Part I

This Annual Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which include, without limitation, statements about the market for our technology, our strategy, competition, expected financial performance and other aspects of our business identified in this Annual Report, as well as other reports that we file from time to time with the Securities and Exchange Commission. Any statements about our business, financial results, financial condition and operations contained in this Annual Report that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “expects,” “intends,” “plans”, “projects,” or similar expressions are intended to identify forward-looking statements. Our actual results could differ materially from those expressed or implied by these forward-looking statements as a result of various factors, including the risk factors described in Part I., Item 1A, “Risk Factors,” and elsewhere in this report. We undertake no obligation to update publicly any forward-looking statements for any reason, except as required by law, even as new information becomes available or other events occur in the future.

MoSys®, MultiBank® and 1T-SRAM® are our trademarks. Product names, trade names and trademarks of other companies are also referred to in this report.

Item 1. Business

Company Overview

We design, develop, market and license memory technologies used by the semiconductor industry and electronic product manufacturers. We have developed a patented semiconductor memory technology, called 1T-SRAM, that offers a combination of high density, low power consumption and high speed at performance and cost levels that other available memory technologies do not match. We license this technology to companies that incorporate, or embed, memory on complex integrated circuits, such as System-on-Chip or SoC. We have also sold memory chips based on our 1T-SRAM technologies, but in 2004, we ceased shipments of 1T-SRAM memory chips. We do not expect to make and sell memory chips in the future.

We signed our first license agreement related to our 1T-SRAM technologies at the end of the fourth quarter of 1998 and recognized licensing revenue from our 1T-SRAM technologies for the first time in the first quarter of 2000. Since then, we have introduced improved and enhanced versions of our technology.

We generate revenue from the licensing of our memory technologies, which consists of licensing revenues, customization services, maintenance and support fees and royalties. Royalty revenues are earned under each of our license agreements when our licensees manufacture or sell products that incorporate any of our 1T-SRAM technologies and report the results to us. Generally, we expect our total sales cycle, or the period from our initial discussion with a prospective licensee to our receipt of royalties from the licensee’s use of our 1T-SRAM technologies, to run from 18 to 24 months after the commencement of the project.

In 2005, we began delivering our new family of 1T-SRAM CLASSIC Memory Macro products to licensees. These macros are silicon-proven, high-density solutions offering customers rapid memory block integration into their SoC designs. They are pre-configured and require minimal additional customization. They are targeted for high volume consumer products that require larger embedded memory to support device enhancements, such as higher resolution cameras and high quality audio and video capabilities.

Industry Background

Trends in the Semiconductor Industry

Electronic products play an increasingly important role in our lives, as evidenced by the growth of the personal computer, wireless communications, networking equipment and consumer electronics markets. These markets are characterized by intensifying competition, rapid innovation, increasing performance requirements and continuing cost pressures. To manufacture electronic products that achieve optimal performance and cost levels, semiconductor companies must produce integrated circuits that offer higher performance, greater functionality and lower cost.

Two important measures of performance are speed and power consumption. Higher-speed integrated circuits allow electronic products to operate faster, enabling the performance of more functions. Reducing the power consumption of integrated circuits contributes to increased battery life and reduced heat generation in electronic products. Reduced power consumption also enables integrated circuit designers to overcome costly design hurdles, such as meeting the thermal limitations of low-cost packaging materials.

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

To avoid the high cost of substantial redesign, semiconductor companies typically use technology that is scalable, which means it can be readily incorporated into multiple generations of manufacturing process technologies. Process technology generations are distinguished in terms of the dimension of the integrated circuit’s smallest topographical features, as measured in microns (one millionth of a meter). The semiconductor industry has continuously developed advanced process technologies that enable the reduction of silicon area on integrated circuits and consequently lower costs. Today, the industry is predominantly using 0.25-micron, 0.18-micron and 0.15-micron manufacturing process technology. However, current designs are now being implemented in 0.13-micron and in 90 nanometers (nm) manufacturing process technologies, with 65nm technologies anticipated in the near future.

Importance of Integration

For decades, the semiconductor industry has continuously increased the value of integrated circuits by improving their density, power consumption, speed and cost. The main driver for these improvements has been the success of shrinking the size of the basic semiconductor building block, or transistor. Transistors have become small enough to make it economical to combine multiple functions, such as microprocessors, graphics, memory, analog components and digital signal processors, on a SoC. Highly integrated circuits such as SoCs often offer advantages in density, power consumption, speed and cost that cannot be matched using separate, discrete integrated circuits. SoCs are essential for most electronic products, such as cellular phones, video game consoles, portable media players, communication and networking equipment and internet appliances, to achieve increasing performance requirements at a reasonable cost.

Importance of Embedded Memory

Historically, semiconductor companies implemented memory in separate integrated circuits. Rather than using separate memory chips, many semiconductor companies today are embedding memory on highly integrated circuits in order to optimize performance and power consumption. At the same time, the increasing sophistication of electronic products is driving a rapid increase in the amount of memory required. Current industry estimates are that more than half of the chip area of a SoC is comprised of embedded memory and this proportion is forecasted to increase in the future with the growth of more memory-intensive applications.

The high cost of incorporating the memory component represents a major challenge to achieving high levels of integration. As embedded memories account for an increasing percentage of the size of a highly integrated circuit, they are often the slowest or limiting function in the circuit. Not only must integrated circuits contain a larger amount of embedded memory, this memory must be dense enough to be economically attractive and must offer sufficiently high speed and low power consumption. In many applications, embedded memory has become a crucial design consideration for determining the overall cost and performance of highly integrated circuits and the growing number of electronic products in which they are incorporated.

Traditional SRAM and Embedded DRAM

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

· it can operate at the same high speeds as other functions of the integrated circuit;

· it provides a simple and familiar interface that allows for quick design into an integrated circuit with less risk that the design will not function according to specification; and

· it utilizes the standard logic manufacturing process that is both economical and the most widely available.

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

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

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

To overcome the density limitations of traditional SRAM, some manufacturers have utilized embedded dynamic random access memory, or embedded DRAM. While embedded DRAM is denser than traditional SRAM, it is typically ten times slower. Manufacturing embedded DRAM also requires additional process steps and results in lower yields, which translate into increased manufacturing time and cost. Additionally, because of its complex interface requirements, embedded DRAM is more difficult to incorporate on integrated circuits, leading to a higher risk of failure. As integrated circuit designers have experimented with embedded DRAM, they have discovered that these limitations of embedded DRAM preclude its use in most applications. Therefore, traditional SRAM continues to be the most widely used technology for embedded memory. One of the major challenges for the semiconductor industry today is to find an embedded memory solution that combines high density, low power consumption, high speed and low cost.

Our Solution

We have developed a series of innovative memory technologies, 1T-SRAM technologies, which provide major advantages over traditional SRAM in density, power consumption and cost, thus making it more economical for designers to incorporate large amounts of embedded memory in their designs. In

addition, our 1T-SRAM technologies offer all the benefits of traditional SRAM, such as high speed, simple interface and ease of manufacturability. Its core circuitry is already production proven in millions of memory chips and offers integrated circuit designers the following characteristics compared to traditional SRAM:

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

Our 1T-SRAM technologies can achieve these advantages while utilizing standard logic manufacturing processes and providing the simple, standard SRAM interface that designers are accustomed to today.

High Density

Embedded memory utilizing our 1T-SRAM technologies is typically two to three times denser than traditional SRAM. Increased density enables manufacturers of electronic products, such as cellular phones, video game consoles and digital cameras and camcorders, to incorporate additional functionality into a single integrated circuit, resulting in overall cost savings. Semiconductor designers can take advantage of the high density of our 1T-SRAM technologies and embed large quantities of high-performance memory and other components that in the past might not have been feasible.

Low Power Consumption

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

High Speed

Embedded memory utilizing our 1T-SRAM technologies typically provides speeds equal to or greater than the speeds of traditional SRAM, especially for larger memory sizes. Our 1T-SRAM memory designs can sustain random access cycle times of less than three nanoseconds. In today’s 0.13-micron manufacturing process technology, our 1T-SRAM technologies can operate with a random access frequency in excess of 400 megahertz for multi-megabit memory.

Manufacturing Process Independence

We have been able to implement our technology without requiring the manufacturer to make any significant changes to either standard logic or alternative manufacturing processes. 1T-SRAM’s portability, or the ease with which it can be implemented in different semiconductor manufacturing facilities, has been proven operational in the fabrication of chips at the world’s largest independent foundries, including Taiwan Semiconductor Manufacturing Co., Ltd., or TSMC, United Microelectronics Corporation, or UMC, Chartered Semiconductor Manufacturing Ltd., or Chartered, and Semiconductor Manufacturing International Corporation, or SMIC. It has also been proven in the manufacturing processes of integrated device manufacturers, or IDM’s, such as Fujitsu and NEC Electronics. 1T-SRAM’s scalability, or the ease with which it can be implemented in different generations of manufacturing processes, has already been demonstrated in the fabrication of chips in 0.25-micron, 0.18-micron, 0.15-micron, 0.13-micron and 90nm process generations, without extensive modifications. We expect our technology to continue to scale

readily to future process generations. This portability and scalability provides for wide availability, inexpensive implementation and quick product time to market for our licensees.

Simplicity of Interface

Our 1T-SRAM technologies internal circuitry connects to the simple, standard SRAM interface that designers are accustomed to today. Our use of this standard high-performance interface minimizes design time, thus optimizing time to market for our licensees. This simple interface also helps minimize the risk that integrated circuit designs will not operate according to specifications.

Our Strategy

Our goal is to establish our 1T-SRAM technologies as the standard for all large embedded memories in SoC applications. We intend to achieve this goal by licensing our technology on a non-exclusive and worldwide basis to foundries, integrated device manufacturers, fabless semiconductor companies and electronic product manufacturers.

The following are integral aspects of our strategy.

Target Large and Growing Markets

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

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

Work Closely with Semiconductor Companies and Foundries to Deliver Optimal Technology Solutions

We work closely with semiconductor companies to gain broad and detailed insight into their and their customers’ current and next-generation technology requirements. This insight helps us identify trends and focus our development efforts on optimizing our technology solution, resulting in shorter product time to market and lower costs. We plan to continue to qualify and license our technology with the leading IDM’s and foundries in order to provide a wide range of manufacturing choices for our customers.

Extend our Technology Offerings

Our goal is to continue to enhance our 1T-SRAM technologies and increase our share of the embedded memory market. We will continue to develop our technology in order to offer even higher-density, lower-power consumption, higher-speed and lower-cost designs for our licensees. As such, we continue to invest heavily in research to develop more advanced memory technologies. Since the introduction of 1T-SRAM in 1998, we have introduced and currently offer the following improvements to the 1T-SRAM technology:

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

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

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

In addition, we have developed new generations of our 1T-SRAM technologies, most recently in the 90nm manufacturing process. We intend to continue to develop our technologies for future process generations such as 65nm and 45nm.

Licensing and Distribution Strategy

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

Licensing

We license our technology to semiconductor companies who incorporate our technology into integrated circuits that they sell to their customers. In addition, we engage in joint marketing activities with foundries, intellectual property companies and design companies to promote our technology to a wide base of customers. These distribution channels have broadened the acceptance and availability of our technology in the industry. As our technology becomes available through an increasing number of channels, we believe it will be less likely that customers will have to alter their procurement practices in order to acquire our technology. We intend to continue to expand significantly this base of strategic relationships to further proliferate our technology.

We form product development and licensing relationships directly with semiconductor companies and original equipment manufacturers or OEM. The prospective licensee’s implementation of our 1T-SRAM technologies typically includes customized development. Usually, these relationships involve both engineering work to implement our technology in the specified product and licensing the technology for manufacture and sale of the product. Although the precise terms contained in our 1T-SRAM macro development and license agreements vary, every agreement provides for the payment of contract fees to us at the beginning of the contract and the joint development of specifications and initial product design and engineering. Contract fees include licensing fees, development fees for customizations based on the achievement of specified development milestones and royalties. The vast majority of our contracts allow billing between milestones based on work performed. Typically under our agreements, the licensee is obligated to complete the project within a stated timeframe and to assist us in completing the final milestone. If we perform the contracted services, usually the licensee is obligated to pay the license fees even if the licensee fails to complete verification or cancels the project prior to completion. The agreements often also provide for the payment of additional contract fees if we provide engineering or manufacturing support services related to the manufacture of the product. Provisions in all of our license agreements require the payment of royalties to us based on the future sale or manufacture of products utilizing our 1T-SRAM technologies. Generally, our licenses grant rights on a non-exclusive, non-transferable basis, limited to the use of our technology as modified for the project covered by the license agreement. Our license agreements generally have a fixed five-year term and are subject to renewal. Each new project requires a separate agreement or an addendum to modify an existing agreement.

We have license agreements with many companies, including Agere Systems, Inc., Agilent Technologies, Analog Devices, Inc., Broadcom Corporation, eSilicon Corporation, Fujitsu Limited, Hitachi, Ltd., Kawasaki Micoroelectronics, Inc., LG Electronics, Inc., LSI Logic Corporation, Marvell Semiconductor, Inc., Matsushita Communication Industrial Co., Ltd., National Semiconductor Corporation, NEC Electronics Corporation, Open-Silicon, Inc., Philips Semiconductors, Inc., Pixelworks, Inc., Pixim, Inc., SMIC, Sanyo Electric Co., Ltd., Sony Corporation, TSMC, UMC, and Via Technologies, Inc.

Joint Marketing Arrangement

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

Custom Memory Designs

We offer directly to our licensees customized 1T-SRAM memory designs to meet their specific design parameters. We also offer a variety of options for optimizing the design specification in order to improve performance and cost effectiveness.

Standard Macro Designs

In addition to licensing our customized 1T-SRAM designs, companies also can license standard 1T-SRAM off-the-shelf memory designs from us, known as CLASSIC Macros. These readily available standard memory designs can assist the licensee in getting its SoC quickly to market.

Technology Licenses

We also offer our technology to semiconductor companies through 1T-SRAM technology license agreements, under which we grant the licensee the additional right to create and modify 1T-SRAM designs to offer to its own customers. The contract fees associated with these arrangements require the licensee to pay us to port our technology to its manufacturing process and develop a template design that the licensee will be able to use to generate future designs. These agreements also obligate the licensee to pay contract fees to us upon the achievement of specified development milestones and may provide for the payment of additional contract fees if we provide engineering or manufacturing support services. Under these agreements we will be entitled to receive royalties based on the future sale or manufacture of products utilizing our 1T-SRAM technologies. The licenses are non-exclusive and non-transferable and authorize the licensee to modify designs for its customers from the template design that we provide under the agreement. Typically, the template design applies only to a specified manufacturing process generation. The licensee may add future process generations to the license agreement for additional contract fees.

Technology

Our innovative 1T-SRAM technologies include many new and proprietary features. These technologies combine the high-density advantages of DRAM with the high performance and utility of SRAM. Underlying this technology are several distinct pieces of our proprietary technology.

Single-Transistor Memory Storage Cell

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

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

MultiBank Technology

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

Pipelined Self-timed Access

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

Refresh Management Circuitry

Refresh operations required to ensure data is maintained to a minimum level in dynamic cells may be performed transparently to a user’s application, allowing designers to fully disregard any of the traditional requirements of dynamic cell arrays.

Leakage Suppression Circuitry

Our unique patented architecture, circuits and proprietary design techniques that manage process leakage allow MoSys 1T-SRAM technologies to be manufactured on any CMOS process, including generic ASIC processes, thus removing the need for complicated embedded memory process development.

TEC® Error Correction Circuitry

We offer our 1T-SRAM technologies with embedded error correction circuitry for higher reliability and quality. This circuitry automatically corrects memory errors during operation, including soft errors caused by high-energy particles, and eliminates the need for laser repair in manufacturing test. This is accomplished without adding any additional silicon area or cost. The TEC® Error Correction Circuitry is currently incorporated into all of our designs developed targeting 0.13-micron and more recent technologies.

1T-Q® Folded Area Capacitor (FAC)

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

Advanced Manufacturing Processes

We have continued to implement our 1T-SRAM technologies on advanced generations of manufacturing processes. As a result, our licensees are able to implement integrated circuits incorporating 1T-SRAM embedded memories on the highest performance manufacturing processes available. The chart below illustrates a sampling of test chips we have made for initially implementing and verifying 1T-SRAM technologies on the latest generations of manufacturing processes nodes. The processes with the smaller micron dimensions have higher random access speeds and typically enable larger capacity memories.

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

Research and Development

Our ability to compete in the future will depend on improving our technology to meet the market’s increasing demand for higher performance and lower cost requirements. We have assembled a team of highly skilled engineers whose activities are focused on developing even higher-density, lower-power consumption, higher-speed and lower-cost 1T-SRAM designs. We expect to continue to focus our research and development efforts on extending our 1T-SRAM technologies and developing new memory technologies. We also intend to continue our focus on porting our technology to additional semiconductor manufacturing facilities and scaling our technology to new generations of manufacturing process technologies.

As of December 31, 2005, we employed 51 engineers, representing 67% of our employees, with specific expertise in circuit design, layout and a variety of manufacturing processes. Effective November 10, 2004, we closed the ATMOS’ research and development facility and terminated the employment of approximately 20 employees of ATMOS. We have a design center in Seoul, South Korea where 10 of our engineers reside. For the years ended December 31, 2005, 2004, and 2003, research and development expenditures totaled approximately $5.8 million, $8.1 million, and $8.7 million, respectively.

Sales and Marketing

As of December 31, 2005, we had a staff of 14 sales and marketing executives managing our technology licensing activities. We have 11 sales and marketing personnel in the United States who are responsible for licensing activities in North America and Asia. Two are located in Sophia-Antipolis, France and are responsible for licensing activities in Europe and the Middle East. One sales and marketing manager is located in Yokohama, Japan and is responsible for licensing activities in Japan. This group manages the negotiation of license agreements, provides technical support during the sales cycle to licensees and administers the contracts. As we have multiple sales channels through our relationships with semiconductor companies, foundries, intellectual property companies and design companies, we do not believe that we require a large internal sales force. Our marketing and promotional activities include participation in industry trade shows, distribution of collateral marketing material, publication of articles in

trade journals and publicizing our licensing activities and technology achievements. We also provide presentations and working sessions with the senior technical and business staff of prospective customers.

Intellectual Property

We regard our patents, copyrights, trademarks, trade secrets and similar intellectual property as critical to our success, and rely on a combination of patent, trademark, copyright, and trade secret laws to protect our proprietary rights. As of December 31, 2005, we held 80 U.S. patents on various aspects of our technology, with expiration dates ranging from 2011 to 2023. These 80 patents include claims relating to multibank partitioning, 1T-SRAM internal operation and circuit techniques, high-speed operation techniques, 1T-SRAM refresh management techniques and the interface of embedded 1T-SRAM storage cells in logic processes. We currently have nine pending U.S. patent applications, and have received notices of allowance with respect to one of these applications. We also hold 40 foreign patents with expiration dates ranging from 2012 to 2022, and we have 19 pending foreign patent applications. There can be no assurance that others will not independently develop similar or competing technology or design around any patents that may be issued to us, or that we will be able to enforce our patents against infringement.

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

Competition

In order to remain competitive, we believe we must continue to provide higher-density, lower-power-consumption, higher-speed and lower-cost technology solutions to the semiconductor industry and electronic product manufacturers. We believe that the principal competitive factors in our industry are—

· density and cost;

· power consumption;

· speed;

· portability to different manufacturing processes;

· scalability to different manufacturing process generations;

· reliability and low manufacturing costs;

· interface requirements; and

· the ease with which technology can be customized for and incorporated into customers’ products.

We believe that our 1T-SRAM technologies offer a high degree of overall performance improvement over traditional SRAM. Semiconductor companies may satisfy their embedded memory needs through traditional SRAM and embedded DRAM. Traditional SRAM relies on publicly available process technology and circuit designs, which semiconductor companies can build internally or acquire through a license from a third party provider, without paying a royalty to us. This is currently the preferred choice for embedded memory solutions in SoCs. Companies providing traditional SRAM embedded memories include Artisan Components and Virage Logic. Embedded DRAM is primarily offered by current or former DRAM suppliers, who utilize their own manufacturing process to compete in the semiconductor foundry business. Suppliers of embedded DRAM include substantial competitors such as Toshiba Ltd. and IBM, among others. Although each of these two embedded DRAM suppliers has experienced some

success in obtaining new customers for its technology, we believe that many semiconductor companies using embedded memory may prefer to license our technology instead of implementing either of these alternatives because of 1T-SRAM’s overall advantages.

Not all embedded memory applications benefit sufficiently from technological advantages offered by our 1T-SRAM technologies to justify the increased cost to the licensee, however. Our licensees and prospective licensees can meet their current needs for embedded memory using other memory solutions with different cost and performance parameters. For example, our technologies are not suitable for replacing lower-cost traditional DRAM memory chips if higher access speed is unnecessary. In addition, alternative solutions may be more cost-effective for memory block sizes of less than 1 megabit, or applications in which the embedded memory portion is less than 20% of the total chip area.

Moreover, some companies assess greater uncertainty and risk in relying on our newly established 1T-SRAM technologies. As a result, our ability to compete effectively may be limited because such companies may prefer to use more established traditional memory solutions that are freely available without a license.

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

Employees

As of December 31, 2005, we had 76 full-time employees, consisting of 51 in research and development and engineering, 14 in sales and marketing and 11 in finance and administration. We believe our future success will depend, in part, on our ability to continue to attract and retain qualified technical and management personnel, particularly highly skilled design engineers involved in new product development, for whom competition is intense. Our employees are not represented by any collective bargaining unit, and we have not experienced any work stoppage. We believe that our employee relations are good.

Available Information

Our Web site address is www.mosys.com. The information in our Web site is not incorporated by reference into this report. Through a link on the Investor section of our Web site, we make available our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission.

Executive Officers

The names of the Company’s executive officers as of December 31, 2005 and certain information about them are set forth below:

Name	Age	Position(s) with the Company
Chester J. Silvestri	57	Chief Executive Officer and Director
Wingyu Leung	51	Executive Vice President, Chief Technical Officer and Director
Dhaval Ajmera	48	Vice President of Worldwide Sales and Business Development

Chester J. Silvestri, Mr. Silvestri was appointed our Chief Executive Officer and a member of our board of directors on July 26, 2005. Mr. Silvestri held the position of Chief Executive Officer, President and a member of Board of Directors at Ceva, Inc., a leading provider of licensable digital signal processor

(DSP) cores and platform-level IP, from June 2003 to May 2005 and also served as Chairman of Ceva’s Board of Directors from February 2004 to May 2005. From January to May 2003, Mr. Silvestri was a private investor and previously, from 1999 to 2002, Mr. Silvestri held the position of Chief Executive Officer of Arcot Systems, a developer of credit card authentication software. Mr. Silvestri also has served as Chief Operating Officer of Tripath Technology, Inc., President of the Microelectronic Division of SUN Microsystems, Inc., and Vice President and General Manager of the Technology Licensing division of MIPS Computer Systems, Inc. Since June 2003, Mr. Silvestri has served as a member of the board of directors of Magma Design Automation, Inc. Mr. Silvestri earned his bachelor of science and master of science degrees in electrical engineering from Michigan State University and his MBA from the Harvard Graduate School of Business.

Wingyu Leung, Dr. Leung has served as our Executive Vice President, Engineering, and Chief Technical Officer and as a member of our board of directors since April 1992. Dr. Leung also served as our Secretary from April 1992 until May 1996 and again from May 1997 until August 2000. Prior to joining us, Dr. Leung served as a technology consultant to several high technology companies, including Rambus, Inc., a developer of a high-speed chip-to-chip interface technology. Prior to that time, Dr. Leung served as a member of the technical staff of Rambus, and as a senior engineering manager at Integrated Device Technology, Inc., where he managed and participated in circuit design activities. Dr. Leung holds a B.S. in electrical engineering from the University of Maryland, a M.S. in electrical engineering from the University of Illinois, and a Ph.D. in electrical engineering and computer science from the University of California at Berkeley.

Dhaval Ajmera, Mr. Ajmera became our Vice President of Worldwide Sales and Business Development on October 3, 2005. Prior to joining the MoSys, Mr. Ajmera held a position of the Vice President of North American Sales at Ceva, Inc., a leading provider of licensable digital signal processor (DSP) cores and platform-level IP, from March 2004 to July 2005. Prior to that, he was Vice President of World Wide Marketing and Sales for Emuzed, Inc., a leader in multimedia solutions from June 2002 through November 2003, and was instrumental in launching the World’s first Media Center PC along with Microsoft and very large PC OEMS Worldwide including HP, Dell, Samsung and others. Mr. Ajmera has a MSEE from University of Florida and BSEE from University of Bombay.

Item 1A. Risk Factors

If any of the following risks actually occur, our business, results of operations and financial condition could suffer significantly.

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

The future prospects of our business depend on the acceptance by our target markets of our 1T-SRAM technologies for embedded memory applications and any future technology we might develop. Our technology is intended to allow our licensees to develop embedded memory integrated circuits to replace other embedded memory technology with different cost and performance parameters. Our 1T-SRAM technologies utilize fundamentally different internal circuitry that is not widely known in the semiconductor industry. Therefore, one of our principal challenges, which we might fail to meet, is to convince a substantial percentage of SoC designers to adopt our technology instead of other memory solutions, which may have proven effective in their products.

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

Our embedded memory technology might not integrate as well as anticipated with other semiconductor functions in all intended applications, which would slow or prevent adoption of our technology and reduce our revenue. Detailed aspects of our technology could cause unforeseen problems in the efficient integration of our technology with other functions of particular integrated circuits. Any significant compatibility problems with our technology could reduce the attractiveness of our solution, impede its acceptance in the industry and result in a decrease in demand for our technology.

Our lengthy licensing cycle and our licensees’ lengthy product development cycles make the operating results of our licensing business difficult to predict.

We anticipate difficulty in accurately predicting the timing and amounts of revenue generated from licensing our 1T-SRAM technologies. The establishment of a business relationship with a potential licensee is a lengthy process, generally taking from three to nine months, and sometimes longer during slower periods in our industry. Following the establishment of the relationship, the negotiation of licensing terms can be time-consuming, and a potential licensee may require an extended evaluation and testing period.

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

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

If the market for SoC integrated circuits does not expand, our business will suffer.

Our ability to achieve sustained revenue growth and profitability in the future will depend on the continued development of the market for SoC integrated circuits, particularly those requiring embedded memory sizes of one megabit or more. In addition, our ability to achieve design wins with customers is dependent upon the growth of embedded memories required in SoCs. SoCs are characterized by rapid technological change and competition from an increasing number of alternate design strategies such as combining multiple integrated circuits to create a System-on-a-Package.

We cannot be certain that the market for SoCs will continue to develop or grow at a rate sufficient to support our business. SoC providers depend on the demand for products requiring SoCs, such as cellular phones, game consoles, PDAs, digital cameras, DVD players and digital media players to name a few. The demand for such products is uncertain and difficult to predict and depends on factors beyond our control. If the market fails to grow or develops more slowly than expected, our business will suffer.

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

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

We might be unable to deliver our customized memory technology within an agreed technical specification in the time frame demanded by our licensees, which could damage our reputation, harm our ability to attract future licensees and adversely impact operating results.

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

In addition, any failure to meet our customers’ timetables, as well as the agreed upon technical specifications of our customized memory technology could lead to the failure to collect, or a delay in collecting royalties and licensing fee payments from our licensees, damage our reputation in the industry, harm our ability to attract new licensees and negatively impact our operating results. Furthermore, a customer may assert that we are responsible for delays and cost overruns and demand reimbursement for some of its costs, which we may elect to reimburse in whole or in part in order to address the customer’s concerns. For example, in 2004, we reduced revenue by $450,000 for a reimbursement given to a customer for excess verification costs incurred by the customer. In 2005, we also settled with one of our licensees for the amount of $375,000 related to a claim made for excess verification costs incurred by the licensee.

Our business model relies on royalties as a key component in the licensing of our technologies, and if we fail to realize expected royalties our operating results will suffer.

We believe that our long-term success is substantially dependent on the receipt of future royalties. Royalty payments owed to us are calculated based on factors such as our licensees’ selling prices, wafer production, and other variables as provided in each license agreement. The amount of royalties we will receive depends on the licensees’ business success, production volumes and other factors beyond our control. This exposes our business model to risks that we cannot minimize directly and may result in significant fluctuations in our royalty revenue and operating results from quarter-to-quarter. We recognize royalty revenue in the quarter in which we receive a royalty report from our licensee. As a result, our recognition of royalty revenue typically lags behind the quarter in which the related integrated circuit is

manufactured or sold by our licensee by at least one quarter. We cannot be certain that our business strategy will be successful in expanding the number of licensees, nor can we be certain that we will receive significant royalty revenue in the future.

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

Our overall revenue has been highly concentrated, with a few customers accounting for a significant percentage of our total revenue. For the year ended December 31, 2005, our two largest customers, NEC and Fujitsu represented 35% and 17% of total revenue, respectively. For the year ended December 31, 2004, our three largest customers NEC, Fujitsu and Marvell represented 19%, 17% and 11% of total revenue, respectively. For the year ended December 31, 2003, our three largest customers, Sony, NEC and UMC represented 17%, 14% and 11% of total revenue, respectively. We expect that a relatively small number of licensees will continue to account for a substantial portion of our revenue for the foreseeable future.

Furthermore, our royalty revenue has been highly concentrated among a few licensees, and we expect this trend to continue for the foreseeable future. In particular, a substantial portion of our licensing and royalty revenue in 2005 and 2004 has come from the licenses for integrated circuits used by Nintendo in its GAMECUBE®. Royalties earned from the production of Gamecube chips incorporating our 1T-SRAM technology represented 14%, 15%, and 11% of total revenue in the 2005, 2004 and 2003, respectively. Nintendo faces intense competitive pressure in the video game market, which is characterized by extreme volatility, costly new product introductions and rapidly shifting consumer preferences, and we cannot assure you that Nintendo’s sales of products incorporating our technology will increase beyond prior or current levels.

As a result of this revenue concentration, our results of operations could be impaired by the decision of a single key licensee or customer to cease using our technology or products or by a decline in the number of products that incorporate our technology that are sold by a single licensee or customer or by a small group of licensees or customers.

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

We might also face credit risks associated with the concentration of our revenue among a small number of licensees and customers. As of December 31, 2005, three customers represented 82% of total trade receivables. Our failure to collect receivables from any customer that represents a large percentage of receivables on a timely basis, or at all, could adversely affect our cash flow or results of operations and might cause our stock price to fall.

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

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

Likewise, we have no control over the product development, pricing and marketing strategies of our licensees, which directly affect the licensing of our technology and corresponding future royalties payable to us from our licensees. Our royalty revenues are subject to our licensees’ ability to market, produce and

ship products incorporating our technology. A decline in sales of our licensees’ royalty-generating products for any reason would reduce our royalty revenue. In addition, seasonal and other fluctuations in demand for our licensees’ products could cause our operating results to fluctuate, which could cause our stock price to fall.

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

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

Additionally, we rely on third-party foundries to manufacture our silicon test chips, to provide references to their customers and to assist us in the focus of our research and development activities. If we are unable to maintain our existing relationships with these foundries or enter into new relationships with other foundries, we will be unable to verify our technologies for their manufacturing processes and our ability to develop new technologies will be hampered. We would then be unable to license our intellectual property to fabless semiconductor companies that use these foundries to manufacture their silicon chips, which is a significant source of our revenues.

Our embedded memory technology is unique and the occurrence of manufacturing difficulties or low production yields, if not corrected, could hinder market acceptance of our technology and reduce future revenue.

Complex technologies like ours could be adversely affected by difficulties in adapting our 1T-SRAM technologies to our licensees’ product designs or to the manufacturing process technology of a particular foundry or semiconductor manufacturer. Some of our customers have experienced lower than expected yields when initially integrating our design into their SoC. We work closely with our customers to resolve any design or process issues in order to achieve the optimum production yield.

Any decrease in manufacturing yields of integrated circuits utilizing our technology could impede the acceptance of our technology in the industry. The discovery of defects or problems regarding the reliability, quality or compatibility of our technology could require significant expenditures and resources to fix, significantly delay or hinder market acceptance of our technology, reduce anticipated revenues and damage our reputation.

Our failure to compete effectively in the market for embedded memory technology could reduce our revenue.

There exists significant competition in the market for embedded memory technologies. Our licensees and prospective licensees can meet their need for embedded memory by using traditional memory solutions with different cost and performance parameters, which they may internally develop or acquire from third-party vendors. In the past two years, the demand for applications for which our 1T-SRAM technologies provide distinct advantages has not experienced significant growth. If alternative technologies are developed that provide comparable system performance at lower cost than our 1T-SRAM technologies for certain applications and/or do not require the payment of comparable royalties, or if the industry

generally demonstrates a preference for applications for which our 1T-SRAM technologies do not offer significant advantages, our ability to realize revenue from our 1T-SRAM technologies could be impaired.

We might be challenged by competitive developers of alternative technologies who are more established, benefit from greater market recognition and have substantially greater financial, development, manufacturing and marketing resources than we have. These advantages might permit these developers to respond more quickly to new or emerging technologies and changes in licensee requirements. We cannot assure you that future competition will not have a material adverse effect on the adoption of our technology and our market penetration.

Our failure to continue to enhance our technology or develop new technology on a timely basis could diminish our ability to attract and retain licensees and product customers.

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

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

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

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

· develop and maintain competitive technology by improving performance and adding innovative features that differentiate our technology from alternative technologies;

· enable the incorporation of enhanced technology in our licensees’ and customers’ products on a timely basis and at competitive prices;

· implement our technology at future manufacturing process generation; and

· respond effectively to new technological developments or new product introductions by others.

Since its introduction in 1998, we have introduced enhancements to our 1T-SRAM technology designed to meet market requirements. However, we cannot assure you that the design and introduction schedules of any additions and enhancements to our existing and future technology will be met, that this technology will achieve market acceptance or that we will be able to license this technology on terms that are favorable to us. Our failure to develop future technology that achieves market acceptance could harm our competitive position and impede our future growth.

We may incur substantial litigation expense, which would adversely affect our profitability.

On March 31, 2004, UniRAM Technology, Inc. filed a complaint against us in the United States District Court for the Northern District of California, alleging trade secret misappropriation and patent infringement. UniRAM’s complaint asserts that it provided trade secret information to Taiwan Semiconductor Manufacturing Corporation (TSMC) in 1996-97 and speculated that we improperly obtained unspecified trade secrets of UniRAM from TSMC in an unknown manner. Subsequent to March 31, 2004, UniRAM has amended its complaint twice to add TSMC as a defendant and additional

allegations to the suit, and to drop all infringement claims of patent infringement with respect to one of the two patents originally identified in the initial complaint. UniRAM continues to assert its claims of patent infringement with respect to the other patent. We believe that UniRAM’s complaint lacks merit and intend to vigorously defend against it.

We expect to incur substantial expenses litigating the matter in 2006, at least, and potentially thereafter. In addition, although we expect to prevail in the lawsuit, if we do not, we may be required to pay substantial damages and/or the attorneys’ fees and expenses of the other party, as well as our own and perhaps the court would enter an injunction. The payment of such damages and expenses could adversely affect our results of operations and cause net losses for the periods in which we record them.

Royalty amounts owed to us might be difficult to verify, and we might find it difficult, expensive and time-consuming to enforce our license agreements.

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

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

Our technology is complex and is intended for use in complicated integrated circuits. A very large number of new and existing products utilize embedded memory, and a large number of companies manufacture and market these products. Because of these factors, policing the unauthorized use of our intellectual property is difficult and expensive. We cannot be certain that we will be able to detect unauthorized use of our technology or prevent other parties from designing and marketing unauthorized products based on our technology. In the event we identify any past or present infringement of our patents, copyrights or trademarks, or any violation of our trade secrets, confidentiality procedures or licensing agreements, we cannot assure you that the steps taken by us to protect our proprietary information will be adequate to prevent misappropriation of our technology. Our inability to protect adequately our intellectual property would reduce significantly the barriers of entry for directly competing technologies and could reduce the value of our technology. Furthermore, we might initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Litigation by us could result in significant expense and divert the efforts of our technical and management personnel, whether or not such litigation results in a determination favorable to us.

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

We rely on a combination of patents, trademarks, copyrights, trade secret laws and confidentiality procedures to protect our intellectual property rights. As of December 31, 2005, we held 80 patents in the United States, which expire at various times from 2011 to 2023, and 40 corresponding foreign patents. In addition, as of December 31, 2005, we had nine patent applications pending in the United States and 19 pending foreign applications, and had received notice of allowance of one patent application pending in the United States. We cannot be sure that any patents will issue from any of our pending applications or that any claims allowed from pending applications will be of sufficient scope or strength, or issued in all countries where our products can be sold, to provide meaningful protection or any commercial advantage

to us. Also, competitors might be able to design around our patents. Failure of our patents or patent applications to provide meaningful protection might allow others to utilize our technology without any compensation to us and impair our ability to increase our licensing revenue.

Any claim that our products or technology infringe third-party intellectual property rights could increase our costs of operation and distract management and could result in expensive settlement costs or the discontinuance of our technology licensing or product offerings.

The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights or positions, which has resulted in often protracted and expensive litigation. For example, on March 31, 2004, we were sued by UniRAM Technology, Inc. in United States District Court for the Northern District of California based on claims of patent infringement and misappropriation of trade secrets that were allegedly disclosed by UniRAM to TSMC, which allegedly improperly provided them to us. Additionally, our licensees or we might, from time to time, receive notice of claims that we have infringed patents or other intellectual property rights owned by others. Litigation against us, including the UniRAM suit, could result in significant expense and divert the efforts of our technical and management personnel, whether or not the litigation results in a determination adverse to us. Although we believe that UniRAM’s claims lack merit and we intend to rigorously defend against them, in the event of an adverse result in any such litigation, we could be required to pay damages in an amount we cannot presently predict, cease the licensing of certain technology and expend resources to develop non-infringing technology or obtain licenses for the infringing technology. We cannot assure you that we would be successful in such development or that such licenses would be available on reasonable terms, or at all.

The discovery of defects in our technology could expose us to liability for damages.

The discovery of a defect in our 1T-SRAM technology could lead our licensees to seek damages from us. Our standard license terms include provisions waiving implied warranties regarding our technology and limiting our liability to our licensees. We also maintain insurance coverage that is intended to protect us against potential liability for defects in our technology. We cannot be certain, however, that the waivers or limitations of liability contained in our license contracts will be enforceable, that insurance coverage will continue to be available on reasonable terms or in amounts sufficient to cover one or more large claims or that our insurer will not disclaim coverage as to any future claim. The successful assertion of one or more large claims that exceed available insurance coverage or changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could cause our expenses to rise significantly and consequently harm our profitability.

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

The size of our company has increased substantially as we grew from 43 employees in January 2001 to 76 employees in December 2005. The efficient management of our planned expansion of the development, licensing and marketing of our technology, including through the acquisition of other companies will require us to continue to—

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

· manage an increasing number of complex relationships with licensees and co-marketers and their customers and other third parties;

· expand our capabilities to deliver our technologies to our customers;

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

· hire additional key management and technical personnel; and

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

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

If we fail to retain key personnel, our business and growth could be negatively affected.

Our business has been dependent to a significant degree upon the services of a small number of executive officers and technical employees, including Dr. Wingyu Leung, our Executive Vice President and Chief Technical Officer. The loss of his services could negatively impact our technology development efforts and our ability to perform our existing agreements and obtain new customers. We generally have not entered into employment or non-competition agreements with any of our employees and do not maintain key-man life insurance on the lives of any of our key personnel.

Our failure to successfully address the potential difficulties associated with our international operations could increase our costs of operation and negatively impact our revenue.

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

· foreign currency exchange fluctuations;

· unanticipated changes in local regulation;

· potentially adverse tax consequences, such as withholding taxes;

· difficulties regarding timing and availability of export and import licenses;

· political and economic instability; and

· reduced or limited protection of our intellectual property.

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

Provisions of our certificate of incorporation and bylaws or Delaware law might delay or prevent a change of control transaction and depress the market price of our stock.

Various provisions of our certificate of incorporation and bylaws might have the effect of making it more difficult for a third party to acquire, or discouraging a third party from attempting to acquire, control of our company. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. Certain of these provisions eliminate cumulative voting in the election of directors, limit the right of stockholders to call special meetings and establish specific procedures for director nominations by stockholders and the submission of other proposals for consideration at stockholder meetings.

We are also subject to provisions of Delaware law which could delay or make more difficult a merger, tender offer or proxy contest involving our company. In particular, Section 203 of the Delaware General Corporation Law prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless specific conditions are met. Any of these provisions could have the effect of delaying, deferring or preventing a change in control, including without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of our common stock.

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

Our stockholder rights plan could prevent stockholders from receiving a premium over the market price for their shares from a potential acquirer.

We have adopted a stockholder rights plan, which entitles our stockholders to rights to acquire additional shares of our common stock generally when a third party acquires 15% of our common stock or commences or announces its intent to commence a tender offer for at least 15% of our common stock. In 2004, we amended our stockholder rights plan twice; once, in connection with the proposed acquisition of corporation by Synopsys, Inc, and a second time to permit the acquisition of shares representing more than 15% of our common stock by a brokerage firm that manages independent customer accounts and generally does not have any discretionary voting power with respect to such shares. Notwithstanding amendments of this nature, our intention is to maintain and enforce the terms of this plan, which could delay, deter or prevent an investor from acquiring us in a transaction that could otherwise result in stockholders receiving a premium over the market price for their shares of common stock.

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

Our executive officers, directors and their affiliates or non-affiliate related entities, in the aggregate, beneficially own approximately 11% of our common stock. These stockholders acting together have the ability to exert substantial influence over all matters requiring the approval of our stockholders, including the election and removal of directors and any proposed acquisition, consolidation or sale of all or substantially all of our assets. In addition, they could dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding an acquisition, consolidation, takeover or other business combination, which might otherwise result in stockholders receiving a premium over the market price for their shares of common stock.

Potential volatility of the price of our common stock could negatively affect your investment.

We cannot assure you that there will continue to be an active trading market for our common stock. Recently, the stock market, as well as our common stock, has experienced significant price and volume fluctuations. Market prices of securities of technology companies have been highly volatile and frequently reach levels that bear no relationship to the operating performance of such companies. These market prices generally are not sustainable and are subject to wide variations. If our common stock trades to unsustainably high levels, it is likely that the market price of our common stock will thereafter experience a material decline. In April 2004, we announced that our board of directors had authorized the repurchase of up to $25 million of our common stock from time to time over the succeeding 12 months, and as result, we repurchased approximately $4.7 million or 1.2 million shares of our common stock. On April 29, 2005, we announced a repurchase program for up to $20 million of outstanding common stock over the next 12 months. Any such repurchases could impact the price of our common stock and increase volatility.

In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We could be the target of similar litigation in the future. Securities litigation could cause us to incur substantial costs, divert management’s attention and resources, harm our reputation in the industry and the securities markets and reduce our profitability.

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

Sales of a substantial number of shares of common stock in the public market could adversely affect the market price of the common stock prevailing from time to time. The number of shares of our common stock available for sale in the public market is limited by restrictions under the Securities Act of 1933, as amended, or the Securities Act, but taking into account sales of stock made in accordance with the provisions of Rules 144(k), 144 and 701, substantially all the shares of common stock currently outstanding are eligible for sale in the public market.

Our Executive Vice President, Chief Technical Officer, and Director, Wingyu Leung has entered into a new plan under Rule 10b5-1 of the Securities Exchange Act of 1934. It provides for aggregate sales of 500,000 shares in blocks of 25,000 shares each on the 3rd day and the 18th day of each month. Sales are executed using a market not held order entered prior to market open on the 3rd day and the 18th day of each month. Trading shall commence on March 3, 2006. The duration of this plan is from February 20, 2006 to December 29, 2006. Sales of the shares are further subject to the volume restrictions set forth in SEC Rule 144(e). The plan provides for termination upon the completion of the specified trading program, the instruction of the stockholder, or the occurrence of other specified events, whichever is earliest. All of the shares are sold through broker-dealers in ordinary market transactions. Pre-designated trading under this plan may cause unexpected declines in the market price of our common stock. In addition, subject to compliance with applicable securities laws and our insider trading policies, each of our directors and executive officers may sell shares of common stock from time to time.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

On May 6, 2005, we signed a new lease agreement for our facility to accommodate our principal administrative, sales, marketing, support and research and development functions. Under the new lease agreement, we occupy approximately 26,000 square feet of space in Sunnyvale, California. This lease expires at the end of June 2010. The lease for our previous facility expired at the end of June 2005. We have leased approximately 19,000 square feet of space in Ontario, Canada for our research and development facility. The lease expires at the end of April 2008. In connection with the closure of ATMOS’ operation, in July 2005, we signed an agreement to sublease the ATMOS facility, which we occupy under long-term leases in Canada. The sublease expires at the end of April 2008. We have leased approximately 3,700 square feet of space in Seoul, South Korea for our engineering design center. This lease expires at the end of April 2008. Additionally, we have leased approximately 1,340 square feet of space in Yokohama, Japan and 140 square feet of space in Sophia-Antipolis, France for our sales and marketing offices. These leases expire at the end of November 2006 and March 2006, respectively. We believe that our existing facilities are adequate to meet our current needs.

Item 3. Legal Proceedings

On March 31, 2004, UniRAM Technology, Inc. filed a complaint against us in the United States District Court for the Northern District of California, alleging trade secret misappropriation and patent infringement. UniRAM’s complaint asserts that it provided trade secret information to Taiwan Semiconductor Manufacturing Corporation (TSMC) in 1996-97 and speculated that we improperly obtained unspecified trade secrets of UniRAM from TSMC in an unknown manner. Subsequent to March 31, 2004, UniRAM amended its complaint twice to add TSMC as a defendant and additional allegations to the suit, and to drop all infringement claims for one of the two patents identified in the initial

complaint. UniRAM continues to maintain its claims of patent infringement with respect to the other patent being asserted against us. In October 2005, the court held a “Markman hearing” to construe and interpret the claims of the patent that UniRAM continues to assert against us and TSMC. As yet, the court has not issued its claim construction ruling. We believe that UniRAM’s complaint lacks merit and intend to vigorously defend against it.

From time to time we may be subject to legal proceedings and claims in the ordinary course of business. These claims, even if not meritorious, could result in the expenditure of significant financial resources.

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

No matter was submitted to a vote of stockholders during the fourth quarter of the fiscal year covered by this report. The 2006 Annual Meeting of Stockholders will be held at 9:30 a.m., local time, on or about May 25, 2006, at our principal executive office located at 755 North Mathilda Avenue, Sunnyvale, California 94085.

Part II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities

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

Quarter ended	High		Low
December 31, 2005	$	6.22	$	4.99
September 30, 2005	$	5.66	$	4.60
June 30, 2005	$	6.18	$	4.83
March 31, 2005	$	6.42	$	5.44
December 31, 2004	$	6.66	$	4.07
September 30, 2004	$	8.30	$	3.67
June 30, 2004	$	13.45	$	6.45
March 31, 2004	$	13.40	$	6.90

Dividend Policy

We have not declared or paid any cash dividends on our common stock and presently intend to retain future earnings, if any, to fund the development and growth of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

On April 29, 2005, we announced a repurchase program for up to $20 million of outstanding common stock over the next 12 months. No repurchases were made pursuant to this program in 2005.

Use of Proceeds from Registered Securities

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

Securities Authorized for Issuance under Equity Compensation Plan

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

Item 6. Selected Financial Data

The following selected financial data presented below are derived from our consolidated financial statements. The selected financial data should be read in conjunction with our financial statements and notes related to those statements, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein.

	Year Ended December 31,
	2005 *			2004 *			2003 *			2002			2001
	(In thousands, except per share data)
Net revenue:
Product	$	10		$	952		$	1,904		$	2,924		$	12,991
Licensing	7,725			4,544			10,418			10,523			6,053
Royalty	4,547			5,325			6,911			14,344			3,446
Total net revenue	12,282			10,821			19,233			27,791			22,490
Cost of net revenue
Product	—			655			1,217			1,668			5,776
Licensing	1,986			1,613			1,970			1,730			633
Total cost of net revenue	1,986			2,268			3,187			3,398			6,409
Gross profit	10,296			8,553			16,046			24,393			16,081
Operating expenses:
Research and development	5,839			8,096			8,741			6,926			5,201
Selling, general and administrative	9,922			13,331			6,432			5,266			5,340
Restructuring expenses	119			585			—			—			—
Total operating expenses	15,880			22,012			15,173			12,192			10,541
Operating income (loss)	(5,584		)	(13,459		)	873			12,201			5,540
Interest and other income	2,591			11,578			1,914			1,539			1,818
Income (loss) before income taxes	(2,993		)	(1,881		)	2,787			13,740			7,358
Income tax benefit (provision)	11			(26		)	(279		)	(1,373		)	(367		)
Net income (loss)	$	(2,982	)	$	(1,907	)	$	2,508		$	12,367		$	6,991
Net income (loss) per share:
Basic	$	(0.10	)	$	(0.06	)	$	0.08		$	0.41		$	0.35
Diluted	$	(0.10	)	$	(0.06	)	$	0.08		$	0.40		$	0.25
Shares used in computing net income (loss) per share:
Basic	30,534			30,750			30,504			29,902			19,709
Diluted	30,534			30,750			30,998			31,275			28,390
Allocation of stock-based compensation to operating expenses
Research and development	$	—		$	44		$	148		$	340		$	781
Selling, general and administrative	36			24			311			316			654
	$	36		$	68		$	459		$	656		$	1,435

	Year Ended December 31,
	2005 *		2004 *		2003		2002		2001
	(In thousands)
Balance Sheet Data:
Cash, cash equivalents and short-term investments and auction rate securities	$	68,650	$	62,349	$	41,365	$	68,433	$	84,293
Working capital	68,179		62,535		44,426		71,213		82,343
Total assets	103,637		104,582		106,892		103,090		89,596
Deferred revenue	1,309		501		506		1,779		3,418
Long-term obligations	196		239		13		25		—
Stockholders’ equity	99,332		100,408		103,511		98,697		84,104

* Derived from the financial statements that are included in Item 8.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying consolidated financial statements and notes included in this report.

Overview

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

Using elements of our existing memory technology as a foundation, however, we completed development of our first memory chips incorporating our 1T-SRAM technologies in the fourth quarter of 1998. We signed our first license agreement related to our 1T-SRAM technologies at the end of the fourth quarter of 1998 and recognized licensing revenue from our 1T-SRAM technologies for the first time in the first quarter of 2000. Since then, we have introduced improved and enhanced versions of our technology, such as 1T-SRAM-R, 1T-SRAM-M, and 1T-SRAM-Q.

During 2002, we purchased ATMOS Corporation, a semiconductor memory company focused on creating high-density, compiler-generated embedded memory solutions for SoC applications. Effective November 10, 2004, we closed the ATMOS research and development facility in Canada and terminated the employment of approximately 20 employees working there. We recorded restructuring charges related to the closure of approximately $119,000 in 2005 and $585,000 in the fourth quarter of 2004. The charges incurred in 2005 were related to our revised estimate due to the new sublease agreement signed in the second quarter of 2005.

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

Sources of Revenue

We generate two types of revenue: licensing and royalties. In the past, we also sold our proprietary memory chips, and prior to 2001, we derived almost all our revenue from them. From 2001 through 2004, product revenue as a percentage of our total revenue declined significantly, while licensing and royalty revenues grew substantially as a percentage of total revenue. In the third quarter of 2001, for the first time, combined license and royalty revenue exceeded product revenue. By the end of third quarter of 2004, we had exited the product business except for minor sales of products required by our historical customers from time-to-time.

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

Our licensing revenue consists of fees for providing circuit design, layout and design verification and granting a license to a customer for embedding our memory technology into its product. For some customers, we also provide engineering support services to assist in the initial production of products utilizing the licensed 1T-SRAM technologies. License fees generally range from $80,000 to several million dollars per contract, depending on the scope and complexity of the development project, and the licensee’s rights. The licensee generally pays the license fees in installments at the beginning of the license term and upon the attainment of specified milestones. The vast majority of our contracts allow billing between milestones based on work performed. All license agreements entered into to date require us to meet performance specifications. Fees collected prior to revenue recognition are recorded as deferred contract revenue. However, if the agreement involves performance specifications that we have significant experience in meeting and the cost of contract completion can be reasonably estimated, we recognize revenue over the period in which the contract services are performed under the percentage of completion accounting method. Revenue is recognized when collectibility is probable. We use actual direct labor hours incurred to measure progress towards completion. We periodically evaluate the actual status of each project to determine whether the estimates to complete each contract remain accurate and update our estimated costs to complete as necessary. Revenue recognized in any period is dependent on our progress toward completion of projects in progress. Significant management judgment and discretion are used to estimate total direct labor hours. Changes in or deviations from these estimates could have a material effect on the amount of revenue we recognize in any period. If the amount of revenue recognized under the percentage of completion method exceeds the amount of billings to a customer, then under the percentage of completion accounting method, we account for the excess amount as an unbilled contract receivable. Our total unbilled contract receivable was $368,000, $57,000 and $1.1 million as of December 31, 2005, 2004, and 2003, respectively. For agreements involving performance specifications that we have not met and for which we lack the historical experience to reasonably estimate the costs, we defer recognition of all revenue until the licensee manufactures products that meet the contract performance specifications and recognize revenue under the completed contract accounting method.

From time to time, a licensee may cancel a project during the development phase. Such a cancellation is not within our control and is often caused by changes in market conditions or the licensee’s business. Cancellations of this nature are an aspect of our licensing business, and most of our newer contracts allow us to retain all payments that we have received or are entitled to collect for items and services provided before the cancellation occurs. We will consider a project to have been canceled even in the absence of specific notice from our licensee, if there has been no activity under the contract for a significant period, and we believe that completion of the contract is unlikely. In this event, we recognize revenue in the amount of cash received, if we have performed a sufficient portion of the development services. If a

cancelled contract had been entered into before the establishment of technological feasibility, the costs associated with the contract would have been expensed prior to the recognition of revenue. In that case, there would be no costs associated with that revenue recognition, and gross margin would increase for the corresponding period. In 2005, we recognized $240,000 of licensing revenue from cancelled contracts, compared to none in 2004 and $759,000 in 2003.

Royalty. Each license agreement provides for royalty payments at a stated rate. We negotiate royalty rates by taking into account such factors as the anticipated volume of the licensee’s sales of products utilizing our technologies and the cost savings to be achieved by the licensee through the use of our technology. Our license agreements require the licensee to report the manufacture or sale of products that include our technology after the end of the quarter in which the sale or manufacture occurs. We recognize royalties from reports provided by the licensee that are received in the quarter immediately following the quarter during which the licensee has sold or manufactured products containing our technology.

As with our licensing revenues, the timing and level of royalties are difficult to predict. They depend on the licensee’s ability to market, produce and sell products incorporating our technology. Many of the products of our licensees that are currently subject to licenses from us are consumer products, such as electronic game consoles, for which demand can be seasonal and generally highest in the fourth quarter. We do not report royalties from products sold in the fourth quarter until the first quarter of the following year. Also, if a licensee holds excess inventory of products using our licensed technology, we are unlikely to report additional royalty revenue attributable to that product until the quarter after the licensee restarts production. For a discussion of factors that could contribute to the fluctuation of our revenues, see Part I, Item 1A. “Risk Factors—Our lengthy licensing cycle and our licensees’ lengthy development cycles will make the operating results of our licensing business difficult to predict,” and “—Anything that negatively affects the business of our licensees could negatively impact our revenue.”

Product sales. In the second quarter of 2004, we notified customers of our decision to discontinue sales of our memory chip products. As of the end of the third quarter of 2004, we had no remaining product inventory. We do not expect to develop, market and sell memory chips in the future.

Critical Accounting Policies

Use of estimates. Our discussion and analysis of our financial condition and results of operation are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis we make these estimates based on our historical experience and on assumptions that we consider reasonable under the circumstances. Actual results may differ from these estimates, and reported results could differ under different assumptions or conditions.

We believe that the following accounting policies are affected by estimates and judgments in the following manner:

Revenue.

Licensing. In accordance with SOP 81-1 “Accounting for performance of construction-type and certain production type contracts”, when license agreements include deliverables that require “significant production, modification or customization”, contract accounting is applied. If a licensing contract involves performance specifications that we have significant experience in meeting and the direct labor hours to be incurred to complete the contract can be reasonably estimated, we recognize the revenue over the period in which the contract services are performed using the percentage of completion method. The percentage of completion method includes judgmental elements, such as determining that we have the experience to meet the design specifications and estimation of the total direct labor hours. We follow this method

because we can obtain reasonably dependable estimates of the direct labor hours to perform the contracted services. The direct labor hours for the development of the licensee’s design are estimated at the beginning of the contract. As these direct labor hours are incurred, they are used as a measure of progress towards completion. We have the ability to reasonably estimate direct labor hours on a contract to contract basis from our experience in developing prior licensee’s designs. During the contract performance period, we review estimates of direct labor hours to complete the contracts as the contract progresses to completion and will revise our estimates of revenue and gross profit under the contract if we revise the estimations of the direct labor hours to complete. Our policy is to reflect any revision in the contract gross profit estimate in reported income in the period in which the facts giving rise to the revision become known. Under the percentage of completion method, provisions for estimated losses on uncompleted contracts are recognized in the period in which the likelihood of such losses is determined.

Prior to 2005, we recorded deferred revenue when cash was received. However, the terms of our license contracts allow us to bill customers upon achieving the milestones stated in the contracts. We believe that now we have adequate history and experience in fulfilling licensing contract obligations to our customers and collecting payments from them. Therefore, starting in 2005, we began recording accounts receivable and deferred revenue at the time of billing. This change had no impact on the statement of operations, or net cash provided by (used in) operations, investing, or financing activities in the statement of cash flows. The December 31, 2004 accounts receivable and deferred revenue amounts are presented by reducing both accounts receivable and deferred revenue by $871,000, consistent with the presentation used in 2004.

For contracts involving design specifications that we have not met previously, we defer the recognition of revenue until the design meets the contractual design specifications and expense the cost of services as incurred. When we have experience in meeting design specifications but do not have significant experience to reasonably estimate the direct labor hours related to services to meet a design specification, we defer both the recognition of revenue and the cost. For these arrangements, we recognize revenue using the completed contract method. Under the completed contract method, we recognize revenue when we have knowledge that the customer has successfully verified our design. In 2005 and 2004, none of our license revenue was recognized under the completed contract method.

We also provide support and maintenance. Under these arrangements, we provide unspecified upgrades, design rule changes and technical support. No other upgrades, products or other post-contract support are provided. When we provide a combination of services related to licensing and support and maintenance to customers, in addition to the considerations noted above, we evaluate the arrangements under EITF 00-21, “Revenue Arrangements with Multiple Deliverables”. Specifically, we analyze the separate elements to determine if vendor specific objective evidence, or VSOE, exists for the undelivered elements. We believe we have established VSOE for our support and maintenance arrangements. These arrangements are renewable annually by the customer. Support and maintenance revenue is recognized at its fair value ratably over the period during which the obligation exists, typically 12 months. The fair value of any support and maintenance obligation is established based on the specified renewal rate for such support and maintenance. Revenue from support and maintenance service represented $512,000 and $60,000 in 2005 and 2004, respectively, and was included in licensing revenue in the statement of operations.

Royalty. Licensing contracts provide also for royalty payments at a stated rate and require licensees to report the manufacture or sale of products that include our 1T-SRAM technologies after the end of the quarter in which the sale or manufacture occurs. We recognize royalties in the quarter in which we receive the licensee’s report. Generally, royalty payments are made by the licensees around the time we receive their reports.

Goodwill. We review goodwill, recorded from the acquisition of ATMOS Corp. in August 2002, for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable in accordance with the Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” The provisions of SFAS No. 142 require that a two-step impairment test be performed on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. Subsequent to the acquisition of ATMOS, its business became an integrated part of our operations. In 2004, we closed the operation of ATMOS as our Canadian research and development facility. Using the guidance in SFAS No. 142, we consider there to be only one reporting unit at the entity level. For step one, we determine the fair value of our reporting unit using the market approach. Under the market approach, we estimate the fair value based on the market value of the reporting unit at the entity level. If the fair value of the reporting unit exceeds the carrying value of net assets assigned to the reporting unit, goodwill is not impaired, and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, we must perform the second step in order to determine the implied fair value of the reporting unit’s goodwill and compare it to the carrying value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we must record an impairment loss equal to the difference. We performed the annual impairment test during the third quarter of 2005 and the test did not indicate impairment of goodwill as of September 30, 2005. As of December 31, 2005, we found no indicators of potential impairment.

Restructuring Charges. Restructuring charges related to the closure of our ATMOS research and development facility in Canada in 2004 require the use of estimates, primarily related to the cost of exiting facilities, including estimates and assumptions related to future maintenance costs, our ability to secure a sub-tenant, and any sublease income to be received in the future.

We accounted for the restructuring charges under SFAS No. 146 Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred rather than at the date of an entity’s commitment to an exit plan. If we fail to make accurate estimates regarding these costs or to accurately estimate the timing of the completion of planned activities, we may be required to record additional expenses or expense reductions in the future.

Tax valuation allowance. When we prepare our consolidated financial statements, we estimate our income tax liability for each of the various jurisdictions where we conduct business. This requires us to estimate our actual current tax exposure and to assess temporary differences that result from differing treatment of certain items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which we show on our consolidated balance sheet under the category of other current assets. The net deferred tax assets are reduced by a valuation allowance if, based upon weighted available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. When we establish a valuation allowance or increase this allowance in an accounting period, we must record a tax expense in our consolidated statement of operations unless the increase is attributable to stock-based compensation deductions, which are recorded directly to equity. We must make significant judgments to determine our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance to be recorded against our net deferred tax asset. As of December 31, 2005, we had a valuation allowance of approximately $10.9 million, of which approximately $6.1 million was attributable to Canadian loss and research and development pool carryforwards, and $4.1million was attributable to U.S. and state net operating loss and tax credit carryforwards.

Results of Operations

The following discussion compares the historical results of operations based on U.S. generally accepted accounting principles for the years ended December 31, 2005, 2004 and 2003. For these three years, results of operations as a percentage of net revenue were as follows:

	Year Ended December 31,
	2005			2004		2003
Net revenue:
Product		—	%	9	%		10	%
Licensing		63		42			54
Royalty		37		49			36
Total net revenue		100		100			100
Cost of net revenue
Product		—		6			6
Licensing		16		15			11
Total cost of net revenue		16		21			17
Gross profit		84		79			83
Operating expenses:
Research and development		48		75			46
Selling, general and administrative		81		123			33
Restructuring expenses		—		5			—
Total operating expenses		129		203			79
Operating income (loss)		(45	)	(124	)		4
Interest and other income		21		106			10
Income tax benefit (provision)		—		—			(1	)
Net income (loss)		(24	)%	(18	)%		13	%

Years Ended December 31, 2005, 2004 and 2003

Revenue. In 2005, total revenue increased to $12.3 million representing a 14% increase from total revenue in 2004. Licensing revenue increased to $7.7 million in 2005 from $4.5 million in 2004 mainly due to increased numbers of projects commenced under new contracts signed in 2005 and revenue generated under a large contract signed in 2003 and completed in 2005. Royalty revenue decreased to $4.5 million in 2005 from $5.3 million in 2004 as customer sales of chips incorporating our technology declined. Royalties related to the production of Nintendo Gamecube chips in 2005 was $1.7 million, which was consistent with royalties in 2004.

In 2004, total revenue decreased to $10.8 million representing a 44% decline from total revenue in 2003. Licensing revenue declined to $4.5 million in 2004 from $10.4 million in 2003 because we did not add new licensing projects to offset the decrease in licensing revenue earned from older projects that we completed in 2004. In 2004, we reduced revenue by $450,000 for a reimbursement given to a customer for excess verification costs incurred by the customer. Royalty revenue decreased to $5.3 million in 2004 from $6.9 million in 2003, which included a one-time past due royalty payment of approximately $713,000 from Conexant. Excluding that one-time payment, total royalties in 2004 declined by approximately $900,000 from 2003, as customer sales of chips incorporating our technology declined. For example, royalties related to the production of Nintendo Gamecube chips represented $1.7 million in 2004 compared to $2.1 million in 2003.

In 2003, total revenue was $19.2 million primarily from licensing and royalty activities. The majority of licensing revenue earned in 2003 was derived from development projects other than Gamecube-related

projects. Royalties earned from the sale of Gamecube chips incorporating our 1T-SRAM technology represented 11% of our total revenue in 2003. A significant portion of royalty revenues from other licensees in 2003 represented sales of royalty-bearing products first shipped in 2002. During the second quarter of 2003, we collected $1.0 million in cash from Conexant for the termination of its October 2000 license agreement with us. That payment consisted of current and past due royalty payments totaling $713,000, and a contract termination fee of $287,000, which we included in other income.

During the years ended December 31, 2005, 2004, and 2003, our product sales totaled $10,000, $952,000 and $1.9 million, respectively. Sales of our memory chips have declined sharply as we shifted our primary focus from product sales to the licensing of our 1T-SRAM technologies after 1999. In the second quarter of 2004, we notified customers of our decision to discontinue sale of our memory chip products. As of the end of the third quarter of 2004, we had no remaining product inventory of value. Accordingly, we will only have minor ongoing sales of products required from time to time by customers. In the future, we do not expect to develop, market and sell memory chips.

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

Gross profit decreased to $8.6 million in 2004 from $16.0 million in 2003 primarily due to the significant decline in our licensing revenue. Our gross profit as a percentage of total revenue decreased to 79% in 2004 from 83% in 2003 primarily due to the decline in licensing gross profit which fell to 65% of total revenue in 2004 from 81% of total revenue in 2003. This decline occurred because we incurred higher cost under new license agreements than we had originally estimated or had historically experienced. In addition, we recognized revenue under some lower margin license projects including a few contracts in which our estimated cost exceeded the amount of revenue to be recognized.

In 2004, product gross margin as a percentage of product revenue decreased to 31% compared to 36% in 2003 mainly due to an inventory write-off of approximately $230,000 in 2004, which was not previously reserved for. In 2003, product gross margin as a percentage of product revenue decreased to 36% compared to 43% in 2002. The decline resulted primarily from lower average selling prices for our memory chips in 2003.

Research and Development. Our research and development expenses include development and design of variations of the 1T-SRAM technologies for use in different manufacturing processes used by licensees and the development and testing of prototypes to prove the technological feasibility of embedding our memory designs in the licensees’ products. Research and development expenses decreased to $5.8 million in 2005 from $8.1 million in 2004 mainly due to the closure of our ATMOS research and development facility in Ottawa, Canada in November of 2004. There were no research and development expenses incurred at the ATMOS facility in 2005 as compared to $2.2 million incurred in 2004.

Research and development expenses decreased to $8.1 million in 2004 from $8.7 million in 2003 mainly because more engineering time was spent on licensing development projects, therefore, more engineering expenses were allocated to cost of licensing revenue in 2004 compared to 2003. Effective November 10, 2004, we closed the ATMOS research and development facility in Ottawa, Canada and terminated the employment of approximately 20 employees working there.

Research and development expenses increased to $8.7 million in 2003 because we had increased engineering staff from our acquisition of ATMOS and to support our memory compiler development. ATMOS’ research and development expenses represented approximately $2.6 million in 2003.

Selling, General and Administrative. Selling, general and administrative expenses decreased to $9.9 million in 2005 from $13.3 million in 2004 primarily due to $5.5 million of expenses incurred in 2004 related to the aborted acquisition by Synopsys, Inc. and legal expenses related to litigation with Synopsys over its abandonment of the acquisition and $800,000 of litigation expenses with respect to the patent infringement and trade secret misappropriation suit brought against us by UniRAM Technology, Inc. incurred in 2004. We did not incur Synopsys-related costs in 2005, but incurred approximately $1.6 million of legal expenses related to the clams brought by UniRAM. Expenses related to testing and assessment of effectiveness of our internal control over financial reporting required by Section 404 of Sarbanes-Oxley Act were approximately $466,000 in 2005. We expect the expenses related to UniRAM litigation and testing and assessment required by Section 404 of Sarbanes-Oxley Act to continue in 2006.

Selling, general and administrative expenses increased to $13.3 million in 2004 from $6.4 million in 2003 due primarily to expenses related to the aborted acquisition by Synopsys and litigation expenses related to litigation with Synopsys and UniRAM. In 2004, expenses related to testing and assessment of effectiveness of our internal control over financial reporting required by Section 404 of Sarbanes-Oxley Act were approximately $690,000. Selling, general and administrative expenses increased to $6.4 million in 2003 due primarily to increased sales and marketing activities, including the establishment of a sales office in Japan in January 2003 and higher professional fees.

Restructuring Charges. On November 10, 2004, we announced our plan to close the ATMOS research and development facility in Canada in order to reduce operating expenses and to further align our business with market conditions, future revenue expectations and planned future product direction. As a part of the plan, we implemented a reduction in workforce of approximately 20 employees, which represented 20% of our workforce.

We recorded restructuring costs of $585,000 in the fourth quarter of 2004, consisting of $179,000 of severance and fringe benefits and lease abandonment charges of $406,000. At December 31, 2004, we have a total restructuring accrual of $429,000, comprised of unpaid employee severance costs of $19,000 and estimated lease abandonment costs of $410,000. All employees to be affected by our reduction in workforce were notified of the termination of their employment on November 10, 2004.

On July 15, 2005, we signed an agreement to sublease the ATMOS facility, which we occupy under a long-term operating lease through April 2008. The sublease expires at the end of April 2008.As a result of the sublease, we incurred $119,000 of additional restructuring expenses in 2005. As of December 31, 2005, we had a total restructuring estimated lease abandonment accrual of $293,000. We review these estimates periodically if these assumptions materially change due to rental market factors, the ultimate restructuring expense for the abandoned facilities would be adjusted.

Interest and Other Income. Interest and other income decreased to $2.6 million in 2005 from $11.6 million in 2004, which included the $10 million Synopsys termination fee related to the aborted acquisition. Interest income increased to $2.6 million in 2005 from $1.5 million in 2004 due to higher interest rates in 2005. Interest and other income increased to $11.6 million in 2004 from $1.9 million in 2003 primarily due to a $10.0 million termination fee paid by Synopsys. In addition, interest income increased slightly to $1.5 million in 2004 from $1.4 million in 2003 as income attributable to higher interest rates in 2004 was impacted adversely by the requirement that we liquidated the short-term and long-term investments in the second quarter of 2004 prior to the abandonment of its acquisition of our company by Synopsys. In 2003, interest and other income increased to $1.9 million primarily due to the $287,000 contract termination fee from Conexant and $241,000 of Canadian research and development incentive credits. Interest income was $1.4 million in 2003. We incurred no interest expense in 2005, 2004, and 2003.

Deferred stock-based compensation cost to employees. During the year ended December 31, 2004, we recorded deferred compensation cost of $74,000, which would be amortized in future periods. No such costs were incurred in 2005 or 2003. The 2004 deferred compensation costs represented the intrinsic value

of options granted to purchase shares of our stock to newly appointed members of our board of directors that had an exercise price less than the fair market value of our common stock on the date of the option grant. This deferred compensation cost will be amortized over the vesting period of 36 months using the graded vesting method.

During the years ended December 31, 2005, 2004, and 2003, we recorded stock compensation expenses of $36,000, $68,000, and $459,000, respectively, of which $0, $50,000 and $211,000, respectively, was attributable to the excess of the fair market value of our common stock over the price at which we granted stock options to employees. In 2005 and 2004, we incurred $36,000 and $5,000, respectively, of stock compensation expenses related to the issuance of options to purchase our stock to newly appointed members of our board of directors that had an exercise price less than the fair market value of our stock on the date of the option grant. Stock compensation expenses in 2004 and 2003 also included $13,000 and $227,000, respectively, for amortization of deferred compensation cost attributable to the fair market value of shares of our common stock issued to certain employees of ATMOS. We also incurred $21,000 of stock compensation expense in 2003 due to modification of our 2000 employee stock option held by a former member of our board of directors.

Deferred compensation expense is being amortized using the graded vesting method over the vesting period of each respective option, generally four years. The accelerated amortization results in expensing approximately 52% of the total award in the first year, 27% in the second year, 15% in the third year and 6% in the fourth year.

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R) which will become effective beginning in the first quarter of 2006. SFAS 123R will result in the recognition of substantial compensation expense relating to our employee stock options and employee stock purchase plans. We currently use the intrinsic value method to measure compensation expense for stock-based awards to its employees. Under this standard, we generally do not recognize any compensation related to stock option grants under our stock option plans or related to the discounts provided under our employee stock purchase plans. Under the new rules however, we will be required to adopt a fair-value-based method for measuring the compensation expense related to employee stock awards. We estimate the impact of adopting SFAS No. 123R will have an earnings impact of approximately nine to ten cents per share in 2006, based on estimated compensation expense from unvested options outstanding as of the end of December 31, 2005. Compensation expense calculated upon adoption of SFAS No. 123R for future grants may differ from pro-forma amounts currently disclosed in our footnotes based on changes in the fair value of our common stock, the treatment of tax benefits, different assumptions and treatment of forfeitures under SFAS No. 123R, and changes in interest rates or other factors. We are currently considering our method of adoption, modified prospective approach or modified retrospective approach.

Provision for Income Taxes. Provisions (benefit) for income taxes of approximately ($11,000), $26,000, and $279,000, were recorded in 2005, 2004, and 2003, respectively. The effective income tax rate was (0.4%) for 2005, 1.4% for 2004, and 10% for 2003. As of December 31, 2005, we had net operating loss carryforwards of approximately $9.4 million for federal tax purposes, approximately $6.9 million for state tax purposes and Canadian loss and research and development pool carryforwards of approximately $12.1 million that we expect to be available to reduce future income tax liabilities to the extent permitted under federal, Canadian and applicable state income tax laws. The net operating loss carryforwards expire from 2008 to 2025. The decrease in our effective tax rate in 2005 was mainly due to a state income tax refund received in 2005 as a result of an amended 2001 California income tax return. In 2006, we anticipate that our effective income tax rate will be less than the federal statutory tax rate but higher than the 2005 effective income tax rate.

Liquidity and Capital Resources

As of December 31, 2005, we had cash and cash equivalents of $9.2 million, short-term investments and auction rate securities of $59.5 million and long-term investments of $17.3 million resulting in a total balance of cash, cash equivalents, and investments of $86.0 million. As of the same date, we had total working capital of $68.2 million. As of December 31, 2004, we had cash and cash equivalents of $31.7 million, short-term investments and auction rate securities of $30.6 million and long-term investments of $24.6 million resulting in a total balance of cash, cash equivalents, and investments of $86.9 million. In July 2001, we completed the sale of a total of 5,750,000 shares of common stock in our initial public offering. We realized total net proceeds of approximately $51.6 million upon the close of the IPO, which proceeds have not been used to fund our operations to date. Our primary capital requirements are to fund working capital needs. We believe that our current focus on licensing and royalty revenues with reduced levels of memory chip sales has generally enabled us to steadily improve our liquidity.

Net cash provided by (used in) operating activities was ($1.3) million, $2.7 million, and $4.7 million for the years ended 2005, 2004 and 2003, respectively. In 2005, net cash used in operating activities consisted primarily of net loss of $3.0 million offset by a non-cash charge of $614,000 for depreciation and amortization and higher deferred revenue of $808,000 in 2005. In addition, net cash used in operating activities in 2005 included tax benefits associated with the exercise of stock options of $482,000, which was recorded under additional paid in capital. In 2004, net cash provided by operating activities consisted primarily of net loss of $1.9 million offset by a non-cash charge of $1.5 million for depreciation and amortization, reduced unbilled contract receivables of $1.0 million, and prepaid expenses and other assets of $858,000, which included a reduction in deferred tax assets in 2004. In addition, net cash provided by operating activities in 2004 included restructuring related liabilities of $429,000. In 2003, net cash provided by operating activities was principally represented by our net profit of $2.5 million plus a non-cash charge of $2.0 million for depreciation and amortization, although deferred revenue associated with cash receipts in excess of recognized revenue declined by $1.3 million.

Net cash provided by (used in) investing activities was approximately ($22.8) million, $7.9 million, and ($10.8) million for the years ended 2005, 2004 and 2003, respectively. Aside from investing in marketable securities, we added $1.1 million of property and equipment in 2005 primarily due to leasehold improvements related to our new office lease for our U.S. corporate headquarters beginning in June 2005, new testing equipment and engineering design software. We purchased $349,000 and $493,000 of property and equipment in 2004 and 2003, respectively, consisting principally of engineering design software.

Net cash provided by (used in) financing activities was approximately $1.5 million, ($982,000), and $1.8 million for the years ended 2005, 2004 and 2003, respectively. In 2005, we received proceeds in the amount of $1.5 million from the exercise of employee options to purchase common stock. On April 29, 2005, we announced a repurchase program for up to $20 million of outstanding common stock over the next 12 months. However, no repurchases were made in 2005. In 2004, the major financing use of cash was $4.7 million for the repurchase of 1.2 million shares of common stock. We received proceeds in the amount of $3.7 million from the exercise of employee options to purchase common stock during 2004. Cash received upon the issuance of common stock in connection with the exercise of options totaled $1.9 million in 2003.

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

· level and timing of licensing and royalty revenues;

· cost, timing and success of technology development efforts;

· market acceptance of our existing and future technologies and products;

· competing technological and market developments;

· cost of maintaining and enforcing patent claims and intellectual property rights;

· variations in manufacturing yields, materials costs and other manufacturing risks;

· costs of acquiring other businesses and integrating the acquired operations;

· profitability of our business; and

· litigation expenses.

We expect that existing cash, and equivalents, short-term and long-term investments along with our existing capital and cash generated from operations, if any, will be sufficient to meet our capital requirements for the foreseeable future. We expect that a licensing business such as ours generally will require less cash to support operations after multiple licensees begin to ship products and pay royalties.

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

Lease Commitments and Off Balance Sheet Financing

The impact that our contractual obligations as of December 31, 2005 are expected to have on our liquidity and cash flow in future periods is as follows:

	Payment Due by Period
	Total		Less than 1 year			1-3 years			4-5 years			Over 5 years
Minimum Lease Commitments	$	2,796		$	870		$	1,367		$	559		$	—
Sublease Income	384			201			183			—			—
Net Lease Commitments	$	2,412		$	669		$	1,184		$	559		$	—

The Company did not have any unconditional purchase obligations as of December 31, 2005.

Recent Accounting Pronouncements

See Note 1 of the Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

Item 7A. Quantitative and Qualitative Discussion of Market Interest Rate Risk

Our investment portfolio consists of money market funds, corporate-backed debt obligations and mortgage-backed government obligations generally due within one year. Our primary objective with investment portfolio is to invest available cash while preserving principal and meeting liquidity needs. In accordance with our investment policy, we place investments with high credit quality issuers and limit the amount of credit exposure to any one issuer. These securities, which approximate $76.8 million as of December 31, 2005, and have an average interest rate of approximately 3.00%, are subject to interest rate risks. As of December 31, 2005, our portfolio had unrealized losses of approximately $389,000 as a result of rising interest rates. We believe these losses are temporary and expect to hold these investments to maturity. However, based on the investment portfolio contents and our ability to hold these investments

until maturity, we believe that if a significant change in interest rates were to occur, it would not have a material effect on our financial condition.

Item 8. Financial Statements and Supplementary Data

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

Quarterly Results of Operations

The following tables set forth unaudited results of operations data for the eight quarters ended December 31, 2005. This unaudited information has been prepared on a basis consistent with our audited financial statements appearing elsewhere in this report and, in the opinion of our management, includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information for the periods presented. The unaudited quarterly information should be read in conjunction with the financial statements and notes included elsewhere in this report. For a discussion of charges and other income pertaining to the aborted acquisition of our company by Synopsys, Inc. and restructuring charges associated with the closing of our ATMOS research and development operation, which significantly affected the last three quarters of 2004, refer to Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations.”

Dec. 31,

Sep. 30,

Jun. 30,

Mar. 31,

Dec. 31,

Sep. 30,

Jun. 30,

Mar. 31,

2005

2004

(In thousands, except per share data)

(Unaudited—All periods)

Net revenue:

Product	$	—		$	—		$	6		$	4		$	33		$	76		$	681		$	162
Licensing	1,339			3,233			1,940			1,213			118			128			1,310			2,988
Royalty	1,063			897			1,121			1,466			1,069			1,488			1,415			1,353
Total net revenue	2,402			4,130			3,067			2,683			1,220			1,692			3,406			4,503
Cost of net revenue
Product	—			—			—			—			25			86			394			150
Licensing	243			668			609			466			519			236			483			375
Total cost of net revenue	243			668			609			466			544			322			877			525
Gross profit	2,159			3,462			2,458			2,217			676			1,370			2,529			3,978
Operating expenses:
Research and development	1,557			1,359			1,320			1,603			1,728			2,174			1,968			2,226
Selling, general and administrative	2,519			2,721			2,206			2,476			1,355			3,949			5,263			2,764
Restructuring expenses	5			—			114			—			585			—			—			—
Total operating expenses	4,081			4,080			3,640			4,079			3,668			6,123			7,231			4,990
Operating income (loss)	(1,922		)	(618		)	(1,182		)	(1,862		)	(2,992		)	(4,753		)	(4,702		)	(1,012		)
Interest and other income	794			679			605			513			550			10,398			269			361
Income (loss) before income taxes	(1,128		)	61			(577		)	(1,349		)	(2,442		)	5,645			(4,433		)	(651		)
Income tax benefit (provision)	44			(11		)	(2		)	(20		)	31			(565		)	378			130
Net income (loss)	$	(1,084	)	$	50		$	(579	)	$	(1,369	)	$	(2,411	)	$	5,080		$	(4,055	)	$	(521	)
Net income (loss) per share:
Basic	$	(0.04	)	$	—		$	(0.02	)	$	(0.04	)	$	(0.08	)	$	0.16		$	(0.13	)	$	(0.02	)
Diluted	$	(0.04	)	$	—		$	(0.02	)	$	(0.04	)	$	(0.08	)	$	0.15		$	(0.13	)	$	(0.02	)
Shares used in computing net income (loss) per share:
Basic	30,698			30,531			30,465			30,442			30,296			31,074			30,786			30,845
Diluted	30,698			31,504			30,465			30,442			30,296			33,350			30,786			30,845

In the third quarter of 2004, interest and other income included a $10 million termination fee paid by Synopsys related to an aborted acquisition.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

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

Monolithic System Technology, Inc.’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls. Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, and principal accounting officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2005.

BDO Seidman, LLP, the independent registered public accounting firm that audited the 2005 consolidated financial statements included in this Annual Report on Form 10-K, has also audited management’s assessment of our internal control over financial reporting and the effectiveness of our internal control over financial reporting as of December 31, 2005, as stated in their report which is included elsewhere herein.

(b) Evaluation of disclosure controls and procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, and principal accounting officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Based on this evaluation, our management concluded that as of December 31, 2005, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our reports filed with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to our management including our Chief Executive Officer and our principal accounting officer, as appropriate to allow timely decisions regarding required disclosure.

There was no change in the internal control over financial reporting during the fourth fiscal quarter of 2005 that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.

Item 9B. Other Information

None.

Part III

Item 10. Directors and Executive Officers of the Registrant

Information regarding our directors is incorporated by reference from the sections titled “Management” and “Section 16(A) Beneficial Ownership Reporting Compliance” in the Registrant’s Proxy Statement for its 2006 Annual Meeting of Stockholders. Information regarding current executive officers found under the heading “Executive Officers” in Item 1 of Part I hereof is also incorporated by reference into this Item 10.

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

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

Item 11. Executive Compensation

The response to this item is incorporated by reference from the section titled “Executive Compensation”, but not from the Sections titled “Executive Compensation—Performance Graph” and “Executive Compensation—Report on Executive Compensation by the Compensation Committee of the Board of Directors”, in the Registrant’s Proxy Statement for its 2006 Annual Meeting of Stockholders.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The response to this item is incorporated by reference from the sections titled “Share Ownership of Certain Beneficial Owners and Management and “Securities Authorized for Issuance Under Equity Compensation Plans” in the Registrant’s Proxy Statement for its 2006 Annual Meeting of Stockholders.

Item 13. Certain Relationships and Related Transactions

The response to this item is incorporated by reference from the section titled “Certain Relationships and Related Transactions” in the Registrant’s Proxy Statement for its 2006 Annual Meeting of Stockholders.

Item 14. Principal Accountant Fees and Services

The response to this item is incorporated by reference from the section titled “Ratification of Independent Registered Public Accounting Firm for 2006” in the Registrant’s Proxy Statement for its 2006 Annual Meeting of Stockholders.

Part IV

Item 15. Exhibits and Financial Statement Schedules

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

(1) Financial Statements and Reports of Independent Registered Public Accounting Firm, which are set forth in the index to Consolidated Financial Statements on pages 48 through 79 of this report.

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

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

(3) Exhibits

2.1(1)		Merger Agreement regarding the Registrant’s reincorporation in Delaware
2.2(4)		Share Purchase Agreement for the shares for ATMOS Corporation
2.3(5)		Agreement and Plan of Reorganization, dated February 23, 2004, among Synopsys, Inc., Mountain Acquisition Sub, Inc., a wholly owned subsidiary of Synopsys, Inc., and Monolithic System Technology, Inc.—Terminated agreement.
2.4(6)		Form of Stockholder Agreement, dated February 23, 2004, among Synopsys, Inc., Mountain Acquisition Sub, Inc., a wholly owned subsidiary of Synopsys, Inc., and the stockholder of Monolithic System Technology, Inc.—Terminated agreement.
3.1		Not currently in use
3.2		Not currently in use
3.3(1)		Restated Certificate of Incorporation of the Registrant
3.4(1)		Bylaws of the Registrant
4.1(1)		Specimen common stock certificate
4.2(1)		Not currently in use
4.3(1)		Rights Agreement
4.3.1(7)		First Amendment to Rights Agreement, dated as of February 23, 2004.
4.3.2(8)		Second Amendment to Rights Agreement, dated as of December 14, 2004.
10.1(1)		Form of Indemnity Agreement between the Registrant and each of its directors and executive officers
10.2(1)		Not currently in use
10.3(1)		1996 Stock Plan and form of Option Agreement thereunder
10.4(1)		Form of Restricted Stock Purchase Agreement
10.5(1)		2000 Employee Stock Option Plan and form of Option Agreement thereunder
10.5.1(9)		Amended and Restated 2000 Equity Incentive and Stock Option Plan
10.6(1)		2000 Employee Stock Purchase Plan and form of Subscription Agreement thereunder
10.7(1)		Not currently in use
10.8(1)		Not currently in use
10.9(1)		Agreement between Nintendo Co., Ltd. and the Registrant dated August 31, 1999
10.10(1)		License Agreement between NEC Corporation and the Registrant dated January 31, 1999
10.11(1)(2)		License Agreement between NEC Corporation and the Registrant dated December 17, 1999
10.12(1)		Not currently in use

10.13(10)		Employment offer letter agreement and Mutual Agreement to Arbitrate between the Registrant and Chester J. Silvestri dated July 21, 2005
10.14(10)		Change-in-Control Agreement between the Registrant and Chester J. Silvestri dated as of July 21, 2005
10.15(10)		Form of Stock Option Agreement pursuant to Amended and Restated 2000 Stock Option and Equity Incentive Plan
10.16		Lease Agreement between Registrant and Sunnyvale Mathilda Investors, LLC dated as of May 6, 2005
10.17		Employment offer letter agreement between the Registrant and Dhaval Ajmera dated October 3, 2005
21.1		List of subsidiaries
23.1		Consent of Independent Registered Public Accounting Firm—BDO Seidman LLP
23.2		Consent of Independent Registered Public Accounting Firm—Ernst and Young LLP
24.1(3)		Power of Attorney
31.1		Rule 13a-14 certification
31.2		Rule 13a-14 certification
32		Section 1350 certification

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

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

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

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

(5) Incorporated by reference to Exhibit 2.1 of the Current Report on Form 8-K filed by Synopsys, Inc. on February 26, 2004, (Commission File No. 000-19807).

(6) Incorporated by reference to Exhibit 2.2 of the Current Report on Form 8-K filed by Synopsys, Inc. on February 26, 2004. (Commission File No. 000-19807).

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

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

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

(10) Incorporated by reference to the same-numbered exhibit to Form 10-Q filed by the Company on August 9, 2005.

MONOLITHIC SYSTEM TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

	Year Ended December 31,
	2005			2004			2003
Net revenue:
Product	$	10		$	952		$	1,904
Licensing	7,725			4,544			10,418
Royalty	4,547			5,325			6,911
Total net revenue	12,282			10,821			19,233
Cost of net revenue
Product	—			655			1,217
Licensing	1,986			1,613			1,970
Total cost of net revenue	1,986			2,268			3,187
Gross profit	10,296			8,553			16,046
Operating expenses:
Research and development	5,839			8,096			8,741
Selling, general and administrative	9,922			13,331			6,432
Restructuring expenses	119			585			—
Total operating expenses	15,880			22,012			15,173
Income (loss) from operations	(5,584		)	(13,459		)	873
Interest and other income	2,591			11,578			1,914
Income (loss) before income taxes	(2,993		)	(1,881		)	2,787
Income tax benefit (provision)	11			(26		)	(279		)
Net income (loss)	$	(2,982	)	$	(1,907	)	$	2,508
Net income (loss) per share:
Basic	$	(0.10	)	$	(0.06	)	$	0.08
Diluted	$	(0.10	)	$	(0.06	)	$	0.08
Shares used in computing net income (loss) per share:
Basic	30,534			30,750			30,504
Diluted	30,534			30,750			30,998
Allocation of stock-based compensation to operating expenses
Research and development	$	—		$	44		$	148
Selling, general and administrative	36			24			311
	$	36		$	68		$	459

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

MONOLITHIC SYSTEM TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)

														Accumulated				Retained
							Additional			Deferred				Other				Earnings
	Common Stock						Paid-In			Stock-Based				Comprehensive				(Accumulated
	Shares		Amount				Capital			Compensation				Income (Loss)				Deficit)				Total
Balance at December 31,2002	30,230			$	302		$	97,796			$	(1,064	)		$	116			$	1,547		$	98,697
Issuance of Common Stock upon exercise of options	439			5			1,460				—				—				—			1,465
Issuance of Common Stock for Employee Stock Purchase Plan	55			—			442				—				—				—			442
Amortization of deferred stock-based compensation and other change in employee status	—			—			21				438				—				—			459
Other comprehensive income—unrealized loss on available-for-sale investments	—			—			—				—				(60		)		—			(60		)
Net income	—			—			—				—				—				2,508			2,508
Comprehensive income																						2,448
Balance at December 31,2003	30,724			307			99,719				(626		)		56				4,055			103,511
Issuance of Common Stock upon exercise of options	688			7			3,226				—				—				—			3,233
Issuance of Common Stock for Employee Stock Purchase Plan	66			1			463				—				—				—			464
Repurchase and Retirement of Common Stock	(1,182	)		(12		)	(4,641		)		—				—				—			(4,653		)
Amortization of deferred stock-based compensation and other change in employee status	—			—			(489		)		557				—				—			68
Other comprehensive income—unrealized loss on available-for-sale investments	—			—			—				—				(308		)		—			(308		)
Net income (loss)	—			—			—				—				—				(1,907		)	(1,907		)
Comprehensive income (loss)																						(2,215		)
Balance at December 31,2004	30,296			303			98,278				(69		)		(252		)		2,148			100,408
Issuance of Common Stock upon exercise of options	406			4			1,205				—				—				—			1,209
Issuance of Common Stock for Employee Stock Purchase Plan	66			1			315				—				—				—			316
Amortization of deferred stock-based compensation	—			—			—				36				—				—			36
Tax benefits associated with exercise of stock options	—			—			482				—				—				—			482
Other comprehensive income—unrealized loss on available-for-sale investments	—			—			—				—				(137		)		—			(137		)
Net income (loss)	—			—			—				—				—				(2,982		)	(2,982		)
Comprehensive income (loss)																						(3,119		)
Balance at December 31,2005	30,768			$	308		$	100,280			$	(33	)		$	(389	)		$	(834	)	$	99,332

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

MONOLITHIC SYSTEM TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

	Year Ended December 31,
	2005			2004			2003
Cash flows from operating activities:
Net income (loss)	$	(2,982	)	$	(1,907	)	$	2,508
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for doubtful accounts	105			—			—
Depreciation and amortization	614			1,460			2,049
Amortization of deferred stock-based compensation	36			68			459
Changes in current assets and liabilities:
Accounts receivable	382			(98		)	(84		)
Unbilled contract receivable	(311		)	1,049			(413		)
Inventories	—			474			563
Prepaid expenses and other assets	765			858			570
Deferred revenue	808			(5		)	(1,273		)
Accounts payable	116			4			(16		)
Accrued expenses and other liabilities	(657		)	391			365
Restructuring liability	(136		)	429			—
Net cash provided by (used in) operating activities	(1,260		)	2,723			4,728
Cash flows from investing activities:
Purchase of property and equipment	(1,051		)	(349		)	(493		)
Proceeds from sales and maturity of marketable securities	225,879			469,336			258,752
Purchase of marketable securities	(247,636		)	(461,047		)	(269,094		)
Net cash provided by (used in) investing activities	(22,808		)	7,940			(10,835		)
Cash flows from financing activities:
Payment of capital lease obligations	—			(26		)	(88		)
Proceeds from issuance of common stock	1,525			3,697			1,907
Repurchase and retirement of common stock	—			(4,653		)	—
Net cash provided by (used in) financing activities	1,525			(982		)	1,819
Net increase (decrease) in cash and cash equivalents	(22,543		)	9,681			(4,288		)
Cash and cash equivalents at beginning of year	31,714			22,033			26,321
Cash and cash equivalents at end of year	$	9,171		$	31,714		$	22,033
Supplemental disclosure:
Cash paid for income taxes	$	29		$	24		$	394

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

MONOLITHIC SYSTEM TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1: The Company and Summary of Significant Accounting Policies

The Company

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

The Company has developed an innovative embedded-memory technology, called 1T-SRAM, which the Company licenses on a non-exclusive and worldwide basis to semiconductor companies and electronic product manufacturers. From its inception in 1991 through 1998, the Company focused primarily on the sale of stand-alone memory products. In the fourth quarter of 1998, the Company changed the emphasis of its business model to focus primarily on the licensing of its 1T-SRAM technologies and completed this transition in 2002 when a majority of the Company’s revenues were derived from licensing and royalty of its 1T-SRAM technologies. In the second quarter of 2004, the Company notified its customers of its decision to discontinue sales of its memory chip products and only license its technology.

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. The Company reports financial results on a calendar fiscal year.

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues under the percentage of completion and expenses during the reported period. Actual results could differ from those estimates.

Foreign Currency Translation

The Company has foreign offices located in Korea, Japan and France, which are operated by subsidiaries of the Company. The functional currency of the Company’s foreign entities is the U.S. dollar. Accordingly, the financial statements of these entities are remeasured into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52, “Foreign Currency Translation.” Exchange gains or losses from remeasurement of monetary assets and liabilities that are not denominated in U.S. dollar were not material for any period presented and are included in the consolidated statements of operations.

Cash Equivalents, Short-term and Long-term Investments

The Company accounts for investments in accordance with Statement of Financial Accounting Standards No. 115 “Accounting for Certain Investments in Debt and Equity Securities”. Management determines the appropriate classification of debt securities at the time of purchase. All securities are classified as available-for-sale. The Company’s short-term and long-term investments are carried at fair value, based on quoted market prices, with the unrealized holding gains and losses reported in stockholders’ equity. The Company evaluates declines in market value for potential impairment if the

decline results in a value below cost and is determined to be other than temporary. Realized gains and losses and declines in the value judged to be other-than-temporary are included in interest income. The cost of securities sold is based on the specific identification method.

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

Allowance for Doubtful Accounts.

The Company determines its allowance for doubtful accounts to ensure its trade receivables balances are not overstated due to uncollectibility. The Company performs ongoing customer credit evaluation within the context of the industry in which it operates. A specific allowance of up to 100% of the invoice value will be provided for any problematic customer balances. Delinquent account balances are written off after management has determined that the likelihood of collection is not possible. As of December 31, 2005, the Company reported a balance of $105,000 in its allowance for doubtful accounts. There was no balance of allowance for doubtful accounts in 2004.

Unbilled Contract Receivable

Under the percentage of completion method, if the amount of revenue recognized exceeds the amount of billings to a customer; the excess amount is carried as an unbilled contract receivable. The Company has recorded $368,000 and $57,000 of unbilled contract receivable as of December 31, 2005 and 2004, respectively.

Property and Equipment

Property and equipment are stated at cost. Depreciation is generally computed using the straight-line method over the estimated useful lives of the assets, generally three years. During the year, the Company wrote off approximately $9.4 million of fully depreciated assets. Depreciation and amortization expense for the years ended December 31, 2005, 2004 and 2003 was $614,000, $1.5 million, and $2.0 million, respectively.

	December 31,
	2005			2004
Property and equipment:
Equipment, furniture and fixtures	$	1,364		$	5,638
Acquired software	836			4,888
	2,200			10,526
Less: Accumulated depreciation	(1,079		)	(9,841		)
	$	1,121		$	685

Valuation of Long-lived Assets

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

Goodwill

The Company reviews goodwill, recorded from the acquisition of ATMOS Corp. on August 2002, for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable in accordance with the Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” The provisions of SFAS No. 142 require that a two-step impairment test be performed on goodwill. In the first step, the Company compares the fair value of each reporting unit to its carrying value. Subsequent to the acquisition of ATMOS, its business became integrated part of the Company’s operations. In 2004, the Company closed the operation of ATMOS as its Canadian research and development facility. Using the guidance in SFAS No. 142, the Company determined that it has only one reporting unit at the entity level. For step one, the Company determines the fair value of its reporting unit using the market approach. Under the market approach, the Company estimates the fair value based on the market value of the reporting unit at the entity level. If the fair value of the reporting unit exceeds the carrying value of net assets to the reporting unit, goodwill is not impaired and the Company is not required to perform further testing. If the carrying value of the net assets to the reporting unit exceeds the fair value of the reporting unit, then the Company must perform the second step in order to determine the implied fair value of the reporting unit’s goodwill and compare it to the carrying value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then the Company must record an impairment loss equal to the difference. The Company performs its annual impairment test during the third quarter of each year and at times impairment indicators are noted. The Company performed the annual impairment test during the third quarter of 2005 and the test did not indicate impairment of goodwill as of September 30, 2005. As of December 31, 2005, the Company found no indicators of potential impairment.

Revenue Recognition

Licensing

Licensing revenue consists of fees earned for engineering development and engineering support services. All contracts the Company has entered into to date require the Company to develop a design that meets a licensee’s specifications. In accordance with SOP 81-1 “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”, when license agreements include deliverables that require “significant production, modification or customization”, contract accounting is applied. When the Company has significant experience in meeting the design specification involved in the contract and the direct labor hours related to services under the contract can be reasonably estimated, the Company recognizes revenue over the period in which the contract services are performed. For these arrangements, the Company recognizes revenue using the percentage of completion method. Revenues are only recognized when collection is probable. The direct labor hours for the development of the licensee’s design are estimated at the beginning of the contract. As these direct labor hours are incurred, they are used as a measure of progress towards completion. The Company has the ability to reasonably estimate the direct labor hours on a contract-by-contract basis based on its experience in developing prior licensees’ designs. The Company periodically evaluates the actual status of each project to ensure that the estimates to complete each contract remain accurate and updates its estimated costs to complete as necessary. Under the percentage of completion method, provisions for estimated losses on uncompleted contracts are recognized in the period in which the likelihood of such losses is determined. Revenue recognized in any period is dependent on the Company’s progress toward completion of projects in progress. Significant management judgment and discretion are used to estimate total direct labor hours. Any changes in or deviation from these estimates could have a material effect on the amount of revenue the Company recognizes in any period. If inherent risks make estimates doubtful, the contract is accounted for under the completed contract method. Completion of the contract is based on the production of integrated circuit devices that have been validated by the customer.

Prior to 2005, the Company recorded deferred revenue when cash was received. However, the terms of the license contracts allow the Company to bill customers upon achieving the milestones stated in the contracts. The Company believes that now it has adequate history and experience in fulfilling licensing contract obligations to its customers and collecting payments from them. Therefore, starting in 2005, the Company began recording accounts receivable and deferred revenue at the time of billing. This change had no impact on the statement of operations, or net cash provided by (used in) operations, investing, or financing activities in the statement of cash flows. The December 31, 2004 accounts receivable and deferred revenue amounts are presented by reducing both accounts receivable and deferred revenue by $871,000, consistent with the presentation used in 2004.

For contracts involving design specifications that the Company has not previously met, the Company defers the recognition of all revenue until the design meets the contractual design specifications and expenses the cost of revenue as incurred. When the Company has experience in meeting design specifications but does not have significant experience to reasonably estimate the cost of services to meet a design specification, the Company defers both the recognition of revenue and the cost. For these arrangements, the Company recognizes revenue using the completed contract method. In 2005 and 2004, none of the Company’s license revenue was recognized under the completed contract method.

The Company also provides support and maintenance. Under these arrangements, the Company provides unspecified upgrades, design rule changes and technical support. No other upgrades, products or other post-contract support are provided. When the Company provides a combination of services related to licensing and support and maintenance to customers, in addition to the considerations noted above, the Company evaluates the arrangements under EITF 00-21, “Revenue Arrangements with Multiple Deliverables”. Specifically, the Company analyzes the separate elements to determine if vendor specific objective evidence, or VSOE, exists for the undelivered elements. The Company believes it has established VSOE for its support and maintenance arrangements. These arrangements are renewable annually by the customer. Support and maintenance revenue is recognized at its fair value ratably over the period during which the obligation exists, typically 12 months. The fair value of any support and maintenance obligation is established based on the specified renewal rate for such support and maintenance. Revenue from support and maintenance service represented $512,000 and $60,000 in 2005 and 2004, respectively, and was included in licensing revenue in the statement of operations.

From time to time, a licensee may cancel a project during the development phase. Such a cancellation is not within the Company’s control and is often caused by changes in market conditions or the licensee’s business. Cancellations of this nature are an aspect of the Company’s licensing business, and, in general license contracts signed since the beginning of 2002 allow the Company to retain all payments that the Company has received or is entitled to collect for items and services provided before the cancellation occurs. Typically under our agreements, the licensee is obligated to complete the project within a stated timeframe, including assisting us in completing the final milestone, and if the Company performs the contracted services, is obligated to pay the license fees even if the licensee fails to complete verification or cancels the project prior to completion. The Company will consider a project to have been canceled even in the absence of specific notice from its licensee, if there has been no activity under the contract for a significant period, and the Company believes that completion of the contract is unlikely. In this event, the Company recognizes revenue in the amount of cash received, if the Company has performed a sufficient portion of the development services. If a cancelled contract had been entered into before the establishment of technological feasibility, the costs associated with the contract would have been expensed prior to the recognition of revenue. In that case, there would be no costs associated with that revenue recognition, and gross margin would increase for the corresponding period. In 2005, the Company recognized $240,000 of licensing revenue from cancelled contracts, compared to none in 2004 and $759,000 in 2003.

Royalty

Licensing contracts provide also for royalty payments at a stated rate and require licensees to report the manufacture or sale of products that include the Company’s technology after the end of the quarter in which the sale or manufacture occurs. The Company recognizes royalties in the quarter in which the Company receives the licensee’s report. Generally, royalty payments are made by the licensees at about the same time as the Company receives their reports. The Company recognized no royalty revenue from terminated contracts in 2005 and 2004, compared to $713,000 in 2003.

Product

Revenue from product sales is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed or determinable, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations. For each of the periods presented, there were no formal acceptance provisions with the Company’s end customers. During 2004, we phased out sales of our proprietary 1T-SRAM memory chips. The Company does not expect to sell memory chips in the future.

Cost of Revenue

Licensing

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

· If licensing revenue is recognized using the percentage of completion method, the associated cost of licensing revenue is recognized in the period in which we incur the engineering costs.

· If licensing revenue is recognized using the completed contract method, and to the extent that the amount of engineering cost does not exceed the amount of the related licensing revenue, this cost is deferred on a contract-by-contract basis from the time we have established technological feasibility of the product to be developed under the license. Technological feasibility is established when we have completed all activities necessary to demonstrate that the licensee’s product can be produced to meet the performance specifications when incorporating our technology. Deferred costs are charged to cost of licensing revenue when the related revenue is recognized.

· For contracts entered into prior to establishing technological feasibility, we do not defer related development costs, but rather expense them in the period in which they are incurred. Consequently, upon completion of these contracts, we recognize the related revenues without any corresponding costs.

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

Royalty

There are no reported costs associated with royalty revenue.

Product

Cost of product revenue consists primarily of costs associated with the manufacture, assembly and testing of the Company’s memory chip products by independent, third-party contractors. There were no

reported costs associated with product revenue in 2005 as the products were sold from the inventory previously written off.

Research and Development

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

Stock-based Compensation

The Company accounts for stock-based compensation arrangements in accordance with the provisions of APB No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees” and complies with the disclosure provisions of Statement of Financial Accounting Standard No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation.” Under APB No. 25, compensation cost is, in general, recognized based on the excess, if any, of the fair market value of the Company’s stock on the date of grant over the amount an employee must pay to acquire the stock. Equity instruments issued to non-employees are accounted for in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force 96-18. Deferred stock-based compensation is being amortized using the graded vesting method over the vesting period of each respective option, which is generally four years.

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

	Year Ended December 31,
	2005			2004			2003
Net income (loss):
As reported	$	(2,982	)	$	(1,907	)	$	2,508
Add: stock-based compensation expense reported in consolidated statements of operations, net of related tax effects	36			68			459
Less: stock compensation related to stock awards assumed during the ATMOS acquisition, net of related tax effects							(248		)
Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects	(6,046		)	(4,434		)	(4,537		)
	$	(8,992	)	$	(6,273	)	$	(1,818	)
Earnings (losses) per share:
Basic—as reported	$	(0.10	)	$	(0.06	)	$	0.08
Basic—pro forma	$	(0.29	)	$	(0.20	)	$	(0.06	)

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

	Year Ended December 31,
Employee stock options	2005		2004		2003
Expected life (in years)	4.0 - 5.0		5.0		5.0
Risk-free interest rate	3.7% - 4.5	%	3.2% - 3.7	%	2.1% - 3.6	%
Volatility	56.7	%	81.5	%	75.9	%
Dividend yield	0	%	0	%	0	%

Employee stock purchase plan shares	2005		2004		2003
Expected life (in years)	1.0		1.0		1.0
Risk-free interest rate	2.8% - 3.5	%	1.2% - 2.2	%	1.1% - 1.4	%
Volatility	44.0	%	80.3	%	69.9	%
Dividend yield	0	%	0	%	0	%

The Company selected the Black-Scholes option valuation model, which is one of the permitted methods to estimate the fair market value of options under SFAS No. 123. The weighted average fair value of options granted during 2005, 2004 and 2003 was $3.38, $4.08, and $4.97, respectively. The weighted average estimated fair value of shares granted under the employee stock purchase plan during 2005, 2004 and 2003 was $2.22, $2.95 and $4.21, respectively. On December 14, 2005, the Company fully accelerated the vesting of all outstanding stock options that have an exercise price greater than or equal to $7.42 and were granted before April 19, 2004, pursuant to the authorization of the Compensation Committee of the board of directors. As a result of this option vesting acceleration, approximately $1.1 million of additional stock-based compensation expense was included in the pro forma stock-based compensation expense of $6.0 million in 2005 under SFAS No. 123.

Per Share Amounts

Basic net income (loss) per share is computed by dividing net income (loss) for the period by the weighted-average number of shares of common stock outstanding during the period. Diluted net income per share for the year ended December 31, 2003 was computed by dividing the net income for the period by the weighted average number of common and potential common equivalent shares outstanding during the period. Potential common shares are composed of incremental shares of common stock issuable upon the exercise of stock options or warrants. Diluted net loss per share for the years ended December 31, 2005 and 2004 are the same as basic net loss per share for the same period because the impact of including potential common shares is anti-dilutive. For the years ended December 31, 2005 and 2004, stock options to purchase 1.4 and 1.3 million shares with exercise prices greater than the average market prices of common stock were excluded from computation of diluted net loss per share as their inclusion would be anti-dilutive. The following table sets forth the computation of basic and diluted net income per share for the periods indicated (in thousands, except per share amounts):

	Year Ended December 31,
	2005			2004			2003
Numerator:
Net income (loss)	$	(2,982	)	$	(1,907	)	$	2,508
Denominator:
Shares used in computing net income (loss) per share:
Basic	30,534			30,750			30,504
Employee stock options and unvested common stock outstanding							494
Diluted	30,534			30,750			30,998
Net income (loss) per share:
Basic	$	(0.10	)	$	(0.06	)	$	0.08
Diluted	$	(0.10	)	$	(0.06	)	$	0.08

Income Taxes

The Company accounts for income taxes using the asset and liability method as prescribed by Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS 109”). Under the asset and liability method, the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities are recognized as deferred tax assets and liabilities. A valuation allowance is established for any deferred tax assets for which realization is more likely than not that all or a portion of the deferred tax assets will not be realized.

Comprehensive Income (Loss)

Statement of Financial Accounting Standards No. 130 “Reporting Comprehensive Income” (“SFAS No. 130”) requires the Company to display comprehensive income and its components as part of the

financial statements. The Company’s only component of comprehensive income (loss) is unrealized gains and losses on available for sale securities. Accumulated other comprehensive income (loss) as of December 31, 2005, 2004 and 2003 was ($389,000), ($252,000) and $56,000, respectively. The changes in other comprehensive income (loss) were as follows, for the years ended December 31, 2005, 2004, and 2003:

	2005			2004			2003
	(in thousands)
Net income (loss)	$	(2,982	)	$	(1,907	)	$	2,508
Net unrealized loss on available-for-sale securities:
Change in net unrealized loss	(137		)	(308		)	(60		)
Comprehensive income (loss)	$	(3,119	)	$	(2,215	)	$	2,448

Segment Reporting

Financial Accounting Standards Board Statement No. 131, “Disclosure about Segments of an Enterprise and Related Information” (“SFAS No. 131”) requires that companies report separately in the financial statements certain financial and descriptive information about operating segment profit or loss, certain specific revenue and expense items and segment assets. The Company operates in one segment, using one measurement of profitability for its business. The Company has sales outside the United States that are described in Note 9. The vast majority of long-lived assets are maintained in the United States.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R) which will become effective beginning in the first quarter of 2006. SFAS 123R will result in the recognition of substantial compensation expense relating to our employee stock options and employee stock purchase plans. The Company currently uses the intrinsic value method to measure compensation expense for stock-based awards to its employees. Under this standard, the Company generally does not recognize any compensation related to stock option under its stock option plans or related to the discounts the Company provided under its employee stock purchase plans. Under the new rules however, the Company will be required to adopt a fair-value-based method for measuring the compensation expense related to employee stock awards. The Company estimates the impact of adopting SFAS No. 123R will have an earnings impact of approximately nine to ten cents per share in 2006, based on estimated compensation expense from unvested options outstanding as of the end of December 31, 2005. Compensation expense calculated upon adoption of SFAS No. 123R for future grants may differ from pro-forma amounts currently disclosed in our footnotes based on changes in the fair value of our common stock, the treatment of tax benefits, different assumptions and treatment of forfeitures under SFAS No. 123R, and changes in interest rates or other factors. The Company is currently considering its method of adoption, modified prospective approach or modified retrospective approach”

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections”, which is a replacement of APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. This statement changes the requirements for the accounting for and reporting of a change in accounting principle. It applies to all voluntary changes in accounting principle. It requires retrospective application to prior periods’ financial statements of changes in accounting principle unless it is impracticable. It is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

Note 2: Restructuring

On November 10, 2004, the Company announced its plan to close the ATMOS research and development facility in Canada to reduce operating expenses and to further align the Company’s business with market conditions, future revenue expectations and planned future product direction. As part of this plan, the Company implemented a reduction in workforce of approximately 20 employees, which represented 20% of its workforce. On July 15, 2005, the Company signed an agreement to sublease the ATMOS facility, which the Company occupies under long-term operating leases through 2008.

The Company had a total restructuring estimated lease abandonment accrual of $293,000 and $429,000 for the years ended 2005 and 2004, respectively. The Company reviews these estimates periodically, and if the pertinent assumptions materially change, the ultimate restructuring expense for the abandoned facilities will be adjusted in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”.

The following table summarizes 2005 activities under the Restructuring Plan (amounts in thousands):

	Abandoned				Severance
	Space				Related				Total
Restructuring liability at December 31, 2004		$	410			$	19		$	429
Less current portion		171				19			190
Long-term portion of restructuring liability		239				—			239
2005 adjustments		121				—			121
Cash payments		(247		)		(18		)	(265		)
Foreign exchange fluctuations		9				(1		)	8
Restructuring liability at December 31, 2005		293				—			293
Less current portion		97				—			97
Long-term portion of restructuring liability		$	196			$	—		$	196

Note 3: Details of Balance Sheet Components and Consolidated Statements of Operations

	December 31,
	2005		2004
	(in thousands)
Prepaid expenses and other current assets:
Deferred costs of revenue	$	24	$	338
Deferred tax assets	1,316		831
Prepaid expenses and other assets	1,292		1,770
	$	2,632	$	2,939
Accrued expenses and other liabilities:
Accrued wages and employee benefits	$	631	$	621
Professional fees	432		711
Deferred rent	51		65
Accrued restructuring liability—current portion	97		190
Income taxes payable	22		19
Withholding tax payable	1,052		1,052
License fees payable	—		453
Other	279		203
	$	2,564	$	3,314

Interest and other income:

	2005			2004		2003
	(in thousands)
Interest Income	$	2,608		$	1,527	$	1,350
Other Income (loss)	(17		)	10,051		564
	$	2,591		$	11,578	$	1,914

In 2004, the Company received the $10 million termination fee from Synopsys as a result of the settlement agreement regarding the aborted merger. In 2003, other income included the $287,000 contract termination fee from Conexant.

Note 4: Fair Value of Financial Instruments

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

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

	2004
			Gross
			Unrealized				Fair
	Cost		Loss				Value
	(in thousands)
Cash	$	7,564		$	—		$	7,564
Cash Equivalents:
Commercial and US government agencies paper	24,150			—			24,150
Total cash and cash equivalents	$	31,714		$	—		$	31,714
Short-term investments and auction rate securities:
US government debt securities	$	11,800		$	(39	)	$	11,761
Corporate notes	17,949			(75		)	17,874
Market auction preferred securities	1,000			—			1,000
Total short-term investments and auction rate securities	$	30,749		$	(114	)	$	30,635
Long-term investments:
US government debt securities	$	17,500		$	(80	)	$	17,420
Corporate notes	7,200			(58		)	7,142
Total long-term investments	$	24,700		$	(138	)	$	24,562

The following table shows the cost and fair value of cash equivalents, short-term and long-term investments based on two maturity groups as of December 31, 2005 (amounts in thousands):

	Cost		Gross Unrealized Loss				Fair Value
Due within 1 year	$	60,730		$	(228	)		$	60,502
Due 1-2 years	17,500			(161		)		17,339
Total	$	78,230		$	(389	)		$	77,841

There were no realized gains or losses for 2005, 2004 and 2003.

The following table shows the fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005 (amounts in thousands):

	Less than 12 months							12 months or greater							Total
	Fair Value			Unrealized Losses				Fair Value			Unrealized Losses				Fair Value			Unrealized Losses
Description of securities:
US Government Debt Securities		$	21,349		$	(141	)		$	12,072		$	(107	)		$	33,421		$	(248	)
Corporate Notes		13,003			(87		)		5,267			(54		)		18,270			(141		)
Total		$	34,352		$	(228	)		$	17,339		$	(161	)		$	51,691		$	(389	)

U.S. Government Debt Securities. The Company’s investment in U.S. Government Debt Securities consists of low risk government agency bonds typically with a rating of AAA. The unrealized losses on the Company’s investments in U.S. Government Debt Securities were caused by interest rate increases during 2005. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2005.

Corporate Notes. The Company’s investment in corporate notes consists primarily of investment grade corporate bonds and notes. The unrealized losses on the Company’s investment grade corporate bonds and notes were caused by interest rate increases during 2005. Due to the fact that the decline in market value is attributable to changes in interest rates and not credit quality, and because the severity and duration of the unrealized losses were not significant, the Company considered these unrealized losses to be temporary at December 31, 2005. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2005.

Note 5: Income Taxes

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

	Year Ended December 31,
	2005			2004			2003
Current portion:
U.S. federal	$	—		$	904		$	634
State	31			(3		)	(2		)
Foreign	(23		)	(104		)	(150		)
	8			797			482
Deferred:
U.S. federal	3			(823		)	(761		)
State	—			—			—
Foreign	—			—			—
	3			(823		)	(761		)
	$	11		$	(26	)	$	(279	)

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

Significant components of the Company’s deferred tax assets and liabilities were as follows:

	December 31,
	2005			2004
Deferred tax assets (liabilities):
Federal and state loss carryforwards	3,586			1,614
Reserves, accruals and other	490			271
Deferred revenue	—			799
Depreciation and amortization	(94		)	(212		)
Deferred compensation	268			455
Research and development credit carryforwards	1,301			2,013
Foreign tax credits	553			435
Canadian loss and research and development pool carryforwards	6,124			6,238
	12,228			11,613
Less: Valuation allowance	(10,912		)	(10,782		)
Net deferred tax assets	$	1,316		$	831

The valuation allowance increased by $130,000 and $2.5 million, during the years ended December 31, 2005 and 2004, respectively. The valuation allowance at December 31, 2005 includes $1.9 million related to stock option deductions, the benefit of which will be credited to additional paid in capital when realized.

As of December 31, 2005, the Company had net operating loss carryforwards of approximately $9.4 million for federal income tax purposes and approximately $6.9 million for state income tax purposes. These losses are available to reduce taxable income and expire beginning 2013 through 2025. The Company also had federal research and development tax credit carryforwards of approximately $750,000, which will expire beginning in 2021, and California research and development credits of approximately $842,000, which do not have an expiration date. The Company had foreign tax credits available for federal income tax purposes of approximately $553,000, which will begin to expire in 2008. The Company had

Canadian operating loss and research and development pool carryforwards of $12.1 million, which will begin to expire in 2008. Utilization of the Company’s net operating loss and tax credit carryforwards may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration or elimination of the net operating loss and tax credit carryforwards before utilization. Management does not believe it is likely that utilization will in fact be significantly limited due to ownership change limitation provisions.

The Company’s U.S. income tax return for 2002 is under examination. Management believes that adequate amounts have been provided for any adjustments that may ultimately result from this examination.

A reconciliation of income taxes provided at the federal statutory rate (35% in 2005, 2004 and 2003) to actual income tax expense follows:

	Year Ended December 31,
	2005			2004			2003
	(in thousands)
Income tax (provision) benefit computed at federal statutory rate	$	1,048		$	659		$	(976	)
State income tax (net of federal benefit)	(4		)	(3		)	(2		)
Foreign income tax at rate different from US statutory rate	(47		)	(28		)	15
Utilization of previously reserved NOL’s	—			—			834
Research & development credits	96			—			—
Valuation allowance changes affecting tax provision	(1,029		)	(641		)	(73		)
Tax benefit from extraterritorial income exclusion	—			—			206
Other	(53		)	(13		)	(283		)
	$	11		$	(26	)	$	(279	)

The domestic and foreign components of earnings before taxes were as follows for the years ended December 31, 2005, 2004 and 2003:

	2005			2004			2003
	(in thousands)
U.S.	$	(2,851	)	$	(1,685	)	$	2,316
Non-U.S.	(142		)	(196		)	471
	$	(2,993	)	$	(1,881	)	$	2,787

Note 6: Guarantees

Indemnifications

In the ordinary course of business, the Company enters into contractual arrangements under which the Company may agree to indemnify the third party to such arrangement from any losses incurred relating to the services they perform on behalf of the Company or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to patent infringement. The maximum amount of indemnification the Company could be required to make under these agreements is generally limited to the fees received by the Company, although in some contracts the Company’s potential obligation could be equal to the third parties’ actual damages and losses. The Company has not estimated the maximum potential amount of indemnification liability under these agreements due to the limited history of prior claims and the unique facts and circumstances applicable to

each particular agreement. To date, the Company has not made any payments related to these indemnifications.

Note 7: Stockholders’ Equity

Common Stock Option Plans

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

The Company’s 2000 employee stock option plan (the “2000 plan”) was adopted in October 2000 in connection with the Company’s reincorporation in the state of Delaware. In 2004, the Company obtained shareholders’ approval to its Amended and Restated 2000 Stock Option and Equity Incentive Plan (the “Amended 2000 Plan”) to provide additional incentive to our employees and directors. The Amended 2000 plan authorizes the board or Committee to grant a broad range of awards in addition to stock options, including stock grants, restricted stock, performance-based awards, restricted stock units representing a right to acquire shares in the future and stock appreciation rights and to determine the applicable terms, including price, of such awards. Under the Amended 2000 plan, the maximum number of shares, which are reserved for issuance is 7,207,000, plus an annual increase of 500,000 on January 1 of each year, or a lesser amount determined by our board of directors. The term of options granted under the Amended 2000 plan may not exceed ten years. The term of all incentive stock options granted to an optionee who, at the time of grant, owns stock representing more than 10% of the voting power of all classes of the Company’s stock may not exceed five years. Generally, 25% of the options granted under the Amended 2000 Plan will vest and become exercisable on the first anniversary of the date of grant, and 1/48th of the options will vest and become exercisable each month thereafter.

The exercise price of incentive stock options granted under the Amended 2000 Plan must be at least equal to the fair market value of the shares on the date of grant. The exercise price of nonstatutory stock options granted under the amended 2000 plan will be determined by the board of directors and the exercise price of a nonqualified stock option will not be subject to any price restriction under the Amended 2000 Plan. No incentive stock option may be granted to any employee who on the date of grant owns more than ten percent of our common stock, unless the exercise price of the option is equal to at least 110% of the fair market value of such shares on the date of grant. In addition, the Amended 2000 Plan provides for automatic acceleration of vesting for options granted to non-employee directors in the event of an acquisition of the Company.

A summary of the status of all the Company’s stock option plans as of December 31, 2003, 2004 and 2005 and changes during the years ended on these dates are presented below (in thousands, except per share amounts):

	Options Outstanding
							Weighted
							Average
	Available			Number of			Exercise
	for Grant			Options			Prices
Balance at December 31, 2002		3,917			4,105			$	7.47
Additional authorized under the 2000 Plan		500
Granted		(1,066	)		1,066			$	7.99
Cancelled		360			(360	)		$	8.60
Exercised		—			(439	)		$	3.30
Balance at December 31, 2003		3,711			4,372			$	7.92
Additional authorized under the 2000 Plan		500
Granted		(3,324	)		3,324			$	4.00
Cancelled		1,251			(1,251	)		$	7.62
Exercised		—			(688	)		$	4.70
Balance at December 31, 2004		2,138			5,757			$	6.11
Additional authorized under the 2000 Plan		500
Granted		(2,648	)		2,648			$	5.41
Cancelled		1,522			(1,522	)		$	5.80
Exercised		—			(406	)		$	2.98
Balance at December 31, 2005		1,512			6,477			$	6.09

Options exercisable under the Company’s options plans were 2.7 million, 2.1 million and 2.3 million in 2005, 2004 and 2003, respectively.

Information relating to stock options outstanding at December 31, 2005 is as follows (in thousands, except per share amounts):

	Options Outstanding at December 31, 2005							Options Exercisable at December 31, 2005
Range of Exercise Price	Number Outstanding		Weighted Average Remaining Contractual Life (in Years)		Weighted Average Exercise Price			Number Outstanding		Weighted Average Exercise Price
$1.00-$4.09		1,870		8.15		$	3.67		696		$	3.35
$4.10-$8.00		3,350		8.86		$	5.82		794		$	7.17
$8.01-$10.00		489		6.14		$	9.46		489		$	9.46
$10.01-$15.69		768		6.26		$	11.06		768		$	11.06
		6,477							2,747

The Company’s board of directors may issue up to 20,000,000 shares of preferred stock without stockholder approval on such terms as the board might determine. The rights of the holders of common stock will be subject to, and might be adversely affected by, the rights of the holders of any preferred stock that might be issued in the future.

On December 14, 2005, the Company fully accelerated the vesting of all outstanding stock options granted under the Company’s Amended 2000 Plan that have an exercise price greater than or equal to $7.42 and were granted before April 19, 2004, pursuant to the authorization of the Compensation Committee of the board of directors. As a result of this action, options to purchase approximately 220,000 shares of the Company’s common stock became immediately exercisable. This option vesting acceleration

eliminated approximately $1.1 million of stock-based compensation expense that would have been recorded over the remaining terms of the affected options under Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which became effective for the Company on January 1, 2006.

On December 14, 2005, pursuant to authorization by the Compensation Committee of the board of directors, the Company commenced an offer of restricted shares of its common stock under the Amended 2000 Plan to the United States employees holding outstanding options to purchase common stock granted before April 19, 2004 having an exercise price of $7.42 or more per share upon the surrender of 100% such options for cancellation. If all eligible options were tendered, the Company would issue approximately 284,000 shares of restricted stock, which would vest in annual installments over three years and would cancel options to purchase approximately 1,276,000 shares of common stock. See Note 11, “Subsequent Events”.

Employee Stock Purchase Plan

The Company’s 2000 employee stock purchase plan was adopted in October 2000 in connection with the Company’s Delaware re-incorporation, to become effective upon the pricing date of the Company’s initial public offering. A total of 500,000 shares of common stock have been reserved for issuance under the purchase plan. In addition, the purchase plan provides for an automatic annual increase in the number of shares reserved under the plan on January 1 of each year, equal to the lesser of 100,000 shares, one percent of the Company’s outstanding shares of common stock on such date or a lesser amount determined by the board of directors. The purchase plan, which is intended to qualify under Section 423 of the Internal Revenue Code, is administered by the board of directors or a committee appointed by the board of directors.

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

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

On December 14, 2005, pursuant to authorization by the Compensation Committee of the board of directors the Company announced that there would be no offering period from January 1, 2006 to June 30, 2006 under the Company’s 2000 Employee Stock Purchase Plan (the “ESPP”). This action avoids the recognition of stock-based compensation expense for shares purchased under the ESPP under SFAS 123R, which took effect for the Company as of January 1, 2006.

Of the 600,000 shares authorized to be issued under the purchase plan, 365,000 shares remained available for issuance at December 31, 2005. Employees purchased 66,000, 66,000 and 55,000 shares in 2005, 2004 and 2003, respectively.

Deferred Stock-based Compensation Cost to Employees

During the year ended December 31, 2004, the Company recorded deferred compensation cost of approximately $74,000, which is amortized to expense over 36 months. The 2004 deferred compensation cost represents the intrinsic value of options granted to purchase shares of the Company’s stock to newly appointed members of the Company’s board of directors that had an exercise price less than the fair market value of the Company’s common stock on the date of the option grant. This deferred compensation cost will be amortized over the option vesting period of 36 months using the graded vesting method. No deferred stock compensation cost was recorded in 2005 or 2003.

During the years ended December 31, 2005, 2004 and 2003, the Company recorded stock compensation expenses of $36,000, $68,000, and $459,000, respectively, of which $0, $50,000, and $211,000, respectively, was attributable to the excess of the fair market value of the Company’s common stock over the price at which the Company granted stock options to employees. Stock compensation expenses in 2005, 2004 and 2003 also included $0, $13,000 and $227,000, respectively, for amortization of deferred compensation cost attributable to the fair market value of shares of the Company’s common stock issued to certain employees of ATMOS. In addition, the Company incurred $5,000 of stock compensation expense in 2004 related to the issuance of options to purchase the Company’s stock to newly appointed members of the Company’s board of directors that had an exercise price less than the fair market value of the Company’s stock on the date of the option grant. The Company also incurred $21,000 of stock compensation expense in 2003 due to modification of the Company’s 2000 employee stock option held by a former member of the Company’s board of directors.

Stockholder Rights Plan

The Company’s Stockholder Rights Plan, which was adopted in October 2000 and became effective June 27, 2001, is intended to protect stockholders from unfair or unfriendly takeover practices. In accordance with this plan, the board of directors declared a dividend distribution of one Series AA preferred stock purchase right on each outstanding share of its common stock held as of June 27, 2001, and on each share of common stock issued by the Company thereafter. Each right entitles the registered holder to purchase from the Company one one-thousandth share of Series AA preferred stock at a price of $110. The rights become exercisable in certain circumstances, including the acquisition by any person or group, or the commencement or announcement of a tender or exchange offer for the acquisition, of beneficial ownership of 15 % or more of the Company’s common stock without the approval of the board of directors (except for certain affiliates prior to the effective date of the Plan as to whom this ownership limit is 25%). The rights do not confer any rights as a stockholder until they are exercised. In the event the rights become exercisable, each right will entitle the holder to acquire shares of common stock of the Company or the acquiring corporation (in the event of merger or similar business combination) having a value equal to twice the purchase price of the right. The rights are redeemable by the Company prior to exercise at $0.01 per right and expire on October 11, 2010.

In 2004, the Company amended its Stockholder Rights Plan twice; once, in connection with the proposed acquisition of the Company by Synopsys, Inc, and a second time to permit the acquisition of shares representing more than 15% of its common stock by a brokerage firm that manages independent customer accounts and generally does not have any discretionary voting power with respect to such shares. Notwithstanding amendments of this nature, the Company’s intention is to maintain and enforce the terms of this plan, which could delay, deter or prevent an investor from acquiring the Company in a transaction

that could otherwise result in stockholders receiving a premium over the market price for their shares of common stock.

Stock Repurchase Plan

On April 19, 2004, the Company announced that its board of directors authorized the repurchase of up to $25 million of its common stock over the next 12 months. The Company repurchased approximately $4.7 million or 1.2 million shares of its common stock in 2004 under that repurchase program. On April 29, 2005, the Company’s board of directors authorized a new stock repurchase program for the purchase of up to $20 million of the Company’s common stock over the next 12 months. No shares were repurchased under the new stock repurchase program in 2005.

Note 8: Retirement Savings Plan

Effective January 1997, the Company adopted the MoSys 401(k) Plan (the “Savings Plan”) which qualifies as a thrift plan under Section 401(k) of the Internal Revenue Code. All full-time employees who are at least 21 years old are eligible to participate in the Savings Plan at the time of hire. Participants may contribute up to 15% of their earnings to the Savings Plan. The Company makes a Matching Contribution on behalf of each Participant in an amount equal to 25% of a Participant’s Deferral Contributions during the Plan Year. The Company made matching contributions of $127,000, $110,000, and $107,000 in 2005, 2004 and 2003, respectively.

Note 9: Business Segments, Concentration of Credit Risk and Significant Customers

The Company has adopted SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information.” Although the Company offers various intellectual property components and services to its customers, the Company does not manage its operations by these intellectual property components and services, but instead views the Company as one operating segment when making business decisions. The Company does not manage its operations on a geographical basis. Revenue attributed to the United States and to all foreign countries is based on the geographical location of the customer. The Company uses one measurement of profitability for its business.

The Company supplies semiconductor memories to the electronics industry. This industry segment is characterized by rapid technological change and significant competition.

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, cash equivalents short-term and long-term investments and accounts receivable. Cash, cash equivalents short-term and long term investments are deposited with high credit quality institutions.

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

	Years Ended December 31,
	2005		2004		2003
North America	$	3,630	$	4,602	$	7,767
Japan	7,636		4,609		7,146
Asia	1,016		1,191		3,969
Europe	—		419		351
Total	$	12,282	$	10,821	$	19,233

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

	Years Ended December 31,
	2005			2004			2003
NEC		35	%		19	%		14	%
Fujitsu		17	%		17	%		—
Marvel		—			11	%		—
UMC		—			—			11	%
Sony		—			—			17	%

Three customers accounted for 40%, 22% and 20% of gross accounts receivable, respectively, at December 31, 2005. Three customers accounted for 46%, 17% and 11% of gross accounts receivable, respectively, at December 31, 2004. The Company performs ongoing credit evaluations of its customers’ financial condition and maintains an allowance for uncollectible accounts receivable based upon the expected collectibility of all accounts receivable. $105,000 was reserved in the allowance for uncollectible accounts receivable in 2005. No amounts were written off in 2004 and 2003.

Net property, plant and equipment, classified by major geographic areas were as follows at December 31, 2005 and 2004.

	December 31,
	2005		2004
	(in thousands)
U.S.	$	1,075	$	621
Non-U.S.	46		64
Total	$	1,121	$	685

Note 10: Commitments and Contingencies

The Company leases its facilities under non-cancelable operating leases that expire in 2006 through 2010. Rent expense was approximately $797,000, $1,157,000, and $1,143,000 for the years ended December 31, 2005, 2004 and 2003, respectively. The leases provide for monthly payments and are being charged to operations ratably over the lease terms. In addition to the minimum lease payments, the Company is responsible for property taxes, insurance and certain other operating costs. Future minimum lease payments under the non-cancelable operating leases as of December 31, 2005 are as follows (in thousands):

Year Ended December 31,	Minimum Lease Commitments			Sublease Income			Net Lease Commitments
2006		$	870		$	201		$	669
2007		842			137			705
2008		525			46			479
2009		370			—			370
2010 and thereafter		189			—			189
Total minimum payments		$	2,796		$	384		$	2,412

In July 2005, one of the Company’s customers filed a claim concerning excess verification costs incurred by the customer in implementing a custom design for 1T-SRAM memory technology under a licensing contract. The claim was settled in December 2005 with a net-down of $304,000 in accounts receivable and contingent liability. There was no contingent liability as of December 31, 2005, however, the Company has given up the right to receive $71,000 in future royalties from this customer, should they be earned.

Legal Matters

On March 31, 2004, UniRAM Technology, Inc. filed a complaint against the Company in the United States District Court for the Northern District of California, alleging trade secret misappropriation and patent infringement. UniRAM’s complaint asserts that it provided trade secret information to Taiwan Semiconductor Manufacturing Corporation (TSMC) in 1996-97 and speculated that we improperly obtained unspecified trade secrets of UniRAM from TSMC in an unknown manner. Subsequent to March 31, 2004, UniRAM amended its complaint twice to add TSMC as a defendant and additional allegations to the suit, and to drop all infringement claims for one of the two patents identified in the initial complaint. The Company believes that UniRAM’s complaint lacks merit and intends to vigorously defend against it. In October 2005, the court held a “Markman hearing” to construe and interpret the claims of the patent which UniRAM continues to assert against the Company and TSMC. As yet, the court has not issued its claim construction order.

From time to time the Company may be subject to legal proceedings and claims in the ordinary course of business. These claims, even if not meritorious, could result in the expenditure of significant financial resources.

Note 11: Subsequent Events

The offer expired at midnight, Pacific Time, on Friday, January 13, 2006. The eligible participants elected to surrender for cancellation an aggregate of approximately 318,054 shares of Company common stock underlying eligible options and received an aggregate of approximately 76,654 shares of restricted Company common stock. The value of the Company’s common stock on the offer termination date was $5.91 per share. Upon the terms and subject to the conditions of the offer, the Company promptly issued to eligible participants restricted shares of Company common stock. No executive officers elected to accept the offer.

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

	MONOLITHIC SYSTEM TECHNOLOGY, INC.
	By:		/s/ CHESTER J. SILVESTRI
			Chester J. Silvestri
			Chief Executive Officer and President

Signature		Title		Date
/s/ CHESTER J. SILVESTRI	Chief Executive Officer and President		March 16, 2006
Chester J. Silvestri	(Principal Executive Officer and Principal
	Financial Officer)
/s/ YOSHIKO RIBAR	Controller (Principal Accounting Officer)		March 16, 2006
Yoshiko Ribar
/s/WINGYU LEUNG	Executive Vice President, Chief Technical Officer		March 16, 2006
Wingyu Leung	and Director
/s/ CARL E. BERG	Director		March 16, 2006
Carl E. Berg
/s/ TOMMY ENG	Director		March 16, 2006
Tommy Eng
/s/ CHI-PING HSU	Director		March 16, 2006
Chi-Ping Hsu
/s/ JAMES D. KUPEC	Director		March 16, 2006
James D. Kupec
/s/ CHENMING HU	Director		March 16, 2006
Chenming Hu

Title of each class		Name of each exchange on which registered
None		None

Part I
Item 1.	Business	4
Item 1A.	Risk Factors	16
Item 1B.	Unresolved Staff Comments	26
Item 2.	Properties	26
Item 3.	Legal Proceedings	26
Item 4.	Submission of Matters to a Vote of Security Holders	27
Part II
Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities	28
Item 6.	Selected Financial Data	29
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 7A.	Quantitative and Qualitative Discussion of Market Interest Rate Risk	40
Item 8.	Financial Statements and Supplementary Data	41
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	41
Item 9A.	Controls and Procedures	42
Item 9B.	Other Information	42
Part III
Item 10.	Directors and Executive Officers of the Registrant	43
Item 11.	Executive Compensation	43
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	43
Item 13.	Certain Relationships and Related Transactions	43
Item 14.	Principal Accountant Fees and Services	43
Part IV
Item 15.	Exhibits and Financial Statement Schedules	44
	Signatures	46

				Additions						Deductions
Description	Balance at beginning of period			Charged to costs and expenses			Charged to other accounts			Amount recovered (written off)				Balance at end of period
Year ended December 31, 2005
Allowance for doubtful accounts		$	—		$	105		$	—		$	—			$	105
Deferred tax asset valuation allowance		$	10,782		$	—		$	133		$	(3	)		$	10,912
Year ended December 31, 2004
Allowance for doubtful accounts		$	—		$	—		$	—		$	—			$	—
Year ended December 31, 2003
Allowance for doubtful accounts		$	—		$	—		$	—		$	—			$	—