Prepared by R.R. Donnelley Financial -- Form 10-Q

10-Q 1 d10q.htm FORM 10-Q Prepared by R.R. Donnelley Financial -- Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

[X]

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

For the quarterly period ended March 31, 2002

[ ]

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

For the transition period ____________ to ____________ .

Commission file number 000-29513

INSILICON CORPORATION

(Exact name of Registrant as specified in its charter)

Delaware		77-0526155
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

411 East Plumeria Drive, San Jose, California 95134

(Address of principal executive offices, including zip code)

(408) 894-1900

(Registrant’s telephone number, including area code)

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

YES		X				NO

As of April 30, 2002 there were 14,969,898, outstanding shares of the Registrant’s common stock, $.001 par value.

INSILICON CORPORATION

FORM 10-Q

INDEX

		Page

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets as of March 31, 2002 and September 30, 2001	3

	Condensed Consolidated Statements of Operations for the Three and Six Months Ended March 31, 2002 and 2001	4

	Condensed Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2002 and 2001	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28

PART II. OTHER INFORMATION

Item 4.	Submission of Matters to a Vote of Security Holders	29

Item 6.	Exhibits and Reports on Form 8-K

	Exhibits	29

	Reports on Form 8-K	29

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

I NSILICON CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

	March 31, 2002			September 30, 2001
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	27,463		$	32,040
Accounts receivable, net of allowances of $277 and $434 at March 31, 2002 and September 30, 2001		3,985			2,606
Other current assets		2,294			2,367

Total current assets		33,742			37,013
Property and equipment, net		840			1,405
Computer software costs, net		5,185			6,912
Goodwill and other intangible assets, net		6,143			6,879
Other assets		51			68

Total assets	$	45,961		$	52,277

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	287		$	658
Payroll and related liabilities		963			1,791
Payable to Phoenix Technologies Ltd.		1,155			1,143
Deferred revenue		2,996			3,124
Purchase consideration payable		—			1,226
Other accrued liabilities		1,798			1,764

Total current liabilities		7,199			9,706
Deferred income taxes		513			513

Commitments and contingencies

Stockholders’ equity:
Preferred stock, par value $0.001; 15,000 shares authorized, none outstanding		—			—
Exchangeable preferred stock, par value $0.001; unlimited shares authorized; 737 and 618 shares issued and outstanding at March 31, 2002 and September 30, 2001		1			1
Common stock, par value $0.001; 100,000 shares authorized, 14,962 and 14,404 shares issued and outstanding at March 31, 2002 and September 30, 2001		15			14
Additional paid-in capital		87,440			85,914
Deferred stock-based compensation		(366	)		(547	)
Accumulated deficit		(48,875	)		(43,338	)
Accumulated translation adjustment		34			14

Total stockholders’ equity		38,249			42,058

Total liabilities and stockholders’ equity	$	45,961		$	52,277

The accompanying notes are an integral part of the condensed consolidated financial statements.

INSILICON CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Three Months Ended March 31,						Six Months Ended March 31,
	2002			2001			2002			2001
Revenue:
License fees	$	3,568		$	3,840		$	6,819		$	8,660
Services		1,658			1,427			3,141			2,635

Total revenue (1)		5,226			5,267			9,960			11,295
Cost of revenue:
License fees		687			292			1,223			538
Services		76			70			131			193
Amortization of purchased technology		322			322			644			636
Restructuring-related write-down of purchased technology		—			—			847			—

Total cost of revenue		1,085			684			2,845			1,367

Gross margin		4,141			4,583			7,115			9,928
Operating expenses:
Research and development		1,774			3,181			3,988			5,363
Sales and marketing		1,913			2,426			3,802			4,751
General and administrative		1,145			1,492			2,259			2,339
Amortization of goodwill and intangible assets		602			1,078			1,163			1,662
Stock-based compensation		124			181			293			324
Restructuring charge		—			—			1,217			—

Total operating expenses		5,558			8,358			12,722			14,439

Loss from operations		(1,417	)		(3,775	)		(5,607	)		(4,511	)
Interest and other income, net		133			471			351			1,007

Loss before income taxes		(1,284	)		(3,304	)		(5,256	)		(3,504	)
Provision (benefit) for income taxes		111			(904	)		281			(904	)

Net loss	$	(1,395	)	$	(2,400	)	$	(5,537	)	$	(2,600	)

Net loss per share:
Basic and diluted	$	(0.09	)	$	(0.16	)	$	(0.36	)	$	(0.18	)

Shares used in per share calculation:
Basic and diluted		15,558			14,866			15,317			14,560

(1) Includes related party revenue from Phoenix Technologies Ltd.	$	31		$	179		$	252		$	952

The accompanying notes are an integral part of the condensed consolidated financial statements.

INSILICON CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Six Months Ended March 31,
	2002			2001
Cash flows from operating activities:
Net loss	$	(5,537	)	$	(2,600	)
Reconciliation of net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		2,587			2,652
Stock-based compensation		293			324
Restructuring and related charges		1,510			—
Change in operating assets and liabilities, net of effects from Xentec acquisition:
Accounts receivable		(1,379	)		2,264
Payable to Phoenix Technologies Ltd.		12			919
Other assets		90			(327	)
Accounts payable		(371	)		(1,187	)
Payroll and related liabilities		(466	)		(686	)
Deferred revenue		(128	)		380
Other accrued liabilities		(1,131	)		(1,342	)
Long-term obligations		—			(904	)

Total adjustments		1,017			2,093

Net cash used in operating activities		(4,520	)		(507	)

Cash flows from investing activities:
Purchases of property and equipment		(69	)		(568	)
Additions to computer software costs		(259	)		(843	)
Purchase of long-term investment		—			(500	)
Acquisition of Xentec, Inc.		—			(3,129	)

Net cash used in investing activities		(328	)		(5,040	)

Cash flows from financing activities:
Proceeds from stock purchases under stock option and stock purchase plans		251			501

Net cash provided by financing activities		251			501

Effect of exchange rate changes on cash and cash equivalents		20			(30	)

Net decrease in cash and cash equivalents		(4,577	)		(5,076	)
Cash and cash equivalents at beginning of period		32,040			38,181

Cash and cash equivalents at end of period	$	27,463		$	33,105

Supplemental disclosure of cash flow information:
Issuance of common stock, exchangeable preferred stock and stock options in connection with the acquisition of Xentec	$	1,289		$	8,167
Deferred stock compensation cost in connection with the acquisition of Xentec		—			(380	)

The accompanying notes are an integral part of the condensed consolidated financial statements.

INSILICON CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1. DESCRIPTION OF BUSINESS

inSilicon Corporation (“inSilicon” or the “Company”) provides communications semiconductor technology, or SIP, that is used by semiconductor and systems companies to design complex semiconductors called systems-on-a-chip, or SOCs, which are critical components of a wide variety of electronic products. The Company provides cores, related silicon subsystems and firmware to customers that use its technologies in digital devices ranging from network routers to handheld computers.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation. The accompanying condensed consolidated financial statements of inSilicon Corporation and its subsidiaries have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The consolidated balance sheet as of September 30, 2001 was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. The information included in this report should be read in conjunction with the Company’s consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2001.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to summarize fairly the Company’s financial position, results of operations and cash flows for the interim periods presented. All significant intercompany accounts and transactions have been eliminated. The operating results for the three and six months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2002 or for any other future period.

The Company was incorporated on November 1, 1999. Prior to that date, the Company was operated as a division of Phoenix Technologies Ltd. (“Phoenix”). As of November 30, 1999, the assets, liabilities and operations of the Company were contributed by Phoenix to inSilicon in exchange for 10.4 million shares of inSilicon’s Series A preferred stock and a warrant to purchase 50,000 shares of common stock. The Company completed an initial public offering in March of 2000, which generated net proceeds of $37.0 million. At that time, all shares of Series A Preferred Stock converted on a one-to-one basis into shares of common stock. As of March 31, 2002, Phoenix owned 10.4 million shares of the Company’s common stock (66.2% of our outstanding common and exchangeable preferred stock ). The Company’s condensed consolidated financial statements include certain costs and expenses incurred by Phoenix and allocated to the Company based upon certain pro rata metrics. See Note 6.

Revenue Recognition. The Company’s revenue is derived from license and re-use fees, royalties, engineering service fees and maintenance and support service fees generated primarily from systems and semiconductor companies. Revenue from software license and re-use fees is generally recognized when a non-cancelable license agreement has been signed, the software product has been shipped, there are no uncertainties surrounding product acceptance, the fees are fixed and determinable, and collection of the receivable is considered probable. Royalties are recognized in the quarter in which the royalty payment is either received from the customer or may be reasonably estimated. Engineering services revenue is generally recognized on a time-and-materials basis or when contractual milestones are met. Maintenance revenue, which relates principally to maintenance and support contracts, is generally recognized ratably over the contract period, which is typically one year. Deferred revenue consists primarily of billings under maintenance contracts in advance of revenue recognition, as well as software license fees that are

INSILICON CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

expected to be recorded as revenue when all uncertainties surrounding the acceptance of the product have been removed.

When a license agreement includes one or more elements to be delivered at a future date, the Company recognizes license revenues based upon the residual method after all elements other than maintenance and engineering services have been delivered. The Company uses vendor specific objective evidence of fair value for the services and the maintenance to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element. The Company recognizes maintenance revenues over the term of the maintenance contract and engineering services as time and materials are incurred as vendor specific objective evidence of fair value for maintenance and engineering services exist.

The Company also enters into a limited number of contracts for services. Such contracts are generally based upon time and material basis, however, revenues from certain fixed-price contracts are recognized on the percentage of completion basis in accordance with AICPA SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts,” which involves the use of estimates. The amount of consulting contracts recognized on a percentage of completion basis has not been material to date. The Company generally does not enter into consulting arrangements concurrent with license arrangements.

In accordance with paragraph 10 of Statement of Position 97-2, “Software Revenue Recognition,” vendor specific objective evidence of fair value of maintenance is determined by reference to the price the customer will be required to pay when it is sold separately (that is, the renewal rate). Generally, each license agreement offers additional maintenance renewal periods at a stated price.

Allowances for estimated returns and customer credits are recorded in the same period as the related revenue.

Use of Estimates. The preparation of the consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates are used for, but not limited to, the allowance for doubtful accounts receivable, sales returns, valuation of goodwill and intangible assets, valuation and realizability of capitalized computer software costs, useful lives for intangible assets and property and equipment, income taxes, and restructuring and related costs. Actual results could differ from these estimates. The operating results for the three and six months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2002, or for any other future period.

Income taxes. Income taxes are accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes.” The Company has not recorded a tax benefit for the carryforward of its’ operating loss because objective evidence was not available as of March 31, 2002 or September 30, 2001 to overcome uncertainty regarding the realizability of the deferred tax assets. Accordingly, a full valuation allowance was recorded against the net deferred tax assets. Income tax expense recorded in fiscal year 2002 is attributable to foreign withholding tax payments related to revenue generated in certain foreign countries in which the Company transacts business. These payments qualify for a foreign tax credit, but the deferred tax asset related to such tax credits was also fully reserved as of March 31, 2002.

Reclassifications. Certain amounts in the prior year’s financial statements have been reclassified to conform to the current year presentation.

INSILICON CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Net Loss Per Share. Basic and diluted net loss per share are calculated by dividing the net loss by the weighted average number of common and exchangeable preferred shares outstanding during the period. Options and warrants could potentially dilute basic earnings per share in the future, but were excluded from the calculation of diluted net loss per share as their effect is antidilutive for the periods presented. Had inSilicon been profitable in the three months ended March 31, 2002 and 2001, diluted earnings per share would have been impacted by the calculated effect using the treasury method of outstanding stock options of 115,000 and 143,000, respectively, and warrants of 50,000 and 50,000, respectively. Had inSilicon been profitable in the six months ended March 31, 2002 and 2001, diluted earnings per share would have been impacted by the calculated effect using the treasury method of outstanding stock options of 72,000 and 285,000, respectively, and warrants of 50,000 and 50,000, respectively.

Recently-issued accounting pronouncements. In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), which establishes new standards for goodwill and other intangible assets. Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually for impairment. Separable intangible assets that have a definite life will continue to be amortized over their useful lives. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to June 30, 2001, SFAS 142 is effective for fiscal years beginning after December 15, 2001. The Company will adopt SFAS 142 on October 1, 2002 when its new fiscal year begins. Upon the adoption of SFAS 142, the Company is required to make any necessary reclassifications in order to comply with the new criteria in SFAS 142 for recognition of intangible assets, and to then evaluate goodwill and intangible assets for impairment in accordance with the new rules of SFAS 142. Any impairment charge recognized upon adoption of SFAS 142 will be recorded in the statement of operations as a cumulative effect of a change in accounting principle. Since any potential impairment charge upon adoption is dependent on the fair value of the Company on the date of adoption, the amount of a charge, if any, will not be known until the date of adoption. At March 31, 2002, the Company had $5.3 million of goodwill, and other intangible assets totaling $0.8 million. Amortization expense for goodwill and other intangible assets was $602,000 and $1,163,000 during the three and six months ended March 31, 2002, respectively.

On October 3, 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), that is applicable to financial statements issued for fiscal years beginning after December 15, 2001. These new rules on asset impairment supersede FASB Statement 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and portions of APB Opinion 30, “Reporting the Results of Operations.” SFAS 144 provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. Classification as held-for-sale is an important distinction since such assets are not depreciated and are stated at the lower of fair value and carrying amount. SFAS 144 also requires expected future operating losses from discontinued operations to be displayed in the period(s) in which the losses are incurred, rather than as of the measurement date as presently required. The Company expects to adopt SFAS 144 on October 1, 2002 when its new fiscal year begins, and does not expect the adoption to have a material effect on the Company’s operating results or financial condition.

NOTE 3. RESTRUCTURING AND ASSET IMPAIRMENT CHARGES

INSILICON CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

leased office facilities at two locations, which resulted in a charge of approximately $249,000, consisting primarily of minimum rental payments through the termination of the leases in mid calendar year 2002. We recognized an impairment loss of $371,000 related to fixed assets used in the development of our products, primarily at our Japan research and development office which handled our Bluetooth product development, and we also recognized an impairment loss of $315,000 related to an assembled workforce intangible asset and acquisition costs which were recorded in connection with our acquisition of the wireless design services group of HD Lab in December 2000. The employees to which this intangible asset related were terminated in connection with the restructuring.

Because we decided to focus our efforts in fiscal 2002 on our core communication products, we terminated the development of our Bluetooth product line, and the related purchased and developed computer software costs with a carrying value of $1.7 million were subject to impairment review as of December 31, 2001. Our Bluetooth product was in the final stages of completion in the first quarter of fiscal 2002, and was scheduled for general release during the second quarter of fiscal 2002. In accordance with the requirements of SFAS 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed,” the software was written-down to estimated net realizable value. This product will be sold on an “as is” basis, without future development, product support, or maintenance. Future revenue was estimated based on expressed interest in the “as is” product from our existing customers, as well as a detailed market analysis of prospective customers. An impairment loss of $847,000 has been recorded in cost of revenue in the consolidated statement of operations for the six months ended March 31, 2002, based on the excess of the carrying value of the asset over estimated future revenue, net of estimated selling costs. Selling costs were estimated based upon historical experience, planned available resources, incentives, and anticipated time required to sell. We made assumptions regarding estimated future cash flows and other factors to determine the net realizable value. Cash flow calculations are based on management’s best estimates, using appropriate assumptions regarding projections of future product revenue and related expenses, among other factors. If these estimates or the facts underlying the related assumptions change in the future, we may be required to record additional impairment charges for the software. Beginning in the second quarter of fiscal 2002, the software is being amortized on the greater of a straight-line basis over a period of 12 months (the estimated remaining life of the product), or based on the ratio of current revenue to total anticipated revenue.

Of the total restructuring charge of approximately $2.1 million recorded in the first quarter of fiscal 2002, $847,000 related to product impairment has been included in cost of revenue, and $1,217,000 is included in operating expenses. Of the total operating expense of $1,217,000, $929,000 is related to research and development activities, $276,000 is related to sales and marketing expense, and $12,000 is related to general and administrative expense. Approximately $432,000 of the restructuring charge was paid during the six months ended March 31, 2002, and $123,000 is included in other accrued expenses at March 31, 2002. The $123,000 will be paid through the fourth quarter of fiscal 2002.

INSILICON CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

NOTE 4. COMPREHENSIVE INCOME (LOSS)

The Company has adopted Statement of Financial Accounting Standards No. 130 (“SFAS 130”), “Reporting Comprehensive Income,” which requires that all items that are required to be recognized under accounting standards as components of comprehensive income or losses (revenue, expenses, gains and losses) be included in comprehensive income or loss. Total comprehensive losses, which include currency translation adjustments, were not materially different from net losses incurred for the three and six months ended March 31, 2002 and 2001.

NOTE 5. GEOGRAPHIC REPORTING

The Company operates in one reportable industry segment, the development and sale of semiconductor intellectual property. The Company makes key decisions and evaluates performance of the Company based on this single industry segment.

Revenue by geographic region for the three and six months ended March 31, 2002 and 2001, was as follows (in thousands):

	Three Months Ended March 31,				Six Months Ended March 31,
	2002		2001		2002		2001
North America	$	3,609	$	2,946	$	5,858	$	6,332
Asia		1,162		649		3,007		2,625
Europe		455		1,672		1,095		2,338

Total revenue	$	5,226	$	5,267	$	9,960	$	11,295

INSILICON CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

NOTE 6. RELATED PARTY TRANSACTIONS

The Company has entered into a Technology Distributor Agreement and a Services and Cost Sharing Agreement with Phoenix. The Technology Distributor Agreement was effective from November 30, 1999, through April 30, 2002, at which time it was terminated by inSilicon. Under the terms of the Technology Distributor Agreement, Phoenix was licensed to distribute certain of the Company’s products in Asia and Phoenix paid the Company a sublicense fee related to such distribution. In February 2002 we entered into an agreement with a third-party distributor to replace the Technology Distributor Agreement .

Under the terms of the Services and Cost Sharing Agreement, Phoenix provides to the Company certain administrative services, such as data processing, telecommunications and information technology support, accounting, financial management, tax preparation and facilities management. These administrative costs are generally allocated to the Company based upon the aggregate cost of the services to Phoenix and the Company multiplied by the pro rata number of the Company’s employees. Generally, either party can terminate the Services and Cost Sharing Agreement on 30 days’ written notice. The Services and Cost-Sharing Agreement has been renewed on a month-to-month basis for all services and costs, and we anticipate the further extension of the agreement through fiscal year 2002. The combined impact of all related party transactions with Phoenix on the consolidated statements of operations is summarized below (in thousands):

	Three Months Ended March 31,				Six Months Ended March 31,
	2002		2001		2002		2001
Revenue	$	31	$	179	$	252	$	952


Costs and expenses:
Cost of revenue		2		3		86		126
Research and development		192		261		395		454
Sales and marketing		140		156		282		311
General and administrative		394		346		800		619

Total costs and expenses	$	728	$	766	$	1,563	$	1,510

During the six months ended March 31, 2002, the Company recognized $62,000 of revenue from a corporation whose Chairman and Chief Executive Officer is a director of the Company. At March 31, 2002, the Company had a $24,000 account receivable from this related party.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report on Form 10-Q, including without limitation this Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21(E) of the Securities Exchange Act of 1934, as amended. These statements include, but are not limited to, statements concerning expected price erosion, plans to make acquisitions, dispositions or strategic investments, expectation of increased sales to original equipment manufacturers, and plans to improve and enhance existing products and develop new products.

The forward-looking statements of the Company are subject to risks and uncertainties. Some of the factors that could cause future results to materially differ from our recent results or those projected in the forward-looking statements include, but are not limited to, significant increases or decreases in demand for our products, increased competition, lower prices and margins, failure to successfully develop and market new products and technologies, competitor introductions of superior products, continued industry consolidation, increased costs resulting from the Company’s separation from Phoenix, instability and currency fluctuations in international markets, product defects, failure to secure intellectual property rights, results of litigation, failure to integrate acquisitions and failure to retain and recruit key employees.

Company Overview

inSilicon Corporation (“inSilicon” or the “Company”) is a leading provider of communications technology that is used by semiconductor and systems companies to design complex semiconductors called systems-on-a-chip that are critical components of a wide variety of electronic products. We provide cores, related silicon subsystems and firmware to over 450 customers that use our technologies in hundreds of different digital devices ranging from network routers to handheld computers.

Prior to our incorporation on November 1, 1999, we operated as a division of Phoenix Technologies Ltd. (“Phoenix”). As of November 30, 1999, Phoenix transferred certain assets to us substantially in exchange for shares of our Series A Preferred Stock and the assumption of certain liabilities. We completed an initial public offering in March of 2000, which generated net proceeds of $37.0 million. At that time, all shares of Series A Preferred Stock converted on a one-to-one basis into shares of common stock. As of March 31, 2002, Phoenix owned 10.4 million shares of our common stock (66.2% of our outstanding common and exchangeable preferred stock).

At the time of separation from Phoenix, we entered into a Services and Cost-Sharing Agreement with Phoenix effective as of November 30, 1999. The services have included data processing, telecommunications, information technology support, accounting, financial management, tax preparation, payroll, stockholder and public relations, legal, human resources administration, procurement, real estate management and other administrative functions. The shared costs include the costs of the office space that we occupy at Phoenix’s headquarters and insurance premiums. Our portion of the costs is equal to the aggregate cost of the services for both companies multiplied by a percentage representing the number of our employees to the total number of employees for both companies. The Services and Cost-Sharing Agreement has been renewed on a month-to-month basis for all services and costs, and we anticipate the further extension of the agreement through fiscal year 2002. Generally, either party can terminate on 30 days’ written notice.

We have incurred operating and net losses for nearly all historical periods. These losses have primarily resulted from two factors: research and development and marketing costs incurred in order to generate market share and product development in order to support future revenue growth; and charges for restructurings, merger costs, and amortization of acquired intangible assets. See further discussion included in “Business Risks.”

You should not consider our historical financial statements to be representative of the operating results, financial position or cash flows to be expected in future periods or what the results of operations, financial position or cash flows would have been had we been a separate, stand-alone entity during the periods presented.

Critical Accounting Policies

Our significant accounting policies are more fully described in Note 2 to our consolidated financial statements. However, certain of our other accounting policies are particularly important to an understanding of our financial position and results of operations. The Company believes the following critical accounting policies effect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates are used for, but not limited to, the allowance for doubtful accounts receivable, sales returns, valuation of goodwill and intangible assets, valuation and realizability of capitalized computer software costs, useful lives for intangible assets and property and equipment, income taxes, and restructuring and related costs. Actual results could differ from these estimates. The operating results for the three and six months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2002, or for any other future period.

We record a provision for estimated sales returns against revenues in the same period that the related revenues are recorded. At March 31, 2002 and September 30, 2001, the allowance for sales returns was $171,000 and $319,000, respectively. This estimate is based on historical sales returns and other factors. Actual results could differ from these estimates.

We record a provision for doubtful accounts against general and administrative expenses in the same period that the related revenues are recorded. At March 31, 2002 and September 30, 2001, the allowance for doubtful accounts was $106,000 and $115,000, respectively. This estimate is based on historical bad debt write-offs, specific identification of probable bad debts based on collection efforts, and other factors. Actual results could differ from these estimates.

During the first quarter of fiscal year 2002, we recorded a restructuring reserve in connection with a workforce reduction plan. This reserve was based on estimates pertaining to employee separation costs and the settlement of contractual obligations resulting from our actions. Although we do not anticipate significant changes, the actual costs may differ from these estimates.

At March 31, 2002 and September 30, 2001, we had net goodwill and other intangible assets of $6.1 million and $6.9 million, respectively, and capitalized computer software costs of $5.2 million and $6.9 million, respectively. In assessing the recoverability of goodwill, other intangible assets, and capitalized computer software costs, we make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. Cash flow calculations are based on management’s best estimates, using appropriate assumptions regarding projections of future product revenue and related expenses, among other factors. If these estimates or the facts underlying the related assumptions change in the future, we may be required to record impairment charges for these assets. During the fourth quarter ended September 30, 2001, we recorded impairment charges in the amount of $9.4 million in connection with assets recorded through the acquisition of Xentec in December 2000. Also, as a result of the workforce reduction plan instituted in the first quarter of fiscal 2002, we recorded an impairment charge of $847,000 for capitalized computer software development costs and $315,000 for intangible assets.

Results of Operations

The following table includes Consolidated Statements of Operations data as a percentage of total revenue:

	Three months ended March 31,				Six months ended March 31,
	2002		2001		2002		2001
Revenue:
License fees	68.3	%	72.9	%	68.5	%	76.7	%
Services	31.7		27.1		31.5		23.3

Total revenue	100.0		100.0		100.0		100.0
Cost of revenue:
License fees	13.1		5.6		12.3		4.8
Services	1.5		1.3		1.3		1.7
Amortization of purchased technology	6.2		6.1		6.5		5.6
Restructuring-related write-down of purchased technology	—		—		8.5		—

Total cost of revenue	20.8		13.0		28.6		12.1

Gross margin	79.2		87.0		71.4		87.9

Operating expenses:
Research and development	33.9		60.4		40.0		47.5
Sales and marketing	36.6		46.1		38.2		42.0
General and administrative	21.9		28.3		22.7		20.7
Amortization of goodwill and intangible assets	11.5		20.5		11.7		14.7
Stock-based compensation	2.4		3.4		2.9		2.9
Restructuring charge	—		—		12.2		—

Total operating expenses	106.3		158.7		127.7		127.8

Loss from operations	(27.1	)	(71.7	)	(56.3	)	(39.9	)
Interest and other income, net	2.5		9.0		3.5		8.9

Loss before income taxes	(24.6	)	(62.7	)	(52.8	)	(31.0	)
Income tax expense (benefit)	2.1		(17.1	)	2.8		(8.0	)

Net loss	(26.7	)%	(45.6	)%	(55.6	)%	(23.0	)%

Revenue

Revenue for the three months ended March 31, 2002 was $5.2 million, a decrease of slightly less than 1% from the comparable period of fiscal 2001. In the second quarter of fiscal 2002 as compared to the second quarter of fiscal 2001, a $272,000 decrease in license revenue was largely offset by a $231,000 increase in revenue from services. The decline in license revenue is partially attributable to a $167,000 decline in related party license revenue from Phoenix Technologies Ltd. On April 30, 2002 we terminated the Technology Distributor Agreement with Phoenix, under which Phoenix distributed certain of our products to customers in specific countries in Asia. In February 2002 we entered into an agreement with a third-party distributor to replace the Technology Distributor Agreement, however no revenue was generated under this agreement in the second quarter of fiscal 2002, and there can be no assurance that any revenue generated in the future under this agreement will be comparable to the level of revenue earned under our agreement with Phoenix. The increase in services revenue in the second quarter of fiscal 2002 as compared to the comparable period of fiscal 2001 is attributable to a $315,000 increase in nonrecurring engineering services earned in our North America region.

For the six months ended March 31, 2002, revenue declined $1.3 million, or 12% from the comparable period of fiscal 2001. During the six months ended March 31, 2002 as compared to the comparable period of fiscal 2001, license revenue decreased $1.8 million, or 21%, while services revenue increased $506,000, or 19%. The decline in license revenue is attributable partly to a $736,000 decrease in related party license revenue from Phoenix, as well as lower levels of initial license fees from customers. We believe license revenue was negatively impacted by the cautious purchasing behavior of our customers, particularly during the first quarter of fiscal 2002 as compared to the first quarter of fiscal 2001. The increase in services revenue in the first half of fiscal 2002 as compared to the comparable period of fiscal 2001 is primarily attributable to an increased level of nonrecurring engineering services earned in our North America region.

Revenue by geographic region for the three and six months ended March 31, 2002 and 2001 was as follows (dollars in thousands):

	Amount				%Change		% of Consolidated Revenue
	2002		2001		%Change		2002		2001
Three months ended March 31:
North America	$	3,609	$	2,946	23	%	69	%	56	%
Asia		1,162		649	79	%	22	%	12	%
Europe		455		1,672	(73	)%	9	%	32	%

Total revenue	$	5,226	$	5,267	(1	)%	100	%	100	%


Six months ended March 31:
North America	$	5,858	$	6,332	(7	)%	59	%	56	%
Asia		3,007		2,625	15	%	30	%	23	%
Europe		1,095		2,338	(53	)%	11	%	21	%

Total revenue	$	9,960	$	11,295	(12	)%	100	%	100	%

North American revenue increased 23% in the second quarter of 2002 as compared to the second quarter of 2001 due in part to a $315,000 increase in nonrecurring engineering services revenue, as well as increased revenue from re-use fees. Revenue in our Asia region increased 79% in the second quarter of fiscal 2002 as compared to the comparable period of fiscal 2001 due to increased initial license and re-use revenue from our Taiwan office, which was more than sufficient to offset the decline in related party revenue from Phoenix. The decline in revenue in our Europe region in the second quarter of fiscal 2002 compared to the comparable period of fiscal 2001 was due primarily to one large nonrecurring customer transaction in the second quarter of 2001, which accounted for 64% of European revenue in the second quarter of 2001.

No customer accounted for more than 10% of our revenue in the three or six month periods ended March 31, 2002.

Gross Margin

Gross margin is revenue less cost of revenue. License fee cost of revenue generally consists of amortization of capitalized software development costs and costs of licensing certain technologies from third-party developers. Services cost of revenue includes internal payroll costs, third-party consulting costs associated with providing nonrecurring engineering services to customers, and related-party costs from Phoenix. Cost of revenue also includes amortization of technology capitalized in connection with the acquisition of other companies, and write-downs of purchased technology. Gross margin for the three and six months ended March 31, 2002 decreased 10% and 28%, respectively, from the corresponding periods of the prior year. As a percentage of revenue, the gross margin in the second quarter of fiscal 2002 was 79%, compared to 87% in the comparable period of fiscal 2001. The decline in the gross margin in the second quarter of fiscal 2002 reflects higher amortization of capitalized software development costs, particularly related to our Bluetooth product, which was released for sale in January 2002. Cost of revenue for the six months ended March 31, 2002 includes an $847,000 impairment loss related to the Bluetooth product, which was recorded in the first quarter of fiscal 2002. (See “Restructuring and Asset Impairment Charges”.) Excluding this write-down of purchased technology, the gross margin as a percentage of revenue for the six months ended March 31, 2002 was 80%, compared to 88% in the comparable period of fiscal 2001. The decline in the gross margin as a percentage of revenue for the six months ended March 31, 2002 reflects an increased level of amortization of capitalized software development costs, as well as an increase in licensing fees to third-party developers, particularly for certain of our USB 2.0 products.

Research and Development Expenses

Research and development expenses consist principally of payroll and related costs associated with the development of semiconductor intellectual property and related software, net of amounts capitalized. Research and development expenses in the second quarter of fiscal 2002 decreased by $1.4 million, or 44%, from the second quarter of fiscal 2001. Research and development expenses in the six months ended March 31, 2002 decreased by $1.4 million, or 26%, from the comparable period of fiscal 2001. The reduction in research and development expense is attributable primarily to the workforce reduction plan that was implemented in early December 2001. Engineering headcount decreased by 33% from March 31, 2001 to March 31, 2002. In addition, during the second quarter of fiscal 2002, $92,000 of development costs were capitalized as software development costs, while no such costs were capitalized in fiscal 2001. As a percentage of revenue, research and development expenses were 34% and 60% in the second quarters of fiscal 2002 and 2001, respectively, and 40% and 48% in the six month periods ended March 31, 2002 and 2001, respectively. The reduction in these percentages largely reflects the benefit of lower spending levels, offset partially by lower revenue in the first half of fiscal 2002

as compared to the first half of fiscal 2001. We expect our research and development expenses in the third quarter of fiscal 2002 to be consistent with the amount recorded in the second quarter of 2002.

Sales and Marketing Expenses

Sales and marketing expenses consist of costs related to advertising, public relations and other marketing, selling and distribution activities. These costs include direct out-of-pocket and payroll expenses. Sales and marketing expenses for the three months ended March 31, 2002, decreased $513,000 (21%) from the comparable period of fiscal 2001. During the first half of fiscal 2002, sales and marketing expenses decreased $949,000 (20%) from the first half of fiscal 2001. This decrease is attributable primarily to expense reductions within the Company’s marketing department which occurred primarily during the last half of fiscal 2001 and the first quarter of fiscal 2002, as we reduced expenditures in this area consistent with declining revenue. As a percentage of revenue, sales and marketing expenses were 37% and 46% in the second quarters of fiscal 2002 and 2001, respectively, and 38% and 42% in the six month periods ended March 31, 2002 and 2001, respectively. The reductions in these percentages reflect the benefit of lower spending levels, offset partially by lower revenue in the first half of fiscal 2002 as compared to the first half of fiscal 2001. We expect our sales and marketing expenses in the third quarter of fiscal 2002 to increase modestly over the amount recorded in the second quarter of 2002, as we plan to increase our marketing efforts consistent with an anticipated increase in demand for our products.

General and Administrative Expenses

General and administrative expenses consist of expenditures for executive, accounting, legal, personnel, recruiting and other administrative functions. General and administrative expenses for the three months ended March 31, 2002, decreased $347,000 (23%) from the corresponding period of fiscal 2001. General and administrative expenses in the six months ended March 31, 2002 decreased by $80,000, or 3%, from the comparable period of fiscal 2001. The decline in expenses in the second quarter of fiscal 2002 as compared to the second quarter of fiscal 2001 is attributable primarily to a $644,000 reduction in bad debt expense, offset partially by severance expenses of $294,000 incurred in connection with the resignation of the Company’s former President and Chief Executive Officer in February, 2002. During the six months ended March 31, 2002, the net impact of these items was offset partially by higher allocations of expense from Phoenix under the Services and Cost-Sharing Agreement, particularly in the first quarter of fiscal 2002 as compared to the first quarter of fiscal 2001. As a percentage of revenue, general and administrative expenses were 22% and 28% in the second quarters of fiscal 2002 and 2001, respectively, and 23% and 21% in the six month periods ended March 31, 2002 and 2001, respectively. The decrease in the second quarter of fiscal 2002 is attributable to lower expenses related to the factors noted above, while the slight increase from the first half of fiscal 2001 to the first half of fiscal 2002 is attributable to lower revenue.

Amortization of Goodwill and Intangible Assets

Amortization of intangible assets represents the straight-line amortization of goodwill and other intangible assets associated with the purchase of Sand Microelectronics, Inc. in September 1998, and Xentec, Inc., acquired in December 2000. Amortization expense for the three months ended March 31, 2002 decreased $476,000 (44%) from the corresponding period of fiscal year 2001. During the first six months of fiscal 2002, amortization expense decreased $499,000 (30%) from the first half of fiscal 2001. These declines are due primarily to the September 30, 2001 impairment charge of $9.4 million for goodwill generated from the December 2000 acquisition of Xentec, Inc. In addition, certain intangible assets associated with the Sand Microelectronics acquisition became fully amortized at the three-year anniversary of the acquisition in September 2001. In January 2002, in connection with the earn-out provisions of our merger agreement with Xentec’s shareholders, we issued 324,500 shares of exchangeable preferred stock, valued at $789,000. This amount has been recorded as goodwill, and is being amortized on straight-line basis over a five-year period. Because the future undiscounted cash

flows which are expected to be generated as a result of the Xentec acquisition are in excess of the carrying value of this goodwill and the other net assets of the acquired company, no impairment loss has been recognized for this goodwill. Beginning in fiscal year 2003, amortization of goodwill and intangible assets will be impacted by our adoption of SFAS No. 142 (See “Recently-issued Accounting Pronouncements”).

Stock-Based Compensation

Stock-based compensation expense consists of amortization of deferred stock compensation associated with stock options granted in December 1999, and stock options granted in connection with the acquisition of Xentec in December 2000, at exercise prices less than the fair market value of our stock at the grant date. Amortization expense related to these options is recognized as the options vest, and totaled $121,000 and $181,000 in the second quarters of fiscal 2002 and fiscal 2001, respectively. Amortization expense totaled $165,000 and $324,000 for the six months ended March 31, 2002 and 2001, respectively. At March 31, 2002, the unamortized balance of deferred stock-based compensation was $366,000. Stock-based compensation expense in the six months ended March 31, 2002 also included $125,000 earned in the first quarter of fiscal 2002, related to common stock with a fair value of $500,000 which was issued to former employees of Xentec in January 2002, based on their continued employment with us through December 2001.

Restructuring and Asset Impairment Charges

In December 2001, in an effort to align our operating expenses with the anticipated level of future revenue, we announced and implemented a workforce reduction plan which resulted in the elimination of approximately 20% of our workforce. As a result of this restructuring, charges totaling $2.1 million were recorded during the first quarter of fiscal 2002. In connection with the elimination of 27 positions, we recorded approximately $282,000 of severance costs. All of these terminations were completed by December 31, 2001. In addition, in December 2001 and early January 2002 we vacated leased office facilities at two locations, which resulted in a charge of approximately $249,000, consisting primarily of minimum rental payments through the termination of the leases in mid calendar year 2002. We recognized an impairment loss of $371,000 related to fixed assets used in the development of our products, primarily at our Japan research and development office which handled our Bluetooth product development, and we also recognized an impairment loss of $315,000 related to an assembled workforce intangible asset and acquisition costs which were recorded in connection with our acquisition of the wireless design services group of HD Lab in December 2000. The employees to which this intangible asset related were terminated in connection with the restructuring.

product revenue and related expenses, among other factors. If these estimates or the facts underlying the related assumptions change in the future, we may be required to record additional impairment charges for the software. Beginning in the second quarter of fiscal 2002, the software is being amortized on the greater of a straight-line basis over a period of 12 months (the estimated remaining life of the product), or based on the ratio of current revenue to total anticipated revenue.

Interest and other income, net

Interest and other income in the second quarter of fiscal 2002 decreased by $338,000, or 72%, from the comparable period of fiscal 2001, and decreased by $656,000, or 65%, during the six months ended March 31, 2002 as compared to the first half of fiscal 2001. These declines are due to lower balances of investable funds, as well as lower short-term interest rates in fiscal 2002 as compared to fiscal 2001.

Income Taxes

We recorded income tax expense of $111,000 for the three months ended March 31, 2002, compared to a tax benefit of $904,000 during the second quarter of fiscal 2001. For the six months ended March 31, 2002, income tax expense totaled $281,000, compared to a tax benefit of $904,000 in the first half of fiscal 2001. The tax benefit recognized in the second quarter and first half of fiscal 2001 represents the maximum benefit that could be recognized from deferred tax assets relating to net operating losses through March 31, 2001. During the six months ended March 31, 2002, we did not record a tax benefit for the carryforward of our operating loss because objective evidence was not available as of March 31, 2002 to overcome uncertainty regarding the realizability of our deferred tax assets. Accordingly, a full valuation allowance was recorded against our net deferred tax assets as of March 31, 2002. The expense recorded in the second quarter and first half of fiscal 2002 is attributable to foreign withholding tax payments related to revenue generated in certain foreign countries in which we transact business. These payments qualify for a foreign tax credit in our U.S. federal tax return, but the deferred tax asset related to such tax credits was also fully reserved as of March 31, 2002.

Liquidity and Capital Resources

At March 31, 2002, we had cash and cash equivalents $27.5 million, consisting of bank deposits and highly liquid securities with an original maturity of less than three months. Our existing balances of cash and cash equivalents are our primary source of liquidity. We presently have no lending arrangements with banks or other potential creditors.

Cash used in operating activities was $4.5 million for the six months ended March 31, 2002, as compared to cash used in operating activities of $507,000 for the six months ended March 31, 2001. Cash used in operating activities during the six months ended March 31, 2002 included the impact of our net loss of $5.5 million, reduced by non-cash charges for depreciation and amortization, stock-based compensation, and restructuring charges totaling $4.4 million. Additional cash was used in the first half of fiscal 2002 due to acquisition-related payments totaling $1.2 million. Accounts receivable increased

due to sales recorded late in the second quarter of 2002, and this increase accounted for a $1.4 million use of cash during the first half of fiscal 2002. Cash used by operating activities during the six months ended March 31, 2001, was primarily attributable to the pre-tax loss of $3.5 million, reduced by non-cash charges for depreciation and amortization, and stock-based compensation.

Cash used in investing activities was $328,000 for the six months ended March 31, 2002, due primarily to additions to computer software costs, including amounts capitalized for internal development. Cash used for investing activities in the first half of fiscal 2001 totaled $5.0 million, primarily due to purchases of Xentec, Inc., and the wireless design services group of HD Lab.

Net cash provided by financing activities was $251,000 for the six months ended March 31, 2002, and $501,000 during the comparable period of fiscal 2001. Net cash provided in both periods related to the proceeds from the exercise of common stock options and the issuance of stock under the employee stock purchase plan.

We expect our future liquidity and capital requirements to vary greatly from quarter to quarter, depending on numerous factors, including the cost, timing and success of product development efforts, the cost and timing of sales and marketing activities, the extent to which our existing and new technologies gain market acceptance, the number and complexity of communications standards, the level and timing of revenues, competing technological and market developments and the costs of maintaining and enforcing patent claims and other intellectual property rights. We believe that our present liquid assets, together with cash generated by our operations, if any, will be sufficient to meet our operating and capital requirements for at least the next 12 months. Thereafter, we believe we will be able to raise any additional funds required through public or private financings, strategic relationships or other arrangements. However, we cannot be certain that any such financing will be available on acceptable terms, or at all, and our failure to raise capital when needed could seriously harm our business. Additional equity financing may be dilutive to the holders of our common stock, and debt financing, if available, may involve restrictive covenants. Moreover, strategic relationships, if necessary to raise additional funds, may require that we relinquish our rights to certain technology.

Recently-issued Accounting Pronouncements

In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), which establishes new standards for goodwill and other intangible assets. Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually for impairment. Separable intangible assets that have a definite life will continue to be amortized over their useful lives. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to June 30, 2001, SFAS 142 is effective for fiscal years beginning after December 15, 2001. The Company will adopt SFAS 142 on October 1, 2002 when its new fiscal year begins. Upon the adoption of SFAS 142, the Company is required to make any necessary reclassifications in order to comply with the new criteria in SFAS 142 for recognition of intangible assets, and to then evaluate goodwill and intangible assets for impairment in accordance with the new rules of SFAS 142. Any impairment charge recognized upon adoption of SFAS 142 will be recorded in the statement of operations as a cumulative effect of a change in accounting principle. Since any potential impairment charge upon adoption is dependent on the fair value of the Company on the date of adoption, the amount of a charge, if any, will not be known until the date of adoption. At March 31, 2002, the Company had $5.3 million of goodwill, and other intangible assets totaling $0.8 million. Amortization expense for goodwill and other intangible assets was $602,000 and $1,163,000 during the three and six months ended March 31, 2002, respectively.

beginning after December 15, 2001. These new rules on asset impairment supersede FASB Statement 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and portions of APB Opinion 30, “Reporting the Results of Operations.” SFAS 144 provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. Classification as held-for-sale is an important distinction since such assets are not depreciated and are stated at the lower of fair value and carrying amount. SFAS 144 also requires expected future operating losses from discontinued operations to be displayed in the period(s) in which the losses are incurred, rather than as of the measurement date as presently required. The Company expects to adopt SFAS 144 on October 1, 2002 when its new fiscal year begins, and does not expect the adoption to have a material effect on the Company’s operating results or financial condition.

Business Risks

The additional following factors should be considered carefully when evaluating us and our business.

The unpredictability of our quarterly operating results may cause the price of our common stock to decline.

We expect our quarterly operating results to fluctuate significantly due to a variety of factors, many of which are outside of our control. Our revenue is difficult to predict and may fluctuate significantly from period to period. Because our expenses are largely independent of our revenue in any particular period, it is difficult to accurately forecast our operating results. Our operating expenses are based, in part, on anticipated future revenue and a high percentage of our expenses are fixed in the short term. As a result, if our revenue is below expectations in any quarter, the negative effect may be magnified by our inability to adjust spending in a timely manner to compensate for the revenue shortfall.

Factors that could cause our revenue and operating results to vary from quarter to quarter include:

•

shifts in demand for and average selling prices of semiconductors that incorporate our technology;

•

large orders or regional spending patterns unevenly spaced over time;

•

the financial terms of our contractual arrangements with our licensees and partners that may provide for significant up-front payments or payments based on the achievement of certain milestones;

•

the relative mix of license revenues, royalties and services;

•

the impact of competition on license revenue or royalty rates;

•

establishment or loss of strategic relationships with semiconductor or systems companies;

•

timing of new technologies and technology enhancements by us and our competitors;

•

seasonality of demand; and

•

changes in development schedules, research and development expenditure levels and product support by us and semiconductor and systems companies.

As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and, accordingly, that these comparisons should not be relied upon as indications of future performance. Due to these and other factors, it is likely that our operating results will be below

market analysts’ expectations in some future quarters, which would cause the market price of our stock to decline.

We have incurred net losses since our inception, and we may not achieve or sustain annual profitability.

We incurred net losses of $19.2 million for fiscal year 2001, $1.3 million for fiscal year 2000 and $12.1 million for fiscal year 1999, and had an accumulated deficit of $43.3 million as of September 30, 2001. Our net loss for the six months ended March 31, 2002 was $5.5 million, and our accumulated deficit was $48.9 million on March 31, 2002. Although we have experienced revenue growth in the past, we cannot assure you that we will be able to grow our revenue in future periods. If we do achieve annual profitability, we cannot be certain that we can sustain or increase profitability on a quarterly or annual basis in the future or at all. This may in turn cause our stock price to decline. In addition, if we do not achieve or sustain profitability in the future, we may be unable to continue our operations.

If semiconductor and systems companies do not adopt our semiconductor intellectual property and use it in the products they sell, our revenues will not grow.

The adoption and continued use of our semiconductor intellectual property by semiconductor and systems companies and an increasing demand for products requiring complex semiconductors, such as portable computing devices and cellular phones, is important to our continued success. The market for merchant semiconductor intellectual property has only recently begun to emerge. Our ability to achieve sustained revenue growth and profitability in the future will depend on the continued development of this market and, to a large extent, on the demand for complex semiconductors. There can be no assurance that the merchant semiconductor intellectual property and complex semiconductor markets will continue to develop or grow at a rate sufficient to support our business. If either of these markets fails to grow or develops slower than expected, our business, operating results and financial condition would be seriously harmed.

We face numerous risks in obtaining agreements with semiconductor and systems companies on terms beneficial to our business, including:

•

the lengthy and expensive process of building a relationship with a potential licensee or prospective partner;

•

the fact that we may compete with the internal development groups of semiconductor and systems companies;

•

the fact that we may be unable to persuade semiconductor and systems companies to rely on us for critical technology;

•

the fact that we may be unable to persuade potential licensees and partners to bear development costs associated with our communications technology;

•

the risk that even after our customers select our communications technology, they may not produce semiconductors using our communications technology; and

•

the risk that even if a particular semiconductor or systems company adopts our communications technology, that the customer may fail due to competition or lack of market acceptance of its products that use our communications technology.

We cannot assure you that we will be able to maintain our current relationships or establish new relationships with additional licensees or partners, and any failure by us to do so could seriously harm our business. None of our current licensees or partners is obligated to license new or future generations of our communications technology.

If we are not able to protect our intellectual property adequately, we will have less proprietary technology to license, which will reduce our revenues and profits.

Our patents, copyrights, trademarks, trade secrets and similar intellectual property are critical to our success. We rely on a combination of patent, trademark, copyright, mask work and trade secret laws to protect our proprietary rights. We own U.S. patents on various aspects of our technology and have several pending U.S. patent applications. We cannot be sure that patents will be issued from any patent applications submitted, that any patents we hold will not be challenged, invalidated or circumvented or that any claims allowed from our patents will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. In addition, the laws of foreign countries may not adequately protect our intellectual property as well as the laws of the United States.

We use various agreements including licenses, employee assignments, independent contractor, third-party nondisclosure, and assignments, to limit access to and distribution of our proprietary information and to obtain license rights or ownership of technology prepared on a work-for-hire or other basis. Even though we have taken all customary industry precautions, we cannot be sure that the steps we take to protect our intellectual property rights will be adequate to deter misappropriation of the rights or that we will be able to detect unauthorized uses and take immediate or effective steps to enforce our rights. We also cannot be sure that the steps we may take to obtain ownership of any contributed intellectual property will be sufficient to assure our ownership of all proprietary rights. We also rely on unpatented trade secrets to protect our proprietary technology, however, we cannot be certain that others will not independently develop or otherwise acquire the same or substantially equivalent technologies or otherwise gain access to our proprietary technology or disclose that technology. We also cannot be sure that we can ultimately protect our rights to our unpatented proprietary technology. In addition, third parties might obtain patent rights that could be used to assert infringement claims against us.

Third parties may claim we are infringing their intellectual property rights, and we could suffer significant litigation or licensing expenses or be prevented from licensing our technology.

Third parties may claim that we are infringing their intellectual property rights, and we may be found to infringe those intellectual property rights. While we do not believe that any of our technologies infringe the valid intellectual property rights of third parties, we may be unaware of intellectual property rights of others that may cover some of our technology and services.

Any litigation regarding patents or other intellectual property could be costly and time-consuming, and divert our management and key personnel from our business operations. The complexity of the technology involved and the uncertainty of the outcome of intellectual property litigation increase these risks. Claims of intellectual property infringement also might require us to enter into costly royalty or license agreements. However, we may not be able to obtain royalty or license agreements on terms acceptable to us, or at all. We also may be subject to significant damages or injunctions against development and licensing of certain of our technologies.

Any acquisitions we make could disrupt our business and harm our financial condition and results of operation.

As part of our growth strategy, we pursue the acquisition of other companies, assets and product lines that either complement or expand our existing business. During fiscal year 2001, we completed two acquisitions. Acquisitions involve a number of special risks, including the diversion of management’s attention to the assimilation of the operations and personnel of the acquired companies, adverse short-term effects on our operating results, integration of financial reporting systems and the amortization or impairment of acquired intangible assets. During fiscal year 2001, we recorded an impairment charge of $9.4 million as a result of the Xentec acquisition. Furthermore, as a result of the discontinuance of our Bluetooth product line in conjunction with the workforce reduction announced in December 2001, during

the first quarter of fiscal year 2002 we recorded an impairment charge of $1.2 million related to capitalized computer software costs and intangible assets. The Bluetooth technology was acquired primarily as a result of the HD Lab acquisition. There can be no assurance that we can successfully integrate acquired businesses or that such businesses will enhance our business. We are unable to predict the likelihood of a material acquisition being completed in the future. We may seek to finance any such acquisition through debt or additional equity financings, which could result in dilution and additional risk for the holders of our common stock.

We anticipate that one or more potential acquisition opportunities, including those that would be material, may become available in the near future. If and when appropriate acquisition opportunities become available, we intend to pursue them actively. No assurance can be given that any acquisition by us will or will not occur, that if an acquisition does occur that it will not materially and adversely affect us or that any such acquisition will be successful in enhancing our business. Our future results of operations will also depend in part on our ability to successfully expand internally by increasing the number of new product lines, and to manage any future growth. No assurance can be given that we will be able to obtain or integrate additional product lines or manage any future growth successfully.

The semiconductor intellectual property market is highly competitive, and we may lose market share to larger competitors with greater resources and to companies that develop their own semiconductor intellectual property using internal design teams.

We will face competition from both existing and new suppliers of semiconductor intellectual property that we anticipate will enter the market. We also compete with the internal development groups of large, vertically integrated semiconductor and systems companies. We also may face competition from suppliers of technologies based on new or emerging technology standards.

We must also differentiate our communications technology from those available or under development by other suppliers or the internal development groups of semiconductor and systems companies, including some of our current and prospective licensees. Many of these internal development groups have substantial programming and design resources and are part of larger organizations with substantial financial and marketing resources. These internal development groups may develop technologies that compete directly with ours or may actively seek to license their own technologies to third parties.

Many of our existing competitors, as well as a number of potential new competitors, have longer operating histories, greater brand recognition and larger customer bases, as well as greater financial and marketing resources, than we do. This may allow them to respond more quickly than we can to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources than we can to the development and promotion of their technologies.

Many of our products are based on standard communication protocols that are available to the general public. As new competitors enter the market, the introduction of competitive products based on these protocols may result in pricing pressure on our existing products, which could limit our ability to increase revenue.

If we are unable to develop enhancements and new generations of our intellectual property, we may be unable to attract or retain customers.

Our future success will depend on our ability to develop enhancements and new generations of our communications technology that satisfy the requirements of new and evolving standards and introduce these new technologies to the marketplace in a timely manner. If our development efforts are not successful or are significantly delayed, or if the characteristics of our communications technology are

not compatible with the requirements of specific product applications, we may be unable to attract or retain customers.

Technical innovations of the type critical to our success are inherently complex and involve several risks, including:

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our ability to anticipate and respond in a timely manner to changes in the requirements of semiconductor and systems companies;

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the emergence of new standards by semiconductor and systems companies;

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the significant research and development investment that is often required before market acceptance, if any, of a particular standard;

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the possibility that even after a significant investment of our resources, the standard will not become accepted by the industry; and

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the introduction of products by our competitors embodying new technologies or features.

Our failure to adequately address these risks could render our existing or future communications technology obsolete and could seriously harm our business. In addition, we cannot assure you that we will have the financial and other resources necessary to develop communications technology in the future, or that any enhancements or new generations of the technology that we develop or procure will generate revenue in excess of the costs of development or procurement.

Rapid product transitions or introductions of new standards may cause our technologies to become obsolete.

From time to time, we or our competitors may announce new technologies or capabilities that may replace or shorten the life cycles of our existing technologies. Announcements of currently planned or other new technologies may cause customers to defer or stop licensing our technologies until those new technologies become available. In addition, announcements of a new standard may cause customers to defer or stop licensing our technologies until that standard becomes available or accepted.

If we do not compete effectively with others to attract and retain key personnel, we may be unable to develop the new communications technology necessary to expand our business.

Our ability to continue to grow successfully requires an effective planning and management process. Since October 31, 1998, we increased our headcount substantially, from 51 employees at that date to 91 employees at October 31, 2000 and 119 employees at November 30, 2001. Since November 30, 2001, primarily as a result of our workforce reduction, our headcount decreased by 28 employees to 91 employees as of March 31, 2002.

Our growth has placed a strain on our resources. As a result of our workforce reduction, those employees remaining will need to bear a larger portion of the required workload. Semiconductor and systems company licensees typically require significant engineering support in the design, testing and manufacture of products incorporating our technology. Accordingly, increases in the adoption of our technology can be expected to increase the strain on our personnel, particularly our engineers.

We believe our future success will depend upon our ability to successfully manage our growth, including attracting and retaining engineers, other highly skilled personnel and senior managers. Our employees are “at will” and are not hired for a specified term. Hiring qualified sales and technical personnel will be difficult due to the limited number of qualified professionals. Competition for these types of employees is intense. We have, in the past, experienced difficulty in recruiting and retaining qualified sales and technical personnel. Our employees are recruited aggressively by our competitors and

by start-up companies. We believe our salaries are competitive, but under certain circumstances, start-up companies can offer more attractive stock option packages. As a result, we have experienced, and may continue to experience, significant employee turnover. Failure to attract and retain personnel, particularly sales and technical personnel, would materially harm our business.

As we seek to expand our operations, we may also significantly strain our financial and management systems and other resources. We cannot be certain that our systems, procedures, controls and facilities will be adequate to support our operations.

International sales of our products account for a significant portion of our revenue which exposes us to risks inherent in international operations.

We market and sell our products and services in the United States and internationally. International sales of our products and services accounted for approximately 31% of our total revenue for the quarter ending March 31, 2002. Our operations outside the United States also expose us to the following general risks associated with international operations:

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disruptions to commercial activities or damage to our facilities as a result of political unrest, war, terrorism, labor strikes and work stoppages;

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difficulties and costs of staffing and managing foreign operations;

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the impact of recessions in economies outside the United States;

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greater difficulty in accounts receivable collection and longer collection periods;

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potential adverse tax consequences, including higher tax rates generally in Asia;

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tariff’s, duties, price controls or other restrictions on foreign currencies or trade barriers imposed by foreign countries; and

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unexpected changes in regulatory requirements of foreign countries.

To the extent that such disruptions and costs interfere with our commercial activities, our results of operations could be harmed.

RISKS RELATED TO THE SEMICONDUCTOR INDUSTRY

A downturn in the semiconductor or electronics businesses would reduce our sales.

In the past our business has benefited from the rapid worldwide growth of the semiconductor industry, which in turn has been fueled by growth in telecommunications, computers and consumer electronics. Continued licenses of our technologies are largely dependent upon the commencement of new design projects by semiconductor and systems companies. However, the semiconductor industry is highly cyclical and subject to rapid technological change. It also has been subject to significant economic downturns at various times, characterized by diminished demand, accelerated erosion of average selling prices and production overcapacity. In addition, the semiconductor industry also periodically experiences increased demand and production capacity constraints. As a result, we may experience substantial period-to-period fluctuations in future operating results due to general semiconductor industry conditions, overall economic conditions or other factors. A number of semiconductor and systems companies have announced layoffs of their employees or the suspension of investment plans, and we have seen a drop-off in demand from these customers. In addition, there have been a number of

mergers in the electronics industry, which may reduce the aggregate level of licenses of our technologies and purchases of our services by the merged companies. Potential slower growth in the electronics industry, a reduced number of design starts, tightening of customers’ operating budgets or continued consolidation among our customers may seriously harm our business.

RISKS RELATED TO OUR SEPARATION FROM PHOENIX TECHNOLOGIES LTD. IN NOVEMBER 1999

We depend on agreements with Phoenix for many important services that may be hard to replace on a cost-effective basis if Phoenix terminates the agreements.

We have entered into agreements with Phoenix that have defined and will continue to define our business relationship. These agreements include a Services and Cost-Sharing Agreement, under which Phoenix provides various, primarily administrative, services to us, including accounting, treasury, tax and information services, and we share with Phoenix certain costs, including facilities and insurance. The Services and Cost-Sharing Agreement initially extended to June 30, 2000 for all services other than accounting; the term for accounting services initially extended to September 30, 2000. The Services and Cost-Sharing Agreement has been renewed on a month-to-month basis for all services and costs, and we anticipate the further extension of the agreement through fiscal year 2002. Generally, either party can terminate on 30 days’ written notice. Consequently, we cannot be sure how long Phoenix will continue to provide us services under the Services and Cost-Sharing Agreement and, if it does not, whether or on what terms we could obtain these services. If we cannot perform these services ourselves or obtain them on acceptable terms, this could materially harm our business. In addition, on April 30, 2002 we terminated a distribution agreement under which Phoenix has acted as a non-exclusive sales representative for us in certain Asian countries. In February 2002 we entered into an agreement with a third-party to replace Phoenix as our distributor, however, there can be no assurance that revenue, if any, generated in the future under this new agreement will be comparable to the level of revenue earned under our agreement with Phoenix.

Since Phoenix can elect all our directors and influence our business for its benefit for at least as long as it owns 50% or more of our shares, Phoenix can take actions beneficial to it at our expense.

For at least as long as Phoenix continues to own more than 50% of our common stock, Phoenix can direct the election of all our directors and exercise a controlling influence over our business, including any mergers or other business combinations, acquisitions or dispositions of assets, future issuances of our common stock or other equity securities, the incurrence of debt and the payment of dividends. Phoenix also can determine matters submitted to a vote of our stockholders without the consent of our other stockholders, prevent or cause a change in who controls us and take other actions that might be favorable to Phoenix.

We may have conflicts of interest with Phoenix that are not resolved in our favor.

We may have conflicts of interest with Phoenix in areas relating to our past and ongoing relationships, including potential competitive business activities, indemnity arrangements, tax and intellectual property matters, registration rights, potential acquisitions or financing transactions, sales or other dispositions by Phoenix of our shares of common stock it holds and the exercise by Phoenix of its ability to control our management and affairs. We also cannot be sure that any conflicts that may arise between us and Phoenix will be resolved in a manner that does not seriously harm us, even if Phoenix does not intend that result.

In addition, the ownership interests of our directors or officers in Phoenix common stock or service as both a director of inSilicon and an officer or director of Phoenix could create or appear to create potential conflicts of interest when directors and officers are faced with decisions that could have different implications for us and Phoenix. One of our current directors is a director and officer of Phoenix.

Loss of the Phoenix affiliation as a result of our separation from Phoenix may damage our relationships with existing licensees or partners or their perceptions of us, which could reduce our revenues.

Licensees of our communications technology or our strategic partners may have chosen our technologies because of the positive reputation of Phoenix or their economic ties to Phoenix. For example, Phoenix may also be a customer for their products. As a separate, stand-alone entity, we may not enjoy these advantages with those customers and partners and it may be harder for us to compete for their continued business. For example, our company name is not as well recognized as the Phoenix brand in certain markets, and as a result our technology licensing could suffer. The loss of the “Phoenix” brand name may hinder our ability to establish new relationships with potential customers and partners, particularly in Asia. In addition, our current customers, suppliers and partners may react negatively to the separation. Although we believe we have all necessary rights to use the brand name “inSilicon,” our rights to use it may be challenged by others.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company’s exposure to the impact of interest rate changes, currency fluctuations, and changes in the market values of its investments has not changed materially from that described in the Company’s Form 10-K Annual Report for the fiscal year ended September 30, 2001.

PART II. OTHER INFORMATION

I TEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company held an Annual Meeting of its Stockholders on February 12, 2002, at which the following occurred:

a) ELECTION OF DIRECTORS: The stockholders elected Raymond J. Farnham to serve until the 2005 Annual Meeting of Stockholders. The vote on the matter was as follows:

		For		Against
Raymond J. Farnham		13,511,915		765,995

b) APPROVAL OF 2000 EMPLOYEE STOCK PURCHASE PLAN, AS AMENDED: The stockholders approved an amendment to the 2000 Employee Stock Purchase Plan to increase the number of shares authorized for issuance thereunder by 300,000 shares to a total of 639,164 shares. There were 14,063,640 votes cast for the amendment, 185,236 votes cast against the amendment, 29,034 abstentions, and no broker non-votes.

c) APPOINTMENT OF INDEPENDENT AUDITORS: The stockholders ratified the selection of Ernst & Young LLP as the Company’s independent public accountants for the current fiscal year. There were 14,260,277 votes cast for the proposal, 15,053 votes cast against the proposal, 2,580 abstentions, and no broker non-votes.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

a) Exhibits.

No additional exhibits since the filing of the Company’s Annual Report on Form 10-K on December 27, 2001.

b) Reports on Form 8-K.

The Company filed three Reports on Form 8-K during the quarter ended March 31, 2002. Information regarding the items reported on is as follows:

Date of Report (as Filed)		Item Reported On
January 24, 2002		The Company announced its financial results for the first fiscal quarter ended December 31, 2001.

February 7, 2002		The Company announced the appointment of Barry A. Hoberman to interim Chief Executive Officer.

March 12, 2002		The Company announced that AMD has licensed inSilicon’s USB 2.0 Transceiver IP for use in future AMD chip designs, and that Oak Technology, Inc. has integrated inSilicon’s USB 2.0 PHY into its new OTI-4110 chip for personal imaging and printing applications.

SIGNATURE

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

		INSILICON CORPORATION

Date:	May 10, 2002	By:	/s/ BRYAN J. LEBLANC
			Bryan J. LeBlanc Executive Vice President and Chief Financial Officer