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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2004.

OR

For the transition period from              to             

Commission file number 000-23084.

Integrated Silicon Solution, Inc.

(Exact name of registrant as specified in its charter)

(408) 969-6600.

(Registrant’s telephone number, including area code)

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

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

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

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

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Item 1. Financial Statements

Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share data)

See accompanying notes to condensed consolidated financial statements.

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Integrated Silicon Solution, Inc.

Condensed Consolidated Balance Sheets

(In thousands)

See accompanying notes to condensed consolidated financial statements.

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Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

See accompanying notes to condensed consolidated financial statements.

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

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

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

2. Stock-based Compensation

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

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

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

3. Concentrations

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

4. Cash, Cash Equivalents and Short-term Investments

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

5. Inventories

The following is a summary of inventories by major category:

6. Other Assets

Other assets consisted of the following:

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

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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

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

7. Comprehensive Income (Loss)

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

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

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

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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

8. Income Taxes

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

9. Per Share Data

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

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

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

10. Use of Estimates

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

11. Impact of Recently Issued Accounting Standards

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

12. Commitments and Contingencies

       Legal Proceedings

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

13. Geographic and Segment Information

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

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

14. Related Party Transactions

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

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

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

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

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

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

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

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

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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

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

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

Accounts receivable from related parties consisted of the following:

The following table shows net sales to related parties:

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Accounts payable to related parties consisted of the following:

15. Investment in Integrated Circuit Solution Inc. (“ICSI”)

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

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

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

16. Follow-on Public Stock Offering

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

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

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

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

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

Overview

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

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

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

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

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

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

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

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

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

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

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

Critical Accounting Policies

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Liquidity and Capital Resources

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

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

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

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

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

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

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

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

Certain Factors Which May Affect Our Business or Future Operating Results

Risks Related to Our Business

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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