Sajan 10-K/A 2005 FY Annual report (amended)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K/A

(Amendment No. 1)

(Mark One)

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

For the fiscal year ended December 31, 2005

OR

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

For the transition period from                          to

Commission file number:  000-51560

MathStar, Inc.

(Exact name of registrant as specified in its charter)

Delaware	41-1881957
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)
19075 Tanasbourne Drive, Suite 200,
Hillsboro, Oregon	97124
(Address of principal executive offices)	(Zip Code)

(503) 726-5500

(Registrant’s telephone number, including area code)

5900 Green Oak Drive, Minnetonka, Minnesota 55343

(Former name, former address and former fiscal year, if changed since last report)

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

Title of each class	Name of each exchange on which registered
Not applicable.	Not applicable.

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes  oNo x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.Yes oNo x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes xNo o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).Yes oNo x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes oNo x

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.

Not applicable. The registrant’s common equity was not publicly traded on The Nasdaq National Market on June 30, 2005, which was the last day of the registrant’s most recently completed second fiscal quarter. The registrant’s common equity began trading on The Nasdaq National Market on October 27, 2005.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at March 17, 2006
Common Stock, $0.01 par value per share	17,447,691 shares

Explanatory Note

This Amendment No. 1 on Form 10-K/A (the “Amendment”) to the Annual Report on Form 10-K for the year ended December 31, 2005, which was originally filed with the Securities and Exchange Commission on March 31, 2006 (the “Original Filing”), is being filed solely for the purpose of replacing the previous dual date of the report of PricewaterhouseCoopers LLP, the independent registered public accounting firm of MathStar, Inc., with a single date.

As a result of this Amendment, the certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934) have become re-executed and re-filed with this Amendment.

This Amendment does not otherwise modify or update disclosures in, or exhibits to, the Original Filing, except for the addition of a consent from PricewaterhouseCoopers LLP, our independent registered public accounting firm.

2

MathStar, Inc.

Form 10-K/A

(Amendment No. 1)

	Page
Part II	4
Item 8. Financial Statements and Supplementary Data	4
Part IV	25
Item 15. Exhibits and Financial Satement Schedules	25
Signatures	26

3

PART II

Item 8. Financial Statements and Supplementary Data

Unaudited quarterly financial data for each of the eight quarters in the two-year period ended December 31, 2005 is as follows (the numbers in the table may not add up due to rounding):

	Three Months Ended
	March 31			June 30			Sept. 30			Dec. 31
	(In thousands, except per share amounts)
2004
Net revenue	$	—		$	—		$	100		$	30
Cost of sales	—			—			45			8
Gross profit	—			—			55			22
Operating expenses:
Research and development	1,280			880			1,342			1,690
Selling, general and administrative	836			987			973			895
Total operating expenses	2,116			1,867			2,315			2,585
Loss from operations	(2,116		)	(1,867		)	(2,260		)	(2,563		)
Other income (expense)	14			19			14			10
Net loss	$	(2,102	)	$	(1,848	)	$	(2,246	)	$	(2,553	)
Basic and diluted net loss per share	$	(0.25	)	$	(0.20	)	$	(0.24	)	$	(0.26	)
Weighted average number of common shares outstanding	8,333			9,101			9,468			9,925
2005
Net revenue	$	15		$	25		$	15		$	79
Cost of sales	7			8			—			37
Gross profit	8			17			15			42
Operating expenses:
Research and development	2,572			2,006			1,806			2,350
Selling, general and administrative	1,023			1,435			1,519			2,081
Total operating expenses	3,595			3,441			3,325			4,431
Loss from operations	(3,587		)	(3,424		)	(3,310		)	(4,389		)
Other income (expense)	7			(476		)	(893		)	(2,863		)
Net loss	$	(3,580	)	$	(3,900	)	$	(4,203	)	$	(7,252	)
Basic and diluted net loss per share	$	(0.32	)	$	(0.35	)	$	(0.37	)	$	(0.49	)
Weighted average number of common shares outstanding	11,155			11,192			11,233			14,870

4

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders
of MathStar, Inc.

In our opinion, the accompanying balance sheets and the related statements of operations, changes in stockholders’ equity and cash flows present fairly, in all material respects, the financial position of MathStar, Inc. (a development stage company) (the “Company”) at December 31, 2004 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, and cumulatively for the period from April 14, 1997 (date of inception) to December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has incurred recurring losses and negative cash flows from operations and will require additional funding to continue its operations. These matters raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
March 30, 2006

5

MathStar, Inc.
(A development stage company)

Balance Sheets

	December 31,
	2004			2005
	(in thousands, except  per share amounts)
Assets
Current assets
Cash and cash equivalents	$	4,132		$	20,149
Accounts receivable	29			75
Prepaid expenses and other current assets	230			1,480
Total current assets	4,391			21,704
Property and equipment, net	109			347
Other assets	4			151
Total assets	$	4,504		$	22,202
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$	251		$	734
Accrued expenses	236			1,294
Total liabilities	487			2,028
Commitments and contingencies (Note 10)
Stockholders’ equity
Preferred stock, $0.01 par value; 10,000 shares authorized; no shares issued and outstanding	—			—
Common stock, $0.01 par value; 90,000 shares authorized; 11,140 and 17,415 shares issued and outstanding at December 31, 2004 and 2005, respectively	111			175
Additional paid-in capital	68,465			105,717
Unearned compensation	—			(2,224		)
Deficit accumulated during the development stage	(64,559		)	(83,494		)
Total stockholders’ equity	4,017			20,174
Total liabilities and stockholders’ equity	$	4,504		$	22,202

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

6

MathStar, Inc.
(A development stage company)

Statements of Operations

	Year Ended December 31,									Cumulative for the Period from Inception (April 14, 1997) Through December 31,
	2003			2004			2005			2005
	(in thousands, except per share amounts)
Revenue	$	50		$	130		$	134		$	880
Cost of sales	—			53			52			105
Gross margin	50			77			82			775
Operating expenses
Research and development	7,903			5,192			8,734			29,967
Selling, general and administrative	3,221			3,691			6,058			19,274
	11,124			8,883			14,792			49,241
Operating loss	(11,074		)	(8,806		)	(14,710		)	(48,466		)
Interest income	47			57			170			1,420
Interest expense	—			—			(4,395		)	(4,591		)
Other income, net	—			—			—			17
Net loss from continuing operations	(11,027		)	(8,749		)	(18,935		)	(51,620		)
Loss from discontinued operations (Note 4)	—			—			—			(31,874		)
Net loss	$	(11,027	)	$	(8,749	)	$	(18,935	)	$	(83,494	)
Basic and diluted loss per share from continuing operations	$	(1.56	)	$	(0.95	)	$	(1.56	)
Basic and diluted loss per share from discontinued operations	$	—		$	—		$	—
Basic and diluted loss per share	$	(1.56	)	$	(0.95	)	$	(1.56	)
Weighted average basic and diluted shares outstanding	7,048			9,209			12,121

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

7

MathStar, Inc.
(A development stage company)

Statements of Changes in Stockholders’ Equity
Cumulative for the Period from Inception (April 14, 1997) Through December 31, 2005

		Price		Common Stock					Additional							Deficit Accumulated During the
	Date	Per Share		Shares		Par Value			Paid-in Capital			Notes Receivable			Unearned Compensation	Development Stage			Total
	(in thousands, except per share amounts)
Issuance of common stock to founders for cash and notes receivable	January 1998	$	0.045	667		$	7		$	23		$	(15	)					$	15
Net income																$	7		7
Balances at December 31, 1998				667		7			23			(15		)	—	7			22
Payments on notes receivable												15							15
Net loss																(15		)	(15		)
Balances at December 31, 1999				667		7			23			—			—	(8		)	22
Issuance of common stock for notes receivable	April 2000	$	.11	2,100		21			209			(230		)					—
Issuance of common stock for cash	June 2000	$	5.25	140		1			735										736
Payments on notes receivable												230							230
Issuance of common stock for cash, net of offering costs of $1,908	July - November 2000	$	8.25	2,235		23			16,511										16,534
Net loss																(1,437		)	(1,437		)
Balances at December 31, 2000				5,142		52			17,478			—			—	(1,445		)	16,085
Issuance of common stock in connection with the acquisition of Digital Mediacom, Inc.	August 2001	$	8.25	1,603		16			13,210										13,226
Issuance of options and warrants in connection with the acquisition of Digital Mediacom, Inc.									5,158										5,158
Stock-based employee compensation									148										148
Stock-based nonemployee compensation									116										116
Repurchase of common stock				(667	)	(7		)	(243		)								(250		)
Net loss																(13,629		)	(13,629		)
Balances at December 31, 2001				6,078		61			35,867			—			—	(15,074		)	20,854
Issuance of common stock for cash, net of offering costs of $1,645	April - August 2002	$	10.50	1,458		14			13,644										13,658
Exercise of stock options				9					47										47
Stock-based employee compensation									528										528
Repurchase of common stock				(500	)	(5		)	(252		)								(257		)
Net loss																(29,709		)	(29,709		)
Balances at December 31, 2002				7,045		70			49,834			—			—	(44,783		)	5,121
Issuance of warrants to purchase common stock for cash, net of offering costs of $697	April - August 2003								5,304										5,304
Issuance of common stock for cash, net of offering costs of $316	December 2003	$	4.80	585		6			2,487										2,493
Exercise of warrants for subscription receivable				18					27										27
Stock-based employee compensation									148										148
Stock-based nonemployee compensation—options									26										26
Net loss																(11,027		)	(11,027		)
Balances at December 31, 2003				7,648		76			57,826			—			—	(55,810		)	2,092

8

MathStar, Inc.
(A development stage company)

Statements of Changes in Stockholders’ Equity (Continued)
Cumulative for the Period from Inception (April 14, 1997) Through December 31, 2005

		Price		Common Stock				Additional							Deficit Accumulated During the
	Date	Per Share		Shares		Par Value		Paid-in Capital			Notes Receivable	Unearned Compensation			Development Stage			Total
	(in thousands, except per share amounts)
Balances at December 31, 2003				7,648		76		57,826			—	—			(55,810		)	2,092
Issuance of common stock for cash, net of offering costs of $970	January - August 2004	$	4.80	1,864		19		7,959										7,978
Exercise of warrants for cash, net of warrant call costs of $279				1,627		16		2,629										2,645
Exercise of stock options				1				1										1
Vesting of warrants issued to nonemployees								50										50
Net loss															(8,749		)	(8,749		)
Balances at December 31, 2004				11,140		111		68,465			—	—			(64,559		)	4,017
Exercise of warrants for cash				101		2		233			—				—			235
Warrants issued in connection with convertible bridge notes				—		—		1,126			—				—			1,126
Discount on convertible bridge notes—beneficial conversion rate				—		—		2,502			—				—			2,502
Vesting of warrants issued to nonemployees				—		—		515			—				—			515
Issuance of common stock in public offering, net of offering costs of $2,967	Oct./Dec. 2005	$	6.00	4,600		46		24,587			—				—			24,633
Restricted common stock issued to employees				457		5		2,736				(2,741		)	—			—
Forfeitures of restricted stock				(11	)	—		(70		)		70			—			—
Bridge note conversion	Dec. 2005	$	4.80	1,128		11		5,419				—			—			5,430
Stock-based employee compensation—restricted stock				—		—						447			—			447
Stock-based employee compensation—options				—		—		204				—			—			204
Net loss				—		—		—				—			(18,935		)	(18,935		)
Balances at December 31, 2005				17,415		$	175	$	105,717		—	$	(2,224	)	$	(83,494	)	$	20,174

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

9

MathStar, Inc.
(A development stage company)

Statements of Cash Flows

	Year Ended December 31,									Cumulative for the Period from Inception (April 14, 1997) Through December 31,
	2003			2004			2005			2005
	(In thousands)
Cash flows from operating activities
Net loss	$	(11,027	)	$	(8,749	)	$	(18,935	)	$	(83,494	)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation	358			183			74			1,533
Amortization of beneficial conversion feature convertible notes and value of warrants issued with convertible notes	—			—			3,628			3,628
Interest expense settled with common stock	—			—			230			230
Amortization of discount on held-to-maturity securities	—			—			—			(233		)
Acquired in-process research and development	—			—			—			4,300
Stock-based compensation	175			50			1,166			2,241
Goodwill impairment	—			—			—			13,306
Change in operating assets and liabilities, net of effects of acquisition
Accounts receivable	—			(29		)	(46		)	70
Prepaid expenses and other assets	302			(101		)	(896		)	(991		)
Accounts payable	68			(188		)	178			281
Accrued expenses	513			(477		)	862			1,076
Net cash used in operating activities	(9,611		)	(9,311		)	(13,740		)	(58,064		)
Cash flows from investing activities
Cash used in acquisition, net of cash acquired	—			—			—			(791		)
Purchase of property and equipment	—			(13		)	(312		)	(1,720		)
Proceeds from sale of discontinued operations	—			—			—			1,752
Purchases of held-to-maturity securities	—			—			—			(10,000		)
Sales of held-to-maturity securities	—			—			—			10,233
Net cash used in investing activities	—			(13		)	(312		)	(526		)
Cash flows from financing activities
Proceeds from issuance of common stock, net of offering costs	2,493			7,978			24,633			66,047
Proceeds from issuance of convertible notes	—			—			5,500			5,500
Payments on convertible notes	—			—			(300		)	(300		)
Proceeds from issuance of warrants to purchase common stock, net of offering costs	5,304			—			—			5,304
Proceeds from exercise of warrants, net of costs	—			2,645			235			2,908
Collection of subscription receivable	—			27			—			27
Proceeds from exercise of stock options	—			1			—			1
Principal payments on notes receivable from stockholders	—			—			—			245
Principal payments on notes payable to stockholders	(125		)	—			—			(250		)
Repurchase of common stock	—			—			—			(257		)
Payments on capital lease obligations	(29		)	—			—			(486		)
Net cash provided by financing activities	7,643			10,651			30,068			78,739
Net (decrease) increase in cash and cash equivalents	(1,968		)	1,327			16,017			20,149
Cash and cash equivalents
Beginning of period	4,773			2,805			4,132			—
End of period	$	2,805		$	4,132		$	20,149		$	20,149
Cash paid during period for interest										26
Significant noncash transactions
Common stock, options and warrants issued in connection with Digital Mediacom, Inc. acquisition	$	—		$	—		$	—		$	18,384
Exercise of warrants for subscription receivable	27			—			—			27
Capital lease obligation incurred for acquisition of fixed assets	—			—			—			426
Repurchase of common stock with notes payable	—			—			—			250
Prepaid licenses included in accrued expenses	—			—			601			601
Conversion of notes payable and $230 of accrued interest into common stock	—			—			5,430			5,430

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

10

MathStar, Inc.
(A development stage company)

Notes to Financial Statements (Continued)
(in thousands, except per share amounts)

1.Nature of the Business and Going Concern

MathStar, Inc. (the “Company”) was incorporated as a Minnesota corporation in April 1997 and reincorporated under Delaware law during 2005. The Company is a fabless semiconductor company addressing the reconfigurable logic markets with a new class of platform chips designed to be high performance, reconfigurable integrated circuits based on the Company’s proprietary silicon object technology. Since its inception, the Company has devoted substantially all of its efforts to business planning, research and development, recruitment of management and technical staff, acquiring operating assets and raising capital. The Company has generated only nominal revenues from the sale of development kits that support customer development of applications for one of the Company’s products, the sale of product prototypes and contractual research and development services. Accordingly, the Company is considered to be in the development stage as defined by Statement of Financial Accounting Standards (“SFAS”) No. 7, Accounting and Reporting by Development Stage Enterprises.

In November 2005, the Company closed on its initial public offering of 4,000 shares of its common stock at $6.00 per share and in December 2005 the Company closed on the underwriter’s overallotment option of 600 shares of the Company’s common stock at $6.00 per share, resulting in net proceeds to the Company of $24,633.

The accompanying financial statements have been prepared on a basis which assumes that the Company will continue as a going concern and which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The Company has a limited operating history and has incurred losses and negative cash flows from operations since inception. The Company expects to incur additional losses and will require additional funding to continue its operations. These circumstances raise substantial doubt about the Company’s ability to continue as a going concern. Management intends to seek additional equity financing during 2006. However, there can be no assurance that such additional funding will be available on terms acceptable to the Company or at all.

2.Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity 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 and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents.

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial instruments, which include cash equivalents, accounts receivable, accounts payable and other accrued expenses, approximate their fair values due to their short maturities and/or market-consistent interest rates.

Property and Equipment

Property and equipment are recorded at cost and depreciated over their estimated useful lives, generally three to five years, using the straight-line method. Upon retirement or sale, the cost of assets disposed of and the related

11

accumulated depreciation are removed from the accounts, and any resulting gain or loss is included in operating results. Repairs and maintenance costs are expensed as incurred.

Patents

The Company has filed applications for patents with the U.S. Patent and Trademark Office. The legal fees and application costs associated with obtaining patents from the U.S. Patent and Trademark Offices are expensed as incurred.

Long-Lived Assets

The recoverability of long-lived assets is assessed periodically or whenever adverse events or changes in circumstances or business climate indicate that the expected cash flows previously anticipated warrant a reassessment. When such reassessments indicate the potential of impairment, all business factors are considered and, if the carrying value of such assets is not likely to be recovered from future undiscounted operating cash flows, they will be written down for financial reporting purposes. See Note 4 regarding assessment of the carrying value of goodwill.

Research and Development

Research and development expenses represent costs incurred for designing and engineering of the Company’s products, including the costs of developing design tools and applications to enable customers to more easily utilize the Company’s products. The Company expenses all research and development costs related to development of its products. Development of certain tools and applications include the development of software. Such research and development expenses are required to be expensed until the point that technological feasibility of the software is established. The Company determines technological feasibility based upon completion of a working model of the software. To date, the period between technological feasibility and general release of the software has been short, such that virtually all of the Company’s software development costs relate to software development during the period prior to technological feasibility. Accordingly, all such costs have been charged to operations as incurred.

Revenue Recognition

Revenue prior to 2003 resulted from contractual research and development services and was recognized as the services were performed. Customer payments received in advance of providing services were recorded as customer deposits. Costs related to these revenues consisted primarily of salary and related benefits of certain employees and were included in operating expenses.

Revenue after 2002 resulted from the sale of prototype products and the sale of product development kits. The Company recognizes revenue for these products when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, collectibility is reasonably assured and there are no post-delivery obligations. During 2004 and 2005, marketing support was paid to a customer of the Company. Such payments are reported as a reduction of revenue in accordance with Emerging Issues Task Force Issue 01-09, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).

During 2005, revenue also resulted from contractual research and development services that was recognized as the services were performed. Costs related to these revenues consisted primarily of salary and related benefits of certain employees and were included in cost of sales.

Stock-Based Compensation

In accordance with SFAS No. 123, Accounting for Stock-Based Compensation, the Company has elected to account for stock-based compensation to employees using the intrinsic value method prescribed in Accounting

12

Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock options granted to employees is measured as the excess, if any, of the fair value of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock. The Company accounts for stock-based compensation to nonemployees using the fair value method prescribed by SFAS No. 123. Compensation cost for stock options granted to nonemployees is measured based on the fair value of the option at the date of grant with the unvested portion revalued at each balance sheet date. Compensation costs, if any, are amortized over the underlying option vesting terms.

The following table presents the pro forma effect on net loss if the Company had applied the fair value recognition provisions for SFAS No. 123 to stock-based employee compensation:

										Cumulative
										for the Period
										from Inception
										(April 14, 1997)
										Through
	Year Ended December 31,									December 31,
	2003			2004			2005			2005
Net loss as reported	$	(11,027	)	$	(8,749	)	$	(18,935	)	$	(83,494	)
Add: Total stock-based employee compensation expense included in net loss, as reported	148			—			651			1,475
Deduct: Total stock-based employee compensation expense determined under fair value based method for all employee awards	(369		)	(174		)	(912		)	(2,697		)
Pro forma net loss	$	(11,248	)	$	(8,923	)	$	(19,196	)	$	(85,163	)
Basic and diluted loss per share:
As reported	$	(1.56	)	$	(0.95	)	$	(1.56	)
Pro forma	$	(1.60	)	$	(0.97	)	$	(1.58	)

Advertising Costs

Advertising costs are charged to operations as incurred. Advertising costs were $4, $3 and $14 for the years ended December 31, 2003, 2004 and 2005, respectively, and $137 cumulative for the period from inception (April 14, 1997) through December 31, 2005.

Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. The asset and liability approach of SFAS No. 109 requires the recognition of deferred tax assets and liabilities for the tax consequences of temporary differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes using enacted tax rates in effect for the years in which the differences are expected to reverse. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

Concentration of Credit Risk

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash and cash equivalents. The Company places its cash and cash equivalents primarily in checking and money market accounts with one financial institution that management considers creditworthy. However, the Federal Deposit Insurance Corporation does not insure most of these accounts.

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Comprehensive Loss

Comprehensive loss, as defined in SFAS No. 130, Reporting Comprehensive Income, includes all changes in equity during a period from nonowner sources. The Company has not had any changes in stockholders’ equity from nonowner sources other than a net loss.

Earnings Per Share

Basic earnings per share are computed by dividing the net loss available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share gives effect to all dilutive potential common shares outstanding during the period, including stock options, warrants and convertible notes payable, using the treasury stock method. Options and warrants to purchase 3,672, 2,611 and 4,021 shares of common stock were outstanding at December 31, 2003, 2004 and 2005, respectively, but were not included in the computation of net loss per share as their effect was anti-dilutive. Common shares issuable upon exercise of the convertible notes payable and related accrued interest and shares of the Company’s contingently issuable restricted stock also were not included in the computation of net loss per share as their effect was anti-dilutive (see Note 6).

New Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R revised SFAS No. 123 and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB Opinion No. 25”). The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based payments using APB Opinion No. 25 and requires that the compensation costs relating to such transactions be recognized in the statement of operations based upon the grant-date fair value of those instruments. The revised statement is effective for the Company in the first quarter of 2006 which begins on January 1, 2006. The Company expects that adoption of SFAS No. 123R will result in significant charges to operations beginning in 2006.

Under SFAS No. 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation costs and the transition method to be used at the date of adoption. The transition methods include prospective and retroactive adoption alternatives. The Company will adopt SFAS No. 123R using the prospective method. Because the Company has historically followed the “minimum value” method permitted by SFAS No. 123, the prospective method will require the Company to record compensation expense only for options issued after the closing of the Company’s initial public offering in November 2005.

In May 2005, the Financial Accounting Standards Board issued SFAS No. 154, Accounting Changes and Error Corrections. This new standard replaces Accounting Principals Board Opinion (“APB”) No. 20, Accounting Changes, and SFAS 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 and applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. APB No. 20 required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This statement requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The provisions of SFAS No. 154 are effective for fiscal years beginning after December 15, 2005. As such, the Company is required to adopt SFAS No. 154 by January 1, 2006. The Company does not expect the adoption of this statement to have an impact on its financial statements.

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3.Selected Balance Sheet Information

The following presents prepaid expenses and other current assets:

	December 31,
	2004		2005
Prepaid license fees	$	108	$	775
Prepaid insurance	25		165
Prepaid rent	—		89
Other	97		451
	$	230	$	1,480

The following presents property and equipment, net:

	December 31,
	2004			2005
Computer equipment	$	896		$	1,003
Purchased software	425			425
Furniture and fixtures	165			370
	$	1,486		$	1,798
Less: Accumulated depreciation	(1,377		)	(1,451		)
Total property and equipment, net	$	109		$	347

Depreciation expense was $358, $183 and $74 for the years ended December 31, 2003, 2004 and 2005 and $1,533 cumulative for the period from inception (April 14, 1997) through December 31, 2005.

The following presents accrued expenses:

	December 31,
	2004		2005
Accrued rent	$	146	$	117
Accrued compensation	90		417
Accrued professional fees	—		320
Other	—		440
Total accrued expenses	$	236	$	1,294

4.   Acquisition and Disposition of Digital Mediacom, Inc.

Acquisition

On August 31, 2001, the Company completed its acquisition of Digital Mediacom, Inc. (“DMC”), a provider of design and engineering services and a developer of physical media device technology. In connection with the merger transaction, the Company acquired all outstanding shares of DMC common stock in exchange for cash of $950 and 1,603 shares of the Company’s common stock. In addition, options and warrants to purchase shares of DMC common stock outstanding immediately prior to the consummation of the merger were assumed by the Company and converted into options and warrants to purchase 781 shares of the Company’s common stock. The total purchase price, including the fair value of converted options and warrants and direct acquisition costs, was $19,402. The purchase price was allocated to the assets acquired and liabilities assumed based upon their fair values. The most significant asset was $4,300 of acquired, in process research and development (see discussion below). The excess of the purchase price over the fair value of the net assets acquired of $14,589 was recorded as goodwill.

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In-Process Research and Development

At the time of acquisition, DMC had certain in process development projects. Management estimated that $4,300 of the purchase price represented the fair value of purchased in process research and development relating to these development projects which had not yet reached technological feasibility and had no alternative future uses. The Company estimated the fair value of the in-process research and development using an income approach, which estimates fair value by discounting the cash flows expected to arise from the development of the in-process projects and future sale of the resulting products.

Goodwill Impairment and Discontinued Operations

In August 2002, due to events and changes in circumstances which included a severe downturn in the market for the acquired in process development projects, management and the Board of Directors committed to a plan to sell the physical media device (“PMD”) operating segment which was comprised of the acquired DMC operations. Accordingly, the Company tested the PMD assets for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, and SFAS No. 142, Goodwill and Other Intangible Assets, and recorded a $13,306 goodwill impairment charge.

On November 15, 2002, the Company closed on the sale of its PMD operating segment for $1,752 in cash. In connection with the sale, the buyer assumed $187 in liabilities, and the Company sold or disposed of all of the valuable technology, property and equipment, licensed software and employees. There was no gain or loss on the sale because the assets of the PMD operating segment were written down to their estimated net realizable value in August 2002.

The operating results from the discontinued PMD operating segment included in the accompanying financial statements were as follows:

	Cumulative for the Period from August 31, 2001 Through December 31, 2002
Operating expenses	$	14,268
Purchased in-process research and development	4,300
Goodwill impairment	13,306
Loss from discontinued operations	$	31,874

5.Note Payable to Stockholder

On January 16, 2002, the Company agreed to purchase 500 shares of the Company’s common stock from a stockholder in exchange for a note payable of $250. The note bore interest at 5% and was due in four equal installments through 2002. At December 31, 2002, the remaining balance due was $125. During 2003, the Company repaid the outstanding balance of this note payable.

6.Stockholders’ Equity

Authorized Shares

The Company’s authorized capital consists of 100,000 shares of capital stock, of which 90,000 shares have been designated as common stock ($0.01 per share par value), and 10,000 shares have been designated as preferred stock ($0.01 per share par value). In addition, 3,411 of the 90,000 shares of common stock have been reserved for issuance under the Company’s Stock Option and Restricted Stock Plans. Each share of common stock entitles the holder to one vote.

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Stock Split

The Company’s Board of Directors and stockholders declared a three-for-one reverse stock split, effective June 10, 2005. The accompanying financial statements and related notes give retroactive effect to this reverse stock split.

Warrants

In connection with its initial public offering, the Company issued warrants to purchase 400 common shares to the selling agent at an exercise price of $7.20 per share expiring in October 2010.

In connection with the convertible notes issued in April 2005 (see”Convertible Notes” below), the Company issued warrants to purchase 367 common shares at an exercise price of $4.80 per share.

In March 2005, the Company granted fully vested warrants to purchase 33 common shares at an exercise price of $6.00 per share to a consultant of the Company. In August 2005, the Company granted warrants to purchase 80 common shares at an exercise price of $6.30 per share to a consultant of the Company. These warrants vest ratably over three years beginning retroactively to October 2004. Total stock compensation expense related to these warrants during the year ended December 31, 2005 was $247. The fair value of the warrants was measured as they were earned using the Black-Scholes option pricing model and the following assumptions at December 31, 2005:  term—10 years; volatility—73.8%; risk-free interest rate—4.35%; and expected dividend yield of zero.

In connection with the issuance of  common stock by the Company from January 2004 to August 2004, the Company issued warrants to the selling agent to purchase 244 shares of common stock at an exercise price of $4.80. 200 of the warrants expire on March 24, 2009, and the remaining 44 warrants expire on August 15, 2009.

In October and December 2004, the Company granted warrants to purchase 253 shares of the Company’s common stock at a price of $6.00 per share to consultants of the Company. Of these warrants, warrants to purchase 170 shares vest over three years and have a ten-year term. The remaining warrants to purchase 83 shares vest based on design wins and have a five-year term. Total stock-based compensation expense related to these warrants during the years ended December 31, 2004 and 2005 and cumulative for the period from inception (April 14, 1997) through December 31, 2005 was $50, $515 and $565, respectively. Unvested stock-based compensation related to these warrants at December 31, 2005 was $840. The fair value of these warrants was measured as they were earned using the Black-Scholes option pricing model and the following assumptions at December 31, 2005: term—10 years; volatility—68%; risk-free interest rate—4.47%; and expected dividend yield of zero.

In the period between April 1, 2003 and July 31, 2003, the Company received proceeds of $5,304 net of $697 of offering costs, in exchange for 2,000 three-year warrants to purchase shares of the Company’s common stock. These warrants, which expire if not exercised three years after issuance, consisted of 1,000 Part A Warrants with an exercise price of $1.50 and 1,000 Part B Warrants with an exercise price of $2.25.

The warrants are redeemable at the Company’s option upon at least 30 days’ notice at a redemption price of $0.01 per warrant under any of the following circumstances:

·Part A and B Warrants are redeemable by the Company when any one of the following transactions closes: i) the sale, lease, exchange or other transfer, directly or indirectly, of all or substantially all of the assets of the Company, ii) the approval by the Company’s stockholders of any plan or proposal for the liquidation or dissolution of the Company, iii) any person or entity becomes the beneficial owner, directly or indirectly, of more than 50% of combined voting power of the outstanding securities of the Company, or iv) a merger or consolidation to which the Company’s stockholders represent less than 50% of the surviving company’s combined voting power of outstanding securities.

·Part A Warrants were redeemable by the Company when the Company gave notice that it had fabricated and successfully tested and demonstrated the functionality of its Field Programmable Object Array chip (the

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“Chip”) and also received commitments from at least two customers that will use the Chip in at least one of each customer’s design programs.

·Part B Warrants are redeemable by the Company when the Company gives notice that it has i) closed on a strategic investment from a company with significant financial resources (as defined) that is a participant in the semiconductor industry or a related industry, or ii) recognized total aggregate cumulative revenue from the sale or license of its silicon object chips of at least $2,500.

During 2004, the Company gave notice that it had achieved the milestones required to permit the Company to redeem the Part A warrants. In December 2004, the Company called for redemption of all Part A warrants. Proceeds from the exercise of Part A warrants to purchase 981 shares and Part B warrants to purchase 646 shares, whose holders voluntarily elected to exercise, were $2,645 net of offering costs of $279. The remaining Part A warrants to purchase 19 shares were exercised in December 2003 and January 2005.

In connection with the sale of warrants to purchase shares of the Company’s common stock from April to July 2003, the Company issued warrants to the selling agent to purchase 200 shares of the Company’s common stock at an exercise price of $4.89. Of these warrants, warrants to purchase 183 shares expire on June 29, 2008, and the remaining warrants to purchase 17 shares expire on July 7, 2008.

In connection with the issuance of common stock by the Company from April 2002 to August 2002, the Company issued warrants to the selling agent to purchase 146 shares of common stock at an exercise price of $10.50. The warrants expire on July 18, 2007.

In connection with the acquisition of DMC in August 2001, warrants to purchase shares of DMC common stock were converted to warrants to purchase 37 shares of the Company’s common stock at an exercise price of $7.76. Of these warrants, warrants to purchase 34 shares expired on various dates through December 31, 2005, and the remaining warrants to purchase 3 shares expire on various dates through March 2006.

In connection with the issuance of common stock by the Company in July and November 2000, the Company issued warrants to the selling agent to purchase 224 shares of common stock at an exercise price of $8.25. All of these warrants had expired as of December 31, 2005.

During December 2003, warrants to purchase 18 shares were exercised in exchange for a subscription receivable for $27. The subscription receivable was paid in January 2004.

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The following table summarizes warrant activity:

	Warrants Outstanding		Price Range Per Share
Warrants outstanding at beginning of period (inception)
Warrants issued in 2000	224		$	8.25
Outstanding at December 31, 2000	224		$	8.25
Warrants issued	36		$	7.77
Outstanding at December 31, 2001	260		$	7.77 - $8.25
Warrants issued	146		$	10.50
Outstanding at December 31, 2002	406		$	7.77 - $10.50
Warrants sold	2,000		$	1.50 - $2.25
Warrants issued	200		$	4.89
Warrants exercised	(18	)	$	1.50
Outstanding at December 31, 2003	2,588		$	1.50 - $10.50
Warrants issued	497		$	4.80 - $6.00
Warrants exercised	(1,627	)	$	1.50 - $2.25
Outstanding at December 31, 2004	1,458		$	1.50 - $10.50
Warrants issued	880		$	4.80 - $7.20
Warrants exercised	(101	)	$	1.50 - $2.25
Warrants expired	(253	)	$	7.77 - $8.25
Outstanding at December 31, 2005	1,984		$	1.50 - $10.50

Notes Receivable

In 1998 and 2000, the Company issued stock to certain stockholders totaling $15 and $230, respectively, under subscription agreements in exchange for notes receivable with no stated interest rate. In 1999 and 2000, the note holders repaid $15 and $230, respectively.

Restricted Stock

In 2004 and 2005, the Company issued 84 and 408 shares of restricted common stock to certain employees of the Company. These shares were granted effective upon the closing of the Company’s initial public offering and will vest on October 26, 2006 so long as the holders are then employees of the Company. The Company is recognizing compensation expense equal to the grant date fair value of the common shares ($2,741) pro rata over the one-year vesting period. During 2005, the Company recognized $447 of compensation expense related to these restricted shares, net of the reversal of $70 compensation expense recorded for 47 restricted shares cancelled before vesting. The remaining estimated compensation expense of $2,224 will be recognized over the remaining vesting period.

Convertible Notes

In April 2005, the Company issued 8% convertible notes totaling $5,500. The notes, which were due on April 28, 2006, bore interest at the rate of 8% per year and were convertible into shares of the Company’s common stock at a price per share equal to 80% of the issuance price of the Company’s stock in an initial public offering, if any. If an initial public offering did not occur on or before April 28, 2006 or any extended maturity date of the notes,

19

the notes would have been convertible into shares of the Company’s common stock at a price of $4.80 per share. The Company could have elected to extend the maturity of the notes for up to six months if an initial public offering had not closed on or before April 28, 2006. However, the notes were payable in full 30 days after the closing date an initial public offering.

In connection with the issuance of the convertible notes, the Company issued to the note holders warrants to purchase up to 367 shares of the Company’s common stock. The warrants, which have a five-year term, are exercisable at a price per share equal to 80% of the issuance price of the Company’s stock in an initial public offering ($4.80). If an initial public offering had not occurred on or before April 28, 2006 or any extended maturity date of the notes, the warrants would have become exercisable at a price of $4.80 per share.

The allocated fair value of the warrants of $1,126 and the value attributable to the beneficial price for conversion of the notes of $2,502 was accounted for as a discount on the convertible notes. The Company was amortizing this discount to interest expense over the original term of the notes. However, following completion of the Company’s initial public offering during the fourth quarter of 2005, the note holders elected to convert $5,430 of the notes and accrued interest into 1,128 shares of common stock, and the remaining $330 of notes and accrued interest was repaid on December 1, 2005 in accordance with the terms of the notes. The remaining unamortized discount on these notes was charged to interest expense during the quarter ended December 31, 2005. Interest expense recorded during the year ended December 31, 2005 related to amortization of the discount was $3,628.

The fair value of the warrants was determined using the Black-Scholes option pricing model and the following assumptions at the date of issuance:  term—five years; volatility—68%; risk-free interest rate—3.79%; and expected dividend yield of zero. The value of the conversion feature was determined using the most beneficial conversion price of the notes at the time of issuance ($4.80 per share) and taking into account the additional discount attributable to the allocated value of the warrants. This approach resulted in a per share conversion price for accounting purposes of approximately $3.81. When compared to the estimated fair value of the Company’s common stock at the time of the issuance of the notes ($6.00 per share), this accounting conversion price provides approximately a $2.19 conversion benefit to the note holders for each of the 1,146 shares into which the notes were convertible.

7.Stock Option Plan

In January 2002, the Company and its stockholders adopted the 2002 Combined Incentive and Nonstatutory Stock Option Plan (the “2002 Plan”). In April 2000, the Company and its stockholders adopted the 2000 Combined Incentive and Nonstatutory Stock Option Plan (the “2000 Plan”). Under the 2002 Plan and the 2000 Plan, 1,000 and 333 shares of the Company’s common stock were reserved for issuance of incentive and nonqualified stock options to directors, officers and employees of and advisers to the Company at exercise prices as determined by the Board of Directors on the date of grant, respectively. These options have exercise prices and vesting terms established by a committee of the Board of Directors at the time of each grant. Vesting terms of outstanding options are generally four years. In no event are the options exercisable more than ten years after the date of grant.

In October 2004, the Company adopted and in June 2005 its stockholders approved the 2004 Amended and Restated Long-Term Incentive Plan (the “2004 Plan”). Under the 2004 Plan, 1,334 shares of the Company’s common stock were reserved for the issuance of restricted stock and incentive and nonqualified stock options to directors, officers and employees of and advisors to the Company at exercise prices as determined by the Board of Directors on the date of grants, respectively.

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In connection with the acquisition of DMC (Note 4), the Company assumed DMC’s stock option plan. 744 shares of the Company’s common stock have been reserved for issuance under the assumed plan and the related options are included in the following table, which summarizes stock option plan activity:

	Shares Available for Grant		Number of Options		Weighted- Average Exercise Price
Outstanding at beginning of period (inception)
Shares reserved	333		—
Options granted in 2000	(187	)	187		$	6.80
Outstanding at December 31, 2000	146		187		$	6.80
Shares reserved for DMC assumed options	744		—
Options assumed from DMC acquisition	(744	)	744		$	1.54
Options granted	(95	)	95		$	8.25
Options cancelled	5		(5	)	$	8.25
Outstanding at December 31, 2001	56		1,021		$	3.10
Shares reserved	1,000		—
Options granted	(796	)	796		$	7.98
Options cancelled	358		(712	)	$	4.76
Options exercised	—		(12	)	$	7.01
Outstanding at December 31, 2002	618		1,093		$	5.50
Options granted	(174	)	174		$	4.89
Options cancelled	130		(183	)	$	6.38
Outstanding at December 31, 2003	574		1,084		$	5.26
Shares reserved	334		—
Options granted	(276	)	276		$	4.80
Options cancelled	128		(206	)	$	4.63
Options exercised	—		(1	)	$	0.87
Restricted stock issued	(84	)	—
Outstanding at December 31, 2004	676		1,153		$	5.79
Shares reserved	1,000		—
Options granted	(1,203	)	1,203		$	5.75
Options cancelled	319		(319	)	$	6.84
Restricted stock issued	(408	)	—
Restricted stock cancelled	47		—
Outstanding at December 31, 2005	431		2,037		$	5.60

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The following table summarizes information about stock options outstanding at December 31, 2005:

	Options Outstanding				Options Exercisable
		Weighted-
		Average	Weighted-			Weighted-
		Remaining	Average			Average
Range of	Number	Contractual	Exercise		Number	Exercise
Exercise Prices	Outstanding	Life	Price		Outstanding	Price
$  0.87	118	1.35	$	0.87	118	$	0.87
$  3.45-$4.89	993	7.47	$	4.72	321	$	4.53
$  5.25	38	4.24	$	5.25	38	$	5.25
$  5.85-$6.30	656	9.61	$	6.24	67	$	6.30
$  8.25	136	4.97	$	8.25	136	$	8.25
$10.50	96	5.88	$	10.50	79	$	10.50
	2,037				758

Stock options outstanding at December 31, 2005, include 56 options that were granted to nonemployees and 1,981 options that were granted to employees. During the year ended December 31, 2003, and cumulative for the period from inception (April 14, 1997) through December 31, 2005, total stock-based compensation expense related to options issued to nonemployees measured using the fair value method as prescribed by SFAS No. 123, was $26 and $142, respectively. Total stock-based compensation expense related to options issued to employees, including options assumed in connection with the acquisition of DMC, measured using the intrinsic value method, as prescribed by APB Opinion No. 25, was $148, $204 and $1,028 for the years ended December 31, 2003 and 2005 and cumulative for the period from inception (April 14, 1997) through December 31, 2005. Compensation expense related to employee stock options that will be amortized into future operating expenses was $932 at December 31, 2005.

The weighted-average fair value of employee options on the date of grant or assumption was as follows:

							Cumulative
							for the Period
							from Inception
							(April 14, 1997)
	Year Ended						Through
	December 31,						December 31,
	2003		2004		2005		2005
For options granted with exercise prices above the fair value of common stock	—		—		—		$	0.01
For options granted with exercise prices at the fair value of common stock	$	0.69	$	0.77	$	3.73	$	1.74
For options granted or assumed with exercise prices below the fair value of common stock	—		—		1.50		$	4.03

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For the purpose of determining fair values using the minimum value method for employee grants and the fair value method for nonemployee grants as prescribed by SFAS No. 123, the Company used the Black-Scholes option pricing model with the following weighted average assumptions:

	Year Ended
	December 31,
	2003		2004		2005
Expected option term—employee	5 years		5 years		5 years
Expected option term—nonemployee	4 years		N/A		N/A
Expected volatility factor—employee (before initial public offering)	0	%	0	%	0	%
Expected volatility factor—employee (after initial public offering)	N/A		N/A		73.8	%
Expected volatility factor—nonemployee	81.60		N/A		N/A
Expected dividend yield	0	%	0	%	0	%
Risk free interest rate—employee	3.01	%	3.51	%	4.35	%
Risk free interest rate—nonemployee	4.53	%	N/A		N/A

8.Income Taxes

The components of deferred income taxes are as follows:

	December 31,
	2004			2005
Net operating loss carryforwards	$	19,447		$	25,461
Research and experimentation credit carryforwards	2,503			2,669
Accrued expenses and stock options	257			822
Total deferred tax assets	22,207			28,952
Valuation allowance	(22,207		)	(28,952		)
Net deferred tax asset	$	—		$	—

The Company has established valuation allowances to fully offset its deferred tax assets due to uncertainty about the Company’s ability to generate the future taxable income necessary to realize these deferred tax assets, particularly in light of the Company’s recent history of significant operating losses. The valuation allowance increases by $6,745 in 2005. Future utilization of available net operating loss carryforwards may be limited under Internal Revenue Code Section 382 as a result of significant changes in ownership. These limitations could result in expiration of these net operating loss carryforwards before they are utilized.

For the years ended December 31, 2004 and 2005, and cumulative for the period from inception (April 14, 1997) through December 31, 2005, the Company has generated federal net operating loss carryforwards of approximately $8,650, $13,937 and $62,554, respectively.

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The Company’s federal net operating loss carryforwards and state net operating loss carryforwards expire in various calendar years from 2014 through 2025. Available research and development credit carryforwards at December 31, 2005, include federal and state amounts of $2,287 and $587, respectively, with expiration dates in calendar years 2015 through 2025.

The Company’s effective income tax rate differs from the U.S. Federal income tax rate as shown below:

	December 31,
	2004		2005
Tax expense (benefit) at the federal statutory rate	(35.00	)%	(35.00	)%
State income tax (benefit), net of federal income tax effect	(5.00	)%	(5.70	)%
Permanent differences	—		7.84	%
Other	(4.83	)%	(2.78	)%
Increase in valuation allowance	44.83	%	35.62	%
Effective tax rate	0.00	%	0.00	%

9.401(k) Savings Plan

During 2000, the Company established a defined contribution savings plan under Section 401(k) of the Internal Revenue Code. This plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. The Company may make contributions to the plan at the discretion of the Board of Directors. The Company has made no contributions to the plan.

10.Commitments

Operating Leases

The Company leases its office and research facilities and certain office equipment under noncancellable operating leases. Total rent expense under these operating leases was $1,403, $859, $1,074 for the years ended December 31, 2003, 2004 and 2005, respectively, and $4,102 cumulative for the period from inception (April 14, 1997) through December 31, 2005.

Future minimum lease payments under noncancellable operating leases at December 31, 2004, are as follows:

Year Ending December 31,
2006	$	1,288
2007	628
2008	269
2009	275
2010	283
2011 and thereafter	47
	$	2,790

Software License Agreements

The Company licenses certain internal use software under noncancellable license agreements. Future payments under noncancellable license agreements at December 31, 2005, were $301.

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PART IV

Item 15. Exhibits and Financial Statement Schedules

(b)           The following exhibits are filed herewith, and this list is the exhibit index.

Exhibit No.	Description of Exhibit	Page
23.1	Consent of PricewaterhouseCoopers LLP
31.01	Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934) (filed electronically herewith).
31.02	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934) (filed electronically herewith).

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K/A (Amendment No. 1) to be signed on its behalf by the undersigned, thereunto duly authorized.

Date:  October 26, 2006	MATHSTAR, INC.
	/s/  James W. Cruckshank
	James W. Cruckshank
	Vice Presidentof Administration  and Chief Financial Officer
	(Principal Financial Officer and Principal Accounting Officer)

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