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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended March 31, 2004.



OR



| ̈ | 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 000-23084.



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Integrated Silicon Solution, Inc.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 77-0199971.                         
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|2231 Lawson Lane, Santa Clara, California                      |  | 95054.                              
|(Address of principal executive offices)                       |  | (Zip Code)                          



(408) 969-6600.

(Registrants telephone number, including area code)



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



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈No  x



The number of outstanding shares of the registrants Common Stock as of May 7, 2004 was 35,678,686.



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##### Table of Contents

TABLE OF CONTENTS



|           |  |                                                                                                                |  |   
|---------- |  | -------------------------------------------------------------------------------------------------------------- |  | --
|PART I     |  | Financial Information                                                                                          |  |   
|           |  |                                                                                                               
|Item 1.    |  | Financial Statements                                                                                           |  |   
|           |  |                                                                                                               
|           |  | Condensed Consolidated Statements of Operations Three and six months ended March 31, 2004 and 2003 (Unaudited) |  | 1 
|           |  |                                                                                                               
|           |  | Condensed Consolidated Balance Sheets March 31, 2004 (Unaudited) and September 30, 2003                        |  | 2 
|           |  |                                                                                                               
|           |  | Condensed Consolidated Statements of Cash Flows Six months ended March 31, 2004 and 2003 (Unaudited)           |  | 3 
|           |  |                                                                                                               
|           |  | Notes to Condensed Consolidated Financial Statements (Unaudited)                                               |  | 4 
|           |  |                                                                                                               
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                          |  | 12
|           |  |                                                                                                               
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                                     |  | 31
|           |  |                                                                                                               
|Item 4.    |  | Controls and Procedures                                                                                        |  | 32
|           |  |                                                                                                               
|PART II    |  | Other Information                                                                                              |  |   
|           |  |                                                                                                               
|Item 1.    |  | Legal Proceedings                                                                                              |  | 32
|           |  |                                                                                                               
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                            |  | 32
|           |  |                                                                                                               
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                                               |  | 33
|           | 
|Signatures |  | 34                                                                                                            



References in this
Report on Form 10-Q to we, us, our and ISSI mean Integrated Silicon Solution, Inc. and all entities owned or controlled by Integrated Silicon Solution, Inc.



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##### Table of Contents

Item 1. Financial Statements



Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share
data)



|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | --------------------------- | ------ | ---- | ------------------------- | ------ | ---- |  | ---- | ------ |  | - | ------- | -
|                                                                                                             |  | Three Months EndedMarch 31, |        |      | Six Months EndedMarch 31, |       
|                                                                                                             |  | 2004                        |        | 2003 |                           |        | 2004 |  | 2003 |       
|Net sales (See Note 14)                                                                                      |  | $                           | 51,504 |      | $                         | 22,312 |      |  | $    | 91,759 |  | $ | 43,350  |  
|Cost of sales                                                                                                |  |                             | 39,619 |      |                           | 18,972 |      |  |      | 70,922 |  |   | 41,232  |  
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Gross profit                                                                                                 |  |                             | 11,885 |      |                           | 3,340  |      |  |      | 20,837 |  |   | 2,118   |  
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Operating expenses:                                                                                          |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Research and development                                                                                     |  |                             | 5,381  |      |                           | 6,134  |      |  |      | 9,921  |  |   | 12,939  |  
|Selling, general and administrative                                                                          |  |                             | 4,162  |      |                           | 3,398  |      |  |      | 8,053  |  |   | 7,056   |  
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Total operating expenses                                                                                     |  |                             | 9,543  |      |                           | 9,532  |      |  |      | 17,974 |  |   | 19,995  |  
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Operating income (loss)                                                                                      |  |                             | 2,342  |      |                           | (6,192 | )    |  |      | 2,863  |  |   | (17,877 | )
|Other income, net                                                                                            |  |                             | 896    |      |                           | 152    |      |  |      | 992    |  |   | 170     |  
|Gain on sale of other investments                                                                            |  |                             | 8,740  |      |                           |       |      |  |      | 8,740  |  |   |        |  
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Income (loss) before income taxes, minority interest and equity in net (income) loss of affiliated companies |  |                             | 11,978 |      |                           | (6,040 | )    |  |      | 12,595 |  |   | (17,707 | )
|Provision for income taxes                                                                                   |  |                             | 366    |      |                           |       |      |  |      | 378    |  |   |        |  
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Income (loss) before minority interest and equity in net income (loss) of affiliated companies               |  |                             | 11,612 |      |                           | (6,040 | )    |  |      | 12,217 |  |   | (17,707 | )
|Minority interest in net loss of consolidated subsidiary                                                     |  |                             |       |      |                           |       |      |  |      |       |  |   | 17      |  
|Equity in net income (loss) of affiliated companies                                                          |  |                             | 900    |      |                           | (930   | )    |  |      | 1,190  |  |   | (1,969  | )
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Net income (loss)                                                                                            |  | $                           | 12,512 |      | $                         | (6,970 | )    |  | $    | 13,407 |  | $ | (19,659 | )
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Basic net income (loss) per share                                                                            |  | $                           | 0.38   |      | $                         | (0.25  | )    |  | $    | 0.43   |  | $ | (0.71   | )
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Shares used in basic per share calculation                                                                   |  |                             | 33,350 |      |                           | 27,708 |      |  |      | 31,000 |  |   | 27,637  |  
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Diluted net income (loss) per share                                                                          |  | $                           | 0.34   |      | $                         | (0.25  | )    |  | $    | 0.39   |  | $ | (0.71   | )
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Shares used in diluted per share calculation                                                                 |  |                             | 36,550 |      |                           | 27,708 |      |  |      | 34,242 |  |   | 27,637  |  
|                                                                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  



See accompanying notes
to condensed consolidated financial statements.



1



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##### Table of Contents

Integrated Silicon Solution, Inc.

Condensed Consolidated Balance Sheets

(In thousands)



|                                                       |  |               |         |   |                    |   |         |  
|------------------------------------------------------ |  | ------------- | ------- | - | ------------------ | - | ------- | -
|                                                       |  | March 31,2004 |         |   | September 30, 2003 |  
|                                                       |  | (unaudited)   |         |   | (1)                |  
|ASSETS                                                 |  |               |         |   |                    |   |         |  
|Current assets:                                        |  |               |         |   |                    |   |         |  
|Cash and cash equivalents                              |  | $             | 27,450  |   |                    | $ | 19,992  |  
|Short-term investments                                 |  |               | 133,100 |   |                    |   | 38,450  |  
|Accounts receivable                                    |  |               | 26,049  |   |                    |   | 10,088  |  
|Accounts receivable from related parties (See Note 14) |  |               | 2,898   |   |                    |   | 2,064   |  
|Inventories                                            |  |               | 27,254  |   |                    |   | 16,638  |  
|Other current assets                                   |  |               | 1,715   |   |                    |   | 1,712   |  
|                                                       |  |               |         |   |                    |   |         |  
|Total current assets                                   |  |               | 218,466 |   |                    |   | 88,944  |  
|Property, equipment, and leasehold improvements, net   |  |               | 4,738   |   |                    |   | 6,295   |  
|Other assets                                           |  |               | 121,755 |   |                    |   | 62,860  |  
|                                                       |  |               |         |   |                    |   |         |  
|Total assets                                           |  | $             | 344,959 |   |                    | $ | 158,099 |  
|                                                       |  |               |         |   |                    |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                   |  |               |         |   |                    |   |         |  
|Current liabilities:                                   |  |               |         |   |                    |   |         |  
|Accounts payable                                       |  | $             | 22,381  |   |                    | $ | 11,788  |  
|Accounts payable to related parties (See Note 14)      |  |               | 6,836   |   |                    |   | 5,442   |  
|Accrued compensation and benefits                      |  |               | 3,751   |   |                    |   | 3,406   |  
|Accrued expenses                                       |  |               | 5,861   |   |                    |   | 5,436   |  
|                                                       |  |               |         |   |                    |   |         |  
|Total current liabilities                              |  |               | 38,829  |   |                    |   | 26,072  |  
|Minority interest                                      |  |               |        |   |                    |   | 78      |  
|Stockholders equity:                                  |  |               |         |   |                    |   |         |  
|Common stock                                           |  |               | 4       |   |                    |   | 3       |  
|Additional paid-in capital                             |  |               | 333,077 |   |                    |   | 233,957 |  
|Accumulated deficit                                    |  |               | (83,921 | ) |                    |   | (97,328 | )
|Unearned compensation                                  |  |               | (263    | ) |                    |   | (268    | )
|Accumulated comprehensive income (loss)                |  |               | 57,233  |   |                    |   | (4,415  | )
|                                                       |  |               |         |   |                    |   |         |  
|Total stockholders equity                             |  |               | 306,130 |   |                    |   | 131,949 |  
|                                                       |  |               |         |   |                    |   |         |  
|Total liabilities and stockholders equity             |  | $             | 344,959 |   |                    | $ | 158,099 |  
|                                                       |  |               |         |   |                    |   |         |  

---

|(1) | Derived from audited financial statements.
|--- | ------------------------------------------



See accompanying notes to condensed consolidated financial statements.



2



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Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)



|                                                                          |  |                           |          |   |      |   |         |  
|------------------------------------------------------------------------- |  | ------------------------- | -------- | - | ---- | - | ------- | -
|                                                                          |  | Six Months EndedMarch 31, |         
|                                                                          |  | 2004                      |          |   | 2003 |  
|Cash flows from operating activities                                      |  |                           |          |   |      |   |         |  
|Net income (loss)                                                         |  | $                         | 13,407   |   |      | $ | (19,659 | )
|Depreciation and amortization                                             |  |                           | 1,889    |   |      |   | 2,446   |  
|Amortization of intangibles and unearned compensation                     |  |                           | 50       |   |      |   | 130     |  
|Gain on sale of shares of Semiconductor Manufacturing International       |  |                           |          |   |      |   |         |  
|Corp. (SMIC)                                                            |  |                           | (8,740   | ) |      |   |        |  
|(Gain) loss on embedded derivative                                        |  |                           | (252     | ) |      |   | 365     |  
|Gain on liquidation of D2Code                                             |  |                           | (282     | ) |      |   |        |  
|Net foreign currency transaction losses                                   |  |                           | (8       | ) |      |   | (6      | )
|Equity in net (income) loss of affiliated companies                       |  |                           | (1,190   | ) |      |   | 1,969   |  
|Minority interest in net loss of consolidated subsidiary                  |  |                           |         |   |      |   | (17     | )
|Net effect of changes in current and other assets and current liabilities |  |                           | (14,751  | ) |      |   | 2,974   |  
|                                                                          |  |                           |          |   |      |   |         |  
|Cash used in operating activities                                         |  |                           | (9,877   | ) |      |   | (11,798 | )
|                                                                          |  |                          
|Cash flows from investing activities                                      |  |                           |          |   |      |   |         |  
|Capital expenditures                                                      |  |                           | (332     | ) |      |   | (847    | )
|Purchases of available-for-sale securities                                |  |                           | (108,200 | ) |      |   | (15,650 | )
|Sales of available-for-sale securities                                    |  |                           | 13,550   |   |      |   | 29,650  |  
|Proceeds from partial sale of SMIC equity securities                      |  |                           | 13,236   |   |      |   |        |  
|                                                                          |  |                           |          |   |      |   |         |  
|Cash provided by (used in) investing activities                           |  |                           | (81,746  | ) |      |   | 13,153  |  
|                                                                          |  |                          
|Cash flows from financing activities                                      |  |                           |          |   |      |   |         |  
|Proceeds from issuance of common stock                                    |  |                           | 99,076   |   |      |   | 643     |  
|Principal payments on notes payable and long-term obligations             |  |                           |         |   |      |   | (84     | )
|                                                                          |  |                           |          |   |      |   |         |  
|Cash provided by financing activities                                     |  |                           | 99,076   |   |      |   | 559     |  
|                                                                          |  |                           |          |   |      |   |         |  
|Effect of exchange rate changes on cash and cash equivalents              |  |                           | 5        |   |      |   | (18     | )
|Net increase in cash and cash equivalents                                 |  |                           | 7,458    |   |      |   | 1,896   |  
|Cash and cash equivalents at beginning of period                          |  |                           | 19,992   |   |      |   | 11,622  |  
|                                                                          |  |                           |          |   |      |   |         |  
|Cash and cash equivalents at end of period                                |  | $                         | 27,450   |   |      | $ | 13,518  |  
|                                                                          |  |                           |          |   |      |   |         |  



See accompanying notes
to condensed consolidated financial statements.



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##### Table of Contents

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



1. Basis of Presentation



The accompanying unaudited condensed financial statements include the accounts of Integrated Silicon Solution, Inc. (the Company) and its consolidated majority owned subsidiaries, after elimination of all significant
intercompany accounts and transactions and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with Rule 10-01 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been
included.



Operating results for the three and six months ended
March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending September 30, 2004 or for any other period. The financial statements included herein should be read in conjunction with the Companys Annual
Report on Form 10-K for the fiscal year ended September 30, 2003.



2.
Stock-based Compensation



The Company applies the
intrinsic-value method prescribed in APB Opinion No. 25, Accounting for Stock issued to Employees, in accounting for employee stock options. Accordingly compensation expense is generally recognized only when options are granted with an
exercise price less than fair value on the date of grant. Any resulting compensation expense would be recognized ratably over the associated service period, which is generally the option vesting term.



The Company has determined pro forma net income (loss) and net income (loss)
per share information as if the fair value method described in SFAS No. 123, Accounting for Stock Based Compensation, had been applied to its employee stock-based compensation. The proforma effect on net income (loss) and net income
(loss) per share is as follows for the three and six month periods ending March 31, 2004 and 2003 (in thousands, except per share data):



|                                                  |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|------------------------------------------------- |  | --------------------------- | ------ | ---- | ------------------------- | ------ | ---- |  | ---- | ------ |  | - | ------- | -
|                                                  |  | Three Months EndedMarch 31, |        |      | Six Months EndedMarch 31, |       
|                                                  |  | 2004                        |        | 2003 |                           |        | 2004 |  | 2003 |       
|Net income (loss)  as reported                   |  | $                           | 12,512 |      | $                         | (6,970 | )    |  | $    | 13,407 |  | $ | (19,659 | )
|Compensation expense                              |  |                             | 1,160  |      |                           | 1,263  |      |  |      | 2,346  |  |   | 2,266   |  
|                                                  |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Net income (loss)  pro forma                     |  | $                           | 11,352 |      | $                         | (8,233 | )    |  | $    | 11,061 |  | $ | (21,925 | )
|                                                  |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Basic net income (loss) per share  as reported   |  | $                           | 0.38   |      | $                         | (0.25  | )    |  | $    | 0.43   |  | $ | (0.71   | )
|Diluted net income (loss) per share  as reported |  | $                           | 0.34   |      | $                         | (0.25  | )    |  | $    | 0.39   |  | $ | (0.71   | )
|Basic net income (loss) per share  pro forma     |  | $                           | 0.34   |      | $                         | (0.30  | )    |  | $    | 0.36   |  | $ | (0.79   | )
|Diluted net income (loss) per share  pro forma   |  | $                           | 0.31   |      | $                         | (0.30  | )    |  | $    | 0.33   |  | $ | (0.79   | )



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##### Table of Contents

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)



3. Concentrations



Sales to Asian Information Technology Inc. accounted for approximately 12% and 10% of total net sales for the three and six months ended March 31, 2004,
respectively. Sales to ATM Electronic Corporation accounted for approximately 10% and 9% of total net sales for the three months and six months ended March 31, 2004, respectively. Sales to ATM Electronic Corporation accounted for approximately 14%
and 12% of total net sales for the three months and six months ended March 31, 2003, respectively. Sales to LG Electronics Inc. accounted for approximately 11% of total net sales for the three months ended March 31, 2003. Sales to Samsung
Electronics Inc. accounted for approximately 12% of total net sales for the three months ended March 31, 2003.



4. Cash, Cash Equivalents and Short-term Investments



Cash, cash equivalents and short-term investments consisted of the following:





|                                         |  |                |         |                   |   |       
|---------------------------------------- |  | -------------- | ------- | ----------------- | - | ------
|                                         |  | (In thousands)
|                                         |  | March 31,2004  |         | September 30,2003
|Cash                                     |  | $              | 21,995  |                   | $ | 13,748
|Money market instruments                 |  |                | 5,455   |                   |   | 6,244 
|Municipal bonds due in more than 3 years |  |                | 133,100 |                   |   | 38,450
|                                         |  |                |         |                   |   |       
|                                         |  | $              | 160,550 |                   | $ | 58,442
|                                         |  |                |         |                   |   |       



5. Inventories



The following is a summary of inventories by major category:



|                     |  |                |        |                   |   |       
|-------------------- |  | -------------- | ------ | ----------------- | - | ------
|                     |  | (In thousands)
|                     |  | March 31,2004  |        | September 30,2003
|Purchased components |  | $              | 14,386 |                   | $ | 6,032 
|Work-in-process      |  |                | 5,421  |                   |   | 1,405 
|Finished goods       |  |                | 7,447  |                   |   | 9,201 
|                     |  |                |        |                   |   |       
|                     |  | $              | 27,254 |                   | $ | 16,638
|                     |  |                |        |                   |   |       



6. Other Assets



Other assets consisted of the following:



|                                         |  |                |         |                   |   |       
|---------------------------------------- |  | -------------- | ------- | ----------------- | - | ------
|                                         |  | (In thousands)
|                                         |  | March 31,2004  |         | September 30,2003
|Investment in ICSI common stock          |  | $              | 15,275  |                   | $ | 13,853
|Investment in ICSI convertible debenture |  |                | 3,570   |                   |   | 2,939 
|Investment in SMIC                       |  |                | 98,793  |                   |   | 42,000
|Other equity investments                 |  |                | 3,914   |                   |   | 3,914 
|Other                                    |  |                | 203     |                   |   | 154   
|                                         |  |                |         |                   |   |       
|                                         |  | $              | 121,755 |                   | $ | 62,860
|                                         |  |                |         |                   |   |       



The market value of
the Companys investment in the common stock and convertible debentures of Integrated Circuit Solution, Inc. (ICSI) at March 31, 2004 was approximately $52.1 million and $3.6



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##### Table of Contents

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)



million, respectively, based on quoted market prices. Since ICSI is accounted for under the equity method of
accounting, the carrying value of the Companys investment in ICSIs common stock differs from the market value. The Companys total carrying value for ICSI common stock as of March 31, 2004 was approximately $19.6 million of which
approximately $4.3 million is included in other comprehensive loss as accumulated foreign currency translation adjustment in the equity portion of the balance sheet.



On March 17, 2004, Semiconductor Manufacturing International Corp. (SMIC) completed an initial public offering
(IPO). SMICs ordinary shares are traded on the Hong Kong Stock Exchange and SMIC American Depository Receipts (ADR) are traded on the New York Stock Exchange. Each SMIC ADR represents fifty (50) ordinary shares. The
Company sold certain shares of its SMIC stock in the IPO, and recorded gross proceeds of approximately $13.2 million in the March 2004 quarter resulting in a pre-tax gain of approximately $8.7 million. Since SMICs IPO, the Company accounts for
its shares in SMIC under the provisions of FASB 115 and has marked its investment to the market value as of March 31, 2004 by increasing other assets and by increasing accumulated comprehensive income in the equity section of the balance sheet. The
cost basis of the Companys shares in SMIC is approximately $37.5 million and the market value at March 31, 2004 was approximately $98.8 million. The market value of SMIC shares is subject to fluctuations and the Companys carrying value
will be subject to adjustments to reflect the current market value. The Companys shares in SMIC are subject to certain lockup restrictions and therefore are not freely tradable. These lockup restrictions generally lapse at the rate of 15% of
the Companys pre-offering shares every 180 days following the IPO. Thus all of the Companys shares in SMIC will be freely tradable 3 years and 180 days following the IPO.



7. Comprehensive Income (Loss)



Comprehensive income (loss) includes net income (loss) as well as other comprehensive income (loss). The Companys other comprehensive income (loss)
consists of changes in cumulative translation adjustment and unrealized gains and losses on investments.



Comprehensive income (loss), net of taxes, was as follows:



|                                                 |  |                             |        |                |                           |        |      |  |      |        |  |   |         |  
|------------------------------------------------ |  | --------------------------- | ------ | -------------- | ------------------------- | ------ | ---- |  | ---- | ------ |  | - | ------- | -
|                                                 |  | Three Months EndedMarch 31, |        |                | Six Months EndedMarch 31, |       
|                                                 |  | 2004                        |        | 2003           |                           |        | 2004 |  | 2003 |       
|                                                 |  |                             |        | (In thousands) |                           |        |     
|Net income (loss)                                |  | $                           | 12,512 |                | $                         | (6,970 | )    |  | $    | 13,407 |  | $ | (19,659 | )
|Other comprehensive income (loss), net of tax:   |  |                             |        |                |                           |        |      |  |      |        |  |   |         |  
|Change in cumulative translation adjustment      |  |                             | 273    |                |                           | (125   | )    |  |      | 39     |  |   | 14      |  
|Change in unrealized gains/losses on investments |  |                             | 61,449 |                |                           | 179    |      |  |      | 61,609 |  |   | (69     | )
|                                                 |  |                             |        |                |                           |        |      |  |      |        |  |   |         |  
|Comprehensive income (loss)                      |  | $                           | 74,234 |                | $                         | (6,916 | )    |  | $    | 75,055 |  | $ | (19,714 | )
|                                                 |  |                             |        |                |                           |        |      |  |      |        |  |   |         |  



The accumulated comprehensive income
(loss) component within the stockholders equity section of the Companys balance sheet is comprised of foreign currency translation adjustments and unrealized gains and losses on investments.



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##### Table of Contents

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)



The components of accumulated other comprehensive loss, net of tax, were as follows:



|                                                                                   |  |                |        |   |                   |   |        |  
|---------------------------------------------------------------------------------- |  | -------------- | ------ | - | ----------------- | - | ------ | -
|                                                                                   |  | March 31,2004  |        |   | September 30,2003 |  
|                                                                                   |  | (In thousands) |       
|Accumulated foreign currency translation adjustments related to investment in ICSI |  | $              | (4,321 | ) |                   | $ | (4,553 | )
|Other accumulated foreign currency translation adjustments                         |  |                | 42     |   |                   |   | 235    |  
|Accumulated net unrealized gain on SMIC                                            |  |                | 61,289 |   |                   |   |       |  
|Accumulated net unrealized gain (loss) on other available-for-sale investments     |  |                | 223    |   |                   |   | (97    | )
|                                                                                   |  |                |        |   |                   |   |        |  
|Total accumulated other comprehensive income (loss)                                |  | $              | 57,233 |   |                   | $ | (4,415 | )
|                                                                                   |  |                |        |   |                   |   |        |  



8. Income Taxes



The provision for income taxes for the three month and six month
periods ended March 31, 2004 of $366,000 and $378,000, respectively, consists of alternative minimum taxes. The Company recorded no provision for income taxes for the three and six month periods ended March 31, 2003 due to its cumulative net
operating loss position for tax purposes and the Companys ability to carryforward those operating losses to reduce fiscal 2004 taxable income.



9. Per Share Data



The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share amounts):



|                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|------------------------------------------------------------ |  | --------------------------- | ------ | ---- | ------------------------- | ------ | ---- |  | ---- | ------ |  | - | ------- | -
|                                                             |  | Three Months EndedMarch 31, |        |      | Six Months EndedMarch 31, |       
|                                                             |  | 2004                        |        | 2003 |                           |        | 2004 |  | 2003 |       
|Numerator for basic and diluted net income (loss) per share: |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Net income (loss)                                            |  | $                           | 12,512 |      | $                         | (6,970 | )    |  | $    | 13,407 |  | $ | (19,659 | )
|                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Denominator for basic net income (loss) per share:           |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Weighted average common shares outstanding                   |  |                             | 33,350 |      |                           | 27,708 |      |  |      | 31,000 |  |   | 27,637  |  
|Dilutive stock options                                       |  |                             | 3,200  |      |                           |       |      |  |      | 3,242  |  |   |        |  
|                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Denominator for diluted net income (loss) per share          |  |                             | 36,550 |      |                           | 27,708 |      |  |      | 34,242 |  |   | 27,637  |  
|                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Basic net income (loss) per share                            |  | $                           | 0.38   |      | $                         | (0.25  | )    |  | $    | 0.43   |  | $ | (0.71   | )
|                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  
|Diluted net income (loss) per share                          |  | $                           | 0.34   |      | $                         | (0.25  | )    |  | $    | 0.39   |  | $ | (0.71   | )
|                                                             |  |                             |        |      |                           |        |      |  |      |        |  |   |         |  



The above diluted
calculation for the three months ended March 31, 2004 and March 31, 2003 does not include approximately 394,000 shares and 6,126,000 shares attributable to options as of March 31, 2004 and 2003, respectively, as their impact would be anti-dilutive.
The above diluted calculation for the six months ended March 31, 2004 and 2003, does not include approximately 414,000 shares and 6,053,000 shares attributable to options as of March 31, 2004 and 2003, respectively, as their impact would be
anti-dilutive. Of the 6,126,000 shares and 6,053,000 shares excluded from the three and six month ended March 31, 2003 calculation, approximately 2,041,000 shares and 2,219,000 shares, respectively, were in the money but excluded solely because the
Company had a net loss for that period.



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##### Table of Contents

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)



10. Use of Estimates



The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates, and such differences, may be material to the financial statements.



11. Impact of Recently Issued Accounting Standards



In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51, (FIN 46). FIN 46 requires certain variable interest entities (VIEs) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new VIEs created
or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period ending after March 15, 2004. The adoption of FIN 46 has not and is not
expected to have a material effect on the Companys financial position, results of operations or cash flows.



12. Commitments and Contingencies

Legal Proceedings



On June 16, 2003, Symbol Technologies, Inc. (Symbol) filed suit against the Company in the Supreme Court of the State of New York. The complaint alleges causes of action for breach of express warranty,
negligent misrepresentation, breach of implied contract, negligence and breach of implied warranty of fitness for a particular purpose related to certain of the Companys products purchased by Symbol. The complaint seeks monetary damages in an
amount of $5.0 million, plus pre-judgment interest and court costs. The Company believes that it has meritorious defenses to the claims alleged by Symbol and intends to defend this suit vigorously.



13. Geographic and Segment Information



The Company has one operating segment, which is to design, develop, and
market high-performance SRAM, DRAM, and other memory products. The following table summarizes the Companys operations in different geographic areas:



|                             |  |                             |        |                           |   |        |  |      |        |  |   |       
|---------------------------- |  | --------------------------- | ------ | ------------------------- | - | ------ |  | ---- | ------ |  | - | ------
|                             |  | Three Months EndedMarch 31, |        | Six Months EndedMarch 31,
|                             |  | 2004                        |        | 2003                      |   | 2004   |  | 2003
|                             |  | (In thousands)             
|Net sales                    |  |                             |        |                           |   |        |  |      |        |  |   |       
|United States                |  | $                           | 6,757  |                           | $ | 3,133  |  | $    | 11,997 |  | $ | 7,246 
|China                        |  |                             | 4,926  |                           |   | 3,582  |  |      | 8,967  |  |   | 6,884 
|Hong Kong                    |  |                             | 12,040 |                           |   | 1,626  |  |      | 19,998 |  |   | 4,945 
|Taiwan                       |  |                             | 15,922 |                           |   | 5,161  |  |      | 25,415 |  |   | 8,818 
|Korea                        |  |                             | 2,491  |                           |   | 4,378  |  |      | 5,612  |  |   | 6,306 
|Other Asia Pacific countries |  |                             | 4,729  |                           |   | 1,871  |  |      | 9,197  |  |   | 3,891 
|Europe                       |  |                             | 4,310  |                           |   | 2,558  |  |      | 9,947  |  |   | 5,241 
|Other North America          |  |                             | 329    |                           |   | 3      |  |      | 626    |  |   | 19    
|                             |  |                             |        |                           |   |        |  |      |        |  |   |       
|Total net sales              |  | $                           | 51,504 |                           | $ | 22,312 |  | $    | 91,759 |  | $ | 43,350
|                             |  |                             |        |                           |   |        |  |      |        |  |   |       



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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)



|                        |  |                |       |                   |   |      
|----------------------- |  | -------------- | ----- | ----------------- | - | -----
|                        |  | March 31,2004  |       | September 30,2003
|                        |  | (In thousands)
|Long-lived assets       |  |                |       |                   |   |      
|United States           |  | $              | 2,705 |                   | $ | 4,307
|Hong Kong               |  |                | 60    |                   |   | 70   
|China                   |  |                | 1,735 |                   |   | 1,918
|Other foreign locations |  |                | 238   |                   |   |     
|                        |  |                |       |                   |   |      
|                        |  | $              | 4,738 |                   | $ | 6,295
|                        |  |                |       |                   |   |      



14. Related Party Transactions



The Company sells and licenses memory products to ICSI.
The Company currently has approximately a 29% ownership interest in ICSI. The Companys Chairman and Chief Executive Officer (CEO), Jimmy S.M. Lee, is a director of ICSI. The Company also provides administrative services to ICSI for
which it is reimbursed.



The Company purchases goods and
contract manufacturing services from ICSI. For the six months ended March 31, 2004 and March 31, 2003, purchases of goods and services were approximately $2,332,000 and $21,000, respectively. The Company also pays ICSI for certain product
development costs, license fees and royalties. For the six months ended March 31, 2004 and March 31, 2003, these charges totaled approximately $570,000 and $256,000, respectively.



The Company receives reimbursement from NexFlash for some patent expenses related to jointly owned patents. The Company
currently has approximately a 14% ownership interest in NexFlash. The Companys Chairman and CEO, Jimmy S.M. Lee, is a director of NexFlash.



The Company provides services to GetSilicon in which the Company currently has approximately a 17% ownership interest. The Companys Chairman and
CEO, Jimmy S.M. Lee, was the Chairman of GetSilicon until May 14, 2002 and continues to serve as a director. For the six months ended March 31, 2004 and March 31, 2003, the Company provided services of approximately $22,000 and $36,000,
respectively, to GetSilicon.



The Company engages GetSilicon
for business-to-business data exchange and professional services. For the six months ended March 31, 2004 and March 31, 2003, the purchase of services was approximately $19,000 and $12,000, respectively.



The Company sells memory products to E-CMOS in which the Company currently
has approximately an 11% ownership interest. The Companys Chairman and CEO, Jimmy S.M. Lee, was the Chairman of E-CMOS until June 2003 and continues to serve as a director.



The Company receives administrative support services and reimburses E-CMOS for expenses incurred on its behalf. For the six
months ended March 31, 2004 and March 31, 2003, the purchase of services and expenses reimbursed by the Company was approximately $206,000 and $233,000, respectively.



The Company sold memory products to Marubun USA Corporation (Marubun USA) in fiscal 2003 and in the first
quarter of fiscal 2004. Hide L. Tanigami, a director of the Company, is the president and chief executive officer of Marubun USA. Effective January 1, 2004, the Company no longer sells products to Marubun USA, but to Marubun Japan.



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##### Table of Contents

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)



The Company purchases goods from SMIC in which the Company has less than a 2% ownership interest. The
Companys Chairman and CEO, Jimmy S.M. Lee, was a director of SMIC until March 2004. For the six months ended March 31, 2004 and March 31, 2003, purchases of goods from SMIC were approximately $16,907,000 and $15,140,000, respectively.



Lip-Bu Tan, a director of the Company, has been a director of
Flextronics since April 3, 2003. The Company sold memory products to Flextronics in fiscal 2003 and fiscal 2004. The Company had been doing business with Flextronics prior to Mr. Tan joining the board of directors of Flextronics.



The Company provides manufacturing support services to Signia in which the
Company currently has approximately a 15% ownership interest. The Companys Chairman and CEO, Jimmy S.M. Lee, is a director of Signia. For the six months ended March 31, 2004 and March 31, 2003, the Company provided services of approximately
$38,000 and $0, respectively, to Signia.



Accounts receivable
from related parties consisted of the following:



|            |  |                |       |                   |   |      
|----------- |  | -------------- | ----- | ----------------- | - | -----
|            |  | March 31,2004  |       | September 30,2003
|            |  | (In thousands)
|E-CMOS      |  | $              | 8     |                   | $ | 39   
|Flextronics |  |                | 499   |                   |   | 355  
|GetSilicon  |  |                |      |                   |   | 31   
|ICSI        |  |                | 828   |                   |   | 276  
|Marubun USA |  |                |      |                   |   | 1,044
|Nexflash    |  |                | 4     |                   |   | 4    
|Signia      |  |                | 1,559 |                   |   | 315  
|            |  |                |       |                   |   |      
|Total       |  | $              | 2,898 |                   | $ | 2,064
|            |  |                |       |                   |   |      



The following table
shows net sales to related parties:



|                             |  |                           |       |      |   |    
|---------------------------- |  | ------------------------- | ----- | ---- | - | ---
|                             |  | Six months endedMarch 31,
|                             |  | 2004                      |       | 2003
|                             |  | (In thousands)           
|Net sales to related parties |  |                           |       |      |   |    
|E-CMOS                       |  | $                         | 49    |      | $ | 17 
|Flextronics                  |  |                           | 1,124 |      |   |   
|ICSI                         |  |                           | 879   |      |   | 157
|Marubun USA                  |  |                           | 2,053 |      |   | 327
|Others                       |  |                           | 39    |      |   |   
|                             |  |                           |       |      |   |    
|Total                        |  | $                         | 4,144 |      | $ | 501
|                             |  |                           |       |      |   |    



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##### Table of Contents

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)



Accounts payable to related parties consisted of the following:



|           |  |                |       |                   |   |      
|---------- |  | -------------- | ----- | ----------------- | - | -----
|           |  | March 31,2004  |       | September 30,2003
|           |  | (In thousands)
|E-CMOS     |  | $              | 9     |                   | $ | 37   
|GetSilicon |  |                | 8     |                   |   | 83   
|ICSI       |  |                | 1,422 |                   |   | 386  
|SMIC       |  |                | 5,397 |                   |   | 4,936
|           |  |                |       |                   |   |      
|Total      |  | $              | 6,836 |                   | $ | 5,442
|           |  |                |       |                   |   |      



15. Investment in Integrated
Circuit Solution Inc. (ICSI)



The following
summarizes financial information for ICSI, an equity investee.



|                                                |  |                |        |                   |   |       
|----------------------------------------------- |  | -------------- | ------ | ----------------- | - | ------
|                                                |  | March 31,2004  |        | September 30,2003
|                                                |  | (In thousands)
|Current assets                                  |  | $              | 89,595 |                   | $ | 82,691
|Property, plant, and equipment and other assets |  |                | 33,909 |                   |   | 36,981
|Current liabilities                             |  |                | 37,865 |                   |   | 41,957
|Long-term debt                                  |  |                | 19,610 |                   |   | 18,812



|                  |  |                           |        |      |   |        |  
|----------------- |  | ------------------------- | ------ | ---- | - | ------ | -
|                  |  | Six Months EndedMarch 31, |       
|                  |  | 2004                      |        | 2003 |  
|                  |  | (In thousands)            |       
|Net sales         |  | $                         | 87,693 |      | $ | 39,786 |  
|Gross profit      |  |                           | 16,214 |      |   | 1,990  |  
|Net income (loss) |  |                           | 5,812  |      |   | (6,916 | )



In the June 2002
quarter, the Company invested approximately $3.2 million in convertible debentures issued by ICSI. As a result of changes in ICSIs convertible debenture price, the Company has recorded an accumulated unrealized gain of approximately $223,000
related to the ICSI convertible debentures. The unrealized gain is included in accumulated other comprehensive income (loss). In addition, in the three and six months ended March 31, 2004, the Company recorded a gain of approximately $311,000 and
$252,000, respectively, related to the increase in the fair value of an embedded derivative associated with the ICSI convertible debenture. The gain associated with the embedded derivative is included in other income (expense). The market value of
the Companys convertible debentures at March 31, 2004 was approximately $3.6 million.



The Company accounts for investments in 50% or less owned companies over which it has the ability to exercise significant influence using the equity method of accounting. As of March 31, 2004, only ICSI is accounted
for using the equity method of accounting. At March 31, 2004 and September 30, 2003, approximately $3.0 million and $1.8 million, respectively, of undistributed earnings of 50% or less owned companies accounted for using the equity method are
included in consolidated retained earnings. The Company periodically reviews these investments for other-than-temporary declines in market value and writes these investments to their fair value when an other-than-temporary decline has occurred.



16. Follow-on Public Stock Offering



In the three month period ended March 31, 2004, the Company completed
a follow-on public offering of its Common Stock whereby it sold 6,025,000 shares at a public offering price of $16.50 per share. Proceeds from this offering, net of commissions, discounts and expenses, were $93.5 million.



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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS



We have made forward-looking statements in this report that are subject to
risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of our operations. Also, when we use words such as believes, expects, anticipates or similar
expressions, we are making forward-looking statements. You should note that an investment in our securities involves certain risks and uncertainties that could affect our future financial results. Our actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain factors, including those set forth in Certain Factors Which May Affect Our Business or Future Operating Results and elsewhere in this report.



We believe it is important to communicate our expectations to our investors.
However, there may be events in the future that we are not able to predict accurately or over which we have no control. The risks described in Certain Factors Which May Affect Our Business or Future Operating Results included in this
report, as well as any cautionary language in this report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements.



All forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by the cautionary statements set forth in this report. Except as required by federal securities laws, we are under no obligation to update any forward-looking statement, whether as a result of new
information, future events, or otherwise.



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



Overview



We are a fabless semiconductor company that designs and markets high performance integrated circuits for the following key markets: (i) digital consumer
electronics, (ii) networking, (iii) mobile communications and (iv) automotive electronics. Our primary products are high speed and low power static random access memories (SRAM) and low and medium density dynamic random access memories
(DRAM). We were founded in October 1988 and initially focused on high performance, low cost SRAM for PC cache memory applications. In 1997, we introduced our first low and medium density DRAM products. In 1996 and 1997, we began to focus
on the networking, internet access and telecommunications markets and, by 1999, revenue from such markets represented a substantial majority of our net sales. Due to our focus on these markets, we recorded revenues of $65.2 million in the quarter
ended December 31, 2000. These markets experienced a substantial downturn beginning in 2001 which resulted in a significant decline in our revenues, significant inventory write-offs and large operating losses. In response to these adverse market
conditions, we increased our focus on the digital consumer electronics, mobile communications and automotive electronics markets and also reduced our operating expenses. As a result of our success in the digital consumer electronics market, sales of
our low and medium density DRAM products have increased significantly and represented a majority of our net sales in fiscal 2003 and in the three and six months ended March 31, 2004.



As a fabless semiconductor company, our business model is less capital intensive because we rely on third parties to
manufacture, assemble and test our products. However, as a result of our dependence on third-party wafer foundries, our ability to increase our unit sales volumes depends on our ability to increase our wafer capacity allocation from current
foundries, add additional foundries and improve yields of die per wafer.



Although average selling prices of our SRAM and DRAM products have generally declined over time, the selling prices are very sensitive to supply and demand conditions in our target markets. For most of fiscal 2003,
average selling prices for our products declined as they had in recent prior years. More recently, market conditions have improved and prices have stabilized and in some cases increased. We expect average selling prices for our products to decline
in the future, principally due to continuing and increased market competition and an increased supply of competitive products in the market. Any future decreases in our average selling



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prices would have an adverse impact on our revenue growth rate, gross margins and operating margins. Our ability to
maintain or increase revenues will be highly dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in quantities sufficient to compensate for the anticipated declines in average selling
prices of existing products. Declining average selling prices will adversely affect gross margins unless we are able to offset such declines with commensurate reductions in per unit costs or changes in product mix in favor of higher margin products.



Revenue from product sales to our direct customers is
recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed and determinable, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance
requirements and there are no remaining significant obligations. A portion of our sales is made to distributors under agreements that provide the possibility of certain sales price rebates and limited product return privileges. Given the
uncertainties associated with the levels of returns and other credits that will be issued to these distributors, we defer recognition of such sales until our products are sold by the distributors to their end customers. Revenue from sales to
distributors who do not have sales price rebates or product return privileges is recognized at the time our products are sold by us to the distributors.



We market and sell our products in Asia, the U.S. and Europe through our direct sales force, distributors and sales representatives. The percentage of our
revenues from customers located outside the U.S. was approximately 70%, 87% and 87% in fiscal 2002, fiscal 2003 and the first six months of fiscal 2004, respectively. The increase in our revenues from Asia is due to our success in the digital
consumer electronics market. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. The percentages of our revenues by region are set forth in the following table:



|       |  |                                 |   |  |                                |   |  |     |  
|------ |  | ------------------------------- | - |  | ------------------------------ | - |  | --- | -
|       |  | Fiscal Years EndedSeptember 30, |   |  | Six Months EndedMarch 31, 2004 |  
|       |  | 2002                            |   |  | 2003                           |   | 
|Asia   |  | 56                              | % |  | 77                             | % |  | 75  | %
|Europe |  | 14                              |   |  | 10                             |   |  | 11  |  
|U.S.   |  | 30                              |   |  | 13                             |   |  | 13  |  
|Other  |  |                                |   |  |                               |   |  | 1   |  
|       |  |                                 |   |  |                                |   |  |     |  
|Total  |  | 100                             | % |  | 100                            | % |  | 100 | %
|       |  |                                 |   |  |                                |   |  |     |  



Our sales are
generally made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog is not a good indicator of our future sales. Cancellations of customer orders or changes in product
specifications could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses.



Since a significant portion of our revenue is from the digital consumer electronics market, our business may be subject to seasonality, with increased
revenues in the third and fourth calendar quarters of each year, when customers place orders to meet year-end holiday demand. However, broad fluctuations in our overall business in the past several years makes it difficult for us to assess the
impact of seasonal factors on our business.



We hold equity
interests in a number of other companies. We acquired these interests for strategic reasons, such as developing a strong relationship with a third-party wafer foundry we rely on to manufacture our products. Our financial results for fiscal 2004 and
fiscal 2003 reflect accounting for Integrated Circuit Solution, Inc. (ICSI) on the equity basis and include our percentage share of the results of ICSIs operations. Our financial results for fiscal 2003 through the period ended
April 30, 2003 reflect accounting for E-CMOS Technology Corporation on the equity basis and include our percentage share of the results of E-CMOS



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operations. Effective May 2003, our ownership of E-CMOS became less than 20% and we began accounting for E-CMOS on the
cost basis. Our financial results for fiscal 2004 and fiscal 2003 reflect accounting for GetSilicon, NexFlash Technologies, Signia Technologies and Semiconductor Manufacturing International Corporation (SMIC) on the cost basis. ICSI is a
Taiwan-based fabless memory supplier, and E-CMOS is a Taiwan-based peripherals interface device company, GetSilicon is a semiconductor supply chain management software company, NexFlash is a Flash memory supplier, Signia Technologies is a developer
of wireless semiconductors, and SMIC is a China-based semiconductor foundry. At March 31, 2004, we owned approximately 29% of ICSI, approximately 11% of E-CMOS, approximately 17% of GetSilicon, approximately 14% of NexFlash, approximately 15% of
Signia Technologies and less than 2% of SMIC. In October 2001, we invested $3.0 million for a 95% interest in D2Code Co. Inc. (D2Code), a subsidiary that we established in Korea to focus on semiconductor design activities. In 2003, we
transferred key designers to our U.S. team, and, in the March 2004 quarter, we completed the liquidation of D2Code.



We are subject to the risks of conducting business internationally, including economic conditions in Asia, particularly Taiwan and China, changes in trade policy and
regulatory requirements, duties, tariffs and other trade barriers and restrictions, the burdens of complying with foreign laws and, possibly, political instability. All of our foundries and assembly and test subcontractors are located in Asia.
Although we transact business predominately in U.S. dollars, we do have some transactions in New Taiwan dollars, in Hong Kong dollars and in China Renminbi. Such transactions expose us to the risk of exchange rate fluctuations. We monitor our
exposure to foreign currency fluctuations, but have not to date adopted any hedging strategy. There can be no assurance that exchange rate fluctuations will not harm our business and operating results in the future.



Critical Accounting Policies



The preparation of financial statements in conformity with accounting
principles generally accepted in the U.S. requires management to make difficult and subjective estimates, judgments and assumptions. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. The estimates and judgments that we use in applying our accounting policies have a
significant impact on the results we report in our financial statements. We base our estimates and judgments on our historical experience combined with knowledge of current conditions and our beliefs of what could occur in the future, considering
the information available at the time. Actual results could differ from those estimates and such differences may be material to our financial statements. We reevaluate our estimates and judgments on an ongoing basis.



Our critical accounting policies which are impacted by our estimates are: (i)
the valuation of our inventory, which impacts cost of goods sold and gross profit; (ii) the valuation of our allowance for sales returns and allowances, which impacts net sales; (iii) the valuation of our allowance for doubtful accounts, which
impacts general and administrative expense; and (iv) the valuation of our non-marketable equity securities, which impacts gains and losses on equity securities when we record impairments. Each of these policies is described in more detail below. We
also have other key accounting policies that may not require us to make estimates and judgments that are as subjective or difficult, for instance, our policies with regard to revenue recognition, including the deferral of revenues on sales to
distributors with sales price rebates and product return privileges. These policies are described in the notes to our financial statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2003.



Valuation of inventory. Our inventories are stated at the lower of
cost or market value. Determining market value requires us to project unit prices and volumes for future periods in which we expect to sell inventory on hand as of the balance sheet date. As a result of these estimates, we may record a charge to
cost of goods sold, which decreases our gross profit, in advance of when the inventory is actually sold to reflect market values that are below our manufacturing and sales commission costs. Conversely, if we sell inventory that has previously been
written down to the lower of cost or market at more favorable prices than we had forecasted at the time of the write-down, our gross profit may be higher. In addition to lower of cost or market write-downs, we also analyze inventory to determine
whether any of it is excess, obsolete or defective. We



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write down to zero dollars (which is a charge to cost of goods sold) the carrying value of inventory on hand in excess of
six months estimated sales volumes to cover estimated excess and obsolete exposures, unless adjustments are made to the forecast based on our judgments for newer products, end of life products or planned inventory increases. In making such
judgments to write down inventory, we take into account the product life cycles which can range from six to 30 months, the stage in the life cycle of the product, and the impact of competitors announcements and product introductions on our
products.



Valuation of allowance for sales returns and
allowances. Net sales consist principally of total product sales less estimated sales returns. To estimate sales returns and allowances, we analyze potential customer specific product application issues, potential quality and reliability issues
and historical returns. We evaluate quarterly the adequacy of the reserve for sales returns and allowances. This reserve is reflected as a reduction to accounts receivable in our consolidated balance sheets. Increases to the reserve are recorded as
a reduction to net sales. Because the reserve for sales returns and allowances is based on our judgments and estimates, particularly as to product application, quality and reliability issues, our reserves may not be adequate to cover actual sales
returns and other allowances. If our reserves are not adequate, our net sales could be adversely affected.



Valuation of allowance for doubtful accounts. We maintain an allowance for doubtful accounts for losses that we estimate will arise from our
customers inability to make required payments for goods and services purchased from us. We make our estimates of the uncollectibility of our accounts receivable by analyzing historical bad debts, specific customer creditworthiness and current
economic trends. Once an account is deemed unlikely to be fully collected, we write down the carrying value of the receivable to the estimated recoverable value, which results in a charge to general and administrative expense, which decreases our
profitability.



Valuation of non-marketable securities.
Our ability to recover our strategic investments in equity securities that are non-marketable and to earn a return on these investments is largely dependent on financial market conditions and the occurrence of liquidity events, such as initial
public offerings, mergers or acquisitions, and private equity transactions. The timing of when any of these events may occur is uncertain and very difficult to predict. In addition, under our accounting policy, we are required to periodically review
all of our investments for impairment. In the case of non-marketable equity securities, this requires significant judgment on our part, including an assessment of the investees financial condition, the existence of subsequent rounds of
financing and the impact of any relevant equity preferences, as well as the investees historical results of operations and projected results and cash flows. If the actual outcomes for the investees are significantly different from their
forecasts, the carrying value of our non-marketable equity securities may be overstated, and we may incur additional charges in future periods, which will decrease our profitability. At March 31, 2004, our strategic investments in non-marketable
securities totaled $3.9 million.



Three Months Ended March 31, 2004
Compared to Three Months Ended March 31, 2003



Net
Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales increased by 131% to $51.5 million in the three months ended March 31, 2004 from $22.3 million in the three months ended March 31, 2003. The
increase in sales was principally due to sales of our new 128 Mb DRAM product. In addition, the average selling prices of our DRAM products, specifically our 64 and 16 Mb products, increased in the three months ended March 31, 2004 compared to the
three months ended March 31, 2003. An increase in unit shipments of our SRAM products in the three months ended March 31, 2004 compared to the three months ended March 31, 2003 more than offset the decline in the average selling prices for such
products resulting in an overall increase in SRAM revenue. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for certain products. However, the average
selling prices for certain of our DRAM and SRAM products increased in the three months ended March 31, 2004 compared to the three months ended December 31, 2003. There can be no assurance that any future price declines will be offset by higher
volumes or by higher prices on newer products.



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Sales to Asian Information Technology Inc. accounted for approximately 12% of our total net sales for the
three months ended March 31, 2004. Sales to ATM Electronic Corporation accounted for approximately 10% of our total net sales for the three months ended March 31, 2004. Sales to ATM Electronic Corporation accounted for approximately 14% of our total
net sales for the three months ended March 31, 2003. Sales to LG Electronics Inc. accounted for approximately 11% of our total net sales for the three months ended March 31, 2003. Sales to Samsung Electronics Inc. accounted for approximately 12% of
our total net sales for the three months ended March 31, 2003. As sales to these customers are executed pursuant to purchase orders and no purchasing contract exists, these customers can cease doing business with us at any time.



Gross Profit. Cost of sales includes die cost from the wafers acquired
from foundries, subcontracted package, assembly and test costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit increased by $8.6 million to $11.9 million in the three months ended March 31, 2004
from $3.3 million in the three months ended March 31, 2003. Gross margin increased to 23.1% in the three months ended March 31, 2004 from 15.0% in the three months ended March 31, 2003. The increase in gross profit was principally due to an increase
in the average selling prices of our DRAM products, specifically our 64 and 16 Mb products, in the three months ended March 31, 2004 compared to the three months ended March 31, 2003. Our gross margin for the three months ended March 31, 2004
benefited from the sale of $0.4 million of parts previously written down to zero carrying value. In addition, our gross profit in the three months ended March 31, 2004 benefited from an increase in unit shipments of our 16 Mb DRAM products as well
as sales of our new 128 Mb DRAM product. Increases in the average selling prices of our DRAM products in the three months ended March 31, 2004 compared to the three months ended March 31, 2003 more than offset any increases in product costs
resulting in higher gross margins for our DRAM products. An increase in unit shipments of our SRAM products in the three months ended March 31, 2004 compared to the three months ended March 31, 2003, more than offset the decline in the average
selling prices for such products resulting in an overall increase in gross profit. We believe that the average selling prices of our products will decline over time and, unless we are able to reduce our cost per unit to the extent necessary to
offset such declines, the decline in average selling prices will result in a material decline in our gross margin. In addition, product unit costs could increase if our suppliers raise prices, which could result in a material decline in our gross
margin. In the past, foundries have raised wafer prices when demand for end products increases. We have recently seen foundries raising wafer prices in response to increased demand conditions. Although we have product cost reduction programs in
place that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. We do not
believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our products or the level of service provided by us.



Research and Development. Research and development expenses decreased by 12% to $5.4 million in the three months ended March 31, 2004 compared to
$6.1 million in the three months ended March 31, 2003. As a percentage of net sales, research and development expenses decreased to 10.4% in the three months ended March 31, 2004 from 27.5% in the three months ended March 31, 2003. The decrease in
absolute dollars was primarily the result of a reduction in expenses associated with the closing of our design centers in Korea and Hong Kong, a reduction of headcount and related expenses in the U.S. and the transfer of some design and engineering
efforts to the lower-cost Asian countries of China and Taiwan. We also limited the focus of our development efforts resulting in a reduction in contracted development costs. In addition, depreciation expense decreased in the three months ended March
31, 2004 compared to the three months ended March 31, 2003. Our research and development expenses could increase in absolute dollars in future periods due to increased costs associated with the development of new products.



Selling, General and Administrative. Selling, general and
administrative expenses increased by 22% to $4.2 million in the three months ended March 31, 2004 from $3.4 million in the three months ended March 31, 2003. As a percentage of net sales, selling, general and administrative expenses decreased to
8.1% in the three months ended March 31, 2004 from 15.2% in the three months ended March 31, 2003. The



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increase in absolute dollars was primarily the result of increased selling commissions associated with higher revenues in
the three months ended March 31, 2004 compared to the three months ended March 31, 2003. In addition, facility expenses increased in the three months ended March 31, 2004 compared to the three months ended March 31, 2003 due to the expiration of our
subleases. If our business activity increases and in response to recent changes in corporate governance rules, we expect our selling, general and administrative expenses will increase in absolute dollars in future quarters, although such expenses
may fluctuate as a percentage of net sales.



Other income,
net. Other income, net increased by $0.7 million to approximately $0.9 million in the three months ended March 31, 2004 from $0.2 million in the three months ended March 31, 2003. In the three months ended March 31, 2004, we recorded a gain of
approximately $0.3 million related to the increase in the fair value of the embedded derivative associated with the ICSI convertible debenture compared to a charge of approximately $0.1 million related to the decline in the fair value of the
embedded derivative associated with the ICSI convertible debenture in the three months ended March 31, 2003. In addition, in the three months ended March 31, 2004, we recorded a gain of approximately $0.3 million in connection with the completion of
the liquidation of our subsidiary D2Code in Korea.



Gain on
sale of investments. On March 17, 2004, SMIC completed an Initial Public Offering (IPO). SMICs ordinary shares are traded on the Hong Kong Stock Exchange and SMIC American Depository Receipts (ADR) are traded on the
New York Stock Exchange. Each SMIC ADR represents fifty (50) ordinary shares. As a result of our sale of certain shares of SMIC in the IPO, we recorded gross proceeds of approximately $13.2 million in the March 2004 quarter resulting in a pre-tax
gain of approximately $8.7 million.



Provision for income
taxes.The provision for income taxes for the three month period ended March 31, 2004 of $366,000 consists of alternative minimum taxes. We recorded no provision for income taxes for the three month period ended March 31, 2003 due to our
cumulative net operating loss position for tax purposes and our ability to carryforward those operating losses to reduce our fiscal 2004 taxable income.



Equity in net income (loss) of affiliated companies.Equity in net income (loss) of affiliated companies increased by $1.8 million to $0.9 million
income in the three months ended March 31, 2004 from $0.9 million loss in the three months ended March 31, 2003. This primarily reflects an increase in income from our percentage share of ICSIs financial results in the three months ended March
31, 2004 compared to the three months ended March 31, 2003.



Six Months
Ended March 31, 2004 Compared to Six Months Ended March 31, 2003



Net Sales. Net sales increased by 112% to $91.8 million in the six months ended March 31, 2004 from $43.4 million in the six months ended March 31, 2003. The increase in sales was principally due to an increase
in both the average selling prices and unit shipments of our DRAM products, specifically our 64 and 16 Mb devices, in the six months ended March 31, 2004 compared to the six months ended March 31, 2003. In addition, sales in the six months ended
March 31, 2004 benefited from shipments of our new 128 Mb DRAM product. An increase in unit shipments of our SRAM products in the six months ended March 31, 2004 compared to the six months ended March 31, 2003, more than offset the decline in the
average selling prices for such products resulting in an overall increase in SRAM revenue. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for
certain products. There can be no assurance that any future price declines will be offset by higher volumes or by higher prices on newer products.



Sales to Asian Information Technology Inc. accounted for approximately 10% of our total net sales for the six months ended March 31, 2004. Sales to ATM
Electronic Corporation accounted for approximately 12% of our total net sales for the six months ended March 31, 2003. As sales to these customers are executed pursuant to purchase orders and no purchasing contract exists, these customers can cease
doing business with us at any time.



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Gross Profit. Gross profit increased by $18.7 million to $20.8 million in the six months ended
March 31, 2004 from $2.1 million in the six months ended March 31, 2003. Gross margin increased to 22.7% in the six months ended March 31, 2004 from 4.9% in the six months ended March 31, 2003. Our gross margin for the six months ended March 31,
2004 benefited from the sale of $0.9 million of parts previously written down to zero carrying value. In addition, in the six months ended March 31, 2003 we recorded inventory write-downs of $4.1 million predominately for lower of cost or market
accounting. Excluding the inventory write-downs in the six months ended March 31, 2003, the increase in gross profit was principally due to an increase in both the average selling prices and unit shipments of our DRAM products, specifically our 64
and 16 Mb devices, in the six months ended March 31, 2004 compared to the six months ended March 31, 2003. In addition, our gross profit in the six months ended March 31, 2004 benefited from sales of our new 128 Mb DRAM product. Increases in the
average selling prices of our DRAM products in the six months ended March 31, 2004 compared to the six months ended March 31, 2003 more than offset any increases in product costs resulting in higher gross margins for our DRAM products. Reductions in
the cost of our SRAM products more than offset declines in the average selling prices of such products in the six months ended March 31, 2004 compared to the six months ended March 31, 2003, resulting in an increase in gross profit. We believe that
the average selling prices of our products will decline over time and, unless we are able to reduce our cost per unit to the extent necessary to offset such declines, the decline in average selling prices will result in a material decline in our
gross margin. In addition, product unit costs could increase if our suppliers raise prices, which could result in a material decline in our gross margin. In the past, foundries have raised wafer prices when demand for end products increases. We have
recently seen some foundries raising wafer prices in response to increased demand conditions. Although we have product cost reduction programs in place that involve efforts to reduce internal costs and supplier costs, there can be no assurance that
product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. We do not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our
products or the level of service provided by us.



Research
and Development. Research and development expenses decreased by 23% to $9.9 million in the six months ended March 31, 2004 from $12.9 million in the six months ended March 31, 2003. As a percentage of net sales, research and development expenses
decreased to 10.8% in the six months ended March 31, 2004 from 29.8% in the six months ended March 31, 2003. The decrease in absolute dollars was primarily the result of a reduction in expenses associated with new product development as we limited
the focus of our development efforts resulting in a reduction in mask costs and contracted development costs. In addition, we reduced research and development expenses through the closing of our design centers in Korea and Hong Kong, a reduction of
headcount and related expenses in the U.S. and the transfer of some design and engineering efforts to the lower-cost Asian countries of China and Taiwan. In addition, depreciation expense decreased in the six months ended March 31, 2004 compared to
the six months ended March 31, 2003.



Selling, General and
Administrative. Selling, general and administrative expenses increased by 14% to $8.1 million in the six months ended March 31, 2004 from $7.1 million in the six months ended March 31, 2003. As a percentage of net sales, selling, general and
administrative expenses decreased to 8.8% in the six months ended March 31, 2004, from 16.3% in the six months ended March 31, 2003. The increase in absolute dollars was primarily the result of increased selling commissions associated with higher
revenues in the six months ended March 31, 2004 compared to the six months ended March 31, 2003. In addition, facility expenses increased in the six months ended March 31, 2004 compared to the six months ended March 31, 2003 due to the expiration of
our subleases.



Other income, net. Other income, net
increased by $0.8 million to $1.0 million in the six months ended March 31, 2004 from $0.2 million in the six months ended March 31, 2003. In the six months ended March 31, 2004, we recorded a gain of approximately $0.4 million related to the
increase in the fair value of the embedded derivative associated with the ICSI convertible debenture compared to a charge of approximately $0.2 million related to the decline in the fair value of the embedded derivative associated with the ICSI
convertible debenture in the six months ended March 31, 2003. In addition, in the three months ended March 31, 2004, we recorded a gain of approximately $0.3 million in connection with the completion of the liquidation of our subsidiary D2Code in
Korea.



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Gain on sale of investments. On March 17, 2004, SMIC completed its IPO. As a result of our sale of
shares of SMIC in the IPO, we recorded gross proceeds of approximately $13.2 million in the March 2004 quarter resulting in a pre-tax gain of approximately $8.7 million.



Provision for Income Taxes.The provision for income taxes for the six month period ended March 31, 2004 of $378,000
consists of alternative minimum taxes. We recorded no provision for income taxes for the six month period ended March 31, 2003 due to our cumulative net operating loss position for tax purposes and our ability to carryforward those operating losses
to reduce our fiscal 2004 taxable income.



Equity in
net income (loss) of affiliated companies.Equity in net income (loss) of affiliated companies increased by $3.2 million to $1.2 million income in the six months ended March 31, 2004 from $2.0 million loss in the six months ended March 31, 2003.
This primarily reflects an increase in income from our percentage share of ICSIs financial results in the six months ended March 31, 2004 compared to the six months ended March 31, 2003.



Minority interest in net loss of consolidated subsidiary.In October
2001, we invested $3.0 million for a 95% interest in D2Code, a subsidiary that we established in Korea to focus on semiconductor design activities. The results of its operations are included in our consolidated financial statements. In fiscal 2003,
we closed D2Code and transferred certain personnel to our facilities. In the March 2004 quarter, we completed the liquidation of D2Code. The minority interest in net loss of consolidated subsidiary decreased to $0 in the six months ended March 31,
2004 from $17,000 in the six months ended March 31, 2003.



Liquidity
and Capital Resources



As of March 31, 2004, our principal
sources of liquidity included cash, cash equivalents and short-term investments of approximately $160.6 million. During the six months ended March 31, 2004 operating activities used cash of approximately $9.9 million compared to $11.8 million used
in the six months ended March 31, 2003. Cash used by operations was primarily due to increases in accounts receivable of $16.8 million, increases in inventory of $10.6 million and increases in other assets of $0.1 million. This was partially offset
by net income of $13.4 million adjusted for depreciation of $1.9 million, the gain on the sale of SMIC shares of $8.7 million, equity in net income of affiliated companies of $1.2 million, other non-cash items of $0.5 million, an increase in
accounts payable of $12.0 million and an increase in accrued expenses of $0.8 million.



In the six months ended March 31, 2004, we used $81.7 million for investing activities compared to $13.2 million generated in the six months ended March 31, 2003. The cash used for investing activities in the six
months ended March 31, 2004 primarily resulted from net purchases of available-for-sale securities of $94.7 million. We generated approximately $13.2 million from our sale of shares in the SMIC IPO in March 2004. The cash generated by investing
activities in the six months ended March 31, 2003 primarily resulted from net sales of available-for-sale securities of $14.0 million.



In the six months ended March 31, 2004, we made capital expenditures of approximately $0.3 million for engineering tools and computer software. We expect
to spend approximately $2.0 million to $5.0 million to purchase capital equipment during the next twelve months, principally for the purchase of design and engineering tools, additional test equipment, and computer software and hardware.



We generated $99.1 million from financing activities during the six months
ended March 31, 2004 compared to $0.6 million in the six months ended March 31, 2003. In the three months ended March 31, 2004, we completed a follow-on public offering of our Common Stock whereby we sold 6,025,000 shares at a public offering price
of $16.50 per share. Proceeds from this offering, net of commissions, discounts and expenses, were $93.5 million. In addition, in the six months ended March 31, 2004, we generated $5.6 million from the issuance of common stock from option exercises
and sales under our employee stock purchase plan. Cash generated from financing activities for the six months ended March 31, 2003 was primarily the result of proceeds from the issuance of common stock from option exercises and sales under our
employee stock purchase plan.



We lease our facilities
including our headquarters in Santa Clara, California, our field sales offices in the U.S. and Europe, and sales and engineering offices in Asia. Our leases expire at various dates through 2007. Our outstanding commitments under these leases are
approximately $5.6 million.



We generally warrant our products
against defects in materials and workmanship for a period of 12 months. Liability for a stated warranty period is usually limited to replacement of defective items or return of amounts paid. Warranty expense has historically been immaterial to our
financial statements.



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Our contractual cash obligations at March 31, 2004 are outlined in the table below:



|                                    |  |                                      |       |             |   |                  |  |                  |       |  |   |    
|----------------------------------- |  | ------------------------------------ | ----- | ----------- | - | ---------------- |  | ---------------- | ----- |  | - | ---
|                                    |  | Payments Due by Period(in thousands)
|Contractual Obligations             |  | Total                                |       | Fiscal 2004 |   | Fiscal2005 2006 |  | Fiscal2007 -2008
|                                    |  |                                      |       |            
|Equipment lease debt                |  | $                                    |      |             | $ |                 |  | $                |      |  | $ |   
|Operating leases                    |  |                                      | 5,615 |             |   | 990              |  |                  | 3,839 |  |   | 786
|Non-cancelable purchase commitments |  |                                      |      |             |   |                 |  |                  |      |  |   |   
|                                    |  |                                      |       |             |   |                  |  |                  |       |  |   |    
|Total contractual cash obligations  |  | $                                    | 5,615 |             | $ | 990              |  | $                | 3,839 |  | $ | 786
|                                    |  |                                      |       |             |   |                  |  |                  |       |  |   |    



We believe our
existing funds will satisfy our anticipated working capital and other cash requirements through at least the next 12 months. We may from time to time take actions to further increase our cash position through equity or debt financings, sales of
shares of investments, bank borrowings, or the disposition of certain assets. From time to time, we may also evaluate potential acquisitions or equity investments including strategic investments in wafer fabrication foundries or assembly and test
subcontractors. To the extent we pursue such transactions, any such transaction could require us to seek additional equity or debt financing to fund such activities. There can be no assurance that any such additional financing could be obtained on
terms acceptable to us, if at all.



Certain Factors Which May Affect Our
Business or Future Operating Results



Risks Related to Our Business



We have incurred significant losses in certain recent periods, and
there can be no assurance that we will be able to sustain profitability in the future.



Though we were profitable in the quarters ended March 31, 2004 and December 31, 2003, we incurred losses in the ten consecutive quarters ended September 30, 2003 totaling $124.0 million. We may incur losses in
subsequent quarters. Our ability to maintain profitability on a quarterly or fiscal year basis in the future will depend on a variety of factors, including our ability to increase net sales, maintain or expand gross margins, introduce new products
on a timely basis, secure sufficient wafer fabrication capacity and control operating expenses. Adverse developments with respect to these or other factors could result in quarterly or annual operating losses in the future.



If we are unable to obtain an adequate supply of wafers, our business will be harmed.



If we are unable to obtain an adequate supply of wafers
from our current suppliers or any alternative sources in a timely manner, our business will be harmed. Our principal manufacturing relationships are with SMIC, Taiwan Semiconductor Manufacturing Corporation, or TSMC, Chartered Semiconductor
Manufacturing, ProMOS Technologies and Powerchip Semiconductor. Each of our wafer foundries also supplies wafers to other semiconductor companies, including certain of our competitors. Although we are allocated specific wafer capacity from our
suppliers, we may not be able to obtain such capacity in periods of tight supply. Recent market conditions in the semiconductor industry and at our suppliers indicate that wafer supply is tightening. If any of our suppliers experience manufacturing
failures or yield shortfalls, choose to prioritize capacity for other uses, or reduce or eliminate deliveries to us, we may not be able to obtain enough wafers to meet the market demand for our products which would adversely affect our revenues.
Once a product is in production at a particular foundry, it is time consuming and costly to have such product manufactured at a different foundry. In addition, we may not be able to qualify additional manufacturing sources for existing or new
products in a timely manner and we cannot be certain that other manufacturing sources would agree to deliver an adequate supply of wafers to us.



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Our operating results are expected to continue to fluctuate and may not meet our financial guidance or published
analyst forecasts. This may cause the price of our common stock to decline significantly.



Our future quarterly and annual operating results are subject to fluctuations due to a wide variety of factors, including:



| |  | the cyclicality of the semiconductor industry;
| | - | ----------------------------------------------



| |  | shortages in foundry, assembly or test capacity;
| | - | ------------------------------------------------



| |  | disruption in the supply of wafers, assembly or test services;
| | - | --------------------------------------------------------------



| |  | declines in average selling prices of our products;
| | - | ---------------------------------------------------



| |  | changes in our product mix which could reduce our gross margins;
| | - | ----------------------------------------------------------------



| |  | decreases in the demand for our products;
| | - | -----------------------------------------



| |  | oversupply of memory products in the market;
| | - | --------------------------------------------



| |  | excess inventory levels at our customers;
| | - | -----------------------------------------



| |  | cancellation of existing orders or the failure to secure new orders;
| | - | --------------------------------------------------------------------



| |  | our failure to introduce new products and to implement technologies on a timely basis;
| | - | --------------------------------------------------------------------------------------



| |  | market acceptance of ours and our customers products;
| | - | ------------------------------------------------------



| |  | economic slowness and low end-user demand;
| | - | ------------------------------------------



| |  | our ability to obtain sufficient flash memory for use in our multi-chip packages;
| | - | ---------------------------------------------------------------------------------



| |  | our failure to anticipate changing customer product requirements;
| | - | -----------------------------------------------------------------



| |  | fluctuations in manufacturing yields at our suppliers;
| | - | ------------------------------------------------------



| |  | our failure to deliver products to customers on a timely basis;
| | - | ---------------------------------------------------------------



| |  | the timing of significant orders;
| | - | ---------------------------------



| |  | increased expenses associated with new product introductions, masks or process changes;
| | - | ---------------------------------------------------------------------------------------



| |  | the ability of customers to make payments to us; and
| | - | ----------------------------------------------------



| |  | the commencement of, or developments with respect to, any litigation or future antidumping proceedings.
| | - | -------------------------------------------------------------------------------------------------------



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Our sales depend on DRAM and SRAM products and reduced demand for these products or a decline in average selling
prices could harm our business.



Approximately 95% of our
net sales are derived from the sale of DRAM and SRAM products, which are subject to unit volume fluctuations and declines in average selling prices that could harm our business. For example, in fiscal 2001, we experienced sequential declines in
revenue from $65.2 million in our December 2000 quarter to $52.0 million in our March 2001 quarter to $20.0 million in our June 2001 quarter to $14.8 million in our September 2001 quarter. These declines were a result of a decrease in unit shipments
of our products due to lower demand for electronic products that use our devices, as well as a decline in the average selling prices of such products. We may not be able to offset any future price declines by higher volumes or by higher prices on
newer products. While we have recently experienced increases in average selling prices for some of our products, historically, average selling prices for semiconductor memory products have declined, and we expect that average selling prices will
decline in the future. Our ability to maintain or increase revenues will depend upon our ability to increase unit sales volume of existing products and introduce and sell new products that compensate for the anticipated declines in the average
selling prices of our existing products.



Our gross margins may decline even
in periods of increasing revenue.



Our gross margin is
affected by a variety of factors including our mix of products sold, average selling prices for our products and cost of wafers. Even when our revenues are increasing, our gross margin may be adversely affected if such increased revenue is from
products with lower margins or declining average selling prices. During periods of strong demand, wafer capacity is likely to be in short supply and we will likely have to pay higher prices for wafers which would adversely affect our gross margin
unless we are able to increase our product prices to offset such costs. Recent market conditions in the semiconductor industry and at our suppliers indicate that wafer supply is tightening. To maintain our gross margins when average selling prices
are declining, we must introduce new products with higher margins or reduce our cost per unit. There can be no assurance that we will be able to increase unit sales volumes, introduce and sell new products or reduce our cost per unit.



We rely on third-party contractors to assemble and test our products and our failure to
successfully manage our relationships with these contractors could damage our relationships with our customers, decrease our sales and limit our growth.



We rely on third-party contractors located in Asia to assemble and test our products. There are significant risks associated with our reliance on these
third-party contractors, including:



| |  | reduced control over product quality;
| | - | -------------------------------------



| |  | potential price increases;
| | - | --------------------------



| |  | reduced control over delivery schedules;
| | - | ----------------------------------------



| |  | capacity shortages;
| | - | -------------------



| |  | their inability to increase production and achieve acceptable yields on a timely basis;
| | - | ---------------------------------------------------------------------------------------



| |  | absence of long-term agreements;
| | - | --------------------------------



| |  | limited warranties on products supplied to us; and
| | - | --------------------------------------------------



| |  | general risks related to conducting business internationally.
| | - | -------------------------------------------------------------



If any of these risks are realized, our business and results of operations could be adversely affected until our subcontractor is able to remedy the
problem or until we are able to secure an alternative subcontractor.



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The loss of a significant customer or a reduction in orders from such a customer could adversely affect our operating
results.



As sales to our customers are executed pursuant
to purchase orders and no purchasing contracts typically exist, our customers can cease doing business with us at any time. In the six months ended March 31, 2004, sales to Asian Information Technology Inc., a distributor in Taiwan, accounted for
approximately 10% of total net sales. In fiscal 2003, sales to ATM Electronic Corporation, a distributor in Taiwan, accounted for approximately 10% of our total net sales. A substantial portion of our sales to ATM were for delivery to Ambit.
Although our revenue has increased in recent periods, we have in the past experienced a significant level of cancelled or reduced orders from some of our major customers that adversely impacted our operating results, particularly at the beginning of
contractions in the semiconductor market, such as the one that was experienced in fiscal 2001. We may not be able to retain our key customers, such customers may cancel or reschedule orders, or in the event of canceled orders, such orders may not be
replaced by other sales. In addition, sales to any particular customer may fluctuate significantly from quarter to quarter, and such fluctuating sales could harm our business and financial results.



We have significant international sales and operations and risks related to our
international activities could harm our operating results.



In the six months ended March 31, 2004, approximately 13% of our net sales was attributable to customers located in the U.S., 11% was attributable to customers located in Europe and 75% was attributable to customers located in Asia. In
fiscal 2003, approximately 13% of our net sales was attributable to customers located in the U.S., 10% was attributable to customers located in Europe and 77% was attributable to customers located in Asia. In fiscal 2002, approximately 30% of our
net sales was attributable to customers located in the U.S., 14% was attributable to customers located in Europe and 56% was attributable to customers located in Asia. We anticipate that sales to international customers will continue to represent a
significant percentage of our net sales. In addition, all of our wafer foundries and assembly and test subcontractors are in Taiwan, China and Singapore.



We are subject to the risks of conducting business internationally, including:



| |  | global economic conditions, particularly in Taiwan and China;
| | - | -------------------------------------------------------------



| |  | travel or other restrictions related to public health issues such as severe acute respiratory syndrome (SARS);
| | - | --------------------------------------------------------------------------------------------------------------



| |  | duties, tariffs and other trade barriers and restrictions;
| | - | ----------------------------------------------------------



| |  | changes in trade policy and regulatory requirements;
| | - | ----------------------------------------------------



| |  | transportation delays;
| | - | ----------------------



| |  | the burdens of complying with foreign laws;
| | - | -------------------------------------------



| |  | foreign currency fluctuations;
| | - | ------------------------------



| |  | imposition of foreign currency controls;
| | - | ----------------------------------------



| |  | language barriers;
| | - | ------------------



| |  | difficulties in hiring experienced engineers in countries such as China;
| | - | ------------------------------------------------------------------------



| |  | difficulties in collecting foreign accounts receivable;
| | - | -------------------------------------------------------



| |  | political instability, including any changes in relations between China and Taiwan; and
| | - | ---------------------------------------------------------------------------------------



| |  | earthquakes and other natural disasters.
| | - | ----------------------------------------



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We have implemented significant cost cutting measures, and we may be required to increase expenses in response to
improving market conditions.



We implemented significant
cost cutting measures during fiscal 2002 and fiscal 2003 in response to poor industry conditions. These cost cutting efforts included:



| |  | reallocating personnel and responsibilities to countries with lower expense structures;
| | - | ---------------------------------------------------------------------------------------



| |  | reducing spending on research and development and capital expenditures;
| | - | -----------------------------------------------------------------------



| |  | reducing our workforce; and
| | - | ---------------------------



| |  | instituting temporary office and facility shutdowns.
| | - | ----------------------------------------------------



Our cost cutting measures may have negatively impacted our efficiency and may not lead to sustained profitability. In addition, our reduction in research and development
spending could harm our ability to introduce new products in the future. If our business activity increases, our operating expenses will need to increase.



Our revenues and business would be harmed if we are not able to successfully develop, introduce and sell new products and develop and implement new manufacturing
technologies in a timely manner.



We operate in highly
competitive, quickly changing markets which are characterized by rapid obsolescence of existing products. As a result, our future success depends on our ability to develop and introduce new products that our customers choose to buy in significant
quantities. If we fail to introduce new products in a timely manner or if our customers products do not achieve commercial success, our business and results of operations could be seriously harmed. The design and introduction of new products
is challenging as such products typically incorporate more functions and operate at faster speeds than prior products. Increasing complexity generally requires smaller features on a chip. This makes developing new generations of products
substantially more difficult than prior generations. If we are unable to design, introduce, market and sell new products successfully, our business and financial results would be seriously harmed.



Our products are complex and could contain defects, which could reduce sales of those
products or result in claims against us.



We develop
complex and evolving products. Despite testing by us and our customers, errors may be found in existing or new products. This could result in a delay in recognition or loss of revenues, loss of market share or failure to achieve market acceptance.
These defects also may cause us to incur significant warranty, support and repair costs, may divert the attention of our engineering personnel from our product development efforts, and could harm our relationships with our customers. The occurrence
of these problems could result in the delay or loss of market acceptance of our products and would likely harm our business. Defects, integration issues or other performance problems in our products could result in financial or other damages to our
customers or could lessen market acceptance of our products. Our customers could also seek and obtain damages from us for their losses. From time to time, we have been involved in disputes regarding product warranty issues and are presently involved
in litigation with Symbol Technologies regarding a product dispute. Although we seek to limit our liability to replacement of defective items or return of amounts paid, a product liability claim brought against us, even if unsuccessful, would likely
be time consuming and could be costly to defend.



Potential intellectual
property claims and litigation could subject us to significant liability for damages and could invalidate our proprietary rights.



In the semiconductor industry, it is not unusual for companies to receive notices alleging infringement of patents or other intellectual property rights
of others. We have been, and from time-to-time expect to be,



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notified of claims that we may be infringing patents, maskwork rights or copyrights owned by third-parties. If it appears
necessary or desirable, we may seek licenses under patents that we are alleged to be infringing. Licenses may not be offered and the terms of any offered licenses may not be acceptable to us.



The failure to obtain a license under a key patent or intellectual property
right from a third party for technology used by us could cause us to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could harm our
business. Furthermore, we may become involved in protracted litigation regarding the alleged infringement by us of third-party intellectual property rights or litigation to assert and protect our patents or other intellectual property rights. Any
litigation relating to patent infringement or other intellectual property matters could result in substantial cost and diversion of our resources, which could harm our business.



We may be unable to effectively protect our intellectual property, which would negatively impact our ability to compete.



We believe that the protection of our intellectual proprietary rights
will continue to be important to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into
confidentiality or license agreements with our employees, consultants and business partners, and control access to and distribution of our documentation and other proprietary information. Despite these efforts, unauthorized parties may attempt to
copy or otherwise obtain and use our proprietary technology. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as do the laws of the U.S. Many U.S. companies have encountered substantial infringement problems in foreign countries, including countries in which we design and sell our
products. We do not currently hold any non-U.S. patents. We cannot be certain that patents will be issued as a result of our pending applications nor can we be certain that any issued patents would protect or benefit us or give us adequate
protection from competing products. For example, issued patents may be circumvented or challenged and declared invalid or unenforceable. We also cannot be certain that others will not develop our unpatented proprietary technology or effective
competing technologies on their own.



We have acquired equity positions for
strategic reasons in other companies which may significantly decrease in value.



Over the last few years, we have acquired equity positions for strategic reasons in other technology companies and we may make similar equity purchases in the future. At March 31, 2004, our strategic investments in
non-marketable securities totaled $3.9 million. These equity securities may not increase in value and there is the possibility that they could decrease in value over time, even to the point of becoming completely worthless. These equity securities
are tested for impairment on a recurring basis and any reductions in the carrying value would lower our profitability. In this regard, we recorded approximately a $1.3 million impairment loss on one of our equity positions in the three months ended
June 30, 2003. In addition, we recorded approximately $0.2 million and $0.4 million in impairment losses during fiscal 2001 and fiscal 2002, respectively.



In addition, we own shares in SMIC with a cost basis of approximately $37.5 million and a market value at March 31, 2004 of approximately $98.8 million.
The market value of SMIC shares is subject to fluctuation and our carrying value will be subject to adjustments to reflect the current market value. Our shares in SMIC are subject to certain lockup restrictions and therefore are not freely tradable.
These lockup restrictions generally lapse at the rate of 15% of the Companys pre-offering shares every 180 days following the IPO. Thus all of our shares in SMIC will be freely tradable 3 years and 180 days following the IPO. As a result of
these lockup restrictions and potential fluctuations in SMICs stock price, we may be unable to realize the market value at March 31, 2004.



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Due to the potential value of our strategic investments, we could be determined to be an investment company and, if
such a determination were made, we would become subject to significant regulation that would adversely affect our business.



We are a fabless semiconductor company engaged in the design and marketing of high performance integrated circuits. We have acquired non-controlling
equity positions in SMIC and other companies for strategic, commercial reasons relating to our primary business. Most of our equity positions are in privately held entities that do not have a readily determinable market value. However, the shares we
hold in our former wholly-owned subsidiary, ICSI, are publicly traded in Taiwan and our shares in SMIC are publicly traded on the Hong Kong Stock Exchange and the New York Stock Exchange. These securities have significant value and may increase in
value in the future. In addition, our equity positions could be considered to be investment securities under the Investment Company Act of 1940 (1940 Act), raising a question of whether we are an investment company required
to register and be regulated under the 1940 Act. We believe that we are primarily engaged in the semiconductor business and that any such securities we own are ancillary and strategically related to our semiconductor business. Accordingly, we do not
believe that we are an investment company. If a court or the SEC disagrees with this interpretation, we may be required to either dispose of a portion of the securities we own in SMIC and other companies to comply with the 1940 Act or register under
the 1940 Act. If we choose to dispose of an additional portion of our securities in SMIC, our ability to secure access to wafer capacity from SMIC may be adversely impacted. If we choose to register as an investment company, we will become subject
to significant regulation under the 1940 Act which would materially adversely affect our ability to operate as a semiconductor company.



Our financial statements account for the results of our former subsidiary, ICSI, on the equity basis and fluctuations in ICSIs results will also impact our
results.



We held approximately 29% of the equity of our
former wholly-owned subsidiary, ICSI, at March 31, 2004. Our financial results for the six months ended March 31, 2004, fiscal 2003 and fiscal 2002 reflect accounting for ICSI on the equity basis and include our percentage share of the results of
ICSIs operations. As a result, our net income/loss will be impacted by the financial results of ICSI. We have limited visibility as to the future financial results of ICSI. Any unexpected fluctuations in ICSIs results would have an
unexpected impact on our net income which could be material to our financial results. ICSIs shares are publicly traded on the Taiwan stock exchange and its share price is subject to market fluctuations. A significant decline in the stock price
of ICSI may require us to record an impairment loss related to these shares.



We may encounter difficulties in effectively integrating acquired businesses.



From time to time, we may acquire other companies that we believe to be complementary to our business. Acquisitions may result in potentially dilutive issuances of equity securities, incurrence of debt and contingent
liabilities, amortization expenses related to intangible assets, and the possible impairment of goodwill, which could harm our profitability. In addition, acquisitions involve numerous risks, including:



| |  | higher than estimated acquisition expenses;
| | - | -------------------------------------------



| |  | difficulties in successfully assimilating the operations, technologies and personnel of the acquired company;
| | - | -------------------------------------------------------------------------------------------------------------



| |  | diversion of managements attention from other business concerns;
| | - | -----------------------------------------------------------------



| |  | risks of entering markets in which we have no, or limited, direct prior experience;
| | - | -----------------------------------------------------------------------------------



| |  | the risk that the markets for acquired products do not develop as expected; and
| | - | -------------------------------------------------------------------------------



| |  | the potential loss of key employees and customers as a result of the acquisition.
| | - | ---------------------------------------------------------------------------------



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In this regard, in February 2002, we acquired Purple Ray, a privately held research and development stage company
developing network search engine and content addressable memory integrated circuits. To date, we have not generated any revenue as a result of this acquisition and none is anticipated. In addition, the transaction resulted in an in-process
technology charge of $4.7 million in our March 31, 2002 quarter. As of June 30, 2003, we had written off substantially all of the value of our acquisition of Purple Ray. Any future acquisitions may not contribute positively to our business or
operating results.



We depend on our ability to attract and retain our key
technical and management personnel.



Our success depends
upon the continued service of our key technical and management personnel, including Jimmy S.M. Lee, our Chairman and Chief Executive Officer, and Gary L. Fischer, our President, Chief Operating Officer, and Chief Financial Officer. Several of our
important manufacturing and other subcontractor relationships are based on personal relationships between our senior executive officers and such parties. In particular, our Chairman and Chief Executive Officer has long-term relationships with our
key foundries. If we were to lose the services of any key executives, it may negatively impact the related business relationships since we have no long-term contractual agreements with such parties. Our success also depends on our ability to
continue to attract, retain and motivate qualified technical personnel, particularly experienced circuit designers and process engineers. The competition for such employees is intense. We have no employment contracts or key person life insurance
policies with or for any of our employees. The loss of the service of one or more of our key personnel could harm our business.



Recently enacted and proposed changes in securities laws and regulations may increase our costs.



The Sarbanes-Oxley Act of 2002 that became law in July 2002, as well as new rules subsequently implemented by the Securities
and Exchange Commission and the Nasdaq Stock Market, have required, and will require, changes to some of our accounting and corporate governance practices, including a report on our internal controls as required by Section 404 of the Sarbanes-Oxley
Act of 2002. We expect these new rules and regulations to increase our accounting, legal and other costs, and to make some activities more difficult, time consuming and/or costly. We also expect these new rules and regulations to make it more
difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These new rules and regulations could also make it more
difficult for us to attract and retain qualified executive officers and qualified members of our board of directors, particularly to serve on our audit committee.



Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States.



We prepare our financial statements in conformity with
accounting principles generally accepted in the U.S. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants, the Securities and Exchange
Commission and various bodies formed to interpret and create appropriate accounting policies. A change in these policies or interpretations could have a significant effect on our reported financial results, and could affect the reporting of
transactions completed before the announcement of a change. For example, while current accounting rules allow us to exclude the expense of stock options from our financial statements, several agencies and entities are considering, and the Financial
Accounting Standards Board (FASB) has proposed changes to US GAAP that, if implemented, would require us to record a charge to earnings for employee stock option grants, likely for all awards unvested at and granted after July 1, 2005. This pending
regulation would negatively impact our earnings. Technology companies generally, and our company, specifically, rely on stock options as a major component of our employee compensation packages. If we are required to expense options, we may be less
likely to sustain profitability or we may have to decrease or eliminate options grants. Decreasing or eliminating option grants may negatively impact our ability to attract and retain qualified employees.



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Our stock price is expected to be volatile, and you may not be able to resell your shares at or above the price you
paid.



The trading price of our common stock has been and
is expected to be subject to wide fluctuations in response to:



| |  | quarter-to-quarter variations in our operating results;
| | - | -------------------------------------------------------



| |  | general conditions or cyclicality in the semiconductor industry or the end markets that we serve;
| | - | -------------------------------------------------------------------------------------------------



| |  | new or revised earnings estimates or guidance by us or industry analysts;
| | - | -------------------------------------------------------------------------



| |  | comments or recommendations issued by analysts who follow us, our competitors or the semiconductor industry;
| | - | ------------------------------------------------------------------------------------------------------------



| |  | aggregate valuations and movement of stocks in the broader semiconductor industry;
| | - | ----------------------------------------------------------------------------------



| |  | announcements of new products, strategic relationships or acquisitions by us or our competitors;
| | - | ------------------------------------------------------------------------------------------------



| |  | increases or decreases in available wafer capacity;
| | - | ---------------------------------------------------



| |  | governmental regulations, trade laws and import duties;
| | - | -------------------------------------------------------



| |  | announcements related to future or existing litigation involving us or any of our competitors;
| | - | ----------------------------------------------------------------------------------------------



| |  | announcements of technological innovations by us or our competitors;
| | - | --------------------------------------------------------------------



| |  | additions or departures of senior management; and
| | - | -------------------------------------------------



| |  | other events or factors, many of which are beyond our control.
| | - | --------------------------------------------------------------



In addition, stock markets have experienced extreme price and trading volume volatility in recent years. This volatility has had a substantial effect on
the market prices of securities of many technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock. For
example, on October 25, 1999, our closing stock price was $5.62, rose to $39.81 on June 21, 2000, and subsequently declined to $7.69 on November 30, 2000.



Risks Related to Our Industry



Foundry capacity can be limited, and we may be required to enter into costly arrangements to secure foundry capacity.



If we are not able to obtain additional foundry capacity as required, our
relationships with our customers would be harmed and our future sales would be adversely impacted. In order to secure foundry capacity, we have entered into in the past, and may enter into in the future, various arrangements with suppliers, which
could include:



| |  | purchases of equity or debt securities in foundries;
| | - | ----------------------------------------------------



| |  | joint ventures;
| | - | ---------------



| |  | process development relationships with foundries;
| | - | -------------------------------------------------



| |  | contracts that commit us to purchase specified quantities of wafers over extended periods;
| | - | ------------------------------------------------------------------------------------------



| |  | increased price for wafers;
| | - | ---------------------------



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| |  | option payments or other prepayments to foundries; and
| | - | ------------------------------------------------------



| |  | nonrefundable deposits with, or loans to, foundries in exchange for capacity commitments.
| | - | -----------------------------------------------------------------------------------------



We may not be able to make any such arrangements in a timely fashion or at all, and such arrangements, if any, may not be on
terms favorable to us. Once we make commitments to secure foundry capacity, we may incur significant financial penalties if we subsequently determine that we are not able to utilize all of that capacity. Such penalties may be substantial and could
harm our financial results.



Our foundries may experience lower than
expected yields which could adversely effect our business.



The manufacture of integrated circuits is a highly complex and technically demanding process. Production yields and device reliability can be affected by a large number of factors. As is typical in the semiconductor industry, our outside
foundries have from time to time experienced lower than anticipated manufacturing yields and device reliability problems, particularly in connection with the introduction of new products and changes in such foundrys processing steps. There can
be no assurance that our foundries will not experience lower than expected manufacturing yields or device reliability problems in the future, which could materially and adversely affect our business and operating results.



Any future downturn in the markets we serve would harm our business and financial results.



Substantially all of our products are incorporated into
products for the digital consumer electronics, networking, mobile communications and automotive electronics markets. Historically, these markets have experienced cyclical depressed business conditions, often in connection with, or in anticipation
of, a decline in general economic conditions or due to adverse supply and demand conditions in such markets. For example, our sales in the networking market declined significantly beginning in 2001 due to very depressed conditions in the overall
networking and communications industry. These adverse conditions continued in 2002 and 2003 and we are unable to predict when or if the networking market will recover. Industry downturns have resulted in reduced demand and declining average selling
prices for our products which adversely affected our business. We expect that industry downturns will occur again, but are unable to predict when any such downturn will occur or how long it will last.



Shifts in industry-wide capacity may cause our results to fluctuate. These shifts may
occur quickly with little or no advance notice. In the past, such shifts have resulted in significant inventory write-downs.



The semiconductor industry is highly cyclical and is subject to significant downturns resulting from excess capacity, overproduction, reduced demand or
technological obsolescence. Shifts in industry-wide capacity from shortages to oversupply or from oversupply to shortages may result in significant fluctuations in our quarterly or annual operating results. These shifts in industry conditions can
occur quickly with little or no advance notice to us. Adverse changes in industry conditions are likely to result in a decline in average selling prices and the stated value of inventory. In fiscal 2001, fiscal 2002 and fiscal 2003, we recorded
inventory write-downs of $38.3 million, $28.6 million and $4.1 million, respectively. The inventory write-downs were predominately for lower of cost or market accounting on our products, and to a lesser extent, excess inventory.



We write down to zero carrying value of inventory on hand in excess of six
months estimated sales volumes to cover estimated excess and obsolete exposures, unless adjustments are made to the forecast based on managements judgments for newer products, end of life products or planned inventory increases. In
making such judgments to write down inventory, management takes into account the product life cycles which can range from six to 30 months, the stage in the life cycle of the product, the impact of competitors announcements and product
introductions on our products.



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We believe that six months is an appropriate period because it is difficult to accurately forecast for a
specific product beyond this time frame due to the potential introduction of products by competitors, technology obsolescence or fluctuations in demand. Our policy regarding excess inventory resulted in inventory write-downs for excess inventory of
approximately $5.7 million for fiscal 2001 and $10.4 million for fiscal 2002. Future additional inventory write-downs may occur due to lower of cost or market accounting, excess inventory or inventory obsolescence.



Strong competition in the semiconductor memory market may harm our business.



The semiconductor memory market is intensely competitive
and has been characterized by an oversupply of product, price erosion, rapid technological change, short product life cycles, cyclical market patterns, and heightened foreign and domestic competition. Many of our competitors offer broader product
lines and have greater financial, technical, marketing, distribution and other resources than us. In particular, a competitor with a materially smaller die size and lower cost could dramatically gain market share in a short period of time. We may
not be able to compete successfully against any of these competitors. Our ability to compete successfully in the memory market depends on factors both within and outside of our control, including:



| |  | the pricing of our products;
| | - | ----------------------------



| |  | the supply and cost of wafers;
| | - | ------------------------------



| |  | product design, functionality, performance and reliability;
| | - | -----------------------------------------------------------



| |  | successful and timely product development;
| | - | ------------------------------------------



| |  | the performance of our competitors and their pricing policies;
| | - | --------------------------------------------------------------



| |  | wafer manufacturing over or under capacity;
| | - | -------------------------------------------



| |  | real or perceived imbalances in supply and demand for our products;
| | - | -------------------------------------------------------------------



| |  | the rate at which OEM customers incorporate our products into their systems;
| | - | ----------------------------------------------------------------------------



| |  | the success of our customers products and end-user demand;
| | - | -----------------------------------------------------------



| |  | access to advanced process technologies at competitive prices;
| | - | --------------------------------------------------------------



| |  | achievement of acceptable yields of functional die;
| | - | ---------------------------------------------------



| |  | the capacity of our third-party contractors to assemble and test our products;
| | - | ------------------------------------------------------------------------------



| |  | the gain or loss of significant customers; and
| | - | ----------------------------------------------



| |  | the nature of our competitors and general economic conditions.
| | - | --------------------------------------------------------------



In addition, we are vulnerable to technology advances utilized by competitors to manufacture higher performance or lower cost products. We may not be able
to compete successfully in the future as to any of these factors. Our failure to compete successfully in these or other areas could harm our business and financial results.



Terrorist attacks, threats of further attacks, acts of war and threats of war may negatively impact all aspects of our operations,
revenues, costs and stock price.



The September 2001
terrorist attacks in the U.S., as well as future events occurring in response or connection to them, including future terrorist attacks against U.S. targets, rumors or threats of war, actual conflicts involving the U.S. or its allies (such as the
war in Iraq), conflict between China and Taiwan, or trade disruptions impacting our domestic or foreign suppliers or our customers, may impact our operations and may, among other things, cause delays or losses in the delivery of wafers or other
products to us and decreased sales of our products. More generally, these events have affected, and are expected to continue to affect, the general economy and customer demand for products sold by our customers. Any of these occurrences could have a
significant impact on our operating results, revenues and costs, which in turn may result in increased volatility in our common stock price and a decline in the price of our common stock.



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Item 3. Quantitative and Qualitative Disclosures about Market Risk



Our financial market risk includes risks associated with international operations and related foreign currencies. We anticipate that international sales
will continue to account for a significant portion of our consolidated revenue. Our international sales are largely denominated in U.S. dollars and therefore are not subject to material foreign currency exchange risk. We have operations in China,
Europe, Taiwan, Hong Kong, India and Korea. Expenses of our international operations are denominated in each countrys local currency and therefore are subject to foreign currency exchange risk; however, through March 31, 2004 we have not
experienced any significant negative impact on our operations as a result of fluctuations in foreign currency exchange rates. We do not currently engage in any hedging activities.



We had short-term investments of $133.1 million at March 31, 2004. The primary objective of our investment activities is to
preserve principal while at the same time maximizing yields without increasing risk. We invest primarily in high-quality, short-term debt instruments such as municipal auction rate certificates and instruments issued by high quality financial
institutions and companies, including money market instruments. A hypothetical one percentage point decrease in interest rates would result in approximately a $1.3 million decrease in our interest income.



We own approximately 29% of ICSI, a public company listed on the Taiwan Stock
Exchange. We account for this investment on the equity basis and our total carrying value of this investment as of March 31, 2004 was approximately $19.6 million of which $15.3 million is included in other assets and $4.3 million is included in
other comprehensive loss in the equity portion of our balance sheet. The market value of our investment in the common stock of ICSI at March 31, 2004 was approximately $52.1 million, based on quoted market prices. The share price of ICSI is subject
to fluctuations. A significant decline in the stock price of ICSI may require us to record a loss related to this investment. In addition, we own approximately $3.6 million of ICSI convertible debentures. As a result of changes in ICSIs
convertible debenture price, as of March 31, 2004, we recorded an accumulated unrealized gain of approximately $223,000 related to the ICSI convertible debentures. This gain was included in other comprehensive loss in the equity portion of our
balance sheet. In addition, in the three and six months ended March 31, 2004, we recorded a gain of approximately $311,000 and $252,000, respectively, related to the increase in the fair value of an embedded derivative associated with the ICSI
convertible debenture. The gain associated with the embedded derivative is included in other income (expense). Any future decline in ICSIs debenture price would result in additional losses.



We own less than 2% of SMIC. On March 17, 2004, SMIC completed its IPO.
SMICs ordinary shares are traded on the Hong Kong Stock Exchange and SMIC American Depository Receipts (ADR) are traded on the New York Stock Exchange. Each SMIC ADR represents fifty (50) ordinary shares. As a result of our sale of
shares of SMIC in the IPO, we recorded gross proceeds of approximately $13.2 million in the March 2004 quarter resulting in a pre-tax gain of approximately $8.7 million. Since SMICs IPO, we account for our shares in SMIC under the provisions
of FASB 115 and have marked our investment to the market value as of March 31, 2004 by increasing other assets and by increasing accumulated comprehensive income in the equity section of the balance sheet. The cost basis of our shares in SMIC is
approximately $37.5 million and the market value at March 31, 2004 was approximately $98.8 million. The market value of SMIC shares is subject to fluctuations and our carrying value will be subject to adjustments to reflect the current market value.
Our shares in SMIC are subject to certain lockup restrictions and therefore are not freely tradable. These lockup restrictions generally lapse at the rate of 15% of our pre-offering shares every 180 days following the IPO. Thus all of our shares in
SMIC will be freely tradable 3 years and 180 days following the IPO. As a result of these lockup restrictions and potential fluctuations in SMICs stock price, we may be unable to realize the market value at March 31, 2004.



We have investments in equity securities of privately held companies for the
promotion of business and strategic objectives of approximately $3.9 million at March 31, 2004. These investments are generally in companies in the semiconductor industry. These investments are included in other assets and are accounted for using
the cost method. For investments in which no public market exists, our policy is to review the operating



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performance, recent financing transactions and cash flow forecasts for such companies in assessing the net realizable
values of the securities of these companies. Impairment losses on equity investments are recorded when events and circumstances indicate that such assets are impaired and the decline in value is other than temporary. In this regard, we recorded
approximately a $1.3 million impairment loss on our investment in Signia Technologies during fiscal 2003.



Item 4. Controls and Procedures



Our Chief Executive Officer and Chief Financial Officer, based on the evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) required by
paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that, as of March 31, 2004, our disclosure controls and procedures were effective to ensure that the information we are required to disclose in reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. During the six months ended March 31, 2004, there was no change in our internal
control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial
reporting.



Part II. OTHER INFORMATION



Item 1. Legal Proceedings



On June 16, 2003, Symbol Technologies, Inc. filed suit against us in the Supreme Court of the State of New York. The complaint alleges causes of action for breach of express warranty, negligent misrepresentation, breach of implied contract,
negligence and breach of implied warranty of fitness for a particular purpose related to certain of our products purchased by Symbol. The complaint seeks monetary damages in an amount of $5.0 million, plus pre-judgment interest and court costs. We
believe that we have meritorious defenses to the claims alleged by Symbol and intend to defend this suit vigorously.



We are not currently subject to any other material pending legal proceedings. However, we may become subject to other lawsuits from time to time in the
ordinary course of our business, and any such lawsuit could harm our business.



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



The Companys Annual Meeting of Stockholders was held on Friday, February 27, 2004 at 3:00 p.m., local time, in San Jose, California.



(a) The following nominees for Directors were elected. Each person elected as a Director will serve until the next annual
meeting of stockholders or until such persons successor is elected and qualified:



|                 |  |                |  |              
|---------------- |  | -------------- |  | -------------
|Name of Nominee  |  | Votes in Favor |  | VotesWithheld
|Jimmy S.M. Lee   |  | 23,790,346     |  | 3,056,069    
|Gary L. Fischer  |  | 24,889,957     |  | 1,956,458    
|Lip-Bu Tan       |  | 24,427,973     |  | 2,418,442    
|Hide L. Tanigami |  | 23,741,001     |  | 3,105,414    
|Chun Win Wong    |  | 25,359,119     |  | 1,487,296    
|Bruce A. Wooley  |  | 26,399,894     |  | 446,521      



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(b) The Companys stockholders approved an amendment to the Companys 1993 Employee Stock
Purchase Plan to increase by 600,000 shares to an aggregate of 2,850,000 shares the number of shares reserved for grant thereunder and to extend the termination date of such plan from February 2, 2005 to February 15, 2015, with 17,861,596 votes in
favor, 2,807,816 votes against, 358,259 votes abstain and 5,818,816 broker non-votes.



(c) The Companys stockholders the ratified the appointment of Ernst & Young, LLP as independent auditors of the Company for the fiscal year ending September 30, 2004, with 26,363,018 votes in favor, 470,341
votes against and 13,056 votes abstain.



Item 6. Exhibits and Reports on Form 8-K



(a) The following exhibits are filed as a part of this report.



|           |  |                                                                                                                             
|---------- |  | ----------------------------------------------------------------------------------------------------------------------------
|Exhibit 31 |  | Certification Pursuant to Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|           | 
|Exhibit 32 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.     



(b) Reports on Form
8-K.



On January 12, 2004, we furnished a
report on Form 8-K related to our results for the first fiscal quarter ended December 31, 2003.



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SIGNATURES



Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                    |  |                                                                                                             
|------------------- |  | ------------------------------------------------------------------------------------------------------------
|                    |  | Integrated Silicon Solution, Inc.                                                                           
|                    |  | (Registrant)                                                                                                
|                    | 
|Dated: May 14, 2004 |  | /s/ Gary L. Fischer                                                                                         
|                    |  | Gary L. Fischer                                                                                             
|                    |  | President, Chief Operating Officer, and Chief Financial Officer (Principal Financial and Accounting Officer)



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