ARTISAN COMPONENTS INC, 10-Q, 2000-02-14

ARTISAN COMPONENTS INC
10-Q, 2000-02-14
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, 1999

[ ] 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, 1999 there were 14,065,387 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, 1999 and September 30, 1999....3
Condensed Statements of Operations
Three Months Ended December 31, 1999 and 1998...............4
Condensed Statements of Cash Flows
Three Months Ended December 31, 1999 and 1998...............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 6 - Exhibits.....................................................26

Signatures.................................................................27
</TABLE>

2
<PAGE> 3

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

<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------ -------------
1999 1999(1)
------------ -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................ $11,449 $15,233
Contract receivables (net of allowance of
$746 at December 31, 1999 and September 30, 1999) ... 9,652 7,721
Marketable securities ................................ 35,709 32,948
Prepaid expenses and other current assets ............ 1,622 1,514
Deferred tax asset ................................... 246 246
------- -------
Total current assets ............................... 58,678 57,662
Property and equipment, net ............................ 5,783 6,133
Deferred tax asset ..................................... 361 361
Other assets ........................................... 237 188
------- -------
Total assets ....................................... $65,059 $64,344
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ................ $ 2,764 $ 3,255
Deferred revenue ..................................... 4,035 3,795
------- -------
Total current liabilities .......................... 6,799 7,050
Deferred rent .......................................... 103 98
Deferred revenue and other long term liabilities ....... 53 76
------- -------
Total liabilities .................................. 6,955 7,224
------- -------
Stockholders' Equity:
Preferred Stock, $0.001 par value:
Authorized: 5,000 shares;
Issued and outstanding: None at December 31,
1999 and September 30, 1999 ......................... -- --
Common Stock, $0.001 par value:
Authorized: 50,000 shares;
Issued and outstanding: 14,065 and 13,909
shares at December 31, 1999 and September 30,
1999, respectively .................................. 14 14
Additional paid in capital ............................ 55,050 54,358
Retained earnings ..................................... 3,040 2,748
------- -------
Total stockholders' equity ......................... 58,104 57,120
------- -------
Total liabilities and stockholders' equity ......... $65,059 $64,344
======= =======
</TABLE>
- ---------------
(1) Derived from the Registrant's audited balance sheet as of September 30,
1999.

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

2
<PAGE> 4

ARTISAN COMPONENTS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS
ENDED DECEMBER 31,
-----------------------
1999 1998
-------- --------
<S> <C> <C>
Revenue:
License ............................... $ 4,445 $ 3,036
Net royalty ........................... 616 --
-------- --------
Total revenue ........................ 5,061 3,036
-------- --------
Cost and expenses:
Cost of license revenue ............... 1,454 1,304
Product development ................... 1,642 1,031
Sales and marketing ................... 1,673 1,068
General and administrative ............ 540 836
-------- --------
Total cost and expenses .............. 5,309 4,239
-------- --------
Operating loss ........................... (248) (1,203)
Other income ............................. 684 456
-------- --------
Income (loss) before provision
for income taxes ...................... 436 (747)
Provision (benefit) for income
taxes ................................. 144 (75)
-------- --------
Net income (loss) ........................ $ 292 $ (672)
======== ========
Basic net income (loss) per share ........ $ 0.02 $ (0.05)
======== ========
Diluted net income (loss) per share ...... $ 0.02 $ (0.05)
======== ========
Shares used in computing:
Basic net income (loss) per share ...... 13,987 13,380
Diluted net income (loss) per share .... 15,210 13,380
</TABLE>

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

3
<PAGE> 5

ARTISAN COMPONENTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS
ENDED
DECEMBER 31,
-----------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ....................... $ 292 $ (672)
Adjustments to reconcile net
income (loss) income to net cash
provided by operating activities:
Depreciation and
amortization ......................... 726 555
Gain on sale/disposal of
fixed assets ......................... (22) (18)
Provision for doubtful
accounts ............................. -- 294
Compensation expense for
options granted ...................... 22 22
Changes in assets and
liabilities:
Contract receivables ................ (1,931) (1,098)
Deferred revenue and other
long term liabilities .............. 240 1,450
Prepaid expenses and other
assets ............................. (187) (380)
Deferred rent ....................... 5 16
Accounts payable and
other liabilities .................. (555) 302
-------- --------
Net cash (used) provided
by operating activities .......... (1,410) 471
-------- --------
Cash flows from investing activities:
Acquisition of property and
equipment .............................. (312) (510)
Proceeds from sale of property
and equipment .......................... 30 30
Purchase of marketable
securities ............................. (11,897) (910)
Proceeds from sale of
marketable securities .................. 9,136 --
-------- --------
Net cash used in
investing activities ............. (3,043) (1,390)

Cash flows from financing activities:
Proceeds from issuance of
Common Stock ........................... 669 40
-------- --------
Net cash provided by
financing activities ............. 669 40
-------- --------
Net decrease in cash and
cash equivalents ......................... (3,784) (879)
Cash and cash equivalents,
beginning of period ...................... 15,233 36,516
-------- --------
Cash and cash equivalents,
end of period ............................ $ 11,449 $ 35,637
======== ========
CASH PAID FOR:
Income taxes ............................ $-- $--
======== ========
SUPPLEMENTAL DISCLOSURE OF
NONCASH ACTIVITIES:
Fixed asset acquisitions in
exchange for accounts payable .......... $ 64 $ 1,536
======== ========
Compensation expense for
options granted ........................ $ 22 $ 22
======== ========
</TABLE>

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

<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. ("Artisan" or 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 September
30, 1999 fiscal 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, 1999 are not
necessarily indicative of the results that may be expected for the fiscal year
ending September 30, 2000 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,
1999 included in the Company's Annual Report on Form 10-K as filed with the
Securities and Exchange Commission.

2. EARNINGS PER SHARE (EPS) DISCLOSURES:

Basic and diluted earnings per share are computed in accordance with
Statement of Financial Accounting Standards No. 128 ("SFAS 128"). 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.

<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,
----------------------
1999 1998
-------- --------
(UNAUDITED)
<S> <C> <C>
Numerator--Basic and Diluted EPS
Net income (loss) .................... $ 292 $ (672)
======== ========
Denominator--Basic EPS
Common stock outstanding ............. 13,987 13,380
-------- --------
Basic net income (loss) per share ...... $ 0.02 $ (0.05)
======== ========
Denominator--Diluted EPS
Denominator--Basic EPS ............... 13,987 13,380
Effect of Dilutive Securities:
Common stock options and warrant ... 1,223 --
-------- --------
15,210 13,380
-------- --------
Diluted net income (loss) per share .... $ 0.02 $ (0.05)
======== ========
</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 per share for the
three month period, because they were anti-dilutive.

3. NEW ACCOUNTING STANDARDS:

In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Investments and Hedging Activities." The
statement establishes accounting and reporting standards requiring that every
derivative instrument be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement also requires that changes
in the derivative's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. To date, the Company has not entered
into any derivative financial instruments or hedging activities. SFAS No. 133,
as amended, is effective for fiscal years beginning after June 15, 2000.

<PAGE> 8

ARTISAN COMPONENTS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)

4. COMPREHENSIVE INCOME:

In June 1997, the Financial Accounting Standards Board issued SFAS No.
130, "Reporting Comprehensive Income." This statement establishes requirements
for disclosure of comprehensive income and became effective for the Company for
its fiscal year 1999, with reclassification of earlier financial statements for
comparative purposes. Comprehensive income generally represents all changes in
stockholders' equity except those resulting from investments of contributions by
stockholders. SFAS 130 requires unrealized gains or losses on the Company's
available-for-sale securities, which prior to adoption were reported separately
in stockholders' equity, to be included in other comprehensive income. The
Company has adopted SFAS 130; however, the effect of the adoption was immaterial
to all periods presented.

5. BUSINESS SEGMENT AND GEOGRAPHICAL INFORMATION:

The Company currently operates in one industry segment, the
semiconductor intellectual property segment, for financial reporting purposes,
and uses one measure of profitability for its business. The Company markets its
products to customers in the North America, Europe and Asia. All of our
long-lived assets are maintained in the United States.

6. 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.

During the first three months of fiscal 2000, the Company issued shares
of Common Stock that resulted in aggregate proceeds of $669,000.

<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, 1999 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 is a leading developer of high performance, high density and low
power embedded memory, standard cell and input/output ("I/O") 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.

Beginning in late fiscal 1996, the Company implemented a royalty-based
business model that is intended to generate revenue from both license fees and
royalties. 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 distribute and sublicense to semiconductor design
companies that manufacture at the same facility. In cases where the
semiconductor manufacturer does not have the infrastructure necessary to
distribute and support the Company's IP components, the Company performs the
distribution function directly to the customers of the semiconductor
manufacturer. License fees and royalties are 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 $250,000 to $700,000 for each product delivered under a contract.
A contract typically calls for an initial payment of approximately one-third of
the license fee with the remainder due upon delivery, generally three to six
months later. Royalty payments are calculated based on per unit sales of ICs or
wafers containing the Company's IP components. Given that the

<PAGE> 10

Company provides its products early in the customer's IC design process, there
is a significant delay between the delivery of a product and the generation of
royalty revenue. See "--Factors Affecting Future Operating Results--Lengthy
Sales Cycle and Design Process."

To date, the substantial majority of the Company's license revenue has
been recognized on a percentage of completion method. Provisions for estimated
losses on uncompleted contracts are recognized in the period in which the
likelihood of such losses is determined. As the completion period for a project
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.

The Company has received royalty reports from some customers since the
third quarter of fiscal 1999. As expected, these royalties have come from a
small number of IC designs that are early in their product life-cycles.
According to contract terms, a portion of these royalty payments is credited
back to customers' accounts to use to pay license fees for future orders to be
placed with the Company. The remaining portion of the royalty is reported as net
royalty revenue. The Company's success will depend on its ability to generate
royalty revenue from a substantially larger number of designs and on many of
these designs achieving large manufacturing volumes. There can be no assurance
that the Company will be successful in expanding the number of royalty bearing
contracts with customers, and there can be no assurance that the Company will
receive significant royalty revenue in the future. See "--Factors Affecting
Future Operating Results--Fluctuations in Operating Results."

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, 1999, Taiwan Semiconductor Manufacturing Corporation ("TSMC"), NEC
Electronics, Inc. ("NEC"), Chartered Semiconductor Manufacturing ("Chartered")
and UMC ("UMC") accounted for 25%, 15%, 13% and 11% of revenue, respectively. In
the three month period ended December 31, 1998, TSMC and UMC accounted for 48%
and 36% 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. The Company's business, operating results and
financial condition may also be materially adversely affected if customers
experience project delays and/or new or existing customers delay new bookings or
fail to place anticipated orders. For example, in the quarter ended December 31,
1999, fewer new orders were placed with the Company than in recent prior
periods, which may adversely affect the Company's results of operations in
future quarters depending on its ability to obtain additional orders. See
"--Factors Affecting Future Operating Results--Customer Concentration; Limited
Customer Base."

<PAGE> 11

Historically, a substantial portion of the Company's revenue has been
derived from customers outside the United States ("international revenue"). In
the three month periods ended December 31, 1999 and 1998, international revenue,
primarily from Asia and Europe, represented approximately 86% and 95%,
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 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, standard cell and I/O products and process setup fees (collectively,
"product license revenue") that together accounted for 80% and 98% of revenue in
the three month periods ended December 31, 1999 and 1998, respectively. For the
period ended December 31, 1999 as compared to the period ended December 31,
1998, this shift in revenue mix was due to faster growth in revenue from support
contracts and net royalties as compared to the growth of product license
revenue. However, the Company expects that product license revenue 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 product license revenue 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 "--Factors Affecting
Future Operating Results--Product Concentration."

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 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. Accordingly, if the Company does
not realize its expected revenue, its business, operating results and financial
condition could be materially adversely affected. The Company has experienced
periods of negative growth as well as declines in the rate of growth of its
revenue as compared with prior periods, primarily due to deterioration in the
demand for semiconductors generally. There can be no assurance that the Company
will experience positive revenue growth in the future. See "--Factors Affecting
Future Operating Results--Fluctuations in Operating Results."

<PAGE> 12

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 and 15,000 shares of Common Stock to non-employees in January 1998,
the Company recorded aggregate deferred compensation of approximately $281,000,
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, of which
approximately $41,000, $80,000, $87,000 and $22,000 have been amortized during
fiscal 1997, 1998, 1999 and the first quarter of fiscal 2000, respectively. In
addition, the amortization will result in charges of approximately $11,000 per
quarter for the following five quarters.

RESULTS OF OPERATIONS

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

THREE MONTHS ENDED
DECEMBER 31,
--------------------
1999 1998
------ ------
<S> <C> <C>
Revenue:
License ........................ 87.8% 100.0%
Net royalty .................... 12.2 --
------ ------
Total revenue ................ 100.0 100.0

Cost and expenses:
Cost of license revenue ........ 28.7 42.9
Product development ............ 32.4 34.0
Sales and marketing ............ 33.1 35.2
General and
administrative ................ 10.7 27.5
------ ------
Total cost and expenses ...... 104.9 139.6
------ ------
Operating loss ................... (4.9) (39.6)
Other income, net ................ 13.5 15.0
------ ------
Income (loss) before provision
for income taxes ................ 8.6 (24.6)
Provision (benefit) for income
taxes ........................... 2.8 (2.5)
------ ------
Net income (loss) ................ 5.8% (22.1)%
====== ======
</TABLE>

Revenue

Revenue increased by 66.7% to $5.1 million for the three month period
ended December 31, 1999 from $3.0 million for the same period last fiscal year.
For the three month period ended December 31, 1999, as compared to the three
month period ended December 31, 1998, the increase in revenue was due to
increases in license revenue from I/O products, support contracts, process setup

<PAGE> 13

fees and standard cell products and the addition of royalty revenue, which was
partially offset by a decrease in license revenue from the Company's memory
products.

Cost and Expenses

Engineering Costs. Engineering costs are allocated between cost of
license 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 revenue under related contracts. Engineering costs increased by
32.6% from $2.3 million in the three month period ended December 31, 1998 to
$3.1 million in the three month period ended December 31, 1999. Engineering
costs as a percentage of revenue decreased from 76.9% to 61.1% in the three
month periods ended December 31, 1998 and 1999, respectively. The absolute
dollar increase in engineering costs of $761,000 in the three month period ended
December 31, 1999, as compared with the same period in fiscal 1999, was
primarily due to increases in headcount and personnel expenses of approximately
$334,000, computer and networking equipment maintenance and expenses,
depreciation and facility expense of approximately $285,000 and increased usage
of subcontractor and other outside services of $227,000, offset by decreased
warranty charges of $85,000.

Cost of License Revenue. Cost of license revenue increased by 11.5%
from $1.3 million in the three month period ended December 31, 1998 to $1.5
million in the three month period ended December 31, 1999. Cost of license
revenue as a percentage of revenue was 42.9% and 28.7% for the three month
periods ended December 31, 1998 and 1999, respectively. The absolute dollar
increase in cost of license revenue of $150,000 in the three month period
ended December 31, 1999 as compared with the same period of fiscal 1999, was
due to increased labor and equipment expenses associated with increased
revenue, offset by decreased warranty charges. The decrease in cost of
license revenue as a percentage of revenue for the three month period ended
December 31, 1999 as compared to the three month period ended December 31,
1998, was due to the addition of net royalty revenue in the period ended
December 31, 1999, as well as to higher revenue efficiency per project hour
in the period ended December 31, 1999.

Product Development Expenses. Product development expenses increased by
59.3% from $1.0 million in the three month period ended December 31, 1998 to
$1.6 million in the three month period ended December 31, 1999. Product
development expenses as a percentage of revenue decreased from 34.0% to
32.4% in the three month periods ended December 31, 1998 and 1999,
respectively. The absolute dollar increase in product development expenses
of $611,000 in the three month period ended December 31, 1999, as compared
with the same period in fiscal 1999, was attributable to an increase in
headcount and personnel-related expenses and to depreciation and maintenance
expenses related to 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
56.6% from $1.1 million in the three month period ended December 31, 1998 to

<PAGE> 14

$1.7 million in the three month period ended December 31, 1999. Sales and
marketing expense as a percentage of revenue decreased from 35.2% to 33.1% in
the three month periods ended December 31, 1998 and 1999, respectively. The
increase in absolute dollars in sales and marketing expenses of $605,000 in the
three month period ended December 31, 1999, as compared with the same period in
fiscal 1999, was primarily attributable to increased headcount and
personnel-related expenses of approximately $531,000, increased trade show
expenses for travel and transportation, setup, staffing and promotions of
approximately $37,000 and increased allocated facilities costs and other
miscellaneous expenses of approximately $37,000.

General and Administrative Expenses. General and administrative expenses
decreased by 35.4% from $836,000 in the three month period ended December 31,
1998 to $540,000 in the three month period ended December 31, 1999. As a
percentage of revenue, general and administrative expenses decreased from 27.5%
to 10.7% in the three month periods ended December 31, 1998 and 1999,
respectively. The absolute dollar decrease of $296,000 in general and
administrative expenses in the three months ended December 31, 1999 as compared
with the three months ended December 31, 1998 was due to a provision for bad
debt recorded in the three month period ended December 31, 1998. The decrease in
general and administrative expenses as a percentage of revenue for the three
month period ended December 31, 1999, as compared to the three month period
ended December 31, 1998, was due to the provision for bad debt recorded in the
period ended December 31, 1998 as well as to the increase in revenue for the
period ended December 31, 1999.

Other Income

Other income increased by 50.0% from $456,000 in the three month period
ended December 31, 1998 to $684,000 in the three month period ended December 31,
1999. Other income as a percentage of revenue decreased from 15.0% to 13.5% for
the three month periods ended December 31, 1998 and 1999, respectively. The
absolute dollar growth in other income in the three month period ended December
31, 1999, as compared with the same period in fiscal 1999, was primarily due to
increased interest income on the Company's investment portfolio resulting from a
shift from tax-free investments into taxable investments.

Income Taxes

The income tax benefit for the three month period ended December 31,
1998, was $75,000 and the income tax provision for the three month period ended
December 31, 1999, was $144,000. For the three month periods ended December 31,
1998 and 1999, respectively, the effective tax rate increased from a benefit of
10.0% to a provision of 33.0%. The increase in the effective tax rate for the
three month period ended December 31, 1999, as compared to the same period of
fiscal 1999, was due to the operating profit recorded by the Company in the
first three months of fiscal 2000.

LIQUIDITY AND CAPITAL RESOURCES

The Company has funded its operations primarily from license revenue
received from inception to December 31, 1999, 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 secondary 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.

<PAGE> 15

The Company's operating activities provided net cash of $471,000 in the
three month period ended December 31, 1998 and used net cash of $1.4 million in
the three month period ended December 31, 1999. Net cash provided by operating
activities in the three month period ended December 31, 1998 was primarily due
to an increase in deferred revenue and depreciation and amortization, partially
offset by an increase in contract receivables and the Company's net loss. Net
cash used by operating activities in the three month period ended December 31,
1999 was due to an increase in contract receivables and a decrease in accounts
payable and other liabilities, partially offset by net income plus depreciation
and amortization.

Net cash used in investing activities was $1.4 million and $3.0 million
in the three month periods ended December 31, 1998 and 1999, respectively. In
the three months ended December 31, 1998 and 1999, investing activities
consisted primarily of net purchases of marketable securities and, to a lesser
extent, purchases of property and equipment.

Net cash provided by financing activities was $40,000 and $669,000 in
the three month periods ended December 31, 1998 and 1999, respectively. Net cash
provided by financing activities in both periods consisted of proceeds from the
issuance of Common Stock.

At December 31, 1999, the Company had cash, cash equivalents and current
marketable securities of $47.2 million. As of December 31, 1999, the Company had
retained earnings of $3.0 million and working capital of $51.9 million that
includes the current portion of deferred revenue of $4.0 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. 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 1998, the Financial Accounting Standards Board issued SFAS
No. 133, "Accounting for Derivative Investments and Hedging Activities." The

<PAGE> 16

statement establishes accounting and reporting standards requiring that every
derivative instrument be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement also requires that changes
in the derivative's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. To date, the Company has not entered
into any derivative financial instruments or hedging activities. SFAS No. 133,
as amended, is effective for fiscal years beginning after June 15, 2000.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to the impact of interest rate changes and
changes in the market values of its investments.

Interest Rate Risk. The Company's exposure to market risk for changes in
interest rates relates primarily to the Company's investment portfolio. The
Company has not used derivative financial instruments in its investment
portfolio. The Company invests its excess cash in high-quality corporate issuers
and in debt instruments of the U.S. Government 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.

Investments in both fixed and floating rate interest-earning instruments
carry a degree of interest rate risk. Fixed rate securities may have their fair
market value adversely impacted due to rising interest rates, while floating
rate securities may produce less income than expected if interest rates fall.
Due in part to these factors, the Company's future investment income may fall
short of expectations due to changes in interest rates or the Company may suffer
losses in principal if forced to sell securities that have declined in market
value due to changes in interest rates.

The table below presents the carrying value and related weighted average
interest rates for the Company's investment portfolio. The carrying values
approximate fair values at December 31, 1999 and 1998. All investments mature in
one year or less.

<TABLE>
<CAPTION>
CARRYING AVERAGE RATE CARRYING AVERAGE RATE
VALUE AT OF RETURN AT VALUE AT OF RETURN AT
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1999 1999 1998 1998
-------------- ------------ -------------- ------------
(IN THOUSANDS) (ANNUALIZED) (IN THOUSANDS) (ANNUALIZED)
<S> <C> <C> <C> <C>
INVESTMENT SECURITIES:
Cash Equivalents -
variable rate ...... $ 1,758 4.9% $ 1,915 4.9%
Money market funds -
variable rate ...... $ 58 5.5% $ 72 1.3%
Cash Equivalents -
fixed rate ......... $ 9,633 6.1% -- --
Short-term investments -
fixed rate ......... $35,709 5.9% $45,248 3.8%
------- -------
Total ...................... $47,158 $47,235
======= =======
</TABLE>

YEAR 2000. To date, the Company has not experienced any disruption of
its business or key systems as a result of Year 2000 problems. Nor has the
Company been informed of any Year 2000 problems encountered by its customers
relating to their use of the Company's products. It is possible, however, that
the Company or its customers may encounter Year 2000 problems later this year.
If such problems were to arise, the Company might incur substantial costs or the
interruption in or a failure of certain normal business activities or
operations, which would hurt the Company's business. If the Company's customers
experience Year 2000 related problems as a result of their use of the Company's
products, then those customers could assert claims for damages, which, if
successful, could result in significant costs to the Company or adversely affect
its ability to sell its products.

<PAGE> 17

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 amount 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 that event, the price of the Company's
Common Stock would likely decline, perhaps substantially.

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. The
Company's business, operating results and financial condition may also be
materially adversely affected if customers experience project delays and/or new
or existing customers delay new bookings or fail to place anticipated orders.
For example, in the quarter ended December 31, 1999, fewer new orders were
placed with the Company than in recent prior periods, which may adversely affect
the Company's results of operations in future quarters depending on its ability
to obtain additional 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. 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

<PAGE> 18

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 has experienced periods of negative growth as well as
declines in the rate of growth of its revenue as compared with prior periods,
primarily due to deterioration in the demand for semiconductors generally. There
can be no assurance that the Company will experience positive revenue growth in
the future.

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
assurance that such delays will not occur in the future. Any delay or failure to
achieve 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 has historically generated revenue from license fees only.
Beginning in late fiscal 1996, the Company implemented a royalty-based business
model that is intended to generate revenue from both license fees and royalties.
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
distribute and sublicense to semiconductor design companies that manufacture at
the same facility. In cases where the semiconductor manufacturer does not have
the infrastructure necessary to distribute and support the Company's IP
components, the Company performs the distribution function directly to the
customers of the semiconductor manufacturer. Given that the Company provides its
products early in the customer's IC design process, there is a significant delay
between the delivery of a product and the generation of royalty revenue. Royalty
payments are calculated based on per unit sales of ICs or wafers containing the
Company's IP components. A portion of these payments is credited back to
customers' accounts to use to pay license fees for future orders to be placed
with the Company. The remaining portion of the royalty is reported as net
royalty revenue. The Company has received royalty reports from some customers
since the third quarter of fiscal 1999. As expected, these royalties have come
from a small number of IC designs that are early in their product life-cycles.
The Company's success will depend on its ability to generate royalty revenue
from a substantially larger number of designs and on many of these designs
achieving large manufacturing volumes. There can be no assurance that the
Company will be successful in expanding the number of royalty bearing contracts
with customers, and there can be no assurance that the Company will receive
significant royalty revenue in the future. See "--Dependence on Semiconductor
Manufacturers; Dependence on Semiconductor and Electronics Industries" and
"--Customer Concentration; Limited Customer Base."

<PAGE> 19

The Company believes that its long term success will be substantially
dependent on future royalties. In addition, the Company will face risks inherent
in a royalty-based business 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 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.

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 emerged. 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 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 primarily competes
against Avant!, Mentor Graphics, the Silicon Architects division of Synopsys,
Virage and Virtual Silicon. 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 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 EDA

<PAGE> 20

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
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
tool 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

<PAGE> 21

condition may fluctuate in the future from period to period as a consequence of
general economic conditions in the semiconductor and electronics industries.

CUSTOMER CONCENTRATION; LIMITED CUSTOMER BASE. The Company has been
dependent on a relatively small number of customers for a substantial portion of
its annual revenue, although the customers comprising this group have changed
from time to time. In the three month period ended December 31, 1999, TSMC, NEC,
Chartered and UMC accounted for 25%, 15%, 13% and 11% of revenue, respectively.
In the three month period ended December 31, 1998, TSMC and UMC accounted for
48% and 36% 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 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 or royalty 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. The Company's business, operating results and financial
condition may also be materially adversely affected if customers experience
project delays and/or new or existing 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 product license revenue, which accounted for 80% and 98% of revenue
in the three month periods ended December 31, 1999 and 1998, respectively. The
Company expects that product license revenue 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
product license revenue 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."

<PAGE> 22

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, operating results and financial condition and
could cause the Company's operating results to fluctuate significantly from
quarter to quarter. For example, in the quarter ended December 31, 1999, fewer
new orders were placed with the Company than in recent prior periods, which may
adversely affect the Company's results of operations in future quarters
depending on its ability to obtain additional orders.

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. Historically, a
substantial portion of the Company's revenue has been international revenue. In
the three month periods ended December 31, 1999 and 1998, international revenue,
primarily from Asia and Europe, represented approximately 86% and 95% of the
Company's revenue, respectively. The Company anticipates that international
revenue will remain a substantial portion of its 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. There can be no
assurance that present or future dislocations with respect to international
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 and 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.

<PAGE> 23

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 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. The Company
must also attract and retain highly skilled managerial, engineering, sales,
marketing and finance personnel. 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 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,
1998 to December 31, 1999, the Company grew from 90 to 104 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

<PAGE> 24

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 royalty 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 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
would divert resources of the Company. Any infringement claim 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 protects its proprietary
technology and processes, in part, through 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.

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.

<PAGE> 25

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
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.
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 "--Liquidity and
Capital Resources."

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. 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.

<PAGE> 26

ITEM 6: Exhibits

(a) Exhibits

27.1 Financial Data Schedule

<PAGE> 27

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 11, 2000

ARTISAN COMPONENTS, INC.
(Registrant)

/s/ Mark R. Templeton
--------------------------------------------
Mark R. Templeton
President and Chief Executive Officer
(Principal Executive and Accounting Officer)

<PAGE> 28

INDEX TO EXHIBITS

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

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-2000
<PERIOD-START> OCT-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 11,449
<SECURITIES> 35,709
<RECEIVABLES> 10,398
<ALLOWANCES> (746)
<INVENTORY> 0
<CURRENT-ASSETS> 58,678
<PP&E> 11,611
<DEPRECIATION> (5,828)
<TOTAL-ASSETS> 65,059
<CURRENT-LIABILITIES> 6,799
<BONDS> 0
0
0
<COMMON> 14
<OTHER-SE> 58,090
<TOTAL-LIABILITY-AND-EQUITY> 65,059
<SALES> 5,061
<TOTAL-REVENUES> 5,061
<CGS> 1,454
<TOTAL-COSTS> 5,309
<OTHER-EXPENSES> (8)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (676)
<INCOME-PRETAX> 436
<INCOME-TAX> 144
<INCOME-CONTINUING> 292
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 292
<EPS-BASIC> .02
<EPS-DILUTED> .02

</TABLE>