UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2004 .

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 000-23084 .

Integrated Silicon Solution, Inc.

(Exact name of registrant as specified in its charter)

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

(408) 969-6600 .

(Registrant’s telephone number, including area code)

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 August 6, 2004 was 36,104,136.

TABLE OF CONTENTS

PART I	Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Statements of Operations Three and nine months ended June 30, 2004 and 2003 (Unaudited)	3
	Condensed Consolidated Balance Sheets June 30, 2004 (Unaudited) and September 30, 2003	4
	Condensed Consolidated Statements of Cash Flows Nine months ended June 30, 2004 and 2003 (Unaudited)	5
	Notes to Condensed Consolidated Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	34
PART II	Other Information
Item 1.	Legal Proceedings	34
Item 6.	Exhibits and Reports on Form 8-K	34
Signatures		35
Certifications

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.

2

Item 1. Financial Statements

Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share data)

	Three Months Ended June 30,					Nine Months Ended June 30,
	2004		2003			2004		2003
Net sales	$	58,129	$	24,285		$	149,888	$	67,635
Cost of sales		44,290		20,271			115,212		61,503
Gross profit		13,839		4,014			34,676		6,132
Operating Expenses:
Research and development		5,615		5,584			15,736		18,523
Selling, general and administrative		4,379		3,039			12,232		10,095
Total operating expenses		9,994		8,623			27,968		28,618
Operating income (loss)		3,845		(4,609	)		6,708		(22,486	)
Other income (expense), net		138		(1,134	)		1,130		(964	)
Gain on sale of investments		—		418			8,740		418
Income (loss) before income taxes, minority interest and equity in net (income) loss of affiliated companies		3,983		(5,325	)		16,578		(23,032	)
Provision for income taxes		119		—			497		—
Income (loss) before minority interest and equity in net income (loss) of affiliated companies		3,864		(5,325	)		16,081		(23,032	)
Minority interest in net loss of consolidated subsidiary		—		—			—		17
Equity in net income (loss) of affiliated companies		1,775		(615	)		2,965		(2,584	)
Net income (loss)	$	5,639	$	(5,940	)	$	19,046	$	(25,599	)
Basic net income (loss) per share	$	0.16	$	(0.21	)	$	0.58	$	(0.92	)
Shares used in basic per share calculation		35,717		27,774			32,572		27,682
Diluted net income (loss) per share	$	0.15	$	(0.21	)	$	0.53	$	(0.92	)
Shares used in diluted per share calculation		38,399		27,774			35,628		27,682

See accompanying notes to condensed consolidated financial statements.

3

Integrated Silicon Solution, Inc.

Condensed Consolidated Balance Sheets

(In thousands)

	June 30, 2004			September 30, 2003
	(unaudited)			(1)
ASSETS
Current assets:
Cash and cash equivalents	$	16,405		$	19,992
Short-term investments		133,400			38,450
Accounts receivable		32,056			10,088
Accounts receivable from related parties (See Note 13)		3,030			2,064
Inventories		38,155			16,638
Other current assets		1,956			1,712
Total current assets		225,002			88,944
Property, equipment, and leasehold improvements, net		4,269			6,295
Other assets		95,007			62,860
Total assets	$	324,278		$	158,099
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	28,411		$	11,788
Accounts payable to related parties (See Note 13)		936			5,442
Accrued compensation and benefits		2,812			3,406
Accrued expenses		6,560			5,436
Total current liabilities		38,719			26,072
Commitments and contingencies
Minority interest		—			78
Stockholders’ equity:
Common stock		4			3
Additional paid-in capital		335,360			233,957
Accumulated deficit		(78,282	)		(97,328	)
Unearned compensation		(240	)		(268	)
Accumulated comprehensive income (loss)		28,717			(4,415	)
Total stockholders’ equity		285,559			131,949
Total liabilities and stockholders’ equity	$	324,278		$	158,099

(1) Derived from audited financial statements.

See accompanying notes to condensed consolidated financial statements.

4

Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

	Nine Months Ended June 30,
	2004			2003
Cash flows from operating activities
Net income (loss)	$	19,046		$	(25,599	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		2,580			3,692
Amortization of intangibles and unearned compensation		73			382
Gain on sale of shares of Semiconductor Manufacturing International Corp. (“SMIC”)		(8,740	)		—
Gain on sale of other investments		—			(418	)
(Gain) loss on embedded derivative		(13	)		365
Gain on liquidation of D2Code		(282	)		—
Loss on impairment of investment		—			1,296
Loss on disposal of fixed assets		—			178
Net foreign currency transaction (gains) losses		(4	)		30
Equity in net (income) loss of affiliated companies		(2,965	)		2,584
Minority interest in net loss of consolidated subsidiary		—			(17	)
Changes in assets and liabilities:
Accounts receivable and accounts receivable from related parties		(22,934	)		—
Inventories		(21,517	)		—
Accounts payable and accounts payable to related parties		12,117			—
Other assets and liabilities		(39	)		(3,490	)
Cash used in operating activities		(22,678	)		(20,997	)
Cash flows from investing activities
Capital expenditures		(554	)		(1,297	)
Purchases of available-for-sale securities		(128,250	)		(16,650	)
Sales of available-for-sale securities		33,300			35,650
Proceeds from partial sale of SMIC equity securities		13,236			—
Proceeds from partial sale of E-CMOS Corporation equity securities		—			2,189
Cash provided by (used in) investing activities		(82,268	)		19,892
Cash flows from financing activities
Proceeds from follow-on public offering		93,523			—
Proceeds from issuance of common stock		7,836			910
Principal payments on notes payable and long-term obligations		—			(128	)
Cash provided by financing activities		101,359			782
Effect of exchange rate changes on cash and cash equivalents		—			(4	)
Net decrease in cash and cash equivalents		(3,587	)		(327	)
Cash and cash equivalents at beginning of period		19,992			11,622
Cash and cash equivalents at end of period	$	16,405		$	11,295

See accompanying notes to condensed consolidated financial statements.

5

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 U.S. generally accepted accounting principles 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 (which are of a normal, recurring nature) considered necessary for fair presentation have been included.

Operating results for the three and nine months ended June 30, 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 nine month periods ending June 30, 2004 and 2003 (in thousands, except per share data):

	Three Months Ended June 30,					Nine Months Ended June 30,
	2004		2003			2004		2003
Net income (loss) – as reported	$	5,639	$	(5,940	)	$	19,046	$	(25,599	)
Compensation expense		1,271		1,180			3,617		3,448
Net income (loss) – pro forma	$	4,368	$	(7,120	)	$	15,429	$	(29,147	)
Basic net income (loss) per share – as reported	$	0.16	$	(0.21	)	$	0.58	$	(0.92	)
Diluted net income (loss) per share – as reported	$	0.15	$	(0.21	)	$	0.53	$	(0.92	)
Basic net income (loss) per share – pro forma	$	0.12	$	(0.26	)	$	0.47	$	(1.05	)
Diluted net income (loss) per share – pro forma	$	0.11	$	(0.26	)	$	0.43	$	(1.05	)

6

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

3. Concentrations

Sales to Asian Information Technology Inc. (“AIT”) accounted for approximately 10% of total net sales for the three and nine months ended June 30, 2004. Sales to AIT accounted for approximately 11% of total net sales for the three months ended June 30, 2003. Sales to ATM Electronic Corporation accounted for approximately 10% of total net sales for the nine months ended June 30, 2003.

4. Cash, Cash Equivalents and Short-term Investments

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

	(In thousands)
	June 30, 2004		September 30, 2003
Cash	$	10,487	$	13,748
Money market instruments		5,918		6,244
Municipal bonds due in more than 3 years		133,400		38,450
	$	149,805	$	58,442

5. Inventories

The following is a summary of inventories by major category:

	(In thousands)
	June 30, 2004		September 30, 2003
Purchased components	$	22,631	$	6,032
Work-in-process		3,128		1,405
Finished goods		12,396		9,201
	$	38,155	$	16,638

6. Other Assets

Other assets consisted of the following:

	(In thousands)
	June 30, 2004		September 30, 2003
Investment in ICSI common stock	$	17,025	$	13,853
Investment in ICSI convertible debenture		3,491		2,939
Investment in SMIC		70,202		42,000
Other equity investments		3,962		3,914
Other		327		154
	$	95,007	$	62,860

The market value of the Company’s investment in the common stock and convertible debentures of Integrated Circuit Solution, Inc. (“ICSI”) at June 30, 2004 was approximately $35.4 million and $3.5 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 June 30, 2004 was approximately $21.3 million of which approximately $4.3 million is included in other comprehensive income as accumulated foreign currency translation adjustment in the equity portion of the balance sheet.

7

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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 June 30, 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 June 30, 2004 was approximately $70.2 million. The market value of SMIC shares is subject to fluctuations and the Company’s carrying value will be subject to adjustments to reflect the current market value. The Company’s shares in SMIC are subject to certain lockup restrictions and therefore are not freely tradable. These lockup restrictions generally lapse at the rate of 15% of the Company’s pre-offering shares every 180 days following the IPO. Thus all of the Company’s shares in SMIC will be freely tradable 3 years and 180 days following the IPO.

7. Comprehensive Income (Loss)

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

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

	Three Months Ended June 30,						Nine Months Ended June 30,
	2004			2003			2004			2003
	(In thousands)
Net income (loss)	$	5,639		$	(5,940	)	$	19,046		$	(25,599	)
Other comprehensive income (loss), net of tax:
Change in cumulative translation adjustment		(55	)		32			(16	)		87
Change in unrealized gains/(losses) on investments		(28,461	)		179			33,148			69
Comprehensive income (loss)	$	(22,877	)	$	(5,729	)	$	52,178		$	(25,443	)

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.

8

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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

	June 30, 2004			September 30, 2003
	(In thousands)
Accumulated foreign currency translation adjustments related to investment in ICSI	$	(4,346	)	$	(4,553	)
Other accumulated foreign currency translation adjustments		12			235
Net unrealized gain on SMIC		32,698			—
Net unrealized gain (loss) on other available-for-sale investments		353			(97	)
Total accumulated other comprehensive income (loss)	$	28,717		$	(4,415	)

8. Income Taxes

The provision for income taxes for the three month and nine month periods ended June 30, 2004 of $119,000 and $497,000, respectively, consists of alternative minimum taxes. The Company recorded no provision for income taxes for the three and nine month periods ended June 30, 2003 due to its cumulative net operating loss position for tax purposes and the Company’s ability to carryforward those operating losses to reduce fiscal 2004 taxable income.

9. Per Share Data

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

	Three Months Ended June 30,					Nine Months Ended June 30,
	2004		2003			2004		2003
Numerator for basic and diluted net income (loss) per share:
Net income (loss)	$	5,639	$	(5,940	)	$	19,046	$	(25,599	)
Denominator for basic net income (loss) per share:
Weighted average common shares outstanding		35,717		27,774			32,572		27,682
Dilutive effect of stock options		2,682		—			3,056		—
Denominator for diluted net income (loss) per share		38,399		27,774			35,628		27,682
Basic net income (loss) per share	$	0.16	$	(0.21	)	$	0.58	$	(0.92	)
Diluted net income (loss) per share	$	0.15	$	(0.21	)	$	0.53	$	(0.92	)

The above diluted calculation for the three months ended June 30, 2004 and June 30, 2003 does not include approximately 466,000 shares and 6,342,000 shares attributable to options as of June 30, 2004 and 2003, respectively, as their impact would be anti-dilutive. The above diluted calculation for the nine months ended June 30, 2004 and 2003, does not include approximately 431,000 shares and 6,151,000 shares attributable to options as of June 30, 2004 and 2003, respectively, as their impact would be anti-dilutive. Of the 6,342,000 shares and 6,151,000 shares excluded from the three and nine month ended June 30, 2003 calculation, approximately 2,837,000 shares and 2,443,000 shares, respectively, were in the money but excluded solely because the Company had a net loss for that period.

9

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. 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.

12. Geographic and Segment Information

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

	Three Months Ended June 30,				Nine Months Ended June 30,
	2004		2003		2004		2003
	(In thousands)
Net sales
United States	$	6,347	$	2,884	$	18,343	$	10,130
China		8,408		5,234		17,374		12,118
Hong Kong		13,628		2,986		33,627		7,931
Taiwan		15,251		7,241		40,666		16,059
Korea		2,338		2,241		7,950		8,547
Other Asia Pacific countries		6,331		1,976		15,529		5,867
Europe		5,414		1721		15,361		6,962
Other North America		412		2		1,038		21
Total net sales	$	58,129	$	24,285	$	149,888	$	67,635

Net sales are classified based upon the location of the customers’ facilities.

	June 30, 2004		September 30, 2003
	(In thousands)
Long-lived assets
United States	$	2,199	$	4,307
Hong Kong		55		70
China		1,731		1,918
Other foreign locations		284		—
	$	4,269	$	6,295

10

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

13. 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 nine months ended June 30, 2004 and June 30, 2003, purchases of goods and services were approximately $3,364,000 and $53,000, respectively. The Company also pays ICSI for certain product development costs, license fees and royalties. For the nine months ended June 30, 2004 and June 30, 2003, these charges totaled approximately $610,000 and $276,000, 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 16% 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 nine months ended June 30, 2004 and June 30, 2003, the Company provided services of approximately $73,000 and $55,000, respectively, to GetSilicon.

The Company engages GetSilicon for business-to-business data exchange and professional services. For the nine months ended June 30, 2004 and June 30, 2003, the purchase of services was approximately $74,000 and $84,000, 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 nine months ended June 30, 2004 and June 30, 2003, the purchase of services and expenses reimbursed by the Company was approximately $335,000 and $333,000, 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.

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. As a result, effective April 2004, the Company no longer considers SMIC to be a related party even though they have an external board member (Lip-Bu Tan) in common. For the six months ended March 31, 2004 and June 30, 2003, purchases of goods from SMIC were approximately $16,907,000 and $27,518,000, 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 Technologies (“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 nine months ended June 30, 2004 and June 30, 2003, the Company provided services of approximately $3,198,000 and $135,000, respectively, to Signia.

11

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Accounts receivable from related parties consisted of the following:

	June 30, 2004		September 30, 2003
	(In thousands)
E-CMOS	$	—	$	39
Flextronics		1,463		355
GetSilicon		12		31
ICSI		685		276
Marubun USA		—		1,044
Nexflash		3		4
Signia		867		315
Total	$	3,030	$	2,064

The following table shows net sales to related parties:

	Nine months ended June 30,
	2004		2003
	(In thousands)
Net sales to related parties
E-CMOS	$	80	$	46
Flextronics		2,528		214
ICSI		1,424		(114	)
Marubun USA		2,053		1,018
Others		167		—
Total	$	6,252	$	1,164

Accounts payable to related parties consisted of the following:

	June 30, 2004		September 30, 2003
	(In thousands)
E-CMOS	$	—	$	37
GetSilicon		63		83
ICSI		873		386
SMIC		—		4,936
Total	$	936	$	5,442

12

INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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

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

	June 30, 2004		September 30, 2003
	(In thousands)
Current assets	$	97,941	$	82,691
Property, plant, and equipment and other assets		32,101		36,981
Current liabilities		42,181		41,957
Long-term debt		18,822		18,812

	Nine Months Ended June 30,
	2004		2003
	(In thousands)
Net sales	$	134,391	$	63,709
Gross profit		26,564		3,833
Net income (loss)		9,687		(8,963	)

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 $353,000 related to the ICSI convertible debentures. The unrealized gain is included in accumulated other comprehensive income (loss). In addition, in the three and nine months ended June 30, 2004, the Company recorded a loss of approximately $239,000 and gain of approximately $13,000, respectively, related to the increase in the fair value of an embedded derivative associated with the ICSI convertible debenture. The gain (loss) associated with the embedded derivative is included in other income (expense). The market value of the Company’s convertible debentures at June 30, 2004 was approximately $3.5 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 June 30, 2004, only ICSI is accounted for using the equity method of accounting. At June 30, 2004 and September 30, 2003, approximately $4.8 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.

15. 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 nine months ended June 30, 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 in fiscal 2004 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

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average selling 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 88% in fiscal 2002, fiscal 2003 and the first nine months of fiscal 2004, respectively. The increase in our revenues from Asia is due to our success in the digital consumer electronics market. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. The percentages of our revenues by region are set forth in the following table:

	Fiscal Years Ended September 30,				Nine Months Ended June 30, 2004
	2002		2003
Asia	56	%	77	%	77	%
Europe	14		10		10
U.S.	30		13		12
Other	—		—		1
Total	100	%	100	%	100	%

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

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

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

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2003 and for fiscal 2004 until their IPO in March 2004, reflect accounting for Semiconductor Manufacturing International Corporation (“SMIC”) on the cost basis. Since SMIC’s IPO, we account for our shares in SMIC under the provisions of FASB 115 and have marked our investment to the market value as of June 30, 2004 by increasing other assets and by increasing accumulated comprehensive income in the equity section of the balance sheet. ICSI is a Taiwan-based fabless memory supplier, 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 June 30, 2004, we owned approximately 29% of ICSI, approximately 11% of E-CMOS, approximately 16% of GetSilicon, approximately 14% of NexFlash, approximately 15% of Signia Technologies and less than 2% of SMIC.

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 selling, 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 generally 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

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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 selling, 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 June 30, 2004, the carrying value of our strategic investments in non-marketable securities totaled $4.0 million.

Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003

Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales increased by 139% to $58.1 million in the three months ended June 30, 2004 from $24.3 million in the three months ended June 30, 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 June 30, 2004 compared to the three months ended June 30, 2003. An increase in unit shipments of our SRAM products in the three months ended June 30, 2004 compared to the three months ended June 30, 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. While the average selling prices for certain of our DRAM and SRAM products increased in the three months ended June 30, 2004 compared to the three months ended March 31, 2004, we anticipate a decline in the average selling prices for our DRAM and certain of our SRAM products in the September 2004 quarter compared to the June 2004 quarter. 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% and 11% of our total net sales for the three months ended June 30, 2004 and June 30, 2003, respectively. As sales to this customer are executed pursuant to purchase orders and no purchasing contract exists, this customer can cease doing business with us at any time.

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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 $9.8 million to $13.8 million in the three months ended June 30, 2004 from $4.0 million in the three months ended June 30, 2003. Gross margin increased to 23.8% in the three months ended June 30, 2004 from 16.5% in the three months ended June 30, 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 June 30, 2004 compared to the three months ended June 30, 2003. Our gross margin for the three months ended June 30, 2004 benefited from the sale of $0.3 million of parts previously written down to zero carrying value. In addition, our gross profit in the three months ended June 30, 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 June 30, 2004 compared to the three months ended June 30, 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 June 30, 2004 compared to the three months ended June 30, 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 this regard, we anticipate a decline in our gross margin in the September 2004 quarter compared to the June 2004 quarter due to expected declines in the average selling prices for our DRAM products. 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 we provide.

Research and Development. Research and development expenses remained flat at $5.6 million in both the three months ended June 30, 2004 and June 30, 2003. As a percentage of net sales, research and development expenses decreased to 10.0% in the three months ended June 30, 2004 from 23.0% in the three months ended June 30, 2003. The expense in absolute dollars remained consistent as an increase in masks set costs and engineering wafers was offset by a decrease in depreciation expense and a reduction in expenses associated with the closing of our design centers in Korea and Hong Kong. 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 44% to $4.4 million in the three months ended June 30, 2004 from $3.0 million in the three months ended June 30, 2003. As a percentage of net sales, selling, general and administrative expenses decreased to 7.5% in the three months ended June 30, 2004 from 12.5% in the three months ended June 30, 2003. The increase in absolute dollars was primarily the result of increased selling commissions associated with higher revenues in the three months ended June 30, 2004 compared to the three months ended June 30, 2003. Facility expenses increased in the three months ended June 30, 2004 compared to the three months ended June 30, 2003 due to the expiration of our subleases. In addition, salary related expenses increased in the three months ended June 30, 2004 compared to the three months ended June 30, 2003 as a result of the cancellation of pay cuts and increased headcount. In response to increases in our business activity as well as 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 (expense), net. Other income, net increased was $0.1 million in the three months ended June 30, 2004 compared to other expense of $(1.1) million in the three months ended June 30, 2003. In the

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three months ended June 30, 2003, we recorded approximately a $1.3 million impairment loss on our investment in Signia Technologies. In the three months ended June 30, 2004, we recorded a charge of approximately $0.2 million related to the decrease in the fair value of the embedded derivative associated with the ICSI convertible debenture. In addition, interest income increased by $0.2 million in the three months ended June 30, 2004 compared to the three months ended June 30, 2003 as the result of higher cash balances.

Gain on sale of investments. In the three months ended June 30, 2003, we sold shares of E-CMOS for approximately $2.2 million which resulted in a pre-tax gain of $0.4 million. We did not sell any investments in the three months ending June 30, 2004.

Provision for income taxes. The provision for income taxes for the three month period ended June 30, 2004 of $119,000 consists of alternative minimum taxes. We recorded no provision for income taxes for the three month period ended June 30, 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 was $1.8 million income in the three months ended June 30, 2004 compared to a $0.6 million loss in the three months ended June 30, 2003. This primarily reflects an improvement in ICSI’s financial results in the three months ended June 30, 2004 compared to the three months ended June 30, 2003.

Nine Months Ended June 30, 2004 Compared to Nine Months Ended June 30, 2003

Net Sales. Net sales increased by 122% to $149.9 million in the nine months ended June 30, 2004 from $67.6 million in the nine months ended June 30, 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 nine months ended June 30, 2004 compared to the nine months ended June 30, 2003. In addition, sales in the nine months ended June 30, 2004 benefited from shipments of our new 128 Mb DRAM product. An increase in unit shipments of our SRAM products in the nine months ended June 30, 2004 compared to the nine months ended June 30, 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. In this regard, we anticipate a decline in the average selling prices for our DRAM and certain of our SRAM products in the September 2004 quarter compared to the June 2004 quarter. 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 nine months ended June 30, 2004. Sales to ATM Electronic Corporation accounted for approximately 10% of our total net sales for the nine months ended June 30, 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. Gross profit increased by $28.6 million to $34.7 million in the nine months ended June 30, 2004 from $6.1 million in the nine months ended June 30, 2003. Gross margin increased to 23.1% in the nine months ended June 30, 2004 from 9.1% in the nine months ended June 30, 2003. Our gross margin for the nine months ended June 30, 2004 benefited from the sale of $1.2 million of parts previously written down to zero carrying value. In addition, in the nine months ended June 30, 2003 we recorded inventory write-downs of $4.1 million predominately for lower of cost or market accounting which adversely impacted our gross margin in such period. Excluding the effect of the inventory write-downs in the nine months ended June 30, 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 nine months ended June 30, 2004 compared to the nine months ended June 30, 2003. In addition, our gross profit in the nine months ended June 30, 2004 benefited from sales of our new 128 Mb DRAM product. Increases in the average selling prices of our DRAM products in the nine months ended June 30, 2004 compared to the nine months ended June 30, 2003 more than offset any increases in product costs resulting in higher gross margins for our DRAM products.

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Reductions in the cost of our SRAM products more than offset declines in the average selling prices of such products in the nine months ended June 30, 2004 compared to the nine months ended June 30, 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 we provide.

Research and Development. Research and development expenses decreased by 15% to $15.7 million in the nine months ended June 30, 2004 from $18.5 million in the nine months ended June 30, 2003. As a percentage of net sales, research and development expenses decreased to 10.5% in the nine months ended June 30, 2004 from 27.4% in the nine months ended June 30, 2003. The decrease in absolute dollars was primarily the result of a reduction in 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 and contracted development costs decreased in the nine months ended June 30, 2004 compared to the nine months ended June 30, 2003.

Selling, General and Administrative. Selling, general and administrative expenses increased by 21% to $12.2 million in the nine months ended June 30, 2004 from $10.1 million in the nine months ended June 30, 2003. As a percentage of net sales, selling, general and administrative expenses decreased to 8.2% in the nine months ended June 30, 2004 from 14.9% in the nine months ended June 30, 2003. The increase in absolute dollars was primarily the result of increased selling commissions associated with higher revenues in the nine months ended June 30, 2004 compared to the nine months ended June 30, 2003. In addition, facility expenses increased in the nine months ended June 30, 2004 compared to the nine months ended June 30, 2003 due to the expiration of our subleases.

Other income (expense), net. Other income, net was $1.1 million in the nine months ended June 30, 2004 compared to other expense of $(1.0) million in the nine months ended June 30, 2003. In the nine months ended June 30, 2003, we recorded approximately a $1.3 million impairment loss on our investment in Signia Technologies. In the nine months ended June 30, 2004, we recorded a gain of approximately $13,000 related to the increase in the fair value of the embedded derivative associated with the ICSI convertible debenture compared to a charge of approximately $365,000 related to the decline in the fair value of the embedded derivative associated with the ICSI convertible debenture in the nine months ended June 30, 2003. Interest income increased by approximately $0.2 million in the nine months ended June 30, 2004 compared to the nine months ended June 30, 2003 as the result of higher cash balances. In addition, in the nine months ended June 30, 2004, we recorded a gain of approximately $0.3 million in connection with the completion of the liquidation of our subsidiary in Korea, D2Code.

Gain on sale of investments. The gain on sale of investments increased by $8.3 million to $8.7 million in the nine months ended June 30, 2004 from $0.4 million in the nine months ended June 30, 2003. 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. In the nine months ended June 30, 2003, we sold shares of E-CMOS for approximately $2.2 million, which resulted in a pre-tax gain of $0.4 million.

Provision for Income Taxes. The provision for income taxes for the nine month period ended June 30, 2004 of $497,000 consists of alternative minimum taxes. We recorded no provision for income taxes for the nine month period ended June 30, 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.

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Equity in net income (loss) of affiliated companies. Equity in net income (loss) of affiliated companies was $3.0 million in the nine months ended June 30, 2004 compared to a $2.6 million loss in the nine months ended June 30, 2003. This primarily reflects an improvement in ICSI’s financial results in the nine months ended June 30, 2004 compared to the nine months ended June 30, 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 nine months ended June 30, 2004 from $17,000 in the nine months ended June 30, 2003.

Liquidity and Capital Resources

As of June 30, 2004, our principal sources of liquidity included cash, cash equivalents and short-term investments of approximately $149.8 million. During the nine months ended June 30, 2004, operating activities used cash of approximately $22.7 million compared to $21.0 million used in the nine months ended June 30, 2003. Cash used by operations was primarily due to increases in accounts receivable of $22.8 million, increases in inventory of $21.5 million and increases in other assets of $0.7 million. This was partially offset by net income of $19.0 million adjusted for depreciation of $2.6 million, the gain on the sale of SMIC shares of $8.7 million, equity in net income of affiliated companies of $3.0 million, other non-cash items of $0.2 million, an increase in accounts payable of $12.1 million and an increase in accrued expenses of $0.5 million.

In the nine months ended June 30, 2004, we used $82.3 million for investing activities compared to $19.9 million generated from investing activities in the nine months ended June 30, 2003. The cash used for investing activities in the nine months ended June 30, 2004 primarily resulted from net purchases of available-for-sale securities of $94.9 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 nine months ended June 30, 2003 primarily resulted from net sales of available-for-sale securities of $19.0 million. In addition, in the nine months ended June 30, 2003, we sold shares of E-CMOS for $2.2 million which resulted in a pre-tax gain of approximately $0.4 million.

In the nine months ended June 30, 2004, we made capital expenditures of approximately $0.6 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 $101.4 million from financing activities during the nine months ended June 30, 2004 compared to $0.8 million in the nine months ended June 30, 2003. In the March 2004 quarter, 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 nine months ended June 30, 2004, we generated $7.9 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 nine months ended June 30, 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 $5.1 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 June 30, 2004 are outlined in the table below:

	Payments Due by Period (in thousands)
Contractual Obligations	Total		Fiscal 2004		Fiscal 2005 –2006		Fiscal 2007 - 2008
Equipment lease debt	$	—	$	—	$	—	$	—
Operating leases		5,138		502		3,853		783
Non-cancelable purchase commitments		1,764		1,764		—		—
Total contractual cash obligations	$	6,902	$	2,266	$	3,853	$	783

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 prior to fiscal 2004, and there can be no assurance that we will be able to sustain profitability in the future.

Though we were profitable in the first three quarters of fiscal 2004, 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 tight or has tightened. 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. In particular, our supply of wafers, especially from SMIC, in the June 2004 quarter was lower than our needs, which adversely impacted our results for such period. Once a product is in production at a particular foundry, it is time consuming and costly to have such product manufactured at a different foundry. In addition, we may not be able to qualify additional manufacturing sources for existing or new products in a timely manner and we cannot be certain that other manufacturing sources would agree to deliver an adequate supply of wafers to us.

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

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

• the cyclicality of the semiconductor industry;

• shortages in foundry, assembly or test capacity;

• disruption in the supply of wafers, assembly or test services;

• declines in average selling prices of our products;

• changes in our product mix which could reduce our gross margins;

• decreases in the demand for our products;

• oversupply of memory products in the market;

• excess inventory levels at our customers;

• cancellation of existing orders or the failure to secure new orders;

• our failure to introduce new products and to implement technologies on a timely basis;

• market acceptance of ours and our customers’ products;

• economic slowness and low end-user demand;

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

• our failure to anticipate changing customer product requirements;

• fluctuations in manufacturing yields at our suppliers;

• our failure to deliver products to customers on a timely basis;

• the timing of significant orders;

• increased expenses associated with new product introductions, masks or process changes;

• the ability of customers to make payments to us; and

• the commencement of, or developments with respect to, any litigation or future antidumping proceedings.

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

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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 in recent quarters, we have experienced increases in average selling prices for some of our products, particularly our DRAM products, historically, average selling prices for semiconductor memory products have declined, and we expect that average selling prices will decline in the future. In this regard, we anticipate a decline in the average selling prices for our DRAM products in the September 2004 quarter compared to the June 2004 quarter. 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. In this regard, we anticipate a decline in our gross margin in the September 2004 quarter compared to the June 2004 quarter due to declines in the average selling prices for our DRAM products. 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 has tightened. In particular, our supply of wafers, especially from SMIC, in the June 2004 quarter was lower than our needs, which adversely impacted our results for such period. To maintain our gross margins when average selling prices are declining, we must introduce new products with higher margins or reduce our cost per unit. There can be no assurance that we will be able to increase unit sales volumes, introduce and sell new products or reduce our cost per unit.

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

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

• reduced control over product quality;

• potential price increases;

• reduced control over delivery schedules;

• capacity shortages;

• their inability to increase production and achieve acceptable yields on a timely basis;

• absence of long-term agreements;

• limited warranties on products supplied to us; and

• general risks related to conducting business internationally.

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

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

As sales to our customers are executed pursuant to purchase orders and no purchasing contracts typically exist, our customers can cease doing business with us at any time. In the nine months ended June 30, 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 nine months ended June 30, 2004, approximately 12% 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 2003, approximately 13% of our net sales was attributable to customers located in the U.S., 10% was attributable to customers located in Europe and 77% was attributable to customers located in Asia. In fiscal 2002, approximately 30% of our net sales was attributable to customers located in the U.S., 14% was attributable to customers located in Europe and 56% was attributable to customers located in Asia. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. In addition, all of our wafer foundries and assembly and test subcontractors are in Taiwan, China and Singapore.

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

• global economic conditions, particularly in Taiwan and China;

• duties, tariffs and other trade barriers and restrictions;

• changes in trade policy and regulatory requirements;

• transportation delays;

• the burdens of complying with foreign laws;

• foreign currency fluctuations;

• imposition of foreign currency controls;

• language barriers;

• difficulties in hiring experienced engineers in countries such as China;

• difficulties in collecting foreign accounts receivable;

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

• political instability, including any changes in relations between China and Taiwan; and

• earthquakes and other natural disasters.

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

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

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

We believe that the protection of our intellectual proprietary rights will continue to be important to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and business partners, and control access to and distribution of our documentation and other proprietary information. Despite these efforts, unauthorized parties may attempt to

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copy or otherwise obtain and use our proprietary technology. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as do the laws of the U.S. Many U.S. companies have encountered substantial infringement problems in foreign countries, including countries in which we design and sell our products. We do not currently hold any non-U.S. patents. We cannot be certain that patents will be issued as a result of our pending applications nor can we be certain that any issued patents would protect or benefit us or give us adequate protection from competing products. For example, issued patents may be circumvented or challenged and declared invalid or unenforceable. We also cannot be certain that others will not develop our unpatented proprietary technology or effective competing technologies on their own.

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

Over the last few years, we have acquired equity positions for strategic reasons in other technology companies and we may make similar equity purchases in the future. At June 30, 2004, our strategic investments in non-marketable securities totaled $4.0 million. These equity securities may not increase in value and there is the possibility that they could decrease in value over time, even to the point of becoming completely worthless. These equity securities are tested for impairment on a recurring basis and any reductions in the carrying value would lower our profitability. In this regard, we recorded approximately a $1.3 million impairment loss on one of our equity positions in the three months ended June 30, 2003. In addition, we recorded approximately $0.2 million and $0.4 million in impairment losses during fiscal 2001 and fiscal 2002, respectively.

In addition, we own shares in SMIC with a cost basis of approximately $37.5 million and a market value at June 30, 2004 of approximately $70.2 million. The market value of SMIC shares is subject to fluctuation and our carrying value will be subject to adjustments to reflect the current market value. Our shares in SMIC are subject to certain lockup restrictions and therefore are not freely tradable. These lockup restrictions generally lapse at the rate of 15% of the Company’s pre-offering shares every 180 days following the IPO. Thus all of our shares in SMIC will be freely tradable 3 years and 180 days following the IPO. As a result of these lockup restrictions and potential fluctuations in SMIC’s stock price, we may be unable to realize the market value at June 30, 2004.

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

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

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

We held approximately 29% of the equity of our former wholly-owned subsidiary, ICSI, at June 30, 2004. Our financial results for the nine months ended June 30, 2004, fiscal 2003 and fiscal 2002 reflect accounting for ICSI on the equity basis and include our percentage share of the results of ICSI’s operations. As a result, our net income/loss will be impacted by the financial results of ICSI. We have limited visibility as to the future financial results of ICSI. Any unexpected fluctuations in ICSI’s results would have an unexpected impact on our net income which could be material to our financial results. ICSI’s shares are publicly traded on the Taiwan stock exchange and its share price is subject to market fluctuations. The market value of our investment in the common stock of ICSI at June 30, 2004 and August 6, 2004 was approximately $35.4 million and $27.3 million, respectively, based on quoted market prices. As our total carrying value of this investment as of June 30, 2004 was approximately $21.3 million, of which $17.0 million is included in other assets and $4.3 million is included in other comprehensive income in the equity portion of our balance sheet, a significant decline in the stock price of ICSI may require us to record an impairment loss related to these shares.

We may encounter difficulties in effectively integrating acquired businesses.

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

• higher than estimated acquisition expenses;

• difficulties in successfully assimilating the operations, technologies and personnel of the acquired company;

• diversion of management’s attention from other business concerns;

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

• the risk that the markets for acquired products do not develop as expected; and

• the potential loss of key employees and customers as a result of the acquisition.

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

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

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

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

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

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

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

Our stock price is expected to be continue to be volatile.

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

• quarter-to-quarter variations in our operating results;

• general conditions or cyclicality in the semiconductor industry or the end markets that we serve;

• new or revised earnings estimates or guidance by us or industry analysts;

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

• aggregate valuations and movement of stocks in the broader semiconductor industry;

• announcements of new products, strategic relationships or acquisitions by us or our competitors;

• increases or decreases in available wafer capacity;

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• governmental regulations, trade laws and import duties;

• announcements related to future or existing litigation involving us or any of our competitors;

• announcements of technological innovations by us or our competitors;

• additions or departures of senior management; and

• other events or factors, many of which are beyond our control.

In addition, stock markets have experienced extreme price and trading volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock. For example, on March 24, 2003, our closing stock price was $2.26 per share, rose to $19.87 per share on January 13, 2004, and subsequently declined to $7.84 per share on July 23, 2004.

Risks Related to Our Industry

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

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

• purchases of equity or debt securities in foundries;

• joint ventures;

• process development relationships with foundries;

• contracts that commit us to purchase specified quantities of wafers over extended periods;

• increased price for wafers;

• option payments or other prepayments to foundries; and

• nonrefundable deposits with, or loans to, foundries in exchange for capacity commitments.

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

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

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

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

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

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

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

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

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

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

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

• the pricing of our products;

• the supply and cost of wafers;

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• product design, functionality, performance and reliability;

• successful and timely product development;

• the performance of our competitors and their pricing policies;

• wafer manufacturing over or under capacity;

• real or perceived imbalances in supply and demand for our products;

• the rate at which OEM customers incorporate our products into their systems;

• the success of our customers’ products and end-user demand;

• access to advanced process technologies at competitive prices;

• achievement of acceptable yields of functional die;

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

• the gain or loss of significant customers; and

• the nature of our competitors and general economic conditions.

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

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

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

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our financial market risk includes risks associated with international operations and related foreign currencies. We anticipate that international sales will continue to account for a significant portion of our consolidated revenue. Our international sales are largely denominated in U.S. dollars and therefore are not subject to material foreign currency exchange risk. We have operations in China, Europe, Taiwan, Hong Kong, India and Korea. Expenses of our international operations are denominated in each country’s local currency and therefore are subject to foreign currency exchange risk; however, through June 30, 2004 we have not experienced any significant negative impact on our operations as a result of fluctuations in foreign currency exchange rates. We do not currently engage in any hedging activities.

We had short-term investments of $133.4 million at June 30, 2004. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without increasing risk. We invest primarily in high-quality, short-term debt instruments such as municipal auction rate certificates and instruments issued by high quality financial institutions and companies, including money market instruments. A hypothetical one percentage point decrease in interest rates would result in approximately a $1.3 million decrease in our interest income.

We own approximately 29% of ICSI, a public company listed on the Taiwan Stock Exchange. We account for this investment on the equity basis and our total carrying value of this investment as of June 30, 2004 was approximately $21.3 million of which $17.0 million is included in other assets and $4.3 million is included in other comprehensive income in the equity portion of our balance sheet. The market value of our investment in the common stock of ICSI at June 30, 2004 was approximately $35.4 million, based on quoted market prices. The share price of ICSI is subject to fluctuations. A significant decline in the stock price of ICSI may require us to record a loss related to this investment. In addition, we own approximately $3.5 million of ICSI convertible debentures. As a result of changes in ICSI’s convertible debenture price, as of June 30, 2004, we recorded an accumulated unrealized gain of approximately $353,000 related to the ICSI convertible debentures. This gain was included in other comprehensive income in the equity portion of our balance sheet. In addition, in the three and nine months ended June 30, 2004, we recorded a gain (loss) of approximately $(239,000) and $13,000, respectively, related to the change in the fair value of an embedded derivative associated with the ICSI convertible debenture. The gain (loss) associated with the embedded derivative is included in other income (expense). Any future decline in ICSI’s debenture price would result in additional losses.

We own less than 2% of SMIC. On March 17, 2004, SMIC completed its IPO. SMIC’s ordinary shares are traded on the Hong Kong Stock Exchange and SMIC American Depository Receipts (“ADR”) are traded on the New York Stock Exchange. Each SMIC ADR represents fifty (50) ordinary shares. As a result of our sale of shares of SMIC in the IPO, we recorded gross proceeds of approximately $13.2 million in the March 2004 quarter resulting in a pre-tax gain of approximately $8.7 million. Since SMIC’s IPO, we account for our shares in SMIC under the provisions of FASB 115 and have marked our investment to the market value as of June 30, 2004 by increasing other assets and by increasing accumulated comprehensive income in the equity section of the balance sheet. The cost basis of our shares in SMIC is approximately $37.5 million and the market value at June 30, 2004 was approximately $70.2 million. The market value of SMIC shares is subject to fluctuations and our carrying value will be subject to adjustments to reflect the current market value. Our shares in SMIC are subject to certain lockup restrictions and therefore are not freely tradable. These lockup restrictions generally lapse at the rate of 15% of our pre-offering shares every 180 days following the IPO. Thus all of our shares in SMIC will be freely tradable 3 years and 180 days following the IPO. As a result of these lockup restrictions and potential fluctuations in SMIC’s stock price, we may be unable to realize the market value at June 30, 2004.

We have investments in equity securities of privately held companies for the promotion of business and strategic objectives of approximately $4.0 million at June 30, 2004. These investments are generally in companies in the semiconductor industry. These investments are included in other assets and are accounted for using the cost method. For investments in which no public market exists, our policy is to review the operating performance, recent financing transactions and cash flow forecasts for such companies in assessing the net realizable values of the securities of these companies. Impairment losses on equity investments are recorded

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when events and circumstances indicate that such assets are impaired and the decline in value is other than temporary. In this regard, we recorded approximately a $1.3 million impairment loss on our investment in Signia Technologies during fiscal 2003.

Item 4. Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer, based on the evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that, as of June 30, 2004, our disclosure controls and procedures were effective to ensure that the information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. During the three months ended June 30, 2004, there was no change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

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

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

Item 6. Exhibits and Reports on Form 8-K

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

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

(b) Reports on Form 8-K.

On April 22, 2004, we furnished a report on Form 8-K related to our results for the second fiscal quarter ended March 31, 2004.

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SIGNATURES

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

	Integrated Silicon Solution, Inc.
	(Registrant)
Dated: August 13, 2004	/s/ Gary L. Fischer
	Gary L. Fischer
	President, Chief Operating Officer,
	and Chief Financial Officer
	(Principal Financial and
	Accounting Officer)

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