**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K**

 

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

 

**For the Fiscal Year December 31,2003, or**

 

| o |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE****SECURITIES EXCHANGE ACT OF 1934** |
|---|--------|-------------------------------------------------------------------------------------------------|

 

**Commission file number: 000-32929**

 

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**MONOLITHICSYSTEM TECHNOLOGY, INC.**

(Exact name of registrant as specified in its charter)

 

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

 

**1020 Stewart DriveSunnyvale, California 94085**

(Address of principal executive offices)

 

**(408) 731-1800**

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b)of the Act:

 

| **Title of each class** |   | **Name of each exchange on which registered** |
|-------------------------|--------|-----------------------------------------------|
| None                    |   | None                                          |

 

Securities registered pursuant to Section 12(g)of the Act:Common Stock, par value $0.01 per shareSeries AA Preferred Stock, par value $0.01 per share

(Title of Class)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to thisForm 10-K. ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange ActRule 12b-2). Yes ý No o

 

The aggregate marketvalue of the common stock held by non-affiliates of the Registrant, as ofJune 30, 2003 was approximately $141,131,000 based upon the last saleprice reported for such date on the Nasdaq National Market. For purposes ofthis disclosure, shares of common stock held by persons who beneficially ownmore than 5% of the outstanding shares of common stock and shares held byofficers and directors of the Registrant have been excluded because suchpersons may be deemed to be affiliates. This determination is not necessarilyconclusive.

 

As of February 23,2004, 30,767,544 shares of the registrant’s common stock, $0.01 per value, wereoutstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

 

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**TABLE OF CONTENTS**

 
|      |   | **Part I**                                                                                  |   |
|-----------|--------|---------------------------------------------------------------------------------------------|--------|
|      |   |                                                                                        |   |
| Item 1.   |   | Business                                                                                    |   |
|      |   |                                                                                        |   |
| Item 2.   |   | Properties                                                                                  |   |
|      |   |                                                                                        |   |
| Item 3.   |   | Legal  Proceedings                                                                          |   |
|      |   |                                                                                        |   |
| Item  4.  |   | Submission  of Matters to a Vote of Security Holders                                        |   |
|      |   |                                                                                        |   |
|      |   | **Part II**                                                                                 |   |
|      |   |                                                                                        |   |
| Item  5.  |   | Market  for Registrant’s Common Equity and Related Stockholder Matters                 |   |
|      |   |                                                                                        |   |
| Item  6.  |   | Selected  Financial Data                                                                    |   |
|      |   |                                                                                        |   |
| Item  7.  |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|      |   |                                                                                        |   |
| Item  7A. |   | Quantitative  and Qualitative Discussion of Market Interest Rate Risk                       |   |
|      |   |                                                                                        |   |
| Item 8.   |   | Financial Statements and Supplementary Data                                                 |   |
|      |   |                                                                                        |   |
| Item 9.   |   | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure       |   |
|      |   |                                                                                        |   |
| Item 9a.  |   | Controls and Procedures                                                                     |   |
|      |   |                                                                                        |   |
|      |   | **Part III**                                                                                |   |
|      |   |                                                                                        |   |
| Item 10.  |   | Directors and Executive Officers of the  Registrant                                         |   |
|      |   |                                                                                        |   |
| Item 11.  |   | Executive Compensation                                                                      |   |
|      |   |                                                                                        |   |
| Item 12.  |   | Security Ownership of Certain Beneficial  Owners and Management                             |   |
|      |   |                                                                                        |   |
| Item 13.  |   | Certain Relationships and Related Transactions                                              |   |
|      |   |                                                                                        |   |
| Item 14.  |   | Principal Accountant Fees and Services                                                      |   |
|      |   |                                                                                        |   |
|      |   | **Part IV**                                                                                 |   |
|      |   |                                                                                        |   |
| Item 15.  |   | Exhibits, Financial Statement Schedules, and  Reports on Form 8-K                           |   |
|      |   |                                                                                        |   |
|      |   | Signatures                                                                                  |   |

 

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**Part I**

 

*ThisAnnual Report on Form 10-K and the documents incorporated herein byreference contain forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934, which include, without limitation, statementsabout the market for our technology, our strategy, competition, expectedfinancial performance and other aspects of our business identified in thisAnnual Report, as well as other reports that we file from time to time with theSecurities and Exchange Commission. Any statements about our business,financial results, financial condition and operations contained in this AnnualReport that are not statements of historical fact may be deemed to be forward-lookingstatements. Without limiting the foregoing, the words “believes,”“anticipates,” “expects,” “intends,” “projects,” or similar expressions areintended to identify forward-looking statements. Our actual results coulddiffer materially from those expressed or implied by these forward-lookingstatements as a result of various factors, including the risk factors describedin Part I., Item1, “Business—Risk Factors,” and elsewhere in this report.We undertake no obligation to update publicly any forward-lookingstatements for any reason, except as required by law, even as new informationbecomes available or other events occur in the future.*

 

MoSys®, MultiBank® and1T-SRAM® are our trademarks. Product names, trade names and trademarks of othercompanies are also referred to in this report.

 

***Item 1.******Business***

 

**CompanyOverview**

 

We design, develop,license and market memory technologies used by the semiconductor industry andelectronic product manufacturers. We have developed a series of patentedsemiconductor memory technologies, called 1T- SRAM technologies, thatoffer a combination of high density, low power consumption and high speed atperformance and cost levels that other available memory technologies do notmatch. We license this technology to companies that incorporate, or embed,memory on complex integrated circuits. We generate revenue from intellectual property licensing, which consistsof licensing and royalty revenues. We also sell memory chips based on our1T-SRAM technologies.

 

Using elements of ourexisting memory technology as a foundation, we completed development of ourfirst memory chips incorporating our 1T-SRAM technologies in the fourth quarterof 1998. Through the second quarter of 2001, almost all of our revenue wasgenerated by product sales of our memory chips. Since then, however, licensingand royalty revenues have represented the majority of our revenues, a trendthat we expect will continue for the foreseeable future. Our licensing revenueconsists of fees paid for engineering development and engineering supportservices. We are entitled to receive royalties under each of our licensingagreements when our licensees manufacture or sell products that incorporate ourtechnology.

 

We signed our firstlicense agreement related to our 1T-SRAM technology at the end of the fourthquarter of 1998 and in the first quarter of 2000 recognized revenue fromlicensing our 1T-SRAM technology for the first time. In 2001, we introducedenhancements to the original technology with 1T-SRAM-M, a lower power versionand 1T-SRAM-R, a version offering improved quality and reliability features. In2002, we introduced 1T-SRAM-Q, which offers twice the density of our originaltechnology.

 

As ofDecember 31, 2003, we had signed license agreements related to our 1T-SRAMtechnologies with 41 companies. Our licensing sales cycle is lengthy.Generally, we expect the period from our initial discussion with a prospectivelicensee to a signed agreement to last from three to six months. Once ourcustomer signs a license agreement, we generally will recognize revenue fromfees for developing and delivering 1T-SRAM designs to the customer over aperiod of 6 to 18 months. If the customer subsequently uses our 1T-SRAMdesign in production, we would not expect to receive any royalty payments until18 to 24 months after the commencement of the project.

 

To expand the range ofmemory technology intellectual property and services available to ourcustomers, we acquired 100% of the outstanding stock of ATMOS Corporation, aCanada based privately held company focused on creating high-density, compiler-generatedembedded memory solutions, effective August 30, 2002. In December 2002, weannounced our first 1T-SRAM compiler for 0.15-micron standard logic processesavailable for the leading foundries. The 1T-SRAM compiler, which is a softwareprogram that allows semiconductor designers to configure memories to meet theirdesign specifications, resulted directly from the ATMOS acquisition.  This compiler broadens the potentialdistribution of our 1T-SRAM technologies by making them available forsemiconductor design applications for which our custom memory designs may notbe cost effective.

 

To complementour existing high-density, low-power 1T-SRAM technologies, we announced theavailability of our low 

 

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power 6T-SRAM-R compilers inJanuary 2004.  The6T-SRAM-R compilers incorporate the same technologies that deliver the qualityand low-power advantages offered by our 1T-SRAM technologies for large memoriesand extend these benefits to small memories of less than one megabit in size,for system-on-chip, or SoC designers. Our new compilers have significant low power advantages as compared toother six-transistor embedded memories.

 

**IndustryBackground**

 

*Trendsin the Semiconductor Industry*

 

Electronic products playan increasingly important role in our lives, as evidenced by the growth of thepersonal computer, wireless communications, networking equipment and consumerelectronics markets. These markets are characterized by intensifyingcompetition, rapid innovation, increasing performance requirements andcontinuing 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 ofperformance are speed and power consumption. Higher-speed integratedcircuits can allow electronic products to operate faster, enabling theperformance of more functions. Reducing the power consumption of integratedcircuits contributes to increased battery life and reduced heat 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 offeringhigh-performance products, semiconductor companies must produce integratedcircuits that are cost effective. High-density integrated circuits require lesssilicon, thus reducing their size and cost. Cost reductions also can be achieved by simplifying the integrated circuit’smanufacturing process and improving the manufacturing yield.

 

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). Thesemiconductor industry has continuously developed advanced process technologiesthat enable the reduction of silicon area on integrated circuits andconsequently lower costs. The industry is predominantly using 0.25-micron,0.18-micron and 0.15-micron manufacturing process technology today. However,current designs are now being implemented in 0.13-micron manufacturing processtechnology, and are now rapidly migrating to 0.09-micron manufacturing processtechnology.

 

*Importanceof Integration*

 

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 single integrated circuit, or SoC. Highly integrated circuitssuch as SoCs often offer advantages in density, power consumption, speed andcost that cannot be matched using separate, discrete integrated circuits. SoCsare essential for most electronic products, such as cellular phones, video gameconsoles, communication and networking equipment and internet appliances, toachieve increasing performance requirements at a reasonable cost.

 

*Importanceof Embedded Memory*

 

Historically,semiconductor companies implemented memory in separate integrated circuits.Rather than using separate memory chips, semiconductor companies today areembedding memory on highly integrated circuits in order to optimize performanceand size. At the same time, the increasing sophistication of electronicproducts is driving a rapid increase in the amount of memory required. Currentindustry estimates are that more than half of the chip area of a SoC iscomprised of embedded memory and this proportion is forecasted to increase inthe future with the growth of more memory-intensive applications.

 

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 circuits contain a larger amount of embeddedmemory, this memory must be dense enough to be economically attractive and mustoffer sufficiently high speed and low power consumption.  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.

 

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*TraditionalSRAM*

 

The most common form of embeddedmemory today utilizes traditional static random access memory, or SRAMtechnology, that we refer to as traditional SRAM. This technology is in thepublic domain and can be used by any semiconductor company. Traditional SRAMhas the following characteristics—

 

•                                          itoperates at the same high speeds as other functions of the integrated circuit;

 

•                                          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 memory requirementsincrease, however, traditional SRAM becomes relatively more expensive comparedto the total cost of the integrated circuit. Specifically, traditional SRAM hasthe 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 manufacturers have utilized embeddeddynamic random access memory, or embedded DRAM. While embedded DRAM is denserthan traditional SRAM, it is typically ten times slower. Manufacturing embeddedDRAM also requires additional process steps and results in low yields, whichtranslate into increased manufacturing time and cost. Additionally, because ofits complex interface requirements, embedded DRAM is more difficult to incorporateon integrated circuits, leading to a higher risk of failure. As integratedcircuit designers have experimented with embedded DRAM, they have discoveredthat these limitations of embedded DRAM preclude its use in almost allapplications. 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.

 

**OurSolution**

 

We have developed aseries of innovative memory technologies, 1T-SRAM technologies, which providemajor advantages over traditional SRAM in density, power consumption and cost,thus making it more economical for designers to incorporate large amounts ofembedded memory in their designs. In addition, our 1T-SRAM technologies offerall the benefits of traditional SRAM, such as high speed, simple interface andease of manufacturability. Its core circuitry is already production proven in millionsof our memory chips and offers integrated circuit designers the followingcharacteristics compared to traditional SRAM:

 
| **Parameters** |   | **Typical  Characteristics of 1T-SRAM technologies vs. traditional SRAM**                                           |
|----------------|--------|---------------------------------------------------------------------------------------------------------------------|
|           |   |                                                                                                                |
| Density        |   | Uses 50% to 80% less  silicon for the same amount of memory                                                         |
| Cost           |   | 50 to 80% less cost for  the same amount of memory                                                                  |
| Power          |   | Can save up to  three-quarters 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.

 

*HighDensity*

 

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.

 

*LowPower Consumption*

 

Embedded memory utilizingour 1T-SRAM technologies can consume as little as one-quarter the power andgenerates less heat 

 

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than traditional SRAM when operating at the samespeed. This feature facilitates longer battery life and reliable operationusing lower-cost packaging.

 

*HighSpeed*

 

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 beimplemented in different semiconductor manufacturing facilities, has beenproven operational in the fabrication of chips at Taiwan SemiconductorManufacturing Co., Ltd., or TSMC, United Microelectronics Corporation, orUMC, and Chartered Semiconductor Manufacturing Ltd., the world’s threelargest independent foundries. 1T-SRAM’s scalability, or the ease withwhich it can be implemented in different generations of manufacturingprocesses, has already been demonstrated in the fabrication of chips in0.25-micron, 0.22-micron, 0.18-micron, 0.15-micron, 0.13-micron and 0.09-micronprocess generations. We expect our technology to continue to scale readily tofuture process generations. This portability and scalability provides for wideavailability, inexpensive implementation and quick product time to market forour licensees.

 

*Simplicityof Interface*

 

Our 1T-SRAM technologies’internal 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.

 

**OurStrategy**

 

Our goal is to establishour 1T-SRAM technologies as the standard for all large embedded memories in SoCapplications. We intend to achieve this goal by licensing our technology on anon-exclusive and worldwide basis to foundries, integrated devicemanufacturers, fabless semiconductor companies and electronic productmanufacturers.

 

Wehave extended the coverage of our technologies to smaller memory blocks by offeringour 6T-SRAM memory compilers.  Utilizingthe same low-power benefits built into our 1T-SRAM technologies, our licenseescan have a complete range of low-powered embedded memory solutions to meettheir demanding SoC requirements.

 

The following are integralaspects of our strategy.

 

*TargetLarge and Growing Markets*

 

We target the large andgrowing market for system-on-a-chip applications. We offer our 1T-SRAMtechnologies that offer chip designers improved performance in embeddedmemories thus optimizing the cost and performance of the SoC.

 

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

 

*WorkClosely with Semiconductor Companies and Foundries to Deliver OptimalTechnology Solutions*

 

We intend to continue towork closely with semiconductor companies to gain broad and detailed insightinto their own and their customers’ current and next-generation technologyrequirements. This insight helps us identify trends and focus our developmentefforts on optimizing our technology solution, resulting in shorter producttime to market and lower costs.

 

We also plan to qualifyand license our technology with the leading foundries. Our close relationshipswith these foundries allow us insight into changing market requirements andaccess to advance manufacturing processes.

 

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*Extendour Technology Offerings*

 

Our goal is to continueto enhance our 1T-SRAM technologies and increase our share of the embeddedmemory market. We will continue to develop our technology in order to offereven 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 and since theintroduction of 1T-SRAM in 1998, we have introduced and currently offer thefollowing improved versions of the technology:

 

•                                          1T-SRAM-R,a version that includes Transparent Error CorrectionTM (TEC), 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 1T-SRAM-R has now become the standardversion of 1T-SRAM in most of our licensing activities.

 

•                                          1T-SRAM-M,a lower power version that is well-suited to particular applications requiringvery low operating and standby power, such as cell phone handsets, digitalcameras, personal digital assistants and other consumer wireless devices. Weintroduced our 1T-SRAM-M in April 2001.

 

•                                          1T-SRAM-Q,an extended density memory that has twice the density of the original versionof our technology and up to four times the density of traditional SRAM.  We introduced our 1T-SRAM-Q inDecember 2002.

 

•                                          6T-SRAM-R, a memory compiler builton the same technologies that deliver the quality and low-power advantagesoffered by our 1T-SRAM technologies for large memories are now incorporatedinto our 6T-SRAM-R compilers to extend these benefits to small memories, thoseless than one megabit in size, in customers’ chip designs.  The compiler, along with our 1T-SRAM technologies, offerssemiconductor designers a complete range of embedded memories to meet theirdemanded SoC requirements.

 

We have developed newgenerations of our 1T-SRAM technologies, most recently in the 0.09-micronmanufacturing process, and intend to continue to develop our technologies forfuture process generations.

 

*Focuson Higher-Margin Licensing Model*

 

The licensing of ourintellectual property consists of licensing and royalty revenues. These revenuesources produce higher gross margins than can be achieved from the sale of ourmemory chips. In particular, royalties received from our licensees have noassociated cost. Therefore, we will continue to focus on the licensing of ourintellectual property as the major source of our future revenue.

 

**Licensingand Distribution Strategy**

 

We offer our technologyon a non-exclusive and worldwide basis to semiconductor companies, electronicproduct manufacturers, foundries, intellectual property companies and designcompanies through product development, technology licensing and joint marketingrelationships.

 

*Licensing*

 

We license our technologyto semiconductor companies who incorporate our technology into integratedcircuits that they then sell to their customers. We also license our technologyto electronic product manufacturers, who then require their suppliers to adoptour technology. In addition, we engage in joint marketing activities withfoundries, intellectual property companies and design companies to promote ourtechnology to a wide base of customers. These distribution channels havebroadened the acceptance and availability of our technology in the industry. Asour technology becomes available through an increasing number of channels, webelieve it will be less likely that customers will have to alter theirprocurement practices in order to acquire our technology. We intend to continueto expand significantly this base of strategic relationships to furtherproliferate our technology.

 

We form productdevelopment and licensing relationships directly with semiconductor companies andelectronic product manufacturers. Generally, we require the prospectivelicensee to identify one or more specific projects for the use of ourtechnology. The prospective licensee’s implementation of our 1T-SRAMtechnologies 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 development andlicense agreements

 

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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. The agreementsusually provide for payment of contract fees to us upon the achievement ofspecified development milestones. The agreements also often provide for thepayment of additional contract fees if we provide engineering or manufacturingsupport services related to the manufacture of the product. Provisions in allof our license agreements require the payment of royalties to us based on thefuture sale or manufacture of products utilizing our 1T-SRAM technologies.Generally, our licenses grant rights on a nonexclusive, nontransferable basis,limited to the use of our technology as modified for the project covered by thelicense agreement or amendment.  Ourlicense agreements generally have a fixed five-year term and are subject torenewal.  Each new project requires aseparate agreement or an addendum to modify an existing agreement.

 

In addition, we alsooffer our technology to semiconductor companies through 1T-SRAM technologylicense agreements, under which we grant the licensee the additional right tocreate and modify 1T-SRAM designs 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 obligate the licensee to pay contract fees to usupon the achievement of specified development milestones and may provide forthe payment of additional contract fees if we provide engineering ormanufacturing support services. Under these agreements we will be entitled toreceive royalties based on the future sale or manufacture of products utilizingour 1T-SRAM technologies. The licenses are nonexclusive and nontransferable andauthorize the licensee to modify designs for its customers from the templatedesign that we provide under the agreement.  Typically, the template design applies only to a specified manufacturingprocess generation.  The licensee mayadd future process generations to the license agreement for additional contractfees.

 

*JointMarketing Arrangement*

 

We have formed jointmarketing relationships with dedicated foundries such as TSMC, UMC andChartered Semiconductor Manufacturing Corporation. These foundries havecooperated with us to prove the manufacturability of integrated circuitsutilizing our 1T-SRAM technologies in their particular manufacturing process.Once manufacturability has been proven, the foundries can then offer theirmanufacturing services to our licensees, and their integrated circuit devicecustomers can fabricate integrated circuits incorporating our 1T-SRAMtechnologies.

 

We also have formed analliance consisting of design service firms to enable our licensees to morerapidly incorporate 1T-SRAM technologies into their design. This DesignServices Alliance (DSA) program is intended to provide our licensees withspecialized support as the use of our technology in SoC designs increases. EachDSA member company has been trained to provide our licensees with designexpertise and product engineering resources in order to reduce the design cycletime as well as accelerate the ramp to volume production.

 

*ProliferateTechnology through a Diverse Distribution Strategy*

 

We license the 1T-SRAMtechnologies in the form of customized memory designs, standard memory designsand memory compilers. We also offer technology licenses, which allow ourlicensee to create our 1T-SRAM designs for its customers, to strategicsemiconductor technology providers, in order to achieve a boarder distributionof our technologies.  Not all of ourtechnology relationships will result in the manufacture and sale of royalty-bearingproducts by our licensees, from which we expect to earn most of our revenues inthe future. Therefore, to increase the number of royalty-generatinglicense agreements for our 1T-SRAM technologies, an important element of ourstrategy is to offer these technologies broadly in order to establish it as anindustry standard.

 

We have license agreementswith many companies, including Agere Systems, Inc., Agilent Technologies,Analog Devices, Inc., Applied Micro Circuits Corporation, Broadcom Corporation,eSilicon Corporation, Fujitsu Limited, Hitachi, Ltd., Hudson Soft CompanyLimited, LG Electronics, Inc., LSI Logic Corporation, Marvell Semiconductor,Inc., Matsushita Communication Industrial Co., Ltd., Motorola, Inc., NationalSemiconductor Corporation, NEC Electronics Corporation, Nintendo, PhilipsSemiconductors, Inc., Pixelworks, Inc., Pixim, Inc., Sanyo Electric Co., Ltd.,SONY Corporation, Stepmind SA, Switchcore AB, TSMC, UMC, Via Technologies,Inc., and Via Networking Technologies, Inc.

 

*CustomMemory Designs*

 

We offer directly to ourlicensees customized 1T-SRAM memory designs to meet their specific designparameters. We also offer a variety of options for optimizing the designspecification in order to improve performance and cost effectiveness.

 

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*StandardMacro Designs*

 

In addition to licensingour customized 1T-SRAM designs, companies also can license standard 1T-SRAMoff-the-shelf memory designs from us. These readily available standard memorydesigns can assist the licensee in getting its SoC quickly to market.

 

*MemoryCompilers*

 

In December 2002, weannounced our first 1T-SRAM compiler for 0.15-micron standard logic processesavailable for the leading foundries. We offer licenses to use these compilers,which will enable our customers to automatically generate and configure memorydesigns utilizing our technologies directly from our website. The memorydesigns produced from our compilers are intended for applications requiringsmaller sizes of embedded memory.

 

In January 2004, weintroduced our 6T-SRAM-R memory compilers to offer our customers a lowpower alternative to traditional embedded six-transistor SRAM in applicationsrequiring smaller memory sizes.  We planto offer future compiler products on advanced generations of manufacturingprocesses.

 

Our compilers are offeredon a per use basis or under an unlimited use license for fees ranging from tenof thousands of dollars to several hundred thousands of dollars.  As with all of our technologies, thelicensee is obligated to pay us royalties for products manufactured or soldutilizing our technologies.

 

*TechnologyLicenses*

 

We have licensed ourtechnologies to the leading foundries; TSMC and UMC.  Increasingly, these foundries are now providing design servicesand third-party intellectual property directly to their customers. Underour technology license agreements, both TSMC and UMC have acquired a right tooffer as part of their design services, 1T-SRAM designs that they create fortheir customers.  Our license agreementswith TSMC and UMC require them to pay us licensing and development fees, aswell as royalties on silicon wafers manufactured by these foundries thatincorporate our licensed technology and a percentage of the design fees thatthey charged for delivering our technology.

 

We also offer and havelicensed our technologies to leading integrated device manufacturers or, IDMs,under technology license agreements.  Under our technology licenseagreement with Fujitsu Limited, which is our first IDM technology licensee, wehave granted Fujitsu a worldwide non-exclusive, non-transferable right to offerits own implementation of our 1T-SRAM technologies directly to its customersalong with its own design and manufacturing services.  Fujitsu has agreed to pay us a license fee for our services inporting our 1T-SRAM technologies to Fujitsu’s manufacturing process.  Fujitsu also is obligated to pay us fees fortechnical support for the first year, and for each additional year thereafterif it requests such support. Further, we will be entitled to receive royaltieson all integrated circuits incorporating our licensed technologies that aresold by Fujitsu and its subsidiaries.

 

*ProductSales*

 

SRAM memory chips satisfya market demand for high-speed memory chips used to store data in electronicproducts. There are several large companies that have chosen to manufactureSRAM chips using traditional technology. Like our 1T-SRAM embedded memorytechnology, our 1T-SRAM chips have small memory cell circuitry, requiring lowpower consumption and operating at high speeds, which makes them a costeffective memory chip solution for networking and date communicationapplications, such as routers, switches and network processors.

 

Suchdata communications applications typically require memory chips in industrystandard sizes and speeds. The memory size of a chip indicates the number ofmemory storage bits on the chip and its speed reflects the rate at which aprocessing system can access the memory.

 

In order to appeal to manufacturers of wired datacommunications applications, we currently sell memory chips with memory size,speed and configuration specifications consistent with those offered by mostmemory chip suppliers. We sell these memory chips primarily to suppliers ofprevious generations of communications equipment, such as Delta Network and Electronics,Flextronics, Maxtek Technology, MCM Japan, and Motorola. As the demand for thisequipment has diminished, our sales of 1T-SRAM memory chips have declinedsubstantially. Because we lack manufacturing resources and other guaranteedsources of supply for 1T-SRAM memory chips, we intend to allocate most of ourengineering resources to the development of 1T-SRAM technologies in support ofour licensing business, instead of rebuilding our product sales business.  Therefore, we anticipate a continued declinein our product sales volume.

 

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**Technology**

 

Our innovative 1T-SRAMtechnologies include many new and proprietary features.  Development of our memory chips during theearly years of our existence was critical to validating elements of the 1T-SRAMtechnologies we license today.  Thesetechnologies combine the high-density advantages of DRAM with the highperformance and utility of SRAM. Underlying this technology are several distinct pieces of our proprietarytechnology.

 

*Single-TransistorMemory Storage Cell*

 

The high density of our1T-SRAM technologies stems from the use of a single-transistor, or 1T,which is similar to DRAM, with a storage cell for each bit of information. Our1T storage cell using one transistor and one capacitor represents a verysignificant improvement in density over the six-transistor storage cells usedby traditional SRAM.

 

The following diagrams,drawn to scale, but not to actual size, are electrical schematics of thetraditional SRAM storage cell and our 1T-SRAM storage cell. The comparison ofthe two diagrams illustrates the small size and reduced complexity of the1T-SRAM storage cell. This results in significant cost savings because lesssilicon space is required by 1T-SRAM storage cells.

 

 

*MultiBankTechnology*

 

The high speed and lowpower consumption of 1T-SRAM are enabled by our MultiBank technology, asillustrated above. This technology efficiently partitions the memory into many,typically hundreds, of fast, small sub-blocks of memory, or banks, that canoperate independently over high-speed data buses. Only one small bankcontaining the required memory data must be active for each access to thememory. Therefore, the remaining banks can stay in a low-power, standby mode,reducing the overall power consumption of the memory.

 

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*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.

 

*RefreshManagement Circuitry*

 

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 to any of the traditional requirements of dynamic cell arrays.

 

*LeakageSuppression Circuitry*

 

Our unique patentedarchitecture, circuits and proprietary design techniques that manage processleakage allow MoSys’ 1T-SRAM technologies to be manufactured on any CMOSprocess, including generic ASIC processes, thus removing the need forcomplicated embedded memory process development.

 

*TransparentError Correction (TEC)*

 

We offer our 1T-SRAMtechnologies with TEC for higher reliability and quality.  TEC automatically corrects memory errorsduring operation, 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.  TEC is also incorporated into our 6T-SRAM-Rmemory compilers extending the same benefits provided in our 1T-SRAMtechnologies to the small memory block requirements in customers’ chipdesigns.

 

*FoldedArea Capacitor (FAC)*

 

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

 

***AdvancedManufacturing Processes***

 

We continue to implementour 1T-SRAM technologies on advanced generations of manufacturing processes. Asa result, our licensees are able to implement integrated circuits incorporating1T-SRAM embedded memories on the highest performance

 

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manufacturing processes available. The chart belowillustrates the advances we have made in implementing and verifying 1T-SRAMtechnologies on the latest generations of manufacturing processes. Theprocesses with the smaller micron dimensions have higher random access speedsand typically enable larger capacity memories.

 
| **Process Generation**        |   | **0.18-micron** |   | **0.15-micron** |   | **0.13-micron** |   | **0.09-micron** |   |
|-------------------------------|--------|-----------------|--------|-----------------|--------|-----------------|--------|-----------------|--------|
|                          |   |            |   |            |   |            |   |            |   |
| Date of 1T-SRAM  Verification |   | January 2000    |   | May 2000        |   | April 2001      |   | January 2003    |   |
| Typical Memory                |   | 1-32            |   | 1-48            |   | 1-64            |   | 1-64            |   |
| Capacity                      |   | megabits        |   | megabits        |   | megabits        |   | megabits        |   |
| Random Access  Speed          |   | 100-350 MHz     |   | 100-400 MHz     |   | 100-450 MHz     |   | 100-450 MHz     |   |

# ** **

# **Researchand Development**

 

Our ability to compete in the future will depend on improving our technologyto meet the market’s increasing demand for higher performance and lower costrequirements. We have assembled a team of highly skilled engineers whoseactivities are focused on developing even higher-density, lower-powerconsumption, higher-speed and lower-cost 1T-SRAM designs. We expect tocontinue to focus our research and development efforts on extending our 1T-SRAMtechnologies and developing new memory technologies. We also intend to continueour focus on porting our technology to additional semiconductor manufacturingfacilities and scaling our technology to new generations of manufacturingprocess technologies.

 

As of December 31, 2003, we employed 67 engineers, representing73% of our employees, with specific expertise in circuit design, layout and avariety of manufacturing processes. In June 2001, we established a designcenter in Seoul, South Korea where nine of our engineers reside. InAugust 30, 2002, we completed our acquisition of ATMOS Corporation wherewe currently employ 18 engineers in our research and development group. For theyears ended December 31, 2003, 2002 and 2001, research and developmentexpenditures totaled approximately $8.6 million, $6.6 million and$4.4 million, respectively.

 

**Salesand Marketing**

 

*Licensing*

 

As of December 31, 2003, we had a staff of nine sales and marketingexecutives managing our technology licensing activities. One is located inSophia-Antipolis, France and is responsible for licensing activities in Europeand the Middle East. Another is located in Tokyo, Japan and is responsible forlicensing activities in Japan. This group manages the negotiation of licenseagreements, provides technical support during the sales cycle to licensees andadministers the contracts. As we have multiple sales channels through ourrelationships with semiconductor companies, foundries, intellectual propertycompanies and design companies, we do not believe that we require a largeinternal sales force. Our marketing and promotional activities includeparticipation in industry trade shows, distribution of collateral marketingmaterial, publication of articles in trade journals and publicizing ourlicensing activities and technology achievements. We also provide presentationsand working sessions with the senior technical and business staff ofprospective customers.

 

*MemoryChips*

 

A portion of our sales and marketing group is also responsible forsales and marketing of our memory chips. Their marketing activities include thecreation of marketing materials and articles for trade publications. We alsouse 19 independent sales representatives throughout North America, Europe andAsia to promote our memory chips to their customers.

 

**IntellectualProperty**

 

We regard our patents, copyrights, trademarks, trade secrets andsimilar intellectual property as critical to our success, and rely on acombination of patent, trademark, copyright, and trade secret laws to protectour proprietary rights. As of December 31, 2003, we held 64 U.S. patentson various aspects of our technology, with expiration dates ranging from 2011to 2023. These 64 patents include claims relating to multibank partitioning,1T-SRAM internal operation and circuit techniques, high-speed operationtechniques, 1T-SRAM refresh management techniques and the interface of embedded1T-SRAM storage cells in logic processes. We currently have 15 pending U.S.patent applications, and have received notices of allowance with respect tofive of these applications. We also hold 36 foreign patents with expirationdates ranging from 2011 to 2022, and we have 26 pending foreign patentapplications. There can be no assurance that others will not independentlydevelop similar or competing technology or design around any patents that maybe issued to us, or that we will be able to enforce our patents againstinfringement.

 

The semiconductor industry is characterized by frequent litigationregarding patent and other intellectual property rights. While 

 

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we have not received formal notice of any infringementof the rights of any third party, questions of infringement in thesemiconductor field involve highly technical and subjective analyses.Litigation may be necessary in the future to enforce our patents and otherintellectual property rights, to protect our trade secrets, to determine thevalidity and scope of the proprietary rights of others, or to defend againstclaims of infringement or invalidity, and there can be no assurance that wewould prevail in any future litigation. Any such litigation, whether or notdetermined in our favor or settled by us, would be costly and would divert theefforts and attention of our management and technical personnel from normalbusiness operations, which would have a material adverse effect on our business,financial condition and results of operations. Adverse determinations inlitigation could result in the loss of our proprietary rights, subject us tosignificant liabilities, require us to seek licenses from third parties orprevent us from licensing our technology, any of which could have a materialadverse effect on our business, financial condition and results of operations.Moreover, the laws of certain foreign countries in which our technology is ormay in the future be licensed may not protect our intellectual property rightsto the same extent as the laws of the United States, thus increasing thepossibility of infringement of our intellectual property.

 

**Competition**

 

In order to remain competitive, we believe we must continue to providehigher-density, lower-power-consumption, higher-speedand lower-cost technology solutions to the semiconductor industry andelectronic product manufacturers. We believe that the principal competitivefactors in our industry are—

 

•                                          density andcost;

 

•                                          powerconsumption;

 

•                                          speed;

 

•                                          portabilityto different manufacturing processes;

 

•                                          scalabilityto different manufacturing process generations;

 

•                                          reliabilityand low manufacturing costs;

 

•                                          interfacerequirements; and

 

•                                          the ease withwhich technology can be customized for and incorporated into customers’products.

 

We believe that our 1T-SRAM technologies offer a high degree of overallperformance improvement over traditional SRAM. In addition, we have added our6T-SRAM-R memory compilers which incorporate many of the featuresbuilt into our 1T-SRAM technologies to deliver a higher standard of quality,combined with a much lower power requirement than other existing traditionalSRAM embedded memory.  Semiconductor companiesmay satisfy their embedded memory needs through traditional SRAM and embeddedDRAM. Traditional SRAM relies on publicly available process technology andcircuit designs, which semiconductor companies can build internally or acquirethrough a license from a third party provider, without paying a royalty to us.Companies providing traditional SRAM embedded memories include ArtisanComponents and Virage Logic, who license their memories through the sale ofcompilers.  Embedded DRAM is primarilyoffered by current or former DRAM suppliers, who utilize their ownmanufacturing process to compete in the semiconductor foundry business.Suppliers of embedded DRAM include substantial competitors such as Toshiba Ltd.and IBM, among others. Although each of these two embedded DRAM suppliers hasexperienced some success in obtaining new customers for its technology, webelieve that many semiconductor companies using embedded memory may prefer tolicense our technology instead of implementing either of these alternativesbecause of 1T-SRAM’s overall advantages.

 

Not all embeddedmemory applications benefit sufficiently from technological advantages offeredby our 1T-SRAM technologies to justify the increased cost to the licensee,however. Our licensees and prospective licensees can meet their current needsfor embedded memory using other memory solutions with different cost andperformance parameters. For example, our technologies are not suitable forreplacing lower-cost traditional DRAM memory chips if higher access speed isunnecessary.  In addition, alternativesolutions may be more cost-effective for memory block sizes of less than 1megabit, or applications in which the embedded memory portion is less than 20%of the total chip area.  To provide atechnology offering for these uses, however, in January 2004 we introduced our6T-SRAM-R memory compilers which incorporate the same quality and low-poweradvantages available in our 1T-SRAM technologies and extend these benefits tothe small memories in customers’ chip designs

 

Moreover, some companies assess greater uncertainty and risk in relyingon our newly established 1T-SRAM technologies. As a result, our ability tocompete effectively may be limited because such companies may prefer to usemore established traditional memory solutions that are freely available withouta license.

 

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Customers for our 1T-SRAM memory chips can choose to purchase SRAMmemory chips from a number of companies, including Cypress SemiconductorCorporation, Integrated Device Technology, Inc. and Samsung Corporation.These suppliers utilize traditional architecture and technology for their SRAMchips, which do not match the performance, low power and cost effectiveness ofour 1T-SRAM memory chips for the applications needed by our current customersfor these chips. However, these suppliers do have the advantage of supplyingmemory chips from their own wafer manufacturing plants and typically offer abroad range of memory products that includes devices other than SRAM memorychips. In addition, these companies have greater access to financial, technicaland other resources than we possess and are able to compete more effectivelyfor most of the SRAM business.

 

**Manufacturing**

 

We have designed the circuitry of our 1T-SRAM technologies so that ourlicensees can manufacture it in standard logic process, as well as other widelyused embedded memory processes.

 

For our stand-alone memory products, we implement a fablessmanufacturing strategy by using relationships with independent foundries.Today, we rely exclusively upon TSMC for our stand-alone productmanufacturing. We also use domestic and offshore subcontractors for assembly,testing and packaging. Assembly and test services provided by thesesubcontractors comply with the requirements of ISO-9000. We presently have nofirm, written commitment with any semiconductor foundry for the fabrication ofour memory chips. All fabrication is conducted on a purchase-order basisat an agreed price that is renegotiated from time to time.

 

**Employees**

 

As of December 31, 2003, we had 92 full-time employees, consistingof 67 in research and development and engineering, 13 in sales and marketing,11 in finance and administration and one in operations. We believe our futuresuccess will depend, in part, on our ability to continue to attract and retainqualified technical and management personnel, particularly highly skilleddesign engineers involved in new product development, for whom competition isintense. Our employees are not represented by any collective bargaining unit,and we have not experienced any work stoppage. We believe that our employeerelations are good.

 

**RecentDevelopment**

 

On February 23, 2004,Synopsys, Inc., or Synopsys, Mountain Acquisition Sub, Inc., a wholly ownedsubsidiary of Synopsys, or, Acquisition Sub, and we, entered into a definitiveagreement and plan of merger and reorganization, or reorganization agreement,which contemplates the acquisition by Synopsys, through Acquisition Sub, of allof our outstanding common stock in a two-step transaction comprised of acombination cash and stock exchange offer for all of the issued and outstandingshares of our common stock for consideration valued at an aggregate of $13.50per share, followed by our merger with Acquisition Sub. In the offer, each shareof our common stock validly tendered (and not withdrawn) would be convertedinto a combination of $6.75 in cash and a fraction of a share of Synopsyscommon stock having a value of $6.75 based on a formula set forth in thereorganization agreement. Synopsys has the right, at any time through the datetwo business days prior to the expiration date of the offer (as it may beextended from time to time), to convert the offer into an all-cash tenderoffer, in which case each share of our common stock would be converted into$13.50 in cash.

 

The reorganizationagreement provides that Acquisition Sub will commence the offer as promptly asreasonably practicable after February 23, 2004. The obligation of AcquisitionSub to accept for exchange and deliver consideration for shares of our commonstock validly tendered in the offer (and not withdrawn) is subject to usual andcustomary conditions pertaining to regulatory events, the absence of a courtorder barring the Merger and the related transactions and the absence ofmaterial litigation or other events giving rise to termination of thereorganization agreement, as well as the following specific conditions: 

 

•              there shall be validly tendered(and not withdrawn) a number of shares of our common stock that, together withany shares that Synopsys or Acquisition Sub already owns, represents 50% of thesum of the aggregate number of shares of our common stock issued andoutstanding immediately priorto the acceptance of shares of the common stock pursuant to the offer, plus theaggregate number of shares of our common stock that can be issued upon theexercise of all vested options, warrants and other rights to acquire our commonstock that are outstanding immediately prior to the acceptance of shares of ourcommon stock pursuant to the offer (the “Minimum Condition”); 

 

•              that Fu-Chieh Hsu and Wing-YuLeung continue to be employed by the Issuer; 

 

•              no more than 25% of the engineersemployed by us who have received offers of at-will employment from Synopsys orAcquisition Sub, on terms no less favorable then the terms of their employmentwith us on the date of the reorganization agreement, shall cease to be employedby us; 

 

•              there is no legal proceedingthreatened or pending to which a governmental body is or is threatened tobecome a party challenging or seeking to restrain or prohibit the acquisitionof or delivery of consideration in exchange for shares of common stock orseeking to prohibit or limit Synopsys’ ownership rights with respect to ourcommon stock acquired through the offer; 

 

•              the shares of Synopsys commonstock to be issued

 

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in the merger (ifthe All-Cash Election is not made) have been approved for listing on the NASDAQNational Market; and 

 

•              that Fu-Chieh Hsu and Wing-YuLeung have executed noncompetition agreements and delivered them to Synopsys.

 

The offer willinitially be scheduled to expire 20 business days following the commencement ofthe offer.  At the election ofAcquisition Sub or us, prior to such expiration, if the Minimum Condition isnot met, the offer period may be extended for additional periods of 20 businessdays, but in no case are such extensions to continue beyond July 31, 2004.

 

If Acquisition Subacquires at least a majority of our outstanding common stock pursuant to theoffer, the reorganization agreement provides that Synopsys will be entitled todesignate a number of directors to our board of directors sufficient to giveAcquisition Sub a proportionate representation on the board (“Acquisition Sub’sProportionate Representation”) equal to that number of directors (rounded up tothe next whole number) that equals the product of the total number of directorson the board multiplied by the percentage that the aggregate number of sharesof our common stock beneficially owned by Synopsys or Acquisition Sub bears tothe total number of shares of our common stock issued and outstanding.  Upon request by Acquisition Sub, we willincrease the size of the board or secure the resignations of the number ofdirectors necessary to provide Acquisition Sub with Acquisition Sub’sProportionate Representation and will cause Synopsys’ designees to be soelected or appointed; provided, however, that until the merger, the board willhave at least two directors who were our directors as of the date of signing ofthe reorganization agreement (or failing the availability of one or both ofsuch directors, a designee of the other such director or the Board).

 

Following theelection or appointment of Synopsys’ designees and until the effective time ofthe reorganization agreement, approval of a majority of the continuingdirectors who were our directors as of the date of signing the reorganizationagreement shall be required for (a) the amendment or waiver of thereorganization agreement on behalf of the Company or the certificate or bylawsof the Company; (b) any termination of the reorganization agreement by theCompany; (c) any extension affecting the performance of any obligations oracts by Synopsys or Acquisition Sub; or (d) any other consent or action bythe board with respect to the reorganization agreement.

 

The reorganizationagreement prohibits us from declaring, setting aside for payment or paying anydividend, or making any other distribution in respect of any shares of itscommon stock or otherwise making any payments to its stockholders in theircapacity as such.

 

If adoption of themerger by a vote of our stockholders is required by applicable law, under theterms of the reorganization agreement, we will take all necessary actions tocomply with such applicable law.

 

If the requirementsof the offer are fulfilled, including the Minimum Condition, and if Synopsys soelects, then

 

•                  Uponconsummation of the merger, our common stock will cease to be quoted on anyquotation system or exchange.

 

•                  Uponconsummation of the merger, our common stock will become eligible fortermination of registration pursuant to Section 12(g)(4) of the Exchange Act.

 

Concurrently with the execution of the reorganizationagreement, Fu-Chieh Hsu, Wingyu Leung, Carl Berg, who are members of our boardof directors, and Clyde J. Berg, Trustee of the 1981 Kara Ann Berg Trust, whotogether represent approximately 29% of our outstanding stock, entered into aseparate stockholder agreement with Synopsys. Each of them has agreed to tender (and not to withdraw his tender) theshares of common stock that he beneficially owns into the offer. Eachstockholder agreement also provides that prior to the tender of his shares ofcommon stock pursuant to the offer, each such stockholder is obligated to votethe shares of common stock beneficially owned by him 

 

•              in favor of the merger, theadoption of the reorganization agreement and the approval of the terms thereofand the transactions contemplated therein; 

 

•           against any action oragreement that would result in a breach in any material respect of any covenantor any other obligation or agreement of ours under the reorganization agreementor in a breach in any material respect of any representation or warranty ofours in the reorganization agreement; 

 

•              against any amendment of ourcertificate of incorporation and by-laws or any other action or agreement thatis intended or could reasonably be expected to impede, interfere with, delay, postponeor discourage the offer or the merger or change in any manner the voting rightsof our common stock.  Pursuant to eachstockholder agreement, each such stockholder has granted an irrevocable proxyto Synopsys to vote his shares of common stock on the matters listed above,which will expire on the earlier of the date upon which the reorganizationagreement is terminated in accordance with its provisions, and the date uponwhich the merger becomes effective.  Eachstockholder retains the power to vote his shares of common stock on all othermatters.

 

The stockholderagreements automatically terminate upon consummation of the merger, upon anyamendment to the reorganization agreement without our consent that decreasesthe per share merger consideration or upon termination of the reorganizationagreement in accordance with its terms. The reorganization agreement may be terminated by—

 

•              mutual consent of Synopsys and us;

 

•              either Synopsys or us if a courtor governmental body issues an order permanently enjoining or making illegalthe merger; 

 

•              either Synopsys or us if the offerexpires without Synopsys having accepted any shares of our common stock or ifthe offer shall not have been accepted by July 31, 2004; 

 

•              Synopsys if our board retracts itsrecommendation of the transaction; 

 

•              us to accept an unsolicited, bonafide written offer by a third party to purchase all of the outstanding sharesof our common stock, after the board of directors determines, consistent withits obligations under the reorganization agreement and its fiduciary duties,that such third party offer is more favorable to our stockholders than theSynopsys offer, after providing Synopsys with an opportunity to amend the offeror enter into an 

 

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                alternative transaction with the Issuer and thenafter paying a termination fee to Synopsys of $10 million;

 

•              Synopsys if our representationsand warranties are materially inaccurate, such that there has been a materialadverse effect on the Issuer, or any of our covenants shall have beenmaterially breached, after we have had an opportunity to cure such breach orinaccuracy, and after paying the Issuer a termination fee of $10 million; 

 

•              us if any of Synopsys’representations and warranties are materially inaccurate or if its covenantsare materially breached, which causes a material adverse effect on Synopsys’ability to consummate the merger, and after Synopsys has had an opportunity tocure such breach or inaccuracy; or 

 

•              Synopsys if a material adverseeffect shall have occurred or is reasonably likely to occur with respect to us,and after paying us a termination fee of $10 million.

 

During the termof each stockholder agreement, the participating stockholder has agreed, exceptas otherwise contemplated by the stockholder agreement, not to grant anyproxies relating to, or sell, transfer, give, pledge, encumber, assign orotherwise dispose of any shares of common stock.  Any additional shares of common stock acquired by such stockholderduring the term of the reorganization agreement also will be subject to thestockholder agreement.

 

We and our board of directorsbelieve that the combination with Synopsys will significantly enhance ourability to realize our strategic goals. With the greater engineering, sales and financial resources possessed bySynopsys, and its substantial distribution channels, we believe we will be ableto more rapidly proliferate our 1T-SRAM technologies, increase the volume ofour licensing activities, increase the number of design projects that we canmanage, innovate more quickly, penetrate more accounts and substantiallyincrease revenue from our intellectual property licensing activities.

 

**Risk Factors**

 

*Ifany of the following risks actually occur, our business, results of operationsand financial condition could suffer significantly.*

 

**Our success depends upon the semiconductor market’s acceptance of our1T-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. Our technologyis intended to allow our licensees to develop embedded memory integratedcircuits to replace other embedded memory technology with different cost andperformance parameters. Our 1T-SRAM technologies utilize fundamentallydifferent internal circuitry that is not widely known in the semiconductorindustry. Therefore, one of our principal challenges, which we might fail tomeet, is to convince a substantial percentage of SOC designers to adopt ourtechnology instead of other memory solutions which have proven effective intheir products.

 

An important part of our strategy to gain marketacceptance is to penetrate new markets by targeting market leaders as licenseesof our technology. This strategy is designed to encourage other participants inthose markets to follow these leaders in adopting our technology. Should ahigh-profile industry participant adopt our technology for one or more of itsproducts but fail to achieve success with those products, other industryparticipants’ perception of our technology could be harmed. Any such eventcould reduce the number of future licenses of our technology. Likewise, were amarket leader to adopt and achieve success with a competing technology, ourreputation and licensing program could be harmed.

 

Our embedded memory technology might not integrate aswell as anticipated with other semiconductor functions in all intendedapplications, which would slow or prevent adoption of our technology and reduceour revenue. Detailed aspects of our technology could cause unforeseen problemsin the efficient integration of our technology with other functions ofparticular integrated circuits. Any significant compatibility problems with ourtechnology could reduce the attractiveness of our solution, impede itsacceptance in the industry and result in a decrease in demand for ourtechnology.

 

**Our lengthy licensing cycle and our licensees’ lengthy product developmentcycles make the operating results of our licensing business difficult topredict.**

 

We anticipatedifficulty in accurately predicting the timing and amounts of revenue generatedfrom licensing our 1T-SRAM technologies. The establishment of a business relationshipwith a potential licensee is a lengthy process, generally taking from three tonine months, and sometimes longer. Following the establishment of therelationship, the negotiation of licensing terms can be time-consuming, and apotential licensee may require an extended evaluation and testing period.

 

Once a licenseagreement has been executed, the timing and amount of licensing and royaltyrevenue from our licensing business will remain difficult to predict. Thecompletion of the licensees’ development projects and the commencement ofproduction will be subject to the licensees’ efforts, development risks andother factors outside our control. Our royalty revenue may depend on suchfactors as success of the licensees’ project, the licensees’ production andshipment volumes, the timing of product shipments and when the licensees reportto us the manufacture or sale of products that include our 1T-SRAMtechnologies. All of these factors will prevent us from making predictions ofrevenue with any certainty and could cause us to experience substantialperiod-to-period

 

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fluctuations in operatingresults.

 

None of ourlicensees are under any obligation to incorporate our technology in any presentor future product or to pursue the manufacture or sale of any productincorporating our technology. A licensee’s decision to complete a project ormanufacture a product is subject to changing economic, marketing or strategicfactors. The long development cycle of our licensees’ products increases therisk that these factors will cause the licensee to change its plans. In thepast, some of our licensees have discontinued development of productsincorporating our technology. These customers’ decisions were based on factorsunrelated to our technology, but, as a result, it is unlikely that we willreceive royalties in connection with those products. We expect thatoccasionally our licensees will discontinue a product line or cancel a productintroduction, which could adversely affect our future operating results andbusiness.

 

**If the market for system-on-a-chipintegrated circuits does not expand, our business may suffer.**

 

Our ability to achieve sustained revenue growth andprofitability in the future will depend on the continued development of themarket for SoC integrated circuits. SoC integrated circuits are characterizedby rapid technological change and competition from an increasing number ofalternate design strategies such as combining multiple integrated circuits tocreate a system-on-a-package. We cannot be certain that the market for SoCintegrated circuits will continue to develop or grow at a rate sufficient tosupport our business.  If the marketfails to grow or develops slower than expected, our business may suffer.

 

**The semiconductor industry is cyclical innature and subject to periodic downturns, which can negatively affect ourrevenue.**

 

Thesemiconductor industry is cyclical and has experienced a pronounced downturnover the past few years.  To respond tothis downturn, many semiconductor manufacturers and their customer have slowedtheir research and development activities, canceled or delayed new productdevelopments, reduced their workforces and inventories and taken a cautiousapproach to acquiring new equipment and technologies.  As a result, our business has been adversely affected in 2003,and we believe that a continued downturn could negatively impact our futurerevenue and profitability.  In thefuture, the cyclical nature of the semiconductor industry may cause ouroperating results to fluctuate significantly from year-to-year, which also maytend to increase the volatility of the price of our common stock.

 

**We might be unable to deliver our customized memory technology in thetime frame demanded by our licensees, which could damage our reputation, harmour ability to attract future licensees and impact operating results.**

 

The majority ofour licenses require us to customize our 1T-SRAM technologies within a certaindelivery timetable. Not all of the factors relating to this customization arewithin our control. There might be factors outside our control that couldinfluence our ability to meet the time requirements under these licenses. Anyfailure to meet significant license milestones could damage our reputation inthe industry, harm our ability to attract new licensees, preclude our receiptof licensing fees and negatively impact our operating results.

 

Generating andrecognizing licensing revenue under these contracts depends on our ability tosuccessfully meet milestones for delivery of 1T-SRAM designs and services.  We may fail to meet a delivery date orperformance criterion, thereby resulting in a delay in revenue recognition orloss of anticipated revenue.

 

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

 

We believe that our long-term success is substantiallydependent on the receipt of future royalties. Royalty payments owed to us are calculated based on factors such as our licensees’ sellingprices, wafer production, and other variables as provided in each licenseagreement.  The amount of royalties wewill receive depends on the licensees’ business success, production volumes andother factors beyond our control.  Thisexposes our business model to risks that we cannot minimize directly and mayresult in significant fluctuations in our royalty revenue and operating resultsfrom quarter-to-quarter.  We recognize royaltyrevenue in the quarter in which we receive a royalty report from ourlicensee.  As a result, our recognitionof royalty revenue typically lags behind the quarter in which the relatedintegrated circuit is manufactured or sold by our licensee by at least onequarter. We cannot be certain that our business strategy will be successful inexpanding the number of licensees, nor can we be certain that we will receivesignificant royalty revenue in the future.

 

**We expect our revenue to be highly concentrated among a small number oflicensees and customers, and our results of operations could be harmed if welose and fail to replace this revenue.**

 

Our royaltyrevenue has been highly concentrated among a few licensees, and we expect thistrend to continue for the foreseeable future. In particular, a substantialportion of our licensing and royalty revenue in 2003, 2002 and 2001 has comefrom the licenses for integrated circuits used by Nintendo in its GAMECUBE®.Gamecube-related revenue represented 13%, 44% and 23% of total revenue in 2003,2002 and 2001, respectively.  Moreover,Nintendo faces intense competitive pressure in the video game market, which ischaracterized by extreme volatility, costly new product introductions andrapidly shifting consumer preferences. Nintendo has publicly announced thatsales of Gamecube units to date have been significantly less than itsexpectations when it launched this video

 

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game console.   We cannot assure you that Nintendo’s salesof product incorporating our technology will increase beyond prior or currentlevels.

 

Furthermore,our overall revenue has been highly concentrated, with a few customersaccounting for a significant percentage of our total revenue. For the yearended December 31, 2003, our three largest customers, SONY, NEC and UMCrepresented 17%, 14%, and 11% of total revenue, respectively. For the yearended December 31, 2002, our two largest customers, NEC and UMCrepresented 38% and 12% of total revenue, respectively. For the year endedDecember 31, 2001, our two largest customers, Cisco Systems and NECrepresented 22% and 19% of total revenue, respectively. We expect that arelatively small number of licensees will continue to account for a substantialportion of our revenue for the foreseeable future.

 

As a result ofthis revenue 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 couldnegatively affect our cash flow and financial condition.**

 

We might alsoface credit risks associated with the concentration of our revenue among asmall number of licensees and customers. As of December 31, 2003, fivecustomers represented 72% of total trade receivables. As of December 31,2002, three customers represented 85% of total trade receivables. Our failureto collect receivables from any customer that represents a large percentage ofreceivables on a timely basis, or at all, could adversely affect our cash flowor results of operations and might cause our stock price to fall.

 

**Anything that negatively affects the businesses of our licensees couldnegatively impact our revenue.**

 

The timing andlevel of our royalties depend on our licensees’ ability to market, produce andship products incorporating our technology. Because we expect licensing androyalty revenue to be the largest source of our future revenue, anything thatnegatively affects a significant licensee or group of licensees couldnegatively affect our results of operations and financial condition. Manyissues beyond our control influence the success of our licensees, including,for example, the highly competitive environment in which they operate, thestrength of the markets for their products, their engineering capabilities andtheir financial and other resources.

 

Likewise, wehave no control over the product development, pricing and marketing strategiesof our licensees, which directly affect sales of their products and thecorresponding royalties payable to us. 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 stock priceto fall.

 

**Our embedded memory technology is new and the occurrence of manufacturingdifficulties, or low production yields could hinder market acceptance of ourtechnology and reduce future revenue.**

 

Complextechnology like ours may contain errors or defects when first incorporated intocustomer products. For example, semiconductor manufacturing yield could beadversely affected by difficulties in adapting our 1T-SRAM technologies to ourlicensees’ product design or to the manufacturing process technology of aparticular foundry or semiconductor manufacturer. Any decrease in manufacturingyields of integrated circuits utilizing our technology could impede theacceptance of our technology in the industry. The discovery of defects orproblems regarding the reliability, quality or compatibility of our technologycould require significant expenditures and resources to fix, significantlydelay or hinder market acceptance of our technology, reduce anticipatedrevenues and damage our reputation.

 

**Our failure to continue to enhance our technology or develop newtechnology on a timely basis could diminish our ability to attract and retainlicensees and product customers.**

 

The existingand potential markets for memory products and technology are characterized byever increasing performance requirements, evolving industry standards, rapidtechnological change and product obsolescence. These characteristics lead tofrequent new product and technology introductions and enhancements, shorterproduct life cycles and changes in consumer demands. In order to attain andmaintain a significant position in the market, we will need to continue toenhance our technology in anticipation of these market trends.

 

In addition,the semiconductor industry might adopt or develop a completely differentapproach to utilizing memory for many applications, which could render ourexisting technology unmarketable or obsolete. We might not be able tosuccessfully develop new technology, or adapt our existing technology, tocomply 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;

 

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•                                          develop and maintain competitivetechnology by improving performance and adding innovative features thatdifferentiate our technology from alternative technologies;

 

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

 

•                                          respond effectively to newtechnological developments or new product introductions by others.

 

Since itsintroduction in 1998, we have introduced enhancements to our 1T-SRAM technologydesigned to meet market requirements. However, we cannot assure you that thedesign and introduction schedules of any additions and enhancements to ourexisting and future technology will be met, that this technology will achievemarket acceptance or that we will be able to license this technology on termsthat are favorable to us. Our failure to develop future technology thatachieves market acceptance could harm our competitive position and impede ourfuture growth.

 

**Ourquarterly revenues may fluctuate significantly and as a result we cannotprovide assurance of our future profitability.**

 

Our quarterlyrevenues have fluctuated in the past, and may in the future as a result of manyfactors, some of which are beyond our control. These factors would include the following:

 

•                  the length of our sales cycle;

 

•                  deferred spending decisions bycustomers;

 

•                  the cyclical nature of thesemiconductor industry and the general economic environment;

 

•                  the timing and completion ofmilestones under license agreements; and

 

•                  changes in the demand forintegrated circuits that incorporate our technology.

 

We believe thatperiod-to-period comparisons of our revenues and operating results are notnecessarily meaningful and these comparisons are not indicators of futureperformance.  We intend to continue ourinvestment in research and development as well as in the marketing andlicensing of our technology in an effort to maximize future results.  If revenue falls below our expectations inany quarter and we are not able to adjust spending in a timely manner, we mayincur an operation loss.  As a result,we cannot assure you that we will be profitable on a quarterly or annual basisin the future.

 

**We rely on semiconductor foundries to assist us in attracting potentiallicensees, and a loss or failure of these relationships could inhibit ourgrowth and reduce our revenue.**

 

Part of ourmarketing strategy relies upon our relationships and agreements withsemiconductor foundries. These foundries have existing relationships, andcontinually seek new relationships, with companies in the markets we target,and have agreed to utilize these relationships to introduce our technology topotential licensees. If we fail to maintain our current relationships withthese foundries, we might fail to achieve anticipated growth.

 

**Royalty amounts owed to us might be difficult to verify, and we mightfind it difficult, expensive and time-consuming to enforce our licenseagreements.**

 

The standardterms of our license agreements require our licensees to document themanufacture and sale of products that incorporate our technology and reportthis data to us after the end of each quarter. Though our standard licenseterms give us the right to audit the books and records of any licensee toattempt to verify the information provided to us in these reports, an audit ofa licensee’s records can be expensive and time consuming, and potentiallydetrimental to the business relationship. A failure to fully enforce theroyalty provisions of our license agreements could cause our revenue todecrease and impede our ability to maintain profitability.

 

**We might not be able to protect and enforce our intellectual propertyrights, which could impair our ability to compete and reduce the value of ourtechnology.**

 

Our technologyis complex and is intended for use in complicated integrated circuits. A verylarge number of new and existing products utilize embedded memory, and a largenumber of companies manufacture and market these products. Because of thesefactors, policing the unauthorized use of our intellectual property isdifficult and expensive. We cannot be certain that we will be able

 

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to detect unauthorized use ofour technology or prevent other parties from designing and marketingunauthorized products based on our technology. Although we are not aware of 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 intellectual property wouldreduce significantly the barriers of entry for directly competing technologiesand could reduce the value of our technology. Furthermore, we might initiateclaims or litigation against third parties for infringement of our proprietaryrights or to establish the validity of our proprietary rights. Litigation by uscould result in significant expense and divert the efforts of our technical andmanagement personnel, whether or not such litigation results in a determinationfavorable to us.

 

**Our existing patents might not provide us with sufficient protection ofour intellectual property, and our patent applications might not result in theissuance of patents, either of which could reduce the value of our coretechnology and harm our business.**

 

We rely on acombination of patents, trademarks, copyrights, trade secret laws andconfidentiality procedures to protect our intellectual property rights. As ofDecember 31, 2003, we held 64 patents in the United States, which expire atvarious times from 2011 to 2022, and 36 corresponding foreign patents. In addition,as of December 31, 2003, we had 15 patent applications pending in the UnitedStates and 26 pending foreign applications, and had received notice ofallowance of five patent applications pending in the United States. We cannotbe sure that any patents will issue from any of our pending applications orthat any claims allowed from pending applications will be of sufficient scopeor strength, or issued in all countries where our products can be sold, toprovide meaningful protection or any commercial advantage to us. Also,competitors might be able to design around our patents. Failure of our patentsor patent applications to provide meaningful protection might allow others toutilize our technology without any compensation to us and impair our ability toincrease our licensing revenue.

 

**Any claim that our products or technology infringe third-partyintellectual property rights could increase our costs of operation and distractmanagement and could result in expensive settlement costs or the discontinuanceof our technology licensing or product offerings.**

 

Thesemiconductor industry is characterized by vigorous protection and pursuit ofintellectual property rights or positions, which has resulted in oftenprotracted and expensive litigation. We are not aware of any currently pendingintellectual property litigation or threatened claim against us. However, ourlicensees or we might, from time to time, receive notice of claims that we haveinfringed patents or other intellectual property rights owned by others.Litigation against us could result in significant expense and divert theefforts of our technical and management personnel, whether or not thelitigation results in a determination adverse to us. In the event of an adverseresult in any such litigation, we could be required to pay substantial damages,cease the licensing of certain technology or the sale of infringing products,and expend significant resources to develop non-infringing technology or obtainlicenses for the infringing technology. We cannot assure you that we would besuccessful in such development or that such licenses would be available onreasonable terms, or at all.

 

**The discovery of defects in our technology could expose us to liabilityfor damages.**

 

The discoveryof a defect in our 1T-SRAM technology could lead our licensees to seek damagesfrom us. Our standard license terms include provisions waiving impliedwarranties regarding our technology and limiting our liability to ourlicensees. We also maintain insurance coverage that is intended to protect usagainst potential liability for defects in our technology. We cannot becertain, however, that the waivers or limitations of liability contained in ourlicense contracts will be enforceable, that insurance coverage will continue tobe available on reasonable terms or in amounts sufficient to cover one or morelarge claims or that our insurer will not disclaim coverage as to any futureclaim. The successful assertion of one or more large claims that exceedavailable insurance coverage or changes in our insurance policies, includingpremium increases or the imposition of large deductible or co-insurancerequirements, could cause our expenses to rise significantly and consequentlyharm our profitability.

 

**Our failure to compete effectively in the market for embedded memorytechnology could reduce our revenue.**

 

There existssignificant competition in the market for embedded memory technologies. Ourlicensees and prospective licensees can meet their need for embedded memory byusing traditional memory solutions with different cost and performanceparameters, which they may internally develop or acquire from third partyvendors. If alternative technologies are developed that provide comparablesystem performance at lower cost than our 1T-SRAM technologies or do notrequire the payment of comparable royalties, or if the industry generallydemonstrates a preference for applications for which our 1T-SRAM technologiesdo not offer significant advantages, our ability to realize revenue from our1T-SRAM technologies could be impaired.

 

We might bechallenged by competitive developers of alternative technologies who are moreestablished, benefit from greater market recognition and have substantiallygreater financial, development, manufacturing and marketing resources than wehave. These advantages might permit these developers to respond more quickly tonew or emerging technologies and changes in licensee requirements. We cannotassure you that future competition will not have a material adverse effect onthe adoption of our technology and our market penetration.

 

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**Our failure to manage the growth of our business could reduce ourpotential revenue and threaten our future profitability.**

 

The size of ourcompany has increased substantially over the past three years, as we grew from43 employees in January 2001 to 92 employees in December 2003. 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 newmarketing channels to penetrate different and broader markets for our 1T-SRAMtechnologies;

 

•                                          manage an increasing number ofcomplex relationships with licensees and co-marketers and their customers andother third parties;

 

•                                          improve our operating systems,procedures and financial controls on a timely basis;

 

•                                          hire additional key managementand technical personnel; and

 

•                                          expand, train and manage ourworkforce and, in particular, our development, sales, marketing and supportorganizations.

 

We cannotassure you that we will adequately manage our growth or meet the foregoingobjectives. A failure to do so could jeopardize our future revenues and causeour stock price to fall.

 

**Any acquisitions we make, such as our acquisition of ATMOS Corporation,could disrupt our business and harm our financial condition.**

 

As part of ourgrowth strategy, we might consider opportunities to acquire other businesses ortechnologies that would complement our current offerings, expand the breadth ofour markets or enhance our technical capabilities. ATMOS Corporation is ouronly acquisition to date. Acquisitions present a number of potential challengesthat could, if not overcome, disrupt our business operations, increase ouroperating costs and reduce the value to us of the acquired company, including—

 

•                                          integration of the acquiredemployees, operations, technologies and products with our existing business andproducts;

 

•                                          focusing management’s time andattention on our core business;

 

•                                          retention of businessrelationships with suppliers and customers of the acquired company;

 

•                                          entering markets in which welack prior experience;

 

•                                          retention of key employees ofthe acquired company; and

 

•                                          amortization of intangibleassets, write-offs, stock-based compensation and other charges relating to theacquired business and our acquisition costs.

 

**If we fail to retain key personnel, our business and growth could benegatively affected.**

 

Our businesshas been dependent to a significant degree upon the services of a small numberof executive officers and technical employees, including Dr. Fu-Chieh Hsu,our Chairman of the Board, President and Chief Executive Officer, andDr. Wingyu Leung, our Executive Vice President and Chief TechnicalOfficer. The loss of their services could negatively impact our technologydevelopment efforts and our ability to perform our existing agreements andobtain new customers. We generally have not entered into employment ornon-competition agreements with any of our employees and do not maintainkey-man life insurance on the lives of any of our key personnel.

 

**Our failure to successfully address the potential difficulties associatedwith our international operations could increase our costs of operation andnegatively impact our revenue.**

 

We are subjectto many difficulties posed by doing business internationally, including—

 

•                                          foreign currency exchangefluctuations;

 

•                                          unanticipated changes in localregulation;

 

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•                                          potentially adverse taxconsequences, such as withholding taxes;

 

•                                          difficulties regarding timingand availability of export and import licenses;

 

•                                          political and economicinstability; and

 

•                                          reduced or limited protection ofour intellectual property.

 

Because weanticipate that licenses to companies that operate primarily outside the UnitedStates will account for a substantial portion of our licensing revenue infuture periods, the occurrence of any of these circumstances couldsignificantly increase our costs of operation, delay the timing of our revenueand harm our profitability.

 

**Provisions of our certificate of incorporation and bylaws or Delaware lawmight delay or prevent a change of control transaction and depress the marketprice of our stock.**

 

Variousprovisions of our certificate of incorporation and bylaws might have the effectof making it more difficult for a third party to acquire, or discouraging athird party from attempting to acquire, control of our company. Theseprovisions could limit the price that certain investors might be willing to payin the future for shares of our common stock. Certain of these provisionseliminate cumulative voting in the election of directors, limit the right ofstockholders to call special meetings and establish specific procedures fordirector nominations by stockholders and the submission of other proposals forconsideration at stockholder meetings.

 

We are alsosubject to provisions of Delaware law which could delay or make more difficulta merger, tender offer or proxy contest involving our company. In particular,Section 203 of the Delaware General Corporation Law prohibits a Delawarecorporation from engaging in any business combination with any interestedstockholder for a period of three years unless specific conditions are met. Anyof these provisions could have the effect of delaying, deferring or preventinga change in control, including without limitation, discouraging a proxy contestor making more difficult the acquisition of a substantial block of our commonstock.

 

Our 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.

 

**Our stockholder rights plan could prevent stockholders from receiving apremium over the market price for their shares from a potential acquiror.**

 

We have adopteda stockholder 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 commences or announces its intent to commence a tenderoffer for at least 15% of our common stock. This plan could delay, deter orprevent an investor from acquiring us in a transaction that could otherwiseresult in stockholders receiving a premium over the market price for theirshares of common stock.

 

**A limited number of stockholders have the ability to influence theoutcome of director elections and other matters requiring stockholder approval.**

 

Our executiveofficers, directors and their affiliates or non-affiliate related entities, inthe aggregate, beneficially own approximately 29% of our common stock. Thesestockholders acting together have the ability to exert substantial influenceover all matters requiring the approval of our stockholders, including theelection and removal of directors and any proposed acquisition, consolidationor sale of all or substantially all of our assets. In addition, they coulddictate the management of our business and affairs. This concentration ofownership could have the effect of delaying, deferring or preventing a changein control, or impeding an acquisition, consolidation, takeover or otherbusiness combination, which might otherwise involve the payment of a premiumfor your shares of our common stock.

 

**Potential volatility of the price of our common stock could negativelyaffect your investment.**

 

We cannotassure you that there will continue to be an active trading market for ourcommon stock. Recently, the stock market, as well as our common stock, hasexperienced significant price and volume fluctuations. Market prices ofsecurities of technology companies have been highly volatile and frequentlyreach levels that bear no relationship to the operating performance of suchcompanies. These market prices generally are not sustainable and are subject towide variations. If our common stock trades to unsustainably high levels, it islikely that the market price of our common stock will thereafter experience amaterial decline.

 

In the past,securities class action litigation has often been brought against a companyfollowing periods of volatility in the market price of its securities. We couldbe the target of similar litigation in the future. Securities litigation couldcause us to incur substantial costs, divert management’s attention andresources, harm our reputation in the industry and the securities markets and

 

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reduce our profitability.

 

**The price of our stock could decrease as a result of shares being sold inthe market by directors, officers and other significant stockholders.**

Sales of asubstantial number of shares of common stock in the public market couldadversely affect the market price of the common stock prevailing from time totime. The number of shares of our common stock available for sale in the publicmarket is limited by restrictions under the Securities Act of 1933, as amended,or the Securities Act, but taking into account sales of stock made inaccordance with the provisions of Rules 144(k), 144 and 701, substantiallyall the shares of common stock currently outstanding are eligible for sale inthe public market.

 

## ***Risks Relating to the Offer and the Merger***

 

**If the offer and merger are notcompleted our stock price may decline, we will have incurred significant costs,we may be liable for termination and other fees and our business may be harmed.**

 

If the offer and merger are not completed, we may be subject to anumber of substantial risks, including the following:

 

•      The price of our common stock may decline,including to the extent the current price of our common stock reflects theprice of the offer;

 

•      We may be required to pay Synopsys atermination fee of $10 million if the reorganization agreement is terminatedunder certain circumstances; 

 

•      We will be required to pay significantcosts related to the offer and the merger, including legal, accounting andfinancial advisory fees, although we are entitled to reimbursement of up to$750,000 for fees and expenses incurred in connection with the offer and mergerupon termination of the reorganization agreement under certain circumstances;and

 

•      Our reputation and relationships with ourcustomers, suppliers, distributors, licensors and employees may be harmed.

** **

**Our business and prospects may havebeen adversely impacted by the offer and merger.**

 

                The negotiationand announcement of the offer and merger, and the uncertainty regarding ourbusiness pending the completion of the offer and merger, may have a number ofnegative affects on our business, including the following:

 

•      Our management will have been divertedfrom day-to-day business operations, possibly leading to a loss of revenues andmarket position;

 

•      Our current and potential customers mayhave delayed or cancelled purchasing decisions in response to the offer andmerger, resulting in a material decline in our revenues;

 

•      Our business partners, includingsuppliers, distributors and licensors, may have adversely changed or terminatedtheir relationships with us in response to the offer and the merger; and

 

•      Our employees may experience uncertaintyabout their future role with us, harming our ability to attract and retain keymanagement, sales and technical personnel.

 

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**The offer and merger may be delayed,modified or terminated because of potential antitrust review by governmentalauthorities.**

 

                Governmentalauthorities could delay the completion of the offer and merger by requestingextensive information regarding its impact on competition. By alleging that theoffer and merger are anti-competitive, they could seek to prevent the offer andmerger, modify the terms of the offer and merger, or impose restrictiveoperating, divestiture or other conditions on the combined company. We believethat the completion of the offer and the merger will not violate any antitrustlaws, however, any of these outcomes could cause harm to us and Synopsys,substantial delay in completing the offer and merger, if it is completed atall, and harm to the combined company if the offer and merger is neverthelesscompleted.

 

**The offer and merger may not becompleted.**

 

The completion of the offer and the merger are subject to certainconditions pursuant to the reorganization agreement which may not be satisfiedor waived.

 

Synopsys’ obligation to accept shares in the offer are subject tocertain conditions.  If the conditionsto the completion of the offer are not satisfied, Synopsys may terminate theoffer and the transaction will not close. The conditions to the completion of the offer by Synopsys include thefollowing:

 

•      that an amount of shares have beentendered that represents more than 50% of the outstanding shares of our commonstock (taking into account shares owned by Synopsys and its subsidiaries andoutstanding options to purchase shares of our common stock);

 

•      that Fu-Chieh Hsu and Wing-Yu Leungcontinue to be employed by us; and

 

•      that no more than 25% of the engineersemployed by us who have received offers of at-will employment from Synopsyswill cease to be employed by us.

 

The closing of the merger is subject to the satisfaction of certainconditions, including the following:

 

•      that, if such a vote is required, thereorganization agreement has been duly adopted by the required vote of ourstockholders;

 

•      that no temporary restraining order,injunction or other order preventing consummation of the merger has been issuedand remains in effect and there are no other applicable legal restrictions thatwould make the merger illegal;

 

•      that the registration statement filed bySynopsys shall have been declared effective by the SEC;

 

•      that the shares of Synopsys common stockto be issued in the offer (if the all-cash election is not made) have beenapproved for listing with The Nasdaq National Market; and

 

•      that Synopsys has accepted all validlytendered shares in the offer.

 

If the reorganization agreement is terminated, the offer and the mergerwill not be completed.  Thereorganization agreement may be terminated under certain circumstances,including the following:

 

•      by the mutual consent of us and Synopsys;

 

•      by us or Synopsys if a court orgovernmental body issues an order permanently enjoining or making illegal themerger;

 

•      by us or Synopsys if the offer expireswithout Synopsys accepting any shares of our common stock or if the offer hasnot been accepted by July 31, 2004;

 

•      by Synopsys if our board retracts itsrecommendation of the offer and the merger;

 

•      by us to accept an unsolicited, bona fidewritten offer by a third party to purchase all of the outstanding shares of ourcommon stock after our board concludes that such offer is more favorable to ourstockholders than the offer and the merger;

 

•      by Synopsys if our representations andwarranties are materially inaccurate resulting in a material adverse effect onus or if our covenants are materially breached and not cured and after payingus a termination fee of $10 million;

 

•      by us if Synopys’ representations andwarranties are materially inaccurate or if its covenants are materiallybreached resulting in a material adverse effect on Synopsys’ ability tocomplete the merger and such breach has not been cured; and

 

•      by Synopsys if a material adverse effectwith respect to us has occurred or is reasonably likely to occur and afterpaying us a termination fee of $10 million.

 

**Synopsys may not realize the benefitsit expects from the offer and merger if the integration is not successful, andthe stock price of any shares of common stock of Synopsys that you receive inthe offer may decline accordingly.**

** **

Synopsys may not realize the benefits it expects from the offer andmerger if Synopsys' operations and our operations are not successfullyintegrated. Among other integration challenges, the combined company musteffectively do the following:

 

•      Integrate our technology and products intoSynopsys' portfolio of intellectual property for system-on-chips and EDA designflow;

 

•      Integrate our revenue model withinSynopsys' revenue model;

 

•      Coordinate Synopsys' and our sales forces,build sales momentum, and minimize the disruption to our business and revenuescaused by the offer and merger;

 

•      Communicate the capabilities of thecombined company and cross-sell related products to Synopsys' and ourcustomers;

 

•      Recruit and retain key personel, includingDr. Fu-Chieh Hsu and Dr. Wing-Yu Leung;

 

•      Incorporate our technical knowledge intoSynopsys' engineering organization;

 

•      Maintain and build key alliances onattractive terms with partners and suppliers;

 

•      Create and effectively implement uniformstandards, controls, procedures, policies and information systems;

 

•      Manage intense demands for management timeand attention caused by the integration efforts; and

 

•      Manage unanticipated expenses, liabilitiesand delays.

 

                Any failure tointegrate Synopsys' operations and our operations successfully could have amaterial adverse effect on the business, prospects and results of operations ofthe combined company.

 

 

***Item 2. Properties***

 

Our principal administrative, sales, marketing, support and researchand development functions are located in a leased facility in Sunnyvale,California. We currently occupy approximately 19,500 square feet of space inthe Sunnyvale facility, the lease for which extends through June 2005. Wehold an option to extend our lease for three additional years. 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. Wehave leased approximately 1,400 square feet of space in Seoul, South Korea forour engineering design center. The lease expires at the end ofApril 2005.  Additionally, we haveleased approximately 900 square feet of space in Tokyo, Japan and 140 squarefeet of space in Sophia-Antipolis, France for our sales and marketing offices.  These leases expire at the end of January2005 and March 2005, respectively. We believe that our existing facilities areadequate to meet our current needs.

 

***Item 3. LegalProceedings***

 

From time to time we may be subject to legal proceedings and claims inthe ordinary course of business. These claims, even if not meritorious, couldresult in the expenditure of significant financial and managerial resources. Weare not aware of any legal proceedings or claims that we believe could harm ourbusiness or cause our revenues or stock price to fall.

 

***Item 4. Submission of Matters to a Vote ofSecurity Holders***

 

No matter was submitted to a vote of stockholders during the fourthquarter of the fiscal year covered by this report.

 

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**Part II**

 

***Item 5. Market for Registrant’s Common Equityand Related Stockholder Matters***

 

Our common stock is quoted on the NASDAQ National Market under thesymbol MOSY. The following table sets forth the range of high and low sales pricesof our common stock for each period indicated.

 
| **Quarter ending**  |   | **High** |   | **Low** |   |
|---------------------|--------|----------|--------|---------|--------|
|                |   |     |   |    |   |
| December 31,  2003  |   | $        | 9.05   |    | $      | 6.64 |   |
| September 30,  2003 |   | $        | 13.12  |    | $      | 8.10 |   |
| June 30, 2003       |   | $        | 9.40   |    | $      | 5.70 |   |
| March 31, 2003      |   | $        | 12.64  |    | $      | 5.35 |   |
| December 31,  2002  |   | $        | 15.38  |    | $      | 6.99 |   |
| September 30,  2002 |   | $        | 10.95  |    | $      | 6.94 |   |
| June 30, 2002       |   | $        | 15.05  |    | $      | 8.26 |   |
| March 31, 2002      |   | $        | 22.77  |    | $      | 10.04 |   |

 

We had 90 shareholders of record as of February 23, 2004. We havenot declared or paid any cash dividends on its common stock and presentlyintends to retain its future earnings, if any, to fund the development andgrowth of its business and, therefore, do not anticipate paying any cashdividends in the foreseeable future.

 

*EquityCompensation Plan Information*

 

*OtherInformation*

 

The Securities and Exchange Commission declared the Company’s firstregistration statement, filed on 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 Companyrealized approximately $51.6 million after offering expenses. To date, theCompany has not used any of the net proceeds of the IPO except to acquireshort-term and long-term investments and cash equivalents. Following the completionof the Company’s IPO, all series of the Company’s issued and outstandingpreferred stock, par value $0.01, converted automatically into 12,731,446shares of its common stock with a par value of $0.01 per share.

 

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***Item6. Selected Financial Data***

 

The following selected financialdata presented below are derived from our consolidated financial statements.The selected financial data should be read in conjunction with our financialstatements 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,**               |   |
|------------------------------------------------|--------|--------------------------------------------|--------|
|                                           |   | **2003**                                   |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|                                           |   | **(in  thousands, except per share data)** |   |
|                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| **Consolidated  Statements of Income Data:**   |   |                                       |   |   |   |   |   |   |   |   |   |
| Net revenue:                                   |   |                                       |   |   |   |   |   |   |   |   |   |
| Product                                        |   | $                                          | 1,904  |   | $ | 2,924 |   | $ | 12,991 |   | $ | 12,893 |   | $ | 15,356 |   |
| Licensing                                      |   | 10,418                                     |   | 10,523 |   | 6,053 |   | 1,440 |   | — |   |
| Royalty                                        |   | 6,911                                      |   | 14,344 |   | 3,446 |   | 10 |   | — |   |
|                                           |   | 19,233                                     |   | 27,791 |   | 22,490 |   | 14,343 |   | 15,356 |   |
|                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Cost of net  revenue:                          |   |                                       |   |   |   |   |   |   |   |   |   |
| Product                                        |   | 1,217                                      |   | 1,668 |   | 5,776 |   | 5,388 |   | 10,062 |   |
| Licensing                                      |   | 1,970                                      |   | 1,730 |   | 633 |   | 517 |   | — |   |
|                                           |   | 3,187                                      |   | 3,398 |   | 6,409 |   | 5,905 |   | 10,062 |   |
| Gross profit                                   |   | 16,046                                     |   | 24,393 |   | 16,081 |   | 8,438 |   | 5,294 |   |
| Operating  expenses:                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Research and  development                      |   | 8,593                                      |   | 6,586 |   | 4,420 |   | 3,341 |   | 3,110 |   |
| Selling, general  and administrative           |   | 6,121                                      |   | 4,950 |   | 4,686 |   | 3,523 |   | 2,388 |   |
| Stock-based  compensation charge*              |   | 459                                        |   | 656 |   | 1,435 |   | 1,085 |   | 107 |   |
| Total operating  expenses                      |   | 15,173                                     |   | 12,192 |   | 10,541 |   | 7,949 |   | 5,605 |   |
| Income (loss)  from operations                 |   | 873                                        |   | 12,201 |   | 5,540 |   | 489 |   | (311 | ) |
| Interest and  other income                     |   | 1,914                                      |   | 1,539 |   | 1,818 |   | 1,149 |   | 520 |   |
| Income before income  taxes                    |   | 2,787                                      |   | 13,740 |   | 7,358 |   | 1,638 |   | 209 |   |
| Provision for  income taxes                    |   | (279                                       | )      | (1,373 | ) | (367 | ) | (308 | ) | (67 | ) |
| Net income                                     |   | $                                          | 2,508  |   | $ | 12,367 |   | $ | 6,991 |   | $ | 1,330 |   | $ | 142 |   |
| Net income per  share—basic               |   | $                                          | 0.08   |   | $ | 0.41 |   | $ | 0.35 |   | $ | 0.13 |   | $ | 0.01 |   |
| —diluted                                  |   | $                                          | 0.08   |   | $ | 0.40 |   | $ | 0.25 |   | $ | 0.05 |   | $ | 0.01 |   |
| Shares used in  computing net income per share |   |                                       |   |   |   |   |   |   |   |   |   |
| —basic                                    |   | 30,504                                     |   | 29,902 |   | 19,709 |   | 10,013 |   | 9,727 |   |
| —diluted                                  |   | 30,998                                     |   | 31,275 |   | 28,390 |   | 25,624 |   | 23,320 |   |

 

----

| * Allocation of  stock-based compensation to operating expenses: |   |   |   |   |   |   |   |   |   |   |   |
|------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Research and  development                                        |   | $      | 148    |   | $      | 340    |   | $      | 781    |   | $      | 574 |   | $ | 56 |   |
| Selling, general  and administrative                             |   | 311    |   | 316    |   | 654    |   | 511    |   | 51     |   |
|                                                             |   | $      | 459    |   | $      | 656    |   | $      | 1,435  |   | $      | 1,085 |   | $ | 107 |   |

 

24

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|                                                |   | **December  31,** |   |
|-----------------------------------------------------|--------|-------------------|--------|
|                                                |   | **2003**          |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|                                                |   |              |   |   |   |   |   |   |   |   |   |
| **Balance  Sheet Data:**                            |   |              |   |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and short-term investments  |   | $                 | 41,365 |   | $ | 68,433 |   | $ | 84,293 |   | $ | 23,397 |   | $ | 12,720 |   |
| Working capital                                     |   | 44,426            |   | 71,213 |   | 82,343 |   | 20,733 |   | 11,908 |   |
| Total assets                                        |   | 106,892           |   | 103,090 |   | 89,596 |   | 29,798 |   | 16,481 |   |
| Deferred revenue                                    |   | 506               |   | 1,779 |   | 3,418 |   | 5,973 |   | 2,045 |   |
| Mandatorily  redeemable convertible preferred stock |   | —            |   | — |   | — |   | 35,591 |   | 30,391 |   |
| Stockholders’  equity (deficit)                |   | 103,511           |   | 98,697 |   | 84,104 |   | (13,852 | ) | (17,666 | ) |
|                                                     |        |                   |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Item7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations***

 

*ThisManagement’s Discussion and Analysis of Financial Condition and Results of Operationsshould be read in conjunction with the accompanying consolidated financialstatements and notes included in this report.*

 

***Overview***

 

We design, develop, license and market 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 as SoCs. Wealso sell memory chips based on our 1T-SRAM technologies.

 

Using elementsof our existing memory technology as a foundation, we completed development ofour first memory chips incorporating our 1T-SRAM technologies in the fourthquarter of 1998. We signed our first license agreement related to our 1T-SRAMtechnologies at the end of the fourth quarter of 1998 and recognized licensingrevenue from our 1T-SRAM technologies for the first time in the first quarterof 2000. In 2001 and 2002, we introduced improved and enhanced versions of ourtechnology, 1T-SRAM-R, 1T-STRAM-M, and 1T-SRAM-Q.

 

We generatemost of our revenue from intellectual property licensingconsisting of bothlicensing revenue and royalties. Our licensing revenue consists of fees paidfor engineering development and engineering support services. Royalty revenuesare earned under each of our licensing agreements when our licenseesmanufacture or sell products that incorporate any of our 1T-SRAM technologiesand report the results to us.

 

As of December31, 2003, we had signed license agreements related to our 1T-SRAM technologieswith 41 companies, 10 of which have paid us royalties to date. Generally, weexpect our total sales cycle, or the period from our initial discussion with aprospective licensee to our receipt of royalties from the licensee’s use of our1T-SRAM technologies, to run from 18 to 24 months.

 

Effective August30, 2002, we purchased 100% of the outstanding stock of ATMOS Corporation, asemiconductor memory companyfocused on creating high-density,compiler-generated embedded memory solutions for SoC applications. The totalpurchase price for the acquisition was approximately $12.4 millionincluding direct transaction costs of $406,000. The total fair value of theconsideration paid to shareholders of ATMOS was $12.0 million, and consisted of$11.7 million in cash and 26,843 shares of our common stock that we issuedto certain ATMOS employees.  The resultsof operations of ATMOS have been included in the Company’s financial statementsfrom the date of acquisition.

 

***Sources of Revenue***

 

We generatethree types of revenue: license fees, royalties and product sales. Prior to2001, we derived almost all our revenue from the sale of memory chips. Sincethe beginning of 2001, product revenue as a percentage of our total revenue hasdeclined significantly, while license fees and royalties have grownsubstantially as a percentage of total revenue. In the third quarter of 2001,for the first time, combined license and royalty revenue exceeded productrevenue. We expect this trend to continue for the foreseeable futureandanticipate further declines in product revenue in 2004.

 

*Licensing.*   Our licenseagreements involve long sales cycles, which makes it difficult to predict whenthe agreements will be 

 

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signed and when, if ever, wewill recognize revenues under the agreements. In addition, our intellectualproperty licensing revenues fluctuate from period to period, and, it isdifficult for us to predict the timing and magnitude of such revenue fromquarter-to-quarter. Moreover, we believe that the amount of licensing revenuesfor any period is not necessarily indicative of results in any future period.Our future revenue results are subject to a number of factors, particularlythose described in Part I, “Business—Risk Factors”.

 

Our licensing revenue consistsof fees for providing circuit design, layout and design verification andgranting a license to a customer that is embedding our memory technology intoits product. For some customers, we also provide engineering support servicesto assist in the commencement of production of products utilizing the licensed1T-SRAM technologies. License fees generally range from one hundred thousanddollars to several million dollars per contract, depending on the scope andcomplexity of the development project, the licensee’s rights and the royaltiesexpected to be received under the agreement. The licensee generally pays thelicense fees in installments at the beginning of the license and upon theattainment of specified milestones. All license agreements entered into to daterequire us to meet performance specifications. For agreements involvingperformance specifications that we have not met and for which we lack thehistorical experience to reasonably estimate the costs, we defer recognition ofrevenue until the licensee manufactures products that meet the contractperformance specifications and recognize revenue under the completed contractaccounting method. Fees collected prior to revenue recognition are recorded asdeferred contract revenue. However, if the agreement involves performancespecifications that we have significant experience in meeting and the cost ofcontract completion can be reasonably estimated, we recognize revenue over theperiod in which the contract services are performed under the percentage ofcompletion accounting method. We use our labor costs incurred to measureprogress towards completion. If the amount of revenue recognized under thepercentage of completion method exceeds the amount of billings to a customer,then under the percentage of completion accounting method, we account for theexcess amount as an unbilled contract receivable. We recognized revenue inexcess of our billings for the first time in the second quarter of 2002. Ourtotal unbilled contract receivable was $1,106,000 and $693,000 as of December 31,2003 and December 31, 2002, respectively.

 

Because ourlicense agreements are associated with lengthy and complicated engineeringdevelopment projects, the completion of development and commencement ofproduction may be difficult for us to predict. Additionally, from time to time, a licensee may cancel a project duringthe development phase. Such a cancellation is not within our control and isoften 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 newer contracts allow us to retain all payments that we have received orare entitled 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 a significant period, 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 hadbeen entered into before the establishment of technological feasibility, thecosts associated with the contract would have been expensed prior to therecognition of revenue. In that case, there would be no costs associated withthat revenue recognition, and gross margin would increase for the correspondingperiod. In 2003, we recognized $759,000 of licensing revenue from cancelledprojects compared to $804,000 in the corresponding period of 2002.

 

*Royalties.*   Each licenseagreement provides for royalty payments at a stated rate. We negotiate royaltyrates by taking into account such factors as the amount of license fees to bepaid, the anticipated volume of the licensee’s sales of products utilizing ourtechnologies and the cost savings to be achieved by the licensee through theuse of our technology. Our license agreements require the licensee to reportthe manufacture or sale of products that include our technology after the endof the quarter in which the sale or manufacture occurs. We recognize royaltiesfrom reports provided by the licensee that are received in the quarterimmediately following the quarter during which the licensee has sold ormanufactured products containing our technology.

 

As with ourlicensing revenues, the timing and level of royalties are difficult topredict.  They depend on the licensee’sability to market, produce and sell products incorporating our technology. Manyof the products currently subject to licenses from us are consumer products,such as electronic game consoles, for which demand can be seasonal andgenerally highest in the fourth quarter. We would report royalties from products sold in the fourth quarter inthe first quarter of the following year. Furthermore, if a licensee holdsexcess inventory of products using our licensed technology, we are unlikely toreport additional royalty revenue attributable to that product until thequarter after the licensee restarts production. For a discussion of factorsthat could contribute to the fluctuation of our revenues, see Part I“Business—Risk Factors". Our lengthy licensing cycle and our licensees’lengthy development cycles will make the operating results of our licensingbusiness difficult to predict,” and “Anything that negatively affects thebusiness of our licensees could negatively impact our revenue.”

 

*Product sales.*   Product sales aretypically on a purchase-order basis, with shipment of product occurring fromone to six months later. Allowances for sales returns or warranty liabilitiesare recorded based upon historical experiences and any specific known pendingcustomer returns. Our products are manufactured, assembled and tested prior toshipment by independent, third-party contractors. We contract for manufacturingservices on a purchase-order basis and have no long-term commitments for thesupply of 

 

26

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any of our memory chip products.

 

Our memory chipsare subject to competitive pricing pressure that might result in fluctuatinggross profits, which we have experienced in the past. Prior to 1999, we soldmost of our memory chips to the personal computer market, which is seasonal,and experienced the strongest demand for these products in the fourth quartereach year. From late 1998 to date, our memory chip sales have consistedprimarily of 1T-SRAM chips sold to customers in the communications equipmentbusiness, and we have not seen the effect of seasonal demand in the market.

 

Thesemiconductor industry has experienced a difficult economic environment anddownturn during the past several years. Most of our memory chip sales are madeto communications equipment manufacturers, which also have experienced a sharpeconomic downturn since 2001. Our product revenues for 2003 were only 65% ofour product revenues for 2002. As a result of these downturns and our continuedfocus on our high margin intellectual property licensing business as the majorsource of our revenue, we expect continued decline in product revenue in 2004.

 

# ***CriticalAccounting Policies***

 

*Use of 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 believe thatthe following accounting policies are affected by estimates and judgments inthe following manner:

 

*Revenue*.

 

*License.* If a licensingcontract involves performance specifications that we have significantexperience in meeting and the cost of contract completion can be reasonablyestimated, we recognize the revenue over the period in which the contractservices are performed using the percentage of completion method.  The percentage of completion method includesjudgmental elements, such as determining that we have the experience to meetthe design specifications and estimation of the total contract costs.  We follow this method because we can obtainreasonably dependable estimates of the costs to perform the contractedservices.  Labor costs for thedevelopment of the licensee’s design are estimated at the beginning of thecontract.  As these costs are incurred,they are used as a measure of progress towards completion.  We have the ability to reasonably estimatelabor cost on a contract to contract basis from our experience in developingprior licensee’s designs.  During thecontract performance period we review estimates of cost to complete thecontracts as the contract progresses to completion and will revise ourestimates of revenue and gross profit under the contract if we revise theestimations of the cost to complete. Our policy is to reflect any revision in the contract gross profitestimate in reported income in the period in which the facts giving rise to therevision become known.  For contractsinvolving design specifications that the Company has not previously met, theCompany defers the recognition of revenue until the design meets thecontractual design specifications and expenses the cost of services asincurred.  When the Company hasexperience in meeting design specifications but does not have significantexperience to reasonably estimate the cost of services to meet a designspecification, the Company defers both the recognition of revenue and thecost.  For these arrangements, theCompany recognizes revenue using the completed contract method.  Under the completed contract method, werecognize revenue when we have knowledge that the customer has successfullyverified our design.

 

Under our support and maintenance arrangements, weprovide unspecified upgrades, design rule changes and technical support.  No other upgrades, products or otherpost-contract support are provided. These arrangements are renewable annually by the customer.  Support and maintenance revenue isrecognized at its fair value ratably over the period during which theobligation exists, typically 12 months. The fair value of any support and maintenance obligation is establishedbased on the specified renewal rate for such support and maintenance.  When we provide a combination of productsand services to customers, in addition to the considerations noted above, weevaluate the arrangements under EITF 00-21, *RevenueArrangements with Multiple Deliverables*, which is effective fortransactions entered into after June 30, 2003. EITF 00-21 addresses certain aspects of accounting for arrangementsunder which we will perform multiple revenue generating activities.  Application of EITF 00-21 did not have amaterial effect on our consolidated financial position or results ofoperations.

 

*Product.*  Revenue from product sales is recognizedupon shipment provided that persuasive evidence of a sales arrangement exists,the price is fixed or determinable, title has transferred, collection ofresulting receivables is reasonably assured, there are no customer acceptancerequirements and there are no remaining significant obligations.  For each of the periods presented, therewere no formal acceptance provisions with our end customers.

 

*Royalty*.  Licensing contracts provide also for royaltypayments at a stated rate and require licensees to report the manufacture orsale of products that include the Company’s technology after the end of thequarter in which the sale or manufacture occurs.  The Company recognizes royalties in the quarter in which theCompany receives the licensee’s report. The Company entered a termination agreement in 2003 with one of its licenseesand recognized $713,000 of royalty revenue from the terminated contract in2003.  There was no royalty revenue fromterminated contracts in 2002.

 

*Inventory.*  We stateinventories at the lower of cost or market, determined using the first-in,first-out method. Our policy is to write down our inventory for estimatedobsolescence or unmarketable inventory to the extent the cost exceeds theestimated market value. We estimate fair market value based on our historicalsales for the last six months and current market conditions. If actual marketconditions are less favorable than those assumed in our estimates, additionalinventory write-downs may be required. Our policy is to reflect any write-downof inventory in reported income for the period in which the facts giving riseto the inventory write-down become known. If previously reserved inventory issold, the reserve is reversed.

 

*Goodwill.*  We review goodwill,recorded from the acquisition of ATMOS Corp. on August 2002, for impairmentannually and whenever events or changes in circumstances indicate the carryingvalue of an asset may not be recoverable in accordance with the Statement ofFinancial Accounting Standards (“SFAS”) No. 142, “Goodwill and OtherIntangible Assets.”  The 

 

27

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provisions of SFAS No. 142require that a two-step impairment test be performed on goodwill.  In the first step, we compare the fair valueof each reporting unit to its carrying value. Using the guidance in SFAS No. 142, we consider there to be only onereporting unit at the entity level.  Forstep one, we determine the fair value of our reporting unit using the marketapproach.  Under the market approach, weestimate the fair value based on the market value of the reporting unit at theentity level.  If the fair value of thereporting unit exceeds the carrying value of net assets assigned to thereporting unit, goodwill is not impaired and we are not required to performfurther testing.  If the carrying valueof the net assets assigned to the reporting unit exceeds the fair value of thereporting unit, then we must perform the second step in order to determine theimplied fair value of the reporting unit’s goodwill and compare it to thecarrying value of the reporting unit’s goodwill.  If the carrying value of a reporting unit’s goodwill exceeds itsimplied fair value, then we must record an impairment loss equal to thedifference.  We performed the annualimpairment test during the third quarter of 2003, and the test did not indicateimpairment of goodwill as of September 30, 2003. As of December 31, 2003, wefound no indicators of potential impairment.

 

*Tax valuation allowance.*  When we prepare our consolidated financial statements, weestimate our income tax liability for each of the various jurisdictions wherewe conduct business. This requires us to estimate our actual current taxexposure and to assess temporary differences that result from differingtreatment of certain items for tax and accounting purposes. These differencesresult in deferred tax assets and liabilities, which we show on our consolidatedbalance sheet under the category of other current assets. The net deferred taxassets are reduced by a valuation allowance if, based upon weighted availableevidence, it is more likely than not that some or all of the deferred taxassets will not be realized. When we establish a valuation allowance orincrease this allowance in an accounting period, we must record a tax expensein our consolidated statement of income unless the increase is attributable tostock based compensation deductions which has been recorded directly to equity.We must make significant judgments to determine our provision for income taxes,our deferred tax assets and liabilities and any valuation allowance to berecorded against our net deferred tax asset. As of December 31, 2003, we had avaluation allowance of approximately $8.2 million of which approximately $6.2million was attributable to Canadian net operating losses and $670,000 wasattributable to stock option deductions.

 

**Results of Operations**

The following discussion comparesthe historical results of operations based on U.S. generally acceptedaccounting principles for the years ended December 31, 2003, 2002 and 2001.These results include ATMOS’s results of operations from August 20, 2002, thedate on which we acquired all of the outstanding stock of ATMOS. As a result,many of the fluctuations in the historical operating results of MoSys in fiscal2003 as compared to fiscal 2002 and fiscal 2001 are due to the acquisition ofATMOS. Results of operations as a percentage of net revenue were as follows:

 
|                                 |   | **Year ended  December 31,** |   |
|--------------------------------------|--------|------------------------------|--------|
|                                 |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                 |   |                         |   |   |   |   |   |
| Net revenue:                         |   |                         |   |   |   |   |   |
| Product                              |   | 9.9                          | %      | 10.5 | % | 57.8 | % |
| Licensing.                           |   | 54.2                         |   | 37.9 |   | 26.9 |   |
| Royalty                              |   | 35.9                         |   | 51.6 |   | 15.3 |   |
|                                 |   |                         |   |   |   |   |   |
|                                 |   | 100.0                        |   | 100.0 |   | 100.0 |   |
| Cost of net  revenue:                |   |                         |   |   |   |   |   |
| Product                              |   | 6.3                          |   | 6.0 |   | 25.7 |   |
| Licensing                            |   | 10.3                         |   | 6.2 |   | 2.8 |   |
|                                 |   |                         |   |   |   |   |   |
|                                 |   | 16.6                         |   | 12.2 |   | 28.5 |   |
|                                 |   |                         |   |   |   |   |   |
| Gross profit                         |   | 83.4                         |   | 87.8 |   | 71.5 |   |
|                                 |   |                         |   |   |   |   |   |
| Operating  expenses:                 |   |                         |   |   |   |   |   |
| Research and  development            |   | 44.7                         |   | 23.7 |   | 19.7 |   |
| Selling, general  and administrative |   | 31.8                         |   | 17.8 |   | 20.8 |   |
| Stock-based  compensation expense    |   | 2.4                          |   | 2.4 |   | 6.4 |   |
|                                 |   |                         |   |   |   |   |   |
| Total operating  expenses            |   | 78.9                         |   | 43.9 |   | 46.9 |   |
|                                 |   |                         |   |   |   |   |   |
| Income from  operations              |   | 4.5                          |   | 43.9 |   | 24.6 |   |
| Interest and  other income           |   | 10.0                         |   | 5.5 |   | 8.1 |   |
| Provision for  income taxes          |   | (1.5                         | )      | (4.9 | ) | (1.6 | ) |
|                                 |   |                         |   |   |   |   |   |
| Net income                           |   | 13.0                         | %      | 44.5 | % | 31.1 | % |

 

28

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*Years Ended December 31, 2003, 2002 and 2001*

 

*Revenue.*  In 2003, totalrevenue decreased to $19.2 million from $27.8 million representing a 31%decline over 2002.  The decline wasmainly attributable to a significant decrease in royalty revenue, whichdeclined to $6.9 million in 2003 from $14.3 million in 2002.    Gamecube-related revenue represented13% of our total revenue in 2003, a decrease from 44% of our total revenue in2002 as Nintendo reduced its purchases of chips incorporating our licensedtechnology for its Gamecube consoles. Royalty revenues from other licenseesincreased in 2003 compared to 2002, however, mainly due to increased sales ofroyalty-bearing products first shipped in 2002. Licensing revenue alsodecreased slightly to $10.4 million in 2003 from $10.5 million in 2002 as weearned licensing revenue from our new projects started in 2003 offset by thedecrease in licensing revenue earned from the older projects phased out in2003.  During the second quarter of2003, we collected $1.0 million in cash from Conexant for the termination ofits October 2000 license agreement with us. This payment consisted of current and past due royalty payments totaling$713,000, and a contract termination fee of $287,000, which we included inother income.

 

 In 2002, total revenue increased to $27.8 million from$22.5 million representing a 24% increase over 2001. The increase wasprimarily due to the significant growth in our revenues from licensing androyalty activities, which increased to $24.9 million from$9.5 million in 2001, a 162% increase. Royalty revenue increased from$3.4 million in 2001 to $14.3 million in 2002. Royalties earned fromthe sale of Gamecube chips incorporating our 1T-SRAM technology represented asignificant portion, 44%, of our total revenue in 2002.  That represented an increase from 23% oftotal revenue in 2001. Royalty revenues from other licensees also increased in2002 as we simultaneously increased and diversified our licensees anddevelopment projects during that year. In 2001, most of the licensing and royalty revenues consisted of feesfor engineering services associated with NEC’s development of chips for theNintendo Gamecube video game console and royalties earned from the subsequentproduction of Gamecube chips incorporating our 1T-SRAM technology. We alsoearned licensing revenue from development projects with a number of otherlicensees.

 

During the years endedDecember 31, 2003, 2002 and 2001, our product sales totaled$1.9 million, $2.9 million and $13.0 million, respectively.Sales of our memory chips have declined steadily as we shifted our primaryfocus from product sales to the licensing of our 1T-SRAM technologies after1999. In addition, our product sales fell in 2003 due to significant downturnsin the semiconductor industry and the communications equipment business, whichis the primary market for our memory chips. We expect continued decline inproduct revenue in 2004 due to our focus on the licensing of our intellectualproperty as the major source of our revenue, which typically produces highergross margins than can be achieved from product revenue.

 

*Gross Profit.*  Gross profit decreased to $16.0 million in 2003 from$24.4 million in 2002 primarily due to the significant decline in ourroyalty revenue, which has no associated costs.  Primarily for this reason, our gross profit as a percentage oftotal revenue decreased to 83% in 2003 from 88% in 2002.  Licensing gross profit declined to 81% in2003 from 84% in 2002 primarily because we recognized revenue under some lowermargin license projects in 2003.

 

In 2002, gross profit increasedto $24.4 million because of the significant increase in licensing androyalty revenue. Gross profit as a percentage of total revenue increased to 88%in 2002 from 72% in 2001 due to the significantly higher proportion oflicensing and royalty revenues, which have much higher gross profit marginsthan product revenues. In 2002, licensing gross profit as a percentage oflicensing revenue declined to 84% compared to 90% in 2001, however, because ourlicensing revenue from contracts accounted for under the completed contractmethod declined to 25% of licensing revenue in 2002 from 69% of licensingrevenue in 2001. Most of those contracts were entered into before technicalfeasibility was established, and therefore, the costs associated with them wereexpensed as research and development expenses before the period in whichrevenue was recognized. In 2002, we recognized revenue on the last of theremaining completed contracts entered before technical feasibility wasestablished.

 

In 2001, gross profit increasedto $16.1 million from $8.4 million in 2000 due to strong growth inlicensing and royalty revenues, which contributed $8.9 million to thetotal gross profit for the year. Gross profit as a percentage of total revenueincreased to 72% in 2001 from 59% in 2000 due to the significantly higherproportion of licensing and royalty revenues.

 

In 2003, product gross margin asa percentage of product revenue decreased to 36% compared to 43% in 2002. Thedecline resulted primarily from lower average selling prices for our memorychips in 2003.  In addition, in 2003 ourfixed manufacturing overhead costs were spread over a reduced number of ourmemory chips shipped in 2003 compared to 2002. Product gross margin as apercentage of product revenue declined to 43% in 2002 compared to 56% in 2001.That decline also was attributable to allocating our fixed

 

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manufacturing overhead costs over a significantly reducednumber of our memory chips shipped in 2002 compared to 2001.

 

*Research andDevelopment.*  Our research and development expensesinclude development and design of variations of the 1T-SRAM technologies foruse in different manufacturing processes used by licensees and the developmentand testing of prototypes to prove the technological feasibility of embeddingour memory designs in the licensees’ products. Research and developmentexpenses increased to $8.6 million in 2003 from $6.6 million in 2002 because wehad increased the engineering staff from our acquisition of ATMOS and tosupport our memory compiler development. ATMOS’s research and development expenses represented approximately $2.6million in 2003.  We anticipate asimilar level of research and development expenses for the foreseeable future.

 

In 2002, research anddevelopment expense increased to $6.6 million from $4.4 million in 2001due to additions to the engineering staff from additional hiring and ouracquisition of ATMOS at the end of August 2002. The ATMOS research anddevelopment expenses represented approximately $867,000 in 2002. Our researchand development expenses increased in 2001 to $4.4 million due toadditions to the engineering staff, and expanded engineering support of ourlicensing activities, including the establishment of the engineering designcenter in Seoul, Korea in June 2001.

 

*Selling, General and Administrative.*  Selling, general and administrative expenses increased to$6.1million in 2003 from $5.0 million in 2002 due primarily to increasedsales and marketing activities, including the establishment of a sales officein Japan in January 2003 and higher professional fees. Selling, general andadministrative expenses increased to $5.0 million in 2002 from$4.7 million in 2001 as increases in administrative, sales and marketingstaff expenses were partially offset by lower commissions on product sales. In2001, selling, general and administrative expense increased to$4.7 million. The increase in 2001 reflected the addition ofadministrative, sales and marketing staff and the expansion of intellectualproperty marketing activities.

 

*Interest andOther Income.*  Interest income reflects interest earned oncash, cash equivalents, short-term and long-term investments. Interest incomewas $1.4 million, $1.5 million and $1.8 million in 2003, 2002, and 2001,respectively. The fluctuation in interest income levels corresponds todifferences in average cash and investment balances for the periods and theapplicable corresponding interest rates, which declined each year in 2003, 2002and 2001. Additionally, in 2003, other income included the $287,000 contracttermination fee from Conexant and $241,000 of Canadian research and developmentincentive tax credits. There was no other income recorded in 2002 and 2001. Weincurred no interest expense in 2003, 2002, and 2001.

 

*Deferred stock-basedcompensation cost to employees.*  During the yearsended December 31, 2003, 2002 and 2001, we recorded deferred compensationcost of approximately $0, $314,000 and $1.5 million, respectively, whichcost is being amortized in future periods. The 2002 deferred compensation costrepresented the shares of common stock issued to certain employees of ATMOSthat were subject to vesting requirements related to the acquisition of ATMOS,which cost is being amortized over the vesting period of 36 months using thegraded vesting method. The deferred compensation cost received during the yearended 2001 represented the excess of the fair market value of our common stockover the great price during the period in which the option were granted.

 

During the years endedDecember 31, 2003, 2002 and 2001, we recorded stock compensation expensesof $459,000, $656,000 and $1.4 million, respectively, of which $211,000,$582,000 and $1.4 million, respectively, was attributable to the excess of thefair market value of our common stock over the price at which we granted stockoptions to employees. Stock compensation expenses in 2003 and 2002 alsoincluded $227,000 and $74,000, respectively, for amortization of deferredcompensation cost attributable to the fair market value of shares of our commonstock issued to certain employees of ATMOS. In addition, we incurred $21,000 ofstock compensation expense in 2003 due to modification of our 2000 employeestock option plan related to a former member of our board of directors.

 

Deferred compensation expense isbneing amortized using the graded vesting method, in accordance with SFAS No.123 and FASB Interpretation No. 28, over the vesting period of each respectiveoption, generally four years. The accelerated amortization results in expensingapproximately 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 forIncome Taxes.*  Provisions for income taxes of approximately$279,000, $1.4 million, and $367,000 were recorded in 2003, 2002 and 2001,respectively. The effective income tax rate was 10% for 2003 and 2002 and 5%for 2001. As of December 31, 2003, we had net operating loss carryforwardsof approximately $3.6 million for federal tax purposes, approximately $2.6million for state tax purposes and approximately $13.5 million for Canadian taxpurposes that we expect to be available to reduce future income tax liabilitiesto the extent permitted under federal, Canadian and applicable state income taxlaws. The federal net operating losses are subject to an annual limitation ofapproximately $2.6 million pursuant to Section 382 of the InternalRevenue Code. The net operating loss carryforwards expire from 2005 to 2023. In2004, we anticipate that our effective income tax rate will be less than thefederal statutory tax rate but higher than the 2003 effective income tax rate.

 

**Liquidity and Capital Resources**

 

As of December 31, 2003, wehad cash and cash equivalents of $22.0 million, short-term investments of$19.3 million and long-term investments of $44.5 million resulting ina total balance of cash, equivalents, and investments of $85.8 million. As ofthe same date, the Company had total working capital of $44.4 million. InJuly 2001, the Company completed the sale of a total of 5,750,000 sharesof common stock in its initial public offering. The Company realized total netproceeds of approximately $51.6 million upon the close of the IPO, whichproceeds have not been used to fund our operations to date. Our primary capitalrequirements are to fund working capital

 

30

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needs. We believe that our current focus on licensing androyalty revenues with reduced levels of memory chip sales has generally enabledus to steadily improve our cash position.

 

Net cash provided by operatingactivities was $4.7 million, $7.9 million, and $8.4 million for theyears ended 2003, 2002, and 2001, respectively. In 2003, net cash provided byoperating activities was principally represented by our net profit of$2.5 million plus a non-cash charge of $2.0 million for depreciationand amortization, although deferred revenue associated with cash receipts inexcess of recognized revenue declined by $1.3 million.

 

In 2002, net cash provided byoperating activities resulted primarily from net income of $12.4 millionplus a non-cash charge of depreciation and amortization of$1.3 million.  Prepaid expenses andother assets increased by $2.9 million as we recorded deferred tax assets of$2.4 million from the realization of tax benefits through the utilizationof net operating loss carryforwards. In addition, deferred revenue declined by$1.6 million and accounts payable declined by $1.3 million. In 2001,net cash provided by operating activities was $8.4 million, consistingprincipally of net profit of $7.0 million plus a non-cash charge of$1.4 million for stock based compensation. In addition, we reducedaccounts receivable by $1.2 million but decreased deferred revenue by $2.6 million.The reduction in deferred revenue in 2001 resulted from the recognition oflicensing and prepaid royalty revenues in excess of additional license feescollected from our customers.

 

Net cash used in investingactivities was approximately $10.8 million, $29.9 million, and$38.4 million for the years ended 2003, 2002, and 2001, respectively.Aside from investing in short-term and long-term marketable securities in allthree years, we purchased $493,000 of property and equipment in 2003, consistingprincipally of engineering design software. In 2002, we purchased$1.4 million of property and equipment consisting of principally ofengineering design software and $12.0 million for the acquisition of ATMOS. In2001, investing activities mainly consisted of investing in short-termmarketable securities of $36.9 million, net and engineering designsoftware purchases.

 

Net cash provided by financingactivities were $1.8 million, $1.0 million, and $54.0 million for theyears ended 2003, 2002, and 2001. Cash received upon the issuance of commonstock in connection with the exercise of options and warrants totaled $1.9million in 2003, $909,000 in 2002 and $2.0 million in 2001.  Also in 2001, we received total net proceedsof $51.6 million upon the close of our IPO.

 

Our future liquidity and capitalrequirements are expected to vary from quarter to quarter, depending onnumerous factors, including—

 

•                                          level and timing of licensing,royalty and memory chip sales revenues;

 

•                                          cost, timing and success oftechnology development efforts;

 

•                                          market acceptance of ourexisting and future technologies and products;

 

•                                          competing technological andmarket developments;

 

•                                          cost of maintaining andenforcing patent claims and intellectual property rights;

 

•                                          variations in manufacturingyields, materials costs and other manufacturing risks; and

 

•                                          costs of acquiring otherbusinesses and integrating the acquired operations.

 

In the event Synopsys does notconsummate its acquisition of our company as contemplated by the reorganizationagreement, we expect that our existing capital and cash generated fromoperations, if any, will be sufficient to meet our capital requirements for theforeseeable future. We expect that a licensing business such as ours generallywill require less cash to support operations after multiple licensees begin toship products and pay royalties. However, we cannot be certain that we will notrequire additional financing at some point in time. Should our cash resourcesprove inadequate, we might need to raise additional funding through public orprivate financing. There can be no assurance that such additional funding willbe available to us on favorable terms, if at all. The failure to raise capitalwhen needed could have a material, adverse effect on our business and financialcondition.

 

**LeaseCommitments and Off Balance Sheet Financing**

 

The impact that our contractual obligations as of December 31,2003 are expected to have on our liquidity and cash flow in future periods isas follows:

 

31

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|                         |   | **Payment  Due by Period** |   |
|------------------------------|--------|----------------------------|--------|
|                         |   | **Total**                  |   | **Less than  1 year** |   | **1-3 years** |   | **4-5 years** |   | **Over 5  years** |   |
|                         |   |                       |   |   |   |   |   |   |   |   |   |
| Operating Lease  Obligations |   | $                          | 3,009  |   | $ | 1,325 |   | $ | 1,183 |   | $ | 501 |   | $ | — |   |
| Capital Lease  Obligations   |   | 28                         |   | 14 |   | 14 |   | — |   | — |   |
|                              |        |                            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Company did not have any unconditional purchase obligations as ofDecember 31, 2003.

 

**RecentAccounting Pronouncements**

 

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.Quantitative******and Qualitative Discussion of Market Interest Rate Risk***

 

Our investment portfolio consists of money market funds, corporate-backeddebt obligations and mortgage-backed government obligations generally duewithin one year. 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 $80.9 million as of December 31,2003, and have an average interest rate of approximately 1.68%, are subject tointerest rate risks. However, based on the investment portfolio contents andour ability to hold these investments until maturity, we believe that if asignificant change in interest rates were to occur, it would not have amaterial effect on our financial condition.

 

***Item 8.******Financial Statements andSupplementary Data***

 

Reference is made to the financial statements listed under the heading(a) (1) Financial Statements and Report of Ernst & Young LLPof Item 15, which financial statements are incorporated by reference inresponse to this Item 8.

 

32

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**QuarterlyResults of Operations**

 

The following tables set forth unaudited results of operations data forthe eight quarters ended December 31, 2003. This unaudited information hasbeen prepared on a basis consistent with our audited financial statementsappearing elsewhere in this report and, in the opinion of our management,includes all adjustments, consisting only of normal recurring adjustments,necessary for a fair presentation of the information for the periods presented.The unaudited quarterly information should be read in conjunction with thefinancial statements and notes included elsewhere in this report.

 
|                                                   |   | **Dec. 31,  2003** |   | **Sep. 30,  2003** |   | **June 30,  2003** |   | **Mar. 31,  2003** |   | **Dec. 31,  2002** |   | **Sep. 30,  2002** |   | **June 30,  2002** |   | **Mar. 31,  2002** |   |
|--------------------------------------------------------|--------|--------------------|--------|--------------------|--------|--------------------|--------|--------------------|--------|--------------------|--------|--------------------|--------|--------------------|--------|--------------------|--------|
|                                                   |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |
| Net revenue:                                           |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |
| Product                                                |   | $                  | 334    |               | $      | 511                |   | $                  | 515    |               | $      | 544                |   | $                  | 599    |               | $      | 784 |   | $ | 648 |   | $ | 893 |   |
| Licensing                                              |   | 1,929              |   | 1,780              |   | 2,196              |   | 4,513              |   | 3,263              |   | 2,756              |   | 2,620              |   | 1,884              |   |
| Royalty                                                |   | 1,088              |   | 1,208              |   | 1,759              |   | 2,856              |   | 3,993              |   | 3,471              |   | 3,262              |   | 3,618              |   |
|                                                   |   | 3,351              |   | 3,499              |   | 4,470              |   | 7,913              |   | 7,855              |   | 7,011              |   | 6,530              |   | 6,395              |   |
| Cost of net  revenue:                                  |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |
| Product                                                |   | 259                |   | 260                |   | 291                |   | 407                |   | 373                |   | 465                |   | 383                |   | 447                |   |
| Licensing                                              |   | 426                |   | 588                |   | 341                |   | 615                |   | 631                |   | 448                |   | 339                |   | 312                |   |
|                                                   |   | 685                |   | 848                |   | 632                |   | 1,022              |   | 1,004              |   | 913                |   | 722                |   | 759                |   |
| Gross profit                                           |   | 2,666              |   | 2,651              |   | 3,838              |   | 6,891              |   | 6,851              |   | 6,098              |   | 5,808              |   | 5,636              |   |
| Research and  development                              |   | 2,087              |   | 2,093              |   | 2,168              |   | 2,245              |   | 2,099              |   | 1,666              |   | 1,490              |   | 1,331              |   |
| Selling, general  and administrative                   |   | 1,463              |   | 1,396              |   | 1,592              |   | 1,670              |   | 1,513              |   | 1,258              |   | 1,187              |   | 992                |   |
| Stock-based  compensation charge                       |   | 38                 |   | 190                |   | 105                |   | 126                |   | 171                |   | 121                |   | 156                |   | 208                |   |
| Total operating  expenses                              |   | 3,588              |   | 3,679              |   | 3,865              |   | 4,041              |   | 3,783              |   | 3,045              |   | 2,833              |   | 2,531              |   |
| Income (loss)  from operations                         |   | (922               | )      | (1,028             | )      | (27                | )      | 2,850              |   | 3,068              |   | 3,053              |   | 2,975              |   | 3,105              |   |
| Interest and  other income                             |   | 461                |   | 311                |   | 652                |   | 490                |   | 347                |   | 392                |   | 433                |   | 367                |   |
| Benefit  (provision) for income taxes                  |   | 46                 |   | 468                |   | (125               | )      | (668               | )      | 691                |   | (689               | )      | (681               | )      | (694               | )      |
| Net income  (loss)                                     |   | $                  | (415   | )                  | $      | (249               | )      | $                  | 500    |               | $      | 2,672              |   | $                  | 4,106  |               | $      | 2,756 |   | $ | 2,727 |   | $ | 2,778 |   |
| Net income  (loss) per share:                          |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |
| Basic                                                  |   | $                  | (0.01  | )                  | $      | (0.01              | )      | $                  | 0.02   |               | $      | 0.09               |   | $                  | 0.14   |               | $      | 0.09 |   | $ | 0.09 |   | $ | 0.09 |   |
| Diluted                                                |   | $                  | (0.01  | )                  | $      | (0.01              | )      | $                  | 0.02   |               | $      | 0.09               |   | $                  | 0.13   |               | $      | 0.09 |   | $ | 0.09 |   | $ | 0.09 |   |
| Shares used in  computing net income (loss) per share: |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |               |   |
| Basic                                                  |   | 30,704             |   | 30,614             |   | 30,395             |   | 30,302             |   | 30,213             |   | 30,090             |   | 29,690             |   | 29,570             |   |
| Diluted                                                |   | 30,704             |   | 30,614             |   | 30,848             |   | 30,539             |   | 31,309             |   | 30,686             |   | 31,318             |   | 31,742             |   |

 

***Item 9******. Changes in and Disagreements withAccountants on Accounting and Financial Disclosure***

 

Not applicable.

 

***Item 9a.******Controls and Procedures***

 

(a)                                  Evaluationof disclosure controls and procedures

 

Under the supervision and with the participation ofour management, including our principle executive officer and principalfinancial officer, we conducted an evaluation of the effectiveness of thedesign and operation of our disclosure controls and procedures, as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, asamended, as of the end of the year covered by this report.  Based on this evaluation, our principalexecutive officer and principal financial officer concluded as of December 31,2003 that our disclosure controls and procedures were effective such that theinformation relating to us, including our consolidated subsidiaries, required tobe disclosed in our reports filed with the Securities and Exchange Commission(i) is recorded, processed, summarized and reported within the time periodsspecified in SEC rules and forms, and (ii) is accumulated and communicated toMoSys’ management, including our principal executive officer and principalfinancial officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

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(b)                                 Changesin internal controls

 

There have been no significant changes in the Company’s internalcontrols or in other factors, which could significantly affect internalcontrols subsequent to the date the Company carried out its evaluation.

 

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**Part III**

 

***Item 10******. Directors and Executive Officersof the Registrant***

 

**Directorsand Executive Officers**

 

The names of theCompany’s Directors and Executive Officers as of December 31, 2003 and certaininformation about them are set forth below:

 
| **Name**            |   | **Age** |   | **Position(s) with the Company**                                                     |
|---------------------|--------|---------|--------|--------------------------------------------------------------------------------------|
| Fu-Chieh Hsu        |   | 47      |   | Chairman of the Board,  President and Chief Executive Officer                        |
|                |   |    |   |                                                                                 |
| Wingyu Leung        |   | 49      |   | Executive Vice  President, Chief Technical Officer and Director                      |
|                |   |    |   |                                                                                 |
| Mark-Eric Jones     |   | 48      |   | Vice President and  General Manager— Intellectual Property                      |
|                |   |    |   |                                                                                 |
| Mark Voll           |   | 49      |   | Vice President, Finance  & Administration, Chief Financial Officer and Secretary |
|                |   |    |   |                                                                                 |
| Andre Hassan        |   | 44      |   | Vice President and  General Manager— Discrete Products                          |
|                |   |    |   |                                                                                 |
| Carl E. Berg(1) (2) |   | 66      |   | Director                                                                             |
|                |   |    |   |                                                                                 |
| Wei Yen(1) (2)      |   | 49      |   | Director                                                                             |

 

----

(1)                                  Memberof Audit Committee

 

(2)                                  Memberof Compensation Committee.

 

*Fu-ChiehHsu.*  Dr. Hsu hasserved as our Chairman of the Board since September 1991 and as itsPresident and Chief Executive Officer since April 1992. Dr. Hsu also servedas our Chief Financial Officer from April 1992 until May 1996. Priorto joining us, Dr. Hsu was the President and Chairman of the Board ofMyson Technology, Inc., a developer of high performance semiconductorproducts, from August 1990 to August 1991. From May 1985 toAugust 1990, Dr. Hsu served as Vice President and Chief TechnologyOfficer of Integrated Device Technology, Inc., a developer of highperformance semiconductor products and modules. Dr. Hsu holds a B.S. inelectrical engineering from National Taiwan University and a M.S. and Ph.D. inelectrical engineering from the University of California at Berkeley.

 

*WingyuLeung.*  Dr. Leunghas served as our Executive Vice President, Engineering, and Chief TechnicalOfficer and as a member of our board of directors since April 1992.Dr. Leung also served as our Secretary from April 1992 untilMay 1996 and again from May 1997 until August 2000. Prior tojoining us, Dr. Leung served as a technology consultant to several hightechnology companies, including Rambus, Inc., a developer of a high-speedchip-to-chip interface technology. Prior to that time, Dr. Leung served asa member of the technical staff of Rambus, and as a senior engineering managerat Integrated Device Technology, Inc., where he managed and participatedin circuit design activities. Dr. Leung holds a B.S. in electricalengineering from the University of Maryland, a M.S. in electrical engineeringfrom the University of Illinois, and a Ph.D. in electrical engineering andcomputer science from the University of California at Berkeley.

 

*Mark-Eric Jones.*  Mr. Jones has served as our VicePresident and General Manager—Intellectual Property since October 1998.Prior to joining our company, Mr. Jones served as Director, IntellectualProperty Division of Mentor Graphics Corporation, a developer of EDA tools andprovider of intellectual property from January 1996 toSeptember 1998. Mr. Jones founded 3SOFT, Inc., a developer ofintellectual property and served as its President and Chief Executive Officerfrom May 1976 to January 1996. Mr. Jones holds a M.A. fromTrinity College, University of Cambridge, United Kingdom.

 

*Mark Voll.*  Mr. Voll has served as our VicePresident of Finance and Administration and Chief Financial Officer sinceJune 2002. Mr. Voll previously held the same position with MoSys fromMarch 1998 to June 2000. From June 2000 to May 2002Mr. Voll served as the Chief Financial Officer for AxisSystems, Inc., a developer of semiconductor verification tools.Mr. Voll holds a B. S. in business administration from Providence College.

 

*Andre Hassan.*  Mr. Hassan has served as our VicePresident and General Manager—Discrete Products since July 2001. Prior tothis, Mr. Hassan was General Manager—Discrete Products fromJanuary 1999 to June 2001. Mr. Hassan was Director of Marketingfrom

 

35

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February 1996to December 1998. Prior to joining our company, Mr. Hassan served asStrategic Marketing Manager for S3, Inc., a developer of semiconductormultimedia products from June 1994 to January 1996. Mr. Hassanholds a B.S. in electrical engineering from Worcester Polytechnic Institute.

 

*CarlE. Berg.* Mr. Berg has served as a member of our board of directors sinceSeptember 1992. Since 1997, Mr. Berg has been the Chairman of theBoard and Chief Executive Officer of Mission West Properties, Inc., a realestate investment trust. Mr. Berg has been actively engaged in theownership, development and management of industrial real estate and in venturecapital investment for over 30 years. He currently serves as a member ofthe board of directors of Mission West Properties, Inc., ValenceTechnology, Inc., a developer of advanced rechargeable battery technology,FOCUS Enhancements, Inc., a developer of video scan conversion products,and Systems Integrated Research Plc, a provider of educational software.Mr. Berg holds a B.A. in business from the University of New Mexico.

 

*WeiYen.*  Dr. Yen hasserved as a member of our board of directors since August 2000. In 2000,Dr. Yen co-founded RouteFree Inc., an audio/video network company,and iKuni, an artificial intelligence company, and has served each company asits Chairman of the Board since its formation. In 1997, he co-founded ArtXIncorporated and served as its Chairman of the Board until 2000, when it wasacquired by ATI Technologies. In 1995, he co-founded Navio Communications andserved as its Chief Executive Officer until 1997 when it merged with NetworkComputers Incorporated, now Liberate Technologies. From 1988 to 1995,Dr. Yen was a Senior Vice President at Silicon Graphics, Inc., wherehe oversaw all five product divisions and two subsidiaries. Dr. Yen wasPresident of Mips Technologies from 1992 to 1993. He currently serves as adirector of the Acer Groups. Dr. Yen received his Ph.D. in electricalengineering from Purdue University.

 

**Committees of theBoard of Directors and Meetings**

** **

Our board ofdirectors has standing Audit and Compensation Committees.  Carl E. Berg and Wei Yen are the currentmembers of both the Audit Committee and the Compensation Committee, as thevacancy created by Paul Russo’s resignation as a director in August 2003 hasnot been filled to date.  Mr. Berg isthe Audit Committee’s financial expert, but that status does not impose on himduties, liabilities or obligations that are greater than the duties,liabilities or obligations otherwise imposed on him as a member of the AuditCommittee and the board of directors. Fu-Chieh Hsu participates in all Compensation Committee discussions and decisionsregarding salaries and incentive compensation for all of our employees andconsultants, except that he is excluded from discussions regarding his ownsalary and incentive compensation.  

 

We do not have anominating committee.  The board doesnot believe that a nominating committee is necessary because all theindependent directors currently serve on the Audit and Compensation Committees,and any additional committee of independent directors would consist of the sameindividuals.  In the event the Synopsysacquisition does not occur, the board intends to fill the vacancy left by Mr.Russo’s resignation and to review and approve nominations for election to theboard of directors at the next annual meeting of stockholders solely byresolution of the independent directors on the board.

 

During the fiscalyear ended December 31, 2003, including telephonic meetings, there were fourmeetings of the board of directors, four meetings of the Audit Committee andfour meetings of the Compensation Committee. Every director attended at least 75% of the meetings of the Board andeach committee held during the period for which he was a director during thefiscal year ended December 31, 2003. In addition, the members of the board of directors, the Compensation Committeeand the Audit Committee acted at times by unanimous written consent pursuant toDelaware law.

 

**Audit CommitteeReport**

** **

The AuditCommittee reviews, acts on and reports to the board of directors with respectto various auditing and accounting matters. Management has primary responsibility for MoSys' financial statementsand the overall reporting process, including MoSys' system of internalcontrols.  The independent auditorsaudit the financial statements prepared by management, express an opinion as towhether those financial statements fairly present the financial position,results of operations and cash flows of MoSys in conformity with accountingprinciples generally accepted in the United States and discuss with the AuditCommittee any issues they believe should be raised with us.  The Audit Committee’s responsibilities underthe Audit Committee charter adopted by the board of directors effective August15, 2000 and amended as of February 22, 2004, include the selection ordismissal of the independent auditors, review of the scope of the annualaudits, and approval of fees to be paid to the independent auditors.  The Audit Committee also monitors theperformance of the independent auditors, and reviews the audit report on theconsolidated financial statements following completion of the audit and theaccounting practices of MoSys with respect to internal accounting and financialcontrols.  

 

The AuditCommittee Charter as amended to date can be found through our websitewww.mosys.com.  The Audit Committee hasdelegated authority to Mr. Berg to pre-approve non-audit services provided byour independent auditors.

 

During the fiscalyear ended December 31, 2003, Messrs. Berg and Yen served on the AuditCommittee for the entire year.  PaulRusso served on the Audit Committee until the end of August 2003.  The Company believes that Messrs. Berg andYen are independent within the meaning of the National Association ofSecurities Dealers, Inc.’s listing standards.

 

The AuditCommittee has reviewed and discussed the audited financial statements of theCompany for fiscal year 2003 with management and Ernst & Young LLP(“E&Y”), MoSys' independent auditors. The Committee discussed with E&Y matters required to be discussed byStatement on Auditing Standards No. 61 (Communication with AuditCommittees).  E&Y provided the AuditCommittee the written disclosures required by Independence Standards BoardStandard No. 1 (Independence Discussions with Audit Committees).  The Audit Committee has discussed E&Y’sindependence with members of that firm. The Audit Committee received written confirmations from management withrespect to the non-audit services provided by E&Y and has consideredwhether the provision of such services is compatible with maintaining theauditor’s independence.  The AuditCommittee has determined that the rendering of such services by E&Y iscompatible with maintaining the auditors’ independence.

 

Based on thediscussions with E&Y concerning the audit, the independence discussions andthe financial statement review, and such other matters deemed relevant andappropriate by the Audit Committee, the Audit Committee recommended to theboard of directors that MoSys financial statements for the fiscal year endedDecember 31, 2003 be included in its 2003 Annual Report on Form 10-K filedwith the Securities and Exchange Commission.

 
|   | The Audit Committee of  the Board of Directors: |
|--------|-------------------------------------------------|
|   |                                            |
|   | Carl E. Berg                                    |
|   | Wei Yen                                         |

 

**Section 16(a)Beneficial Ownership Reporting Compliance**

 

                Section 16(a) of the Securities Exchange Act of 1934,as amended, requires our directors, executive officers and persons who own morethan 10% of a registered class of the Company’s equity securities to file withthe SEC initial reports of ownership and reports of changes in ownership ofcommon stock and other equity securities of ours.  Directors, executive officers and greater than 10% holders arerequired by SEC regulation to furnish us with copies of all Section 16(a)reports they file.  Based solely on ourreview of Forms 3 and 4 received during 2003 and Forms 5 (or any writtenrepresentations) received with respect to fiscal year 2003, we believe that alldirectors, executive officers and 10% stockholders complied with all applicableSection 16(a) filing requirements during 2003.

 

 

**Codeof Ethics**

 

We adopted a codeof ethics that applies to all of our employees. The code of ethics is designedto deter wrongdoing and to promote, among other things, honest and ethicalconduct, full, fair, accurate, timely, and understandable disclosures in reportsand documents submitted to the Securities and Exchange Commission and otherpublic communications, compliance with applicable governmental laws, rules andregulations, the prompt internal reporting of violations of the code to anappropriate person or persons identified in the code and accountability foradherence to such code.

 

The code of ethicsis available on our website www.mosys.com. If we make any substantive amendments to the code of ethics or grant anywaiver, including any implicit waiver, from a provision of the code to ourChief Executive Officer, Chief Financial Officer or Corporate Controller, orpersons performing similar functions, where such amendment or waiver isrequired to be disclosed under applicable SEC rules, we intend to disclose thenature of such amendment or waiver on our website.

 

***Item 11. Executive Compensation***

 

**SummaryCompensation Table**

 

The followingSummary Compensation Table sets forth summary information as to compensationreceived by our Chief Executive Officer and each of the four other most highlycompensated persons who were serving as executive officers of the Company as ofDecember 31, 2003.

 

 
|                                                                            |   |                     |    |                                |    |   |   | **Long-term  Compensation** |   |
|---------------------------------------------------------------------------------|--------|--------------------------|---------|-------------------------------------|---------|--------|--------|-----------------------------|--------|
|                                                                            |   |                     |    | **Securities  Underlying  Options** |    |
| **Name**                                                                        |   | **Annual  Compensation** |    |                                |
| **Year**                                                                        |   | **Salary($)**            |    | **Bonus($)**                        |    |
| Fu-Chieh Hsu   Chairman of the Board, President and  Chief Executive Officer    |   | 2003                     |    | $                                   | 279,108 |   | $      | 72,663                      |   | 113,621 |   |
|                                                                            | 2002   |                     | 266,167 |                                | 73,979  |   | 81,691 |                        |
|                                                                            | 2001   |                     | 238,000 |                                | 57,040  |   | 60,000 |                        |
|                                                                            |   |                     |    |                                |    |   |   |                        |   |
| Wingyu Leung  Executive Vice President, Chief Technical  Officer and Director   |   | 2003                     |    | 232,950                             |    | 58,130 |   | 92,897                      |   |
|                                                                            | 2002   |                     | 221,833 |                                | 65,123  |   | 67,353 |                        |
|                                                                            | 2001   |                     | 198,000 |                                | 57,040  |   | 50,000 |                        |
|                                                                            |   |                     |    |                                |    |   |   |                        |   |
| Mark-Eric Jones  Vice President and General Manager—Intellectual  Property |   | 2003                     |    | 206,792                             |    | 29,065 |   | 61,448                      |   |
|                                                                            | 2002   |                     | 197,000 |                                | 36,273  |   | 48,676 |                        |
|                                                                            | 2001   |                     | 184,000 |                                | 35,650  |   | 40,000 |                        |
|                                                                            |   |                     |    |                                |    |   |   |                        |   |
| Andre Hassan  General Manager—Discrete Products                            |   | 2003                     |    | 171,871                             |    | 29,065 |   | 61,448                      |   |
|                                                                            | 2002   |                     | 160,250 |                                | 34,417  |   | 48,676 |                        |
|                                                                            | 2001   |                     | 148,875 |                                | 35,650  |   | 40,000 |                        |
|                                                                            |   |                     |    |                                |    |   |   |                        |   |
| Mark Voll*                                                                      |   | 2003                     |    | 178,238                             |    | 2,085  |   | 26,710                      |   |
| Vice President, Finance  & Administration, Chief                            |   | 2002                     |    | 87,500                              |    | — |   | 200,000                     |   |
| Financial Officer and  Secretary                                                |   |                     |    |                                |    |   |   |                        |   |
|                                                                                 |        |                          |         |                                     |         |        |        |                             |        |  |  |

----

* Mr. Voll became anexecutive officer in June 2002.

 

**OptionGrants in Last Fiscal Year**

 

The followingtable provides information regarding the grant of stock options during fiscalyear 2003 to the named executive 

 

36

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officers.

 
|            |   | **Number of  securities  underlying  options  granted (1)** |   | **% of total  options  granted to  employees in  2003 (2)** |   | **Exercise  Price (3)** |   | **Expiration  Date** |      | **Potential  realizable value at  assumed annual rates of  stock price appreciation for  option term (4)** |   |
|-----------------|--------|-------------------------------------------------------------|--------|-------------------------------------------------------------|--------|-------------------------|--------|----------------------|-----------|------------------------------------------------------------------------------------------------------------|--------|
|            |   |                                                        |   |                                                        |   | **5%**                  |   | **10%**              |      |
|            |   |                                                        |   |                                                        |   |                    |   |                 |      |                                                                                                       |   |   |   |
| Fu-Chieh Hsu    |   | 53,621                                                      |   | 5.03                                                        | %      | $                       | 6.89   |                 | 4/16/2013 |                                                                                                       | $      | 232,344 |   | $ | 588,806 |   |
|            |   | 60,000                                                      |   | 5.63                                                        | %      | 9.81                    |   | 9/2/2013             |      | 370,167                                                                                                    |   | 938,077 |   |
| Wingyu Leung    |   | 42,897                                                      |   | 4.03                                                        | %      | 6.89                    |   | 4/16/2013            |      | 185,876                                                                                                    |   | 471,047 |   |
|            |   | 50,000                                                      |   | 4.69                                                        | %      | 9.81                    |   | 9/2/2013             |      | 308,473                                                                                                    |   | 781,731 |   |
| Mark-Eric Jones |   | 21,448                                                      |   | 2.01                                                        | %      | 6.89                    |   | 4/16/2013            |      | 92,936                                                                                                     |   | 235,518 |   |
|            |   | 40,000                                                      |   | 3.75                                                        | %      | 9.81                    |   | 9/2/2013             |      | 246,778                                                                                                    |   | 625,385 |   |
| Andre Hassan    |   | 21,448                                                      |   | 2.01                                                        | %      | 6.89                    |   | 4/16/2013            |      | 92,936                                                                                                     |   | 235,518 |   |
|            |   | 40,000                                                      |   | 3.75                                                        | %      | 9.81                    |   | 9/2/2013             |      | 246,778                                                                                                    |   | 625,385 |   |
| Mark Voll       |   | 1,710                                                       |   | 0.16                                                        | %      | 6.89                    |   | 4/16/2013            |      | 7,410                                                                                                      |   | 18,777 |   |
|            |   | 25,000                                                      |   | 2.35                                                        | %      | 9.81                    |   | 9/2/2013             |      | 154,236                                                                                                    |   | 390,865 |   |
|                 |        |                                                             |        |                                                             |        |                         |        |                      |           |                                                                                                            |        |  |  |  |  |  |

 

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(1)                                  Optionsare incentive stock options to the extent qualified and nonstatutory optionsotherwise. All of the options have a 10-year term and generally terminate ifnot exercised with 90 days following the executive’s employment with theCompany or the expiration date, whichever occurs earlier. Each of the namedexecutive officers in the table received an option grant under the 2000Employee Stock Option Plan on September 2, 2003. Those options vest as to 25%of the shares subject to each option on the first anniversary of the grant dateand 1/36th of the shares subject to each option vest monthlythereafter. In addition, on April 16, 2003 each of such named executiveofficers received additional options under the 2000 Employee Stock Option Planas bonuses for the Company’s performance as measured against certainpre-established performance goals for each officer. The bonus stock optionswere immediately vested as to 50% of the shares of Common Stock on the grantdate. The remaining option shares vest ratably each month over the two-yearperiod following the grant date, subject to continued service.

 

(2)                                  Thepercentage of total options granted is based upon options to purchase an aggregateof 1,065,624 shares of Common Stock granted during the fiscal year endedDecember 31, 2003 to Company employees, including the named executiveofficers and outside Directors.

 

(3)                                  Alloptions were granted at an exercise price equal to the fair market value of theCompany’s Common Stock on the grant date. Fair market value for the two groupsof option grants was equal to the closing price on the NASDAQ National Marketon April 16, 2003 and September 2, 2003, respectively.

 

(4)                                  Potentialrealizable value has been calculated by assuming that the market price of theCommon Stock appreciates 5% and 10% each year from the date of grant of theoptions until the expiration of the options. These assumed annual rates ofappreciation were used in compliance with the rules of the SEC and are notintended to forecast future price appreciation of the Common Stock. The actualvalue realized from the options could be substantially higher or lower than thevalues reported above, depending upon the future appreciation or depreciationof the Common Stock during the option period and the timing of the exercise ofthe options. Unless the executive officer remains employed until he vests inthe option shares and the market price of the Common Stock appreciates over theoption term, no value will be realized from the option grants made to theexecutive officers.

 

**AggregatedOption Exercises in Last Fiscal Year and Fiscal Year-End Values**

 

The followingtable provides information regarding the aggregate exercises of options by eachof the named executive officers. In addition, this table includes the number ofshares covered by both exercisable and unexercisable stock options as ofDecember 31, 2003, and the value of “in-the-money” options, which valuesrepresent the positive spread between the exercise price of any such optionsand the fiscal year-end value of the Company’s Common Stock.

 
|            |   | **Shares  acquired  on exercise** |   | **Value  Realized (1)** |   | **Number of  Securities  Underlying Unexercised  Options At December 31, 2003** |    | **Value of  in-the Money  Options At  December 31, 2003 (3)** |    |
|-----------------|--------|-----------------------------------|--------|------------------------------|--------|--------------------------------------------------------------------------------------|---------|--------------------------------------------------------------------|---------|
|            |   |                              |   | **Exercisable (2)**     |   | **Unexercisable**                                                                    |    | **Exercisable**                                                    |    | **Unexercisable** |   |
|            |   |                              |   |                         |   |                                                                                 |    |                                                               |    |   |   |   |   |
| Fu-Chieh Hsu    |   | —                            |   | $                            | — |                                                                                 | 287,088 |                                                               | 143,224 |   | $ | 1,078,250 |   | $ | 34,598 |   |
| Wingyu Leung    |   | 30,000                            |   | 183,300                      |   | 201,337                                                                              |    | 118,913                                                            |    | 607,263 |   | 27,916 |   |
| Mark-Eric Jones |   | 97,500                            |   | 752,345                      |   | 291,126                                                                              |    | 90,498                                                             |    | 1,526,786 |   | 14,907 |   |
| Andre Hassan    |   | 50,000                            |   | 508,500                      |   | 191,355                                                                              |    | 89,769                                                             |    | 808,417 |   | 14,491 |   |
| Mark Voll       |   | —                            |   | —                       |   | 76,140                                                                               |    | 150,570                                                            |    | 1,915 |   | 958 |   |
|                 |        |                                   |        |                              |        |                                                                                      |         |                                                                    |         |  |  |  |  |  |  |  |

 

37

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----

                                                Valuebased on the fair market value of Common Stock on the date of exercise less theoption exercise price.

 

(2)                                  Pursuantto the option agreements for option grants made under the Company’s 1996 StockPlan, the option holders were entitled to elect to exercise all or any part oftheir vested and unvested options at any time. Any shares of Common Stockreceived by the optionee on exercise of unvested options become subject to theCompany’s right of repurchase pursuant to a restricted stock purchaseagreement. The number of shares so obtained that are subject to the Company’sright of repurchase decreases over time in accordance with the vesting scheduleapplicable to the unvested options exercised. Accordingly, all options grantedto the named executive officers under the 1996 plan are deemed to beexercisable for the purpose of the following table, even thoughMessrs. Hsu, Leung, Jones and Hassan had 4,687, 4,167, 3,750, and 3,021unvested shares, respectively, subject to repurchase at December 31, 2003.

 

(3)                                  Valuebased on the fair market value of Common Stock of $8.57 on December 31,2003, less the option exercise price.

 

**EmploymentContracts, Termination of Employment and Change-in-Control Agreements**

 

We currently haveconfidentiality and invention assignment agreements in place with the namedexecutive officers. We do not, however, have any compensatory plan orarrangement with the named executive officers that is activated upon theresignation, termination or retirement of any of these executive officers, upona change in control of our company, or upon a change in the named executiveofficer’s responsibilities following a change in control.

 

**Compensationof Directors**

 

In 2003, membersof our board of directors did not receive compensation for their services asdirectors. In August 2000, we granted options to purchase 10,000 shares ofcommon stock to Mr. Berg for the years beginning in each March of 1997through 2002 under our 1996 Stock Option Plan. We granted options to purchase10,000 shares of common stock in each of five consecutive years to Dr. Yenfor the years beginning in each August from 2000 through 2004. All of theseoptions vest during each year at a rate of approximately 833 shares each month.

 

Our 2000 EmployeeStock Option Plan provides that options will be granted to non-employeedirectors pursuant to an automatic, nondiscretionary grant mechanism. Eachnon-employee director receives automatically a grant of an option to purchase10,000 shares of common stock each year at an exercise price set at the fairmarket value of the Common Stock on the date of grant. These options vest at arate of approximately 833 shares each month. Pursuant to this provision theCompany granted options in 2003 to Mr. Berg to purchase 10,000 shares ofCommon Stock, which options begin vesting in March 2005, and 10,000 sharesof common stock to Dr. Yen, which options begin vesting inAugust 2006. No additional options will be granted to non-employeedirectors for service during any year in which the director has already beengranted options in a like or greater number.

 

**CompensationCommittee Interlocks and Insider Participation**

 

The CompensationCommittee of the board of directors is responsible for determining salaries,incentives and other forms of compensation for directors, officers and otheremployees, and administers our incentive compensation and benefit plans.  During 2003, none of our executive officersserved as a member of the board of directors or compensation committee of anyentity that had one or more of its executive officers serving as a member ofour board of directors or Compensation Committee.  Neither Mr. Berg nor Mr. Yen was an officer or employee of oursduring 2003, or at any other time.

 

**Reporton Executive Compensation by the Compensation Committee of the Board ofDirectors**

 

The CompensationCommittee currently is comprised of independent members of the board ofdirectors.  The board of directors hasdelegated to the Compensation Committee responsibility for reviewing,recommending and approving our compensation policies and benefitsprograms.  The Compensation Committeealso has the principal responsibility for the administration of our stockplans, including approving stock option grants to executive officers.

 

**Compensation Philosophy**

** **

Our executivecompensation policy is designed to attract and retain qualified executivepersonnel by providing executives with a competitive total compensation packagebased in large part on the executive’s contribution to our financial andoperational success, the executive’s personal performance and increases instockholder value as measured by our stock price.

 

**CompensationProgram**

 

The compensationpackage for our executive officers comprises the following three components:

 

*BaseSalary*.  The CompensationCommittee determines the base salary of each executive based on the executive’sscope of responsibility, past accomplishments and experience and personalperformance, internal comparability considerations and data regarding theprevailing compensation levels for comparable positions in relevant competingexecutive labor markets.  TheCompensation Committee may give different weight to each of these factors foreach executive, as it deems appropriate. In selecting comparable companies for the purpose of setting competitivecompensation for executives, the Compensation Committee considers many factorsnot directly associated with stock price performance, such as geographiclocation, annual revenue and profitability, organizational structure, developmentstage and market capitalization.

 

*AnnualIncentive Compensation*. In 2003 and prior years, each of the executive officers could earnannual bonuses set at a percentage of his or her base salary on the basis ofMoSys' performance as measured against certain pre-established performancemeasures, principally revenues, and the attainment of individual objectives setfor each officer, other than the CEO, based upon the CEO’srecommendations.  The CompensationCommittee established the performance objectives for the CEO.  Based on performance against theirobjectives certain executive officers did receive bonus payments in 2003.

 

*StockOptions*.  TheCompensation Committee believes that granting stock options to executives andother key employees on an ongoing basis gives them a strong incentive tomaximize stockholder value and aligns their interests with those of otherstockholders.  The CompensationCommittee determines stock option grants under the 2000 Employee Stock OptionPlan to all MoSys executive officers and employees.  In determining the size of stock option grants under the annualbonus program for officers, the Compensation Committee takes into account theexecutive’s current position with and responsibilities in setting the annualtarget grant.  The percentage of thetarget grant awarded to the officer depends upon MoSys' performance againstspecified revenue, net income and              

 

 

38

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intellectual propertylicensing revenue objectives for each half of the fiscal year.  Generally, each stock option grant allowsthe executive to purchase shares of the common stock at a price per share equalto the market price on the date the option is granted, but the Compensation Committeehas the power to grant options at a lower price if considered appropriate underthe circumstances.  Each stock optiongrant generally becomes exercisable, or vests, in installments over time,contingent upon the executive’s continued employment with MoSys.

 

In 2003, theCompensation Committee approved stock bonus grants under the 2000 EmployeeStock Option Plan to certain executive officers based upon MoSys' performanceas measured against certain pre-established performance goals for each officerduring the second half of 2002.  Those optionsvest 50% immediately and the remaining 50% vests monthly over two years.  The exercise price was equal to the fairmarket value of the common stock on the grant date.  The Compensation Committee has determined that executiveofficers, including the CEO, will not be eligible to receive bonus optiongrants with respect to MoSys' performance during fiscal 2003.

 

*Compensationof Chief Executive Officer*. In 2003, the compensation for Fu-Chieh Hsu, the CEO, was comprised ofthe three components described above, and is reviewed annually.  In setting Dr. Hsu’s compensation packagefor fiscal year 2003, the Compensation Committee intended to provide a basesalary competitive with that paid to other chief executive officers incompeting executive labor markets, and to make a significant portion of thetotal compensation package contingent upon MoSys' financial and operationalperformance.  During the fiscal year,Dr. Hsu received a base salary of $279,108. Dr. Hsu was awarded a total cash bonus of approximately $72,663 basedprimarily on the achievement of financial and operational targets.

 

*Compliancewith Internal Revenue Code Section 162(m)*.  Section 162(m) of the Internal Revenue Codegenerally disallows a tax deduction to publicly-held companies for compensationpaid to certain executive officers, to the extent that compensation paid to theofficer exceeds $1 million during MoSys' taxable year.  The compensation paid to MoSys' executiveofficers for the year ended December 31, 2003 did not exceed the $1 millionlimit per officer.  In addition, theMoSys employee stock option plans and executive incentive option grants havebeen structured so that any compensation deemed paid to an executive officer inconnection with the exercise of his or her outstanding options with an exerciseprice per share equal to the fair market value per share of the common stock onthe grant date will qualify as performance-based compensation that will not besubject to the $1 million limitation. The Compensation Committee does not expect to take any action at thistime to modify cash compensation payable to the executive officers to avoid theapplication of Section 162(m).

 
|   | The Compensation  Committee of the Board of Directors: |
|--------|--------------------------------------------------------|
|   |                                                   |
|   | Carl E. Berg                                           |
|   | Wei Yen                                                |

 

***Item 12.******Security Ownership of CertainBeneficial Owners and Management***

 

The followingtable sets forth certain information as of February 23, 2004, concerningthe ownership of common stock by (i) each stockholder of known by us to bethe beneficial owner of more than 5% of the outstanding shares of Common Stock,(ii) each current member of the board of directors, (iii) eachexecutive officer named in the Summary Compensation Table appearing under“Executive Compensation,” above and (iv) all current directors and executiveofficers as a group.

 

Beneficialownership is determined in accordance with Rule 13d-3 of the SecuritiesExchange Act of 1934, as amended, and includes all shares over which thebeneficial owner exercises voting or investment power. Options and warrants topurchase common stock that are presently exercisable or exercisable within60 days of February 23, 2004 and are included in the total number ofshares beneficially owned for the person holding those options or warrants areconsidered outstanding for the purpose of calculating percentage ownership ofthe particular holder. We have relied on information supplied by its officers,directors and certain stockholders and on information contained in filings withthe SEC. Except as otherwise indicated, and subject to community property lawswhere applicable, we believe, based on information provided by these persons,that the persons named in the table have sole voting and investment power withrespect to all shares of common stock shown as beneficially owned by them.

 

39

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| **Name (1)**                                                                                    |   | **Number of  Shares  Beneficially  Owned** |   | **Shares  Issuable on  Exercise of  Outstanding Options  Within  60 days of  February 23, 2004** |   | **Percent of  Outstanding  Shares (2)** |   |
|-------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
| Wasatch Advisors, Inc.  150 Social Hall Avenue,  Salt Lake City,  UT 84111                      |   | 3,137,034                                  |   | —                                                                                           |   | 10.2                                    | %      |
| Wellington Management Company, LLP (‘WMC’) (3)  75 State St.,  Boston, MA  02109 |   | 2,804,500                                  |   | —                                                                                           |   | 9.1                                     | %      |
| William Blair & Company, LLC  222 W. Adams Street,  Chicago, IL  60606                 |   | 2,413,407                                  |   | —                                                                                           |   | 7.8                                     | %      |
| 1981 Kara Ann Berg Trust, Clyde J. Berg, Trustee (4)  10050 Bandley Drive,  Cupertino, CA 94014 |   | 2,304,830                                  |   | —                                                                                           |   | 7.5                                     | %      |
| Putnam Investments (5)  One Post Office Square,  Boston, MA  02109                         |   | 1,842,443                                  |   | —                                                                                           |   | 6.0                                     | %      |
| **Current  Directors**                                                                          |   |                                       |   |                                                                                             |   |                                    |   |
| Fu-Chieh Hsu (6)                                                                                |   | 3,747,114                                  |   | 307,114                                                                                          |   | 12.1                                    | %      |
| Wingyu Leung (7)                                                                                |   | 3,108,704                                  |   | 218,024                                                                                          |   | 10.0                                    | %      |
| Carl E. Berg (8)                                                                                |   | 200,829                                    |   | 70,833                                                                                           |   |                                    | *      |
| Wei Yen                                                                                         |   | 285,926                                    |   | 35,926                                                                                           |   |                                    | *      |
| **Named  Executive Officers who are not Directors**                                             |   |                                       |   |                                                                                             |   |                                    |   |
| Mark-Eric Jones                                                                                 |   | 303,302                                    |   | 303,302                                                                                          |   | 1.0                                     | %      |
| Andre Hassan                                                                                    |   | 210,299                                    |   | 202,948                                                                                          |   |                                    | *      |
| Mark Voll                                                                                       |   | 132,950                                    |   | 92,950                                                                                           |   |                                    | *      |
| All current  directors and executive officers as a group (7 persons)                            |   | 7,989,124                                  |   | 1,231,097                                                                                        |   | 25.0                                    | %      |

 

----

*                                         Representsholdings of less than one percent.

 

(1)                                  Unlessindicated otherwise, the address of each person listed in the table is c/oMonolithic System Technology, Inc., 1020 Stewart Drive, Sunnyvale,California 94085.

 

(2)                                  Thepercentage of beneficial ownership is based on 30,767,544 shares of commonstock outstanding as of February 23, 2004 and excluding all shares ofcommon stock issuable upon the exercise of outstanding options other than theshares so issuable upon the exercise of options held and exercisable within60 days of February 23, 2004 by the named person.

 

(3)           According to a Schedule 13G filedwith the Securities and Exchange Commission on February 12, 2004 by WellingtonManagement Company, LLP (“WMC”), in its capacity as an investment advisor.  WMC has reported that the 2,804,500 sharesare owned of record by its clients.  WMChas reported that it has shared power to vote or direct the vote of 1,519,100shares and shared power to dispose or direct the disposition of 2,804,500shares.

 

(4)                                  ClydeJ. Berg is Carl E. Berg’s brother, and Carl Berg’s adult daughter is the solebeneficiary of this trust. These shares were shares distributed by West CoastVenture Capital Limited, L.P. (“West Coast”) in connection with the liquidationof West Coast, effective June 2002. Mr. Berg disclaims beneficialownership of all these shares.

 

(5)           According to a Schedule 13G filedwith the Securities and Exchange Commission on February 13, 2004 by Putnam, LLCd/b/a Putnam Investments (“PI”), on behalf of itself and Marsh & McLennanCompanies, Inc. (“MMC”), Putnam Investment Management, LLC (“PIM”) and ThePutnam Advisory Company, LLC (“PAC”). PI, which is a wholly-owned subsidiary of MMC, wholly owns tworegistered investment advisers:  (a)PIM, which is the investment advisor to the Putnam family of mutual funds, and(b) PAC, which is the investment advisor to Putnam’s institutionalclients.  According to the Schedule13G:  (i) PI has shared votingpower over 1,087,783 shares and shared dispositive power over 1,842,443 shares,(ii) PIM has shared dispositive power over 588,050 shares, and (iii) PAChas shared voting power over 1,087,783 shares and shared dispositive power over1,254,393 shares.

 

(6)                                  Includes480,000 shares of common stock held by Dr. Hsu as trustee for trustsestablished for the benefit of Dr. Hsu’s children and 40,000 shares ofcommon stock held directly by such children.

 

(7)                                  Includes600,000 shares of common stock held by Dr. Leung as trustee of trustsestablished for the benefit of Dr. Leung’s children.

 

(8)                                  Includes124,998 shares held by Berg & Berg Enterprises, LLC, of whichMr. Berg is the sole manager. These shares were distributed by West Coastin connection with its liquidation, effective June 2002. Mr. Bergdisclaims beneficial ownership of these shares, except to the extent of hispecuniary interest in them. Also includes 4,998 shares owned by Mr. Berg’swife. Mr. Berg disclaims beneficial ownership of these shares.

 

40

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# **Equity Compensation Plan Information**

 

The followingtable provides information as of December 31, 2003 regarding equitycompensation plans approved by the Company’s security holders. The Company doesnot have any equity compensation plans that have not been approved by oursecurity holders.

 
| **Plan Category**                                       |   | **Number of  securities  to be issued upon  exercise of outstanding  options, warrants and  rights** |   | **Weighted-average  exercise price  of outstanding options, warrants  and rights** |   | **Number of  securities remaining available  for future issuance under equity  compensation plans (excluding securities  reflected in column (a))** |        |
|---------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|-------------|
| Equity  compensation plans approved by security holders |   | 4,372,000                                                                                            |   | $                                                                                  | 7.92   |                                                                                                                                                | 4,010,000(1 | ) |
|                                                         |        |                                                                                                      |        |                                                                                    |        |                                                                                                                                                     |             |  |

 

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(1)                                  Consistsof 3,712,000 shares of Common Stock available for future issuance under the2000 Employee Stock Option Plan and 298,000 shares of Common Stock availablefor future issuance under the 2000 Employee Stock Purchase Plan, in each caseas of December 31, 2003. In addition, the 2000 Employee Stock Option Planprovides for an annual increase in the number of shares reserved under the planon January 1 of each year, equal to the lesser of 500,000 shares, twopercent of the Company’s outstanding shares of Common Stock on such date or alesser amount determined by the Board of Directors. The 2000 Employee StockPurchase Plan provides for an annual increase in the number of shares reservedunder the plan on January 1 of each year, equal to the lesser of 100,000shares, one percent of the outstanding shares of Common Stock on such date or alesser amount determined by the Board of Directors.

 

***Item 13.******Certain Relationships and RelatedTransactions***

 

Since January 1, 2003, we have not entered into any materialtransaction with any of our directors, executive officers or holders of morethan 5% of the common stock, or with any persons in which directors, namedexecutive officers or such stockholders have direct or indirect materialinterests.

 

***Item 14******. Accountant Fees and Services***

 

The Audit Committee meetswith Ernst & Young LLP (“E&Y”) several times a year. At suchtimes, the Audit Committee reviews both audit and non-audit services performedby E&Y as well as the fees charged for such services. The Audit Committeehas delegated its authority to the chairman of the Audit Committee topreapprove requests for non-audit services. Among other things, the Audit Committeeor the chairman of the Committee examines the effect that performance ofnon-audit services may have upon the independence of the auditors.

** **

**Fees Incurred by the Company for Ernst & Young LLP**

 

Thefollowing table shows the fees paid or accrued (in thousands) by us for theaudit and other services provided by Ernst & Young LLP for fiscal 2003and 2002. During the fiscal year ended December 31, 2003 and 2002, no feeswere billed by E&Y for information technology consulting.

 

|                    |   | **2003** |   | **2002** |   |
|-------------------------|--------|----------|--------|----------|--------|
| Audit Fees (1)          |   | $        | 387    |     | $      | 206 |   |
| Audit-Related  Fees (2) |   | 42       |   | 105      |   |
| Tax Fees (3)            |   | 43       |   | 83       |   |
|                    |   |     |   |     |   |
| Total                   |   | $        | 472    |     | $      | 394 |   |

 

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(1)           Auditfees represent fees for professional services provided in connection with theaudit of our financial statements and review of our quarterly financialstatements.

 

(2)           Audit-relatedfees consisted primarily of accounting consultations for 2003. For 2002,audit-related fees include fees in connection with the acquisition of ATMOS andother accounting related consultations.

 

(3)           Taxfees consisted primarily of income tax compliance and related tax services.

 

41

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**Part IV**

 

***Item 15.******Exhibits, Financial StatementSchedules and Reports on the Form 8K***

 

(a)                                  Thefollowing documents are filed as part of this report:

 

(1)                                  FinancialStatements and Report of Ernst & Young LLP Independent Auditors, whichare set forth in the index to Consolidated Financial Statements on pages F-1through F-30 of this report.

 
| Report  of Ernst & Young LLP Independent Auditors |   |
|-------------------------------------------------------|--------|
| Consolidated  Balance Sheets                          |   |
| Consolidated  Statements of Income                    |   |
| Consolidated  Statements of Stockholders’ Equity |   |
| Consolidated  Statements of Cash Flows                |   |
| Notes  to Consolidated Financial Statements           |   |

 
| (2)   |   |    | Financial Statement  Schedule—Schedule II—Valuation and Qualifying Accounts                                                                                                                                   |
|-------|--------|---------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (3)   |   |    | Exhibits                                                                                                                                                                                                                |
| 2.1   |   | *       | Merger Agreement  regarding the Registrant’s reincorporation in Delaware                                                                                                                                           |
| 2.2   |   | ***     | Share Purchase  Agreement for the shares for ATMOS Corporation                                                                                                                                                          |
| 2.3   |   | #       | Agreement and Plan of  Reorganization, dated February 23, 2004, among Synopsys, Inc., Mountain  Acquisition Sub, Inc., a wholly owned subsidiary of Synopsys, Inc., and  Monolithic System Technology, Inc.             |
| 2.4   |   | ##      | Form of Stockholder  Agreement, dated February 23, 2004, among Synopsys, Inc., Mountain  Acquisition Sub, Inc., a wholly owned subsidiary of Synopsys, Inc., and the  stockholder of Monolithic System Technology, Inc. |
| 3.1   |   |    | Not currently in use                                                                                                                                                                                                    |
| 3.2   |   |    | Not currently in use                                                                                                                                                                                                    |
| 3.3   |   | *       | Restated Certificate of  Incorporation of the Registrant                                                                                                                                                                |
| 3.4   |   | *       | Bylaws of the  Registrant                                                                                                                                                                                               |
| 4.1   |   | *       | Specimen common stock  certificate                                                                                                                                                                                      |
| 4.2   |   | *       | Third Amended and  Restated Investor Rights Agreement dated September 27, 1997                                                                                                                                          |
| 4.3   |   | *       | Rights Agreement                                                                                                                                                                                                        |
| 10.1  |   | *       | Form of Indemnity  Agreement between the Registrant and each of its directors and executive  officers                                                                                                                   |
| 10.2  |   | *       | 1992 Stock Option Plan  and form of Option Agreement thereunder                                                                                                                                                         |
| 10.3  |   | *       | 1996 Stock Plan and  form of Option Agreement thereunder                                                                                                                                                                |
| 10.4  |   | *       | Form of Restricted  Stock Purchase Agreement                                                                                                                                                                            |
| 10.5  |   | *       | 2000 Employee Stock  Option Plan and form of Option Agreement thereunder                                                                                                                                                |
| 10.6  |   | *       | 2000 Employee Stock  Purchase Plan and form of Subscription Agreement thereunder                                                                                                                                        |
| 10.7  |   | *       | Standard Industrial  Lease, dated September 24, 1996, between the Registrant and McCandless  Properties                                                                                                                 |
| 10.8  |   | *       | First Amendment to  Lease, dated June 30, 2000, between the Registrant and McCandless Properties                                                                                                                        |
| 10.9  |   | *       | Agreement between  Nintendo Co., Ltd. and the Registrant dated August 31, 1999                                                                                                                                          |
| 10.10 |   | †* | License Agreement  between NEC Corporation and the Registrant dated January 31, 1999                                                                                                                                    |

 

42

----

 
| 10.11 |   | †* | License Agreement  between NEC Corporation and the Registrant dated December 17, 1999 |
|-------|--------|---------|---------------------------------------------------------------------------------------|
| 10.12 |   | *       | Employment Agreement  between Registrant and F. Judson Mitchell dated July 17, 2000   |
| 21.1  |   |    | List of subsidiaries                                                                  |
| 23.1  |   |    | Consent of Ernst &  Young LLP Independent Auditors                                |
| 24.1  |   | **      | Power of Attorney                                                                     |
| 31.1  |   |    | Rule 13a-14  certification                                                       |
| 31.2  |   |    | Rule 13a-14  certification                                                       |
| 32    |   |    | Section 1350  certification                                                      |

 

----

| *      |   |   |   | Incorporated by  reference to the same-numbered exhibit to the Company’s Registration  Statement on Form S-1, as amended, originally filed August 4, 2000, declared  effective June 27, 2001 (Commission file No. 333-43122). |
|--------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| † |   |   |   | Portions of this  exhibit have been omitted pursuant to Order Granting Confidential Treatment  Under the Securities Act of 1933 dated June 27, 2001 (Commission File No.  333-43122—CF#10183).                                |
| **     |   |   |   | Set forth on  page 44 of this report.                                                                                                                                                                                         |
| ***    |   |   |   | Incorporated by  reference to the same-numbered exhibit to the Company’s report on Form 8-K/A  filed on November 13, 2002.                                                                                                    |
| #      |   |   |   | Incorporated by  reference to Exhibit 2.1 of the Current Report on Form 8-K filed by Synopsys,  Inc. on February 26, 2004, (Commission File No. 000-19807).                                                                        |
| ##     |   |   |   | Incorporated by  reference to Exhibit 2.2 of the Current Report on Form 8-K filed by Synopsys,  Inc. on February 26, 2004. (Commission File No. 000-19807).                                                                        |

 

(b)                                 Reportson Form 8-K

 

OnNovember 13, 2003, we filed a report on Form 8-K regarding our results ofoperations and financial condition for the third quarter of 2003.

 

43

----

 

**SIGNATURES**

 

Pursuant to the requirements of the Section 13 or 15(d) of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized, on the12th day of March 2004.

 
|   |   | Monolithic  System Technology, Inc. |
|--------|--------|-------------------------------------|
|   |   |                                |
|   |   |                                |
|   |   | By:                                 | /s/ Fu-Chieh Hsu |
|   |   |                                | Fu-Chieh Hsu  Chairman of the Board, President and  Chief Executive Officer |
|   |   |                                |   |
|   |   | By:                                 | /s/ Mark Voll |
|   |   |                                | Mark Voll |
|   |   |                                | Vice President,  Finance and  Chief Financial Officer  (Principal Financial and Accounting Officer) and Secretary |
|   |   |                                |   |

 

 

**POWER OF ATTORNEY**

 

KNOW ALL MEN BY THESE PRESENTS, that each person whose signatureappears below constitutes and appoints Fu-Chieh Hsu and Mark Voll, and each ofthem, as his true and lawful attorneys-in-fact and agents, with full power ofsubstitution and resubstitution, for him and in his name, place and stead, inany and all capacities, to sign any and all amendments to his Report onForm 10-K, and to file the same, with all exhibits thereto, and other documentsin connection therewith, with the Securities and Exchange Commission, grantingunto said attorneys-in-fact and agents, and each of them, full power andauthority to do and perform each and every act and thing requisite andnecessary to be done in connection therewith, as fully to all intents andpurposes as he might or could do in person, hereby ratifying and confirming allthat said attorneys-in-fact and agents, or any of them, or their or hissubstitute or substitutes, may lawfully do or cause to be done by virtuehereof.

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| **Signature**    |   | **Title**                                                                                                         |   | **Date**        |
|------------------|--------|-------------------------------------------------------------------------------------------------------------------|--------|-----------------|
|             |   |                                                                                                              |   |            |
| /s/ Fu-Chieh Hsu |   | Chairman of the Board,  President  and Chief Executive Officer  (Principal Executive Officer)                     |   | March 12, 2004  |
| Fu-Chieh Hsu     |   |                                                                                                              |
| /s/ Mark Voll    |   | Vice President, Finance  and Chief Financial  Officer (Principal Financial and Accounting  Officer) and Secretary |   | March 12, 2004  |
| Mark Voll        |   |                                                                                                              |
| /s/ Wingyu Leung |   | Director                                                                                                          |   | March 12 , 2004 |
| Wingyu Leung     |   |                                                                                                              |   |            |

 

44

----

 
| **Signature**    |   | **Title** |   | **Date**        |
|------------------|--------|-----------|--------|-----------------|
|             |   |      |   |            |
| /s/ Carl E. Berg |   | Director  |   | March 12 , 2004 |
| Carl E. Berg     |   |      |   |            |
|             |   |      |   |            |
| /s/ Wei Yen      |   | Director  |   | March 12 , 2004 |
| Wei Yen          |   |      |   |            |

 

45

----

 

**MONOLITHICSYSTEM TECHNOLOGY, INC.**

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**

 
| Report of Ernst &  Young LLP Independent Auditors |   |
|-------------------------------------------------------|--------|
| Consolidated Balance Sheets                           |   |
| Consolidated  Statements of Income                    |   |
| Consolidated  Statements of Stockholders’ Equity |   |
| Consolidated Statements  of Cash Flows                |   |
| Notes to Consolidated Financial  Statements           |   |
| Schedule II  Valuation and Qualifying Accounts        |   |

 

i

----

 

**REPORT OFINDEPENDENT AUDITORS**

 

TheBoard of Directors and Stockholders of

MonolithicSystem Technology, Inc.

 

We have audited the accompanying consolidatedbalance sheets of Monolithic System Technology, Inc. as ofDecember 31, 2003 and 2002, and the related consolidated statements ofincome, stockholders’ equity, and cash flows for each of the three years in theperiod ended December 31, 2003. Our audits also included the financialstatement schedule listed in the Index at Item 15(a). These financialstatements and schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements andschedule based on our audits.

 

We conducted our audits in accordance withauditing standards generally accepted in the United States. Those standardsrequire that we plan and perform the audits to obtain reasonable assuranceabout whether the financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes 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 financial statements referredto above present fairly, in all material respects, the consolidated financialposition of Monolithic System Technology, Inc. at December 31, 2003and 2002, and the consolidated results of their operations and their cash flowsfor each of the three years in the period ended December 31, 2003, inconformity with accounting principles generally accepted in the United States.Also, in our opinion, the related financial statement schedule, when consideredin relation to the basic financial statements taken as a whole, presents fairlyin all material respects the information set forth therein.

 

|   |   | ERNST  & YOUNG LLP |
|--------|--------|------------------------|

 

SanJose, California

January26, 2004

 

F-1

----

 

**MONOLITHICSYSTEM TECHNOLOGY, INC.**

**CONSOLIDATEDBALANCE SHEETS**

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

 
|                                                                                                                                                                    |   | **December  31,** |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|
|                                                                                                                                                                    |   | **2003**          |    | **2002** |   |
|                                                                                                                                                                    |   |              |    |   |   |
| **ASSETS**                                                                                                                                                              |   |              |    |   |   |
| Current assets:                                                                                                                                                         |   |              |    |   |   |
| Cash and cash  equivalents                                                                                                                                              |   | $                 | 22,033  |   | $ | 26,321 |   |
| Short-term  investments                                                                                                                                                 |   | 19,332            |    | 42,112 |   |
| Accounts  receivable                                                                                                                                                    |   | 1,027             |    | 943 |   |
| Unbilled  contract receivable                                                                                                                                           |   | 1,106             |    | 693 |   |
| Inventories                                                                                                                                                             |   | 474               |    | 1,037 |   |
| Prepaid expenses  and other current assets                                                                                                                              |   | 3,822             |    | 4,475 |   |
| Total current  assets                                                                                                                                                   |   | 47,794            |    | 75,581 |   |
| Long-term  investments                                                                                                                                                  |   | 44,462            |    | 11,400 |   |
| Property and  equipment, net                                                                                                                                            |   | 1,796             |    | 3,352 |   |
| Goodwill                                                                                                                                                                |   | 12,326            |    | 12,326 |   |
| Other assets                                                                                                                                                            |   | 514               |    | 431 |   |
| Total assets                                                                                                                                                            |   | $                 | 106,892 |   | $ | 103,090 |   |
|                                                                                                                                                                    |   |              |    |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                          |   |              |    |   |   |
| Current  liabilities:                                                                                                                                                   |   |              |    |   |   |
| Accounts payable                                                                                                                                                        |   | $                 | 116     |   | $ | 132 |   |
| Accrued expenses  and other liabilities                                                                                                                                 |   | 2,733             |    | 2,368 |   |
| Deferred revenue                                                                                                                                                        |   | 506               |    | 1,779 |   |
| Current portion  of capital lease obligations                                                                                                                           |   | 13                |    | 89 |   |
| Total current  liabilities                                                                                                                                              |   | 3,368             |    | 4,368 |   |
| Long-term  portion of capital lease obligations                                                                                                                         |   | 13                |    | 25 |   |
| Commitments and  contingencies                                                                                                                                          |   |              |    |   |   |
| Stockholders’  equity:                                                                                                                                             |   |              |    |   |   |
| Preferred stock,  $0.01 par value; 20,000 shares authorized; none issued and outstanding at  December 31, 2003 and December 31, 2002                          |   | —            |    | — |   |
| Common stock,  $0.01 par value; 120,000 shares authorized; 30,724 shares and 30,230 shares  issued and outstanding at December 31, 2003 and December 31, 2002 |   | 307               |    | 302 |   |
| Additional  paid-in capital                                                                                                                                             |   | 99,719            |    | 97,796 |   |
| Deferred  stock-based compensation                                                                                                                                      |   | (626              | )       | (1,064 | ) |
| Accumulated  other comprehensive income                                                                                                                                 |   | 56                |    | 116 |   |
| Retained  earnings                                                                                                                                                      |   | 4,055             |    | 1,547 |   |
| Total  stockholders’ equity                                                                                                                                        |   | 103,511           |    | 98,697 |   |
| Total  liabilities and stockholders’ equity                                                                                                                        |   | $                 | 106,892 |   | $ | 103,090 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

F-2

----

 

**MONOLITHICSYSTEM TECHNOLOGY, INC.**

**CONSOLIDATEDSTATEMENTS OF INCOME**

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

 
|                                                           |   | **Year Ended  December 31,** |   |
|----------------------------------------------------------------|--------|------------------------------|--------|
|                                                           |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                                           |   |                         |   |   |   |   |   |
| Net revenue:                                                   |   |                         |   |   |   |   |   |
| Product                                                        |   | $                            | 1,904  |   | $ | 2,924 |   | $ | 12,991 |   |
| Licensing                                                      |   | 10,418                       |   | 10,523 |   | 6,053 |   |
| Royalty                                                        |   | 6,911                        |   | 14,344 |   | 3,446 |   |
|                                                           |   | 19,233                       |   | 27,791 |   | 22,490 |   |
| Cost of net  revenue:                                          |   |                         |   |   |   |   |   |
| Product                                                        |   | 1,217                        |   | 1,668 |   | 5,776 |   |
| Licensing                                                      |   | 1,970                        |   | 1,730 |   | 633 |   |
|                                                           |   | 3,187                        |   | 3,398 |   | 6,409 |   |
| Gross profit                                                   |   | 16,046                       |   | 24,393 |   | 16,081 |   |
| Operating  expenses:                                           |   |                         |   |   |   |   |   |
| Research and  development                                      |   | 8,593                        |   | 6,586 |   | 4,420 |   |
| Selling, general  and administrative                           |   | 6,121                        |   | 4,950 |   | 4,686 |   |
| Stock-based  compensation expense                              |   | 459                          |   | 656 |   | 1,435 |   |
| Total operating  expenses                                      |   | 15,173                       |   | 12,192 |   | 10,541 |   |
| Income from  operations                                        |   | 873                          |   | 12,201 |   | 5,540 |   |
| Interest and  other income                                     |   | 1,914                        |   | 1,539 |   | 1,818 |   |
| Income before  provision for income taxes                      |   | 2,787                        |   | 13,740 |   | 7,358 |   |
| Provision for  income taxes                                    |   | (279                         | )      | (1,373 | ) | (367 | ) |
| Net income                                                     |   | $                            | 2,508  |   | $ | 12,367 |   | $ | 6,991 |   |
|                                                           |   |                         |   |   |   |   |   |
| Net income per  share:                                         |   |                         |   |   |   |   |   |
| Basic                                                          |   | $                            | 0.08   |   | $ | 0.41 |   | $ | 0.35 |   |
| Diluted                                                        |   | $                            | 0.08   |   | $ | 0.40 |   | $ | 0.25 |   |
| Shares used in  computing net income per share:                |   |                         |   |   |   |   |   |
| Basic                                                          |   | 30,504                       |   | 29,902 |   | 19,709 |   |
| Diluted                                                        |   | 30,998                       |   | 31,275 |   | 28,390 |   |
| Allocation of  stock-based compensation to operating expenses: |   |                         |   |   |   |   |   |
| Research and  development                                      |   | $                            | 148    |   | $ | 340 |   | $ | 781 |   |
| Selling, general  and administrative                           |   | 311                          |   | 316 |   | 654 |   |
|                                                           |   | $                            | 459    |   | $ | 656 |   | $ | 1,435 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

F-3

----

 

**MONOLITHICSYSTEM TECHNOLOGY, INC.**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)**

**(In thousands)**

** **
|                                                                                   |              |   |       | **Additional  Paid-In  Capital** |   | **Notes  Receivable  from  Stockholders** |   | **Deferred  Stock-BasedCompensation** |   | **Accumulated  Other  Comprehensive  Income** |   | **Retained  Earnings  (Accumulated Deficit)** |   | **Total** |   |
|----------------------------------------------------------------------------------------|-------------------|--------|------------|----------------------------------|--------|-------------------------------------------|--------|---------------------------------------|--------|----------------------------------------------------|--------|-----------------------------------------------|--------|-----------|--------|
|                                                                                   |              |   |
|                                                                                   |              |   |
|                                                                                   | **Common  Stock** |   |
|                                                                                   | **Shares**        |   | **Amount** |                             |
| Balance at December 31, 2000                                                           |              | 10,352 |       | 103                              |   | 6,342                                     |   | (408                                  | )      | (2,078                                             | )      | —                                        |   | (17,811   | )      | (13,852 | ) |
| Issuance of Common Stock in initial public offering, net of issuance  costs            |              | 5,750  |       | 58                               |   | 51,496                                    |   | —                                |   | —                                             |   | —                                        |   | —    |   | 51,554 |   |
| Conversion of preferred stock into common stock                                        |              | 12,731 |       | 127                              |   | 35,464                                    |   | —                                |   | —                                             |   | —                                        |   | —    |   | 35,591 |   |
| Issuance of Common Stock upon exercise of options                                      |              | 310    |       | 3                                |   | 784                                       |   | —                                |   | —                                             |   | —                                        |   | —    |   | 787 |   |
| Issuance of Common Stock upon exercise of warrants                                     |              | 349    |       | 4                                |   | 1,423                                     |   | (277                                  | )      | —                                             |   | —                                        |   | —    |   | 1,150 |   |
| Repayment of note issued to stockholder                                                |              | — |       | —                           |   | —                                    |   | 432                                   |   | —                                             |   | —                                        |   | —    |   | 432 |   |
| Deferred stock-based compensation                                                      |              | — |       | —                           |   | 1,464                                     |   | —                                |   | (1,464                                             | )      | —                                        |   | —    |   | — |   |
| Amortization of deferred stock-based compensation and other change in  employee status |              | — |       | —                           |   | (701                                      | )      | —                                |   | 2,136                                              |   | —                                        |   | —    |   | 1,435 |   |
| Other comprehensive income — unrealized gain on available-for-sale  investments   |              | — |       | —                           |   | —                                    |   | —                                |   | —                                             |   | 16                                            |   | —    |   | 16 |   |
| Net income                                                                             |              | — |       | —                           |   | —                                    |   | —                                |   | —                                             |   | —                                        |   | 6,991     |   | 6,991 |   |
| Comprehensive income                                                                   |              |   |       |                             |   |                                      |   |                                  |   |                                               |   |                                          |   |      |   | 7,007 |   |
| Balance at December 31, 2001                                                           |              | 29,492 |       | 295                              |   | 96,272                                    |   | (253                                  | )      | (1,406                                             | )      | 16                                            |   | (10,820   | )      | 84,104 |   |
| Issuance of Common Stock upon exercise of options                                      |              | 159    |       | 2                                |   | 498                                       |   | —                                |   | —                                             |   | —                                        |   | —    |   | 500 |   |
| Issuance of Common Stock for Employee Stock Purchase Plan                              |              | 47     |       | —                           |   | 409                                       |   | —                                |   | —                                             |   | —                                        |   | —    |   | 409 |   |
| Issuance of Common Stock for acquisition of ATMOS                                      |              | 62     |       | —                           |   | 622                                       |   | —                                |   | (314                                               | )      | —                                        |   | —    |   | 308 |   |
| Issuance of Common Stock upon exercise of cashless warrants                            |              | 470    |       | 5                                |   | (5                                        | )      | —                                |   | —                                             |   | —                                        |   | —    |   | — |   |
| Repayment of note issued to stockholder                                                |              | — |       | —                           |   | —                                    |   | 253                                   |   | —                                             |   | —                                        |   | —    |   | 253 |   |
| Amortization of deferred stock-based compensation and other change in  employee status |              | — |       | —                           |   | —                                    |   | —                                |   | 656                                                |   | —                                        |   | —    |   | 656 |   |
| Other comprehensive income — unrealized gain on available-for-sale  investments   |              | — |       | —                           |   | —                                    |   | —                                |   | —                                             |   | 100                                           |   | —    |   | 100 |   |
| Net income                                                                             |              | — |       | —                           |   | —                                    |   | —                                |   | —                                             |   | —                                        |   | 12,367    |   | 12,367 |   |
| Comprehensive income                                                                   |              |   |       |                             |   |                                      |   |                                  |   |                                               |   |                                          |   |      |   | 12,467 |   |
| Balance at December 31, 2002                                                           |              | 30,230 |       | 302                              |   | 97,796                                    |   | —                                |   | (1,064                                             | )      | 116                                           |   | 1,547     |   | 98,697 |   |
| Issuance of Common Stock upon exercise of options                                      |              | 439    |       | 5                                |   | 1,460                                     |   | —                                |   | —                                             |   | —                                        |   | —    |   | 1,465 |   |
| Issuance of Common Stock for Employee Stock Purchase Plan                              |              | 55     |       | —                           |   | 442                                       |   | —                                |   | —                                             |   | —                                        |   | —    |   | 442 |   |
| Amortization of deferred stock-based compensation and other change in  employee status |              | — |       | —                           |   | 21                                        |   | —                                |   | 438                                                |   | —                                        |   | —    |   | 459 |   |
| Other comprehensive income — unrealized loss on available-for-sale  investments   |              | — |       | —                           |   | —                                    |   | —                                |   | —                                             |   | (60                                           | )      | —    |   | (60 | ) |
| Net income                                                                             |              | — |       | —                           |   | —                                    |   | —                                |   | —                                             |   | —                                        |   | 2,508     |   | 2,508 |   |
| Comprehensive income                                                                   |              |   |       |                             |   |                                      |   |                                  |   |                                               |   |                                          |   |      |   | 2,448 |   |
|                                                                                   |              |   |       |                             |   |                                      |   |                                  |   |                                               |   |                                          |   |      |   |   |   |
| Balance at December 31, 2003                                                           |              | 30,724 |       | $                                | 307    |                                      | $      | 99,719                                |   | $                                                  | — |                                          | $      | (626      | )      | $ | 56 |   | $ | 4,055 |   | $ | 103,511 |   |
|                                                                                        |                   |        |            |                                  |        |                                           |        |                                       |        |                                                    |        |                                               |        |           |        |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are anintegral part of these financial statements.

 

F-4

----

 

**MONOLITHICSYSTEM TECHNOLOGY, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
|                                                                                                    |   | **Year Ended  December 31,** |   |
|---------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                                    |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                                                                                    |   |                         |   |   |   |   |   |
| **Cash  flows from operating activities:**                                                              |   |                         |   |   |   |   |   |
| Net income                                                                                              |   | $                            | 2,508  |   | $ | 12,367 |   | $ | 6,991 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                      |   |                         |   |   |   |   |   |
| Depreciation and  amortization                                                                          |   | 2,049                        |   | 1,315 |   | 811 |   |
| Amortization of  deferred stock-based compensation                                                      |   | 459                          |   | 656 |   | 1,435 |   |
| Interest income  on notes receivable from stockholder                                                   |   | —                       |   | (8 | ) | (38 | ) |
| Changes in  current assets and liabilities:                                                             |   |                         |   |   |   |   |   |
| Accounts  receivable                                                                                    |   | (84                          | )      | (600 | ) | 1,203 |   |
| Unbilled  contract receivable                                                                           |   | (413                         | )      | (693 | ) | — |   |
| Inventories                                                                                             |   | 563                          |   | 656 |   | 452 |   |
| Prepaid expenses  and other assets                                                                      |   | 570                          |   | (2,917 | ) | 161 |   |
| Deferred revenue                                                                                        |   | (1,273                       | )      | (1,639 | ) | (2,555 | ) |
| Accounts payable                                                                                        |   | (16                          | )      | (1,292 | ) | (661 | ) |
| Accrued  liabilities                                                                                    |   | 365                          |   | 40 |   | 649 |   |
| Net cash  provided by operating activities                                                              |   | 4,728                        |   | 7,885 |   | 8,448 |   |
| **Cash  flows from investing activities:**                                                              |   |                         |   |   |   |   |   |
| Purchase of  property and equipment                                                                     |   | (493                         | )      | (1,356 | ) | (1,529 | ) |
| Purchase of  available-for-sale investments                                                             |   | (236,032                     | )      | (207,804 | ) | (44,414 | ) |
| Proceeds from  maturity of short-term investments                                                       |   | 258,752                      |   | 202,722 |   | 7,500 |   |
| Purchase of  long-term investments                                                                      |   | (33,062                      | )      | (11,400 | ) | — |   |
| Acquisition of  business and related expenses, net of cash acquired                                     |   | —                       |   | (12,049 | ) | — |   |
| Net cash used in  investing activities                                                                  |   | (10,835                      | )      | (29,887 | ) | (38,443 | ) |
| **Cash  flows from financing activities:**                                                              |   |                         |   |   |   |   |   |
| Payment of  capital lease obligations                                                                   |   | (88                          | )      | (210 | ) | — |   |
| Repayment of  notes receivable from stockholder                                                         |   | —                       |   | 261 |   | 432 |   |
| Proceeds from  issuance of common stock                                                                 |   | 1,907                        |   | 909 |   | 787 |   |
| Proceeds from  exercise of common stock warrants                                                        |   | —                       |   | — |   | 1,188 |   |
| Net proceeds  from initial public offering of common stock                                              |   | —                       |   | — |   | 51,554 |   |
| Net cash  provided by financing activities                                                              |   | 1,819                        |   | 960 |   | 53,961 |   |
|                                                                                                    |   |                         |   |   |   |   |   |
| Net increase  (decrease) in cash and cash equivalents                                                   |   | (4,288                       | )      | (21,042 | ) | 23,966 |   |
| Cash and cash equivalents  at beginning of period                                                       |   | 26,321                       |   | 47,363 |   | 23,397 |   |
| Cash and cash  equivalents at end of period                                                             |   | $                            | 22,033 |   | $ | 26,321 |   | $ | 47,363 |   |
|                                                                                                    |   |                         |   |   |   |   |   |
| **Supplemental  disclosure:**                                                                           |   |                         |   |   |   |   |   |
| Cash paid for  income taxes                                                                             |   | $                            | 394    |   | $ | 3,255 |   | $ | 110 |   |
| Conversion of  preferred stock to common stock                                                          |   | $                            | — |   | $ | — |   | $ | 35,591 |   |
| Deferred  compensation from common shares related to ATMOS acquisition subject to  vesting requirements |   | $                            | — |   | $ | 314 |   | $ | — |   |
| Cashless warrant  exercises                                                                             |   | $                            | — |   | $ | 5 |   | $ | — |   |

 

The accompanying notes are anintegral part of these financial statements.

 

F-5

----

 

**MONOLITHIC SYSTEMTECHNOLOGY, INC.**

**NOTES T****O CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1—The Company and Summary of Significant AccountingPolicies:**

 

## ***The Company***

 

Monolithic System Technology, Inc. (the“Company”) was incorporated in California on September 16, 1991 to design,develop and market high performance semiconductor memory products andtechnologies used by the semiconductor industry and electronic productmanufacturers. On September 12, 2000, the stockholders approved theCompany’s reincorporation in Delaware.

 

The Company has developed an innovative embedded-memorytechnology, called 1T-SRAM, which the Company licenses on a non-exclusive andworldwide basis to semiconductor companies and electronic productmanufacturers. From its inception in 1991 through 1998, the Company focusedprimarily on the sale of stand-alone memory products. In the fourthquarter of 1998, the Company changed the emphasis of its business model tofocus primarily on the licensing of its 1T-SRAM technologies and completed thistransition in 2002 when a majority of our revenues were derived from licensingand royalty of our 1T-SRAM technologies.

 

## ***Basis ofPresentation***

 

The consolidated financial statements include theaccounts of the Company and its wholly-owned subsidiaries. Allsignificant intercompany transactions and balances have been eliminated inconsolidation. The Company reports financial results on a calendar fiscal year.Certain amounts reported in previous years have been reclassified to conformthe 2003 presentation.

 

## ***Use of estimates***

 

The preparation of financial statements inaccordance with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, the disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reported period. Actual resultscould differ from those estimates.

 

***Revenue Recognition***

*** ***

*Licensing*

 

Licensing revenue consists of fees paid forengineering development and engineering support services. All contracts we haveentered into to date require that the Company develop a design that meets alicensee's specifications. For contracts involving design specifications thatthe Company has not previously met, the Company defers the recognition ofrevenue until the design meets the contractual design specifications andexpenses the cost of services 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, the Companydefers both the recognition of revenue and the cost. For these arrangements,the Company recognizes revenue using the completed contract method. However, ifthe Company has significant experience in meeting the design specificationinvolved in the contract and the cost of services under the contract can bereasonably estimated, then 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. Labor costs forthe development of the licensee's design are estimated at the beginning of thecontract. As these costs are incurred, they are used as a measure of progresstowards completion. The Company has the ability to reasonably estimate laborcost on a contract-by-contract basis based on its experience in developingprior licensees' designs.

 

Under our support and maintenance arrangements, weprovide unspecified upgrades, design rule changes and technical support. Noother upgrades, products or other post-contract support are provided. Thesearrangements are renewable annually by the customer. Support and maintenancerevenue is recognized at its fair value ratably over the period during whichthe obligation exists, typically 12 months. The fair value of any support andmaintenance obligation is established based on the specified renewal rate forsuch support and maintenance. When we provide a combination of products andservices to customers, in addition to the considerations noted above, weevaluate the arrangements under EITF 00-21, *RevenueArrangements with Multiple Deliverables*, which is effective fortransactions entered into after June 30, 2003. EITF 00-21 addresses certainaspects of accounting for arrangements under which we will perform multiplerevenue generating activities. Application of EITF 00-21 did not have amaterial effect on our consolidated financial position or results ofoperations.

 

From time to time, a licensee may cancel a projectduring the development phase. The cancellation is not within the Company'scontrol and is often caused by changes in market conditions or the licensee'sbusiness. Generally, the Company's contracts allow it to retain all paymentsthat the Company has received or is entitled to collect for items and servicesprovided before the cancellation occurs. The Company will consider a project tohave been canceled even in the absence of specific notice from its licensee ifthere has been no activity under the contract for a significant period, and theCompany believes that completion of the contract is unlikely. In this event,the Company recognizes revenue in the amount of cash received, if it hasperformed a sufficient portion of the development services.  In 2003, 2002, and 2001 the Company recognized$759,000, $804,000, and $617,000 of licensing revenue from cancelled projects,respectively.

 

F-6

----

 

*Product*

 

Revenue from product sales is recognized upon shipment provided thatpersuasive evidence of a sales arrangement exists, the price is fixed ordeterminable, title has transferred, collection of resulting receivables isreasonably assured, there are no customer acceptance requirements and there areno remaining significant obligations.  For each of the periods presented,there were no formal acceptance provisions with our end customers.

 

*Royalty*

 

Licensing contracts provide also for royaltypayments at a stated rate and require licensees to report the manufacture orsale of products that include the Company’s technology after the end of thequarter in which the sale or manufacture occurs. The Company recognizesroyalties in the quarter in which the Company receives the licensee’sreport.  The Company entered atermination agreement in 2003 with one of its licensees and recognized $713,000of royalty revenue from the terminated contract in 2003.  There was no royalty revenue from terminatedcontracts in 2002 and 2001.

 

***Inventory***

 

We state inventories at the lower of cost ormarket, determined using the first-in, first-out method. Our policy is to writedown our inventory for estimated obsolescence or unmarketable inventory to theextent the cost exceeds the estimated market value. We base the estimate on ourassumptions about historical and forecasted sales and market conditions. Ifactual market conditions are less favorable than those assumed in ourestimates, additional inventory write-downs might be required. Our policyis to reflect any revaluation of inventory in reported income for the period inwhich the facts giving rise to the inventory revaluation become known.

 

***Goodwill***

* *

We review goodwill, recordedfrom the acquisition of ATMOS Corp. on August 2002, for impairment annually andwhenever events or changes in circumstances indicate the carrying value of anasset may not be recoverable in accordance with the Statement of FinancialAccounting Standards (“SFAS”) No. 142, “Goodwill and Other IntangibleAssets.”  The provisions of SFASNo. 142 require that a two-step impairment test be performed on goodwill.  In the first step, we compare the fair valueof each reporting unit to its carrying value. Using the guidance in SFAS No. 142, we consider there to be only onereporting unit at the entity level.  Forstep one, we determine the fair value of our reporting unit using the marketapproach.  Under the market approach, weestimate the fair value based on the market value of the reporting unit at theentity level.  If the fair value of thereporting unit exceeds the carrying value of net assets to the reporting unit,goodwill is not impaired and we are not required to perform furthertesting.  If the carrying value of thenet assets to the reporting unit exceeds the fair value of the reporting unit,then we must perform the second step in order to determine the implied fairvalue of the reporting unit’s goodwill and compare it to the carrying value ofthe reporting unit’s goodwill.  If thecarrying value of a reporting unit’s goodwill exceeds its implied fair value,then we must record an impairment loss equal to the difference. We performedthe annual impairment test during the third quarter of 2003, and the test didnot indicate impairment of goodwill as of September 30, 2003.  In addition, every quarter we assess whetherthere are indicators of potential impairment. As of December 31, 2003, we found no indicators of potential impairment.

 

### ***Foreign Currency Translation***

 

The Company hasforeign offices located in Canada, Korea, Japan and France, which are operatedby subsidiaries of the Company.  Thefunctional currency of the Company’s foreign entities is the U.S. dollar.Accordingly, the financial statements of these entities, which are maintainedin the local currency, are remeasured into U.S. dollars in accordance withStatement of Financial Accounting Standards No. 52, “Foreign CurrencyTranslation.” Exchange gains or losses from remeasurement of monetary assetsand liabilities that are not denominated in U.S. dollar were not material forany period presented and are included in the consolidated income statements.

 

## ***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. TheCompany’s short-term and long-term investments are carried at fair value, basedon quoted market prices, with the unrealized holding gains and losses reportedin stockholders’ equity. Realized gains and losses and declines in the valuejudged to be other-than-temporary are included in interest income. The cost ofsecurities sold is based on the specific identification method.

 

The Company invests its excess cash in moneymarket accounts and debt instruments and considers all highly liquid debtinstruments purchased with an original maturity of three months or less to becash equivalents. Investments with original maturities greater than threemonths and remaining maturities less than one year are classified as short-terminvestments. Investments with remaining maturities greater than one year areclassified as long-term investments.

 

F-7

----

 

## ***Property andequipment***

 

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.

 

## ***Valuation oflong-lived assets***

 

Long-lived assets, such as property, plant andequipment, are evaluated for impairment whenever events or changes incircumstances indicate the carrying value of an asset may not be recoverable.An impairment loss is recognized when estimated undiscounted future cash flowsexpected to result from the use of the asset plus net proceeds expected fromdisposition of the asset (if any) are less than the carrying value of theasset. When impairment is identified, the carrying amount of the asset isreduced to its estimated fair value.

 

F-8

----

 

## ***Cost of revenue***

 

*Product*

 

Cost of product revenue consists primarily ofcosts associated with the manufacture, assembly and testing of our memory chipproducts by independent, third-party contractors.

 

*Licensing*

 

Cost oflicensing revenue consists primarily of engineering costs directly related toengineering development projects specified in agreements we have with licenseesof our 1T-SRAM technologies. These projects typically include customization of1T-SRAM circuitry to enable embedding our memory on a licensee’s integratedcircuit and may include engineering support to assist in the commencement ofproduction of a licensee’s products. We recognize costs of licensing revenue inthe following manner:

 

•                  If licensing revenue is recognizedusing the percentage of completion method, the associated cost of licensingrevenue is recognized in the period in which we incur the engineering expense.

 

•                  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 time wehave established technological feasibility of the product to be developed underthe license. Technological feasibility is established when we have completedall activities necessary to demonstrate that the licensee’s product can beproduced to meet the performance specifications when incorporating ourtechnology. Deferred costs are charged to cost of licensing revenue when therelated revenue is recognized.

 

•                  For contracts entered into priorto establishing technological feasibility, we do not defer related developmentcosts, but rather expense them in the period in which they are incurred. Consequently,upon completion of these contracts, we recognize the related revenues withoutany corresponding costs.

 

F-9

----

 

*Royalty*

 

## ***There are no reported costs associated with royalty revenue.***

## *** ***

## ***Shipping and handling***

 

Costs related to shipping and handling have beenincluded in costs of sales for all periods presented. These costs are notmaterial.

 

## ***Advertising***

 

Advertising costs are expensed as incurred and arenot material.

 

## ***Unbilled contractreceivable***

 

Under the percentage of completion method, if theamount of revenue recognized exceeds the amount of billings to a customer; theexcess amount is carried as an unbilled contract receivable. We recorded $1.1million and $693,000 of unbilled contract receivable as of December 31,2003 and December 31, 2002, respectively.

 

*** ******Researchand development***

 

We generallyrecord engineering cost as research and development expense in the periodincurred.

 

## ***Stock-basedcompensation***

 

The Company accounts for stock-based compensationarrangements in accordance with the provisions of APB No. 25 (“APBNo. 25”), “Accounting for Stock Issued to Employees” and complies with thedisclosure provisions of Statement of Financial Accounting StandardNo. 123 (“SFAS No. 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 theCompany’s stock on the date of grant over the amount an employee must pay toacquire the stock. Equity instruments issued to non-employees are accounted forin accordance with the provisions of SFAS No. 123 and Emerging Issues TaskForce 96-18. Deferred stock-based compensation is being amortized usingthe graded vesting method in accordance with Financial Accounting StandardsBoard Interpretation No. 28 (“FIN No. 28”) over the vesting period ofeach respective option, which is generally four years. Under the graded vestingmethod, each option grant is separated into portions based on its vestingterms, which results in acceleration of amortization expense for the overallaward compared to the straight line method.

 

## ***SFAS No. 123pro forma disclosures***

 

Had compensation cost for the Company’s optionplans been determined based on the fair value at the grant dates, as prescribedin SFAS 123, the Company’s net income (loss) would have been as follows(in thousands, except per share amounts):

 
|                                                                                                                         |   | **Years  Ended December 31,** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                                                                         |   | **2003**                      |   | **2002** |   | **2001** |   |
|                                                                                                                         |   |                          |   |   |   |   |   |
| Net income  (loss):                                                                                                          |   |                          |   |   |   |   |   |
| As reported                                                                                                                  |   | $                             | 2,508  |   | $ | 12,367 |   | $ | 6,991 |   |
| Stock-based  compensation expense reported in consolidated statements of income                                              |   | 211                           |   | 582 |   | 1,435 |   |
| Total  stock-based compensation expense determined under fair value based method for  all awards, net of related tax effects |   | (4,537                        | )      | (3,229 | ) | (1,948 | ) |
| Pro forma                                                                                                                    |   | $                             | (1,818 | ) | $ | 9,720 |   | $ | 6,478 |   |
| Earnings  (losses) per share:                                                                                                |   |                          |   |   |   |   |   |
| Basic—as  reported                                                                                                      |   | $                             | 0.08   |   | $ | 0.41 |   | $ | 0.35 |   |
| Basic—pro forma                                                                                                         |   | $                             | (0.06  | ) | $ | 0.33 |   | $ | 0.33 |   |
| Diluted—as  reported                                                                                                    |   | $                             | 0.08   |   | $ | 0.40 |   | $ | 0.25 |   |
| Diluted—pro  forma                                                                                                      |   | $                             | (0.06  | ) | $ | 0.31 |   | $ | 0.23 |   |

 

The fair value of each grant is estimated on thedate of grant using the Black-Scholes method with the followingassumptions used for grants during the applicable periods:

 

F-10

----

 
|                       |   | **Years  ended December 31,** |   |
|----------------------------|--------|------------------------------------|--------|
| **Employee stock options** |   | **2003**                           |   | **2002** |   | **2001** |   |
|                       |   |                               |   |   |   |   |   |
| Expected life  (in years)  |   | 5.0                                |   | 5.0 |   | 5.0 |   |
| Risk-free  interest rate   |   | 2.1%-3.6                           | %      | 2.7%-4.7 | % | 3.2%-4.8 | % |
| Volatility                 |   | 0.8                                |   | 0.7 |   | 0.6 |   |
| Dividend yield             |   | 0                                  | %      | 0 | % | 0 | % |

 
| **Employee stock purchase plan  shares** |   | **2003** |   | **2002** |   | **2001** |   |
|------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Expected life  (in years)                |   | 1.0      |   | 1.0      |   | —   |   |
| Risk-free  interest rate                 |   | 1.1%-1.4 | %      | 1.8%-2.3 | %      | —   |   |
| Volatility                               |   | 0.7      |   | 0.8      |   | —   |   |
| Dividend yield                           |   | 0        | %      | 0        | %      | —   |   |

 

The Company selected the Black-Scholesoption valuation model, which is one of the permitted methods to estimate thefair market value of options under SFAS No. 123. The Black-Scholesoption valuation model was developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable. Inaddition, option valuation models require the input of highly subjectiveassumptions, including the expected stock price volatility. Because theCompany’s employee stock options have characteristics significantly differentfrom those of traded options, and because changes in the subjective inputassumptions can materially affect the fair value estimated, in the opinion ofmanagement, the existing models do not necessarily provide a reliable singlemeasure of the fair value of employee stock options. The weighted average fairvalue of options granted during 2003, 2002 and 2001 was $4.97, $4.30 and $3.14respectively. The weighted average estimated fair value of shares granted underthe employee stock purchase plan during 2003 and 2002 was $4.21 and $4.26,respectively.

 

## ***Net income pershare***

 

Basic net income per share is computed by dividingnet income for the period by the weighted-average number of shares ofcommon stock outstanding during the period. Diluted net income per share iscomputed by dividing the net income for the period by the weighted averagenumber of common and potential common equivalent shares outstanding during theperiod. Potential common shares are composed of incremental shares of commonstock issuable upon the exercise of stock options and warrants and common stockissuable upon conversion of redeemable convertible preferred stock.

 

## ***Income taxes***

 

The Company accounts for deferred income taxesunder the liability approach whereby the expected future tax consequences oftemporary differences between the book and tax basis of assets and liabilitiesare recognized as deferred tax assets and liabilities. A valuation allowance isestablished for any deferred tax assets for which realization is uncertain.

 

## ***Comprehensiveincome***

 

Statement of Financial Accounting StandardsNo. 130 “Reporting Comprehensive Income” (“SFAS No. 130”) requiresthe Company to display comprehensive income and its components as part of thefinancial statements. The Company’s only component of comprehensive income isunrealized gains and losses on available for sale securities. Accumulated othercomprehensive income, as of December 31, 2003 and 2002 was $56,000 and$116,000, respectively.

 

The changes in other comprehensive income (loss),net of taxes, were as follows, for the years ended December 31, 2003,2002, and 2001:

 
|                                                          |   | **2003** |   | **2002** |   | **2001** |   |
|---------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                          |   |     |   |     |   |     |   |
| Net income                                                    |   | $        | 2,508  |     | $      | 12,367   |   | $ | 6,991 |   |
| Net unrealized  gain (loss) on available-for-sale securities: |   |     |   |     |   |     |   |
| Change in net  unrealized gains (losses)                      |   | (60      | )      | 100      |   | 16       |   |
| Comprehensive  income                                         |   | $        | 2,448  |     | $      | 12,467   |   | $ | 7,007 |   |

 

F-11

----

 

## ***Segment reporting***

 

Financial Accounting Standards Board StatementNo. 131, “Disclosure about Segments of an Enterprise and RelatedInformation” (“SFAS No. 131”) requires that companies report separately inthe financial statements certain financial and descriptive information aboutoperating segments profit or loss, certain specific revenue and expense itemsand segment assets. The Company operates in one segment, using one measurementof profitability for its business. The Company has sales outside the UnitedStates that are described in Note 10. The majority of long-lived assetsare maintained in the United States.

 

## ***Recent accountingpronouncements***

 

In November 2002, the EITF reached a consensus on Issue No. 00-21, “RevenueArrangements with Multiple Deliverables” (“EITF Issue No. 00-21”). EITF IssueNo. 00-21 provides guidance on how to account for arrangements thatinvolve the delivery or performance of multiple products, services and/orrights to use assets. The provisions of EITF Issue No. 00-21 were appliedto revenue arrangements entered into after June 30, 2003.  Although the provisions in this consensus applyto many of our license development contracts, the adoption of EITF Issue No.00-21 did not have a material effect on the Company’s financial position,results of operations, or cash flows for the year ended December 31, 2003.

 

In November2002, the Financial Accounting Standards Board (FASB) issued FASBInterpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN No.45”). FIN No. 45 requires that upon issuance of a guarantee, a guarantor mustrecognize a liability for the fair value of an obligation assumed under aguarantee. FIN No. 45 also requires additional disclosures by a guarantor inits interim and annual financial statements about the obligations associatedwith guarantees issued. The recognition provisions of FIN No. 45 are effectivefor any guarantees issued or modified after December 31, 2002. The disclosurerequirements are effective for financial statements of interim or annualperiods ending after December 15, 2002. The adoption of FIN No. 45 did not havea material effect on the Company’s financial position, results of operations,or cash flows.  See Note 7,“Guarantees”.

 

InJanuary 2003, the FASB issued Interpretation No. 46, “Consolidation of VariableInterest Entities” (“FIN No. 46”).  FINNo. 46, which was also revised by the FASB in December 2003, requiresconsolidation of variable interest entities (VIE) by the entity’s primarybeneficiary if the entity’s equity investors do not have characteristics of acontrolling financial interest or sufficient equity at risk.  FIN No. 46 is effective immediately for allnew VIEs created or acquired after January 31, 2003.  As amended by FASB Staff Position No. FIN No. 46-6, FIN No. 46 iseffective for variable interests in a VIE created or acquired before February1, 2003 at the end of the first interim or annual period ending after December15, 2003. FIN No. 46 requires certain disclosures in financial statementsissued after January 31, 2003, if it is reasonably possible that the Companywill consolidate or disclose information about VIEs when FIN No. 46 becomeseffective.  The Company has not investedin any VIEs created after January 31, 2003.

 

In April 2003, the FASB issued Statement of FinancialAccounting Standards No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities” (“SFAS No. 149”) which amends and clarifiesaccounting for derivative instruments and hedging activities under SFAS No.133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No.133”).  SFAS No. 149 provides guidancerelating to decisions made (a) as part of the Derivatives Implementation Groupprocess, (b) in connection with other FASB projects dealing with financialinstruments and (c) regarding implementation issues raised in the applicationof the definition of a derivative and the characteristics of a derivative thatcontains financing components.  SFAS No.149 is effective for contracts entered into or modified and for hedging relationshipsdesignated after June 30, 2003.  Theadoption of SFAS No. 149 did not have a material impact on the Company’sfinancial condition or results of operations for the year ended December 31,2003, as the Company has not entered into any derivative instruments.

 

In May 2003, the FASB issued SFAS No. 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity” (“SFAS No. 150”) which requires freestanding financial instruments suchas mandatorily redeemable shares, forward purchase contracts and written putoptions to be reported as liabilities by their issuers as well as related newdisclosure requirements.  The provisionsof SFAS No. 150 are effective for instruments entered into or modified afterMay 31, 2003 and pre-existing instruments as of the beginning of the firstinterim period that commences after June 15, 2003.  The adoption of SFAS No. 150 did not have a material impact onthe Company’s financial condition or results of operations for the year ended December31, 2003.

 

F-12

----

 

**Note 2—Acquisition**

 

## ***Acquisition ofATMOS Corporation***

 

On August 30, 2002, the Company completed theacquisition of 100% of the outstanding stock of ATMOS Corporation. ATMOS is asemiconductor memory company that focuses on creating high-density, compiler-generatedembedded memory solution for System-on-a-Chip (“SoC”) applications. The totalpurchase price for the acquisition was approximately $12.4 million,including direct transaction costs of $406,000. The consideration paid to ATMOSshareholders consisted of a combination of $11.7 million in cash and26,843 shares of common stock issued to certain ATMOS employees, with acombined total fair value of $12.0 million. Under the purchase method ofaccounting the common stock was valued at $11.47 per share using the Company’saverage stock price for a five-day period consisting of two days before, theday of and two days after June 10, 2002, the announcement date on whichthe number of shares to be issued was fixed. The Company loaned $500,000 toATMOS under a promissory note due on July 31, 2002, which becamenon-refundable upon completion of the acquisition, and has been included in thecash portion of the purchase price. ATMOS now operates as a wholly ownedsubsidiary of the Company and its financial statements for the year endedDecember 31, 2002 include the results of operations and financialcondition of ATMOS from the date of acquisition.

 

In addition, the Company issued 34,900 shares ofcommon stock subject to a vesting period and paid cash of $153,000 to ATMOScontinuing employees in exchange for their outstanding stock of ATMOS. Theshares and cash are subject to forfeiture in the event that the employees ceaseto be employed by MoSys and consequently are being accounted for ascompensation rather than acquisition cost. The Company recorded approximately$314,000 of unearned compensation related to the shares subject to vestingperiod, which will be amortized over the vesting period of 36 months usingthe graded vesting method. The cash will cease to be restricted on the firstanniversary of the closing date; therefore, it was amortized over12 months.

 

As part of the closing agreement, the Company andVirage Logic Corporation agreed to a mutual release with respect to claimsrelating to the Company’s acquisition of ATMOS in addition to potential claimsunder certain agreements and transactions between ATMOS and Virage Logic.

 

The acquisition has been accounted for as apurchase and accordingly, the accompanying financial statements include theresults of operations of ATMOS subsequent to the acquisition date. The purchaseprice has been allocated to the tangible assets acquired based on management’sestimate of their fair values, and to the intangible assets acquired based ontheir estimated fair values as determined by an independent appraisal. Thepurchase price allocation is as follows (in thousands):

 
| Tangible assets  acquired:       |   |   |   |
|----------------------------------|--------|--------|--------|
| Cash                             |   | $      | 84     |   |
| Prepaids and  other assets       |   | 390    |   |
| Fixed Assets                     |   | 1,643  |   |
| Total tangible  assets           |   | 2,117  |   |
| Total  liabilities acquired      |   | 2,002  |   |
| Intangible  assets acquired:     |   |   |   |
| Net tangible  assets acquired    |   | 115    |   |
| Goodwill                         |   | 12,326 |   |
| Total purchase  price allocation |   | $      | 12,441 |   |

 

Goodwill is reviewed annually for impairment basedon estimated future undiscounted cash flows attributable to goodwill, or morefrequently, if impairment indicators arise. In the event such cash flows arenot expected to be sufficient to recover the recorded value of goodwill, it iswritten down to its estimated fair value. We performed the annual impairment test during the thirdquarter of 2003, and the test did not indicate impairment of goodwill as ofSeptember 30, 2003.As of December 31, 2003, wefound no indicators of potential impairment and therefore, no such charges have been recorded for the period endedDecember 31, 2003 related to the ATMOS acquisition. For income taxpurposes, the entire amount of goodwill is deductible and amortized over15 years.

 

 At the closing of the acquisition, an escrow account wasestablished to satisfy any unidentified claims against ATMOS.  The amount held in escrow, net of claimsrecovered by the Company, was released to the ATMOS shareholders in October of2003.

 

## ***Unaudited ProForma Information***

 

The following unaudited pro forma informationpresents the consolidated results of operations of the Company, as if theacquisition of ATMOS had occurred at the beginning of the periods presented.The pro forma 2002 and 2001 result of operations combine the consolidatedresults of operations of the Company for the 12 months endedDecember 31, 2002 and 2001 with the historical results of 

 

F-13

----

 

operations of ATMOS for the 12 months ended December 31, 2002and 2001, respectively. The pro forma adjustments in 2001 and 2002 include$153,000 of cash compensation paid subject to forfeiture and $196,000 of stockcompensation expenses associated with shares issued subject to forfeiture.Unearned compensation of $314,000 is amortized using the graded method over thevesting period of three years, which results in the amortization ofapproximately 62% in the first year. The unaudited pro forma information doesnot purport to be indicative of what would have occurred had the acquisitionbeen made as of the beginning of the periods presented or of results which mayoccur in the future.

 
|                                            |   | **Year  ended December 31,**                       |   |
|-------------------------------------------------|--------|---------------------------------------------------------|--------|
|                                            |   | **2002**                                                |   | **2001** |   |
|                                            |   | **(In  thousands, except****per   share amounts)** |   |
|                                            |   |                                                    |   |   |   |
| Revenues                                        |   | $                                                       | 27,893 |   | $ | 22,808 |   |
| Net income                                      |   | 8,120                                                   |   | 680 |   |
| Net income per  share:                          |   |                                                    |   |   |   |
| Basic                                           |   | $                                                       | 0.27   |   | $ | 0.03 |   |
| Diluted                                         |   | $                                                       | 0.26   |   | $ | 0.02 |   |
|                                            |   |                                                    |   |   |   |
| Shares used in  computing net income per share: |   |                                                    |   |   |   |
| Basic                                           |   | 29,963                                                  |   | 19,771 |   |
| Diluted                                         |   | 31,423                                                  |   | 28,640 |   |

 

 

**Note 3—Details of Balance Sheet Components andConsolidated Statements of Income:**

 
|                                           |   | **December  31,**  |   |
|------------------------------------------------|--------|--------------------|--------|
|                                           |   | **2003**           |   | **2002** |   |
|                                           |   | **(in thousands)** |   |
| **Inventories:**                               |   |               |   |   |   |
| Work-in-progress                               |   | $                  | 195    |   | $ | 477 |   |
| Finished goods                                 |   | 279                |   | 560 |   |
|                                           |   | $                  | 474    |   | $ | 1,037 |   |
|                                           |   |               |   |   |   |
| **Prepaid  expenses and other current costs:** |   |               |   |   |   |
| Deferred costs  of revenue                     |   | $                  | 3      |   | $ | 506 |   |
| Deferred tax  assets                           |   | 1,654              |   | 2,415 |   |
| Prepaid expenses  and other assets             |   | 2,165              |   | 1,554 |   |
|                                           |   | $                  | 3,822  |   | $ | 4,475 |   |
|                                           |   |               |   |   |   |
| **Property  and equipment:**                   |   |               |   |   |   |
| Equipment,  furniture and fixtures             |   | $                  | 6,219  |   | $ | 6,148 |   |
| Acquired  Software                             |   | 4,501              |   | 4,121 |   |
|                                           |   |               |   |   |   |
|                                           |   | 10,720             |   | 10,269 |   |
| Less:  Accumulated depreciation                |   | (8,924             | )      | (6,917 | ) |
|                                           |   | $                  | 1,796  |   | $ | 3,352 |   |

 
| **Accrued expenses and other liabilities:** |   |   |   |   |   |
|---------------------------------------------|--------|--------|--------|--------|--------|
| Accrued wages  and employee benefits        |   | $      | 831    |   | $      | 857 |   |
| Professional  fees                          |   | 326    |   | 266    |   |
| Deferred rent                               |   | 175    |   | 230    |   |
| Income taxes  payable                       |   | 188    |   | 695    |   |
| Withholding tax  payable                    |   | 1,052  |   | — |   |
| Other                                       |   | 161    |   | 320    |   |
|                                        |   | $      | 2,733  |   | $      | 2,368 |   |

 

Depreciation expense for the years ended December 31, 2003, 2002 and2001 were $1.7 million, $1.0 million and $507,000, respectively.

 

 

F-14

----

 

**Interestand other income**

 
|            |   | **2003**            |       | **2002**  |       | **2001**  |       |
|-----------------|--------|---------------------|------------|-----------|------------|-----------|------------|
|            |   | **(in  thousands)** |       |
|            |   |                |       |      |       |      |       |
| Interest Income |   | 1,350               |       | 1,539     |       | 1,818     |       |
| Other Income    |   | 564                 |       | —    |       | —    |       |
|            |   |                |       |      |       |      |       |
| **Total**       |   | **1,914**           | ** ** | **1,539** | ** ** | **1,818** | ** ** |

 

                In 2003, other income included the $287,000 contracttermination fee from Conexant. The Company did not incur interest expense in2003, 2002, or 2001.

 

F-15

----

 

**Note4**:  **Fair Value of Financial Instruments**

 

The estimated fair valuesof financial instruments outstanding at fiscal year-ends were as follows:

 
|                                         |   | **2003**            |   |
|----------------------------------------------|--------|---------------------|--------|
|                                         |   | **Adjusted  Cost**  |   | **Gross  Unrealized Gain** |   | **Gross  Unrealized Loss** |   | **Estimated  Fair Value** |   |
|                                         |   | **(in  thousands)** |   |
|                                         |   |                |   |   |   |   |   |   |   |
| Cash                                         |   | $                   | 4,883  |   | $ | — |   | $ | — |   | $ | 4,883 |   |
| Cash  Equivalents:                           |   |                |   |   |   |   |   |   |   |
| Commercial and  US government agencies paper |   | 17,150              |   | — |   | — |   | 17,150 |   |
|                                         |   |                |   |   |   |   |   |   |   |
| Total cash and  cash equivalents             |   | $                   | 22,033 |   | $ | — |   | $ | — |   | $ | 22,033 |   |
|                                              |   |                |   |   |   |   |   |   |   |
| Short-term  investments:                     |   |                |   |   |   |   |   |   |   |
| US government  debt securities               |   | $                   | 3,700  |   | $ | — |   | $ | — |   | $ | 3,700 |   |
| Corporate notes                              |   | 6,760               |   | 22 |   | — |   | 6,782 |   |
| Market auction  preferred securities         |   | 8,850               |   | — |   | — |   | 8,850 |   |
|                                         |   |                |   |   |   |   |   |   |   |
| Total short-term  investments                |   | $                   | 19,310 |   | $ | 22 |   | $ | — |   | $ | 19,332 |   |
|                                              |   |                |   |   |   |   |   |   |   |
| Long-term  investments:                      |   |                |   |   |   |   |   |   |   |
| US government  debt securities               |   | $                   | 39,707 |   | $ | 27 |   | $ | — |   | $ | 39,734 |   |
| Corporate notes                              |   | 4,721               |   | 7 |   | — |   | 4,728 |   |
|                                         |   |                |   |   |   |   |   |   |   |
| Total long-term  investments                 |   | $                   | 44,428 |   | $ | 34 |   | $ | — |   | $ | 44,462 |   |
|                                              |   |                |   |   |   |   |   |   |   |

 
|                                         |   | **2002**            |   |
|----------------------------------------------|--------|---------------------|--------|
|                                         |   | **Adjusted  Cost**  |   | **Gross  Unrealized Gain** |   | **Gross  Unrealized Loss** |   | **Estimated  Fair Value** |   |
|                                         |   | **(in  thousands)** |   |
|                                         |   |                |   |   |   |   |   |   |   |
| Cash                                         |   | $                   | 3,407  |   | $ | — |   | $ | — |   | $ | 3,407 |   |
| Cash  Equivalents:                           |   |                |   |   |   |   |   |   |   |
| Commercial and  US government agencies paper |   | 22,914              |   | — |   | — |   | 22,914 |   |
|                                         |   |                |   |   |   |   |   |   |   |
| Total cash and  cash equivalents             |   | $                   | 26,321 |   | $ | — |   | $ | — |   | $ | 26,321 |   |
|                                              |   |                |   |   |   |   |   |   |   |
| Short-term  investments:                     |   |                |   |   |   |   |   |   |   |
| US government  debt securities               |   | $                   | 22,132 |   | $ | 46 |   | $ | — |   | $ | 22,178 |   |
| Corporate notes                              |   | 13,399              |   | 26 |   | — |   | 13,425 |   |
| Market auction  preferred securities         |   | 2,500               |   | — |   | — |   | 2,500 |   |
| Foreign debt  securities                     |   | 4,008               |   | 1 |   | — |   | 4,009 |   |
|                                         |   |                |   |   |   |   |   |   |   |
| Total short-term  investments                |   | $                   | 42,039 |   | $ | 73 |   | $ | — |   | $ | 42,112 |   |
|                                              |   |                |   |   |   |   |   |   |   |
| Long-term  investments:                      |   |                |   |   |   |   |   |   |   |
| US government  debt securities               |   | $                   | 6,500  |   | $ | 51 |   | $ | — |   | $ | 6,551 |   |
| Corporate notes                              |   | 4,857               |   | — |   | 8 |   | 4,849 |   |
|                                         |   |                |   |   |   |   |   |   |   |
| Total long-term  investments                 |   | $                   | 11,357 |   | $ | 51 |   | $ | 8 |   | $ | 11,400 |   |
|                                              |   |                |   |   |   |   |   |   |   |

 

 

                Thefollowing table shows the fair value and net carrying amount of cashequivalents and short-term and long-term investments based on the following twomaturity groups as of December 31, 2003: 

 

|               |   | **Adjusted  Cost** |   | **Gross  Unrealized Gain** |   | **Estimated  Fair Value** |   |
|--------------------|--------|--------------------|--------|----------------------------|--------|---------------------------|--------|
|               |   |               |   |                       |   |                      |   |
| Due within 1  year |   | $                  | 36,460 |                       | $      | 22                        |   | $ | 36,482 |   |
| Due 1-2  years     |   | 44,428             |   | 34                         |   | 44,462                    |   |
|               |   |               |   |                       |   |                      |   |
| Total              |   | $                  | 80,888 |                       | $      | 56                        |   | $ | 80,944 |   |
|                    |   |               |   |                       |   |                      |   |

 

                Therewere no realized gains or losses for 2003, 2002 and 2001.

 

**Note 5—Income Taxes:**

 

The provision for income taxes consists of thefollowing (in thousands):

 
|             |   | **Year Ended  December 31,** |   |
|------------------|--------|------------------------------|--------|
|             |   | **2003**                     |   | **2002** |   | **2001** |   |
|             |   |                         |   |   |   |   |   |
| Current portion: |   |                         |   |   |   |   |   |
| U.S. federal     |   | $                            | (634   | ) | $ | 3,567 |   | $ | 261 |   |
| State            |   | 2                            |   | 121 |   | 106 |   |
| Foreign          |   | 150                          |   | 100 |   | — |   |
|             |   | (482                         | )      | 3,788 |   | 367 |   |
|             |   |                         |   |   |   |   |   |
| Deferred         |   |                         |   |   |   |   |   |
| U.S. federal     |   | 761                          |   | (2,415 | ) | — |   |
| State            |   | —                       |   | — |   | — |   |
| Foreign          |   | —                       |   | — |   | — |   |
|             |   | 761                          |   | (2,415 | ) | — |   |
|             |   |                         |   |   |   |   |   |
| Total            |   | $                            | 279    |   | $ | 1,373 |   | $ | 367 |   |

 

Deferred tax assets consist of the following (inthousands):

 
|                                           |   | **December  31,** |   |
|------------------------------------------------|--------|-------------------|--------|
|                                           |   | **2003**          |   | **2002** |   |
|                                           |   |              |   |   |   |
| **Deferred  tax assets:**                      |   |              |   |   |   |
| Federal and  state loss carryforwards          |   | $                 | 1,357  |   | $ | 923 |   |
| Inventory                                      |   | 460               |   | 238 |   |
| Reserves and  accruals                         |   | 279               |   | 409 |   |
| Deferred revenue                               |   | 311               |   | 373 |   |
| Depreciation and  amortization                 |   | (499              | )      | 265 |   |
| Deferred  compensation                         |   | 257               |   | 260 |   |
| Research and  development credit carryforwards |   | 1,164             |   | 646 |   |
| Foreign tax  credits                           |   | 387               |   | — |   |
| Canadian net  operating loss                   |   | 6,173             |   | — |   |
|                                           |   | 9,889             |   | 3,114 |   |
| Less: Valuation  allowance                     |   | (8,235            | )      | (699 | ) |
| Net deferred tax  assets                       |   | $                 | 1,654  |   | $ | 2,415 |   |

 

F-16

----

 

The valuation allowance increased by$7.5 million and decreased by $4.1 million, during the years endedDecember 31, 2003 and 2002, respectively. Of the total increase of $7.5 million, $6.2 million is attributable toCanadian net operating losses and approximately $670,000 is attributable tostock option deductions.

 

As of December 31, 2003, the Company had netoperating loss carryforwards of approximately $3.6 million for federalincome tax purposes and approximately $2.6 million for state income taxpurposes. These losses are available to reduce taxable income and expirebeginning 2005 through 2023. The Company also had federal research anddevelopment tax credit carryforwards of approximately $790,000, which willexpire beginning in 2008, and California research and development credits ofapproximately $380,000 which do not have an expiration date.  The Company had foreign tax creditsavailable for federal income tax purposes of approximately $387,000 which willbegin to expire in 2008.  The Companyhad Canadian net operating loss carryforwards of $13.5 million, which willbegin to expire in 2005.  Because ofcertain changes in the ownership of the Company in December 1996, there isan annual limitation of approximately $2.6 million on the use of federalnet operating loss carryforwards and on the use of federal research anddevelopment credits pursuant to Section 382 of the Internal Revenue Code.

 

The Company’s U.S. income tax return for 2001 isunder examination.  Management believesthat adequate amounts have been provided for any adjustments that mayultimately result from this examination.

 

A reconciliation of income taxes provided at thefederal statutory rate (35% in 2003, 2002 and 2001) to actual income taxexpense follows:

 
|                                                         |   | **Year Ended  December 31,** |   |
|--------------------------------------------------------------|--------|------------------------------|--------|
|                                                         |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                                         |   | **(in  thousands)**          |   |
|                                                         |   |                         |   |   |   |   |   |
| Income tax  provision computed at federal statutory rate     |   | $                            | 976    |   | $ | 4,809 |   | $ | 2,575 |   |
| State income tax  (net of federal benefit)                   |   | 2                            |   | 608 |   | 69 |   |
| Foreign income  tax at rate different from US statutory rate |   | (15                          | )      | 100 |   | — |   |
| Utilization of  previously reserved NOL’s               |   | (834                         | )      | (932 | ) | (2,575 | ) |
| Utilization of  tax credits                                  |   | —                       |   | (200 | ) | — |   |
| Change in  valuation allowance                               |   | 73                           |   | (3,197 | ) | — |   |
| Alternative  minimum taxes                                   |   | —                       |   | — |   | 298 |   |
| Tax benefit from  extraterritorial income exclusion          |   | (206                         | )      | — |   | — |   |
| Other                                                        |   | 283                          |   | 185 |   | — |   |
|                                                         |   | $                            | 279    |   | $ | 1,373 |   | $ | 367 |   |

 

The domestic andforeign components of earnings before taxes were as follows for the years endedDecember 31, 2003, 2002 and 2001:

 

|     |   | **2003**            |   | **2002** |   | **2001** |   |
|----------|--------|---------------------|--------|----------|--------|----------|--------|
|     |   | **(in  thousands)** |   |
|     |   |                |   |     |   |     |   |
| U.S.     |   | $                   | 2,316  |     | $      | 13,549   |   | $ | 7,358 |   |
|     |   |                |   |     |   |     |   |
| Non-U.S. |   | 471                 |   | 191      |   | —   |   |
|     |   |                |   |     |   |     |   |
|     |   | $                   | 2,787  |     | $      | 13,740   |   | $ | 7,358 |   |

 

**Note 6—Net Income Per Share:**

 

Basic net income per share iscomputed by dividing net income for the period by the weighted-average numberof shares of common stock outstanding during the period. Diluted net income pershare is computed by dividing the net income available to common stockholders forthe period by the weighted average number of common and potential commonequivalent shares outstanding during the period. Potential common equivalentshares are composed of incremental shares of common stock issuable upon theexercise of stock options and warrants. For the twelve months ending December 31, 2003, outstanding employeestock options of 2.1 million shares were not included in the calculation ofdiluted net income per share as they were anti-dilutive. The following table sets forth the computation of basic and diluted netincome per share for the periods indicated (in thousands, except per shareamounts):

 
|                                                          |   | **Year Ended  December 31,** |   |
|---------------------------------------------------------------|--------|------------------------------|--------|
|                                                          |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                                          |   |                         |   |   |   |   |   |
| Numerator:                                                    |   |                         |   |   |   |   |   |
| Net income                                                    |   | $                            | 2,508  |   | $ | 12,367 |   | $ | 6,991 |   |
| Denominator:                                                  |   |                         |   |   |   |   |   |
| Shares used in  computing net income per share:               |   |                         |   |   |   |   |   |
| Basic                                                         |   | 30,504                       |   | 29,902 |   | 19,709 |   |
| Employee stock  options and unvested common stock outstanding |   | 494                          |   | 1,083 |   | 1,581 |   |
| Warrants                                                      |   | —                       |   | 290 |   | 734 |   |
| Preferred stock                                               |   | —                       |   | — |   | 6,366 |   |
| Diluted                                                       |   | 30,998                       |   | 31,275 |   | 28,390 |   |
| Net income per  share:                                        |   |                         |   |   |   |   |   |
| Basic                                                         |   | $                            | 0.08   |   | $ | 0.41 |   | $ | 0.35 |   |
| Diluted                                                       |   | $                            | 0.08   |   | $ | 0.40 |   | $ | 0.25 |   |

 

F-17

----

 

**Note 7—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.  Suchindemnification obligations may not be subject to maximum loss clauses.  To date, we have not made any paymentsrelated to these indemnifications.

 

***Product Warranties:***

 

The Company generally offers a 90-day warranty forits memory chip products. The Company provides reserves for the estimated costsof product warranties at the time revenue is recognized. The Company estimatesthe costs of its warranty obligations based on its historical experience ofreplacement costs incurred for the last 90 days in correcting productfailures. The Company periodically assesses the adequacy of its recordedwarranty liabilities and adjusts the amounts as necessary. Accordingly, theCompany assessed the level of warranty reserve as of December 31, 2003 anddetermined that no warranty reserve was necessary.

 

The following table presents the changes in theCompany’s warranty reserve during the years ended December 31, 2003, 2002and 2001 (in thousands):

 
| Warranty reserve  balance as of December 31, 2000 |   | $      | (155   | )      |
|---------------------------------------------------|--------|--------|--------|--------|
| Accrued warranty  expense                         |   | — |   |
| Usage of  warranty reserve                        |   | 100    |   |
| Warranty reserve  balance as of December 31, 2001 |   | (55    | )      |
| Accrued warranty  expense                         |   | (131   | )      |
| Usage of  warranty reserve                        |   | 186    |   |
| Warranty reserve  balance as of December 31, 2002 |   | — |   |
| Accrued warranty  expense                         |   | — |   |
| Usage of  warranty reserve                        |   | — |   |
| Warranty reserve  balance as of December 31, 2003 |   | $      | — |   |

 

**Note 8—Stockholders’ Equity (Deficit):**

 

## ***Common StockWarrants***

 

The following table summarizes the activity ofoutstanding warrants (in thousands, except per share amounts):

 
|                                                                                                                 |   | **Common  Stock  under Warrants** |   | **Exercise  Price per  Share** |   |
|----------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|--------------------------------|--------|
|                                                                                                                 |   |                              |   |                           |   |
| Outstanding at  December 31, 2000                                                                                    |   | 3,315                             |   | $5.50-$8.50                    |   |
| Exercised  warrants, granted to Series F and Series F-1 Preferred stockholders  and Dell Computer          |   | (349                              | )      | $0-$5.50                       |   |
| Expired  warrants, previously granted to Series F and Series F-1 Preferred  stockholders and Dell Computer |   | (1,766                            | )      | $5.50-$8.50                    |   |
|                                                                                                                 |   |                              |   |                           |   |
| Outstanding and  exercisable at December 31, 2001                                                                    |   | 1,200                             |   | $6.50                          |   |
| Exercised  warrants issued to TSMC in connection with termination of a capacity  agreement                           |   | (1,200                            | )      | $6.50                          |   |
| Outstanding and  exercisable at December 31, 2002 and 2003                                                           |   | —                            |   |                           |   |

 

F-18

----

 

The following assumptions were applied whenestimating the fair value of the above warrants using the Black-Scholesoption pricing model: dividend yield of 0%, risk-free interest rate of5.45%-5.84%, contractual terms of 3.5 years to 4.25 years andvolatility of 40%-60%. The fair market values of common stock underlying theabove warrants ranged from $1.00 to $2.00 on dates of issuance. Pursuant to theterms of an amended common stock purchase warrant for the purchase of 1,200,000shares of our common stock at $6.50 per share, on June 14, 2002, TSMCexercised the warrant on a net basis by surrendering the warrant when the fairmarket value of the common stock was $10.69 per share and receiving 470,346shares of common stock. Resale of the shares was subject to a lock-up agreementunder which TSMC agreed not to sell or otherwise dispose of the shares for aperiod of 180 days after June 14, 2002. In June 2001, theCompany issued 90,000 shares of common stock to Dell Computer upon its cashlessexercise of a warrant to purchase 600,000 shares of common stock. This warranthad an exercise price of $8.50 per share and was exercised on a net basis at afair value of $10.00 per share of common stock, an amount that approximated theinitial public offering price in July 2001. In April 2001, theCompany issued 259,000 shares of common stock pursuant to the exercise ofwarrants to purchase 1,515,000 shares of common stock at $5.50 per share, andthe balance of the warrants for the purchase of 1,256,000 shares expiredwithout exercise.  No warrants wereoutstanding as of December 31, 2003.

 

## ***Common StockOption Plans***

 

The 1992 Stock Option Plan (the “1992 Plan”)authorizes the board of directors to grant incentive stock options andnonqualified stock options for up to 3,300,000 shares of common stock toemployees, directors and consultants. Under the 1992 Plan, incentive stockoptions are to be granted at a price not less than 100% of the fair value of thestock at the date of grant, as determined by the board of directors.Nonqualified stock options are to be granted at a price not less than 85% ofthe fair value of the stock at the date of grant, as determined by the board ofdirectors. Options generally vest over a four-year period and are exercisablefor a maximum period of ten years after the date of grant. The 1992 Plan wasterminated in 1996, and no further options were granted under the plan.

 

In 1996, the Company adopted the 1996 Stock Plan(the “1996 Plan”), which authorizes the board of directors to grant incentivestock options and nonqualified stock options for up to 2,500,000 shares ofcommon stock to employees, directors and consultants. The option terms underthe 1996 Plan are substantially the same as the 1992 Plan except that optionsgranted under the 1996 Plan may be exercised immediately. Common stockpurchased pursuant to the exercise of an unvested option is subject torepurchase by the Company, at the exercise price, under certain conditions.Options generally vest over a four-year period and are exercisable for amaximum period of ten years after the date of grant.

 

The Company’s 2000 employee stock option plan (the“2000 plan”) was adopted in October 2000 in connection with the Company’sreincorporation in the state of Delaware. A total of 6,207,000 shares of commonstock have been reserved for issuance under the 2000 plan. In addition, the2000 plan provides for an automatic annual increase in the number of sharesreserved under the plan on January 1 of each year beginning in 2001, equalto the lesser of 500,000 shares, two percent of the Company’s outstandingshares of common stock on such date or a lesser amount determined by the boardof directors. The term of options granted under the 2000 plan may not exceedten years. The term of all incentive stock options granted to an optionee who,at the time of grant, owns stock representing more than 10% of the voting powerof all classes of the Company’s stock may not exceed five years. Generally, 25%of the options granted under the 2000 plan will vest and become exercisable onthe first anniversary of the date of grant, and 1/48th of the options will vestand become exercisable each month thereafter.

 

The exercise price of incentive stock optionsgranted under the 2000 plan must be at least equal to the fair market value ofthe shares on the date of grant. The exercise price of nonstatutory stockoptions granted under the 2000 plan will be determined by the board ofdirectors, but in no event will be less than 85% of the fair market value ofthe common stock on the date of grant. The exercise price of any incentivestock option or nonstatutory stock option granted to a ten-percent stockholdermust equal at least 110% of the fair market value of the common stock on thedate of grant.

 

A summary of the status of all the Company’s stockoption plans as of December 31, 2001, 2002 and 2003 and changes during theyears ended on these dates are presented below (in thousands, except per shareamounts):

 

F-19

----

 
|                                       |   | **Options  Outstanding** |   |
|--------------------------------------------|--------|--------------------------|--------|
|                                       |   | **Available  for Grant** |   | **Number of  Shares** |   | **Weighted  Average  Exercise  Prices** |   |
|                                       |   |                     |   |   |   |   |   |
| Balance at  December 31, 2000              |   | 5,279                    |   | 2,751 |   | $ | 3.98 |   |
| Authorized under  the 2000 Plan            |   | 207                      |   |   |   |   |   |
| Granted                                    |   | (1,191                   | )      | 1,191 |   | $ | 8.79 |   |
| Cancelled                                  |   | 588                      |   | (588 | ) | $ | 3.71 |   |
| Exercised                                  |   | —                   |   | (310 | ) | $ | 2.72 |   |
| Expired  ungranted under the 1992 Plan     |   | (246                     | )      | — |   |   |   |
| Balance at  December 31, 2001              |   | 4,637                    |   | 3,044 |   | $ | 6.05 |   |
| Additional  authorized under the 2000 Plan |   | 500                      |   |   |   |   |   |
| Granted                                    |   | (1,534                   | )      | 1,534 |   | $ | 10.02 |   |
| Cancelled                                  |   | 314                      |   | (314 | ) | $ | 8.43 |   |
| Exercised                                  |   | —                   |   | (159 | ) | $ | 2.93 |   |
| Balance at  December 31, 2002              |   | 3,917                    |   | 4,105 |   | $ | 7.47 |   |
| Additional  authorized under the 2000 Plan |   | 500                      |   |   |   |   |   |
| Granted                                    |   | (1,066                   | )      | 1,066 |   | $ | 7.99 |   |
| Cancelled                                  |   | 360                      |   | (360 | ) | $ | 8.60 |   |
| Exercised                                  |   | —                   |   | (439 | ) | $ | 3.30 |   |
| Balance at  December 31, 2003              |   | 3,711                    |   | 4,372 |   | $ | 7.92 |   |

 

Information relating to stock options outstandingat December 31, 2003 is as follows (in thousands, except per shareamounts):

 
|                        |   | **Options  Outstanding at December 31, 2003** |   | **Options  Exercisable at  December 31, 2003**                 |                    |
|-----------------------------|--------|-----------------------------------------------|--------|----------------------------------------------------------------|-------------------------|
|                        |   | **Number  Outstanding**                       |   | **Weighted  Average  Remaining  Contractual Life  (in Years)** |                    | **Weighted  Average  Exercise Price** |   |   |
|                        |   |                                          |   |                                                           | **Number  Outstanding** |   | **Weighted   Average  Exercise Price** |   |
|                        |   |                                          |   |                                                           |                    |   |
| **Range of Exercise Price** |   |                                          |   |                                                           |                    |   |
|                        |   |                                          |   |                                                           |                    |   |   |   |   |   |   |
| $1.00-$4.00                 |   | 637                                           |   | 4.58                                                           |                    | $ | 1.02 |   | 636 |   | $ | 1.02 |   |
| $4.01-$8.00                 |   | 1,487                                         |   | 8.14                                                           |                    | $ | 7.33 |   | 670 |   | $ | 7.44 |   |
| $8.01-$10.00                |   | 1,010                                         |   | 8.42                                                           |                    | $ | 9.41 |   | 380 |   | $ | 9.60 |   |
| $10.01-$16.00               |   | 1,238                                         |   | 8.18                                                           |                    | $ | 10.97 |   | 572 |   | $ | 11.03 |   |
|                        |   | 4,372                                         |   |                                                           |                    |   |   | 2,258 |   |   |   |

 

Our 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.

 

## ***Employee stockpurchase plan***

 

The Company’s 2000 employee stock purchase planwas adopted in October 2000 in connection with the Company’s Delawarere-incorporation, to become effective upon the pricing date of the Company’sinitial public offering. A total of 400,000 shares of common stock have beenreserved for issuance under the purchase plan. In addition, the purchase planprovides for an automatic annual increase in the number of shares reservedunder the plan on January 1 of each year, equal to the lesser of 100,000shares, one percent of the Company’s outstanding shares of common stock on suchdate or a lesser amount determined by the board of directors. The purchaseplan, which is intended to qualify under Section 423 of the InternalRevenue Code, is administered by the board of directors or a committeeappointed by the board of directors.

 

Employees, including officers and employeedirectors but excluding 5% stockholders, are eligible to participate if theyare customarily employed for at least 20 hours per week and for more thanfive months in any calendar year. The purchase plan permits eligible employeesto purchase common stock through payroll deductions, which may not exceed 10%of an employee’s compensation. Employees will be permitted to invest a maximumof $25,000 in any offering period.

 

F-20

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The purchase plan has been implemented in a seriesof overlapping offering periods, each to be approximately 12 months induration. The initial offering period under the purchase plan began onJune 27, 2001 and expired on July 1, 2002, which was the first day ofthe third offering period. Offering periods begin on the first trading day onor after January 1 and July 1 of each year and end on the lasttrading day in the period ending twelve months later. Each participant isgranted an option on the first day of the offering period, and such option willbe automatically exercised at the end of month six of the offering period andon the last day of the offering period. The purchase price of the common stockunder the purchase plan is equal to 85% of the lesser of the fair market valueper share of common stock on the start date of the offering period or on thedate on which the option is exercised. Employees may end their participation inan offering period at any time during that period, and participation endsautomatically on termination of employment with the Company. The purchase planwill terminate in June 2010, unless sooner terminated by the board ofdirectors.

 

Of the 400,000 shares authorized to be issuedunder the purchase plan, 298,000 shares remained available for issuance atDecember 31, 2003. Employees purchased 55,000 and 47,000 shares in 2003and 2002, respectively.  No shares werepurchased under the plan in 2001.

 

## ***Deferred stock-basedcompensation cost to employees***

 

During the years ended December 31,2003, 2002 and 2001, the Company recorded deferred compensation cost ofapproximately $0, $314,000 and $1.5 million, respectively, which wouldamortize in future periods. The 2002 deferred compensation cost represented theshares of common stock issued to certain employees of ATMOS that were subjectto vesting requirements related to the acquisition of ATMOS, which cost isbeing amortized over the vesting period of 36 months using the graded vestingmethod. The deferred compensation cost recorded during the year ended 2001represented the excess of the fair market value of the Company's common stockover the grant price during the period in which the options were granted. 

 

During the years endedDecember 31, 2003, 2002 and 2001, the Company recorded stock compensationexpenses of $459,000, $656,000 and $1.4 million, respectively, of which$211,000, $582,000 and $1.4 million, respectively, was attributable to theexcess of the fair market value of the Company's common stock over the price atwhich the Company granted stock options to employees. Stock compensationexpenses in 2003 and 2002 also included $227,000 and $74,000, respectively, foramortization of deferred compensation cost attributable to the fair marketvalue of shares of the Copmpany's common stock issued to certain employees ofATMOS. In addition, the Company incurred $21,000 of stock compensation expensein 2003 due to modification of the Company's 2000 employee stock option planrelated to a former member of the board of directors.

 

Deferred compensation expense isbeing amortized using the graded vesting method, in accordance with SFAS No.123 and FASB Interpretation No. 28, over the vesting period of each respectiveoption, generally four years. The accelerated amortization results in expensingapproximately 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.

 

## ***Stockholder RightsPlan***

 

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 each outstandingshare of its common stock held as of June 27, 2001, and on each share ofcommon stock issued by the Company thereafter. Each right entitles theregistered holder to purchase from the Company one one-thousandth share ofSeries AA preferred stock at a price of $110. The rights become exercisable incertain circumstances, including the acquisition by any person or group, or thecommencement or announcement of a tender or exchange offer for the acquisition,of beneficial ownership of 15 percent or more of the Company’s commonstock 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 onOctober 11, 2010.

 

***Notes receivable from related parties***

 

In April 2001, certain holders of warrantsissued in connection with Series F and F-1 preferred stock exercised theirrights to purchase 43,000 shares of common stock at $5.50 per share, inexchange for promissory notes. The notes total $239,000, are bearing interestof 9%, and are full recourse. All of these notes had been paid in full as ofDecember 31, 2003.

 

F-21

----

 

**Note 9—Retirement Savings Plan:**

 

Effective January 1997, the Company adoptedthe MoSys 401(k) Plan (the “Savings Plan”) which qualifies as a thrift planunder Section 401(k) of the Internal Revenue Code. All full-time employeeswho are at least 21 years old are eligible to participate in the SavingsPlan at the time of hire. Participants may contribute up to 15% of theirearnings to the Savings Plan. The Company makes a Matching Contribution onbehalf of each Participant in an amount equal to 25% of a Participant’sDeferral Contributions during the Plan Year. The Company made matchingcontributions of $107,000, $98,000 and $84,000 in 2003, 2002 and 2001,respectively.

 

**Note 10—Business Segments, Concentration of Credit Riskand Significant Customers:**

 

TheCompany has adopted SFAS No. 131, “Disclosure about Segments of an Enterpriseand Related Information.” Although the Company offers various intellectualproperty components and services to its customers, the Company does not manageits operations by these intellectual property components and services, butinstead views the Company as one operating segment when making businessdecisions. The Company does not manage its operations on a geographical basis.Revenue attributed to the United States and to all foreign countries is basedon the geographical location of the customer. The Company uses one measurementof 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.

 

The Company sells its products and licenses its 1T-SRAMtechnologies to customers in the Far East, North America and Europe as follows(in thousands):

 
|          |   | **Years  Ended December 31,** |   |
|---------------|--------|-------------------------------|--------|
|          |   | **2003**                      |   | **2002** |   | **2001** |   |
|          |   |                          |   |   |   |   |   |
| North America |   | $                             | 7,767  |   | $ | 8,007 |   | $ | 12,405 |   |
| Japan         |   | 7,146                         |   | 13,365 |   | 5,891 |   |
| Asia          |   | 3,969                         |   | 5,646 |   | 3,808 |   |
| Europe        |   | 351                           |   | 773 |   | 386 |   |
| Total         |   | $                             | 19,233 |   | $ | 27,791 |   | $ | 22,490 |   |

 

Customers who accounted for at least 10% of totalrevenues were as follows:

 
|          |   | **Year Ended  December 31,** |   |
|---------------|--------|------------------------------|--------|
|          |   | **2003**                     |   | **2002** |   | **2001** |   |
|          |   |                         |   |   |   |   |   |
| Sony          |   | 17                           | %      | — |   | — |   |
| NEC           |   | 14                           | %      | 38 | % | 19 | % |
| UMC           |   | 11                           | %      | 12 | % | — |   |
| Cisco Systems |   | —                       |   | — |   | 22 | % |

 

Five customers accounted for 21%, 18%, 12%, 11%and 10% of gross accounts receivable, respectively, at December 31, 2003.  Also, five customers accounted for 19%, 15%,12%, 12% and 12% of gross accounts receivable, respectively, atDecember 31, 2002.  The Companyperforms ongoing credit evaluations of its customers’ financial condition andmaintains an allowance for uncollectible accounts receivable based upon theexpected collectibility of all accounts receivable. No amounts were written offin 2003, 2002 and 2001.

 

Net property, plant and equipment, classified bymajor geographic areas were as follows at December 31, 2003 and 2002.

 
|     |   | **December 31,** |   |
|----------|--------|-----------------------|--------|
|     |   | **2003**              |   | **2002** |   |
|     |   | **(in  thousands)**   |   |
|     |   |                  |   |   |   |
| U.S.     |   | $                     | 1,110  |   | $ | 1,880 |   |
| Non-U.S. |   | 686                   |   | 1,472 |   |
| Total    |   | $                     | 1,796  |   | $ | 3,352 |   |

 

F-22

----

 

**Note 11—Commitments and Contingencies:**

 

The Company leases its facilities undernon-cancelable operating leases that expire in 2005 and 2008. Rent expense wasapproximately $1,143,000, $925,000 and $793,000 for the years endedDecember 31, 2003, 2002 and 2001, respectively. The leases provide formonthly payments and are being charged to operations ratably over the leaseterms. In addition to the minimum lease payments, the Company is responsiblefor property taxes, insurance and certain other operating costs.

 

The Company leases certain equipment undernon-cancelable lease agreements that are accounted for as capital leases. Equipmentunder capital lease arrangements included in property and equipment aggregatedapproximately $176,000 at December 31, 2003 and December 31, 2002. Relatedaccumulated depreciation was approximately $161,000 and $108,000 at December31, 2003 and 2002, respectively.

 

Future minimum lease payments under thenon-cancelable operating leases as of December 31, 2003 are as follows (inthousands):

 
| **Year Ended December 31,**        |   | **Operating  Leases** |   | **Capital  Leases** |   |
|------------------------------------|--------|-----------------------|--------|---------------------|--------|
|                               |   |                  |   |                |   |
| 2004                               |   | $                     | 1,325  |                | $      | 14 |   |
| 2005                               |   | 825                   |   | 14                  |   |
| 2006                               |   | 358                   |   | —              |   |
| 2007                               |   | 372                   |   | —              |   |
| 2008                               |   | 129                   |   | —              |   |
| Total minimum  payments            |   | $                     | 3,009  |                | $      | 28 |   |
|                               |   |                  |   |                |   |
| Less amount  representing interest |   |                  |   | 2                   |   |
|                               |   |                  |   | 26                  |   |
| Less current  portion              |   |                  |   | 13                  |   |
| Long term  portion                 |   |                  |   | $                   | 13     |   |

 

## ***Legal Matters***

 

From time to time the Company may be subject tolegal proceedings and claims in the ordinary course of business. These claims,even if not meritorious, could result in the expenditure of significantfinancial and managerial resources. The Company is not aware of any legal proceedingsor claims that the Company believes believe could harm our business or causeits revenues or stock price to fall.

 

**Note 12—Subsequent Events (Unaudited):**

 

On February 23, 2004, Synopsys, Inc., a Delaware corporation(“Synopsys”), Mountain Acquisition Sub, Inc., a Delaware corporation and awholly owned subsidiary of Synopsys (“Acquisition Sub”), and the Companyentered into a definitive Agreement and Plan of Merger and Reorganization (the“Reorganization Agreement”) which contemplates the acquisition by Synopsys,through Acquisition Sub, of all of the outstanding common stock of MoSys in atwo-step transaction comprised of a combination cash and stock exchange offerfor all of the issued and outstanding shares of MoSys common stock forconsideration valued at an aggregate of $13.50 per share of the Company’scommon stock (the “Offer”), followed by a merger of Acquisition Sub with andinto the Company (the “Merger”). In the Offer, each share of MoSys common stockvalidly tendered (and not withdrawn) would be converted into a combination of$6.75 in cash and a fraction of a share of Synopsys common stock having a valueof $6.75 based on a formula set forth in the Reorganization Agreement. Synopsyshas the right, at any time through the date two business days prior to theexpiration date of the Offer (as it may be extended from time to time), toconvert the Offer into an all-cash tender offer, in which case each share ofthe Company’s common stock would be converted into $13.50 in cash.

 

F-23

----

 

 

**Schedule II****—Valuation and QualifyingAccounts**

**(In thousands)**

 
| **Description**                              |   | **Balance at  beginning of  period** |   | **Charged to  expenses** |   | **Credited  to  expenses** |   | **Balance at  end of  period** |   |
|----------------------------------------------|--------|--------------------------------------|--------|--------------------------|--------|----------------------------|--------|--------------------------------|--------|
|                                         |   |                                 |   |                     |   |                       |   |                           |   |
| Allowance for  doubtful accounts receivable: |   |                                 |   |                     |   |                       |   |                           |   |
| Fiscal year  ended December 31, 2003         |   | $                                    | — |                     | $      | —                     |   | $                              | — |   | $ | — |   |
| Fiscal year  ended December 31, 2002         |   | $                                    | 200    |                     | $      | 75                         |   | $                              | 275    |   | $ | — |   |
| Fiscal year  ended December 31, 2001         |   | $                                    | 200    |                     | $      | —                     |   | $                              | — |   | $ | 200 |   |

 

S-1

----