ARTISAN COMPONENTS INC
10-Q, 1999-02-12
SEMICONDUCTORS & RELATED DEVICES
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<PAGE>   1

================================================================================

                                  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 period ended December 31, 1998

                                       OR

[ ]      Transition report pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934

Commission file number:  000-23649

                            ARTISAN COMPONENTS, INC.
             (Exact name of registrant as specified in its charter)

               DELAWARE                                77-0278185
   (State or other jurisdiction of       (I.R.S. Employer Identification Number)
    incorporation or organization)

                               1195 Bordeaux Drive
                           Sunnyvale, California 94089
                    (Address of principal executive offices)

                         Telephone Number (408) 734-5600
              (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 December 31, 1998 there were 13,387,437 shares of the Registrant's Common
Stock outstanding.


================================================================================

<PAGE>   2

                             ARTISAN COMPONENTS, INC.

                                   Form 10-Q

                                     INDEX


<TABLE>
<CAPTION>
                                                                        Page No.
                                                                        --------
<S>                                                                     <C>
Cover Page..................................................................1
Index.......................................................................2

PART I - Financial Information

     ITEM 1 - Financial statements

     Condensed Balance Sheets - December 31, 1998 and September 30, 1998....3
     Condensed Statements of Operations
                Three Months Ended December 31, 1998 and 1997...............4
     Condensed Statements of Cash Flows -- Three Months Ended
                 December 31, 1998 and 1997.................................5
     Notes to Condensed Financial Statements................................6

     ITEM 2 - Management's Discussion and Analysis of Financial
                 Condition and Results of Operations........................9

PART II - Other Information

     ITEM 2 - Changes in Securities and Use of Proceeds....................26

     ITEM 6 - Exhibits.....................................................27

Signatures.................................................................28
</TABLE>



                                       2
<PAGE>   3

                           ARTISAN  COMPONENTS, INC.
                           CONDENSED BALANCE SHEETS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)


<TABLE>
<CAPTION>
                                                        DECEMBER 31      SEPTEMBER 30,
                                                          -------          -------
                                                           1998             1998(1)
                                                          -------          -------
                                                        (UNAUDITED)
<S>                                                     <C>              <C>
                       ASSETS
Current assets:
  Cash and cash equivalents ....................          $35,637          $36,516
  Contract receivables (net of allowance of
   $724 and $430 at December 31, 1998 and
   September 30, 1998, respectively) ...........            5,856            5,052
  Marketable securities ........................           11,598           10,688
  Prepaid expenses and other current assets ....            1,777            1,350
                                                          -------          -------
    Total current assets .......................           54,868           53,606
Property and equipment, net ....................            6,866            5,387
Deferred tax asset .............................               82               82
Other assets ...................................              367              414
                                                          -------          -------
    Total assets ...............................          $62,183          $59,489
                                                          =======          =======
        LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
  Accounts payable and accrued expenses ........          $ 3,542          $ 1,704
  Deferred tax liability .......................              976              976
  Deferred revenue .............................            2,525            1,052
                                                          -------          -------
    Total current liabilities ..................            7,043            3,732
Deferred rent ..................................               69               53
Deferred revenue and other long term liabilities              142              165
                                                          -------          -------
    Total liabilities ..........................            7,254            3,950
                                                          -------          -------
Stockholders' Equity:
 Convertible Preferred Stock, $0.001 par value:
  Authorized: 5,000 shares at December 31, 1998
   and September 30, 1998
  Issued and outstanding: None at December 31,
   1998 and September 30, 1998 .................               --               --
 Common Stock, $0.001 par value:
  Authorized: 50,000 shares;
  Issued and outstanding: 13,387 and 13,368
   shares at December 31, 1998 and September 30,
   1998, respectively ..........................               13               13
 Additional paid in capital ....................           52,297           52,235
 Retained earnings .............................            2,619            3,291
                                                          -------          -------
    Total stockholders' equity .................           54,929           55,539
                                                          -------          -------
    Total liabilities and stockholders' equity .          $62,183          $59,489
                                                          =======          =======
</TABLE>

- -------
(1) Derived from the Registrant's audited Balance Sheet as of September 30,
1998.

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



                                       3
<PAGE>   4

                            ARTISAN COMPONENTS, INC.

                         CONDENSED STATEMENTS OF OPERATIONS

                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                  (UNAUDITED)


<TABLE>
<CAPTION>
                                                      THREE MONTHS
                                                    ENDED DECEMBER 31,
                                               ---------------------------
                                                 1998               1997
                                               --------           --------
<S>                                            <C>                <C>     
Revenue .............................          $  3,036           $  3,329
Cost and expenses:
  Cost of revenue ...................             1,304              1,024
  Product development ...............             1,031                843
  Sales and marketing ...............             1,068                785
  General and administrative ........               836                455
                                               --------           --------
    Total cost and expenses .........             4,239              3,107
                                               --------           --------
Operating (loss) income .............            (1,203)               222
Other income ........................               456                115
                                               --------           --------
(Loss) income before provision
   for income taxes .................              (747)               337
(Benefit) provision for income
   taxes ............................               (75)               130
                                               --------           --------
Net (loss) income ...................          $   (672)          $    207
                                               ========           ========
Basic net (loss) income per share ...          $  (0.05)          $   0.04
                                               ========           ========
Diluted net (loss) income per share .          $  (0.05)          $   0.02
                                               ========           ========
Shares used in computing:
  Basic net (loss) income per share .            13,380              5,705
  Diluted net (loss) income per share            13,380             10,060
</TABLE>



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



                                       4
<PAGE>   5

                             ARTISAN COMPONENTS, INC.

                       CONDENSED STATEMENTS OF CASH FLOWS
                                   (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                       THREE MONTHS
                                                          ENDED
                                                       DECEMBER 31,
                                               ---------------------------
                                                 1998               1997
                                               --------           --------
<S>                                           <C>                <C>
Cash flows from operating activities:
  Net (loss) income .................          $   (672)          $    207
  Adjustments to reconcile net
   (loss) income to net cash provided
   by operating activities:
    Depreciation and
     amortization ...................               555                310
    Gain on sale/disposal of
     fixed assets ...................               (18)                --
    Provision for doubtful
     accounts .......................               294                 --
    Compensation expense for
     options granted ................                22                 12
    Changes in assets and
     liabilities:
      Contract receivables ..........            (1,098)              (494)
      Deferred revenue ..............             1,450                772
      Prepaid expenses and other
       assets .......................              (380)              (503)
      Deferred rent .................                16                 (2)
      Deferred taxes ................                --               (102)
      Accounts payable and
       other liabilities ............               302                503
                                               --------           --------
        Net cash provided by
         operating activities .......               471                703
                                               --------           --------
Cash flows from investing activities:
  Acquisition of property and
   equipment ........................              (510)            (1,728)
  Proceeds from sale of property
   and equipment ....................                30                 --
  Purchase of marketable
   securities .......................              (910)                --
  Proceeds from sale of
   marketable securities ............                --                986
                                               --------           --------
        Net cash used in
         investing activities .......            (1,390)              (742)
                                               --------           --------
Cash flows from financing activities:
  Proceeds from issuance of
   Common Stock .....................                40                  7
                                               --------           --------
        Net cash provided by
         financing activities .......                40                  7
                                               --------           --------
Net (decrease) in cash
 and cash equivalents ...............              (879)               (32)
Cash and cash equivalents,
 beginning of period ................            36,516              1,069
                                               --------           --------
Cash and cash equivalents,
 end of period ......................          $ 35,637           $  1,037
                                               ========           ========
CASH PAID FOR:
  Income taxes ......................          $     --           $     10
                                               ========           ========
SUPPLEMENTAL DISCLOSURE OF
 NONCASH ACTIVITIES:
  Fixed asset acquisitions in
   exchange for accounts payable ....          $  1,536           $     50
                                               ========           ========
Compensation expense for
   options granted ..................          $     22           $     12
                                               ========           ========
</TABLE>



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



                                       5
<PAGE>   6

                             ARTISAN COMPONENTS, INC.

                    NOTES TO CONDENSED FINANCIAL STATEMENTS
                                  (Unaudited)


1.   BASIS OF PRESENTATION:

         The accompanying unaudited condensed financial statements of ARTISAN
COMPONENTS, INC. (the "Company") have been prepared in accordance with generally
accepted accounting principles ("GAAP") for interim financial information and in
accordance with the rules and regulations of the Securities and Exchange
Commission. Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring adjustments)
considered necessary for a fair presentation have been included. The year end
balance sheet data was derived from the audited financial statements and does
not include all disclosures required by GAAP. Operating results for the three
month period ended December 31, 1998 are not necessarily indicative of the
results that may be expected for the fiscal year ending September 30, 1999 or
any other future period. The unaudited, condensed, interim financial statements
contained herein should be read in conjunction with the audited financial
statements and footnotes for the year ended September 30, 1998 included in the
Company's Annual Report on Form 10-K as filed with the Securities and Exchange
Commission on December 23, 1998.

2. EARNINGS PER SHARE (EPS) DISCLOSURES:

         The Company adopted the provisions of Statement of Financial Accounting
Standards No. 128, Earnings Per Share ("SFAS 128") effective December 31, 1997.
SFAS 128 requires the presentation of basic and diluted earnings per share.
Basic EPS is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
is computed giving effect to all dilutive potential common shares that were
outstanding during the period. Dilutive potential common shares consist of the
incremental common shares issuable upon the conversion of convertible preferred
stock (using the "if converted" method) and exercise of stock options and
warrants for all periods. Dilutive potential common shares are not included
during periods in which the Company experienced a net loss as the impact would
be anti-dilutive. All prior period earnings per share amounts have been restated
to comply with SFAS 128.



<PAGE>   7

                            ARTISAN COMPONENTS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED)
                                  (Unaudited)


2. EARNINGS PER SHARE (EPS) DISCLOSURES (con't):

         In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted EPS is
provided as follows (in thousands, except per share amounts).



<TABLE>
<CAPTION>
                                                    THREE MONTHS ENDED
                                                       DECEMBER 31,
                                                ---------------------------
                                                  1998               1997
                                                --------           --------
                                                        (Unaudited)
<S>                                             <C>                <C>     
Numerator--Basic and Diluted EPS
  Net (loss) income ..................          $   (672)          $    207
                                                ========           ========
Denominator--Basic EPS
  Common stock outstanding ...........            13,380              5,705
                                                --------           --------
Basic net (loss) income per share ....          $  (0.05)          $   0.04
                                                ========           ========
Denominator--Diluted EPS
  Denominator--Basic EPS .............            13,380              5,705
  Effect of Dilutive Securities:
    Common stock options and warrant .                --                969
    Convertible preferred stock ......                --              3,386
                                                --------           --------
                                                  13,380             10,060
                                                --------           --------
Diluted net (loss) income per share ..          $  (0.05)          $   0.02
                                                ========           ========
</TABLE>

         Stock options to purchase 2,384,551 shares of Common Stock at prices
ranging from $0.01 to $17.125 per share were outstanding at December 31, 1998
but were not included in the computation of diluted net (loss) income per share,
because they were anti-dilutive.

3.  NEW ACCOUNTING STANDARDS:

         In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes
standards for reporting and displaying comprehensive income and its components
in financial statements. The Company implemented SFAS No. 130 during the first
quarter of fiscal 1999 and has restated the prior periods presented to comply
with SFAS No. 130. There was no difference between the Company's net (loss)
income and its total comprehensive income for the three month periods ended
December 31, 1998 and December 31, 1997.



<PAGE>   8

                           ARTISAN COMPONENTS, INC.
              NOTES TO CONDENSED FINANCIAL STATEMENTS--CONTINUED
                                  (Unaudited)


         In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for reporting information about operating segments in annual financial
statements and requires the reporting of selected information about operating
segments in interim financial reports issued to stockholders. SFAS No. 131 is
effective for the Company's 1999 fiscal year that commenced October 1, 1998,
with interim reporting required in the second year of application. The Company
currently operates in only one industry segment, and therefore considers that
SFAS No. 131 will not have any impact on the disclosures in the financial
statements.

         In March 1998, the Accounting Standards Executive Committee issued SOP
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" which is effective for fiscal years beginning after December 15,
1998. SOP 98-1 provides guidance on accounting for the costs of computer
software developed or obtained for internal use. The adoption of SOP 98-1 is not
expected to have a material impact on the Company.

4. STOCKHOLDERS' EQUITY:

         On February 6, 1998, the Company completed the public offering of
3,015,000 shares of Common Stock under a registration statement declared
effective by the Securities and Exchange Commission on February 2, 1998 that
resulted in aggregate proceeds of $30,150,000 and underwriting commissions and
discounts of $2,110,500. In connection with such public offering, certain
stockholders of the Company sold an additional 320,000 shares of the Company's
Common Stock.

         On May 5, 1998, the Company completed the public offering of 956,190
shares of Common Stock under a registration statement declared effective by the
Securities and Exchange Commission on April 29, 1998 that resulted in aggregate
proceeds of $17,211,420 and underwriting commissions and discounts of $946,628.
In connection with such offering, certain stockholders of the Company sold an
additional 2,343,810 shares of the Company's Common Stock.



<PAGE>   9

                            ARTISAN COMPONENTS, INC.
                     Management's Discussion and Analysis of
                 Financial Condition and Results of Operations


         The following discussion should be read in conjunction with the
Condensed Unaudited Financial Statements and the Notes thereto included
elsewhere herein and the audited financial statements contained in the Company's
Annual Report on Form 10-K for the year ended September 30, 1998 as filed with
the Securities and Exchange Commission. The following 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 21E of the Securities Exchange Act of 1934,
as amended. The forward looking statements contained herein are based on current
expectations and entail various risks and uncertainties that could cause actual
results to differ materially from those expressed in such forward looking
statements. For a more detailed discussion of these and other business risks,
see "--Factors Affecting Future Operating Results."

OVERVIEW

         Artisan Components, Inc. ("Artisan" or the "Company") is a leading
developer of high performance, low power and high density embedded memory and
other intellectual property ("IP") components for the design and manufacture of
complex integrated circuits ("ICs"). The Company licenses its products to
semiconductor manufacturers and fabless semiconductor companies for the design
of ICs used in complex, high volume applications, such as portable computing
devices, cellular phones, consumer multimedia products, automotive electronics,
personal computers and workstations.

         Revenue consists of license fees received under the terms of license
agreements with customers to provide the Company's IP component products.
Typically, a customer licenses one or more products that are accompanied by
layout databases, views to support a customer's IC design tool environment and
design methodology documentation. The license of the Company's products
typically involves a sales cycle of six to 12 months and often coincides with a
customer's migration to a new manufacturing process. The Company's contracts
generally require a customer to pay a license fee to Artisan ranging from
approximately $300,000 to $700,000 for each product delivered under a contract.
A contract typically calls for an upfront payment of approximately one third of
the full contract value with the remainder due upon delivery, generally three to
six months later. See "--Factors Affecting Future Operating Results--Lengthy
Sales Cycle and Design Process."

         To date, the substantial majority of the Company's revenue has been
recognized on a percentage of completion method. Provisions for estimated losses
on the uncompleted contracts are recognized in the period in which the
likelihood of such losses is determined. As the completion period for a project
generally ranges from three to six months, revenue in any quarter is dependent
on the Company's progress toward completion of the project. There can be no
assurance that the Company's estimates will be accurate, and, in the event they
are not, the Company's business, operating results and financial condition in
subsequent periods could be materially adversely affected.



<PAGE>   10

         Currently, license fees represent substantially all of the Company's
revenue. Beginning in late fiscal 1996, however, the Company began
implementation of a royalty based business model that is intended to generate
revenue from both license fees and future royalties. Royalties will be based on
per unit sales of ICs and will generally vary in proportion to the silicon area
of an IC occupied by the Company's IP components. To date, the Company has
received no royalty revenue, and it does not anticipate receiving any until late
fiscal 1999 due to the typical length of time required for the Company to design
a component for a customer and for such customer to design, manufacture and
bring to market a product incorporating such component. There can be no
assurance that the Company will be successful in expanding the number of royalty
bearing contracts with customers. The Company generally licenses its products on
a nonexclusive, worldwide basis to major semiconductor manufacturers and grants
these manufacturers the right to distribute the Company's IP components to their
internal design teams and to fabless semiconductor companies that manufacture at
the same facility. Given that Artisan provides its products early in the
customer's IC design process, there will be a significant delay between the
delivery of a product and the generation of royalty revenue. There can be no
assurance that the Company will receive any royalty revenue or that, if it does,
the amount will be significant. See "--Factors Affecting Future Operating
Results--Dependence on New Business Model."

         The Company has been dependent on a relatively small number of
customers for a substantial portion of its revenue, although the customers
comprising this group have changed from time to time. In the three month period
ended December 31, 1998, Taiwan Semiconductor Manufacturing Corporation ("TSMC")
and UMC Group ("UMC Group") accounted for 48% and 36% of revenue, respectively.
In the three month period ended December 31, 1997, OKI Electric Industry Co.,
Ltd. ("OKI"), Fujitsu Microelectronics, Inc. ("Fujitsu"), ATI Technologies, Inc.
("ATI"), ST-MICROELECTRONICS S.r.l. ("ST") and NEC Electronics, Inc. ("NEC")
accounted for 21%, 18%, 17%, 16% and 14% of revenue, respectively. The Company
anticipates that its revenue will continue to depend on a limited number of
major customers for the foreseeable future, although the companies considered to
be major customers and the percentage of revenue represented by each major
customer may vary from period to period depending on the addition of new
contracts and the number of designs utilizing the Company's products. The
limited number of semiconductor manufacturers to which the Company can license
its products may also have a material adverse effect on the Company's business,
operating results and financial condition if any of the Company's customers
suffers a deterioration in financial condition or there is a decline in the
demand for the semiconductors produced by such manufacturers. For example, in
the three month period ended December 31, 1998, the Company experienced delays
in customer projects primarily due to the financial and/or business condition of
two of its customers that caused the Company to fall short of revenue
expectations and also resulted in an operating loss for that period. The
Company's business, operating results and financial condition may be materially
adversely affected if such customers' project delays continue and/or new or
other customers delay new bookings or fail to place anticipated orders. See
"--Factors Affecting Future Operating Results--Customer Concentration; Limited
Customer Base."

         A substantial portion of the Company's revenue is derived from
customers outside the United States. In the three month periods ended December
31, 1998 and 1997, revenue from customers outside the United States, primarily
in Asia and Europe, represented approximately 95% and 60%, respectively, of the
Company's revenue. The Company anticipates that international revenue will
remain a substantial portion of its revenue in the future. To date, all of the



<PAGE>   11

revenue from international customers has been denominated in U.S. dollars. See
"--Factors Affecting Future Operating Results--Risks Associated with
International Customers."

         The Company derives substantially all of its revenue from sales of its
memory and standard cell products that, together, accounted for 89% and 98% of
revenue in the three month periods ended December 31, 1998 and 1997,
respectively. The Company expects that memory products, in combination with
standard cell products, will continue to account for a substantial portion of
the Company's revenue for the foreseeable future. There can be no assurance that
the Company will continue to derive revenue from memory or standard cell
products and a decline in revenue from such products would have a material
adverse effect on the Company's business, operating results and financial
condition. The Company's future financial performance will depend in significant
part on the successful development, introduction and customer acceptance of new
products.

         Since the Company's inception in April 1991, each of the Company's cost
and expense categories has progressively increased as the Company has added
personnel and increased its activities in these areas. The Company intends to
continue making significant expenditures, particularly those associated with
engineering and sales and marketing, and expects that these costs and expenses
will continue to be a large percentage of revenue in future periods. Whether
such expenses increase or decrease as a percentage of revenue will be
substantially dependent upon the rate of change of the Company's revenue.

         The Company in the past has experienced delays in the progress of
certain projects, and there can be no assurance that such delays will not occur
in the future. Any delay or failure to achieve such progress could result in
damage to customer relationships and the Company's reputation, under-utilization
of engineering resources or a delay in the market acceptance of the Company's
products, any of which could have a material adverse effect on the Company's
business, operating results and financial condition. In addition, the Company's
contracts with customers generally may be canceled without cause, and if a
customer cancels or delays performance under any such contracts, the Company's
business, operating results and financial condition could be materially
adversely affected. The Company's costs and expenses will be based in part on
the Company's expectations of future revenue from license fees. Accordingly, if
the Company does not realize its expected revenue, its business, operating
results and financial condition could be materially adversely affected. For
example, in the three month period ended December 31, 1998, the Company
experienced delays in customer projects due to the financial and/or business
condition of some of its customers that caused the Company to fall short of
revenue expectations and also resulted in an operating loss for that period. The
Company does not expect that the rate of growth of its revenues in fiscal 1998
will be sustainable in fiscal 1999 due to deterioration in the demand for
semiconductors generally, potentially leading to a decline in new bookings and
increasing the likelihood of delays in current projects due to the financial
and/or business condition of some of the Company's customers. See "--Factors
Affecting Future Operating Results--Fluctuations in Operating Results."

         In connection with the grant of options for the purchase of 96,200
shares of Common Stock to employees during the period from December 1996 through
March 1997, the Company recorded aggregate deferred compensation of
approximately $198,000 representing the difference between the deemed fair value
of the Common Stock and the option exercise price at the date of grant. Such
deferred compensation is amortized over the vesting period relating to the
options, 



<PAGE>   12

of which approximately $12,000 was amortized during the three month period ended
December 31, 1998. All of such amounts were recorded in product development
expenses. In addition, the amortization will result in charges over the next
nine quarters aggregating approximately $11,000 per quarter, all of which will
be recorded in product development expenses.

RESULTS OF OPERATIONS

         The following table sets forth for the periods indicated selected
statements of operations data as a percentage of revenue:


<TABLE>
<CAPTION>
                                          THREE MONTHS ENDED
                                             DECEMBER 31,
                                        ----------------------
                                        1998             1997
                                        -----            -----
<S>                                     <C>              <C>   
Revenue ......................          100.0%           100.0%
Cost and expenses:
  Cost of revenue ............           42.9             30.7
  Product development ........           34.0             25.3
  Sales and marketing ........           35.2             23.6
  General and
   administrative ............           27.5             13.7
                                        -----            -----
    Total cost and expenses ..          139.6             93.3
                                        -----            -----
Operating (loss) income ......          (39.6)             6.7
Other income, net ............           15.0              3.4
                                        -----            -----
(Loss) income before provision
 for income taxes ............          (24.6)            10.1
(Benefit) provision for income
 taxes .......................           (2.5)             3.9
                                        -----            -----
Net (loss) income ............          (22.1)%            6.2%
                                        =====            =====
</TABLE>

Revenue

         Revenue decreased by 8.8% from $3.3 million in the three month period
ended December 31, 1997 to $3.0 million in the three month period ended December
31, 1998. The decline in revenue in the three month period ended December 31,
1998 as compared with the same period in fiscal 1998 was primarily attributable
to a decrease in licensing revenue for the Company's memory and standard cell
products, which was partially offset by an increase in license revenue for I/O
products and the recognition of revenues from support contracts.

Cost and Expenses

         Engineering Costs. Engineering costs are allocated between cost of
revenue and product development expenses. Engineering efforts devoted to
developing products for specific customer projects are recognized as cost of
revenue. The balance of engineering costs, incurred for general development of
Artisan's technology, is charged to product development. Engineering costs
generally are charged as incurred and do not necessarily correspond to the
recognition of 



<PAGE>   13

revenue under related contracts. Engineering costs increased by 25.1% from $1.9
million in the three month period ended December 31, 1997 to $2.3 million in the
three month period ended December 31, 1998. Engineering costs as a percentage of
revenue increased from 56.0% in the three month period ended December 31, 1997
to 77.0% in the three month period ended December 31, 1998. The absolute dollar
increase in engineering costs in the three month period ended December 31, 1998,
as compared with the same period in fiscal 1998, was primarily due to an
increase in engineering headcount and, to a lesser extent, purchases of computer
equipment, software tools and networking infrastructure and equipment.

                  Cost of Revenue. Cost of revenue increased by 27.3% from $1.0
         million in the three month period ended December 31, 1997 to $1.3
         million in the three month period ended December 31, 1998. Cost of
         revenue as a percentage of revenue was 30.7% and 42.9% for the three
         month periods ended December 31, 1997 and 1998, respectively. The
         absolute dollar increase in cost of revenue in the three month period
         ended December 31, 1998, as compared with the same period of fiscal
         1998, was due to an increase in headcount and costs associated with
         delivering product to, and supporting, a growing customer base.

                  Product Development Expenses. Product development expenses
         increased by 22.3% from $843,000 in the three month period ended
         December 31, 1997 to $1.0 million in the three month period ended
         December 31, 1998. Product development expenses as a percentage of
         revenue increased from 25.3% to 34.0% in the three month periods ended
         December 31, 1997 and 1998, respectively. The increase in product
         development expenses in the three month period ended December 31, 1998,
         as compared with the same period in fiscal 1998, was attributable to an
         increase in engineering headcount and, to a lesser extent, purchases of
         computer equipment, software tools and networking infrastructure and
         equipment.

         Sales and Marketing Expenses. Sales and marketing expenses include
salaries, commissions, travel expenses and costs associated with trade shows,
advertising and other marketing efforts. Costs of pre-sale customer support are
also charged to sales and marketing. Sales and marketing expenses increased by
36.1% from $785,000 in the three month period ended December 31, 1997 to $1.1
million in the three month period ended December 31, 1998. Sales and marketing
expense as a percentage of revenue increased from 23.6% to 35.2% in the three
month periods ended December 31, 1997 and 1998, respectively. The increase in
absolute dollars in sales and marketing expenses in the three month period ended
December 31, 1998, as compared with the same period in fiscal 1998, was
primarily attributable to increases in sales and marketing headcount,
commissions expense and travel to support an expanded customer coverage model.

         General and Administrative Expenses. General and administrative
expenses increased by 83.7% from $455,000 in the three month period ended
December 31, 1997 to $836,000 in the three month period ended December 31, 1998.
As a percentage of revenue, general and administrative expenses increased from
13.7% to 27.5% in the three month periods ended December 31, 1997 and 1998,
respectively. The absolute dollar increase in general and administrative
expenses in the first quarter of fiscal 1999 as compared with the same period in
fiscal 1998, was primarily due to an increase in the provision for doubtful
accounts receivable related to deterioration in the financial and/or business
condition of two of the Company's customers.



<PAGE>   14

Other Income

         Other income increased by 296.5% from $115,000 in the three month
period ended December 31, 1997 to $456,000 in the three month period ended
December 31, 1998. Other income as a percentage of revenue increased from 3.4%
to 15.0% for the three month periods ended December 31, 1997 and 1998,
respectively. The growth in other income in the three month period ended
December 31, 1998, as compared with the same period in fiscal 1998, primarily
reflects interest income earned on the proceeds from the Company's February 1998
initial public offering and the Company's April 1998 public offering.

Income Taxes

         The income tax provision was $130,000 for the three month period ended
December 31, 1997 and for the three month period ended December 31, 1998, the
income tax benefit was $75,000. The effective tax rate decreased from 38.6% to a
benefit of 10.0% for the three month periods ended December 31, 1997 and 1998,
respectively. The decrease in effective tax rates for the respective periods was
primarily due to the operating loss recorded by the Company in the first quarter
of fiscal 1999 and was also due to the Company investing the proceeds from its
public offerings in securities that are exempt from federal taxation.

LIQUIDITY AND CAPITAL RESOURCES

         The Company has funded its operations primarily from license revenue
received from inception to December 31, 1998, the net proceeds of $27.1 million
from its February 1998 initial public offering of Common Stock, the net proceeds
of $15.8 million from its April 1998 public offering of Common Stock and, to a
lesser extent, the proceeds of approximately $7.7 million from the sale of
Preferred Stock and a warrant.

         The Company's operating activities provided net cash of $703,000 and
$471,000 in the three month periods ended December 31, 1997 and 1998,
respectively. Net cash provided by operating activities in the three month
period ended December 31, 1997 was due to net income, depreciation and
amortization, an increase in deferred revenue and increases in accounts payable
and other liabilities, and was partially offset by an increase in contract
receivables and an increase in prepaid expenses and other assets. Net cash
provided by operating activities in the three month period ended December 31,
1998 was due to depreciation and amortization, an increase in deferred revenue
and increases in accounts payable and other liabilities and was partially offset
by the Company's net loss, an increase in net contract receivables and an
increase in prepaid expenses and other assets.

         Net cash used in investing activities was $742,000 and $1.4 million in
the three month periods ended December 31, 1997 and 1998, respectively. In the
three month period ended December 31, 1997, investing activities consisted
primarily of purchases of property and equipment partially offset by proceeds
from sales of marketable securities. In the three month period ended December
31, 1998, investing activities consisted of purchases of property and equipment
and purchases of marketable securities.

         Net cash provided by financing activities was $7,000 and $40,000 in the
three month periods ended December 31, 1997 and 1998, respectively. Net cash
provided by financing activities in both periods consisted of proceeds from the
issuance of Common Stock.



<PAGE>   15

         At December 31, 1998, the Company had cash, cash equivalents and
current marketable securities of $47.2 million. As of December 31, 1998, the
Company had retained earnings of $2.6 million and working capital of $47.8
million, including the current portion of deferred revenue of $2.5 million.

         The Company intends to continue to invest heavily in the development of
new products and enhancements to its existing products. The Company's future
liquidity and capital requirements will depend upon numerous factors, including
the costs and timing of expansion of product development efforts and the success
of these development efforts, the costs and timing of expansion of sales and
marketing activities, the extent to which the Company's existing and new
products gain market acceptance, competing technological and market
developments, the costs involved in maintaining and enforcing patent claims and
other intellectual property rights, the level and timing of license revenue,
available borrowings under line of credit arrangements and other factors. The
Company believes that its current cash and investment balances and any cash
generated from operations and from available or future debt financing will be
sufficient to meet the Company's operating and capital requirements for at least
the next 12 months. The Company anticipates spending approximately $2.6 million
for capital expenditures over the next 12 months. However, from time to time,
the Company may be required to raise additional funds through public or private
financing, strategic relationships or other arrangements. There can be no
assurance that such funding, if needed, will be available on terms attractive to
the Company, or at all. Furthermore, any additional equity financing may be
dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. Strategic arrangements, if necessary to raise additional
funds, may require the Company to relinquish its rights to certain of its
technologies or products. The failure of the Company to raise capital when
needed could have a material adverse effect on the Company's business, operating
results and financial condition. See "--Factors Affecting Future Operating
Results--Future Capital Needs; Uncertainty of Additional Funding."

NEW ACCOUNTING STANDARDS

         In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes
standards for reporting and displaying comprehensive income and its components
in financial statements. The Company implemented SFAS No. 130 during the first
quarter of fiscal 1999 and has restated all prior periods presented to comply
with SFAS No. 130. There was no difference between the Company's net (loss)
income and its total comprehensive income for the three month periods ended
December 31, 1998 and December 31, 1997.

         In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for reporting information about operating segments in annual financial
statements and requires the reporting of selected information about operating
segments in interim financial reports issued to stockholders. SFAS No. 131 is
effective for the Company's 1999 fiscal year that commenced October 1, 1998,
with interim reporting required in the second year of application. The Company
currently operates in only one industry segment, and therefore considers that
SFAS No. 131 will not have any impact on the disclosures in the financial
statements.

         In March 1998, the Accounting Standards Executive Committee issued SOP
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" which is effective for fiscal years beginning after December 15,



<PAGE>   16

1998. SOP 98-1 provides guidance on accounting for the costs of computer
software developed or obtained for internal use. The adoption of SOP 98-1 is not
expected to have a material impact on the Company.

YEAR 2000 READINESS

The Year 2000 issue is the result of computer programs being written using two
digits rather than four digits to define the applicable year. In other words,
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. The Company is currently reviewing its products and its
internal use systems and software in order to identify and modify those
products, systems and software that are not Year 2000 compliant. The costs
associated with this review effort are not incremental to the Company and
represent a reallocation of existing resources. Additionally, in the normal
course of business, the Company has made capital investments in certain third
party software and hardware systems to address its operational needs. These
systems, which are intended to improve efficiency and productivity, have been
certified Year 2000 compliant by the respective vendors and have been or will be
installed by July 31, 1999. To date, all of these capital projects were part of
the Company's capital plan and their timing was not accelerated as a result of
the Year 2000 issue. Total estimated expenditures related to these capital
projects for the quarter ended December 31, 1998 were $2.0 million. While the
Company believes it has made substantial progress in resolving all identified
Year 2000 issues, additional testing is planned during fiscal 1999 to reasonably
ensure Year 2000 readiness. Irrespective of the outcome of such testing, the
Company believes it will be able to continue to conduct its business, possibly
at reduced volume, using its existing Year 2000 compliant systems and software
until any remaining Year 2000 issues have been resolved. The Company is also
reviewing its building and utility systems (heat, light, phones, etc.) for the
impact of the Year 2000 issue. Many of these systems are Year 2000 ready.
Although there can be no assurance that the Company will be able to complete any
required modifications prior to the year 2000, that unanticipated events will
not occur, or that the Company will be able to identify any remaining Year 2000
issues before problems manifest themselves, it is management's belief that the
Company is taking adequate action to address all related issues. Management does
not expect the financial impact of Year 2000 compliance to be material to the
Company's financial position, results of operations or cash flows.

         The Company has begun to conduct an analysis to determine the extent to
which its major suppliers' systems (insofar as they relate to the Company's
business) are subject to the Year 2000 issue. The Company is currently unable to
predict the extent to which the Year 2000 issue will affect its suppliers or the
extent to which it would be vulnerable to its suppliers' failure to remediate
any Year 2000 issues on a timely basis. The failure of a major supplier to
convert its systems on a timely basis to those that are Year 2000 compliant or a
conversion that is incompatible with the Company's systems could have a material
adverse effect on the business, financial condition or results of operations of
the Company.

         The Company's products work in combination with semiconductor designs
and planning tools in environments developed by other vendors and interact with
other operating environments. It is likely that, commencing in the year 2000,
the functionality of certain operating environments will be adversely affected
when one or more component products of the environment is unable to process
four-digit characters representing years and, therefore, the operating
environment would not be Year 2000 compliant. There can be no assurance that the
Company's fully compliant products will be able to function properly when



<PAGE>   17

integrated with other vendors' noncompliant component products. Nor can there be
any assurance that the failure of certain operating environments with which the
Company's products work in combination will not have a material adverse effect
on the business, financial condition or results of operation of the Company.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         The Company's exposure to market risk for changes in interest rates
relates primarily to the Company's investment portfolio. The Company places its
investments with high credit issuers and, by policy, limits the amount of credit
exposure to any one issuer. As stated in its policy, the Company is averse to
principal loss and seeks to preserve its invested funds by limiting default
risk, market risk and reinvestment risk.

         The Company mitigates default risk by investing in high credit quality
securities and by positioning its portfolio to respond appropriately to a
significant reduction in a credit rating of any investment issuer or guarantor.
The portfolio includes only marketable securities with active secondary or
resale markets to ensure portfolio liquidity.

         The table below presents the carrying value and related weighted
average interest rates for the Company's investment portfolio. The carrying
value approximates fair value at December 31, 1998. All investments mature in
one year or less.

<TABLE>
<CAPTION>
                                                             AVERAGE RATE OF
                                                                RETURN AT
                                         CARRYING VALUE     DECEMBER 31, 1998
                                         --------------     -----------------
                                          (IN THOUSANDS)       (ANNUALIZED)
<S>                                      <C>                <C>
INVESTMENT SECURITIES:
Cash Equivalents - variable rate             $ 1,915             4.86%
Money market funds - variable rate           $    72             1.25%
Short-term investments - fixed rate          $45,248             3.75%
                                             -------
       Total investment securities           $47,235
                                             =======
</TABLE>

FACTORS AFFECTING FUTURE OPERATING RESULTS

         FLUCTUATIONS IN OPERATING RESULTS. The Company's operating results have
fluctuated in the past as a result of a number of factors including the
relatively large size and small number of customer orders during a given period;
the timing of customer orders; delays in the design process due to changes by a
customer to its order after it is placed; the Company's ability to achieve
progress on percentage of completion contracts; the length of the Company's
sales cycle; the Company's ability to develop, introduce and market new products
and product enhancements; the timing of new product announcements and
introductions by the Company and its competitors; market acceptance of the
Company's products; the demand for semiconductors and end user products that
incorporate semiconductors; and general economic conditions. The Company's
future operating results may fluctuate from quarter to quarter and on an annual
basis as a result of these and other factors, in particular the relatively large
size and small number of customer orders during a given period and the rate of
royalties recognized in a given period. Accordingly, it is likely that in some
future quarter the Company's operating results will be below the expectations of
public market analysts and investors. In such event, 



<PAGE>   18

the price of the Company's Common Stock would likely decline, perhaps
substantially. For example, on December 16, 1998, the Company announced that it
expected revenue in the fiscal quarter ended December 31, 1998 to be lower than
industry analysts' expectations. The limited number of semiconductor
manufacturers to which the Company can license its products may also have a
material adverse effect on the Company's business, operating results and
financial condition if any of the Company's customers suffers a deterioration in
financial condition or there is a decline in the demand for the semiconductors
produced by such manufacturers. For example, in the three month period ended
December 31, 1998, the Company experienced delays in customer projects primarily
due to the financial and/or business condition of two of its customers that
caused the Company to fall short of revenue expectations and also resulted in an
operating loss for that period. The Company's business, operating results and
financial condition may be materially adversely affected if such customers'
project delays continue and/or new or other customers delay new bookings or fail
to place anticipated orders.

         Revenue in any quarter is dependent on a number of factors, and is not
predictable with any degree of certainty. Since the Company's expense levels are
based in part on management's expectations regarding future revenue, if revenue
is below expectations in any quarter, the adverse effect may be magnified by the
Company's inability to adjust spending in a timely manner to compensate for any
revenue shortfall. The Company also intends to increase its sales and marketing
expenses in an attempt to broaden its market coverage. The Company's costs and
expenses will be based in part on the Company's expectations of future revenue
from product licenses. Accordingly, if the Company does not realize its expected
revenue, its business, operating results and financial condition could be
materially adversely affected.

         The Company's sales cycle can be lengthy and is subject to a number of
risks over which the Company has little or no control. As a result of the
significant dollar amounts represented by a single customer order, the timing of
the receipt of an order can have a significant impact on the Company's revenue
for a particular period. In addition, because the Company's revenue is
concentrated among a small number of customers, a decline or a delay in the
recognition of revenue from one customer in a period may cause the Company's
business, operating results and financial condition in such period to be
materially adversely affected and may lead to significant fluctuations from
quarter to quarter. Any significant or ongoing failure to obtain new orders from
customers or to collect outstanding accounts receivable would have a material
adverse effect on the Company's business, operating results and financial
condition. The Company does not expect that the rate of growth of its revenues
in fiscal 1998 will be sustainable in fiscal 1999 due to deterioration in the
demand for semiconductors generally, potentially leading to a decline in new
bookings and increasing the likelihood of delays in current projects due to the
financial and/or business condition of some of the Company's customers.

         To date, a substantial majority of the Company's revenue has been
recognized on a percentage of completion method. Provisions for estimated losses
on the uncompleted contracts are recognized in the period in which the
likelihood of such losses is determined. As the completion period ranges from
three to six months, revenue in any quarter is dependent on the Company's
progress toward completion of the project. There can be no assurance that the
Company's estimates will be accurate, and, in the event they are not, the
Company's business, operating results and financial condition in subsequent
periods could be materially adversely affected. From time to time, the Company
experiences delays in the progress of certain projects, and there can be no 



<PAGE>   19
assurance that such delays will not occur in the future. Any delay or failure to
achieve such progress could result in damage to customer relationships and the
Company's reputation, under-utilization of engineering resources or a delay in
the market acceptance of the Company's products, any of which could have a
material adverse effect on the Company's business, operating results and
financial condition. In addition, the Company's contracts with customers
generally may be canceled without cause, and, if a customer cancels or delays
performance under any such contracts, the Company's business, operating results
and financial condition could be materially adversely affected.

         DEPENDENCE ON EMERGENCE OF MERCHANT IP COMPONENT MARKET AND BROAD
MARKET ACCEPTANCE OF THE COMPANY'S PRODUCTS. The market for merchant IP
components has only recently begun to emerge. The Company's 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 single chip system ("System-on-a-Chip") ICs. There can be no assurance
that the merchant IP component and System-on-a-Chip markets will continue to
develop or grow at a rate sufficient to support the Company's business. If
either of these markets fails to grow or develops slower than expected, the
Company's business, operating results and financial condition would be
materially adversely affected. To date, the Company's IP products have been
licensed only by a limited number of customers. The vast majority of the
Company's existing and potential customers currently rely on components
developed internally and/or by other vendors. The Company's future growth, if
any, is dependent on the adoption of, and increased reliance on, merchant IP
components by both existing and potential customers. Moreover, if the Company's
products do not achieve broad market acceptance, the Company's business,
operating results and financial condition would be materially adversely
affected.

         COMPETITION. The Company's strategy of targeting semiconductor
manufacturers that participate in, or may enter, the System-on-a-Chip market
requires the Company to compete in intensely competitive markets. Within the
merchant segment of the IP component market, the Company competes primarily
against Aspec Technology, Inc., Avant! Corporation, Duet Corporation, Mentor
Graphics Corporation and the Silicon Architects division of Synopsys, Inc. In
addition, the Company may face competition from consulting firms and companies
that typically have operated in the generic library segment of the IP market and
that now seek to offer customized IP components as enhancements to their generic
solutions. The Company also faces significant competition from the internal
design groups of the semiconductor manufacturers that are expanding their
manufacturing capabilities and portfolio of IP components to participate in the
System-on-a-Chip market. These internal design groups compete with the Company
for access to the parent's IP component requisitions and may eventually compete
with the Company to supply IP components to third parties on a merchant basis.
There can be no assurance that internal design groups will not expand their
product offerings to compete directly with those of the Company or will not
actively seek to participate as merchant vendors in the IP component market by
selling to third party semiconductor manufacturers or, if they do, that the
Company will be able to compete against them successfully. In addition to
competition from companies in the merchant IP component market, the Company
faces competition from vendors that supply electronic design automation ("EDA")
software tools, including certain of those mentioned above, and there can be no
assurance that the Company will be able to compete successfully against them.

         The Company expects competition to increase in the future from existing
competitors and from new market entrants with products that may be less
expensive than the Company's IP components or that may provide better



<PAGE>   20

performance or additional features not currently provided by the Company. Many
of the Company's current and potential competitors have substantially greater
financial, technical, manufacturing, marketing, distribution and other
resources, greater name recognition and market presence, longer operating
histories, lower cost structures and larger customer bases than the Company. As
a result, they may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements. In addition, certain of the Company's
principal competitors offer a single vendor solution, since, in the case of EDA
tools companies, they maintain their own EDA design tools and IP libraries or,
in the case of internal design groups, they provide IP components developed to
utilize the qualities of a given manufacturing process, and may therefore
benefit from certain capacity, cost and technical advantages. The Company's
ability to compete successfully in the emerging market for IP components will
depend upon certain factors, many of which are beyond the Company's control
including, but not limited to, success in designing new products; implementing
new designs at smaller process geometries; access to adequate EDA tools (many of
which are licensed from the Company's current or potential competitors); the
price, quality and timing of new product introductions by the Company and its
competitors; the emergence of new IP component interchangeability standards; the
widespread licensing of IP components by semiconductor manufacturers or their
design groups to third party manufacturers; the ability of the Company to
protect its intellectual property; market acceptance of the Company's IP
components; success of competitive products; market acceptance of products using
System-on-a-Chip ICs; and industry and general economic conditions. There can be
no assurance that the Company will be able to compete successfully in the
emerging merchant IP component market.

         DEPENDENCE ON SEMICONDUCTOR MANUFACTURERS; DEPENDENCE ON SEMICONDUCTOR
AND ELECTRONICS INDUSTRIES. The Company's success is substantially dependent
both on the adoption of the Company's technology by semiconductor manufacturers
and on an increasing demand for products requiring complex System-on-a-Chip ICs,
such as portable computing devices, cellular phones, consumer multimedia
products, automotive electronics, personal computers and workstations. The
Company is subject to many risks beyond its control that influence the success
of its customers, including, among others, competition faced by each customer in
its particular industry, market acceptance of the customer's products that
incorporate the Company's technology, the engineering, sales and marketing
capabilities of the customer, and the financial and other resources of the
customer.

         The semiconductor and electronics products industries are characterized
by rapid technological change, frequent introductions of new products, short
product life cycles, fluctuations in manufacturing capacity and pricing and
gross margin pressures. Each of these industries is highly cyclical and has
periodically experienced significant downturns, often in connection with or in
anticipation of declines in general economic conditions during which the number
of new IC design projects often decreases. Revenue from licenses of the
Company's products is influenced by the level of design efforts by its
customers, and factors negatively affecting these industries could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company's business, operating results and financial
condition may fluctuate in the future from period to period as a consequence of
general economic conditions in the semiconductor and electronics industries.

         DEPENDENCE ON NEW BUSINESS MODEL. The Company has historically
generated revenue from license fees. Beginning in late fiscal 1996, however, the
Company 



<PAGE>   21

began implementation of a royalty based business model that is intended to
generate revenue from both license fees and future royalties. The Company is
still in the process of implementing this royalty based business model. The
Company believes the introduction, as opposed to the operation, of the royalty
based business model has been a limited success in that the majority of the
Company's licensees, including all new licensees with whom the Company has
contracted since August 1996, have agreed to a royalty based model. However,
certain licensees, which have previously contracted with the Company on a
license fee only basis, have resisted conversion to a royalty based model. As a
result, the Company believes that until all of its customers have adopted the
royalty based model, the introduction of such model can only be described as a
limited success. There can be no assurance that the Company will be able to
complete the implementation of the royalty based model successfully, or that,
when fully implemented, this model will have the anticipated benefits. The
failure of the Company to implement its new business model successfully could
have a material adverse effect on the Company's business, operating results and
financial condition. To date, the Company has received no royalty revenue, and
it does not anticipate receiving any prior to late fiscal 1999 due to the
typical length of time required for the Company to design a component for a
customer and for such customer to design, manufacture and bring to market a
product incorporating such component. There can be no assurance that the Company
will ever receive any royalty revenue or that, if it does, the amount will be
significant. See "--Dependence on Semiconductor Manufacturers; Dependence on
Semiconductor and Electronics Industries" and "--Customer Concentration; Limited
Customer Base."

         The Company believes that its long term success will be substantially
dependent on future royalties. However, even if the Company successfully
implements its new business model, the Company will face risks inherent in such
a model. In particular, the Company's ability to forecast royalty revenue will
be limited by factors that are beyond the Company's ability to control or assess
in advance. Royalties, if any, will be recognized in the quarter in which the
Company receives a royalty report from its customers and will be dependent upon
fluctuating sales volumes. In addition, under the royalty based business model,
the Company's revenue will be dependent upon the sales by its customers of
products that incorporate the Company's technology. Even if the Company's
technology is adopted, there can be no assurance that it will be used in a
product that is ultimately brought to market, achieves commercial acceptance or
results in significant royalties to the Company. The Company will also face
risks relating to the accuracy and completeness of the royalty collection
process.

         CUSTOMER CONCENTRATION; LIMITED CUSTOMER BASE. The Company has been
dependent on a relatively small number of customers for a substantial portion of
its revenue, although the customers comprising this group have changed from time
to time. In the three month period ended December 31, 1998, TSMC and UMC Group
accounted for 48% and 36% of revenue, respectively. In the three month period
ended December 31, 1997, OKI, Fujitsu, ATI, ST and NEC accounted for 21%, 18%,
17% 16% and 14% of revenue, respectively. The Company anticipates that its
revenue will continue to depend on a limited number of major customers for the
foreseeable future, although the companies considered to be major customers and
the percentage of revenue represented by each major customer may vary from
period to period depending on the addition of new contracts and the number of
designs utilizing the Company's products. None of the Company's customers has a
written agreement with the Company that obligates it to license future
generations of products or new products, and there can be no assurance that any
customer will license IP components from the Company in 



<PAGE>   22

the future. In addition, there can be no assurance that any of the Company's
customers will ship products incorporating the Company's technology or that, if
such shipments occur, they will generate significant revenue. The loss of one or
more of the Company's major customers, reduced orders by one or more of such
customers, the failure of one or more customers to pay license fees due to the
Company or the failure of a customer to ship products containing the Company's
IP components could materially adversely affect the Company's business,
operating results and financial condition. For example, in the three month
period ended December 31, 1998, the Company experienced delays in customer
projects primarily due to the financial and/or business condition of two of its
customers that caused the Company to fall short of revenue expectations and also
resulted in an operating loss for that period. The Company's business, operating
results and financial condition may be materially adversely affected if such
customers' project delays continue and/or new or other customers delay new
bookings or fail to place anticipated orders.

         The Company faces numerous risks in successfully obtaining orders from
customers on terms consistent with the Company's business model, including,
among others, the lengthy and expensive process of building a relationship with
a potential customer before reaching an agreement with such party to license the
Company's products; persuading large semiconductor manufacturers to work with,
to rely for critical technology on, and to disclose proprietary information to,
a smaller company, such as the Company; and persuading potential customers to
bear certain development costs associated with development of customized
components. There are a relatively limited number of semiconductor manufacturers
to which the Company can license its technology in a manner consistent with its
business model and there can be no assurance that such manufacturers will rely
on merchant IP components or adopt the Company's products. See "--Competition."

         PRODUCT CONCENTRATION. The Company derives substantially all of its
revenue from sales of its memory and standard cell products that, together,
accounted for 89% and 98% of revenue in the three month periods ended December
31, 1998 and 1997, respectively. The Company expects that memory products, in
combination with standard cell products, will continue to account for a
substantial portion of the Company's revenue for the foreseeable future. There
can be no assurance that the Company will continue to derive revenue from memory
or standard cell products and a decline in revenue from such products would have
a material adverse effect on the Company's business, operating results and
financial condition. The Company's future financial performance will depend in
significant part on the successful development, introduction and customer
acceptance of new products. See "--New Product Development and Technological
Change."

         LENGTHY SALES CYCLE AND DESIGN PROCESS. The license of the Company's
products typically involves a significant commitment of capital by the customer
and a purchase will often be timed to coincide with a customer's migration to a
new manufacturing process. Potential customers generally commit significant
resources to an evaluation of available IP solutions and require the Company to
expend substantial time, effort and resources to educate them about the value of
the Company's products. A variety of factors, including factors over which the
Company has little or no control, may cause potential customers to favor an
alternate solution or to delay or forego a license of the Company's products. As
a result of these and other factors, the sales cycle for the Company's products
is long, typically ranging from six to 12 months. The Company's ability to
forecast the timing and scope of specific sales is limited, and delay of or
failure to complete one or more large contracts could have a material adverse
effect on the Company's business, 



<PAGE>   23

operating results and financial condition and could cause the Company's
operating results to fluctuate significantly from quarter to quarter.

         Once the Company receives and accepts an order from a customer, the
Company must commit significant resources to customizing its products for the
customer's manufacturing process. This customization is complex and time
consuming and is subject to a number of risks over which the Company has little
or no control, including the customer's adjustments and alterations of its
manufacturing process or the timing of migration to a new process. Typically,
this customization takes from three to six months to complete. Delays in product
customization could have a material adverse effect on the Company's business,
operating results and financial condition and could cause the Company's
operating results to vary significantly from quarter to quarter.

         RISKS ASSOCIATED WITH INTERNATIONAL CUSTOMERS. A substantial portion of
the Company's revenue is derived from customers outside the United States. In
the three month periods ended December 31, 1998 and 1997, revenue derived from
customers outside the United States, primarily in Asia and Europe, represented
approximately 95% and 60% of the Company's revenue, respectively. The Company
anticipates that international revenue will remain a substantial portion of
revenue in the future. To date, all of the revenue from international customers
has been denominated in U.S. dollars. In the event that the Company's
competitors denominate their sales in a currency that becomes relatively
inexpensive in comparison to the U.S. dollar, the Company may experience fewer
orders from international customers whose business is based primarily on the
less expensive currency. During the quarter ended December 31, 1998, the Company
continued to experience delays in the receipt of orders expected from existing
and prospective foreign customers whose businesses were negatively affected by
the decline in the demand for semiconductors as well as the general
deterioration in economic conditions in their countries or in such customers'
financial condition. There can be no assurance that the deferred orders will be
placed in future periods or at all. There can be no assurance that present or
future dislocations with respect to the Asian financial markets will not have a
material adverse effect on the Company's business, operating results and
financial condition. The Company intends to continue to expand its sales and
marketing activities in Asia and Europe. The Company's expansion of its
international business involves a number of risks including the impact of
possible recessionary environments in economies outside the United States;
political and economic instability; exchange rate fluctuations; longer accounts
receivable collection periods; greater difficulty in accounts receivable
collection; unexpected changes in regulatory requirements; reduced or limited
protection for intellectual property rights; export license requirements;
tariffs and other trade barriers and potentially adverse tax consequences. There
can be no assurance that the Company will be able to sustain or increase revenue
derived from international customers or that the foregoing factors will not have
a material adverse effect on the Company's business, operating results and
financial condition.

         NEW PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE. The Company's
customers compete in the semiconductor industry, which is subject to rapid
technological change, frequent introductions of new products, short product life
cycles, changes in customer demands and requirements and evolving industry
standards. The development of new manufacturing processes, the introduction of
products embodying new technologies and the emergence of new industry standards
can render existing products obsolete and unmarketable. Accordingly, the
Company's future success will depend on its ability to continue to enhance its
existing products and to develop and introduce new products that satisfy
increasingly 



<PAGE>   24

sophisticated customer requirements and that keep pace with new product
introductions, emerging manufacturing process technologies and other
technological developments in the semiconductor industry. Any failure by the
Company to anticipate or respond adequately to changes in manufacturing
processes or customer requirements, or any significant delays in product
development or introduction, would have a material adverse effect on the
Company's business, operating results and financial condition. There can be no
assurance that the Company will not experience difficulties that could delay or
prevent the successful development, introduction and sale of new or enhanced
products or that such new or enhanced products will achieve market acceptance.
Any delay in release dates of new or enhanced products could materially
adversely affect the Company's business, operating results and financial
condition. The Company could also be exposed to litigation or claims from its
customers in the event that it does not satisfy its delivery commitments. There
can be no assurance that any such claim would not have a material adverse effect
on the Company's business, operating results and financial condition.

         DEPENDENCE ON KEY PERSONNEL. The Company's success depends in large
part on the continued contributions of its key management, engineering, sales
and marketing personnel, many of whom are highly skilled and would be difficult
to replace. None of the Company's senior management or key technical personnel
is bound by an employment contract. In addition, the Company does not currently
maintain key man life insurance covering its key personnel. The Company believes
that its success depends to a significant extent on the ability of its
management to operate effectively, both individually and as a group. Competition
for such personnel is intense, and there can be no assurance that the Company
will be successful in attracting and retaining such personnel. The loss of the
services of any of the key personnel, the inability to attract or retain
qualified personnel in the future or delays in hiring required personnel,
particularly engineers, could have a material adverse effect on the Company's
business, operating results and financial condition.

         MANAGEMENT OF GROWTH. The ability of the Company to license its
products and manage its business successfully in a rapidly evolving market
requires an effective planning and management process. The Company's rapid
growth has placed, and is expected to continue to place, a significant strain on
the Company's managerial, operational and financial resources. From December 31,
1997 to December 31, 1998, the Company grew from 72 to 90 employees or full-time
equivalents. The Company's customers rely heavily on the Company's technological
expertise in designing, testing and manufacturing products incorporating the
Company's IP components. Relationships with new customers generally require
significant engineering support. As a result, any increase in the demand for the
Company's products will increase the strain on the Company's personnel,
particularly its engineers. The Company's financial and management controls,
reporting systems and procedures are also limited. Although some new controls,
systems and procedures have been implemented, the Company's future growth, if
any, will depend on its ability to continue to implement and improve
operational, financial and management information and control systems on a
timely basis, together with maintaining effective cost controls, and any failure
to do so would have a material adverse effect on the Company's business,
operating results and financial condition. Further, the Company will be required
to manage multiple relationships with various customers and other third parties
and must successfully implement its new business model. There can be no
assurance that the Company's systems, procedures or controls will be adequate to
support the Company's operations or that the Company's management will be able
to achieve the rapid execution necessary to offer its services and 



<PAGE>   25

products successfully and to implement its business plan. The Company's
inability to manage any future growth effectively would have a material adverse
effect on the Company's business, operating results and financial condition.

         RISKS ASSOCIATED WITH PROTECTION OF INTELLECTUAL PROPERTY. The Company
relies primarily on a combination of nondisclosure agreements and other
contractual provisions and patent, trademark, trade secret and copyright law to
protect its proprietary rights. Failure of the Company to enforce its patents,
trademarks or copyrights or to protect its trade secrets could have a material
adverse effect on the Company's business, operating results and financial
condition. There can be no assurance that such intellectual property rights can
be successfully asserted in the future or will not be invalidated, circumvented
or challenged. From time to time, third parties, including competitors of the
Company, may assert patent, copyright and other intellectual property rights to
technologies that are important to the Company. There can be no assurance that
third parties will not assert infringement claims against the Company in the
future, that assertions by third parties will not result in costly litigation or
that the Company would prevail in any such litigation or be able to license any
valid and infringed patents from third parties on commercially reasonable terms.
Litigation, regardless of the outcome, could result in substantial cost and
diversion of resources of the Company. Any infringement claims or other
litigation against or by the Company could materially adversely affect the
Company's business, operating results and financial condition.

         In certain instances, the Company has elected to rely on trade secret
law rather than patent law to protect its proprietary technology. However, trade
secrets are difficult to protect. The Company seeks to protect its proprietary
technology and processes, in part, by confidentiality agreements with its
employees and customers. There can be no assurance that these contracts will not
be breached, that the Company will have adequate remedies for any breach, or
that the Company's trade secrets will not otherwise become known or be
independently discovered by competitors. In addition, effective trade secret
protection may be unavailable or limited in certain foreign countries.

         In addition, there can be no assurance that competitors of the Company,
many of which have substantial resources and have made substantial investments
in competing technologies, do not have, or will not seek to apply for and
obtain, patents that will prevent, limit or interfere with the Company's ability
to make, use or sell its products either in the United States or in
international markets. There can be no assurance that the Company will not in
the future become subject to patent infringement claims and litigation or
interference proceedings declared by the United States Patent and Trademark
Office ("USPTO") to determine the priority of inventions. The defense and
prosecution of intellectual property suits, USPTO interference proceedings and
related legal and administrative proceedings are both costly and time consuming.
Any such suit or proceeding involving the Company could have a material adverse
effect on the Company's business, operating results and financial condition.

         FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company
intends to continue to invest heavily in the development of new products and
enhancements to its existing products. The Company's future liquidity and
capital requirements will depend upon numerous factors, including the costs and
timing of expansion of product development efforts and the success of these
development efforts, the costs and timing of expansion of sales and marketing
activities, the extent to which the Company's existing and new products gain



<PAGE>   26

market acceptance, competing technological and market developments, the costs
involved in maintaining and enforcing patent claims and other intellectual
property rights, the level and timing of license revenue, available borrowings
under line of credit arrangements and other factors. The Company believes that
the its current cash balances and investment balances and any cash generated
from operations and from available or future debt financing will be sufficient
to meet the Company's operating and capital requirements for at least the next
12 months. The Company anticipates spending approximately $2.6 million for
capital expenditures over the next 12 months. However, from time to time, the
Company may be required to raise additional funds through public or private
financing, strategic relationships or other arrangements. There can be no
assurance that such funding, if needed, will be available on terms attractive to
the Company, or at all. Furthermore, any additional equity financing may be
dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. Strategic arrangements, if necessary to raise additional
funds, may require the Company to relinquish its rights to certain of its
technologies or products. The failure of the Company to raise capital when
needed could have a material adverse effect on the Company's business, operating
results and financial condition.

         POTENTIAL VOLATILITY OF STOCK PRICE. The trading price of the Company's
Common Stock has in the past been and could in the future be subject to
significant fluctuations in response to quarterly variations in the Company's
results of operations; announcements regarding the Company's product
developments; announcements of technological innovations or new products by the
Company, its customers or competitors; release of reports by securities
analysts; changes in security analysts' recommendations; developments or
disputes concerning patents or proprietary rights or other events. Also, at some
future time, the Company's revenues and results of operations may be below the
expectations of public market securities analysts or investors, resulting in
significant fluctuations in the market price of the Company's Common Stock. For
example, on December 16, 1998, the Company announced that it expected revenue in
the fiscal quarter ended December 31, 1998 to be lower than industry analysts'
expectations. In addition, the securities markets have from time to time
experienced significant price and volume fluctuations which have particularly
affected the market prices for high technology companies and which often are
unrelated and disproportionate to the operating performance of particular
companies. These broad market fluctuations as well as general economic,
political and market conditions, may adversely affect the market price of the
Company's Common Stock. In the past, following periods of volatility in the
market price of a company's stock, securities class action litigation has
occurred against that company. Such litigation could result in substantial costs
and would at a minimum divert management's attention and resources, which could
have a material adverse effect on the Company's business, financial condition
and results of operations. Any adverse determination in such litigation could
also subject the Company to significant liabilities.


ITEM 2: Changes in Securities and Use of Proceeds

         Use of Proceeds. With respect to the requirements of Item 701(f) of
Regulation S-K regarding the reporting of use of proceeds, pursuant to the
information required to be reported by Item 701(f)(4)(viii), the Company funded
its operations in the quarter ended December 31, 1998 with cash provided by
operations and did not expend the proceeds of its initial public offering. The
proceeds have been invested in short and long term securities until such time as
the Company has need of them.



<PAGE>   27

ITEM 6: Exhibits

     (a)  Exhibits

        27.1   Financial Data Schedule



<PAGE>   28

                                   SIGNATURES

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

Dated:  February 12, 1999

                             ARTISAN COMPONENTS, INC.
                                    (Registrant)

                             /s/ Mark R. Templeton
                             --------------------------------------------
                             Mark R. Templeton
                             Chief Executive Officer

                             /s/ Robert D. Selvi
                             --------------------------------------------
                             Robert D. Selvi
                             Vice President, Finance and Chief Financial Officer



<PAGE>   29

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBITS
- --------
<S>                                     <C>
27.1 Financial Data Schedule
</TABLE>

<TABLE> <S> <C>

<ARTICLE> 5
<MULTIPLIER> 1,000
       
<S>                             <C>
<PERIOD-TYPE>                   3-MOS
<FISCAL-YEAR-END>                          SEP-30-1999
<PERIOD-START>                             OCT-01-1998
<PERIOD-END>                               DEC-31-1998
<CASH>                                          35,637
<SECURITIES>                                    11,598
<RECEIVABLES>                                    6,580
<ALLOWANCES>                                     (724)
<INVENTORY>                                          0
<CURRENT-ASSETS>                                54,868
<PP&E>                                          10,240
<DEPRECIATION>                                 (3,374)
<TOTAL-ASSETS>                                  62,183
<CURRENT-LIABILITIES>                            7,043
<BONDS>                                              0
                                0
                                          0
<COMMON>                                            13
<OTHER-SE>                                      52,297
<TOTAL-LIABILITY-AND-EQUITY>                    62,183
<SALES>                                          3,036
<TOTAL-REVENUES>                                 3,036
<CGS>                                            1,304
<TOTAL-COSTS>                                    4,239
<OTHER-EXPENSES>                                   (8)
<LOSS-PROVISION>                                     0
<INTEREST-EXPENSE>                               (448)
<INCOME-PRETAX>                                  (747)
<INCOME-TAX>                                      (75)
<INCOME-CONTINUING>                              (672)
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                                     (672)
<EPS-PRIMARY>                                    (.05)
<EPS-DILUTED>                                    (.05)
        

</TABLE>



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