under these operating leases was $1,403, $859, $1,074 for the yearsended December 31, 2003, 2004 and 2005, respectively, and $4,102cumulative for the period from inception (April 14, 1997) throughDecember 31, 2005.

Future minimumlease payments under noncancellable operating leases at December 31, 2004,are as follows:

| Year Ending December 31, | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------|------------|
| 2006                                    |       | $          | 1,288      |   |
| 2007                                    |       | 628        |       |
| 2008                                    |       | 269        |       |
| 2009                                    |       | 275        |       |
| 2010                                    |       | 283        |       |
| 2011 and  thereafter                    |       | 47         |       |
|                                    |       | $          | 2,790      |   |

 

**Software LicenseAgreements**

The Company licenses certain internal use softwareunder noncancellable license agreements. Future payments under noncancellablelicense agreements at December 31, 2005, were $301.

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**PART IV**

**Item15. Exhibits and Financial Statement Schedules**

(b)           The following exhibits are filedherewith, and this list is the exhibit index.
| Exhibit No. | ** ** | **Description of Exhibit**                                                                                                                                                                                  | ** ** | **Page** | ** ** |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| 23.1             |       | Consent of  PricewaterhouseCoopers LLP                                                                                                                                                                                |       |     |       |
| 31.01            |       | Certification of  the Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the  Securities Exchange Act of 1934) (filed electronically herewith). |       |     |       |
| 31.02            |       | Certification of  the Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the  Securities Exchange Act of 1934) (filed electronically herewith). |       |     |       |

** **

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** **

**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this Annual Report on Form 10-K/A(Amendment No. 1) to be signed on its behalf by the undersigned, thereunto dulyauthorized.
| Date:  October 26, 2006 | MATHSTAR, INC.                                                 |
|------------------------------|---------------------------------------------------------------------|
|                         | /s/  James W. Cruckshank                                       |
|                         | James W. Cruckshank                                                 |
|                         | *Vice Presidentof Administration  and Chief Financial Officer* |
|                         | *(Principal Financial Officer and Principal  Accounting Officer)*   |

 

 

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