**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Fiscal Year December 31, 2006 or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Commission file number: 000-32929**

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**MOSYS, INC.**

(Exact name of registrantas specified in its charter)

| **Delaware**                     |   | **77-0291941**          |
|----------------------------------|--------|-------------------------|
| (State or other  jurisdiction of |   | (IRS Employer           |
| incorporation or  organization)  |   | Identification  Number) |

 

**755 N. Mathilda Avenue, Suite 100**

**Sunnyvale, California 94085**

(Address of principalexecutive offices)

**(408) 731-1800**

(Registrant’s telephone number, including area code)

Securities registeredpursuant to Section 12(b) of the Act:

| **Title of each class**                  |   | **Name of  each exchange on which registered** |
|------------------------------------------|--------|------------------------------------------------|
| Common Stock, par  value $0.01 per share |   | Global Market of  the NASDAQ Stock Market, LLC |

 

Securities registeredpursuant to Section 12(g) of the Act:

| **Series AA Preferred Stock,  par value $0.01 per share** | ** ** | **None** |
|----------------------------------------------------------------|------------|----------|
| (Title of Class)                                               |       |     |

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.  Yes o   No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.  Yes o   No x

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

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, tothe best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.  o

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

| Large accelerated filer o |   | Accelerated  filer x |   | Non-accelerated  filer o |
|--------------------------------|--------|---------------------------|--------|-------------------------------|

 

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

The aggregate market valueof the common stock held by non-affiliates of the Registrant, as of June 30,2006 was approximately $226,308,485 based upon the last sale price reported forsuch date on the Nasdaq National Market. For purposes of this disclosure,shares of common stock held by persons who beneficially own more than 5% of theoutstanding shares of common stock and shares held by officers and directors ofthe Registrant have been excluded because such persons may be deemed to be affiliates.This determination is not necessarily conclusive. As of March 1, 2007,31,665,476 shares of the registrant’s common stock, $0.01 per value, wereoutstanding.

 

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**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the registrant’s proxy statement to bedelivered to stockholders in connection with the registrant’s 2007 AnnualMeeting of Stockholders to be held on or about May 25, 2007 areincorporated by reference into Part III of this Form 10-K. Theregistrant intends to file its proxy statement within 120 days after its fiscalyear end.

 

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**TABLE OF CONTENTS**

| **Part I**   |
|-------------------|
| Item 1.           |   | Business |   | 4 |
| Item  1A.         |   | Risk Factors |   | 17 |
| Item 1B.          |   | Unresolved Staff Comments |   | 25 |
| Item 2.           |   | Properties |   | 25 |
| Item  3.          |   | Legal Proceedings |   | 26 |
| Item 4.           |   | Submission of Matters to a Vote of Security Holders |   | 26 |
| **Part II**  |
| Item 5.           |   | Market for Registrant’s Common Equity and Related  Stockholder Matters and Issuer Purchases of Equity Securities |   | 27 |
| Item  6.          |   | Selected  Financial Data |   | 29 |
| Item 7.           |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |   | 30 |
| Item 7A.          |   | Quantitative and Qualitative Disclosures About Market  Risk |   | 40 |
| Item 8.           |   | Financial Statements and Supplementary Data |   | 40 |
| Item 9.           |   | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure |   | 41 |
| Item 9A.          |   | Controls and Procedures |   | 41 |
| Item  9B.         |   | Other  Information |   | 42 |
| **Part III** |
| Item 10.          |   | Directors, Executive Officers and Corporate Governance |   | 43 |
| Item 11.          |   | Executive Compensation |   | 43 |
| Item 12.          |   | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters |   | 43 |
| Item 13.          |   | Certain Relationships and Related Transactions, and  Director Independence |   | 43 |
| Item 14.          |   | Principal Accountant Fees and Services |   | 43 |
| **Part IV**  |
| Item 15.          |   | Exhibits and Financial Statement Schedules |   | 44 |
|              |   | Signatures |   | 46 |

 

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**Part I**

*This Annual Reporton Form 10-K and the documents incorporated herein by referencecontain forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934, which include, without limitation, statements about the market forour technology, our strategy, competition, expected financial performance andother aspects of our business identified in this Annual Report, as well asother reports that we file from time to time with the Securities and ExchangeCommission. Any statements about our business, financial results, financialcondition and operations contained in this Annual Report that are notstatements of historical fact may be deemed to be forward-lookingstatements. Without limiting the foregoing, the words “believes,” “anticipates,”“expects,” “intends,” “plans”, “projects,” or similar expressions are intendedto identify forward-looking statements. Our actual results could differmaterially from those expressed or implied by these forward-lookingstatements as a result of various factors, including the risk factors describedin Part I., Item 1A, “Risk Factors,” and elsewhere in this report. Weundertake no obligation to update publicly any forward-looking statementsfor any reason, except as required by law, even as new information becomesavailable or other events occur in the future.*

MoSys®, MultiBank®,1T-SRAM®, 1T-SRAM-R®, 1T-SRAM-M®, and 1T-SRAM-Q® are our trademarks. Productnames, trade names and trademarks of other companies are also referred to inthis report.

**Item1.**                        Business

**Company Overview**

We design, develop, market and license memorytechnologies used by the semiconductor industry and electronic productmanufacturers. We have developed a patented semiconductor memory technology,called 1T-SRAM, that offers a combination of high density, low powerconsumption and high speed at performance and cost levels that other availablememory technologies do not match. We license this technology to companies thatincorporate, or embed memory on complex integrated circuits, such assystem-on-chips (SoCs). We have also in the past sold memory chips based on our1T-SRAM technologies, but in 2004, we ceased actively selling them. We do notexpect to make and sell memory chips in the future.

Using elements of our existing memory technology as afoundation, we completed development of the first memory chips incorporatingour 1T-SRAM technologies in the fourth quarter of 1998. We signed our firstlicense agreement related to our 1T-SRAM technologies at the end of the fourthquarter of 1998 and recognized licensing revenue from our 1T-SRAM technologiesfor the first time in the first quarter of 2000. Since then, we have introducedimproved and enhanced versions of our technology, such as 1T-SRAM-R, 1T-SRAM-M,and 1T-SRAM-Q.

We generate revenue from licensing our memorytechnologies, which revenue consists of licensing revenues, customizationservices, maintenance and support fees and royalties. Royalty revenues areearned under each of our license agreements when our licensees manufacture orsell products that incorporate any of our 1T-SRAM technologies and report theresults to us. Generally, we expect our total sales cycle, or the period fromour initial discussion with a prospective licensee to our receipt of royaltiesfrom the licensee’s use of our 1T-SRAM technologies, to run from 18 to24 months after the commencement of the project. The portion of our salescycle from the initial discussion to the receipt of license fees may run fromsix to twelve months, depending on the complexity of the proposed project anddegree of customization required.

In 2005, we begandelivering our new family of 1T-SRAM CLASSIC Memory Macro products tolicensees. These macros are silicon-proven, high-density solutions offeringcustomers rapid memory block integration into their SoC designs. They arepre-configured and require minimal additional customization and we believe theywill enable us to increase our penetration of the market for very dense, lowpower, high speed embedded memory applications.

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**Industry Background**

*Trends in theSemiconductor Industry*

The personal computer, wireless communications,networking equipment and consumer electronics markets are characterized byintensifying competition, rapid innovation, increasing performance requirementsand continuing cost pressures. To manufacture electronic products that achieveoptimal performance and cost levels, semiconductor companies must produceintegrated circuits that offer higher performance, greater functionality andlower cost.

Two important measures of performance are speed andpower consumption. Higher-speed integrated circuits allow electronicproducts to operate faster, enabling the performance of more functions.Reducing the power consumption of integrated circuits contributes to increasedbattery life and reduced heat and electro magnetic field (EMF) generation inelectronic products. Reduced power consumption also enables integrated circuitdesigners to overcome costly design hurdles, such as meeting the thermallimitations of low-cost packaging materials.

In addition to offering high-performance products,semiconductor companies must produce integrated circuits that are costeffective. High-density integrated circuits require less silicon, thus reducingtheir size and cost. Cost reductions also can be achieved by simplifying theintegrated circuit’s manufacturing process and improving the manufacturingyield.

To avoid the high cost ofsubstantial redesign, semiconductor companies typically use technology that isscalable, which means it can be readily incorporated into multiple generationsof manufacturing process technologies. Process technology generations aredistinguished in terms of the dimension of the integrated circuit’s smallesttopographical features, as measured in microns (one millionth of a meter) ornanometers (one billionth of a meter). The semiconductor industry hascontinuously developed advanced process technologies that enable the reductionof silicon area on integrated circuits and consequently lower costs. Today, theindustry is predominantly using 0.13-micron, 0.15-micron, and 90nanometers (nm) manufacturing process technologies. However, new designs arenow being implemented in 65nm with even smaller manufacturing processtechnologies anticipated in the near future.

*Importance ofIntegration*

For decades, thesemiconductor industry has continuously increased the value of integratedcircuits by improving their density, power consumption, speed and cost. Themain driver for these improvements has been the success of shrinking the sizeof the basic semiconductor building block, or transistor. Transistors havebecome small enough to make it economical to combine multiple functions, suchas microprocessors, graphics, memory, analog components and digital signalprocessors, on a SoC. Highly integrated circuits such as SoCs often offeradvantages in density, power consumption, speed and cost that cannot be matchedusing separate, discrete integrated circuits. SoCs are essential for mostelectronic products, such as cellular phones, video game consoles, portablemedia players, communication and networking equipment and internet appliances,to achieve increasing performance requirements at a reasonable cost.

*Importance of EmbeddedMemory*

Historically, semiconductor companies implementedmemory in separate integrated circuits. Rather than using separate memorychips, many semiconductor companies today are embedding memory on highlyintegrated circuits in order to optimize performance and power consumption. Atthe same time, the increasing sophistication of electronic products is drivinga rapid increase in the amount of memory required. The amount of area comprisedof embedded memory on a SoC is continuing to grow due to increasing complexityof applications requiring more data and program code and system price and size 

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constraints which dictatethat more information be stored in local memories on the chip rather than indiscrete memory chips.

The high cost ofincorporating the memory component represents a major challenge to achievinghigh levels of integration. As embedded memories account for an increasingpercentage of the size of a highly integrated circuit, they are often theslowest or limiting function in the circuit. Not only must integrated circuitscontain a larger amount of embedded memory, this memory must be dense enough tobe economically attractive and must offer sufficiently high speed and low powerconsumption. In many applications, embedded memory has become a crucial designconsideration for determining the overall cost and performance of highlyintegrated circuits and the growing number of electronic products in which theyare incorporated.

*Traditional SRAMand Embedded DRAM*

The most commonform of embedded memory today utilizes traditional static random access memory,or SRAM. This technology is in the public domain and can be designed by anysemiconductor company. Traditional SRAM has the following characteristics—

·       itcan operate at the same high speeds as other functions of the integratedcircuit;

·       itprovides a simple and familiar interface that allows for quick design into anintegrated circuit with less risk that the design will not function accordingto specification; and

·       itutilizes the standard logic manufacturing process that is both economical andthe most widely available.

As memoryrequirements increase, however, traditional SRAM becomes relatively moreexpensive compared to the total cost of the integrated circuit. Specifically,traditional SRAM has the following drawbacks that can lead to higher cost—

·       itrequires a substantial amount of silicon area because of its low density; and

·       itconsumes a significant amount of power when operating at high speeds.

To overcome the densitylimitations of traditional SRAM, some SoC manufacturers have utilized embeddeddynamic random access memory, or embedded DRAM. While embedded DRAM is denserthan traditional SRAM, it is dramatically slower. Manufacturing embedded DRAMalso requires additional process steps and results in lower yields, whichtranslate into increased manufacturing time and cost. Additionally, because ofits complex interface requirements, embedded DRAM is more difficult toincorporate on integrated circuits, leading to a higher risk of failure. Asintegrated circuit designers have experimented with embedded DRAM, they havediscovered that these limitations of embedded DRAM preclude its use in mostapplications. Therefore, traditional SRAM continues to be the most widely usedtechnology for embedded memory. One of the major challenges for thesemiconductor industry today is to find an embedded memory solution thatcombines high density, low power consumption, high speed and low cost.

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**Our Solution**

Ourinnovative 1T-SRAM technologies provide major advantages over traditional SRAMin density, power consumption and cost, thus making it more economical fordesigners to incorporate large amounts of embedded memory in their designs. Inaddition, our 1T-SRAM technologies offer all the benefits of traditional SRAM,such as high speed, simple interface and ease of manufacturability. Its corecircuitry is already production proven in millions of memory chips and offersintegrated circuit designers the following characteristics compared totraditional SRAM:

| Parameters | ** ** | ** **                                                                                                         | ** ** | **Typical Characteristics of 1T-SRAM technologies vs. traditional SRAM** |
|------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|
| Density    |       | Uses 50% to 75% less  silicon for the same amount of memory                                                        |
| Cost       |       | 50% to 70% less cost for  the same amount of memory                                                                |
| Power      |       | Can save up to 75% of  the power when operating at the same speed                                                  |
| Speed      |       | Can provide speeds equal to or greater than those  offered by traditional SRAM, especially for larger memory sizes |

 

Our 1T-SRAM technologiescan achieve these advantages while utilizing standard logic manufacturingprocesses and providing the simple, standard SRAM interface that designers areaccustomed to today.

*High Density*

Embedded memory utilizingour 1T-SRAM technologies is typically two to three times denser thantraditional SRAM. Increased density enables manufacturers of electronicproducts, such as cellular phones, video game consoles and digital cameras andcamcorders, to incorporate additional functionality into a single integratedcircuit, resulting in overall cost savings. Semiconductor designers can takeadvantage of the high density of our 1T-SRAM technologies and embed largequantities of high-performance memory and other components that in the pastmight not have been feasible.

*Low PowerConsumption*

Embedded memory utilizingour 1T-SRAM technologies can consume as little as one-quarter the power andgenerates less heat than traditional SRAM when operating at the same speed.This feature facilitates longer battery life, reduces system level coolingcosts and enables reliable operation using lower-cost packaging.

*High Speed*

Embedded memory utilizingour 1T-SRAM technologies typically provides speeds equal to or greater than thespeeds of traditional SRAM, especially for larger memory sizes. Our 1T-SRAMmemory designs can sustain random access cycle times of less than threenanoseconds. In today’s 0.13-micron manufacturing process technology, our1T-SRAM technologies can operate with a random access frequency in excess of400 megahertz for multi-megabit memory.

*ManufacturingProcess Independence*

We have been able toimplement our technology without requiring the manufacturer to make anysignificant changes to either standard logic or alternative manufacturingprocesses. 1T-SRAM’s portability, or the ease with which it can be implementedin different semiconductor manufacturing facilities, has been provenoperational in the fabrication of chips at the world’s largest independentfoundries, including Taiwan Semiconductor Manufacturing Co., Ltd., or TSMC,United Microelectronics Corporation, or UMC, Chartered SemiconductorManufacturing Ltd., or Chartered, and Semiconductor Manufacturing InternationalCorporation, or SMIC. It has also been proven in the manufacturing processes ofintegrated 

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devicemanufacturers, or IDM’s, such as Fujitsu Limited and NEC Electronics. 1T-SRAM’sscalability, or the ease with which it can be implemented in differentgenerations of manufacturing processes, has already been demonstrated in thefabrication of chips in 0.25-micron, 0.18-micron, 0.15-micron,0.13-micron and 90nm process generations, without extensivemodifications. We expect our technology to continue to scale readily to futureprocess generations. This portability and scalability provides for wideavailability, inexpensive implementation and quick product time to market forour licensees.

*Simplicity ofInterface*

Our 1T-SRAM technologiesinternal circuitry connects to the simple, standard SRAM interface thatdesigners are accustomed to today. Our use of this standard high-performanceinterface minimizes design time, thus optimizing time to market for ourlicensees. This simple interface also helps minimize the risk that integratedcircuit designs will not operate according to specifications.

**Our Strategy**

Our goal is to establish our 1T-SRAM technologies asthe standard for all large embedded memories in SoC applications. We intend toachieve this goal by licensing our technology on a non-exclusive and worldwidebasis to foundries, integrated device manufacturers, fabless semiconductorcompanies and electronic product manufacturers.

The following are integralaspects of our strategy.

*Target Large andGrowing Markets*

We target the large and growing market for SoCapplications requiring large embedded memories, which are in excess of onemegabyte, with our 1T-SRAM technologies that offer chip designers improvedperformance in embedded memories thus optimizing the cost and performance ofthe SoC.

Although our 1T-SRAMtechnologies are applicable to many markets, we presently focus on the rapidlygrowing consumer electronics and communications sectors. These sectorsincreasingly require embedded memory solutions with higher density, lower powerconsumption, higher speeds and lower cost. We also will focus over the longerterm on other markets that are projected to achieve strong, long-term growth.

*Work Closely withSemiconductor Companies and Foundries to Deliver Optimal Technology Solutions*

We work closely withsemiconductor companies and foundries to gain broad and detailed insight intotheir and their customers’ current and next-generation technology requirements.This insight helps us identify trends and focus our development efforts onoptimizing our technology solution, resulting in shorter product time to marketand lower costs. We plan to continue to qualify and license our technology withthe leading IDM’s and foundries in order to provide a wide range ofmanufacturing choices for our customers.

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*Extend ourTechnology Offerings*

Our goal is tocontinue to enhance our 1T-SRAM technologies and increase our share of theembedded memory market. We will continue to develop our technology in order tooffer even higher-density, lower-power consumption, higher-speedand lower-cost designs for our licensees. As such, we continue to investheavily in research to develop more advanced memory technologies. Since theintroduction of 1T-SRAM in 1998, we have introduced and currently offer thefollowing improvements to the 1T-SRAM technology:

·       TEC® Error Correction Circuitry, whichautomatically corrects memory errors during operation, including soft errorscaused by high-energy particles, and eliminates the need for laser repair inmanufacturing test. This is accomplished without adding silicon area or cost.Introduced in November 2001, our TEC® Error CorrectionCircuitry has now become the standard within 1T-SRAM in most of ourlicensing activities.

·       Lowerpower version of 1T-SRAM memory macros, well-suited to particular applicationsrequiring very low operating and standby power, such as cell phone handsets,digital cameras, personal digital assistants and other consumer, wirelessdevices. We introduced the 1T-SRAM Low-Power family of products in April 2001.

·       1T-SRAMwith extended density memory (twice the density of the original version of ourtechnology) and up to four times the density of traditional SRAM. Theseproducts embed our advanced, folded capacitor 1T-Q bit cell. We introduced our1T-Q-based products in December 2002.

In addition, we havedeveloped new generations of our 1T-SRAM technologies, including the 90nm and65nm manufacturing process. We intend to continue to develop our technologiesfor future process generations such as 45nm and beyond.

**Licensing andDistribution Strategy**

We offer our technology on a non-exclusive andworldwide basis to semiconductor companies, electronic product manufacturers,foundries, intellectual property companies and design companies through productdevelopment, technology licensing and joint marketing relationships.

We license our technologyto semiconductor companies who incorporate our technology into integratedcircuits that they sell to their customers. In addition, we engage in jointmarketing activities with foundries, intellectual property companies and designcompanies to promote our technology to a wide base of customers. Thesedistribution channels have broadened the acceptance and availability of ourtechnology in the industry. As our technology becomes available through anincreasing number of channels, we believe it will be less likely that customerswill have to alter their procurement practices in order to acquire ourtechnology. We intend to continue to expand significantly this base ofstrategic relationships to further proliferate our technology.

*Project Licenses*

We form productdevelopment and licensing relationships directly with semiconductor companies.In these relationships, the prospective licensee’s implementation of our1T-SRAM technologies typically includes customized development. Usually, theserelationships involve both engineering work to implement our technology in thespecified product and licensing the technology for manufacture and sale of theproduct. Although the precise terms contained in our 1T-SRAM macro developmentand license agreements vary, every agreement provides for the payment ofcontract fees to us at the beginning of the contract and the joint developmentof specifications and initial product design and engineering. Contract feesinclude licensing fees, development fees for customizations based on theachievement of specified 

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developmentmilestones and royalties. The vast majority of our contracts allow billingbetween milestones based on work performed. If we perform the contractedservices, usually the licensee is obligated to pay the license fees even if thelicensee cancels the project prior to completion. The agreements often alsoprovide for the payment of additional contract fees if we provide engineeringor manufacturing support services related to the manufacture of the product.Provisions in all of our license agreements require the payment of royalties tous based on the future sale or manufacture of products utilizing our 1T-SRAMtechnologies. Generally, our licenses grant rights on a non-exclusive,non-transferable basis, limited to the use of our technology as modified forthe project covered by the license agreement. Our license agreements generallyhave a fixed five-year term and are subject to renewal. Each new projectrequires a separate agreement or an addendum to modify an existing agreement.

We have license agreementswith many companies, including, but not limited to, Agere Systems, Inc.,Agilent Technologies, Analog Devices, Inc., Broadcom Corporation, eSiliconCorporation, Fujitsu Limited, Hitachi, Ltd., Kawasaki Micoroelectronics, Inc.,LG Electronics, Inc., LSI Logic Corporation, Marvell Semiconductor, Inc.,Matsushita Communication Industrial Co., Ltd., National SemiconductorCorporation, NEC Electronics Corporation, Nexuschips Co. Ltd., Open-Silicon, Inc.,Philips Semiconductors, Inc., Pixelworks, Inc., Pixim, Inc.,Progate Group Corporation, SMIC, Sanyo Electric Co., Ltd., Sony Corporation,TSMC, UMC, Via Technologies, Inc., and Yamaha Corporation.

*Joint MarketingArrangements*

We have formed jointmarketing relationships with dedicated foundries such as TSMC, UMC, Charteredand SMIC. These foundries have cooperated with us to prove themanufacturability of integrated circuits utilizing our 1T-SRAM technologies intheir particular manufacturing process. Once manufacturability has been proven,the foundries can then offer their manufacturing services to our licensees, andtheir integrated circuit device customers can fabricate integrated circuitsincorporating our 1T-SRAM technologies.

*Design Licenses*

We offer directly to our licensees customized 1T-SRAMmemory designs to meet their specific design parameters. We also offer avariety of options for optimizing the design specification in order to improveperformance and cost effectiveness.

Companies also can licensestandard 1T-SRAM off-the-shelf memory designs from us, known as CLASSICMacros. These readily available pre-qualified standard memory designs canassist the licensee in getting its SoC quickly to market.

*Technology Licenses*

We also offer our technology to semiconductorcompanies and foundries through 1T-SRAM technology license agreements, underwhich we grant the licensee the additional right to create and modify 1T-SRAMdesigns to offer to its own customers. The contract fees associated with thesearrangements require the licensee to pay us to port our technology to itsmanufacturing process and develop a template design that the licensee will beable to use to generate future designs. These agreements also may obligate thelicensee to pay contract fees upon the achievement of specified developmentmilestones and may provide for the payment of additional contract fees forengineering or manufacturing support services. Royalties are payable based onthe future sale or manufacture of products utilizing our 1T-SRAM technologies.The licenses are non-exclusive and non-transferable and authorize the licenseeto modify designs for its customers from the template design that we provideunder the agreement. Typically, the template design applies only to a specifiedmanufacturing process generation. The licensee may add future processgenerations to the license agreement for additional contract fees.

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**Technology**

Our innovative 1T-SRAMtechnologies include many new and proprietary features. These technologiescombine the high-density advantages of DRAM with the high performance andutility of SRAM. Underlying this technology are several distinct pieces ofproprietary technology.

*Single-TransistorMemory Storage Cell*

The high density of our 1T-SRAM technologies stemsfrom the use of a single-transistor, or 1T, which is similar to DRAM,with a storage cell for each bit of information. Our 1T storage cell using onetransistor and one capacitor represents a very significant improvement indensity over the six-transistor storage cells used by traditional SRAM.

Thefollowing diagrams, drawn to scale, but not to actual size, are electricalschematics of the traditional SRAM storage cell and our 1T-SRAM storage cell.The comparison of the two diagrams illustrates the small size and reducedcomplexity of the 1T-SRAM storage cell. This results in significant costsavings because less silicon space is required by 1T-SRAM storage cells.
|  |  |
|--|--|

 

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*MultiBank Technology*

Thehigh speed and low power consumption of 1T-SRAM are enabled by our MultiBanktechnology, as illustrated below. This technology efficiently partitions thememory into many, typically hundreds, of fast, small sub-blocks of memory, orbanks, that can operate independently over high-speed data buses. Only onesmall bank containing the required memory data must be active for each accessto the memory. Therefore, the remaining banks can stay in a low-power, standbymode, reducing the overall power consumption of the memory.

***PipelinedSelf-timed Access***

The easy to use standardSRAM interface of 1T-SRAM technologies is enabled by our innovative andproprietary circuit designs, generating all the necessary dynamic memory arrayoperation timing signals transparently to user’s application.

*Refresh ManagementCircuitry*

Refresh operationsrequired to ensure data is maintained to a minimum level in dynamic cells maybe performed transparently to a user’s application, allowing designers to fullydisregard any of the traditional requirements of dynamic cell arrays.

*Leakage SuppressionCircuitry*

Our unique patentedarchitecture, circuits and proprietary design techniques that manage processleakage allow MoSys 1T-SRAM technologies to be manufactured on anycomplementary metal—oxide—semiconductor (CMOS) process, including genericapplication-specific integrated circuit (ASIC) processes, thus removing theneed for complicated embedded memory process development.

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*TEC® Error Correction Circuitry*

We offer our 1T-SRAMtechnologies with embedded error correction circuitry for higher reliabilityand quality. This circuitry automatically corrects memory errors duringoperation, including soft errors caused by high-energy particles, andeliminates the need for laser repair in manufacturing test. This isaccomplished without adding any additional silicon area or cost. The TEC® ErrorCorrection Circuitry is currently incorporated into all of our designs.

*1T-Q*® Folded Area Capacitor(FAC)

Using an innovativecapacitor technology called Folded Area Capacitor (FAC), we can provide ourlicensees with a very high-density memory solution. Requiring only twoadditional non-critical masks during the manufacturing process, with 1T-Q® Folded Area Capacitor our 1T-SRAM products canachieve densities up to four times that of traditional SRAM and twice thedensity of the original version of our technology.

***Advanced Manufacturing Processes***

Wehave continued to implement our 1T-SRAM technologies on advanced generations ofmanufacturing processes. As a result, our licensees are able to implementintegrated circuits incorporating 1T-SRAM embedded memories on the highestperformance manufacturing processes available. The chart below illustrates asampling of test chips we have made for initially implementing and verifying1T-SRAM technologies on the latest generations of manufacturing processesnodes. The processes with the smaller micron dimensions have higher randomaccess speeds and typically enable larger capacity memories.

| **Processes Generation** | ** ** | ** **        | ** ** | **0.18-micron** | ** ** | **0.15-micron** | ** ** | **0.13-micron**    | ** ** | **90nm** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------|------------|-----------------|------------|--------------------|------------|----------|------------|
| Date of 1T-SRAM  Verification |       | January 2000 |       | May 2000   |       | April 2001 |       | December 2005 |       |
| Typical Memory                |       | 1-32              |       | 1-48            |       | 1-64            |       | 1-128              |       |
| Capacity                      |       | megabits          |       | megabits        |       | megabits        |       | megabits           |       |

 

**Research andDevelopment**

Our ability to compete in the future depends onimproving our technology to meet the market’s increasing demand for higherperformance and lower cost requirements. We have assembled a team of highlyskilled engineers whose activities are focused on developing even higher-density,lower-power consumption, higher-speed and lower-cost 1T-SRAMdesigns. We expect to continue to focus our research and development efforts onextending our 1T-SRAM technologies to the 65nm process geometry and developingnew memory technologies, such as a flash memory version of our 1T-SRAMtechnology. We also intend to continue our focus on porting our technology toadditional semiconductor manufacturing facilities and scaling our technology tonew generations of manufacturing process technologies.

As of December 31,2006, we employed 56 engineers, representing 70% of our employees, withspecific expertise in circuit design, layout and a variety of manufacturingprocesses. Effective November 10, 2004, we closed the ATMOS’ research anddevelopment facility and terminated the employment of approximately 20employees of ATMOS. We have a design center in Seoul, South Korea where 11 ofour engineers reside. For the years ended December 31, 2006, 2005, and2004, research and development expenditures totaled approximately $8.2 million,$5.8 million, and $8.1 million, respectively.

**Sales and Marketing**

As of December 31, 2006, we had 13 sales andmarketing personnel, representing 16% of our employees, managing our licensingactivities. We have 10 sales and marketing personnel in the United States whoare responsible for licensing activities in North America, Asia and Europe. Twosales personnel 

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are located in Yokohama,Japan and one is located in Seoul, South Korea. The sales personnel manage thenegotiation of license agreements, provide technical support during the salescycle to licensees and administer the contracts. Effective September 30,2006, we closed our office in Sophia-Antipolis, France and terminated two salespersonnel there.

As we have multiple saleschannels through our relationships with semiconductor companies, foundries,intellectual property companies and design companies, we do not believe that werequire a large internal sales force. Our marketing and promotional activitiesinclude participation in industry trade shows, distribution of collateralmarketing material, publication of articles in trade journals and publicizingour licensing activities and technology achievements. We also providepresentations and working sessions with the senior technical and business staffof prospective customers.

**IntellectualProperty**

We regard our patents, copyrights, trademarks, tradesecrets and similar intellectual property as critical to our success, and relyon a combination of patent, trademark, copyright, and trade secret laws toprotect our proprietary rights. As of December 31, 2006, we held 82 U.S.patents on various aspects of our technology, with expiration dates rangingfrom 2011 to 2023. These 82 patents include claims relating to multibankpartitioning, 1T-SRAM internal operation and circuit techniques, high-speedoperation techniques, 1T-SRAM refresh management techniques and the interfaceof embedded 1T-SRAM storage cells in logic processes. We currently have 15pending U.S. patent applications for which we have not yet received any noticesof allowance. We also hold 52 foreign patents with expiration dates rangingfrom 2012 to 2022, and we have 20 pending foreign patent applications. Therecan be no assurance that others will not independently develop similar orcompeting technology or design around any patents that may be issued to us, orthat we will be able to enforce our patents against infringement.

The semiconductor industryis characterized by frequent litigation regarding patent and other intellectualproperty rights. Our licensees or we might, from time to time, receive noticeof claims that we have infringed patents or other intellectual property rightsowned by others. Our successful protection of our patents and otherintellectual property rights are subject to a number of factors, particularlythose described in Part I, Item 1A. “Risk Factors.”

**Competition**

In orderto remain competitive, we believe we must continue to provide higher-density,lower-power-consumption, higher-speed and lower-costtechnology solutions to the semiconductor industry and electronic productmanufacturers. We believe that the principal competitive factors in ourindustry are—

·       densityand cost;

·       powerconsumption;

·       speed;

·       portabilityto different manufacturing processes;

·       scalabilityto different manufacturing process generations;

·       reliabilityand low manufacturing costs;

·       interfacerequirements;

·       theease with which technology can be customized for and incorporated intocustomers’ products; and

·       levelof technical support provided.

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We believe that our 1T-SRAM technologies offer a highdegree of overall performance improvement over traditional SRAM. We havedesigned the circuitry of our 1T-SRAM technologies so that our licensees canmanufacture it in standard logic process, as well as other widely used embeddedmemory processes. Semiconductorcompanies may satisfy their embedded memory needs through traditionalSRAM and embedded DRAM, however. Traditional SRAM relies on publicly availableprocess technology and circuit designs, which semiconductor companies can buildinternally or acquire through a license from a third party provider, withoutpaying a royalty to us. This is currently the preferred choice for embeddedmemory solutions in SoCs requiring less density. Companies providingtraditional SRAM embedded memories include ARM Holdings PLC and Virage Logic.Embedded DRAM is primarily offered by current or former DRAM suppliers, whoutilize their own manufacturing process to compete in the semiconductor foundrybusiness. Suppliers of embedded DRAM include substantial competitors such asToshiba Ltd. and IBM, among others. Although each of these two embedded DRAMsuppliers has experienced some success in obtaining new customers for itstechnology, we believe that many semiconductor companies using embedded memorymay prefer to license our technology instead of implementing either of thesealternatives because of 1T-SRAM’s overall advantages.

Not all embedded memory applications benefitsufficiently from technological advantages offered by our 1T-SRAM technologiesto justify the increased cost to the licensee, however. Our licensees andprospective licensees can meet their current needs for embedded memory usingother memory solutions with different cost and performance parameters. Forexample, our technologies are not suitable for replacing lower-cost traditionalDRAM memory chips if higher access speed is unnecessary. In addition,alternative solutions may be more cost-effective for memory block sizes of lessthan 1 megabit, or applications in which the embedded memory portion is lessthan 20% of the total chip area.

Moreover, some companiesassess greater uncertainty and risk in relying on our newly established 1T-SRAMtechnologies. As a result, our ability to compete effectively may be limitedbecause such companies may prefer to use more established traditional memorysolutions that are freely available without a license.

**Employees**

As of December 31,2006, we had 80 full-time employees, consisting of 56 in research anddevelopment and engineering, 13 in sales and marketing and 11 in finance andadministration. We believe our future success depends, in part, on our abilityto continue to attract and retain qualified technical and management personnel,particularly highly skilled design engineers involved in new productdevelopment, for whom competition is intense. Our employees are not representedby any collective bargaining unit, and we have not experienced any workstoppage. We believe that our employee relations are good.

**AvailableInformation**

Our website address iswww.mosys.com. The information in our website is not incorporated by referenceinto this report. Through a link on the Investor section of our website, wemake available our annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, and any amendments to those reportsfiled or furnished pursuant to Section 13(a) or 15(d) of theSecurities Exchange Act of 1934 as soon as reasonably practicable after theyare filed with, or furnished to, the Securities and Exchange Commission.

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**Executive Officers**

Thenames of the Company’s executive officers and certain information about themare set forth below:

| **Name**             | ** ** | ** ** | ** ** | **Age**                                                                   | ** ** | **Position(s) with the Company** |
|----------------------|------------|------------|------------|---------------------------------------------------------------------------|------------|---------------------------------------|
| Chester J. Silvestri |       | 58         |       | Chief Executive Officer  and Director                                     |
| James R. Pekarsky    |       | 47         |       | Vice President of  Finance and Administration and Chief Financial Officer |
| Wingyu Leung         |       | 52         |       | Executive Vice  President, Chief Technical Officer and Director           |
| Raj Singh            |       | 51         |       | Vice President of Marketing and Business Development  and Worldwide Sales |

 

*Chester J. Silvestri,*   Mr. Silvestriwas appointed our Chief Executive Officer and a member of our board ofdirectors on July 26, 2005. Mr. Silvestri held the position of Chief Executive Officer, President and amember of Board of Directors at Ceva, Inc., a leading provider of licensabledigital signal processor (DSP) cores and platform-level IP, from June 2003to May 2005 and also served as Chairman of Ceva’s Board of Directors from February 2004to May 2005. From January to May 2003, Mr. Silvestri was aprivate investor and previously, from 1999 to 2002, Mr. Silvestri held theposition of Chief Executive Officer of Arcot Systems, a developer of creditcard authentication software. Mr. Silvestri also has served as ChiefOperating Officer of Tripath Technology, Inc., President of theMicroelectronic Division of SUN Microsystems, Inc., and Vice President andGeneral Manager of the Technology Licensing division of MIPS Computer Systems, Inc.Since June 2003, Mr. Silvestri has served as a member of the board ofdirectors of Magma Design Automation, Inc. Mr. Silvestri earned hisbachelor of science and master of science degrees in electrical engineeringfrom Michigan State University and his MBA from the Harvard Graduate School ofBusiness.

*James R. Pekarsky,*   Mr. Pekarsky became our Vice President of Finance and Administrationand Chief Financial Officer on March 20, 2006. Prior to joining theCompany, Mr. Pekarsky served as Chief Financial Officer of AccelChip,which was acquired by Xilinx in January 2006, from November 2003until January 2006. Prior to joining AccelChip, Mr. Pekarsky servedas CFO of Virage Logic from May 1999 to November 2003. His priorpositions include Director and General Manager at Mentor Graphics from January 1997to May 1999, including its Emulation Division in Paris, France andEmbedded Software Division in San Jose, California. Before joining MentorGraphics, Mr. Pekarsky held senior management positions in finance andoperations at Advanced Molecular Systems, Sclavo Diagnostics, a clinicaldiagnostic company in Milan, Italy, and Bio-Rad Laboratories. Mr. Pekarskyreceived a bachelor of science in Accounting from Indiana University ofPennsylvania and an MBA in Finance from Golden Gate University.

*Wingyu Leung,**  *Dr. Leung has served as ourExecutive Vice President, Engineering, and Chief Technical Officer and as amember of our board of directors since April 1992. Dr. Leung alsoserved as our Secretary from April 1992 until May 1996 and again fromMay 1997 until August 2000. Prior to joining us, Dr. Leungserved as a technology consultant to several high technology companies,including Rambus, Inc., a developer of a high-speed chip-to-chip interfacetechnology. Prior to that time, Dr. Leung served as a member of thetechnical staff of Rambus, and as a senior engineering manager at IntegratedDevice Technology, Inc., where he managed and participated in circuitdesign activities. Dr. Leung holds a B.S. in electrical engineering fromthe University of Maryland, a M.S. in electrical engineering from theUniversity of Illinois, and a Ph.D. in electrical engineering and computerscience from the University of California at Berkeley.

*Raj Singh,*   Mr. Singhbecame our Vice President of Marketing and Business Development on October 6,2006. Prior to joining the Company, Mr. Singh held a position fromSynfora, a privately held electronic design automation (EDA) company where hewas the Vice President of Sales and Marketing 

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until December 2005.Prior to joining Synfora he served as the Vice President of Worldwide Sales ofVirage Logic for three years. Before joining Virage Logic, Mr. Singh wasthe Executive Vice President and General Manager at 3Dlabs until itsacquisition by Creative Technology in 2002. Before joining 3Dlabs, Mr. Singhspent five years with Dupont, where he was the Business Manager and, mostrecently, Vice President of Dupont Pixel operation. Mr. Singh graduatedwith honors from Kings College, Aberdeen, University of Scotland, receiving acombined masters degree in English Literature.

***Item 1A.***                  RiskFactors

*If any ofthe following risks actually occur, our business, results of operations andfinancial condition could suffer significantly.*

**Our success dependsupon the semiconductor market’s acceptance of our 1T-SRAM technologies.**

The future prospects of our business depend on theacceptance by our target markets of our 1T-SRAM technologies for embeddedmemory applications and any future technology we might develop. We have notachieved substantial or rapid growth in 1T-SRAM technology licensing revenuefrom 2003-2006 and cannot be assured of realizing such growth in thefuture. Our technology is intended to allow our licensees to develop embeddedmemory integrated circuits to replace other embedded memory technology withdifferent cost and performance parameters. Our 1T-SRAM technologiesutilize fundamentally different internal circuitry that is not widely known inthe semiconductor industry. Therefore, one of our principal challenges, whichwe might fail to meet, is to convince a substantial percentage of SoC designersto adopt our technology instead of other memory solutions, which may haveproven effective in their products. Failure to meet this challenge is likely toadversely affect our revenues, net income and cash flows and depress thetrading price of our common stock.

An important part of ourstrategy to gain market acceptance is to penetrate new markets by targetingmarket leaders as licensees of our technology. This strategy is designed toencourage other participants in those markets to follow these leaders inadopting our technology. If a high-profile industry participant adopts ourtechnology for one or more of its products but fails to achieve success withthose products, or is unable to successfully implement our technology, otherindustry participants’ perception of our technology could be harmed. Any suchevent could reduce the number of future licenses of our technology. Likewise,if a market leader were to adopt and achieve success with a competingtechnology, our reputation and licensing program could be harmed.

**Our lengthy licensing cycle and our licensees’ lengthyproduct development cycles make the operating results of our licensing businessdifficult to predict.**

We anticipate difficultyin accurately predicting the timing and amounts of revenue generated fromlicensing our 1T-SRAM technologies. The establishment of a businessrelationship with a potential licensee is a lengthy process, generally takingfrom three to nine months, and sometimes longer during slower periods in ourindustry. Following the establishment of the relationship, the negotiation oflicensing terms can be time-consuming, and a potential licensee may require anextended evaluation and testing period.

Once a license agreement has been executed, the timingand amount of licensing and royalty revenue from our licensing business remaindifficult to predict. The completion of the licensee’s development projects andthe commencement of production are subject to the licensee’s efforts,development risks and other factors outside our control. Our royalty revenuewill depend on such factors as success of the licensee’s project, thelicensee’s production and shipment volumes, the timing of product shipments andwhen the licensee reports to us the manufacture or sale of products thatinclude our 1T-SRAM technologies. All of these factors will prevent us frommaking predictions of revenue with any certainty and could cause us toexperience substantial period-to-period fluctuations in operating results.

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None of our licensees areunder any obligation to incorporate our technology in any present or futureproduct or to pursue the manufacture or sale of any product incorporating ourtechnology. A licensee’s decision to complete a project or manufacture a productis subject to changing economic, marketing or strategic factors. The longdevelopment cycle of a licensee’s products increases the risk that thesefactors will cause the licensee to change its plans. In the past, some of ourlicensees have discontinued development of products incorporating ourtechnology. Although in most cases their decisions were based on factorsunrelated to our technology, it is unlikely that we will receive royalties inconnection with those products. We expect that occasionally our licensees willdiscontinue a product line or cancel a product introduction, which couldadversely affect our future operating results and business.

**If the market forSoC integrated circuits does not expand, our business will suffer.**

Our ability to achieve sustained revenue growth andprofitability in the future will depend on the continued development of themarket for SoC integrated circuits, particularly those requiring embeddedmemory sizes of one megabit or more. In addition, our ability to achieve designwins with customers is dependent upon the growth of embedded memories requiredin SoCs. SoCs are characterized by rapid technological change and competitionfrom an increasing number of alternate design strategies such as combiningmultiple integrated circuits to create a System-on-a-Package.

We cannot be certain thatthe market for SoCs will continue to develop or grow at a rate sufficient tosupport our business, or that if such growth does occur, that it will lead tosignificant growth in our business. SoC providers depend on the demand forproducts requiring SoCs, such as cellular phones, game consoles, PDAs, digitalcameras, DVD players and digital media players to name a few. The demand forsuch products is uncertain and difficult to predict and depends on factorsbeyond our control. If the market fails to grow or develops more slowly thanexpected, our business will suffer.

**The semiconductor industry is cyclical in nature andsubject to periodic downturns, which can negatively affect our revenue.**

The semiconductor industry is cyclical and hasexperienced pronounced downturns for sustained periods of up to several years.To respond to any downturn, many semiconductor manufacturers and theircustomers will slow their research and development activities, cancel or delaynew product developments, reduce their workforces and inventories and take acautious approach to acquiring new equipment and technologies. As a result, ourbusiness has been in the past and could be adversely affected in the future byan industry downturn, which could negatively impact our future revenue andprofitability. Also, the cyclical nature of the semiconductor industry maycause our operating results to fluctuate significantly from year-to-year, whichmay tend to increase the volatility of the price of our common stock.

**We might be unable to deliver our customized memorytechnology within an agreed technical specification in the time frame demandedby our licensees, which could damage our reputation, harm our ability toattract future licensees and adversely impact operating results.**

Many of our licenses require us to deliver acustomized 1T-SRAM memory block or several blocks, within an agreed technicalspecification by a certain delivery timetable. This requires us to furnish aunique design for each customer, which can make the developmentschedule difficult to predict and involves extensive interaction with ourcustomers’ engineers. From time to time, we experience delays in delivering ourcustomized memory technology that meets the agreed technical specifications,which can result from slower engineering progress than we originallyanticipated or there might be factors outside of our control, such as thecustomer’s delay in completing verification of the customer’s chip. Such delaysmay affect the timing of recognition of revenues from a particular project andcan adversely affect our operating results.

In addition, any failureto meet our customers’ timetables, as well as the agreed upon technicalspecifications of our customized memory technology could lead to the failure tocollect, or a delay in 

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collectingroyalties and licensing fee payments from our licensees, damage our reputationin the industry, harm our ability to attract new licensees and negativelyimpact our operating results. Furthermore, a customer may assert that we areresponsible for delays and cost overruns and demand reimbursement for some ofits costs, which we may elect to reimburse in whole or in part in order toaddress the customer’s concerns. For example, in 2004, we reduced revenue by$450,000 for a reimbursement to a customer for excess verification costsincurred by the customer. In 2005, we also settled with one of our licenseesfor the amount of $375,000 related to a claim made for excess verificationcosts incurred by the licensee. In 2006, no reimbursement of licensee costs wasincurred.

**Our business model relies on royalties as a keycomponent in the licensing of our technologies, and if we fail to realizeexpected royalties our operating results will suffer.**

We believe that ourlong-term success is substantially dependent on the receipt of futureroyalties. Royalty payments owed to us are calculated based on factors such asour licensees’ selling prices, wafer production, and other variables as providedin each license agreement. The amount of royalties we will receive depends onthe licensees’ business success, production volumes and other factors beyondour control. This exposes our business model to risks that we cannot minimizedirectly and may result in significant fluctuations in our royalty revenue andoperating results from quarter-to-quarter. We cannot be certain that ourbusiness strategy will be successful in expanding the number of licensees, norcan we be certain that we will receive significant royalty revenue in thefuture.

**Our revenue has been highly concentrated among a smallnumber of licensees and customers, and our results of operations could beharmed if we lose and fail to replace this revenue.**

Our overall revenue has been highly concentrated, witha few customers accounting for a significant percentage of our total revenue.For the year ended December 31, 2006, our two largest customers, NEC andFujitsu represented 27% and 25% of total revenue, respectively. For the yearended December 31, 2005, our two largest customers, NEC and Fujitsurepresented 35% and 17% of total revenue, respectively. For the year ended December 31,2004, our three largest customers NEC, Fujitsu and Marvell represented 19%, 17%and 11% of total revenue, respectively. We expect that a relatively smallnumber of licensees will continue to account for a substantial portion of ourrevenue for the foreseeable future.

Our royalty revenue also has been highly concentratedamong a few licensees, and we expect this trend to continue for the foreseeablefuture. In particular, a substantial portion of our licensing and royaltyrevenue in 2006, 2005 and 2004 has come from the licenses for integratedcircuits used by Nintendo. Royalties earned from the production of Nintendogaming devices incorporating our 1T-SRAM technology represented 16%, 14%, and15% of total revenue in the 2006, 2005 and 2004, respectively. Nintendo facesintense competitive pressure in the video game market, which is characterizedby extreme volatility, costly new product introductions and rapidly shiftingconsumer preferences, and we cannot assure you that Nintendo’s sales ofproducts incorporating our technology will increase beyond prior or currentlevels.

As a result of thisrevenue concentration, our results of operations could be impaired by thedecision of a single key licensee or customer to cease using our technology orproducts or by a decline in the number of products that incorporate ourtechnology that are sold by a single licensee or customer or by a small groupof licensees or customers.

**Our revenue concentration may also pose credit risks,which could negatively affect our cash flow and financial condition.**

We might also face creditrisks associated with the concentration of our revenue among a small number oflicensees and customers. As of December 31, 2006, one customer represented89% of total 

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tradereceivables. Although trade receivables from this customer were subsequentlycollected, our failure to collect receivables from any customer that representsa large percentage of receivables on a timely basis, or at all, could adverselyaffect our cash flow or results of operations and might cause our stock priceto fall.

**Anything thatnegatively affects the businesses of our licensees could negatively impact ourrevenue.**

The timing and level of our licensing and royaltyrevenues are dependent on our licensees and the business environment in whichthey operate. Licensing and royalty revenue are the largest source of ourrevenues; anything that negatively affects a significant licensee or group oflicensees could negatively affect our results of operations and financialcondition. Many issues beyond our control influence the success of ourlicensees, including, for example, the highly competitive environment in whichthey operate, the strength of the markets for their products, their engineeringcapabilities and their financial and other resources.

Likewise, we have nocontrol over the product development, pricing and marketing strategies of ourlicensees, which directly affect the licensing of our technology andcorresponding future royalties payable to us from our licensees. Our royaltyrevenues are subject to our licensees’ ability to market, produce and shipproducts incorporating our technology. A decline in sales of our licensees’royalty-generating products for any reason would reduce our royalty revenue. Inaddition, seasonal and other fluctuations in demand for our licensees’ productscould cause our operating results to fluctuate, which could cause our stockprice to fall.

**We rely on semiconductor foundries to assist us inattracting potential licensees, and a loss or failure of these relationshipscould inhibit our growth and reduce our revenue.**

Part of our marketing strategy relies upon ourrelationships and agreements with semiconductor foundries, such as TSMC, UMC,Chartered, and SMIC among others. These foundries have existing relationships,and continually seek new relationships, with companies in the markets wetarget, and they have agreed to utilize these relationships to introduce ourtechnology to potential licensees. If we fail to maintain and expand ourcurrent relationships with these foundries, we might fail to achieveanticipated growth. Our relationship with these foundries is not exclusive, andthey are free to promote or develop other embedded memory technologies,including their own. The foundries’ promotions of alternative technologiesreduce the size of our potential market and may adversely affect our revenuesand operating results.

Additionally, we rely onthird-party foundries to manufacture our silicon test chips, to providereferences to their customers and to assist us in the focus of our research anddevelopment activities. If we are unable to maintain our existing relationshipswith these foundries or enter into new relationships with other foundries, wewill be unable to verify our technologies for their manufacturing processes andour ability to develop new technologies will be hampered. We would then be unableto license our intellectual property to fabless semiconductor companies thatuse these foundries to manufacture their silicon chips, which is a significantsource of our revenues.

**Our embedded memory technology is unique and theoccurrence of manufacturing difficulties or low production yields, if notcorrected, could hinder market acceptance of our technology and reduce futurerevenue.**

Complex technologies like ours could be adverselyaffected by difficulties in adapting our 1T-SRAM technologies to our licensees’product designs or to the manufacturing process technology of a particularfoundry or semiconductor manufacturer. Some of our customers have experiencedlower than expected 

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yields when initiallyintegrating our design into their SoC. We work closely with our customers toresolve any design or process issues in order to achieve the optimum productionyield.

Any decrease inmanufacturing yields of integrated circuits utilizing our technology couldimpede the acceptance of our technology in the industry. The discovery ofdefects or problems regarding the reliability, quality or compatibility of ourtechnology could require significant expenditures and resources to fix,significantly delay or hinder market acceptance of our technology, reduceanticipated revenues and damage our reputation.

**Our failure to compete effectively in the market forembedded memory technology could reduce our revenue.**

There exists significant competition in the market forembedded memory technologies. Our licensees and prospective licensees can meettheir need for embedded memory by using traditional memory solutions withdifferent cost and performance parameters, which they may internally develop oracquire from third-party vendors. In the recent years, the demand for applicationsfor which our 1T-SRAM technologies provide distinct advantages has notexperienced significant growth. If alternative technologies are developed thatprovide comparable system performance at lower cost than our 1T-SRAMtechnologies for certain applications and/or do not require the payment ofcomparable royalties, or if the industry generally demonstrates a preferencefor applications for which our 1T-SRAM technologies do not offer significantadvantages, our ability to realize revenue from our 1T-SRAM technologies couldbe impaired.

We might be challenged bycompetitive developers of alternative technologies who are more established,benefit from greater market recognition and have substantially greaterfinancial, development, manufacturing and marketing resources than we have.These advantages might permit these developers to respond more quickly to newor emerging technologies and changes in licensee requirements. We cannot assureyou that future competition will not have a material adverse effect on theadoption of our technology and our market penetration.

**Our failure to continue to enhance our technology ordevelop new technology on a timely basis could diminish our ability to attractand retain licensees and product customers.**

The existing and potential markets for memory productsand technology are characterized by ever increasing performance requirements,evolving industry standards, rapid technological change and productobsolescence. These characteristics lead to frequent new product and technologyintroductions and enhancements, shorter product life cycles and changes inconsumer demands. In order to attain and maintain a significant position in themarket, we will need to continue to enhance our technology in anticipation ofthese market trends.

In addition, the semiconductor industry might adopt ordevelop a completely different approach to utilizing memory for manyapplications, which could render our existing technology unmarketable orobsolete. We might not be able to successfully develop new technology, or adaptour existing technology, to comply with these innovative standards.

Our futureperformance depends on a number of factors, including our ability to—

·       identify target markets andrelevant emerging technological trends, including new standards and protocols;

·       develop and maintaincompetitive technology by improving performance and adding innovative featuresthat differentiate our technology from alternative technologies;

·       enable the incorporation ofenhanced technology in our licensees’ and customers’ products on a timely basisand at competitive prices;

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·       implementour technology at future manufacturing process generations; and

·       respondeffectively to new technological developments or new product introductions byothers.

Since its introduction in1998, we have introduced enhancements to our 1T-SRAM technology designed tomeet market requirements. However, we cannot assure you that the design andintroduction schedules of any additions and enhancements to our existing andfuture technology will be met, that this technology will achieve marketacceptance or that we will be able to license this technology on terms that arefavorable to us. Our failure to develop future technology that achieves marketacceptance could harm our competitive position and impede our future growth.

**Any claim that our products or technology infringethird-party intellectual property rights could increase our costs of operationand distract management and could result in expensive settlement costs or thediscontinuance of our technology licensing or product offerings. In addition,we may incur substantial litigation expense, which would adversely affect ourprofitability.**

The semiconductor industryis characterized by vigorous protection and pursuit of intellectual propertyrights or positions, which has resulted in often protracted and expensivelitigation. For example, on March 31, 2004, we were sued by UniRAMTechnology, Inc. in United States District Court for the Northern Districtof California based on claims of patent infringement and misappropriation oftrade secrets that were allegedly disclosed by UniRAM to TSMC, which allegedlyimproperly provided them to us. In October 2006, we settled thislitigation with a payment of $2.4 million to UniRAM, which we paid in full inthe fourth quarter of 2006. Since the inception of that lawsuit, our totalexpenses related to it were $4.0 million. Our licensees or we might, from timeto time, receive notice of claims that we have infringed patents or otherintellectual property rights owned by others. Litigation against us,particularly patent litigation such as the UniRAM suit, can result insignificant expense and divert the efforts of our technical and managementpersonnel, whether or not the litigation has merit or results in adetermination adverse to us.

**Royalty amounts owed to us might be difficult toverify, and we might find it difficult, expensive and time-consuming to enforceour license agreements.**

The standard terms of ourlicense agreements require our licensees to document the manufacture and saleof products that incorporate our technology and generally report this data tous after the end of each quarter. Though our standard license terms give us theright to audit the books and records of any licensee to attempt to verify theinformation provided to us in these reports, an audit of a licensee’s recordscan be expensive and time consuming, and potentially detrimental to thebusiness relationship. A failure to fully enforce the royalty provisions of ourlicense agreements could cause our revenue to decrease and impede our abilityto maintain profitability.

**We might not be able to protect and enforce ourintellectual property rights, which could impair our ability to compete andreduce the value of our technology.**

Our technology is complexand is intended for use in complicated integrated circuits. A very large numberof new and existing products utilize embedded memory, and a large number ofcompanies manufacture and market these products. Because of these factors,policing the unauthorized use of our intellectual property is difficult andexpensive. We cannot be certain that we will be able to detect unauthorized useof our technology or prevent other parties from designing and marketingunauthorized products based on our technology. In the event we identify anypast or present infringement of our patents, copyrights or trademarks, or anyviolation of our trade secrets, confidentiality procedures or licensingagreements, we cannot assure you that the steps taken by us to protect ourproprietary information will be adequate to prevent misappropriation of ourtechnology. Our inability to protect adequately our 

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intellectualproperty would reduce significantly the barriers of entry for directlycompeting technologies and could reduce the value of our technology.Furthermore, we might initiate claims or litigation against third parties forinfringement of our proprietary rights or to establish the validity of ourproprietary rights. Litigation by us could result in significant expense anddivert the efforts of our technical and management personnel, whether or notsuch litigation results in a determination favorable to us.

**Our existing patents might not provide us withsufficient protection of our intellectual property, and our patent applicationsmight not result in the issuance of patents, either of which could reduce thevalue of our core technology and harm our business.**

We rely on a combinationof patents, trademarks, copyrights, trade secret laws and confidentialityprocedures to protect our intellectual property rights. As of December 31,2006, we held 82 patents in the United States, which expire at various timesfrom 2011 to 2023, and 52 corresponding foreign patents. In addition, as of December 31,2006, we had 15 patent applications pending in the United States and 20 pendingforeign application, and we have not received any notices of allowance withrespect to these applications. We cannot be sure that any patents will issuefrom any of our pending applications or that any claims allowed from pendingapplications will be of sufficient scope or strength, or issued in allcountries where our products can be sold, to provide meaningful protection orany commercial advantage to us. Also, competitors might be able to designaround our patents. Failure of our patents or patent applications to providemeaningful protection might allow others to utilize our technology without anycompensation to us and impair our ability to increase our licensing revenue.

**The discovery ofdefects in our technology could expose us to liability for damages.**

The discovery of a defect in our 1T-SRAM technologycould lead our licensees to seek damages from us. Our standard license termsinclude provisions waiving implied warranties regarding our technology andlimiting our liability to our licensees. We cannot be certain, however, thatthe waivers or limitations of liability contained in our license contracts willbe enforceable.

**Ourfailure to manage the expansion of our operations could reduce our potentialrevenue and threaten our future profitability.**

Thesize of our company has increased substantially as we grew from 43 employees inJanuary 2001 to 80 employees in December 2006. The efficientmanagement of our planned expansion of the development, licensing and marketingof our technology, including through the acquisition of other companies willrequire us to continue to—

·       implement and manage new marketing channels topenetrate different and broader markets for our 1T-SRAM technologies;

·       managean increasing number of complex relationships with licensees and co-marketersand their customers and other third parties;

·       expandour capabilities to deliver our technologies to our customers;

·       improveour operating systems, procedures and financial controls on a timely basis;

·       hireadditional key management and technical personnel; and

·       expand,train and manage our workforce and, in particular, our development, sales,marketing and support organizations.

We cannot assure you that we will adequately manageour growth or meet the foregoing objectives. A failure to do so couldjeopardize our future revenues and cause our stock price to fall.

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**If we fail to retain key personnel, our business andgrowth could be negatively affected.**

Our business has beendependent to a significant degree upon the services of a small number ofexecutive officers and technical employees, including Dr. Wingyu Leung,our Executive Vice President and Chief Technical Officer. The loss of hisservices could negatively impact our technology development efforts and ourability to perform our existing agreements and obtain new customers. Wegenerally have not entered into employment or non-competition agreements withany of our employees and do not maintain key-man life insurance on the lives ofany of our key personnel.

**Ourfailure to successfully address the potential difficulties associated with ourinternational operations could increase our costs of operation and negativelyimpact our revenue.**

We aresubject to many difficulties posed by doing business internationally, including—

·       foreign currency exchange fluctuations;

·       unanticipatedchanges in local regulation;

·       potentiallyadverse tax consequences, such as withholding taxes;

·       politicaland economic instability; and

·       reducedor limited protection of our intellectual property.

Because we anticipate thatlicenses to companies that operate primarily outside the United States willaccount for a substantial portion of our licensing revenue in future periods,the occurrence of any of these circumstances could significantly increase ourcosts of operation, delay the timing of our revenue and harm our profitability.

**Provisionsof our certificate of incorporation and bylaws or Delaware law might delay orprevent a change of control transaction and depress the market price of ourstock.**

Various provisions of ourcertificate of incorporation and bylaws might have the effect of making it moredifficult for a third party to acquire, or discouraging a third party fromattempting to acquire, control of our company. These provisions could limit theprice that certain investors might be willing to pay in the future for sharesof our common stock. Certain of these provisions eliminate cumulative voting inthe election of directors, limit the right of stockholders to call specialmeetings and establish specific procedures for director nominations bystockholders and the submission of other proposals for consideration atstockholder meetings.

We are also subject toprovisions of Delaware law which could delay or make more difficult a merger,tender offer or proxy contest involving our company. In particular, Section 203of the Delaware General Corporation Law prohibits a Delaware corporation fromengaging in any business combination with any interested stockholder for aperiod of three years unless specific conditions are met. Any of theseprovisions could have the effect of delaying, deferring or preventing a changein control, including without limitation, discouraging a proxy contest ormaking more difficult the acquisition of a substantial block of our commonstock.

Our board of directors mayissue up to 20,000,000 shares of preferred stock without stockholder approvalon such terms as the board might determine. The rights of the holders of commonstock will be subject to, and might be adversely affected by, the rights of theholders of any preferred stock that might be issued in the future.

**Ourstockholder rights plan could prevent stockholders from receiving a premiumover the market price for their shares from a potential acquirer.**

We have adopted astockholder rights plan, which entitles our stockholders to rights to acquireadditional shares of our common stock generally when a third party acquires 15%of our common stock or 

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commencesor announces its intent to commence a tender offer for at least 15% of ourcommon stock. In 2004, we amended our stockholder rights plan twice; once, in connectionwith the proposed acquisition of corporation by Synopsys, Inc, and a secondtime to permit the acquisition of shares representing more than 15% of ourcommon stock by a brokerage firm that manages independent customer accounts andgenerally does not have any discretionary voting power with respect to suchshares. Notwithstanding amendments of this nature, our intention is to maintainand enforce the terms of this plan, which could delay, deter or prevent aninvestor from acquiring us in a transaction that could otherwise result instockholders receiving a premium over the market price for their shares ofcommon stock.

**Potential volatility of the price of our common stockcould negatively affect your investment.**

We cannot assure you thatthere will continue to be an active trading market for our common stock.Recently, the stock market, as well as our common stock, has experiencedsignificant price and volume fluctuations. Market prices of securities oftechnology companies have been highly volatile and frequently reach levels thatbear no relationship to the operating performance of such companies. Thesemarket prices generally are not sustainable and are subject to wide variations.If our common stock trades to unsustainably high levels, it is likely that themarket price of our common stock will thereafter experience a material decline.In the past we have announced share repurchase programs approved by our boardof directors and might adopt such repurchase programs from time to time. Anysuch share repurchases could impact the price of our common stock and increasevolatility.

In the past, securitiesclass action litigation has often been brought against a company followingperiods of volatility in the market price of its securities. We could be thetarget of similar litigation in the future. Securities litigation could causeus to incur substantial costs, divert management’s attention and resources,harm our reputation in the industry and the securities markets and reduce ourprofitability.

**Theprice of our stock could decrease as a result of shares being sold in themarket by directors, officers and other significant stockholders.**

Sales of a substantialnumber of shares of common stock in the public market could adversely affectthe market price of the common stock prevailing from time to time. From time totime members of our board of directors and management may implement safe harborstock trading plans under Rule 10b5-1 of the SecuritiesExchange Act of 1934. Pre-designated trading under such plans may causeunexpected declines in the market price of our common stock. In addition,subject to compliance with applicable securities laws and our insider tradingpolicies, each of our directors and executive officers may sell shares ofcommon stock from time to time.

***Item1B.***                  Unresolved Staff Comments

None.

***Item2.***                          Properties

Our principaladministrative, sales, marketing, support and research and developmentfunctions are located in a leased facility in Sunnyvale, California. Wecurrently occupy approximately 26,000 square feet of space in the Sunnyvalefacility, the lease for which extends through June 2010. We have leasedapproximately 19,000 square feet of space in Ontario, Canada for our researchand development facility. The lease expires at the end of April 2008. Inconnection with the closure of ATMOS’ operation, in July 2005, we signedan agreement to sublease the ATMOS facility, which we occupy under long-termleases in Canada. The sublease expires at the end of April 2008. We haveleased approximately 3,700 square feet of space in Seoul, South Korea for ourengineering design center. This lease expires at the end of April 2008. InDecember 2006, we signed a new lease agreement for our sales office inJapan. Under the new lease agreement, we occupy approximately 1,200 square feetof space in Tokyo, Japan. This lease expires in December 2008. Effective September 30,2006, we closed our office located in Sophia-Antipolis, 

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France,thus, we no longer have a facility there. We believe that our existing facilitiesare adequate to meet our current needs.

***Item3.***                          Legal Proceedings

On March 31, 2004, UniRAM Technology, Inc.filed a complaint against us in the United States District Court for theNorthern District of California, alleging trade secret misappropriation andpatent infringement. UniRAM’s complaint asserts that it provided trade secretinformation to TSMC in 1996-97 and speculated that we improperly obtainedunspecified trade secrets of UniRAM from TSMC in an unknown manner. Subsequentto March 31, 2004, UniRAM amended its complaint twice to add TSMC as adefendant and additional allegations to the suit, and to drop all infringementclaims for one of the two patents identified in the initial complaint. On October 24,2006, we entered into a settlement agreement with UniRAM under which we andUniRAM agreed to dismiss all outstanding claims and counterclaims withprejudice, and we paid UniRAM $2.4 million and received a completerelease of all claims as well as a future fully paid license for ourselves andall of our licensees with respect to UniRAM’s relevant intellectual property.

From time to time we may be subject to legalproceedings and claims in the ordinary course of business. These claims, evenif not meritorious, could result in the expenditure of significant financialresources and diversion of management efforts.

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

No matter was submitted toa vote of stockholders during the fourth quarter of the fiscal year covered bythis report. The 2007 Annual Meeting of Stockholders will be held at 9:30 a.m.,local time, on or about May 25, 2007, at our principal executive officelocated at 755 North Mathilda Avenue, Sunnyvale, California 94085.

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**Part II**

***Item 5.****                          Marketfor Registrant’s Common Equity and Related Stockholder Matters and IssuerPurchases of Equity Securities*

Our common stock is listedon Global Market of the NASDAQ Stock Market under the symbol MOSY and prior to August 1,2006 was quoted on the NASDAQ National Market. The following table sets forththe range of high and low sales prices of our common stock for each periodindicated. We had 33 shareholders of record as of March 1, 2007.

| **Quarter ended**   | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------|------------|------------|------------|----------|------------|---------|------------|
| December 31, 2006   |       | $          | 9.81       |     | $          | 6.44    |       |
| September 30, 2006  |       | $          | 8.20       |     | $          | 5.65    |       |
| June 30, 2006*      |       | $          | 9.30       |     | $          | 7.57    |       |
| March 31, 2006*     |       | $          | 8.86       |     | $          | 5.32    |       |
| December 31, 2005*  |       | $          | 6.22       |     | $          | 4.99    |       |
| September 30, 2005* |       | $          | 5.66       |     | $          | 4.60    |       |
| June 30, 2005*      |       | $          | 6.18       |     | $          | 4.83    |       |
| March 31, 2005*     |       | $          | 6.42       |     | $          | 5.44    |       |

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*                    As quoted onthe NASDAQ National Market

*Dividend Policy*

We have not declared orpaid any cash dividends on our common stock and presently intend to retainfuture earnings, if any, to fund the development and growth of our businessand, therefore, do not anticipate paying any cash dividends in the foreseeablefuture.

*Purchases of EquitySecurities by the Issuer and Affiliated Purchasers*

On April 29, 2005, weannounced a repurchase program for up to $20 million of outstanding commonstock over the next 12 months. No shares were repurchased under the program,which expired on April 29, 2006.

*Stock PerformanceGraph*

The following graph compares cumulative totalstockholder return on the Company’s common stock with that of the S&P 500Index and the S&P Technology Sector Index for the period 2001 through 2006.The comparison assumes that $100 was invested on December 31, 2001 in theCompany’s common stock, the stocks included in the S&P 500 Index and thestocks included in the S&P Technology Sector Index.

The comparisons shown inthe graph below are based upon historical data, and the Company cautions thatthe stock price performance shown in the graph below is not indicative of, norintended to forecast, the potential future performance of the Company’s commonstock. Information used in the graph was obtained from Standard and Poor’swebsite, a source believed to be reliable, but the Company is not responsiblefor any errors or omissions in such information.

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**Comparison ofFive-Year Cumulative Total Return**

| ** **                        | ** ** | **12/31/2001** | ** ** | **12/31/2002** | ** ** | **12/31/2003** | ** ** | **12/31/2004** | ** ** | **12/31/2005** | ** ** | **12/31/2006** | ** ** |   |
|-----------------------------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|--------|
| MOSYS, INC.                       |       |           | 100.00     |           |       |           | 58.64      |           |       |           | 41.60      |           |       |   | 30.24 |   |   |   | 26.70 |   |   |   | 44.90 |   |   |
| S & P  500               |       |           | 100.00     |           |       |           | 76.63      |           |       |           | 96.85      |           |       |   | 105.56 |   |   |   | 108.73 |   |   |   | 123.54 |   |   |
| S & P  TECHNOLOGY SECTOR |       |           | 100.00     |           |       |           | 62.43      |           |       |           | 91.48      |           |       |   | 93.44 |   |   |   | 93.79 |   |   |   | 101.01 |   |   |

 

*Use of Proceedsfrom Registered Securities*

The Securities andExchange Commission declared the Company’s first registration statement, filedon Form S-1 under the Securities Act of 1933 (File No. 333-43122)relating to the Company’s initial public offering (IPO) of its common stock,effective on June 27, 2001. The Company realized approximately $51.6million after offering expenses. To date, the Company has not used any of thenet proceeds of the IPO except to acquire short-term and long-term investmentsand cash equivalents.

Securities Authorized for Issuance under EquityCompensation Plan

See Item 12.—Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters.

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***Item 6.****                          SelectedFinancial Data*

Theselected financial data presented below are derived from our consolidatedfinancial statements. The selected financial data should be read in conjunctionwith our financial statements and notes related to those statements, and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included herein.

| ** **                                                                             | ** ** | **Year Ended December 31,**                         | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006***                                                          | ** ** | **2005*** | ** ** | **2004*** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                             | ** ** | **(In thousands, except per share data)** | ** ** |
| Net revenue:                                                                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Product                                                                                |       | $                                                                  | —     |   | $ | 10 |   | $ | 952 |   | $ | 1,904 |   | $ | 2,924 |   |
| Licensing                                                                              |       | 9,096                                                              |       | 7,725 |   | 4,544 |   | 10,418 |   | 10,523 |   |
| Royalty                                                                                |       | 5,813                                                              |       | 4,547 |   | 5,325 |   | 6,911 |   | 14,344 |   |
| Total net revenue                                                                      |       | 14,909                                                             |       | 12,282 |   | 10,821 |   | 19,233 |   | 27,791 |   |
| Cost of net revenue:                                                                   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Product                                                                                |       | —                                                             |       | — |   | 655 |   | 1,217 |   | 1,668 |   |
| Licensing                                                                              |       | 1,498                                                              |       | 1,986 |   | 1,613 |   | 1,970 |   | 1,730 |   |
| Total cost of net revenue                                                              |       | 1,498                                                              |       | 1,986 |   | 2,268 |   | 3,187 |   | 3,398 |   |
| Gross profit                                                                           |       | 13,411                                                             |       | 10,296 |   | 8,553 |   | 16,046 |   | 24,393 |   |
| Operating  expenses:                                                                   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Research and development                                                               |       | 8,156                                                              |       | 5,839 |   | 8,096 |   | 8,741 |   | 6,926 |   |
| Selling, general and administrative                                                    |       | 11,370                                                             |       | 9,922 |   | 13,331 |   | 6,432 |   | 5,266 |   |
| Litigation settlement                                                                  |       | 2,400                                                              |       | — |   | — |   | — |   | — |   |
| Restructuring expenses                                                                 |       | —                                                             |       | 119 |   | 585 |   | — |   | — |   |
| Total operating expenses                                                               |       | 21,926                                                             |       | 15,880 |   | 22,012 |   | 15,173 |   | 12,192 |   |
| Income (loss) from operations                                                          |       | (8,515                                                             | )          | (5,584 | ) | (13,459 | ) | 873 |   | 12,201 |   |
| Interest and other income                                                              |       | 3,286                                                              |       | 2,591 |   | 11,578 |   | 1,914 |   | 1,539 |   |
| Income (loss) before income taxes                                                      |       | (5,229                                                             | )          | (2,993 | ) | (1,881 | ) | 2,787 |   | 13,740 |   |
| Income tax benefit (provision)                                                         |       | (109                                                               | )          | 11 |   | (26 | ) | (279 | ) | (1,373 | ) |
| Net income (loss)                                                                      |       | $                                                                  | (5,338     | ) | $ | (2,982 | ) | $ | (1,907 | ) | $ | 2,508 |   | $ | 12,367 |   |
| Net income (loss)  per share:                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                                                                  |       | $                                                                  | (0.17      | ) | $ | (0.10 | ) | $ | (0.06 | ) | $ | 0.08 |   | $ | 0.41 |   |
| Diluted                                                                                |       | $                                                                  | (0.17      | ) | $ | (0.10 | ) | $ | (0.06 | ) | $ | 0.08 |   | $ | 0.40 |   |
| Shares used in computing  net income (loss) per share:                                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                                                                  |       | 31,298                                                             |       | 30,534 |   | 30,750 |   | 30,504 |   | 29,902 |   |
| Diluted                                                                                |       | 31,298                                                             |       | 30,534 |   | 30,750 |   | 30,998 |   | 31,275 |   |
| Allocation of stock-based  compensation to cost of net revenue and operating expenses: |       |                                                               |       |   |   |   |   |   |   |   |   |
| Cost of net revenue                                                                    |       | $                                                                  | 225        |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Research and development                                                               |       | 993                                                                |       | — |   | 44 |   | 148 |   | 340 |   |
| Selling, general and administrative                                                    |       | 1,528                                                              |       | 36 |   | 24 |   | 311 |   | 316 |   |
|                                                                                   |       | $                                                                  | 2,746      |   | $ | 36 |   | $ | 68 |   | $ | 459 |   | $ | 656 |   |

 

| ** **                                                                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006***                                  | ** ** | **2005*** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                     | ** ** | **(In thousands)**                    | ** ** |
| **Balance Sheet Data:**                                                        | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash, cash equivalents and short-term investments and  auction rate securities |       | $                                          | 81,807     |   | $ | 68,650 |   | $ | 62,349 |   | $ | 41,365 |   | $ | 68,433 |   |
| Working capital                                                                |       | 84,698                                     |       | 68,179 |   | 62,535 |   | 44,426 |   | 71,213 |   |
| Total assets                                                                   |       | 103,760                                    |       | 103,637 |   | 104,582 |   | 106,892 |   | 103,090 |   |
| Deferred revenue                                                               |       | 619                                        |       | 1,309 |   | 501 |   | 506 |   | 1,779 |   |
| Long-term obligations                                                          |       | 54                                         |       | 196 |   | 239 |   | 13 |   | 25 |   |
| Stockholders’ equity                                                      |       | 100,915                                    |       | 99,332 |   | 100,408 |   | 103,511 |   | 98,697 |   |
| Cash dividend                                                                  |       | —                                     |       | — |   | — |   | — |   | — |   |
|                                                                                |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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*                    Derivedfrom the financial statements that are included in Item 8.

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***Item 7.****                          Management’sDiscussion and Analysis of Financial Condition and Results of Operations*

*This Management’s Discussion and Analysis of FinancialCondition and Results of Operations should be read in conjunction with theaccompanying consolidated financial statements and notes included in thisreport.*

***Overview***

We design, develop, market and license memorytechnologies used by the semiconductor industry and electronic productmanufacturers. We have developed a patented semiconductor memory technology,called 1T-SRAM that offers a combination of high density, low power consumptionand high speed at performance and cost levels that other available memorytechnologies do not match. We license this technology to companies thatincorporate, or embed, memory on complex integrated circuits, such as SoCs. Wehave also sold memory chips based on our 1T-SRAM technologies, but in 2004, weceased actively selling them. We do not expect to make and sell memory chips inthe future.

Using elements of our existing memory technology as afoundation, we completed development of our first memory chips incorporatingour 1T-SRAM technologies in the fourth quarter of 1998. We signed our firstlicense agreement related to our 1T-SRAM technologies at the end of the fourthquarter of 1998 and recognized licensing revenue from our 1T-SRAM technologiesfor the first time in the first quarter of 2000. Since then, we have introducedimproved and enhanced versions of our technology, such as 1T-SRAM-R, 1T-SRAM-M,and 1T-SRAM-Q.

We generate revenue from licensing our memorytechnologies, which revenue consists of licensing revenues, customizationservices, maintenance and support fees and royalties. Royalty revenues areearned under each of our license agreements when our licensees manufacture orsell products that incorporate any of our 1T-SRAM technologies and report theresults to us. Generally, we expect our total sales cycle, or the period fromour initial discussion with a prospective licensee to our receipt of royaltiesfrom the licensee’s use of our 1T-SRAM technologies, to run from 18 to24 months after the commencement of the project. The portion of our salescycle from the initial discussion to the receipt of license fees may run fromsix to 12 months, depending on the complexity of the proposed project anddegree of customization required.

In 2005, we begandelivering our new family of 1T-SRAM CLASSIC Memory Macro products tolicensees. These macros are silicon-proven, high-density solutions offeringcustomers rapid memory block integration into their SoC designs. They arepre-configured and require minimal additional customization, and we believethey will enable us to increase our penetration of the market for very dense,low power, high speed embedded memory applications.

***Sources of Revenue***

We generate two types of revenue: licensing androyalties.

*Licensing.*   Our license agreements involvelong sales cycles, which makes it difficult to predict when the agreements willbe signed. In addition, our licensing revenues fluctuate from period-to-period,and it is difficult for us to predict the timing and magnitude of such revenuefrom quarter-to-quarter. Moreover, we believe that the amount of licensingrevenues for any period is not necessarily indicative of results in any futureperiod. Our future revenue results are subject to a number of factors,particularly those described in Part I, Item 1A. “Risk Factors.”

Our licensing revenue consists of fees for providingcircuit design, layout and design verification and granting a license to acustomer for embedding our memory technology into its product. For somecustomers, we also provide engineering support services to assist in theinitial production of products utilizing the licensed 1T-SRAM technologies.License fees generally range from $100,000 to several million dollars percontract, depending on the scope and complexity of the development project, andthe extent of 

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the licensee’s rights. Thelicensee generally pays the license fees in installments at the beginning ofthe license term and upon the attainment of specified milestones. The vastmajority of our contracts allow billing between milestones based on workperformed. Fees billed prior to revenue recognition are recorded as deferredrevenue.

For license agreements that do not require significantdevelopment, modification or customization, revenues are recognized when thereis persuasive evidence of an arrangement, delivery has occurred, fees are fixedor determinable and collectibility is probable. If any of these criteria is notmet, we defer recognizing the revenue until such time as all criteria are met. Forlicense agreements where  a license isgranted and  no other deliverables arerequired, revenues are recognized when persuasive evidence of an arrangementexists, fees are fixed or determinable and collectibility is probable. However,if the agreement involves performance specifications that we have significantexperience in meeting and the cost of contract completion can be reasonablyestimated, we recognize revenue over the period in which the contract servicesare performed under the percentage of completion accounting method. We useactual direct labor hours incurred to measure progress towards completion. Weperiodically evaluate the actual status of each project to determine whetherthe estimates to complete each contract remain accurate and update ourestimated costs to complete as necessary. Revenue recognized in any period isdependent on our progress toward completion of projects in progress.Significant management judgment and discretion are used to estimate totaldirect labor hours. Changes in or deviations from these estimates could have amaterial effect on the amount of revenue we recognize in any period. If theamount of revenue recognized under the percentage of completion method exceedsthe amount of billings to a customer, then under the percentage of completionaccounting method, we account for the excess amount as an unbilled contractreceivable. Our total unbilled contract receivable was $360,000 and $368,000 asof December 31, 2006 and 2005, respectively. For agreements involvingperformance specifications that we have not met and for which we lack thehistorical experience to reasonably estimate the costs, we defer recognition ofall revenue and related direct costs until all deliverables are met andrecognize revenue under the completed contract accounting method.

From time to time, a licensee may cancel a projectduring the development phase. Such a cancellation is not within our control andis often caused by changes in market conditions or the licensee’s business.Cancellations of this nature are an aspect of our licensing business, and mostof our contracts allow us to retain all payments that we have received or areentitled to collect for items and services provided before the cancellationoccurs. We will consider a project to have been canceled even in the absence ofspecific notice from our licensee, if there has been no activity under thecontract for more than six months, and we believe that completion of thecontract is unlikely. In this event, we recognize revenue in the amount of cashreceived, if we have performed a sufficient portion of the developmentservices. If a cancelled contract had been entered into before theestablishment of technological feasibility, the costs associated with thecontract would have been expensed prior to the recognition of revenue. In thatcase, there would be no costs associated with that revenue recognition, andgross margin would increase for the corresponding period. In 2006, werecognized $225,000 of licensing revenue from cancelled contracts, compared to$240,000 in 2005 and none in 2004.

*Royalty.*   Each of our license agreements provides forroyalty payments at a stated rate. We negotiate royalty rates by taking intoaccount such factors as the anticipated volume of the licensee’s sales ofproducts utilizing our technologies and the cost savings to be achieved by thelicensee through the use of our technology. Our license agreements generallyrequire the licensee to report the manufacture or sale of products that includeour technology after the end of the quarter in which the sale or manufactureoccurs.

As with ourlicensing revenues, the timing and level of royalties are difficult to predict.They depend on the licensee’s ability to market, produce and sell productsincorporating our technology. Many of the products of our licensees that arecurrently subject to licenses from us are consumer products, such as 

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electronicgame consoles, for which demand can be seasonal and generally highest in thefourth quarter. For a discussion of factors that could contribute to thefluctuation of our revenues, see Part I, Item 1A. “Risk Factors—Our lengthylicensing cycle and our licensees’ lengthy product development cycle will makethe operating results of our licensing business difficult to predict,” and“—Anything that negatively affects the businesses of our licensees couldnegatively impact our revenue.”

***Critical Accounting Policies and Estimates***

*Useof estimates.*   Our discussion andanalysis of our financial condition and results of operation are based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make certain estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses. On an ongoing basis we make these estimates based on our historicalexperience and on assumptions that we consider reasonable under thecircumstances. Actual results may differ from these estimates, and reportedresults could differ under different assumptions or conditions

We apply estimates and judgments in the followingmanner:

*LicensingRevenue Recognition.**  *Forlicense agreements that do not require significant development, modification orcustomization, revenues are recognized when there is persuasive evidence of anarrangement, delivery has occurred, fees are fixed or determinable and collectibilityis probable. If any of these criteria are not met, we defer recognizing therevenue until such time as all criteria are met. For license agreements, whichrequire no deliverables, revenues are recognized when persuasive evidence of anarrangement exists, fees are fixed or determinable and collectibility isprobable. As a consequence, the timing of this revenue recognition depends uponour subjective evaluation of each of these elements.

For those contracts requiring us to develop a designthat meets a licensee’s specifications, we apply SOP 81-1 “Accounting forPerformance of Construction-Type and Certain Production-Type Contracts”. Inaccordance with SOP 81-1 when license agreements include deliverablesthat require “significant production, modification or customization”, contractaccounting is applied. If a licensing contract involves performancespecifications that we have significant experience in meeting and the directlabor hours to be incurred to complete the contract can be reasonably estimated,we recognize the revenue over the period in which the contract services areperformed using the percentage of completion method. The percentage ofcompletion method includes judgmental elements, such as determining that wehave the experience to meet the design specifications and estimation of thetotal direct labor hours. We follow this method because we can obtainreasonably dependable estimates of the direct labor hours to perform thecontracted services. The direct labor hours for the development of the licensee’sdesign are estimated at the beginning of the contract. As these direct laborhours are incurred, they are used as a measure of progress towards completion.We have the ability to reasonably estimate direct labor hours on acontract-by-contract basis from our experience in developing prior licensee’sdesigns. During the contract performance period, we review estimates of directlabor hours to complete the contracts as the contract progresses to completionand will revise our estimates of revenue and gross profit under the contract ifwe revise the estimations of the direct labor hours to complete. Our policy isto reflect any revision in the contract gross profit estimate in reportedincome in the period in which the facts giving rise to the revision becomeknown. Under the percentage of completion method, provisions for estimatedlosses on uncompleted contracts are recognized in the period in which thelikelihood of such losses is determined.

For contracts involving design specifications that wehave not met previously, we defer the recognition of revenue until the designmeets the contractual design specifications and expense the cost of services asincurred. When we have experience in meeting design specifications but believethat we do not have significant experience to reasonably estimate the directlabor hours related to services to meet a design specification, we defer boththe recognition of revenue and the cost. For these arrangements, we recognize 

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revenue using thecompleted contract method. Under the completed contract method, we recognizerevenue when we complete the milestones. In 2006 and 2005, none of our licenserevenue was recognized under the completed contract method.

We also provide support and maintenance under many ofour license agreements. Under these arrangements, we provide unspecifiedupgrades, design rule changes and technical support. No other upgrades,products or other post-contract support are provided. When we provide acombination of services related to licensing and support and maintenance tocustomers, in addition to the considerations noted above, we evaluate thearrangements under EITF 00-21, “Revenue Arrangements with MultipleDeliverables”. Specifically, we analyze the separate elements to determine ifvendor specific objective evidence, or VSOE, exists for the undeliveredelements. We believe we have established VSOE for our support and maintenancearrangements. These arrangements are renewable annually by the customer.Support and maintenance revenue is recognized at its fair value ratably overthe period during which the obligation exists, typically 12 months. Revenuefrom support and maintenance service represented $287,000 and $512,000 in 2006and 2005, respectively, and was included in licensing revenue in the statementof operations.

*RoyaltyRevenue Recognition.*   Licensing contracts alsoprovide for royalty payments at a stated rate based on actual units producedand/or sold. Licensees generally report the manufacture or sale of productsthat include our 1T-SRAM technologies after the end of the quarter in which thesale or manufacture occurs. As such, we generally recognize royalties in thequarter in which we receive the licensee’s report. In addition, in the fourthquarter of 2006, we recognized royalty revenue related in the same quarter of2006 due to a contract amendment with a customer, which enabled us to reportroyalty revenue one quarter earlier than the previous contract. As a result ofthis contract amendment, additional royalty revenue representing 30% of totalrevenue was recognized in the fourth quarter of 2006. In future quarters, wewill continue to recognize royalty revenue related to this amendment in thesame quarter in which the units are sold. In the first quarter of 2006, webegan recognizing two types of prepaid royalties: pre-production royalties,which cover a fixed number of future unit shipments and are paid in a lump sumwhen we enter into the licensing contract, and post-production royalties, whichare paid in a lump sum after the licensee commences production of theroyalty-bearing product and applied against future unit shipments. In eithercase, payments from these prepaid royalties are non-refundable. Under currentcontracts, pre-production prepaid royalties are inseparable from our licensingactivities. Thus, we include pre-production prepaid royalties in licensingrevenue. Post-production prepaid royalties, which are recognized at the time ofthe billing provided that no future performance obligations exist, are includedin royalty revenue.

*Deferredtax valuation allowance.**  *When we prepare our consolidated financialstatements, we estimate our income tax liability for each of the variousjurisdictions where we conduct business. This requires us to estimate ouractual current tax exposure and to assess temporary differences that resultfrom differing treatment of certain items for tax and accounting purposes. Thesedifferences result in deferred tax assets and liabilities, which we show on ourconsolidated balance sheet under the category of other current assets. The netdeferred tax assets are reduced by a valuation allowance if, based uponweighted available evidence, it is more likely than not that some or all of thedeferred tax assets will not be realized. We must make significant judgments todetermine our provision for income taxes, our deferred tax assets andliabilities and any valuation allowance to be recorded against our net deferredtax asset. As of December 31, 2006, we had a valuation allowance ofapproximately $12.5 million, of which approximately $5.1 million wasattributable to Canadian loss and research and development pool carryforwards,and $6.3 million was attributable to U.S. and state net operating loss and taxcredit carryforwards.

*Stock-based compensation.**  *We adopted Financial AccountingStandards Board (FASB) Standard No. 123 (revised 2004), “Share-BasedPayment” (SFAS 123(R)) effective January 1, 2006 and selected the modifiedprospective transition method, which requires us to recognize the fair value ofthe stock-based compensation in the net income (loss) in the current and futureperiods and not to restate the impact of 

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the adoption on theprior period financial statements. Upon adoption, we began estimating the valueof employee stock options on the date of grant using the Black-Scholes model.Prior to the adoption of SFAS 123(R), the value of each employee stock optionwas estimated on the date of grant using the Black-Scholes model for thepurpose of the pro forma financial disclosure in accordance with Statement ofFinancial Accounting Standard 123 (SFAS 123), “Accounting for Stock-BasedCompensation”. The determination of fair value of share-based payment awards onthe date of grant using an option-pricing model is affected by our stock priceas well as assumptions regarding a number of highly complex and subjectivevariables. These variables include, but are not limited to the expected stockprice volatility over the term of the awards, and actual and projected employeestock option exercise behaviors. The expected term of options granted isderived from historical data on employee exercises and post-vesting employmenttermination behavior. The expected volatility is based on the historical andimplied volatility of our stock price. Based on unvested stock optionsoutstanding as of December 31, 2006, the total compensation costs expectedto be recognized over a weighted average period of approximately 2.72 years isapproximately $8.1 million. See note 7—Stock-based Compensation in the notes toour consolidated financial statements for more discussion.

**Results ofOperations**

The following discussion compares the historicalresults of operations based on U.S. generally accepted accounting principlesfor the years ended December 31, 2006, 2005 and 2004. For these threeyears, results of operations as a percentage of net revenue were as follows:

| ** **                          | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenue:                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Product                             |       |                                       | —     | % |   |   | — | % |   | 9 | % |
| Licensing                           |       |                                       | 61         |   |   |   | 63 |   |   | 42 |   |
| Royalty                             |       |                                       | 39         |   |   |   | 37 |   |   | 49 |   |
| Total net revenue                   |       |                                       | 100        |   |   |   | 100 |   |   | 100 |   |
| Cost of net revenue:                |       |                                       |       |   |   |   |   |   |   |   |   |
| Product                             |       |                                       | —     |   |   |   | — |   |   | 6 |   |
| Licensing                           |       |                                       | 10         |   |   |   | 16 |   |   | 15 |   |
| Total cost of net  revenue          |       |                                       | 10         |   |   |   | 16 |   |   | 21 |   |
| Gross profit                        |       |                                       | 90         |   |   |   | 84 |   |   | 79 |   |
| Operating expenses:                 |       |                                       |       |   |   |   |   |   |   |   |   |
| Research and development            |       |                                       | 55         |   |   |   | 48 |   |   | 75 |   |
| Selling, general and administrative |       |                                       | 76         |   |   |   | 81 |   |   | 123 |   |
| Restructuring expenses              |       |                                       | —     |   |   |   | — |   |   | 5 |   |
| Litigation settlement               |       |                                       | 16         |   |   |   | — |   |   | — |   |
| Total operating  expenses           |       |                                       | 147        |   |   |   | 129 |   |   | 203 |   |
| Operating loss                      |       |                                       | (57        | ) |   |   | (45 | ) |   | (124 | ) |
| Interest and  other income          |       |                                       | 22         |   |   |   | 21 |   |   | 106 |   |
| Income tax  benefit (provision)     |       |                                       | —     |   |   |   | — |   |   | — |   |
| Net loss                            |       |                                       | (35        | )% |   |   | (24 | )% |   | (18 | )% |

 

*Years Ended December 31,2006, 2005 and 2004*

*Revenue.**  *In 2006, total revenue increased to $14.9 millionrepresenting a 21% increase from total revenue in 2005. Licensing revenueincreased to $9.1 million in 2006 from $7.7 million in 2005 due to 

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revenue recognized fromseveral significant licensing contracts for our 90nm and 65nm processtechnology in 2006. Royalty revenue increased to $5.8 million in 2006 from $4.5million in 2005 primarily due to a contract amendment with a customer, whichallowed us to report royalty revenue one quarter earlier than the previouscontract. As a result of this contract amendment, additional royalty revenue representing10% of total revenue was recognized in 2006. In future quarters, we willcontinue to recognize royalty revenue related to this amendment in the samequarter in which the units are sold. In 2006, the royalty earned from theproduction of GAMECUBE chips decreased to 3% of total revenue, compared to 14%in 2005, as the GAMECUBE video game products approached the end of theirproduct life cycles.

In 2005, total revenue increased to $12.3 millionrepresenting a 14% increase from total revenue in 2004. Licensing revenueincreased to $7.7 million in 2005 from $4.5 million in 2004 mainly due toincreased numbers of projects commenced under new contracts signed in 2005 andrevenue generated under a large contract signed in 2003 and completed in 2005.Royalty revenue decreased to $4.5 million in 2005 from $5.3 million in 2004 ascustomer sales of chips incorporating our technology declined. Royaltiesrelated to the production of Nintendo GAMECUBE chips in 2005 was $1.7 million,which was consistent with royalties in 2004.

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In 2004, total revenue was $10.8 million primarilyfrom licensing and royalty activities. Total revenue was reduced by $450,000for a reimbursement given to a customer for excess verification costs incurredby the customer.

During the years ended December 31, 2006 and2005, our product sales were minimal. During the year ended December 31,2004, product sales were $952,000. In the second quarter of 2004, we notifiedcustomers of our decision to discontinue sale of our memory chip products. Asof the end of the third quarter of 2004, we had no remaining product inventoryof value.

*GrossProfit.*   Gross profit increased to $13.4 millionin 2006 from $10.3 million in 2005 mainly due to an increase in our licensingrevenue. Our gross profit as a percentage of total revenue increased to 90% in2006 from 84% in 2005 primarily due to a higher licensing gross profit, whichincreased to 84% of total licensing revenue in 2006 from 74% of total licensingrevenue in 2005. This increase in licensing gross profit as a percentage oflicensing revenue resulted from lower costs for fulfilling our obligationsunder large high margin contracts and our CLASSIC Memory Macro projects. Thiscost reduction was partially offset by stock-based compensation expense of$225,000 recorded under SFAS 123(R). There was no stock-based compensationexpense related to SFAS 123(R) in 2005. In addition, pre-productionprepaid royalties included in licensing revenue contributed to an increasedgross profit as a percentage of total revenue because such royalties have noassociated cost.

Gross profit increased to $10.3 million in 2005 from$8.6 million in 2004 primarily due to an increase in our licensingrevenue. Our gross profit as a percentage of total revenue increased to 84% in2005 from 79% in 2004 primarily due to a higher licensing gross profit, whichincreased to 74% of total licensing revenue in 2005 from 65% of total licensingrevenue in 2004. This increase occurred because of a lower cost for fulfillingour obligations under new license agreements which required less customization.

Gross profit decreased to $8.6 million in 2004primarily due to the significant decline in our licensing revenue. Our grossprofit as a percentage of total revenue decreased to 79% in 2004 due to thedecline in licensing gross profit which fell to 65% of total revenue in 2004.This decline occurred because we incurred higher cost under new licenseagreements than we had originally estimated or had historically experienced. Inaddition, we recognized revenue under some lower margin license projectsincluding a few contracts in which our estimated cost exceeded the amount ofrevenue to be recognized.

*Researchand Development.**  *Ourresearch and development expenses include development and design of variationsof the 1T-SRAM technologies for use in different manufacturing processes usedby licensees and the development and testing of prototypes to prove thetechnological feasibility of embedding our memory designs in the licensees’products. Research and development expenses increased to $8.2 million in 2006from $5.8 million in 2005. This increase was primarily attributable to a lowerallocation of expenses to cost of licensing revenue in 2006 because of the highmargin contracts, which requires less customization and engineering efforts.Research and development expenses also increased as a result of the stock-basedcompensation expense of $993,000 under SFAS 123(R).

Research and development expenses decreased to $5.8million in 2005 from $8.1 million in 2004 mainly due to the closure of ourATMOS research and development facility in Ottawa, Canada in November of2004. There were no research and development expenses incurred at the ATMOSfacility in 2005 as compared to $2.2 million incurred in 2004.

Research and development expenses decreased to $8.1million in 2004 mainly because more engineering time was spent on licensingdevelopment projects, and therefore, more engineering expenses were allocatedto cost of licensing revenue in 2004. Effective November 10, 2004, weclosed the ATMOS research and development facility in Ottawa, Canada andterminated the employment of approximately 20 employees working there.

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*Selling,General and Administrative.**  *Selling,general and administrative expenses increased to $11.4 million in 2006 from$9.9 million in 2005 mainly due to stock-based compensation expense of $1.5million under SFAS 123(R). Expenses related to the UniRAM litigation in 2006totaled approximately $1.7 million. Expenses related to testing and assessment of effectiveness of ourinternal control over financial reporting required by Section 404 ofSarbanes-Oxley Act were approximately $411,000 in 2006.

Selling, general and administrative expenses decreasedto $9.9 million in 2005 from $13.3 million in 2004 when we incurred $5.5million of expenses related to the aborted acquisition by Synopsys, Inc.and legal expenses related to litigation with Synopsys over its abandonment ofthe acquisition, as well as $800,000 of expenses related to the UniRAMlitigation. We did not incur Synopsys-related costs in 2005, but incurredapproximately $1.6 million of legal expenses related to the clams brought byUniRAM. Expenses related to testing and assessment of effectiveness of ourinternal control over financial reporting required by Section 404 ofSarbanes-Oxley Act were approximately $466,000 in 2005.

In addition to the Synopsys and UniRAM-relatedexpenses in 2004, expenses related to testing and assessment of effectivenessof our internal control over financial reporting required by Section 404of Sarbanes-Oxley Act were approximately $690,000.

*LitigationSettlement.**  *On October 24,2006, we entered into a settlement agreement with UniRAM under which we and UniRAMagreed to dismiss all outstanding claims and counterclaims with prejudice, andwepaid UniRAM $2.4 million and received a complete release of all claims as wellas a future fully paid license for ourselves and all of our licensees withrespect to UniRAM’s relevant intellectual property.

*Interestand Other Income.**  *Interestand other income increased to $3.3 million in 2006 from $2.6 million in 2005primarily due to higher interest rates but offset by a charge of $511,000recorded in 2006 related to Japan withholding taxes paid by Japanese licenseeson our behalf. We do not expect any additional withholding tax reimbursement inthe future as the U.S. - Japan income tax treaty that took effect July 1,2004 generally eliminated withholding taxes on royalties. Interest and otherincome decreased to $2.6 million in 2005 from $11.6 million in 2004, whichincluded a $10 million merger termination fee paid by Synopsys. Interest incomeincreased to $2.6 million in 2005 from $1.5 million in 2004 due to higherinterest rates in 2005.

*Stock-basedCompensation.  **As a result of the adoption of SFAS 123(R) effectiveJanuary 1, 2006, $2.7 million was recognized as stock-based compensationexpense during the year ended December 31, 2006. Of this amount, $19,000was*related to the issuance of options to purchase our stockto newly appointed members of our board of directors that had an exercise priceless than the fair market value of our stock on the date of the option grant,which is permitted under our option plan.

During the years ended December 31, 2005 and2004, we recorded stock compensation expenses of $36,000 and $68,000,respectively, of which $0 and, $50,000, respectively, was attributable to theexcess of the fair market value of our common stock over the price at which wegranted stock options to employees, which was permitted under our option plan.In 2005 and 2004, we incurred $36,000 and $5,000, respectively, of stockcompensation expenses related to the issuance of options to purchase our stockto newly appointed members of our board of directors that had an exercise priceless than the fair market value of our stock on the date of the option grant,which was permitted under our option plan. Stock compensation expenses in 2004also included $13,000 for amortization of deferred compensation cost attributableto the fair market value of shares of our common stock issued to certainemployees of ATMOS.

During the year ended December 31, 2004, werecorded deferred compensation cost of $74,000, which would be amortized infuture periods. No such costs were incurred in 2005. The 2004 deferredcompensation costs represented the intrinsic value of options granted topurchase shares of our stock to newly appointed members of our board ofdirectors that had an exercise price less than the fair market 

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value of our common stockon the date of the option grant, which was permitted under our option plan.This deferred compensation cost is being amortized over the vesting period of36 months using the graded vesting method.

Prior to the adoption of SFAS 123(R), deferred compensationexpense was amortized using the graded vesting method over the vesting periodof each respective option, generally four years. The accelerated amortizationresults in expensing approximately 52% of the total award in the first year,27% in the second year, 15% in the third year and 6% in the fourth year.

*Provision for Income Taxes.  *Provisions(benefit) for income taxes of approximately $109,000, ($11,000), and $26,000,were recorded in 2006, 2005, and 2004, respectively. The effective income tax ratewas 2.1% for 2006, (0.4%) for 2005, and 1.4% for 2004. As of December 31,2006, we had net operating loss carryforwards of approximately $13.9 millionfor federal tax purposes, approximately $11.5 million for state tax purposesand Canadian loss and research and development pool carryforwards ofapproximately $13.0 million that are available to reduce future income taxliabilities to the extent permitted under federal, Canadian and applicablestate income tax laws. The net operating loss carryforwards expire from 2008 to2026. The change in our effective tax rate in 2006 was mainly due to anincrease in foreign taxes. In 2007, we anticipate that our effective income taxrate will be less than the federal statutory tax rate but higher than the 2006effective income tax rate.

**Liquidity andCapital Resources**

As of December 31, 2006, we had cash and cashequivalents of $11.1 million, short-term investments and auction ratesecurities of $70.7 million and long-term investments of $2.5 million resultingin a total balance of cash, cash equivalents, and investments of $84.3 million.As of the same date, we had total working capital of $84.7 million. As of December 31,2005, we had cash and cash equivalents of $9.2 million, short-terminvestments and auction rate securities of $59.5 million and long-terminvestments of $17.3 million resulting in a total balance of cash, cashequivalents, and investments of $86.0 million. As of the same date, we hadtotal working capital of $68.2 million. Our primary capital requirementsare to fund working capital needs. We believe that our current focus onlicensing and royalty revenues with reduced levels of memory chip sales hasgenerally enabled us to steadily improve our liquidity.

Net cash provided by (used in) operating activitieswas ($5.6) million, ($1.3) million, and $2.7 million for the years ended 2006,2005 and 2004, respectively. In 2006, net cash used in the operating activitiesprimarily consisted of the net loss $5.3 million, an increase in accountsreceivable by $1.9 million, reduced deferred revenue of $690,000 and decreasedaccrued expenses and other liabilities of $756,000 offset by the non-cashimpact of stock-based compensation of $2.7 million under SFAS 123(R), and anon-cash charge of $474,000 for depreciation and amortization. In 2005, netcash used in operating activities consisted primarily of net loss of$3.0 million offset by a non-cash charge of $614,000 for depreciation andamortization and higher deferred revenue of $808,000. In addition, net cashused in operating activities in 2005 included tax benefits associated with theexercise of stock options of $482,000, which was recorded under additional paidin capital. In 2004, net cash provided by operating activities consistedprimarily of net loss of $1.9 million offset by a non-cash charge of$1.5 million for depreciation and amortization, reduced unbilled contractreceivables of $1.0 million, and prepaid expenses and other assets of $858,000,which included a reduction in deferred tax assets in 2004. In addition, netcash provided by operating activities in 2004 included restructuring relatedliabilities of $429,000

Net cash provided by (used in) investing activitieswas approximately $3.7 million, ($22.8) million, and $7.9 million for the yearsended 2006, 2005, and 2004, respectively. In 2006, in addition to the investingactivity of marketable securities, we purchased $208,000 of property andequipment, consisting principally of engineering design software. In 2005,aside from investing in marketable securities, we added $1.1 million ofproperty and equipment primarily due to leasehold improvements related to ournew office lease 

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for our U.S. corporateheadquarters beginning in June 2005, new testing equipment and engineeringdesign software. We also purchased $349,000 of property and equipment in 2004,consisting principally of engineering design software.

Net cash provided by (used in) financing activitieswas approximately $3.8 million, $1.5 million, and ($982,000) for the yearsended 2006, 2005, and 2004, respectively. We received proceeds in the amount of$3.8 million and $1.5 million in 2006 and 2005, respectively, from the exerciseof employee options to purchase common stock. In 2004, the major financing useof cash was $4.7 million for the repurchase of 1.2 million shares of commonstock. We received proceeds in the amount of $3.7 million from the exercise ofemployee options to purchase common stock during 2004.

Our futureliquidity and capital requirements are expected to vary from quarter to quarter,depending on numerous factors, including—

·       leveland timing of licensing and royalty revenues;

·       cost,timing and success of technology development efforts, including meetingcustomer design specifications;

·       marketacceptance of our existing and future technologies and products;

·       competingtechnological and market developments;

·       costof maintaining and enforcing patent claims and intellectual property rights;

·       variationsin manufacturing yields, materials costs and other manufacturing risks;

·       costsof acquiring other businesses and integrating the acquired operations; and

·       profitabilityof our business.

We expect that existing cash, and equivalents,short-term and long-term investments along with our existing capital and cashgenerated from operations, if any, will be sufficient to meet our capitalrequirements for the foreseeable future. We expect that a licensing businesssuch as ours generally will require less cash to support operations.

However, we cannot becertain that we will not require additional financing at some point in time.Should our cash resources prove inadequate, we may need to raise additionalfunding through public or private financing. There can be no assurance thatsuch additional funding will be available to us on favorable terms, if at all.The failure to raise capital when needed could have a material, adverse effecton our business and financial condition.

**Lease Commitmentsand Off Balance Sheet Financing**

Theimpact that our contractual obligations as of December 31, 2006 areexpected to have on our liquidity and cash flow in future periods is asfollows:

| ** **       | ** ** | **Payment Due by Period** | ** ** |
|------------------|------------|------------------------------------------|------------|
| ** **       | ** ** | **Total**                                | ** ** | **Less than 1 year** | ** ** | **1-3 years** | ** ** | **Over 4 years** | ** ** |
| Operating Lease: |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Obligations      |       | $                                        | 1,983      |   |   | $ | 863 |   |   |   | $ | 1,120 |   |   |   | $ | — |   |   |
| Sublease Income  |       | 271                                      |       |   | 210 |   |   |   | 61 |   |   |   | — |   |   |
|             |       | $                                        | 1,712      |   |   | $ | 653 |   |   |   | $ | 1,059 |   |   |   | $ | — |   |   |

 

The Company did not haveany unconditional purchase obligations as of December 31, 2006.

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**Recent AccountingPronouncements**

**SeeNote 1 of the Consolidated Financial Statements for a full description ofrecent accounting pronouncements including the respective expected dates ofadoption and effects on results of operations and financial condition.**

***Item 7A.****                  Quantitativeand Qualitative Disclosures About Market Risk*

Our investment portfolioconsists of money market funds, auction rate securities, corporate-backeddebt obligations and mortgage-backed government obligations. Theportfolio dollar-weighted average maturity of these investments is withintwelve months. Our primary objective with investment portfolio is to investavailable cash while preserving principal and meeting liquidity needs. Inaccordance with our investment policy, we place investments with high creditquality issuers and limit the amount of credit exposure to any one issuer.These securities, which approximate $73.2 million as of December 31, 2006and have an average interest rate of approximately 4.9%, are subject tointerest rate risks. As of December 31, 2006, our portfolio had unrealizedlosses of approximately $79,000 as a result of rising interest rates. Webelieve these losses are temporary and expect to hold these investments tomaturity. However, based on the investment portfolio contents and our abilityto hold these investments until maturity, we believe that if a significantchange in interest rates were to occur, it would not have a material effect onour financial condition.

***Item 8.****                          FinancialStatements and Supplementary Data*

Reference is made to thefinancial statements listed under the heading (a) (1) FinancialStatements and Reports of BDO Seidman LLP and Ernst & Young LLPof Item 15, which financial statements are incorporated by reference inresponse to this Item 8.

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**Quarterly Resultsof Operations**

Thefollowing tables set forth unaudited results of operations data for the eightquarters ended December 31, 2006. This unaudited information has beenprepared on a basis consistent with our audited financial statements appearingelsewhere in this report and, in the opinion of our management, includes alladjustments, consisting only of normal recurring adjustments, necessary for afair presentation of the information for the periods presented. The unauditedquarterly information should be read in conjunction with the financialstatements and notes included elsewhere in this report. 

| ** **   | ** ** | **Dec. 31,**                                                  | ** ** | **Sep. 30,** | ** ** | **Jun. 30,** | ** ** | **Mar. 31,** | ** ** | **Dec. 31,** | ** ** | **Sep. 30,** | ** ** | **Jun. 30,** | ** ** | **Mar. 31,** | ** ** |
|--------------|------------|--------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|
| ** **   | ** ** | **2006**                                                           | ** ** | **2006**          | ** ** | **2006**          | ** ** | **2006**          | ** ** | **2005**          | ** ** | **2005**          | ** ** | **2005**          | ** ** | **2005**          | ** ** |
| ** **   | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **   | ** ** | **(Unaudited—All periods)**                              | ** ** |
| Net revenue: |       |                                                               |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|              |            |                                                                    |            |                   |            |                   |            |                   |            |                   |            |                   |            |                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

| Product                                                |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | 6     |   |   |   | $ | 4      |   |   |
|--------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|-------|--------|--------|--------|---|--------|--------|--------|
| Licensing                                              |   |   | 1,794  |   |   |   | 3,333  |   |   |   | 1,701  |   |   |   | 2,268  |   |   |   | 1,339  |   |   |   | 3,233  |   |   |   | 1,940  |   |   |   | 1,213  |   |   |
| Royalty                                                |   |   | 3,215  |   |   |   | 705    |   |   |   | 639    |   |   |   | 1,254  |   |   |   | 1,063  |   |   |   | 897    |   |   |   | 1,121  |   |   |   | 1,466  |   |   |
| Total net revenue                                      |   |   | 5,009  |   |   |   | 4,038  |   |   |   | 2,340  |   |   |   | 3,522  |   |   |   | 2,402  |   |   |   | 4,130  |   |   |   | 3,067  |   |   |   | 2,683  |   |   |
| Cost of net  revenue:                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Licensing                                              |   |   | 592    |   |   |   | 172    |   |   |   | 381    |   |   |   | 353    |   |   |   | 243    |   |   |   | 668    |   |   |   | 609    |   |   |   | 466    |   |   |
| Total cost of net revenue                              |   |   | 592    |   |   |   | 172    |   |   |   | 381    |   |   |   | 353    |   |   |   | 243    |   |   |   | 668    |   |   |   | 609    |   |   |   | 466    |   |   |
| Gross profit                                           |   |   | 4,417  |   |   |   | 3,866  |   |   |   | 1,959  |   |   |   | 3,169  |   |   |   | 2,159  |   |   |   | 3,462  |   |   |   | 2,458  |   |   |   | 2,217  |   |   |
| Operating  expenses:                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development                               |   |   | 2,057  |   |   |   | 2,018  |   |   |   | 2,129  |   |   |   | 1,952  |   |   |   | 1,557  |   |   |   | 1,359  |   |   |   | 1,320  |   |   |   | 1,603  |   |   |
| Selling, general and administrative                    |   |   | 2,585  |   |   |   | 3,350  |   |   |   | 2,806  |   |   |   | 2,629  |   |   |   | 2,519  |   |   |   | 2,721  |   |   |   | 2,206  |   |   |   | 2,476  |   |   |
| Litigation settlement                                  |   |   | — |   |   |   | 2,400  |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Restructuring expenses                                 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 5      |   |   |   | — |   |   |   | 114    |   |   |   | — |   |   |
| Total operating expenses                               |   |   | 4,642  |   |   |   | 7,768  |   |   |   | 4,935  |   |   |   | 4,581  |   |   |   | 4,081  |   |   |   | 4,080  |   |   |   | 3,640  |   |   |   | 4,079  |   |   |
| Operating income (loss)                                |   |   | (225   | )      |   |   | (3,902 | )      |   |   | (2,976 | )      |   |   | (1,412 | )      |   |   | (1,922 | )      |   |   | (618   | )      |   |   | (1,182 | )      |   |   | (1,862 | )      |   |
| Interest and other income                              |   |   | 865    |   |   |   | 1,043  |   |   |   | 926    |   |   |   | 452    |   |   |   | 794    |   |   |   | 679    |   |   |   | 605    |   |   |   | 513    |   |   |
| Income (loss) before income taxes                      |   |   | 640    |   |   |   | (2,859 | )      |   |   | (2,050 | )      |   |   | (960   | )      |   |   | (1,128 | )      |   |   | 61     |   |   |   | (577   | )      |   |   | (1,349 | )      |   |
| Income tax benefit (provision)                         |   |   | (73    | )      |   |   | (8     | )      |   |   | (14    | )      |   |   | (14    | )      |   |   | 44     |   |   |   | (11    | )      |   |   | (2     | )      |   |   | (20    | )      |   |
| Net income (loss)                                      |   |   | $      | 567    |   |   |   | $      | (2,867 | )      |   |   | $      | (2,064 | )      |   |   | $      | (974   | )      |   |   | $      | (1,084 | )      |   |   | $      | 50     |   |   |   | $      | (579  | )      |   |   | $ | (1,369 | )      |   |
| Net income (loss) per share:                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                  |   |   | $      | 0.02   |   |   |   | $      | (0.09  | )      |   |   | $      | (0.07  | )      |   |   | $      | (0.03  | )      |   |   | $      | (0.04  | )      |   |   | $      | 0.00   |   |   |   | $      | (0.02 | )      |   |   | $ | (0.04  | )      |   |
| Diluted                                                |   |   | $      | 0.02   |   |   |   | $      | (0.09  | )      |   |   | $      | (0.07  | )      |   |   | $      | (0.03  | )      |   |   | $      | (0.04  | )      |   |   | $      | 0.00   |   |   |   | $      | (0.02 | )      |   |   | $ | (0.04  | )      |   |
| Shares used in  computing net income (loss) per share: |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                  |   |   | 31,492 |   |   |   | 31,386 |   |   |   | 31,293 |   |   |   | 31,022 |   |   |   | 30,698 |   |   |   | 30,531 |   |   |   | 30,465 |   |   |   | 30,442 |   |   |
| Diluted                                                |   |   | 32,461 |   |   |   | 31,386 |   |   |   | 31,293 |   |   |   | 31,022 |   |   |   | 30,698 |   |   |   | 31,504 |   |   |   | 30,465 |   |   |   | 30,442 |   |   |

 

***Item 9.****                          Changesin and Disagreements with Accountants on Accounting and Financial Disclosure*

None.

***Item 9A.****                  Controlsand Procedures*

(a)           Management’s annualreport on internal control over financial reporting

MoSys, Inc.’s management is responsible forestablishing and maintaining adequate internal control over financialreporting, as such term is defined in Rules 13a-15(f ) and 15d-15(f)) underthe Securities Exchange Act of 1934. Indesigning and evaluating the disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives and management necessarily is required to apply its judgmentin evaluating the cost-benefit relationship of possible controls. Underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer, we conducted an evaluationof the effectiveness of our internal control over financial reporting based onthe framework in *Internal Control—IntegratedFramework*issued by the Committee of Sponsoring 

41

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Organizations of theTreadway Commission. Based on the evaluation, our management concluded that ourinternal control over financial reporting was effective as of December 31,2006.

BDO Seidman, LLP,the independent registered public accounting firm that audited the 2006consolidated financial statements included in this Annual Report on Form 10-K,has also audited management’s assessment of our internal control over financialreporting and the effectiveness of our internal control over financialreporting as of December 31, 2006, as stated in their report which isincluded under Item 15, below.

(b)          Evaluation of disclosurecontrols and procedures

Under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, we conducted an evaluation ofthe effectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934. Based on this evaluation, our managementconcluded that as of December 31, 2006, our disclosure controls andprocedures were effective such that the information relating to us, includingour consolidated subsidiaries, required to be disclosed in our reports filedwith the Securities and Exchange Commission (SEC) is recorded, processed,summarized and reported within the time periods specified in SEC rules andforms and is accumulated and communicated to our management including our ChiefExecutive Officer and our Chief Financial Officer, as appropriate to allowtimely decisions regarding required disclosure.

(c)           Changes in internalcontrol

There was no change in theinternal control over financial reporting during the fourth fiscal quarter of2006 that has materially affected, or is reasonably likely to materially affectour internal control over financial reporting.

***Item 9B.****                  OtherInformation*

None.

42

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**Part III**

***Item 10.****                   Directors,Executive Officers and Corporate Governance*

Information regarding our directors is incorporated byreference from the sections titled “Management,” “Corporate Governance,” and “Section 16(A) BeneficialOwnership Reporting Compliance” in the Registrant’s Proxy Statement for its2007 Annual Meeting of Stockholders. Information regarding current executiveofficers found under the heading “Executive Officers” in Item 1 of Part Ihereof is also incorporated by reference into this Item 10.

We have adopted a code of ethics that applies to allof our employees. The code of ethics is designed to deter wrongdoing and topromote, among other things, honest and ethical conduct, full, fair, accurate,timely, and understandable disclosures in reports and documents submitted tothe Securities and Exchange Commission and other public communications,compliance with applicable governmental laws, rules and regulations, theprompt internal reporting of violations of the code to an appropriate person orpersons identified in the code and accountability for adherence to such code.

The code of ethics isavailable on our website www.mosys.com. If we make any substantive amendmentsto the code of ethics or grant any waiver, including any implicit waiver, froma provision of the code to our Chief Executive Officer, Chief Financial Officeror Corporate Controller, or persons performing similar functions, where suchamendment or waiver is required to be disclosed under applicable SEC rules, weintend to disclose the nature of such amendment or waiver on our website.

***Item 11.****                   ExecutiveCompensation*

The response to this itemis incorporated by reference from the section titled “Executive Compensation”and “Executive Compensation—Report on Executive Compensation by theCompensation Committee of the Board of Directors”, in the Registrant’s ProxyStatement for its 2007 Annual Meeting of Stockholders.

***Item 12.****                   SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters*

The response to this itemis incorporated by reference from the sections titled “Share Ownership ofCertain Beneficial Owners and Management and “Securities Authorized forIssuance Under Equity Compensation Plans” in the Registrant’s Proxy Statementfor its 2007 Annual Meeting of Stockholders.

***Item 13.****                   CertainRelationships and Related Transactions, and Director Independence*

The response to this itemis incorporated by reference from the sections titled “Management-Directors,” “CorporateGovernance,” and “Certain Relationships and Related Transactions” in theRegistrant’s Proxy Statement for its 2007 Annual Meeting of Stockholders.

***Item 14.****                   PrincipalAccountant Fees and Services*

The response to this itemis incorporated by reference from the section titled “Ratification ofIndependent Registered Public Accounting Firm for 2007” in the Registrant’sProxy Statement for its 2007 Annual Meeting of Stockholders.

43

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**Part IV**

***Item 15.****                   Exhibitsand Financial Statement Schedules*

(a)           The following documentsare filed as part of this report:

(1)         FinancialStatements and Reports of Independent Registered Public Accounting Firm, whichare set forth in the index to Consolidated Financial Statements on pages 46through 78 of this report.

| Reports of Independent  Registered Public Accounting Firm—BDO Seidman LLP           |   | 50 |   |
|------------------------------------------------------------------------------------------|--------|----|--------|
| Report  of Independent Registered Public Accounting Firm—Ernst & Young LLP |   | 52 |   |
| Consolidated  Balance Sheets                                                             |   | 53 |   |
| Consolidated  Statements of Operations                                                   |   | 54 |   |
| Consolidated  Statements of Stockholders’ Equity                                    |   | 55 |   |
| Consolidated  Statements of Cash Flows                                                   |   | 56 |   |
| Notes to  Consolidated Financial Statements                                              |   | 57 |   |

 

(2)         Financial StatementSchedule—Schedule II—Valuation and Qualifying Accounts

(3)         Exhibits 

| 2.1(1)     |   | Merger Agreement regarding the Registrant’s  reincorporation in Delaware                                                                   |   |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 2.2(4)     |   | Share Purchase Agreement for the shares for ATMOS  Corporation                                                                                  |   |
| 3.1        |   | Not currently in use                                                                                                                            |   |
| 3.2        |   | Not currently in use                                                                                                                            |   |
| 3.3(1)     |   | Restated Certificate of Incorporation of the  Registrant                                                                                        |   |
| 3.3.1      |   | Certificate of Amendment to Restated Certificate of  Incorporation                                                                              |   |
| 3.4(1)     |   | Bylaws of the Registrant                                                                                                                        |   |
| 4.1(1)     |   | Specimen common stock certificate                                                                                                               |   |
| 4.2(1)     |   | Not currently in use                                                                                                                            |   |
| 4.3(1)     |   | Rights Agreement                                                                                                                                |   |
| 4.3.1(5)   |   | First Amendment to Rights Agreement, dated as of  February 23, 2004.                                                                       |   |
| 4.3.2(6)   |   | Second Amendment to Rights Agreement, dated as of  December 14, 2004.                                                                      |   |
| 10.1(1)    |   | Form of Indemnity Agreement between the  Registrant and each of its directors and executive officers                                       |   |
| 10.2(1)    |   | Not currently in use                                                                                                                            |   |
| 10.3(1)*   |   | 1996 Stock Plan and form of Option Agreement  thereunder*                                                                                       |   |
| 10.4(1)    |   | Form of Restricted Stock Purchase Agreement*                                                                                               |   |
| 10.5(1)    |   | 2000 Employee Stock Option Plan and form of Option  Agreement thereunder*                                                                       |   |
| 10.5.1(7)  |   | Amended and Restated 2000 Equity Incentive and Stock  Option Plan*                                                                              |   |
| 10.6(1)    |   | 2000 Employee Stock Purchase Plan and form of  Subscription Agreement thereunder*                                                               |   |
| 10.13(8)*  |   | Employment offer letter agreement and Mutual  Agreement to Arbitrate between the Registrant and Chester J. Silvestri dated July 21,  2005* |
| 10.14(8)*  |   | Change-in-Control Agreement between the Registrant  and Chester J. Silvestri dated as of July 21, 2005*                                    |
| 10.15(8)*  |   | Form of Stock Option Agreement pursuant to  Amended and Restated 2000 Stock Option and Equity Incentive Plan*                              |
| 10.16(9)   |   | Lease Agreement between Registrant and Sunnyvale  Mathilda Investors, LLC dated as of May 6, 2005                                          |
| 10.17(10)* |   | Employment offer letter agreement between the  Registrant and Dhaval Ajmera dated October 3, 2005*                                         |
|            |        |                                                                                                                                                 |        |  |  |

44

----

 

| 10.18(11)* |   | Employment Agreement between Registrant and James R.  Pekarsky dated as of March 7, 2006 and March 20, 2006*                           |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.19(11)* |   | Indemnity Agreement Registrant and James R. Pekarsky  dated as of March 20, 2006*                                                           |
| 10.20(11)* |   | Change-in-control Agreement between Registrant and  James R. Pekarsky dated as of March 20, 2006*                                           |
| 10.21(11)* |   | Stock Option Incentive Grant Agreement for Stock  Option Grant pursuant to the Amended and Restated 2000 Stock Option and  Equity Incentive Plan |
| 10.22*     |   | Employment offer letter agreement between the  Registrant and Raj Singh dated October 6, 2006*                                              |
| 10.23*     |   | Change-in-control Agreement between Registrant and  Raj Singh dated as of October 6, 2006*                                                  |
| 21.1       |   | List of subsidiaries                                                                                                                             |
| 23.1       |   | Consent of Independent Registered Public Accounting  Firm—BDO Seidman LLP                                                                   |
| 23.2       |   | Consent of Independent Registered Public Accounting  Firm—Ernst & Young LLP                                                        |
| 24.1(3)    |   | Power of Attorney                                                                                                                                |
| 31.1       |   | Rule 13a-14 certification                                                                                                                   |
| 31.2       |   | Rule 13a-14 certification                                                                                                                   |
| 32         |   | Section 1350 certification                                                                                                                  |

----

(1)          Incorporated byreference to the same-numbered exhibit to the Company’s Registration Statementon Form S-1, as amended, originally filed August 4, 2000,declared effective June 27, 2001 (Commission file No. 333-43122).

(2)          Portions of this exhibithave been omitted pursuant to Order Granting Confidential Treatment Under theSecurities Act of 1933 dated June 27, 2001 (Commission File No. 333-43122—CF#10183).

(3)          Set forth on page 46of this report.

(4)          Incorporated byreference to the same-numbered exhibit to the Company’s report on Form 8-K/Afiled on November 13, 2002.

(5)          Incorporated byreference to Exhibit 1 to Form 8-A/A filed by the Company on December 22,2004 (Commission File No. 000-32929).

(6)          Incorporated byreference to Exhibit 4.01 to Form 8-K filed by the Company on December 20,2004 (Commission File No. 000-32929).

(7)          Incorporated byreference to the Company’s proxy statement on Schedule 14A filed by the Companyon October 7, 2004 (Commission File No. 000-32929).

(8)          Incorporated byreference to the same-numbered exhibit to Form 10-Q filed by theCompany on August 9, 2005 (Commission File No. 000-32925).

(9)          Incorporated byreference to the same-numbered exhibit to Form 10-K filed by theCompany on March 16, 2005 (Commission File No. 000-32929).

(10) Incorporated by reference to the same-numbered exhibit to Form 10-Kfiled by the Company on March 16, 2005 (Commission File No. 000-32929).

(11) Incorporated by reference to the same-numbered exhibit to Form 10-Qfiled by the Company on May 9, 2006 (Commission File No. 000-32929).

*                    Managementcontract, compensatory plan or arrangement.

45

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**SIGNATURES**

Pursuant to therequirements of the Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, on the 13th day of March 2007.

|        | MOSYS, INC. |
|--------|-------------|
|   | By:         | /s/ CHESTER J. SILVESTRI |
|   |        | Chester J. Silvestri |
|   |        | Chief Executive Officer  and President |
|   | By:         | /s/ JAMES R. PEKARSKY |
|   |        | James R. Pekarsky |
|   |        | Vice President of  Finance and Administration and |
|   |        | Chief Financial Officer |

 

**POWEROF ATTORNEY**

KNOW ALL MEN BY THESEPRESENTS, that each person whose signature appears below constitutes andappoints Chester J. Silvestri and James R. Pekarsky as his true and lawfulattorney-in-fact and agents, with full power of substitution andresubstitution, for him and in his name, place and stead, in any and allcapacities, to sign any and all amendments to this Report on Form 10-K,and to file the same, with all exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange Commission, grantingunto said attorney-in-fact and agents full power and authority to do andperform each and every act and thing requisite and necessary to be done inconnection therewith, as fully to all intents and purposes as he might or coulddo in person, hereby ratifying and confirming all that said attorney-in-factand agents, or his substitute or substitutes, may lawfully do or cause to bedone by virtue hereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

| Signature                | ** ** | ** **                                         | ** ** | ** **          | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------------------------|------------|----------------------------------------------------|------------|---------------------|-----------|------------|------------|------------|----------|------------|
| /s/ CHESTER J. SILVESTRI |       | Chief Executive  Officer, President and Director   |       | March 13, 2007 |
| Chester J.  Silvestri    |       |                                               |       |                |
| /s/ JAMES R. PEKARSKY    |       | Vice President of  Finance and Administration and  |       | March 13, 2007 |
| James R. Pekarsky        |       | Chief Financial  Officer                           |       |                |
| /s/ WINGYU LEUNG         |       | Executive Vice  President, Chief Technical Officer |       | March 13, 2007 |
| Wingyu Leung             |       | and Director                                       |       |                |
| /s/ CARL E. BERG         |       | Director                                           |       | March 13, 2007 |
| Carl E. Berg             |       |                                               |       |                |
| /s/ TOMMY ENG            |       | Director                                           |       | March 13, 2007 |
| Tommy Eng                |       |                                               |       |                |
| /s/ CHI-PING HSU         |       | Director                                           |       | March 13, 2007 |
| Chi-Ping Hsu             |       |                                               |       |                |
| /s/ JAMES D. KUPEC       |       | Director                                           |       | March 13, 2007 |
| James D. Kupec           |       |                                               |       |                |
| /s/ CHENMING HU          |       | Director                                           |       | March 13, 2007 |
| Chenming Hu              |       |                                               |       |                |

 

46

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**INDEX OF EXHIBITS**

| 2.1(1)     |   | Merger Agreement  regarding the Registrant’s reincorporation in Delaware                                                                     |
|------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.2(4)     |   | Share Purchase  Agreement for the shares for ATMOS Corporation                                                                                    |
| 3.1        |   | Not currently in  use                                                                                                                             |
| 3.2        |   | Not currently in  use                                                                                                                             |
| 3.3(1)     |   | Restated  Certificate of Incorporation of the Registrant                                                                                          |
| 3.3.1      |   | Certificate of  Amendment to Restricted Certificate of Incorporation                                                                              |
| 3.4(1)     |   | Bylaws of the  Registrant                                                                                                                         |
| 4.1(1)     |   | Specimen common  stock certificate                                                                                                                |
| 4.2(1)     |   | Not currently in  use                                                                                                                             |
| 4.3(1)     |   | Rights Agreement                                                                                                                                  |
| 4.3.1(5)   |   | First Amendment  to Rights Agreement, dated as of February 23, 2004.                                                                         |
| 4.3.2(6)   |   | Second Amendment  to Rights Agreement, dated as of December 14, 2004.                                                                        |
| 10.1(1)    |   | Form of  Indemnity Agreement between the Registrant and each of its directors and  executive officers                                        |
| 10.2(1)    |   | Not currently in  use                                                                                                                             |
| 10.3(1)*   |   | 1996 Stock Plan  and form of Option Agreement thereunder*                                                                                         |
| 10.4(1)    |   | Form of  Restricted Stock Purchase Agreement                                                                                                 |
| 10.5(1)    |   | 2000 Employee  Stock Option Plan and form of Option Agreement thereunder                                                                          |
| 10.5.1(7)  |   | Amended and  Restated 2000 Equity Incentive and Stock Option Plan                                                                                 |
| 10.6(1)    |   | 2000 Employee  Stock Purchase Plan and form of Subscription Agreement thereunder                                                                  |
| 10.13(8)*  |   | Employment offer  letter agreement and Mutual Agreement to Arbitrate between the Registrant and  Chester J. Silvestri dated July 21, 2005*   |
| 10.14(8)*  |   | Change-in-Control  Agreement between the Registrant and Chester J. Silvestri dated as of  July 21, 2005*                                     |
| 10.15(8)*  |   | Form of  Stock Option Agreement pursuant to Amended and Restated 2000 Stock Option and  Equity Incentive Plan*                               |
| 10.16(9)   |   | Lease Agreement  between Registrant and Sunnyvale Mathilda Investors, LLC dated as of  May 6, 2005                                           |
| 10.17(10)* |   | Employment offer  letter agreement between the Registrant and Dhaval Ajmera dated  October 3, 2005*                                          |
| 10.18(11)* |   | Employment  Agreement between Registrant and James R. Pekarsky dated as of March 7,  2006 and March 20, 2006*                           |
| 10.19(11)* |   | Indemnity  Agreement Registrant and James R. Pekarsky dated as of March 20, 2006*                                                            |
| 10.20(11)* |   | Change-in-control  Agreement between Registrant and James R. Pekarsky dated as of March 20,  2006*                                           |
| 10.21(11)* |   | Stock Option  Incentive Grant Agreement for Stock Option Grant pursuant to the Amended and  Restated 2000 Stock Option and Equity Incentive Plan* |
| 10.22*     |   | Employment offer  letter agreement between the Registrant and Raj Singh dated October 6,  2006*                                              |
| 10.23*     |   | Change-in-control  Agreement between Registrant and Raj Singh dated as of October 6, 2006*                                                   |
| 21.1       |   | List of  subsidiaries                                                                                                                             |
| 23.1       |   | Consent of  Independent Registered Public Accounting Firm-BDO Seidman LLP                                                                         |
| 23.2       |   | Consent of  Independent Registered Public Accounting Firm-Ernst & Young LLP                                                              |
| 24.1(3)    |   | Power of Attorney                                                                                                                                 |
| 31.1       |   | Rule 13a-14  certification                                                                                                                   |
| 31.2       |   | Rule 13a-14  certification                                                                                                                   |
| 32         |   | Section 1350  certification                                                                                                                  |

 

47

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----

(1)   Incorporatedby reference to the same-numbered exhibit to the Company’s RegistrationStatement on Form S-1, as amended, originally filed August 4,2000, declared effective June 27, 2001 (Commission file No. 333-43122).

(2)   Portions ofthis exhibit have been omitted pursuant to Order Granting ConfidentialTreatment Under the Securities Act of 1933 dated June 27, 2001 (CommissionFile No. 333-43122—CF#10183).

(3)   Set forthon page 46 of this report.

(4)   Incorporatedby reference to the same-numbered exhibit to the Company’s report on Form 8-K/Afiled on November 13, 2002.

(5)   Incorporatedby reference to Exhibit 1 to Form 8-A/A filed by the Company onDecember 22, 2004 (Commission File No. 000-32929).

(6)   Incorporatedby reference to Exhibit 4.01 to Form 8-K filed by the Companyon December 20, 2004 (Commission File No. 000-32929).

(7)   Incorporatedby reference to the Company’s proxy statement on Schedule 14A filed by theCompany on October 7, 2004 (Commission File No. 000-32929).

(8)   Incorporatedby reference to the same-numbered exhibit to Form 10-Q filed by theCompany on August 9, 2005 (Commission File No. 000-32925).

(9)   Incorporatedby reference to the same-numbered exhibit to Form 10-K filed by theCompany on March 16, 2005 (Commission File No. 000-32929).

 (10) Incorporated by reference to the same-numberedexhibit to Form 10-K filed by the Company on March 16, 2005(Commission File No. 000-32929).

(11) Incorporated by reference to the same-numbered exhibit to Form 10-Qfiled by the Company on May 9, 2006 (Commission File No. 000-32929).

*                    Managementcontract, compensatory plan or arrangement.

48

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**MOSYS, INC.INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

| Reports of Independent  Registered Public Accounting Firm—BDO Seidman LLP           |   | 50 |
|------------------------------------------------------------------------------------------|--------|----|
| Report  of Independent Registered Public Accounting Firm—Ernst & Young LLP |   | 52 |
| Consolidated  Balance Sheets                                                             |   | 53 |
| Consolidated  Statements of Operations                                                   |   | 54 |
| Consolidated  Statements of Stockholders’ Equity                                    |   | 55 |
| Consolidated  Statements of Cash Flows                                                   |   | 56 |
| Notes to  Consolidated Financial Statements                                              |   | 57 |
| Schedule II: Valuation and Qualifying Accounts                                           |   | 78 |

 

49

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**ReportofIndependent Registered Public Accounting Firm**

Board of Directors and StockholdersMoSys, Inc.Sunnyvale, California

We have audited the accompanying consolidated balancesheets of MoSys, Inc. as of December 31, 2006 and 2005 and therelated consolidated statements of operations, stockholders’ equity, and cashflows for the years then ended. These financial statements are theresponsibility of the MoSys’ management. We have also audited Schedule II—Valuationand Qualifying Accounts as of and for the years ended December 31, 2006and 2005. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of MoSys at December 31, 2006 and 2005, and the results of itsoperations and its cash flows for the years then ended, in conformity withaccounting principles generally accepted in the United States of America. Also,in our opinion, Schedule II—Valuation and Qualifying Accounts presents fairly,in all material respects, the information set forth therein as of and for theyears ended December 31, 2006 and 2005.

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of MoSys’ internal control over financial reporting as of December 31,2006, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO) and our report dated March 12, 2007 expressed an unqualifiedopinion thereon.

As discussed in Note 1 tothe consolidated financial statements, effective January 1, 2006, theCompany adopted the provisions of Statement of Financial Accounting Standards(SFAS) No. 123 (revised 2004), “Share-Based Payment”, (SFAS 123(R)).

/s/ BDO Seidman, LLP

San Francisco, CaliforniaMarch 12, 2007

50

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**Reportof Independent Registered Public Accounting Firm on InternalControl over Financial Reporting**

Boardof Directors and StockholdersMoSys, Inc.Sunnyvale, California

Wehave audited management’s assessment, included in the accompanying ManagementReport on Internal Control over Financial Reporting, that MoSys, Inc.maintained effective internal control over financial reporting as of December 31,2006, based on criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (the COSO criteria)”. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company aremade only in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Inour opinion, management’s assessment that MoSys maintained effective internalcontrol over financial reporting as of December 31, 2006, is fairlystated, in all material respects, based on the COSO criteria. Also in ouropinion, MoSys maintained, in all material respects, effective internal controlover financial reporting as of December 31, 2006, based on the COSOcriteria.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets as of December 31, 2006 and 2005 and therelated consolidated statements of operations, stockholders’ equity, and cashflows for the years then ended, and the 2006 and 2005 financial statementschedule listed in the accompanying index, of MoSys and our report dated March 12,2007, expressed an unqualified opinion thereon.

/s/ BDO Seidman, LLP

San Francisco, CaliforniaMarch 12, 2007

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**Reportof Independent Registered Public AccountingFirm**

The Board of Directors and Stockholders ofMoSys, Inc.

We have audited the accompanying consolidatedstatements of operations, stockholders’ equity, and cash flows of MoSys, Inc.for the year ended December 31, 2004. Our audits also included thefinancial statement schedule listed in the Index at Item 15(a)(2) for theyear ended December 31, 2004. These financial statements and schedule arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements and schedule based on ouraudit.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audits to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated results of their operations and their cashflows for the year ended December 31, 2004, in conformity with U.S.generally accepted accounting principles. Also, in our opinion, the related financialstatement schedule for the year ended December 31, 2004, when consideredin relation to the basic financial statements taken as a whole, presents fairlyin all material respects the information set forth therein.

|                      |   | */s/  Ernst &  Young LLP* |
|----------------------|--------|----------------------------------------------|
| San Jose, California |   |                                         |
| March 15, 2005  |   |                                         |

 

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**MOSYS, INC.CONSOLIDATED BALANCE SHEETS(In thousands, except per share data)**

| ** **                                                                                                                                                              | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                              | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                              |       |                  |       |   |   |
| Current assets:                                                                                                                                                         |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                               |       | $                     | 11,118     |   | $ | 9,171 |   |
| Short-term investments and auction rate securities                                                                                                                      |       | 70,689                |       | 59,479 |   |
| Accounts receivable, net                                                                                                                                                |       | 2,491                 |       | 638 |   |
| Unbilled contract receivable                                                                                                                                            |       | 360                   |       | 368 |   |
| Prepaid expenses and other current assets                                                                                                                               |       | 2,831                 |       | 2,632 |   |
| Total current assets                                                                                                                                                    |       | 87,489                |       | 72,288 |   |
| Long-term  investments                                                                                                                                                  |       | 2,492                 |       | 17,339 |   |
| Property and  equipment, net                                                                                                                                            |       | 855                   |       | 1,121 |   |
| Goodwill                                                                                                                                                                |       | 12,326                |       | 12,326 |   |
| Other assets                                                                                                                                                            |       | 598                   |       | 563 |   |
| Total assets                                                                                                                                                            |       | $                     | 103,760    |   | $ | 103,637 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                          | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                                                    |       |                  |       |   |   |
| Accounts payable                                                                                                                                                        |       | $                     | 307        |   | $ | 236 |   |
| Accrued expenses and other liabilities                                                                                                                                  |       | 1,865                 |       | 2,564 |   |
| Deferred revenue                                                                                                                                                        |       | 619                   |       | 1,309 |   |
| Total current liabilities                                                                                                                                               |       | 2,791                 |       | 4,109 |   |
| Long-term portion  of restructuring liability                                                                                                                           |       | 54                    |       | 196 |   |
| Total liabilities                                                                                                                                                       |       | 2,845                 |       | 4,305 |   |
| Commitment and  contingencies                                                                                                                                           |       |                  |       |   |   |
| Stockholders’  equity:                                                                                                                                             |       |                  |       |   |   |
| Preferred stock, $0.01 par value; 20,000 shares  authorized; none issued and outstanding at December 31, 2006 and  December 31, 2005                          |       | —                |       | — |   |
| Common stock, $0.01 par value; 120,000 shares  authorized; 31,638 shares and 30,768 shares issued and outstanding at  December 31, 2006 and December 31 2005, |       | 316                   |       | 308 |   |
| Additional paid-in capital                                                                                                                                              |       | 106,850               |       | 100,280 |   |
| Deferred stock-based compensation                                                                                                                                       |       | —                |       | (33 | ) |
| Accumulated other comprehensive loss                                                                                                                                    |       | (79                   | )          | (389 | ) |
| Retained deficit                                                                                                                                                        |       | (6,172                | )          | (834 | ) |
| Total stockholders’ equity                                                                                                                                         |       | 100,915               |       | 99,332 |   |
| Total liabilities  and stockholders’ equity                                                                                                                        |       | $                     | 103,760    |   | $ | 103,637 |   |

 

The accompanying notes are an integral part of these financial statements.

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**MOSYS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)**

| ** **                                                                                             | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenue:                                                                                           |       |                                       |       |   |   |   |   |
| Product                                                                                                |       | $                                          | —     |   | $ | 10 |   | $ | 952 |   |
| Licensing                                                                                              |       | 9,096                                      |       | 7,725 |   | 4,544 |   |
| Royalty                                                                                                |       | 5,813                                      |       | 4,547 |   | 5,325 |   |
| Total net revenue                                                                                      |       | 14,909                                     |       | 12,282 |   | 10,821 |   |
| Cost of net  revenue                                                                                   |       |                                       |       |   |   |   |   |
| Product                                                                                                |       | —                                     |       | — |   | 655 |   |
| Licensing                                                                                              |       | 1,498                                      |       | 1,986 |   | 1,613 |   |
| Total cost of net revenue                                                                              |       | 1,498                                      |       | 1,986 |   | 2,268 |   |
| Gross profit                                                                                           |       | 13,411                                     |       | 10,296 |   | 8,553 |   |
| Operating  expenses:                                                                                   |       |                                       |       |   |   |   |   |
| Research and development                                                                               |       | 8,156                                      |       | 5,839 |   | 8,096 |   |
| Selling, general and administrative                                                                    |       | 11,370                                     |       | 9,922 |   | 13,331 |   |
| Litigation settlement                                                                                  |       | 2,400                                      |       | — |   | — |   |
| Restructuring expenses                                                                                 |       | —                                     |       | 119 |   | 585 |   |
| Total operating expenses                                                                               |       | 21,926                                     |       | 15,880 |   | 22,012 |   |
| Loss from operations                                                                                   |       | (8,515                                     | )          | (5,584 | ) | (13,459 | ) |
| Interest and  other income                                                                             |       | 3,286                                      |       | 2,591 |   | 11,578 |   |
| Loss before income taxes                                                                               |       | (5,229                                     | )          | (2,993 | ) | (1,881 | ) |
| Income tax  benefit (provision)                                                                        |       | (109                                       | )          | 11 |   | (26 | ) |
| Net loss                                                                                               |       | $                                          | (5,338     | ) | $ | (2,982 | ) | $ | (1,907 | ) |
| Net loss per  share:                                                                                   |       |                                       |       |   |   |   |   |
| Basic                                                                                                  |       | $                                          | (0.17      | ) | $ | (0.10 | ) | $ | (0.06 | ) |
| Diluted                                                                                                |       | $                                          | (0.17      | ) | $ | (0.10 | ) | $ | (0.06 | ) |
| Shares used in computing  net loss per share:                                                          |       |                                       |       |   |   |   |   |
| Basic                                                                                                  |       | 31,298                                     |       | 30,534 |   | 30,750 |   |
| Diluted                                                                                                |       | 31,298                                     |       | 30,534 |   | 30,750 |   |
| Allocation of  stock-based compensation to cost of net revenue and operating expenses  included above: |       |                                       |       |   |   |   |   |
| Cost of licensing revenue                                                                              |       | $                                          | 225        |   | $ | — |   | $ | — |   |
| Research and development                                                                               |       | 993                                        |       | — |   | 44 |   |
| Selling, general and administrative                                                                    |       | 1,528                                      |       | 36 |   | 24 |   |
|                                                                                                   |       | $                                          | 2,746      |   | $ | 36 |   | $ | 68 |   |

 

The accompanying notes are an integral part of these financial statements.

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**MOSYS, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(In thousands)**

| ** **                                                                         | ** ** | ** **            | ** ** | **Additional** | ** ** | **Deferred**    | ** ** | **Other**         | ** ** | **Retained**           | ** ** | ** **    | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|---------------|------------|
| ** **                                                                         | ** ** | **Common Stock** | ** ** | **Paid-In**    | ** ** | **Stock-based** | ** ** | **Comprehensive** | ** ** | **Earnings**           | ** ** | ** **    | ** ** |
| ** **                                                                         | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Capital**     | ** ** | **Compensation**  | ** ** | **Income (Loss)** | ** ** | **(Deficit)** | ** ** | **Total** | ** ** |
| Balance at December 31, 2003                                                  |       |                  | 30,724     |           |       |            | $          | 307               |       |                   |       | $             | 99,719     |   |   |   | $ | (626 | ) |   |   | $ | 56 |   |   |   | $ | 4,055 |   |   | $ | 103,511 |   |
| Issuance of Common Stock upon exercise of options                                  |       |                  | 688        |           |       |            | 7          |              |       |                   | 3,226      |          |       |   | — |   |   |   | — |   |   |   | — |   |   | 3,233 |   |
| Issuance of Common Stock for Employee Stock Purchase  Plan                         |       |                  | 66         |           |       |            | 1          |              |       |                   | 463        |          |       |   | — |   |   |   | — |   |   |   | — |   |   | 464 |   |
| Repurchase and retirement                                                          |       |                  | (1,182     | )              |       |            | (12        | )                 |       |                   | (4,641     | )             |       |   | — |   |   |   | — |   |   |   | — |   |   | (4,653 | ) |
| Stock based compensation                                                           |       |                  | —     |           |       |            | —     |              |       |                   | (489       | )             |       |   | 557 |   |   |   | — |   |   |   | — |   |   | 68 |   |
| Other comprehensive income—unrealized loss on  available-for-sale investments |       |                  | —     |           |       |            | —     |              |       |                   | —     |          |       |   | — |   |   |   | (308 | ) |   |   | — |   |   | (308 | ) |
| Net loss                                                                           |       |                  | —     |           |       |            | —     |              |       |                   | —     |          |       |   | — |   |   |   | — |   |   |   | (1,907 | ) |   | (1,907 | ) |
| Comprehensive loss                                                                 |       |                  |       |           |       |            |       |              |       |                   |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   | (2,215 | ) |
| Balance at December 31, 2004                                                  |       |                  | 30,296     |           |       |            | $          | 303               |       |                   |       | $             | 98,278     |   |   |   | $ | (69 | ) |   |   | $ | (252 | ) |   |   | $ | 2,148 |   |   | $ | 100,408 |   |
| Issuance of Common Stock upon exercise of options                                  |       |                  | 406        |           |       |            | 4          |              |       |                   | 1,205      |          |       |   | — |   |   |   | — |   |   |   | — |   |   | 1,209 |   |
| Issuance of Common Stock for Employee Stock Purchase  Plan                         |       |                  | 66         |           |       |            | 1          |              |       |                   | 315        |          |       |   | — |   |   |   | — |   |   |   | — |   |   | 316 |   |
| Stock based compensation                                                           |       |                  | —     |           |       |            | —     |              |       |                   | —     |          |       |   | 36 |   |   |   | — |   |   |   | — |   |   | 36 |   |
| Tax benefits associated with exercise of stock  options                            |       |                  | —     |           |       |            | —     |              |       |                   | 482        |          |       |   | — |   |   |   | — |   |   |   | — |   |   | 482 |   |
| Other comprehensive income—unrealized loss on  available-for-sale investments |       |                  | —     |           |       |            | —     |              |       |                   | —     |          |       |   | — |   |   |   | (137 | ) |   |   | — |   |   | (137 |   |
| Net loss                                                                           |       |                  | —     |           |       |            | —     |              |       |                   | —     |          |       |   | — |   |   |   | — |   |   |   | (2,982 | ) |   | (2,982 | ) |
| Comprehensive loss                                                                 |       |                  |       |           |       |            |       |              |       |                   |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   | (3,119 | ) |
| Balance at December 31, 2005                                                  |       |                  | 30,768     |           |       |            | $          | 308               |       |                   |       | $             | 100,280    |   |   |   | $ | (33 | ) |   |   | $ | (389 | ) |   |   | $ | (834 | ) |   | $ | 99,332 |   |
| Issuance of Common Stock upon exercise of options                                  |       |                  | 752        |           |       |            | 8          |              |       |                   | 3,640      |          |       |   | — |   |   |   | — |   |   |   | — |   |   | 3,648 |   |
| Issuance of Common Stock for Restricted Stock Awards                               |       |                  | 74         |           |       |            | —     |              |       |                   | —     |          |       |   | — |   |   |   | — |   |   |   | — |   |   |   |   |
| Issuance of Common Stock for Employee Stock Purchase  Plan                         |       |                  | 44         |           |       |            | —     |              |       |                   | 184        |          |       |   | — |   |   |   | — |   |   |   | — |   |   | 184 |   |
| Stock-based Compensation                                                           |       |                  | —     |           |       |            | —     |              |       |                   | 2,746      |          |       |   | 33 |   |   |   | — |   |   |   | — |   |   | 2,779 |   |
| Other comprehensive income—unrealized loss on  available-for-sale investments |       |                  | —     |           |       |            | —     |              |       |                   | —     |          |       |   | — |   |   |   | 310 |   |   |   | — |   |   | 310 |   |
| Net loss                                                                           |       |                  | —     |           |       |            | —     |              |       |                   | —     |          |       |   | — |   |   |   | — |   |   |   | (5,338 | ) |   | (5,338 | ) |
| Comprehensive loss                                                                 |       |                  |       |           |       |            |       |              |       |                   |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   | (5,028 | ) |
| Balance at  December 31, 2006                                                 |       |                  | 31,638     |           |       |            | $          | 316               |       |                   |       | $             | 106,850    |   |   |   | $ | — |   |   |   | $ | (79 | ) |   |   | $ | (6,172 | ) |   | $ | 100,915 |   |

 

The accompanying notes are an integral part of these financial statements.

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**MOSYS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**

| ** **                                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Cash flows from operating  activities:**                                                 |       |                                       |       |   |   |   |   |
| Net loss                                                                                   |       | $                                          | (5,338     | ) | $ | (2,982 | ) | $ | (1,907 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                                       |       |   |   |   |   |
| Provision for doubtful accounts                                                            |       | —                                     |       | 105 |   | — |   |
| Depreciation and amortization                                                              |       | 474                                        |       | 614 |   | 1,460 |   |
| Stock based compensation                                                                   |       | 2,746                                      |       | 36 |   | 68 |   |
| Changes in  current assets and liabilities:                                                |       |                                       |       |   |   |   |   |
| Accounts receivable                                                                        |       | (1,853                                     | )          | 382 |   | (98 | ) |
| Unbilled contract receivable                                                               |       | 8                                          |       | (311 | ) | 1,049 |   |
| Inventories                                                                                |       | —                                     |       | — |   | 474 |   |
| Prepaid expenses and other assets                                                          |       | (201                                       | )          | 283 |   | 858 |   |
| Deferred revenue                                                                           |       | (690                                       | )          | 808 |   | (5 | ) |
| Accounts payable                                                                           |       | 71                                         |       | 116 |   | 4 |   |
| Accrued expenses and other liabilites                                                      |       | (756                                       | )          | (657 | ) | 391 |   |
| Restructuring liability                                                                    |       | (85                                        | )          | (136 | ) | 429 |   |
| Tax benefits associated with exercise of stock  options                                    |       | —                                     |       | 482 |   | — |   |
| Net cash provided by (used in) operating activities                                        |       | (5,624                                     | )          | (1,260 | ) | 2,723 |   |
| **Cash flows from investing  activities:**                                                 |       |                                       |       |   |   |   |   |
| Purchase of property and equipment                                                         |       | (208                                       | )          | (1,051 | ) | (349 | ) |
| Proceeds from sales and maturity of marketable  securities                                 |       | 170,041                                    |       | 225,879 |   | 469,336 |   |
| Purchase of marketable securities                                                          |       | (166,094                                   | )          | (247,636 | ) | (461,047 | ) |
| Net cash provided by (used in) investing activities                                        |       | 3,739                                      |       | (22,808 | ) | 7,940 |   |
| **Cash flows from financing  activities:**                                                 |       |                                       |       |   |   |   |   |
| Payment of capital lease obligations                                                       |       | —                                     |       | — |   | (26 | ) |
| Proceeds from issuance of common stock                                                     |       | 3,832                                      |       | 1,525 |   | 3,697 |   |
| Repurchase and retirement of common stock                                                  |       | —                                     |       | — |   | (4,653 | ) |
| Net cash provided by (used in) financing activities                                        |       | 3,832                                      |       | 1,525 |   | (982 | ) |
| Net increase  (decrease) in cash and cash equivalents                                      |       | 1,947                                      |       | (22,543 | ) | 9,681 |   |
| Cash and cash  equivalents at beginning of year                                            |       | 9,171                                      |       | 31,714 |   | 22,033 |   |
| Cash and cash  equivalents at end of year                                                  |       | $                                          | 11,118     |   | $ | 9,171 |   | $ | 31,714 |   |
| **Supplemental  disclosure:**                                                              |       |                                       |       |   |   |   |   |
| Cash paid for income taxes                                                                 |       | $                                          | 42         |   | $ | 29 |   | $ | 24 |   |
| Stock based  compensation included in prepaid expenses and other assets                    |       | $                                          | 33         |   | $ | — |   | $ | — |   |

 

The accompanying notes are an integral part of these financial statements.

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**MOSYS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**Note 1: TheCompany and Summary of Significant Accounting Policies**

***The Company***

MoSys, Inc. (the “Company”) was incorporated inCalifornia on September 16, 1991 to design, develop and market high performancesemiconductor memory products and technologies used by the semiconductorindustry and electronic product manufacturers. On September 12, 2000, thestockholders approved the Company’s reincorporation in Delaware.

The Company has developedan innovative embedded-memory technology, called 1T-SRAM, which theCompany licenses on a non-exclusive and worldwide basis to semiconductorcompanies and electronic product manufacturers. From its inception in 1991through 1998, the Company focused primarily on the sale of stand-alonememory products. In the fourth quarter of 1998, the Company changed theemphasis of its business model to focus primarily on the licensing of its1T-SRAM technologies and completed this transition in 2002 when a majority ofthe Company’s revenues were derived from licensing and royalty of its 1T-SRAMtechnologies. In the second quarter of 2004, the Company notified its customersof its decision to discontinue sales of its memory chip products and onlylicense its technology.

***Basis of Presentation***

The consolidated financialstatements include the accounts of the Company and its wholly-ownedsubsidiaries. All intercompany transactions and balances have been eliminatedin consolidation. The Company reports financial results on a calendar fiscalyear. Certain amounts reported in previous years have been reclassed to conformthe 2006 presentation.

***Use of Estimates***

The preparation offinancial statements in accordance with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues under the percentage ofcompletion and expenses during the reported period. Actual results could differfrom those estimates.

***Foreign Currency Translation***

The Company has foreignoffices located in Korea and Japan, which are operated by subsidiaries of theCompany. The functional currency of the Company’s foreign entities is the U.S.dollar. Accordingly, the financial statements of these entities are remeasuredinto U.S. dollars in accordance with Statement of Financial AccountingStandards No. 52, “Foreign Currency Translation.” Exchange gains or lossesfrom remeasurement of monetary assets and liabilities that are not denominatedin U.S. dollar were not material for any period presented and are included inthe consolidated statements of operations.

***Cash Equivalents, Short-term and Long-term Investments***

The Company accounts for investments in accordancewith Statement of Financial Accounting Standards No. 115 “Accounting forCertain Investments in Debt and Equity Securities”. Management determines theappropriate classification of debt securities at the time of purchase. Allsecurities are classified as available-for-sale. The Company’s short-term andlong-term investments are carried at fair value, based on quoted market prices,with the unrealized holding gains and losses reported in 

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stockholders’ equity. TheCompany evaluates declines in market value for potential impairment if thedecline results in a value below cost and is determined to be other thantemporary. Realized gains and losses and declines in the value judged to beother-than-temporary are included in interest income. The cost of securitiessold is based on the specific identification method.

The Company invests itsexcess cash in money market accounts and debt instruments and considers allhighly liquid debt instruments purchased with an original maturity of threemonths or less to be cash equivalents. Investments with original maturitiesgreater than three months and remaining maturities less than one year areclassified as short-term investments. Investments with remaining maturitiesgreater than one year are classified as long-term investments.

***Allowance for Doubtful Accounts***

The Company determines itsallowance for doubtful accounts to ensure that its trade receivables balancesare not overstated due to uncollectibility. The Company performs ongoingcustomer credit evaluations within the context of the industry in which itoperates. A specific allowance of up to 100% of the invoice value will beprovided for any problematic customer balances. Delinquent account balances arewritten off after management has determined that the likelihood of collectionis not possible. There was no balance of allowance for doubtful accounts in2006. As of December 31, 2005, the Company reported a balance of $105,000in its allowance for doubtful accounts.

***Unbilled Contract Receivable***

Under the percentage ofcompletion method, if the amount of revenue recognized exceeds the amount ofbillings to a customer; the excess amount is carried as an unbilled contractreceivable. The Company has recorded $360,000 and $368,000 of unbilled contractreceivable as of December 31, 2006 and 2005, respectively.

***Property and Equipment***

Property and equipment are stated at cost.Depreciation is generally computed using the straight-line method over theestimated useful lives of the assets, generally three years. In 2005, theCompany wrote off approximately $9.4 million of fully depreciated assets.Depreciation and amortization expense for the years ended December 31,2006, 2005, and 2004 was $474,000, $614,000, and $1.5 million, respectively.

| ** **                        | ** ** | **December 31,**   | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(in thousands)** | ** ** |
| **Property  and equipment:**      |       |                    |       |   |   |
| Equipment, furniture and fixtures |       | $                       | 1,468      |   | $ | 1,364 |   |
| Acquired software                 |       | 935                     |       | 836 |   |
|                              |       | 2,403                   |       | 2,200 |   |
| Less: Accumulated depreciation    |       | (1,548                  | )          | (1,079 | ) |
|                              |       | $                       | 855        |   | $ | 1,121 |   |

 

***Valuation of Long-lived Assets***

Long-lived assets, such asproperty, plant and equipment, are evaluated for impairment whenever events orchanges in circumstances indicate the carrying value of an asset may not berecoverable. An impairment loss is recognized when estimated undiscountedfuture cash flows expected to result from the use of the asset plus netproceeds expected from disposition of the asset (if any) are less than thecarrying value of the asset. When impairment is identified, the carrying amountof the asset is reduced to its estimated fair value.

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***Goodwill***

The Company reviewsgoodwill, recorded from the acquisition of ATMOS Corp. on August 2002, forimpairment annually and whenever events or changes in circumstances indicatethe carrying value of an asset may not be recoverable in accordance with theStatement of Financial Accounting Standards (SFAS) No. 142, “Goodwill andOther Intangible Assets.”  The provisionsof SFAS No. 142 require that a two-step impairment test be performed ongoodwill. In the first step, the Company compares the fair value of eachreporting unit to its carrying value. Subsequent to the acquisition of ATMOS,its business became an integrated part of the Company’s operations. In 2004,the Company closed the operation of ATMOS at its Canadian research anddevelopment facility. Using the guidance in SFAS No. 142, the Companydetermined that it has only one reporting unit at the entity level. For stepone, the Company determines the fair value of its reporting unit using themarket approach. Under the market approach, the Company estimates the fairvalue based on the market value of the reporting unit at the entity level. Ifthe fair value of the reporting unit exceeds the carrying value of net assetsto the reporting unit, goodwill is not impaired and the Company is not requiredto perform further testing. If the carrying value of the net assets to thereporting unit exceeds the fair value of the reporting unit, then the Companymust perform the second step in order to determine the implied fair value ofthe reporting unit’s goodwill and compare it to the carrying value of thereporting unit’s goodwill. If the carrying value of a reporting unit’s goodwillexceeds its implied fair value, then the Company must record an impairment lossequal to the difference. The Company performs its annual impairment test duringthe third quarter of each year and at times impairment indicators are noted.The Company performed the annual impairment test during the third quarter of2006 and the test did not indicate impairment of goodwill as of September 30,2006. As of December 31, 2006, the Company found no indicators ofpotential impairment.

***Revenue Recognition***

*Licensing*

Licensing revenue consists of fees earned fortechnology license agreements, engineering development and engineering supportservices. For the license agreements that do not require significantdevelopment, modification or customization, revenues are generally recognizedwhen there is persuasive evidence of an arrangement, fees are fixed ordeterminable, delivery has occurred and collectibility is probable. If any ofthese criteria are not met, revenues are deferred until such time as allcriteria have been met. For those license agreements where  a license is granted and no otherdeliverables are required, revenues are recognized when there is persuasiveevidence of an arrangement, fees are fixed or determinable and collectibilityis probable.

For those contracts requiring the Company to develop adesign that meets a licensee’s specifications, the Company applies SOP 81-1“Accounting for Performance of Construction-Type and Certain Production-TypeContracts”. In accordance with SOP 81-1, when license agreements includedeliverables that require “significant production, modification orcustomization”, contract accounting is applied. When the Company hassignificant experience in meeting the design specification involved in thecontract and the direct labor hours related to services under the contract canbe reasonably estimated, the Company recognizes revenue over the period inwhich the contract services are performed. For these arrangements, the Companyrecognizes revenue using the percentage of completion method. The direct laborhours for the development of the licensee’s design are estimated at thebeginning of the contract. As these direct labor hours are incurred, they areused as a measure of progress towards completion. The Company has the abilityto reasonably estimate the direct labor hours on a contract-by-contract basisbased on its experience in developing prior licensees’ designs. The Companyperiodically evaluates the actual status of each project to ensure that theestimates to complete each contract remain accurate and updates its estimatedcosts to complete as necessary. Under the percentage of completion method,provisions for estimated losses on uncompleted contracts are recognized in theperiod in which the likelihood of such 

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losses is determined.Revenue recognized in any period is dependent on the Company’s progress towardcompletion of projects in progress. Significant management judgment anddiscretion are used to estimate total direct labor hours. Any changes in ordeviation from these estimates could have a material effect on the amount ofrevenue the Company recognizes in any period. If inherent risks make estimatesdoubtful, the contract is accounted for under the completed contract method.

For contracts involving design specifications that theCompany has not previously met, the Company defers the recognition of allrevenue until the design meets the contractual design specifications andexpenses the cost of revenue as incurred. When the Company has experience inmeeting design specifications but does not have significant experience toreasonably estimate the cost of services to meet a design specification, theCompany defers both the recognition of revenue and the cost. For thesearrangements, the Company recognizes revenue using the completed contractmethod. In 2006 and 2005, none of the Company’s license revenue was recognizedunder the completed contract method.

The Company also provides support and maintenance.Under these arrangements, the Company provides unspecified upgrades, design rule changesand technical support. No other upgrades, products or other post-contractsupport are provided. When the Company provides a combination of servicesrelated to licensing and support and maintenance to customers, in addition tothe considerations noted above, the Company evaluates the arrangements underEITF 00-21, “Revenue Arrangements with Multiple Deliverables” todetermine if objective and reliable evidence exists for the undeliveredelements. Currently, the Company believes it has established vendor specificobjective evidence, or VSOE, for its support and maintenance arrangements.These arrangements are renewable annually by the customer. Support andmaintenance revenue is recognized at its fair value ratably over the periodduring which the obligation exists, typically 12 months.

From time to time, alicensee may cancel a project during the development phase. Such a cancellationis not within the Company’s control and is often caused by changes in marketconditions or the licensee’s business. Cancellations of this nature are anaspect of the Company’s licensing business, and, in general license contractssigned since the beginning of 2002 allow the Company to retain all paymentsthat the Company has received or is entitled to collect for items and servicesprovided before the cancellation occurs. Typically under the Company’s licenseagreements, the licensee is obligated to complete the project within a statedtimeframe, including assisting the Company in completing the final milestone,and if the Company performs the contracted services, is obligated to pay thelicense fees even if the licensee fails to complete verification or cancels theproject prior to completion. For accounting purposes the Company will considera project to have been canceled even in the absence of specific notice from itslicensee, if there has been no activity under the contract for six months orlonger, and the Company believes that completion of the contract is unlikely.In this event, the Company recognizes revenue in the amount of cash received,if the Company has performed a sufficient portion of the development services.If a cancelled contract had been entered into before the establishment oftechnological feasibility, the costs associated with the contract would havebeen expensed prior to the recognition of revenue. In that case, there would beno costs associated with that revenue recognition, and gross margin wouldincrease for the corresponding period. The Company recognized $225,000 and$240,000 of licensing revenue from cancelled contracts in 2006 and 2005,respectively.

*Royalty*

Licensing contracts alsoprovide for royalty payments at a stated rate based on actual units producedand require licensees to report the manufacture or sale of products thatinclude the Company’s 1T-SRAM technologies after the end of the quarter inwhich the sale or manufacture occurs. The Company generally recognizesroyalties in the quarter in which the Company receives the licensee’s report.In addition, in the fourth quarter of 2006, the Company recognized royaltyrevenue in the same quarter of 2006 due to a contract amendment with acustomer, which enabled the Company to report royalty revenue one quarter 

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earlierthan the previous contract. As a result of this contract amendment, additional royaltyrevenue representing 30% of total revenue was recognized in the fourth quarterof 2006. In future quarters, the Company will continue to recognize royaltyrevenue related this amendment in the same quarter in which the units are sold.Beginning with the first quarter of 2006, the Company is recognizing two typesof prepaid royalties: pre-production royalties, which cover a fixed number offuture unit shipments and are paid in a lump sum when the Company enters intothe licensing contract, and post-production royalties, which are paid in a lumpsum after the licensee commences production of the royalty-bearing product andapplied against future unit shipments. In either case, payments from theseprepaid royalties are non-refundable. Under current contracts, pre-productionprepaid royalties are inseparable from the Company’s licensing activities.Thus, the Company includes pre-production prepaid royalties in licensingrevenue as contract services are performed. Post-production prepaid royalties,which are recognized at the time of the billing provided that no futureperformance obligations exist, are included in royalty revenue.

*Product*

Revenue from product salesis recognized upon shipment provided that persuasive evidence of a sales arrangementexists, the price is fixed or determinable, title has transferred, collectionof resulting receivables is reasonably assured, there are no customeracceptance requirements and there are no remaining significant obligations. Foreach of the periods presented, there were no formal acceptance provisions withthe Company’s end customers. During 2004, we phased out sales of ourproprietary 1T-SRAM memory chips. The Company does not expect to sell memorychips in the future.

***Cost of Revenue***

*Licensing*

Cost of licensingrevenue consists primarily of engineering costs directly related to engineeringdevelopment projects specified in agreements the Company has with licensees ofits 1T-SRAM technologies. These projects typically include customization of 1T-SRAMcircuitry to enable embedding its memory on a licensee’s integrated circuit andmay include engineering support to assist in the commencement of production ofa licensee’s products. The Company recognizes costs of licensing revenue in thefollowing manner:

•     If licensing revenue isrecognized using the percentage of completion method, the associated cost oflicensing revenue is recognized in the period in which the Company incurs theengineering costs.

•     If licensing revenue isrecognized using the completed contract method, and to the extent that theamount of engineering cost does not exceed the amount of the related licensingrevenue, this cost is deferred on a contract-by-contract basis from the timethe Company has established technological feasibility of the product to bedeveloped under the license. Technological feasibility is established when theCompany has completed all activities necessary to demonstrate that thelicensee’s product can be produced to meet the performance specifications whenincorporating its technology. Deferred costs are charged to cost of licensingrevenue when the related revenue is recognized.

•     For contracts entered intoprior to establishing technological feasibility, the Company does not deferrelated development costs, but rather expense them in the period in which theyare incurred. Consequently, upon completion of these contracts, the Companyrecognizes the related revenues without any corresponding costs.

In addition, cost oflicensing revenue includes costs related to support and maintenance services.

*Royalty*

There are no reportedcosts associated with royalty revenue.

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*Product*

Cost of product revenueconsists primarily of costs associated with the manufacture, assembly andtesting of the Company’s memory chip products by independent, third-partycontractors. There were no reported costs associated with product revenue in2005 as the products were sold from the inventory previously written off.

***Research and Development***

Engineering cost isgenerally recorded as research and development expense in the period incurred.

***Stock-based Compensation***

Prior to January 1, 2006, the Company accountedfor stock-based compensation arrangements in accordance with the provisions ofAPB No. 25 (APB 25), “Accounting for Stock Issued to Employees” andcomplied with the disclosure provisions of Statement of Financial AccountingStandard No. 123 (SFAS 123), “Accounting for Stock-Based Compensation.”

Effective January 1, 2006, the Company adoptedStatement of Financial Accounting Standards (SFAS) No. 123 (revised 2004),“Share-Based Payment*”*, (SFAS123(R)), which establishes accounting for recognizing the fair value of thestock-based payment awards. Accordingly, the expense of these awards isrecognized over the requisite service period, usually the vesting period, basedon the grant-date fair value.

The Company elected to adopt the modified prospectivetransition method as provided by SFAS 123(R). This method requires the Companyto apply the provision of SFAS 123(R) to all stock-based payment awardsafter the adoption date. In accordance with the method, the Company’sconsolidated financial statements for prior period have not been restated toreflect, and do not include, the impact of SFAS 123(R).

The adoption of SFAS123(R) had and will have a material impact on the Company’s consolidatedfinancial position and results of operations. See Note 7 for furtherinformation regarding the stock-based compensation assumptions and expenses,including pro forma disclosures for prior periods as if the Company hadrecorded stock-based compensation expense.

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*Per Share Amounts*

Basicnet income (loss) per share is computed by dividing net income (loss) for theperiod by the weighted-average number of shares of common stockoutstanding during the period. Potential common shares are composed ofincremental shares of common stock issuable upon the exercise of stock optionsor warrants. Diluted net loss per share for the years ended December 31,2006, 2005 and 2004 are the same as basic net loss per share for the sameperiod because the impact of including potential common shares isanti-dilutive. For the years ended December 31, 2006, 2005 and 2004, stockoptions to purchase 727,000, 1.4 million and 1.3 million shares with exerciseprices greater than the average market prices of common stock were excludedfrom computation of diluted net loss per share as their inclusion would beanti-dilutive. The following table sets forth the computation of basic anddiluted net income per share for the periods indicated (in thousands, exceptper share amounts):

| ** **                                    | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Numerator:                                    |       |                                       |       |   |   |   |   |
| Net loss                                      |       | $                                          | (5,338     | ) | $ | (2,982 | ) | $ | (1,907 | ) |
| Denominator:                                  |       |                                       |       |   |   |   |   |
| Shares used in  computing net loss per share: |       |                                       |       |   |   |   |   |
| Basic                                         |       | 31,298                                     |       | 30,534 |   | 30,750 |   |
| Diluted                                       |       | 31,298                                     |       | 30,534 |   | 30,750 |   |
| Net loss per share:                           |       |                                       |       |   |   |   |   |
| Basic                                         |       | $                                          | (0.17      | ) | $ | (0.10 | ) | $ | (0.06 | ) |
| Diluted                                       |       | $                                          | (0.17      | ) | $ | (0.10 | ) | $ | (0.06 | ) |

 

***Income Taxes***

The Company accounts for income taxes using the assetand liability method as prescribed by Statement of Financial AccountingStandards No. 109, “Accounting for Income Taxes” (SFAS 109). Under theasset and liability method, the expected future tax consequences of temporarydifferences between the book and tax basis of assets and liabilities are recognizedas deferred tax assets and liabilities. A valuation allowance is establishedfor any deferred tax assets for which realization is more likely than not thatall or a portion of the deferred tax assets will not be realized.

In June 2006, the Financial Accounting StandardsBoard (FASB) issued Interpretation (FIN) No. 48, “Accounting forUncertainty in Income Taxes-an interpretation of FASB Statement No. 109.”This Interpretation prescribes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return, and provides guidanceon derecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition. This Interpretation is effective forfiscal years beginning after December 15, 2006. Uponadoption, the cumulative effect of applying the recognition and measurementprovisions of FIN 48, if any, shall be reflected as an adjustment to theopening balance of retained earnings. The Company does not expect that theadoption of FIN 48 will have a material impact on its consolidated financialposition, results of operations or cash flows.

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***Comprehensive Loss***

Statementof Financial Accounting Standards No. 130, “Reporting Comprehensive Income” (SFAS No. 130) requires theCompany to display comprehensive income and its components as part of thefinancial statements. The Company’s only component of comprehensive loss isunrealized gains and losses on available for sale securities. Accumulated othercomprehensive loss as of December 31, 2006, 2005, and 2004 was ($79,000),($389,000) and ($252,000), respectively. The changes in other comprehensiveloss were as follows, for the years ended December 31, 2006, 2005, and2004:

| ** **                                                      | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                      | ** ** | **(in thousands)** | ** ** |
| Net loss                                                        |       | $                       | (5,338     | )        | $          | (2,982   | )          | $ | (1,907 | ) |
| Change in net  unrealized loss on available-for-sale securities |       | 310                     |       | (137     | )          | (308     | )          |
| Comprehensive loss                                              |       | $                       | (5,028     | )        | $          | (3,119   | )          | $ | (2,215 | ) |

 

***Segment Reporting***

Financial AccountingStandards Board Statement No. 131, “Disclosure about Segments of anEnterprise and Related Information” (SFAS 131) requires that companies reportseparately in the financial statements certain financial and descriptiveinformation about operating segment profit or loss, certain specific revenueand expense items and segment assets. The Company operates in one segment,using one measurement of profitability for its business. The Company has salesoutside the United States that are described in Note 9. The vast majorityof long-lived assets are maintained in the United States.

***Recent Accounting Pronouncements***

In June 2006, the FASB issued Interpretation No. 48,“Accounting for Uncertainty in Income Taxes” (FIN 48)—an interpretation of FASBStatement No. 109. This Interpretation prescribes a recognition thresholdand measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return,and provides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure, and transition. FIN 48 is effectivefor fiscal years beginning after December 15, 2006 and, as such, theCompany must adopt FIN 48 at January 1, 2007.

In September 2006, the FASB issued Statement ofFinancial Accounting Standards (SFAS) No. 157, “Fair Value Measurement”,(SFAS 157). SFAS 157 defines fair value, establishes a framework for measuringfair value in GAAP, and expands disclosures about fair value measurements. ThisStatement is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears. The Company is currently evaluating the impact SFAS 157 will have on itsconsolidated financial statements.

In September 2006,the SEC issued Staff Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements” (SAB 108). SAB 108 expresses the SEC Staff’s views regardingthe process of quantifying financial statement misstatements. SAB 108 addressesthe diversity in quantifying financial statement misstatements and thepotential under current practice used by the Company for the build up ofimproper amounts on the balance sheet. The guidance is applicable to theCompany for fiscal years ending after December 31, 2006.

**Note 2:Restructuring**

On November 10, 2004, the Company announced itsplan to close the ATMOS research and development facility in Canada to reduceoperating expenses and to further align the Company’s business 

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with market conditions,future revenue expectations and planned future product direction. As part ofthis plan, the Company implemented a reduction in workforce of approximately 20employees, which represented 20% of its workforce. On July 15, 2005, theCompany signed an agreement to sublease the ATMOS facility, which the Companyoccupies under long-term operating leases through 2008.

TheCompany had a total restructuring estimated lease abandonment accrual of$208,000 and $293,000 at December 31, 2006 and 2005, respectively. TheCompany reviews these estimates periodically, and if the pertinent assumptionsmaterially change, the ultimate restructuring expense for the abandonedfacilities will be adjusted in accordance with SFAS No. 146, “Accountingfor Costs Associated with Exit or Disposal Activities”. The following tablesummarizes 2006 activities under the Restructuring Plan (amounts in thousands):

| ** **                                         | ** ** | **Abandoned** | ** ** |
|----------------------------------------------------|------------|---------------|------------|
| ** **                                         | ** ** | **Space**     | ** ** |
| Restructuring  liability at December 31, 2005 |       |          | $          | 293 |   |   |
| Cash payments                                      |       |          | (100       | ) |   |
| Adjustment                                         |       |          | 15         |   |   |
| Restructuring  liability at December 31, 2006 |       |          | $          | 208 |   |   |
| Current portion                                    |       |          | $          | 154 |   |   |
| Long term portion                                  |       |          | $          | 54 |   |   |

 

**Note 3: Details of Balance Sheet Components and Consolidated Statements ofOperations**

| ** **                                     | ** ** | **December 31,**   | ** ** |
|------------------------------------------------|------------|-------------------------|------------|
| ** **                                     | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in thousands)** | ** ** |
| **Prepaid  expenses and other current costs:** |       |                    |       |   |   |
| Deferred costs of revenue                      |       | $                       | 73         |   | $ | 24 |   |
| Deferred tax assets                            |       | 1,316                   |       | 1,316 |   |
| Prepaid expenses and other assets              |       | 1,442                   |       | 1,292 |   |
|                                           |       | $                       | 2,831      |   | $ | 2,632 |   |
| **Accrued  expenses and other liabilities:**   |       |                    |       |   |   |
| Accrued wages and employee benefits            |       | $                       | 950        |   | $ | 631 |   |
| Deferred Incentive from Lessor                 |       | 216                     |       | 278 |   |
| Professional fees                              |       | 130                     |       | 432 |   |
| Deferred rent                                  |       | 67                      |       | 51 |   |
| Accrued restructuring liability                |       | 154                     |       | 97 |   |
| Income taxes payable                           |       | 77                      |       | 22 |   |
| Withholding tax payable                        |       | —                  |       | 1,052 |   |
| Other                                          |       | 271                     |       | 1 |   |
|                                           |       | $                       | 1,865      |   | $ |       2,564 |   |

 

| **Interest and other income** |   |   |   |   |   |   |   |
|-------------------------------|--------|--------|--------|--------|--------|--------|--------|

 

| ** **              | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **              | ** ** | **(in thousands)** | ** ** |
| Interest Income         |       | $                       | 3,822      |     | $          | 2,608    |       | $ | 1,527 |   |
| Other Income  (Expense) |       | (536                    | )          | (17      | )          | 10,051   |       |
| Total                   |       | $                       | 3,286      |     | $          | 2,591    |       | $ | 11,578 |   |

 

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In 2006, deferred costs ofrevenue included the stock-based compensation expense of $33,000. In 2006, theCompany recorded charges of $511,000 related to the reimbursement of Japanwithholding taxes paid by Japanese licensees on the behalf of the Company. TheCompany does not expect any additional withholding tax reimbursement in thefuture as the U.S. - Japan income taxtreaty that took effect July 1, 2004 generally eliminated withholdingtaxes on royalties. In 2004, the Company received a $10 milliontermination fee from Synopsys as a result of the settlement agreement regardingthe aborted merger.

**Note 4:  Fair Value of Financial Instruments**

Theestimated fair values of financial instruments outstanding at fiscal year-endswere as follows (in thousands):

| ** **                                                | ** ** | **2006** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|
| ** **                                                | ** ** | **Cost** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Fair  Value** | ** ** |
| Cash                                                      |       | $        | 8,520      |   |   | $ | — |   |   | $ | 8,520 |   |
| Cash equivalents:                                         |       |     |       |   |   |   |   |   |   |
| Commercial paper                                          |       | 2,600    |       |   | (2 | ) |   | 2,598 |   |
| Total cash and cash equivalents                           |       | $        | 11,120     |   |   | $ | (2 | ) |   | $ | 11,118 |   |
| Short-term  investments and auction rate securities:      |       |     |       |   |   |   |   |   |   |
| Corporate notes                                           |       | $        | 24,892     |   |   | $ | (38 | ) |   | $ | 24,854 |   |
| US government debt securities                             |       | 22,166   |       |   | (31 | ) |   | 22,135 |   |
| Market auction rate certificates                          |       | 23,700   |       |   | — |   |   | 23,700 |   |
| Total short-term investments and auction rate  securities |       | $        | 70,758     |   |   | $ | (69 | ) |   | $ | 70,689 |   |
| Long-term  investments:                                   |       |     |       |   |   |   |   |   |   |
| US government debt securities                             |       | $        | 2,500      |   |   | $ | (8 | ) |   | $ | 2,492 |   |
| Total long-term  investments                              |       | $        | 2,500      |   |   | $ | (8 | ) |   | $ | 2,492 |   |

 

| ** **                                                | ** ** | **2005** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|
| ** **                                                | ** ** | **Cost** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Fair  Value** | ** ** |
| Cash                                                      |       | $        | 8,148      |   |   | $ | — |   |   | $ | 8,148 |   |
| Cash Equivalents:                                         |       |     |       |   |   |   |   |   |   |
| Commercial and US government agencies paper               |       | 1,027    |       |   | (4 | ) |   | 1,023 |   |
| Total cash and cash equivalents                           |       | $        | 9,175      |   |   | $ | (4 | ) |   | $ | 9,171 |   |
| Short-term  investments and auction rate securities:      |       |     |       |   |   |   |   |   |   |
| Corporate notes                                           |       | $        | 12,063     |   |   | $ | (83 | ) |   | $ | 11,980 |   |
| US government debt securities                             |       | 21,490   |       |   | (141 | ) |   | 21,349 |   |
| Market auction rate certificates                          |       | 26,150   |       |   | — |   |   | 26,150 |   |
| Total short-term investments and auction rate  securities |       | $        | 59,703     |   |   | $ | (224 | ) |   | $ | 59,479 |   |
| Long-term  investments:                                   |       |     |       |   |   |   |   |   |   |
| US government debt securities                             |       | $        | 12,179     |   |   | $ | (107 | ) |   | $ | 12,072 |   |
| Corporate notes                                           |       | 5,321    |       |   | (54 | ) |   | 5,267 |   |
| Total long-term  investments                              |       | $        | 17,500     |   |   | $ | (161 | ) |   | $ | 17,339 |   |

 

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Costand fair value of cash equivalents, short-term and long-term investments basedon two maturity groups at fiscal year ends were as follows (in thousands):

| ** **        | ** ** | **2006** | ** ** |
|-------------------|------------|----------|------------|
| ** **        | ** ** | **Cost** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Fair  Value** | ** ** |
| Due within 1 year |       | $        | 73,358     |   |   | $ | (71 | ) |   | $ | 73,287 |   |
| Due 1-2 years     |       | 2,500    |       |   | (8 | ) |   | 2,492 |   |
| Total             |       | $        | 75,858     |   |   | $ | (79 | ) |   | $ | 75,779 |   |

 

| ** **        | ** ** | **2005** | ** ** |
|-------------------|------------|----------|------------|
| ** **        | ** ** | **Cost** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Fair  Value** | ** ** |
| Due within 1 year |       | $        | 60,730     |   |   | $ | (228 | ) |   | $ | 60,502 |   |
| Due 1-2 years     |       | 17,500   |       |   | (161 | ) |   | 17,339 |   |
| Total             |       | $        | 78,230     |   |   | $ | (389 | ) |   | $ | 77,840 |   |

 

Thefollowing table shows the fair value of the Company’s investments withunrealized losses that are not deemed to be other-than-temporarily impaired,aggregated by investment category and length of time that individual securitieshave been in a continuous unrealized loss position at December 31, 2006(in thousands):

| ** **                            | ** ** | **Less than 12 months** | ** ** | **12 months or greater** | ** ** | **Total**           | ** ** |
|---------------------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|---------------------|------------|
| ** **                            | ** ** | **Fair Value**                    | ** ** | **Unrealized  Losses**                  | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
| Description of  securities:           |       |                                   |       |                                    |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| US government  debt securities        |       |                                   | $          | 22,135                                  |       |                |       | $ | (31 | ) |   |   | $ | 2,492 |   |   |   | $ | (8 | ) |   |   | $ | 24,627 |   |   |   | $ | (39 | ) |   |
| Corporate notes  and commercial paper |       |                                   | 27,452     |                                    |       |                | (40        | ) |   |   | — |   |   |   | — |   |   |   | 27,452 |   |   |   | (40 | ) |   |
| Total                                 |       |                                   | $          | 49,587                                  |       |                |       | $ | (71 | ) |   |   | $ | 2,492 |   |   |   | $ | (8 | ) |   |   | $ | 52,079 |   |   |   | $ | (79 | ) |   |

** **

**U.S. Government Debt Securities.**   The Company’sinvestment in U.S. government debt securities consists of low risk governmentagency bonds typically with a rating of AAA. The unrealized losses on theCompany’s investments in U.S. government debt securities were caused byinterest rate increases during 2006. Because the Company has the ability andintent to hold these investments until a recovery of fair value, which may bematurity, the Company does not consider these investments to beother-than-temporarily impaired at December 31, 2006.

**Corporate Notes.**   The Company’sinvestment in corporate notes consists primarily of investment grade corporatebonds and notes. The unrealized losses on the Company’s investment gradecorporate bonds and notes were caused by interest rate increases during 2006.Due to the fact that the decline in market value is attributable to changes ininterest rates and not credit quality, and because the severity and duration ofthe unrealized losses were not significant, the Company considered theseunrealized losses to be temporary at December 31, 2006. Because theCompany has the ability and intent to hold these investments until a recoveryof fair value, which may be maturity, the Company does not consider theseinvestments to be other-than-temporarily impaired at December 31, 2006.

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**Note 5:  Income Taxes**

Theprovision (benefit) for income taxes consists of the following (in thousands):

| ** **       | ** ** | **Year Ended December 31,** | ** ** |
|------------------|------------|--------------------------------------------|------------|
| ** **       | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Current portion: |       |                                       |       |   |   |   |   |
| U.S. federal     |       | $                                          | —     |   | $ | — |   | $ | (904 | ) |
| State            |       | 6                                          |       | (31 | ) | 3 |   |
| Foreign          |       | 103                                        |       | 23 |   | 104 |   |
|             |       | 109                                        |       | (8 | ) | (797 | ) |
| Deferred:        |       |                                       |       |   |   |   |   |
| U.S. federal     |       | —                                     |       | (3 | ) | 823 |   |
| State            |       | —                                     |       | — |   | — |   |
| Foreign          |       | —                                     |       | — |   | — |   |
|             |       | —                                     |       | (3 | ) | 823 |   |
| Total            |       | $                                          | 109        |   | $ | (11 | ) | $ | 26 |   |

 

Deferred income taxes reflect the net tax effects oftemporary differences between the carrying amount of assets and liabilities forfinancial reporting purposes and the amounts used for income tax purposes.

Significant components of the Company’s deferred taxassets and liabilities were as follows (in thousands):

| ** **                                                     | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                     | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **Deferred tax assets (liabilities):**          |       |                  |       |   |   |
| Federal and state loss carryforwards                           |       | $                     | 4,608      |   | $ | 3,586 |   |
| Reserves, accruals and other                                   |       | 462                   |       | 490 |   |
| Depreciation and amortization                                  |       | (54                   | )          | (94 | ) |
| Deferred stock-based compensation                              |       | 686                   |       | 268 |   |
| Research and development credit carryforwards                  |       | 1,758                 |       | 1,301 |   |
| Foreign tax credits                                            |       | 1,211                 |       | 553 |   |
| Canadian loss and research and development pool  carryforwards |       | 5,106                 |       | 6,124 |   |
|                                                           |       | 13,777                |       | 12,228 |   |
| Less: Valuation  allowance                                     |       | (12,461               | )          | (10,912 | ) |
| Net deferred tax assets                                        |       | $                     | 1,316      |   | $ | 1,316 |   |

 

The valuation allowance increased by $1.5 million, and$130,000 during the years ended December 31, 2006 and 2005, respectively. Thevaluation allowance at December 31, 2006 includes $1.9 million related tostock option deductions incurred prior to January 1, 2006, the benefit ofwhich will be credited to additional paid in capital when realized.

As of December 31, 2006, the Company had netoperating loss carryforwards of approximately $13.9 million for federal incometax purposes and approximately $11.5 million for state income tax purposes.These losses are available to reduce taxable income and expire beginning 2013through 2026. Approximately $2.3 million of federal net operating losscarryforwards and $1.8 million of state net operating loss carryforwards from2006 are related to excess tax benefits from stock-based compensation and willbe charged to additional paid in capital when utilized.

The Company also had federal research and developmenttax credit carryforwards of approximately $957,000, which will expire beginningin 2021, and California research and development credits of 

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approximately $1.2million, which do not have an expiration date. The Company had foreign taxcredits available for federal income tax purposes of approximately $1.2 million,which will begin to expire in 2008. The Company had Canadian operating loss andresearch and development pool carryforwards of $13.0 million, which will beginto expire in 2008.

Utilization of the Company’s net operating loss andtax credit carryforwards may be subject to a substantial annual limitation dueto the ownership change limitations provided by the Internal Revenue Code andsimilar state provisions. Such an annual limitation could result in theexpiration or elimination of the net operating loss and tax creditcarryforwards before utilization. Management does not believe it is likely thatutilization will in fact be significantly limited due to ownership changelimitation provisions.

The Company’s U.S. income tax return for 2002 has beenexamined and is under appeal. Management believes that adequate amounts havebeen provided for any adjustments that may ultimately result from thisexamination.

Areconciliation of income taxes provided at the federal statutory rate (35% in2006, 2005 and 2004) to actual income tax expense follows (in thousands):

| ** **                                                     | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income tax  benefit computed at U.S. statutory rate            |       | $                                          | (1,830     | ) | $ | (1,048 | ) | $ | (659 | ) |
| State income tax  (net of federal benefit)                     |       | 6                                          |       | 4 |   | 3 |   |
| Foreign income  tax at rate different from U.S. statutory rate |       | 168                                        |       | 47 |   | 28 |   |
| Research &  development credits                       |       | (113                                       | )          | (96 | ) | — |   |
| Foreign tax  credit                                            |       | (433                                       | )          | — |   | — |   |
| Stock-based  compensation                                      |       | 341                                        |       | — |   | — |   |
| Valuation  allowance changes affecting tax provision           |       | 1,948                                      |       | 1,029 |   | 641 |   |
| Other                                                          |       | 22                                         |       | 53 |   | 13 |   |
| Income tax benefit  (provision)                                |       | $                                          | 109        |   | $ | (11 | ) | $ | 26 |   |

 

Thedomestic and foreign components of earnings before taxes were as follows (inthousands):

| ** ** | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| U.S.       |       | $                                          | (5,158     | ) | $ | (2,851 | ) | $ | (1,685 | ) |
| Non-U.S.   |       | (71                                        | )          | (142 | ) | (196 | ) |
|       |       | $                                          | (5,229     | ) | $ | (2,993 | ) | $ | (1,881 | ) |

 

**Note 6:Guarantees**

***Indemnifications***

In the ordinary course ofbusiness, the Company enters into contractual arrangements under which theCompany may agree to indemnify the third party to such arrangement from anylosses incurred relating to the services they perform on behalf of the Companyor for losses arising from certain events as defined within the particularcontract, which may include, for example, litigation or claims relating topatent infringement. The maximum amount of indemnification the Company could berequired to make under these agreements is generally limited to the feesreceived by the Company, although in some contracts the Company’s potentialobligation could be equal to the third parties’ actual damages and losses. TheCompany has not estimated the maximum potential amount of indemnificationliability under these agreements due to the limited history of prior claims andthe unique facts and circumstances applicable to 

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eachparticular agreement. To date, the Company has not made any payments related tothese indemnifications.

**Note 7:Stock-based Compensation**

**Equity CompensationPlans**

***Common Stock Option Plans***

In 1996, the Company adopted the 1996 Stock Plan (the “1996Plan”), which authorizes the board of directors to grant incentive stockoptions and nonqualified stock options for up to 2,500,000 shares of commonstock to employees, directors and consultants. The option terms under the 1996Plan are substantially the same as the 1992 Plan except that options grantedunder the 1996 Plan may be exercised immediately. Common stock is purchasedpursuant to the exercise of a maximum period of ten years after the date ofgrant.

The Company’s 2000 employee stock option plan (the “2000Plan”) was adopted in October 2000 in connection with the Company’sreincorporation in Delaware. In 2004, the Company obtained stockholder approvalof its Amended and Restated 2000 Stock Option and Equity Incentive Plan (the “Amended2000 Plan”) to provide additional incentive to its employees and directors. TheAmended 2000 Plan authorizes the board of directors or the compensationcommittee of the board of directors to grant a broad range of awards inaddition to stock options, including stock grants, restricted stock,performance-based awards, restricted stock units representing a right toacquire shares in the future and stock appreciation rights and to determine theapplicable terms, including price, of such awards. Under the Amended 2000 Plan,the maximum number of shares reserved for issuance is 7,207,000, plus an annualincrease of 500,000 on January 1 of each year, or a lesser amountdetermined by our board of directors. The term of options granted under theAmended 2000 Plan may not exceed ten years. The term of all incentive stockoptions granted to an optionee who, at the time of grant, owns stockrepresenting more than 10% of the voting power of all classes of the Company’sstock may not exceed five years. Generally, 25% of the options granted underthe Amended 2000 Plan will vest and become exercisable on the first anniversaryof the date of grant, and 1/48th of the options will vest and becomeexercisable each month thereafter.

The exercise price of incentive stock options granted underthe Amended 2000 Plan must be at least equal to the fair market value of theshares on the date of grant. The exercise price of nonstatutory stock optionsgranted under the Amended 2000 Plan will be determined by the board ofdirectors or the compensation committee and the exercise price of anonstatutory stock option is not subject to any price restriction under theAmended 2000 Plan. No incentive stock option may be granted to any employee whoon the date of grant owns more than 10% of the Company’s common stock, unlessthe exercise price of the option is equal to at least 110% of the fair marketvalue of such shares on the date of grant. In addition, the Amended 2000 Planprovides for automatic acceleration of vesting for options granted to non-employeedirectors in the event of an acquisition of the Company. Generally, optionsgranted under the Amended 2000 Plan after March 30, 2006 vest over afour-year period and are exercisable for a maximum period of six years afterthe date of grant.

The Company may also awardshares to new employees as a material inducement to the acceptance ofemployment with the Company, which awards are not made under the Amended 2000Plan. These grants must be approved by the compensation committee of the boardof directors, a majority of the independent directors or authorized executiveofficer, as determined under NASDAQ Marketplace Rules.

***Employee Stock Purchase Plan***

The Company’s 2000 employee stock purchase plan wasadopted in October 2000 in connection with the Company’s Delawarere-incorporation, to become effective upon the pricing date of the Company’s 

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initial public offering. Atotal of 500,000 shares of common stock have been reserved for issuance underthe purchase plan. In addition, the purchase plan provides for an automaticannual increase in the number of shares reserved under the plan on January 1of each year, equal to the lesser of 100,000 shares, one percent of the Company’soutstanding shares of common stock on such date or a lesser amount determinedby the board of directors. The purchase plan, which is intended to qualifyunder Section 423 of the Internal Revenue Code, is administered by theboard of directors or a committee appointed by the board of directors.

Employees, including officers and employee directorsbut excluding 5% stockholders, are eligible to participate if they arecustomarily employed for at least 20 hours per week and for more than fivemonths in any calendar year. The purchase plan permits eligible employees topurchase common stock through payroll deductions, which may not exceed 10% ofan employee’s compensation. Employees will be permitted to invest a maximum of$25,000 in any offering period.

The purchase plan has been implemented in a series ofoverlapping offering periods, each to be approximately 12 months induration. Offering periods begin on the first trading day on or after January 1and July 1 of each year and end on the last trading day in the periodending twelve months later. Each participant is granted an option on the firstday of the offering period, and such option will be automatically exercised atthe end of month six of the offering period and on the last day of the offeringperiod. The purchase price of the common stock under the purchase plan is equalto 85% of the lesser of the fair market value per share of common stock on thestart date of the offering period or on the date on which the option isexercised. Employees may end their participation in an offering period at anytime during that period, and participation ends automatically on termination ofemployment with the Company. The purchase plan will terminate in June 2010,unless sooner terminated by the board of directors.

Pursuant to authorizationby the compensation committee of the board of directors, the Company’s 2000Employee Stock Purchase Plan (the “ESPP”) is currently inactive.

**Stock-basedCompensation Expense**

Effective January 1, 2006, the Company adoptedSFAS 123(R). See Note 1 for a description of the adoption of SFAS123(R). As aresult of the adoption of SFAS 123(R), $2.7 million was recognized asstock-based compensation expense in 2006. The total compensation cost ofoptions granted, but not yet vested, as of December 31, 2006 was $8.1million, which is expected to be recognized as expense over a weighted averageperiod of approximately 2.72 years. Basic and diluted loss per share for theyear ended December 31, 2006 was $(0.17). The net effect on loss per share(basic and diluted) of the adoption of SFAS 123(R) for the year endedDecember 31, 2006 was $0.09.

SFAS 123(R) requires the Company to present thetax benefits resulting from tax deductions in excess of the compensation costrecognized from the exercise of stock options as financing cash flows in theStatement of Cash Flows. Such tax benefit would have been presented asoperating cash flows under SFAS 123. For the year ended December 31, 2006,there were no such tax benefits associated with the exercise of stock optionsdue to the Company’s loss position.

In November 2005, theFASB issued FASB Staff Position (FSP) No. FAS 123(R) -3, “Transition ElectionRelated to Accounting for Tax Effects of Share-Based Payment Awards” (FSP123R-3). The Company has elected toadopt the alternative transition (short-cut) method described in the FSP 123R-3 for calculating the taxeffects of stock-based compensation pursuant toSFAS 123R. The alternative transition method includes simplified methods toestablish the beginning balance of the additional paid-in capital pool (APIC pool)related to the tax effects of employee stock-based compensation and todetermine the subsequent impact on the APIC pool and Consolidated Statements ofCash Flows of the tax effects of employee stock-based compensation awards thatare outstanding upon adoption of SFAS 123R.

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**ValuationAssumptions and Expense Information under SFAS 123(R)**

Asprescribed in SFAS 123(R), the fair value of the Company’s share-based paymentawards for the year ended December 31, 2006 is estimated on the grant dateusing a Black-Scholes valuation method and an option-pricing model with thefollowing assumptions:

| ** **                           | ** ** | **Year Ended December 31,** | ** **   |
|--------------------------------------|------------|--------------------------------------------|--------------|
| **Employee stock options** | ** ** | ** **                                 | ** **   | **2006** | ** ** |
| Expected life (in  years)            |       |                                       | 4.0          |   |   |
| Risk-free  interest rate             |       |                                       | 4.4% - 5.1   | % |   |
| Volatility                           |       |                                       | 47.1% - 56.0 | % |   |
| Dividend yield                       |       |                                       | 0            | % |   |
|                                      |            |                                            |              |  |  |  |  |

 

The risk-free interest rate is derived from the DailyTreasury Yield Curve Rates as published by Department of the Treasury as of thegrant date for terms equal to the expected terms of the options. The expectedvolatility is based on the combination of historical volatility, excluding thevolatility during the period of one time non-recurring event, which was theaborted Synopsis acquisition for the Company in 2004, and the expected futurevolatility of the Company’s stock price. The expected term of options grantedis derived from historical data based on employee exercises and post-vestingemployment termination behavior. The dividend yield of zero is applied sincethe Company never paid dividends and has no intention to pay dividends in thenear future.

The stock-based compensation expense of $2.7 millionincluded compensation expense for share-based awards granted prior to, but notyet vested as of January 1, 2006 based on the grant date fair valueestimated in accordance with the pro forma provisions of SFAS 123 andcompensation expense for the share-based awards granted subsequent to January 1,2006, based on the grant date fair value estimated in accordance with theprovisions of SFAS 123(R). As required by SFAS 123(R), the stock-basedcompensation expense is calculated with the estimated forfeiture rate. Anannualized forfeiture rate of 15% is used as a best estimate of futureforfeitures based on the Company’s historical forfeiture experience. Under thetrue-up provisions of SFAS 123(R), the stock-based compensation expense will beadjusted in later periods if the actual forfeiture rate differs from theestimate.

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Asummary of the status of all the Company’s stock option grants as of December 31,2004, 2005 and 2006 and changes during the years ended on those dates arepresented below (in thousands, except exercise price):

| ** **                                 | ** ** | **Options Outstanding** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | ** **                   | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                 | ** ** | ** **                   | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                 | ** ** | **Available**                | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| ** **                                 | ** ** | **for Grant**           | ** ** | **Shares** | ** ** | **Prices** | ** ** |
| Balance at  December 31, 2003         |       |                         | 3,711      |   |   |   | 4,372 |   |   |   | $ | 7.92 |   |   |
| Additional  authorized under the 2000 Plan |       |                         | 500        |   |   |   |   |   |   |   |   |   |   |
| Granted                                    |       |                         | (3,324     | ) |   |   | 3,324 |   |   |   | $ | 4.00 |   |   |
| Cancelled                                  |       |                         | 1,251      |   |   |   | (1,251 | ) |   |   | $ | 7.62 |   |   |
| Exercised                                  |       |                         |       |   |   |   | (688 | ) |   |   | $ | 4.70 |   |   |
| Balance at  December 31, 2004         |       |                         | 2,138      |   |   |   | 5,757 |   |   |   | $ | 6.11 |   |   |
| Additional authorized  under the 2000 Plan |       |                         | 500        |   |   |   |   |   |   |   |   |   |   |
| Granted                                    |       |                         | (2,648     | ) |   |   | 2,648 |   |   |   | $ | 5.41 |   |   |
| Cancelled                                  |       |                         | 1,522      |   |   |   | (1,522 | ) |   |   | $ | 5.80 |   |   |
| Exercised                                  |       |                         |       |   |   |   | (406 | ) |   |   | $ | 2.98 |   |   |
| Balance at  December 31, 2005         |       |                         | 1,512      |   |   |   | 6,477 |   |   |   | $ | 6.09 |   |   |
| Additional  authorized under the 2000 Plan |       |                         | 500        |   |   |   |   |   |   |   |   |   |   |
| Granted                                    |       |                         | (1,547     | ) |   |   | 1,547 |   |   |   | $ | 7.51 |   |   |
| Cancelled                                  |       |                         | 1,129      |   |   |   | (1,129 | ) |   |   | $ | 7.91 |   |   |
| Exercised                                  |       |                         |       |   |   |   | (752 | ) |   |   | $ | 4.85 |   |   |
| Expired                                    |       |                         | (1,063     | ) |   |   |   |   |   |   |   |   |   |
| Inducement grant                           |       |                         | 475        |   |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2006         |       |                         | 1,006      |   |   |   | 6,143 |   |   |   | $ | 6.27 |   |   |

 

Options exercisable under the Company’s options planswere 2.6 million, 2.7 million, and 2.1 million in 2006, 2005, and 2004,respectively.

Asummary of the status of the Company’s restricted stock awards during 2006 isas follows (in thousands, except fair value):

| ** **                                   | ** ** | ** **         | ** ** | **Weighted**        | ** ** |
|----------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                   | ** ** | ** **         | ** ** | **Average**         | ** ** |
| ** **                                   | ** ** | **Number of** | ** ** | **Grant-Date**      | ** ** |
| ** **                                   | ** ** | **Shares**         | ** ** | **Fair Value** | ** ** |
| Non-vested shares  at December 31, 2005 |       |               | —     |                |       |   | $ | — |   |   |
| Granted                                      |       |               | 74         |                |       |   | $ | 5.91 |   |   |
| Vested                                       |       |               | —     |                |       |   | $ | — |   |   |
| Cancelled                                    |       |               | —     |                |       |   | $ | — |   |   |
| Non-vested shares at December 31,  2006 |       |               | 74         |                |       |   | $ | 5.91 |   |   |

 

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Thefollowing table summarizes significant ranges of outstanding and exercisableoptions as of December 31, 2006 (in thousands, except contractual life andexercise price):

| ** **                                 | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | ** **                   | ** ** | **Weighted Average**    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | ** **                   | ** ** | **Remaining**                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Number**                   | ** ** | **Contractual Life**    | ** ** | **Weighted Average** | ** ** | **Number** | ** ** | **Weighted Average** | ** ** |
| **Range of Exercise Price** | ** ** | ** **                   | ** ** | **Outstanding**              | ** ** | **(in Years)** | ** ** | **Exercise Price** | ** ** | **Exercisable** | ** ** | **Exercise Price** | ** ** |
| $1.00-$4.09                                |       |                         | 1,334      |                         |       |   | 7.20 |   |   |   | $ | 3.66 |   |   |   | 696 |   |   |   | $ | 3.48 |   |   |
| $4.10-$8.00                                |       |                         | 3,804      |                         |       |   | 7.66 |   |   |   | $ | 6.18 |   |   |   | 1,154 |   |   |   | $ | 6.10 |   |   |
| $8.01-$10.00                               |       |                         | 600        |                         |       |   | 5.30 |   |   |   | $ | 9.43 |   |   |   | 368 |   |   |   | $ | 9.70 |   |   |
| $10.01-$15.69                              |       |                         | 405        |                         |       |   | 5.09 |   |   |   | $ | 11.00 |   |   |   | 405 |   |   |   | $ | 11.00 |   |   |
| $1.00-$15.69                               |       |                         | 6,143      |                         |       |   |   |   |   |   |   |   |   |   | 2,623 |   |   |   |   |   |   |
|                                            |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Pro FormaInformation Prior to the Adoption of SFAS 123(R)**

Prior to January 1, 2006, the Company accountedfor stock-based compensation arrangements in accordance with theprovisions of APB No. 25 (APB 25), “Accounting for Stock Issued toEmployees” and complies with the disclosure provisions of Statement ofFinancial Accounting Standard No. 123 (“SFAS 123”), “Accounting for Stock-BasedCompensation.” Under APB No. 25, compensation cost is, in general,recognized based on the excess, if any, of the fair market value of the Company’sstock on the date of grant over the amount an employee must pay to acquire thestock. Equity instruments issued to non-employees are accounted for inaccordance with the provisions of SFAS No. 123 and Emerging Issues TaskForce 96-18. Deferred stock-based compensation is beingamortized using the graded vesting method over the vesting period of eachrespective option, which is generally four years.

Hadcompensation cost for the Company’s option plans been determined based on thefair value at the grant dates, as prescribed in SFAS 123, the Company’snet income (loss) would have been as follows (in thousands, except per shareamounts):

| ** **                                                                                                                  | ** ** | **Year Ended  December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Net loss:                                                                                                                   |       |                                   |       |   |   |
| As reported                                                                                                                 |       | $                                      | (2,982     | ) | $ | (1,907 | ) |
| Stock-based compensation expense reported in  consolidated statements of operations, net of related tax effects             |       | 36                                     |       | 68 |   |
| Total stock-based compensation expense determined  under fair value based method for all awards, net of related tax effects |       | (6,046                                 | )          | (4,434 | ) |
| Pro forma net loss                                                                                                          |       | $                                      | (8,992     | ) | $ | (6,273 | ) |
| Losses per share:                                                                                                           |       |                                   |       |   |   |
| Basic and diluted—as reported                                                                                          |       | $                                      | (0.10      | ) | $ | (0.06 | ) |
| Basic and  diluted—pro forma                                                                                           |       | $                                      | (0.29      | ) | $ | (0.20 | ) |

 

Thefair value of each grant is estimated on the date of grant using the Black-Scholesmethod with the following assumptions used for grants during the applicableperiods:

| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| **Employee stock options** | ** ** | ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected life (in  years)            |       | 4.0 - 5.0                             |       | 5.0 |   |
| Risk-free  interest rate             |       | 3.7% - 4.5%                           |       | 3.2% - 3.7% |   |
| Volatility                           |       | 56.7%                                      |       | 81.5% |   |
| Dividend yield                       |       | 0%                                         |       | 0% |   |
|                                      |            |                                            |            |  |  |  |  |

 

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| **Employee stock purchase plan shares** | ** ** | ** **       | ** ** | **2005**       | ** ** | **2004** | ** ** |
|-------------------------------------------------------------|------------|------------------|------------|----------------|------------|----------|------------|
| Expected life (in  years)                                   |       | 1.0              |       | 1.0            |       |
| Risk-free  interest rate                                    |       | 2.8% - 3.5% |       | 1. - 2.2% |       |
| Volatility                                                  |       | 44.0%            |       | 80.3%          |       |
| Dividend yield                                              |       | 0%               |       | 0%             |       |

 

**Note 8.Stockholders’ Equity**

The Company’s board ofdirectors may issue up to 20,000,000 shares of preferred stock withoutstockholder approval on such terms as the board might determine. The rights ofthe holders of common stock will be subject to, and might be adversely affectedby, the rights of the holders of any preferred stock that might be issued inthe future.

***Stockholder Rights Plan***

The Company’s Stockholder Rights Plan, which wasadopted in October 2000 and became effective June 27, 2001, isintended to protect stockholders from unfair or unfriendly takeover practices.In accordance with this plan, the board of directors declared a dividenddistribution of one Series AA preferred stock purchase right on eachoutstanding share of its common stock held as of June 27, 2001, and oneach share of common stock issued by the Company thereafter. Each rightentitles the registered holder to purchase from the Company one one-thousandthshare of Series AA preferred stock at a price of $110. The rights becomeexercisable in certain circumstances, including the acquisition by any personor group, or the commencement or announcement of a tender or exchange offer forthe acquisition, of beneficial ownership of 15 % or more of the Company’scommon stock without the approval of the board of directors (except for certainaffiliates prior to the effective date of the Plan as to whom this ownershiplimit is 25%). The rights do not confer any rights as a stockholder until theyare exercised. In the event the rights become exercisable, each right willentitle the holder to acquire shares of common stock of the Company or theacquiring corporation (in the event of merger or similar business combination)having a value equal to twice the purchase price of the right. The rights areredeemable by the Company prior to exercise at $0.01 per right and expire on October 11,2010.

In 2004, the Companyamended its Stockholder Rights Plan twice; once, in connection with theproposed acquisition of the Company by Synopsys, Inc, and a second time topermit the acquisition of shares representing more than 15% of its common stockby a brokerage firm that manages independent customer accounts and generallydoes not have any discretionary voting power with respect to such shares.Notwithstanding amendments of this nature, the Company’s intention is tomaintain and enforce the terms of this plan, which could delay, deter orprevent an investor from acquiring the Company in a transaction that couldotherwise result in stockholders receiving a premium over the market price fortheir shares of common stock.

**Note 9:Retirement Savings Plan**

Effective January 1997,the Company adopted the MoSys 401(k) Plan (the “Savings Plan”) whichqualifies as a thrift plan under Section 401(k) of the InternalRevenue Code. All full-time employees who are at least 21 years old areeligible to participate in the Savings Plan at the time of hire. Participantsmay contribute up to 15% of their earnings to the Savings Plan. The Companymakes a Matching Contribution on behalf of each Participant in an amount equalto 25% of a Participant’s Deferral Contributions during the Plan Year. TheCompany made matching contributions of $153,000, $127,000, and $110,000, in2006, 2005, and 2004, respectively.

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**Note 10:Business Segments, Concentration of Credit Risk and Significant Customers**

The Company has adopted SFAS No. 131, “Disclosureabout Segments of an Enterprise and Related Information.” Although the Companyoffers various intellectual property components and services to its customers,the Company does not manage its operations by these intellectual propertycomponents and services, but instead views the Company as one operating segmentwhen making business decisions. The Company does not manage its operations on ageographical basis. Revenue attributed to the United States and to all foreigncountries is based on the geographical location of the customer. The Companyuses one measurement of profitability for its business.

The Company supplies semiconductor memories to theelectronics industry. This industry segment is characterized by rapidtechnological change and significant competition.

Financial instruments that potentially subject theCompany to significant concentrations of credit risk consist principally ofcash, cash equivalents, short-term and long-term investments and accountsreceivable. Cash, cash equivalents, short-term and long term investments aredeposited with high credit quality institutions.

TheCompany sold its products and licensed its 1T-SRAM technologies to customers inthe Far East, North America and Europe as follows (in thousands):

| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| United States |       | $                                           | 3,165      |   | $ | 3,630 |   | $ | 4,602 |   |
| Japan         |       | 9,010                                       |       | 7,636 |   | 4,609 |   |
| Taiwan        |       | 1,710                                       |       | 479 |   | 1,007 |   |
| Asia          |       | 659                                         |       | 537 |   | 184 |   |
| Europe        |       | 365                                         |       | — |   | 419 |   |
| Total         |       | $                                           | 14,909     |   | $ | 12,282 |   | $ | 10,821 |   |

 

Customerswho accounted for at least 10% of total revenues were as follows:

| ** ** | ** ** | **Years Ended December 31,** | ** ** |
|------------|------------|---------------------------------------------|------------|
| ** ** | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| NEC        |       |                                        | 27         | % |   |   | 35 | % |   |   | 19 | % |   |
| Fujitsu    |       |                                        | 25         | % |   |   | 17 | % |   |   | 17 | % |   |
| Marvel     |       |                                        | 4          | % |   |   | 0 | % |   |   | 11 | % |   |

 

One customer accounted for 89% of gross accountsreceivable at December 31, 2006. Three customers accounted for 40%, 22%and 20% of gross accounts receivable, respectively, at December 31, 2005.The Company performs ongoing credit evaluations of its customers’ financialcondition and maintains an allowance for uncollectible accounts receivablebased upon the expected collectibility of all accounts receivable. Allowancefor uncollectible accounts receivable was $0 and $105,000 at December 31,2006 and 2005, respectively. Uncollectible amount of $65,000 was written off in2006. No amounts were written off in 2005 and 2004.

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Netproperty, plant and equipment, classified by major geographic areas were asfollows at December 31, 2006 and 2005 (in thousands):

| ** ** | ** ** | **December 31,**   | ** ** |
|------------|------------|-------------------------|------------|
| ** ** | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** ** | ** ** | **(in thousands)** | ** ** |
| U.S.       |       | $                       | 830        |   | $ | 1,075 |   |
| Non-U.S.   |       | 25                      |       | 46 |   |
| Total      |       | $                       | 855        |   | $ | 1,121 |   |

 

**Note 11:Commitments and Contingencies**

TheCompany leases its facilities under non-cancelable operating leases that expirein 2007 through 2010. Rent expense was approximately $699,000, $797,000, and$1,157,000, for the years ended December 31, 2006, 2005, and 2004,respectively. The leases provide for monthly payments and are being charged tooperations ratably over the lease terms. In addition to the minimum leasepayments, the Company is responsible for property taxes, insurance and certainother operating costs. Future minimum lease payments under the non-cancelableoperating leases as of December 31, 2006 are as follows (in thousands):

| **Year Ended December 31,** | ** ** | ** ** | ** ** | **Minimum Lease  Commitments** | ** ** | **Sublease Income** | ** ** | **Net Lease  Commitments** | ** ** |
|--------------------------------------------|------------|------------|------------|-------------------------------------|------------|--------------------------|------------|---------------------------------|------------|
| 2007                                       |       |       | $          | 863                                 |       |                     |       | $                               | 210        |   |   |   | $ | 653 |   |   |
| 2008                                       |       |       | 561        |                                |       |                     | 61         |                            |       |   | 500 |   |   |
| 2009                                       |       |       | 370        |                                |       |                     | —     |                            |       |   | 370 |   |   |
| 2010 and  thereafter                       |       |       | 189        |                                |       |                     | —     |                            |       |   | 189 |   |   |
| Total minimum payments                     |       |       | $          | 1,983                               |       |                     |       | $                               | 271        |   |   |   | $ | 1,712 |   |   |

 

There were no contingentliabilities as of December 31, 2006. In July 2005, one of the Company’scustomers filed a claim concerning excess verification costs incurred by thecustomer in implementing a custom design for 1T-SRAM memory technology under alicensing contract. The claim was settled in December 2005 with a net-downof $304,000 in accounts receivable and contingent liability. There was nocontingent liability as of December 31, 2005, however, the Company hasgiven up the right to receive $71,000 in future royalties from this customer,which was fully offset by the running royalties received during 2006.

***Legal Matters***

On March 31, 2004, UniRAM Technology, Inc.filed a complaint against us in the United States District Court for theNorthern District of California, alleging trade secret misappropriation andpatent infringement. Subsequent to March 31, 2004, UniRAM amended itscomplaint twice to add TSMC as a defendant and additional allegations to thesuit, and to drop all infringement claims for one of the two patents identifiedin the initial complaint. On October 24, 2006, the Company settled alloutstanding litigation with UniRAM Technology, Inc. related to the tradesecret misappropriation and patent infringement suit filed in 2004 by UniRAM. Underthe settlement agreement, the companies agreed to dismiss all outstandingclaims and counterclaims with prejudice. The Company paid UniRAM $2.4 million,and received a complete release of all claims as well as a future fully paidlicense for itself and all of its licensees to UniRAM’s relevant intellectualproperty.

From time to time the Company may be subject to legalproceedings and claims in the ordinary course of business. These claims, evenif not meritorious, could result in the expenditure of significant financialresources and diversion of management efforts.

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**Schedule II—Valuationand Qualifying Accounts(In thousands)**

| ** **                         | ** ** | ** **            | ** ** | **Additions**       | ** ** | **Deductions**      | ** ** | ** **    | ** ** |
|------------------------------------|------------|-----------------------|------------|---------------------|------------|---------------------|------------|---------------|------------|
| ** **                         | ** ** | **Balance at**   | ** ** | **Charged to** | ** ** | **Charged to** | ** ** | **Amount**    | ** ** | **Balance at** | ** ** |
| ** **                         | ** ** | **beginning of** | ** ** | **costs and**  | ** ** | **other**           | ** ** | **recovered** | ** ** | **end of** | ** ** |
| **Description**                    | ** ** | ** **            | ** ** | **period**          | ** ** | **expenses**        | ** ** | **accounts**  | ** ** | **(written off)** | ** ** | **period** | ** ** |
| Allowance for doubtful  accounts   |       |                  |       |                |       |                |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Year ended  December 31, 2006 |       |                  | $          | 105                 |       |                |       | $             | —     |   |   |   | $ | — |   |   |   | $ | (105 | ) |   |   | $ | — |   |   |
| Year ended  December 31, 2005 |       |                  | $          | —              |       |                |       | $             | 105        |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 105 |   |   |
| Year ended  December 31, 2004 |       |                  | $          | —              |       |                |       | $             | —     |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
|                                    |            |                       |            |                     |            |                     |            |               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

** **

 

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