ARTISAN COMPONENTS INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2000

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

COMMISSION FILE NO. 000-23649

ARTISAN COMPONENTS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 77-0278185
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)

1195 BORDEAUX DRIVE 94089
SUNNYVALE, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 734-5600
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.001
PAR VALUE PER SHARE

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 [ ]

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

The aggregate market value of the Common Stock held by non-affiliates of
the registrant as of October 31, 2000 was $65,503,812. Shares of Common Stock
held by each executive officer, director and by each person who owns 5% or more
of the outstanding Common Stock have been excluded in that such persons may be
deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.

The number of shares of the registrant's Common Stock outstanding as of
October 31, 2000 was 14,766,683.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant has incorporated by reference into Part III of this Annual
Report on Form 10-K portions of its Proxy Statement for the 2001 Annual Meeting
of Stockholders to be held March 7, 2001.

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PART I

ITEM 1. BUSINESS

This Annual Report on Form 10-K and the information incorporated by
reference herein contain "forward looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and such forward looking statements involve risks and uncertainties. When
used in this Report, the words "expects," "anticipates" and "estimates" and
similar expressions are intended to identify forward-looking statements. Such
statements are subject to risks and uncertainties that could cause actual
results to differ materially from those predicted. These risks and uncertainties
include those discussed below and those discussed in "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Factors
Affecting Future Operating Results". Artisan Components, Inc. undertakes no
obligation to publicly release any revisions to these forward looking statements
to reflect events or circumstances after the date this Report is filed with the
Securities and Exchange Commission or to reflect the occurrence of unanticipated
events.

GENERAL

Artisan Components, Inc. (the "Company" or "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 offers highly differentiated memory, standard cell and I/O components
that meet the acute needs of complex single chip system ("System-on-a-Chip") ICs
for performance, power and density. Together, memory, standard cell and I/O
components constitute approximately 80% of the silicon area on a typical
System-on-a-Chip IC. The Company's products are optimized for each customer's
manufacturing process and are delivered ready for use with industry standard and
proprietary IC design tools. 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.

The Company primarily licenses its products on a nonexclusive, worldwide
basis to major semiconductor manufacturers and grants these manufacturers the
right to distribute its IP components to their internal design teams and to
fabless semiconductor 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. The Company believes that this licensing approach encourages
proliferation of the Company's products and provides a highly efficient
distribution channel for its IP components. Artisan has licensed its products to
many leading semiconductor manufacturers including Chartered Semiconductor
Manufacturing Ltd. ("Chartered"), Conexant Systems, Inc. ("Conexant"), Fujitsu
Microelectronics, Inc. ("Fujitsu"), Hitachi, Ltd. ("Hitachi"), Hyundai
Electronics Industries Co., Ltd. ("Hyundai"), Infineon Technologies AG
("Infineon"; formerly known as Siemens Semiconductors), NEC Corporation ("NEC"),
Oki Electric Industry Co., Ltd. ("OKI"), VLSI Technology, Inc. (now part of
Philips Semiconductors), Sanyo Electric Co. Ltd. ("Sanyo"), Sharp Corporation
("Sharp"), STMicroelectronics Group ("ST"; formerly known as SGS-THOMSON
Microelectronics, S.r.l.), Taiwan Semiconductor Manufacturing Company Ltd.
("TSMC"), Toshiba Corporation ("Toshiba") and UMC Group ("UMC").

The Company was incorporated in California in April 1991 as VLSI Libraries
Incorporated and changed its name to Artisan Components, Inc. in March 1997. The
Company reincorporated in Delaware in January 1998. The Company's principal
executive offices are located at 1195 Bordeaux Drive, Sunnyvale, California
94089, its telephone number is (408) 734-5600 and its website is
www.artisan.com. Artisan, Process-Perfect, SAGE, Integral and the Artisan logo
are trademarks of the Company. This Annual Report on Form 10-K also includes
product names and other trade names and trademarks of the Company and of other
organizations.

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INDUSTRY BACKGROUND

The development of the merchant IP component market has resulted from the
continuing horizontal specialization in the semiconductor industry, a trend that
has been driven by a growth in design complexity due to increases in
manufacturing capacity and an increasing focus on core competencies. In the
1970s, semiconductor companies were vertically integrated and responsible for
all aspects of IC production, including IC design, electronic design automation
("EDA") tool design, IP component design and IC manufacturing. In the 1980s,
application specific integrated circuit ("ASIC") companies developed a new
approach that allowed their customers to perform the logic design of an IC while
they performed the detailed physical implementation of the design and
manufactured the IC. In addition, standalone EDA tool vendors achieved success
by providing software design tools to complement those developed by internal
divisions of semiconductor companies. The early 1990s saw the emergence of a
number of fabless semiconductor companies that chose to focus on specific design
expertise, take advantage of the availability of excess semiconductor
manufacturing capacity and avoid the capital expenditures necessary to build
fabrication facilities. Throughout this period, semiconductor manufacturers
continued to focus on their core competencies: semiconductor design and
manufacturing processes. Today, with the emergence of System-on-a-Chip ICs,
semiconductor manufacturers are beginning to outsource the design of particular
IP components critical to the successful development of System-on-a-Chip ICs.

Over the past three decades, advances in semiconductor manufacturing
processes have enabled the transistor density on ICs to double every 18 months.
Today, it is possible to place nearly 100 million transistors on a single IC.
State of the art fabrication facilities of the 1980s produced ICs using process
geometries of 1.0um (one millionth of a meter). Current state-of-the-art
fabrication facilities use 0.15um process geometries, and many semiconductor
manufacturers have begun the transition to facilities using 0.13um and 0.10um
processes. These advances enable the manufacture of highly complex
System-on-a-Chip ICs, resulting in substantial performance, power, cost and
reliability improvements over conventional multi-chip systems on printed circuit
boards ("PCB Systems"). System-on-a-Chip ICs combine all of the functionality of
PCB Systems onto a single IC and are optimal for use in complex, high volume
applications such as portable computing devices, cellular phones, consumer
multimedia products, automotive electronics, personal computers and
workstations.

[Printed Circuit Board System Diagram]

As shown above, in both a PCB System and in a System-on-a-Chip, the primary
building blocks may include memory, standard cell (logic), I/O, microprocessor,
digital signal processor ("DSP"), mixed-signal and analog components. However,
integration of these components into System-on-a-Chip ICs at deep submicron
process geometries is far more complex than the design of a traditional PCB
System. With continuing advances in manufacturing processes, an increasing
number of individual transistors must be designed and tested and, consequently,
the gap is increasing between what can be manufactured and what can

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be designed within the time to market requirements of these products. As a
result, the full value of today's semiconductor manufacturing processes is
rarely realized, with designers settling for partial utilization of the process
in the interest of meeting cost and schedule requirements. Given shorter product
life cycles and the importance of reducing time to market, the use of merchant
IP components to leverage design and manufacturing capabilities can be a
significant competitive advantage to semiconductor manufacturers.

Semiconductor manufacturers require solutions that fully utilize their
manufacturing processes in order to maximize performance, speed and density
while reducing time to market. Although the merchant EDA industry has
successfully developed partial solutions to increase design productivity, EDA
tools have not completely overcome the time constraints posed by the need to
create IP components for each IC design in a compressed time to market window.
Merchant suppliers of portable generic IP libraries have also improved design
productivity by offering products designed to work with many manufacturing
processes. However, these generic libraries do not fully utilize the depth and
strengths of a particular manufacturing process. Semiconductor manufacturers
have also tried to expand their design resources, but establishing and
maintaining a large internal design group may divert finite resources from a
semiconductor manufacturer's core competencies. Despite the development and use
of EDA tools and generic libraries and the expansion of internal design
resources, the rapid pace of manufacturing process improvements has continued to
outstrip design capabilities. As a result, the Company believes many
semiconductor manufacturers are using merchant IP components in order to
maximize the performance of their product offerings and improve their time to
market.

ARTISAN STRATEGY

The Company's objective is to be the leading provider of high performance
IP components to the semiconductor industry. The Company's strategy is based
upon the following key elements:

Focus on Key Components for High Volume System-on-a-Chip ICs. The
Company has targeted the rapidly growing System-on-a-Chip industry with
highly differentiated memory, standard cell and I/O components. Together,
these components constitute approximately 80% of the silicon area on a
typical System-on-a-Chip IC. Improvements in the performance of these
components can have a substantial impact on the overall performance of the
IC.

Target Leading Semiconductor Manufacturers. The Company focuses on
licensing its products to the world's leading semiconductor manufacturers.
These manufacturers represent the largest revenue potential for the Company
because they utilize the most advanced manufacturing processes, manufacture
the largest number of ICs, have the most pressing need for high performance
IP components and face the greatest time to market pressures.

Generate Revenue through Innovative Business Model. The Company
generates revenue through a combination of license fees, maintenance and
support contracts and royalty payments. The Company charges manufacturers a
license fee for the right to manufacture semiconductors containing the
Company's products. In addition, manufacturers agree to pay the Company
royalties based on manufacturing volumes. Once a manufacturer has licensed
a product from the Company and in order to maximize royalties, the
manufacturer is encouraged to distribute the product to teams designing
integrated circuits for production at the manufacturer's facility. In cases
where the manufacturer may not have the infrastructure to distribute the
Company's products to design teams, the Company performs the distribution
function through its web site as well as through an in-house telemarketing
organization. As a result, the Company believes its license agreements will
facilitate the broad and rapid penetration of the Company's products into
multiple designs, and thereby increase potential 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 gross royalty payments is
credited back to the customer's account for use as payment of license fees
for future orders to be placed with the Company. The remaining portion of
the royalty is reported as net royalty revenue. The amount of credit back
that can be earned by a customer is limited to the cumulative amount of
orders placed by that customer for a given process technology.

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Proliferate Artisan's IP Components throughout Customer Designs. The
Company intends to establish itself as the de facto supplier of key IP
components across multiple IC designs and new product generations for each
customer. By making its IP components easy to integrate into the customer's
design methodologies and supporting both industry standard and proprietary
IC design tools, Artisan facilitates the ready inclusion of its IP
components in a large number of designs.

Leverage Product Development Process. Artisan has developed a large
portfolio of IP building blocks and design tools that allows the Company to
develop new products rapidly. As its customer relationships mature, the
Company believes that the development time for additional products for a
customer will decrease due to the Company's growing base of knowledge and
understanding of the customer's manufacturing processes. The Company
intends to continue to improve the efficiency of its product development
process in order to decrease product delivery time.

Maintain Technological Leadership. The Company believes that its
customers evaluate IP components based on speed, density, power, quality,
reliability and price. Against these evaluation criteria, the Company
believes that it currently has a position of technological leadership. The
Company intends to maintain its technological leadership position by
continuing to develop a significant portfolio of IP building blocks upon
which it can base new generations of products and by making enhancements to
existing products. The Company also intends to maintain its expertise in
state of the art manufacturing processes by working with customers during
their new process development efforts.

THE ARTISAN SOLUTION

The Company's IP components are designed to offer customers the following
benefits:

Performance, Power and Reliability. Artisan delivers high performance,
high density, low power and highly reliable IP components through a
combination of design expertise, proprietary technology and design tools.
The Company's IP components, which are customized, verified and tested for
a particular manufacturing process, require little or no integration by
customers and have been proven by use in over 80 different manufacturing
processes. Many of the Company's products are designed to achieve speeds in
excess of 1 GHz.

Significant Time to Market Advantages. The Company enables
semiconductor manufacturers to reduce the time required to bring new ICs to
market by (i) eliminating the customer's need to design IP components, (ii)
delivering products designed for a specific manufacturing process and (iii)
delivering products ready for use with industry standard and proprietary IC
design tools. The Company's products can be reused in multiple customer
designs, which reduces the design cycle and decreases time to market for
new ICs.

Long Term Product Development Path. Artisan's IP component technology
provides semiconductor manufacturers with reliable building blocks for
future generations of their complex IC designs. Artisan's ability to adapt
and customize IP components used in one process and one design for reuse in
additional designs and processes, provides each customer with a ready
source of reliable IP components for future designs and processes. This
enables the Company's customers to standardize on Artisan products,
accelerate their product development and focus internal engineering
resources on core competencies, including semiconductor design and
manufacturing processes.

Cost Effective Solutions. As semiconductor geometries shrink and the
complexity of IC designs increases, the cost to design System-on-a-Chip ICs
increases significantly. By providing reliable products with significant
time to market benefits, Artisan enables customers to reduce design costs,
minimize integration costs and increase manufacturing yield. Moreover, by
using the Company's products, semiconductor manufacturers avoid the cost of
recruiting and training a significant group of engineers dedicated to IP
component design.

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PRODUCTS

Artisan's current family of IP components includes high performance, high
density and low power memory, standard cell and I/O components. Initial license
fees typically range from $250,000 to $700,000 per product, depending on the
amount of customization and the number of design views and models required.

Artisan's products are developed and delivered using a proprietary
methodology that includes a set of design tools, techniques and specific design
expertise that the Company calls "Process-Perfect." This methodology ensures
that the IP components produced by Artisan are designed to achieve the best
combination of performance, density, power and yield for a given manufacturing
process. In addition, the Company has created a flexible portfolio of IP
building blocks. This portfolio, combined with the Process-Perfect methodology,
allows the Company to satisfy its customers' schedule and quality requirements
in a cost effective manner. Artisan's IP components are easily integrated into a
variety of customer design methodologies and support industry standard IC design
tools, including those from EDA tool vendors such as Cadence Design Systems,
Inc. ("Cadence"), Synopsys, Inc. ("Synopsys") and Avant! Corporation ("Avant!"),
as well as customers' proprietary IC design tools. To support these various IC
design tool environments, each of the Company's products includes a
comprehensive set of verified tool models.

Memory Products

Artisan's embedded memory products include random access memories ("RAMs"),
read only memories ("ROMs") and register files. The Company's high speed, high
density and low power products include single-and dual-port RAM and ROM products
and single-, dual- and triple-port register files. The Company's embedded memory
products are configurable and vary in size to meet the customer's specification.
For example, the Company's memory products will support sizes from 2 to 128 bits
wide and from 8 to 16,384 words. All of the Company's memory products include
features such as a power down mode, low voltage data retention and fully static
operation. In addition, the Company's memory products may optionally include
built-in test interfaces that support popular test methodologies.

High Speed Memory Family. The high speed products are designed to
achieve speeds in excess of 1 GHz for 0.13mm manufacturing processes. The
Company achieves the high performance of its memory products through a
combination of proprietary design innovations that include latch based
sense amplifiers, high speed row select technology, precise core cell
balancing and rapid recovery bitlines.

High Density Memory Family. The high density products are designed for
applications where achieving the lowest possible manufacturing cost is
critical. These are typically consumer applications with high manufacturing
volumes. To achieve the lowest possible manufacturing cost for these
products, the Company utilizes proprietary circuit and layout techniques to
reduce the overall area of the memories. In addition, the Company uses
specific design and analysis techniques to enhance production yield.

Low Power Memory Family. The low power products are designed to
prolong battery life when used in battery-powered electronic systems. These
products achieve low power through a combination of proprietary design
innovations that include latch based sense amplifiers, a power efficient
banked memory architecture, precise core cell balancing and unique address
decoder and driver circuitry.

Standard Cell Products

Artisan's SAGE-X standard cell product includes over 500 cells optimized
for each customer's preferred manufacturing process and IC design tool
environment to result in greater density as compared to competitive standard
cell products. The Company offers standard cell products that are optimized for
high performance, high density or low power to meet the needs of different
markets.

I/O Products

The Company's Integral I/O library includes over 600 standard I/O
functions. The Company also offers a wide variety of specialized I/O products
that are compatible with industry standard PCI, GTL, AGP and
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PECL interfaces. In addition, the Company offers I/O products for many
additional industry standard interfaces. Every I/O product utilizes each
customer's proprietary manufacturing process rules, pad pitch and ESD
requirements, resulting in superior performance, reliability and
manufacturability.

PRODUCT DEVELOPMENT

The Company has targeted the rapidly growing System-on-a-Chip market with
high performance, high density and low power memory, standard cell and I/O
products. Because of the complexity of these products, the design and
development process at Artisan is a multidisciplinary effort requiring expertise
in electronic circuit design, process technology, physical layout, design
software, model generation, data analysis and processing and general IC design.
These activities involve the development of more advanced versions of the
Company's products and the continued development of new products for current and
anticipated manufacturing processes.

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 while the balance
of engineering costs, incurred for general development of Artisan's technology,
is charged to product development. The Company expects that it will continue to
invest substantial funds for engineering activities. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Factors Affecting Future Operating Results -- New Product Development and
Technological Change."

SALES, MARKETING AND DISTRIBUTION

The Company primarily licenses its products on a nonexclusive, worldwide
basis to major semiconductor manufacturers and grants these manufacturers the
right to distribute its IP components to their internal design teams and to
fabless semiconductor companies that manufacture at their 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 using the Company's web site as well as its in-house telemarketing
organization. The Company believes its sales, marketing and distribution
approach gives it an advantage over its competitors since the Company is able to
leverage its customers' sales and marketing organizations and avoid the costs
associated with hiring, training and compensating the large sales force
necessary to negotiate with each end-user customer. The Company has a sales
office in Tokyo, Japan, and in August 2000, the Company established a European
presence with an office located in Paris, France. Additionally, the Company
relies in part on a consulting company in Korea to assist its sales efforts in
that market.

Historically, a substantial portion of the Company's revenue has been
derived from customers outside the United States ("international revenue"). In
fiscal 2000, 1999 and 1998, international revenue, primarily in Asia and Europe,
represented 86%, 67% and 84%, 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 "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors Affecting
Future Operating Results -- Risks Associated with International Customers."

CUSTOMERS

The Company is focused on licensing its products to semiconductor
manufacturers and fabless semiconductor companies. Many of the world's leading
semiconductor manufacturers are among the Company's customers including:
Chartered, Conexant, Fujitsu, Hitachi, Hyundai, Infineon, NEC, OKI, VLSI
Technology, Inc. (now part of Philips Semiconductors), Sanyo, Sharp, ST, TSMC
and UMC. The Company's royalty-based business model enables aggressive product
distribution and licensing to fabless semiconductor companies who are the
customers of the semiconductor manufacturers. To date, the Company has licensed
its products to hundreds of these semiconductor companies.

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In addition, Artisan has several industry partner programs whereby members
provide a wide variety of soft IP and microprocessor solutions, design services
and tool support to streamline the design process for Artisan library users.
Many of the Company's current industry partners are listed in the table below.

ARTISAN'S PARTNERS

Advancel Logic Corporation IKOS Systems RealChip, Inc.
Altius Solutions, Inc. Incentia Design Systems SangHwa Micro Technology, Inc
Aptix Corporation Infinite Technology Sapphire Design Automation
ARC Cores Limited Corporation Sequence Design, Inc.
Arcadia Design Systems, Inc. Innovative Semiconductors, Sci-worx GmbH
Aristo Technology, Inc. Inc. Silicon Access Networks, Inc.
ASIC International, Inc. Integrated Silicon Systems, Silicon Perspective, Corporation
ATMOS Corporation Ltd. SiLutia, Inc.
Aurora VLSI, Inc. InternetCAD.com, Inc. Simplex Solutions, Inc.
Averant, Inc. InTime Software, Inc. SmartSand, Inc.
Axis Systems, Inc. Jennic, Ltd. Sonics, Inc.
BOPS, Inc. LavaLogic SOTA Design Technology, Inc.
Cadence Design Systems Legend Design Technology, Static Free Software
cadMOS Design Technology, Inc. Inc. Sycon Design, Inc.
CMOS Chips, Inc Lexra, Inc. Synopsys, Inc.
CreOsys, Inc. LogicVision Syntest Technologies, Inc.
CynApps, Inc. MacroTech Research, Inc. Target Compiler Technologies N.V.
Dai Nippon Printing Co., Ltd. Magma Design Automation Tensilica, Inc.
Denali Software, Inc. Mentor Graphics Corporation Tera Systems, Inc.
Easics NV MIPS Technologies, Inc. Tharas Systems, Inc.
e-MDT, Inc. Monterey Design Systems, Toppan Printing Co., Ltd.
Enabling Technology, Inc. Inc. Transtechnic International, Inc.
Flextronics Semiconductor Morphics Technology, Inc. Ultima Interconnect Technology, Inc.
FOCAM Technologies, Inc. MOSAID Technology, Inc. VeraTest, Inc.
Gain Technology Corporation Moscape, a Magma Company Verplex Systems, Inc.
GDA Technologies, Inc. MOSIS Videon, Inc.
Genesys Testware MystiCom, Ltd. Virtual IP Group, Inc.
Get2Chip.com, Inc. Numerical Technologies, Inc. Voom, Inc.
Global Unichip Corporation Palmchip Corporation White Eagle Systems Technology, Inc.
Goya Technology Parthus Technologies PLC Xentec, Inc.
GreenForest Consulting, Inc. picoTurbo, Inc. X-VEIN, Inc.
Progate Group Corporation
QThink
Quadic Systems, Inc.
QuArc, Inc.
Quickturn, A Cadence Company

The Company has been dependent on a relatively small number of customers
for a substantial portion of its annual revenue, although the customers
composing this group have changed from time to time. 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 an 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 royalty revenue. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors Affecting
Future Operating Results -- Customer Concentration; Limited Customer Base and
Competition."

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 market, the Company competes primarily against Avant!, Nurlogic Corporation
("Nurlogic"), the Silicon Architects division of Synopsys, Virage Logic
("Virage") and Virtual Silicon Technologies ("Virtual Silicon"). In addition,
the Company may face competition from consulting firms and

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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.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors Affecting Future Operating Results -- Competition."

PATENTS AND INTELLECTUAL PROPERTY PROTECTION

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. The Company has an active
program to protect its proprietary technology through the filing of patents. As
of September 30, 2000, the Company had 14 U.S. patents granted, 7 patent
applications pending before the U.S. Patent and Trademark Office ("USPTO") and
had filed six patent applications in foreign countries.

The Company also relies on trademark and trade secret laws to protect its
intellectual property. The Company protects its trade secrets and other
proprietary information through confidentiality agreements with its employees
and customers in addition to other security measures. Despite these efforts,
there can be no assurance that others will not gain access to the Company's
trade secrets, that such trade secrets will not be independently discovered by
competitors or that the Company can meaningfully protect its intellectual
property. In addition, effective trade secret protection may be unavailable or
limited in certain foreign countries. Although the Company intends to protect
its rights vigorously, there can be no assurance that such measures will be
successful. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Factors Affecting Future Operating Results -- Risks
Associated with Protection of Intellectual Property."

EMPLOYEES

Artisan's employee population grew 7% during the past year. As of September
30, 2000, the Company had 108 employees and full-time equivalents compared to
101 at the end of the prior fiscal year. None of the Company's employees is
represented by a labor union or is subject to a collective bargaining agreement.
The Company has never experienced a work stoppage and believes that its
relations with employees are good.

EXECUTIVE OFFICERS

The executive officers of the Company, their positions and their ages (as
of September 30, 2000) are as follows:

NAME AGE POSITION
---- --- --------

Mark R. Templeton......................... 41 President, Chief Executive Officer and
Director
Scott T. Becker........................... 40 Chief Technical Officer and Director
Joy E. Leo................................ 39 Vice President, Finance and Administration
and Chief Financial Officer
Dhrumil Gandhi............................ 43 Vice President, Engineering
Eduard Weichselbaumer..................... 47 Vice President, Worldwide Sales
Brent Dichter............................. 39 Vice President, Product/Program Management

Mark R. Templeton has served as President, Chief Executive Officer and a
director of the Company since April 1991 when he co-founded the Company. From
April 1990 to March 1991, Mr. Templeton was director of the Custom IC Design
Group at Mentor Graphics, an EDA company. From October 1984 to March 1990, he
held various positions with Silicon Compilers Systems Corporation ("Silicon
Compilers"), an EDA company, with the last position being Director of the Custom
IC Design Group.

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Scott T. Becker has served as Chief Technical Officer and a director of the
Company since April 1991 when he co-founded the Company. From April 1990 to
April 1991, he was manager of the library development group at the IC Division
of Mentor Graphics. From May 1985 to April 1990, he was responsible for library
development at Silicon Compilers.

Joy E. Leo joined the Company as Vice President of Finance and
Administration and Chief Financial Officer in September 2000. From January 2000
to August 2000, she served as Vice President of Finance and Administration and
Chief Financial Officer for IMP, Inc. From August 1998 to January 2000, she was
Vice President of Finance, Operations and Administration at Innomedia
Incorporated. From June 1995 to January 1998, she was Vice President and Chief
Financial Officer for Philips Components, a division of Royal Philips
Electronics N.V.

Dhrumil Gandhi has served as Vice President of Engineering of the Company
since May 1993. From July 1983 to May 1993, he served as Senior Manager for
Advanced ASIC Design Systems at Mentor Graphics.

Eduard Weichselbaumer has served as the Vice President of Worldwide Sales
of the Company since May 2000. From January 1998 to December 1999 he headed the
Worldwide Library Sales and Business Development team at Synopsys, Inc. From
1994 to 1997 he was President and COO of Pacific Silicon Technologies. Prior to
1994 he held senior management positions with HHB Systems, LSI Logic and
Fairchild Semiconductor.

Brent Dichter has served as the Vice President of Product/Program
Management of the Company since March 2000 and as Director of Engineering from
November 1998 to March 2000. From January 1997 to November 1998, he served as
Vice President of Silicon Technology at Multi Dimensional Computing. From July
1995 to January 1997, he was Director of Strategic Marketing for Xilinx
Incorporated.

ITEM 2. PROPERTIES

The Company's executive, administrative and technical offices currently
occupy 32,660 square feet in Sunnyvale, California, under a lease that expires
in 2004. The Company sublets to a third party the 16,797 square foot space it
formerly occupied in San Jose, California. The lease on the San Jose space
expires in February 2001. In addition, as of September 30, 2000, the Company
also leases sales and support offices in North Andover, Massachusetts, Paris,
France and Tokyo, Japan. The Company is currently seeking additional space and
believes that it will be available on commercially reasonable terms.

ITEM 3. LEGAL PROCEEDINGS

The Company is not currently a party to any legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

10
11

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

PRICE RANGE OF COMMON STOCK

The Company's Common Stock has been quoted on the Nasdaq National Market
under the symbol "ARTI" since the Company's initial public offering on February
3, 1998. Prior to such time, there was no public market for the Common Stock of
the Company. As of October 31, 2000, there were approximately 132 stockholders
of record of the Common Stock. The following table sets forth for the periods
indicated the high and low sale prices per share of the Common Stock as reported
on the Nasdaq National Market.

FISCAL YEAR ENDING FISCAL YEAR ENDING
SEPTEMBER 30, 2000 SEPTEMBER 30, 1999
------------------ -------------------
HIGH LOW HIGH LOW
------- ------- -------- -------

First Quarter................................ $23.500 $ 7.250 $11.375 $4.375
Second Quarter............................... $30.000 $14.500 $ 7.688 $5.000
Third Quarter................................ $21.188 $ 7.563 $12.250 $4.219
Fourth Quarter............................... $14.750 $ 7.250 $14.375 $8.125

On December 15, 2000, the reported last sale price of the Common Stock on
the Nasdaq National Market was $7.69 per share.

DIVIDEND POLICY

Since March 1996, when the Company converted to a C corporation from a
subchapter S corporation, the Company has not declared or paid any cash
dividends on its Common Stock or other securities. The Company presently intends
to retain future earnings, if any, for use in the operation and expansion of its
business and does not anticipate paying cash dividends in the foreseeable
future.

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12

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and Notes thereto included
elsewhere in this Annual Report on Form 10-K. The balance sheet data as of
September 30, 2000 and 1999 and the statement of operations data for the fiscal
years ended September 30, 2000, 1999 and 1998 are derived from the financial
statements that have been audited by PricewaterhouseCoopers LLP, independent
accountants, and which are included elsewhere in this Annual Report on Form
10-K. The balance sheet data as of September 30, 1998, 1997 and 1996 and the
statement of operations data for the fiscal years ended September 30, 1997 and
1996 are derived from the financial statements that have been audited by
PricewaterhouseCoopers LLP, independent accountants, and which are not included
in this Annual Report on Form 10-K. Historical results are not necessarily
indicative of results to be expected in the future.

FISCAL YEAR ENDED SEPTEMBER 30,
---------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------ ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
License........................................... $17,042 $14,138 $16,568 $8,912 $4,147
Net royalty....................................... 3,250 729 -- -- --
------- ------- ------- ------ ------
Total revenue............................. 20,292 14,867 16,568 8,912 4,147
Total cost and expenses............................. 21,622 18,292 14,494 8,169 3,574
------- ------- ------- ------ ------
Operating income/(loss)............................. (1,330) (3,425) 2,074 743 573
Other income, net................................... 2,945 2,024 1,175 297 96
------- ------- ------- ------ ------
Income/(loss) before provision/(benefit) for income
taxes............................................. 1,615 (1,401) 3,249 1,040 669
Provision/(benefit) for income taxes................ 533 (858) 923 356 137
------- ------- ------- ------ ------
Net income/(loss)................................... $ 1,082 $ (543) $ 2,326 $ 684 $ 532
======= ======= ======= ====== ======
Basic net income/(loss) per share (historical)(2)... $ 0.08 $ (0.04) $ 0.22 $ 0.13 $ 0.11
======= ======= ======= ====== ======
Diluted net income/(loss) per share
(historical)(2)................................... $ 0.07 $ (0.04) $ 0.18 $ 0.07 $ 0.08
======= ======= ======= ====== ======
Pro forma net income data (unaudited)(1)............ $ 409
Diluted net income per share (pro forma)(2)......... $ 0.06
======
Shares used in computing:
Basic net income/(loss) per share................. 14,334 13,569 10,457 5,456 5,040
======= ======= ======= ====== ======
Diluted net income/(loss) per share............... 15,456 13,569 12,917 9,657 7,010
======= ======= ======= ====== ======

AT SEPTEMBER 30,
---------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------ ------
(IN THOUSANDS)

CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities... $54,016 $48,181 $47,204 $4,554 $2,958
Working capital.................................... 57,069 50,612 49,874 4,352 2,268
Total assets....................................... 71,930 64,344 59,489 12,011 5,172
Long term liabilities, net of current portion...... 235 174 218 49 15
Total stockholders' equity......................... $63,454 $57,120 $55,539 $9,348 $4,292

- ---------------
(1) Prior to March 1996, the Company was a subchapter S corporation and,
therefore, was not subject to entity level taxation. Pro forma net income
includes pro forma tax expense as if the Company were taxed as a C
corporation in fiscal 1996.

(2) For an explanation of net income/(loss) per share and shares used in per
share calculations, see Note 13 of the Notes to Consolidated Financial
Statements included elsewhere in this Annual Report on Form 10-K.

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13

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion should be read in conjunction with the Financial
Statements and Notes thereto included elsewhere in this Annual Report on Form
10-K. Certain statements in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" are forward looking statements.
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. Forward looking statements can often be identified by the use of
forward looking words such as "may," "will," "could," "should," "expect,"
"believe," "anticipate," "estimate," "continue," "plan," "intend," "project," or
other similar words. 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 I/O components for the design and
manufacture of complex 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.
The Company's contracts generally require a customer to pay a portion of the
license fees upon signing of the contract with the final payment due within 30
to 60 days after the completion of customization, which generally takes three to
six months. Royalty payments are calculated based on per unit sales of ICs or
wafers containing the Company's IP components. 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.

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 four of its customers. Net
royalty revenue was 16% and 5% of total revenue in fiscal 2000 and 1999,
respectively. According to contract terms, a portion of each royalty payment is
credited back to the customer's account for use as payment of license fees for
future orders placed with the Company. The remaining portion of the royalty is
reported as net royalty revenue. The amount of credit back that can be earned by
a customer is limited to the cumulative amount of orders placed by that customer
for a given process technology. The Company's success will depend, in part, on
its ability to generate royalty revenue from a substantially larger number of
designs and on many of these designs achieving large

13
14

manufacturing volumes. See "-- Factors Affecting Future Operating
Results -- Fluctuations in Operating Results -- Dependence on License Fee and
Royalty Royalty-Based Business Model."

The Company has been dependent on a relatively small number of customers
for a substantial portion of its revenue, although the customers composing this
group have changed from time to time. In fiscal 2000, TSMC, Sharp and NEC
accounted for 35%, 12% and 10% of revenue, respectively. In fiscal 1999, NEC,
TSMC, Conexant and UMC accounted for 25%, 19%, 14% and 13% of revenue,
respectively. In fiscal 1998, TSMC, OKI and UMC accounted for 14%, 11% and 11%
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. See "-- Factors Affecting Future Operating
Results -- Customer Concentration; Limited Customer Base."

Historically, a substantial portion of the Company's revenue has been
international revenue. In fiscal 2000, 1999 and 1998, international revenue,
primarily in Asia and Europe, represented 86%, 67% and 84%, 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."

While net royalty revenue accounted for 16% of total revenue in fiscal
2000, the Company derives a substantial majority of all of its revenue from
license fees associated with sales of its products, including support and
maintenance, that together accounted for 84%, 95% and 100% of total revenue in
fiscal 2000, 1999 and 1998, respectively. Although the percent of revenue
represented by license revenue has declined, the Company expects that license
revenue will continue to account for a substantial portion of the Company's
revenue for the foreseeable future. See "-- Results of Operations" and
"-- 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 generally 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.

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, some of the
Company's older 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,
in the past, experienced periods of negative growth as well as declines in the
rate of growth of its revenue as compared with prior periods. 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."

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

14
15

the options, of which approximately $56,000, $87,000 and $80,000 were amortized
during fiscal 2000, 1999 and 1998, respectively.

RESULTS OF OPERATIONS

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

YEAR ENDED SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------

Revenue:
License................................................... 84.0% 95.1% 100.0%
Net royalty............................................... 16.0 4.9 0.0
----- ----- -----
Total revenue..................................... 100.0 100.0 100.0
----- ----- -----
Costs and expenses:
Cost of revenue........................................... 26.9 40.1 30.0
Product development....................................... 33.7 31.1 21.6
Sales and marketing....................................... 34.5 34.3 24.3
General and administrative................................ 11.5 17.5 11.6
----- ----- -----
Total cost and expenses........................... 106.6 123.0 87.5
----- ----- -----
Operating income/(loss)..................................... (6.6) (23.0) 12.5
Other income, net........................................... 14.5 13.6 7.1
----- ----- -----
Income/(loss) before provision for income taxes............. 7.9 (9.4) 19.6
Provision/(benefit) for income taxes........................ 2.6 (5.7) 5.6
----- ----- -----
Net income/(loss)........................................... 5.3% (3.7)% 14.0%
===== ===== =====

FISCAL YEARS 2000, 1999 AND 1998

CHANGE CHANGE
2000 INC /(DEC) 1999 INC /(DEC) 1998
------- ---------- ------- ---------- -------
(DOLLARS IN THOUSANDS)

Total Revenue................... $20,292 36.5% $14,867 (10.3)% $16,568

Artisan's total revenue increased by 36.5% in fiscal 2000 compared to
fiscal 1999. The increase in total revenue was primarily attributable to an
increase in net royalty revenue of $2.5 million, increased revenue from support
and maintenance contracts of $1.3 million and increased licensing of I/O, memory
and standard cell products of $1.6 million in fiscal 2000. Gross royalty
payments are calculated based on per unit sales of ICs or wafers containing the
Company's IP components. Total gross royalties for fiscal 2000 were $4.9
million. From this amount, a portion was credited back to the customer's account
for use as payment of license fees for future orders to be placed with the
Company. The remaining portion of the royalty, or $3.3 million in fiscal 2000,
was reported as net royalty revenue. Total gross royalties for fiscal 1999 were
$1.1 million. Of this amount, $729,000 was reported as net royalty revenue in
fiscal 1999.

The 10.3% decrease in fiscal 1999 total revenue, as compared to fiscal 1998
total revenue, was primarily attributable to a $3.9 million decrease in
licensing revenues from the Company's memory products due to reduced customer
orders for these products, partially offset by the addition of net royalty
revenue of $729,000 and by increases in revenue from support contracts and
licensing of I/O and standard cell products of $1.5 million. Total gross
royalties for fiscal 1999 were $1.1 million.

15
16

Cost and Expenses

CHANGE CHANGE
2000 INC /(DEC) 1999 INC /(DEC) 1998
------- ---------- ------- ---------- ------
(DOLLARS IN THOUSANDS)

Engineering costs (incl. cost of
revenue and product development)... $12,299 16.2% $10,588 24.0% $8,542

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 expensed as
incurred. Engineering costs increased by 16.2% in fiscal 2000. The absolute
dollar increase in engineering costs of $1.7 million in fiscal 2000, as compared
with fiscal 1999, was primarily due to an increase in headcount and personnel
expenses of $1.0 million, increased computer and networking equipment
maintenance and depreciation of $517,000 and increased use of outside
contractors of $220,000.

Engineering costs increased 24.0% in fiscal 1999. The absolute dollar
increase in engineering costs of $2.0 million was primarily due to an increase
in headcount and personnel expenses of $1.4 million and increased computer and
networking equipment maintenance and depreciation of $628,000.

CHANGE CHANGE
2000 INC /(DEC) 1999 INC /(DEC) 1998
------ ---------- ------ ---------- ------
(DOLLARS IN THOUSANDS)

Cost of Revenue.............. $5,462 (8.3)% $5,957 20.1% $4,962

Cost of revenue decreased by 8.3% in fiscal 2000. The absolute dollar
decrease in cost of revenue of $495,000 in fiscal 2000, as compared with
fiscal 1999, was due to fewer engineering hours allocated to
revenue-generating projects in fiscal 2000.

Cost of revenue increased by 20.1% in fiscal 1999. The absolute dollar
increase in cost of revenue of $995,000 in fiscal 1999, as compared with
fiscal 1998, was due to increases in headcount and costs associated with
delivering product to, and supporting, a growing customer base.

CHANGE CHANGE
2000 INC /(DEC) 1999 INC /(DEC) 1998
------ ---------- ------ ---------- ------
(DOLLARS IN THOUSANDS)

Product Development
Expenses........................ $6,837 47.6% $4,631 29.4% $3,580

Product development expenses increased by 47.6% in fiscal 2000. The
absolute dollar increase in product development expenses of $2.2 million in
fiscal 2000, as compared with fiscal 1999, was attributable to an increase
in headcount and personnel expenses, increased computer and networking
equipment maintenance and depreciation costs and increased use of outside
contractors. The Company expects that product development expenses will
continue to increase in absolute dollars.

Product development expenses increased by 29.4% in fiscal 1999. The
absolute dollar increase in product development expenses of $1.1 million in
fiscal 1999, as compared with fiscal 1998, was attributable to an increase
in headcount and personnel expenses and increased computer and networking
equipment maintenance and depreciation costs.

CHANGE CHANGE
2000 INC /(DEC) 1999 INC /(DEC) 1998
------ ---------- ------ ---------- ------
(DOLLARS IN THOUSANDS)

Sales and Marketing Expenses....... $6,999 37.1% $5,105 26.7% $4,030

Sales and marketing expenses include salaries, commissions, travel expenses
and costs associated with trade shows, advertising and other marketing efforts.
Sales and marketing expenses increased by 37.1% in fiscal 2000. The increase in
absolute dollars in sales and marketing expenses of $1.9 million in fiscal 2000,
as compared with fiscal 1999, was attributable to increased headcount and
personnel-related expenses of approximately $1.4 million, as well as higher
travel expense of $359,000 and increases in other expenses of $155,000.
Headcount and related costs, travel costs and facilities and equipment costs
increased due to the

16
17

continued investment to support an increasing end user customer base. Marketing
program expenses decreased because of a reduction in the amount of collateral
and documentation materials, as these materials are now primarily provided
electronically. The Company expects sales and marketing expenses to increase in
absolute dollars in the future as the Company increases headcount to expand
account coverage and provide increased end user customer support.

Sales and marketing expenses increased by 26.7% in fiscal 1999. The
increase in absolute dollars of $1.1 million in sales and marketing expenses in
fiscal 1999, as compared with fiscal 1998, was attributable to increased
headcount and personnel-related expenses of approximately $381,000, higher
travel expenses of $350,000 and increased advertising and trade show expenses
plus investment in new marketing programs of approximately $311,000. Advertising
and trade show expenses increased in fiscal 1999 because the Company attended
numerous small trade shows and allocated more resources to enhance its profile
with potential end-user customers at the Design Automation Conference trade
show. New marketing program expenditures increased in fiscal 1999 as a result of
the Company's investment in telemarketing personnel and collateral materials to
support its growing end-user customer base.

CHANGE CHANGE
2000 INC /(DEC) 1999 INC /(DEC) 1998
------ ---------- ------ ---------- ------
(DOLLARS IN THOUSANDS)

General and Administrative
Expenses..................... $2,324 (10.6)% $2,599 35.2% $1,922

General and administrative expenses decreased by 10.6% in fiscal 2000. The
absolute dollar decrease in general and administrative expenses of $275,000 in
fiscal 2000, as compared with fiscal 1999, was due to lower bad debt expense of
$394,000, lower headcount and personnel-related expenses of approximately
$101,000, offset by increased legal fees and outside recruitment services of
$220,000, due primarily to the Company's need for legal counsel during the time
that no in-house counsel was employed with the Company and professional
recruiting fees for the Company's new Chief Financial Officer. The Company
expects general and administrative expenses to grow in absolute dollars in
future periods as the Company expands its operations.

General and administrative expenses increased by 35.2% in fiscal 1999. The
absolute dollar increase in general and administrative expenses of $677,000 in
fiscal 1999, as compared with fiscal 1998, was due to bad debt expense related
to deterioration in the financial and/or business condition of two of the
Company's customers and an increase in the general reserve for doubtful accounts
totaling $369,000, headcount additions in late fiscal 1998 which increased 1999
expenses by approximately $135,000 and increased costs of public reporting,
additional accounting and legal fees, increased insurance costs and professional
recruiting fees totaling $173,000, primarily due to the Company's status as a
publicly-held company for only part of fiscal 1998 but for all of fiscal 1999.

CHANGE CHANGE
2000 INC /(DEC) 1999 INC /(DEC) 1998
------ ---------- ------ ---------- ------
(DOLLARS IN THOUSANDS)

Other Income, net.............. $2,945 45.5% $2,024 72.3% $1,175

Other income increased by 45.5% in fiscal 2000. The growth in other income
of $921,000 in fiscal 2000, as compared with fiscal 1999, reflected a higher
rate of return on the Company's investment portfolio as well as a larger
portfolio balance during fiscal 2000.

Other income increased by 72.3% in fiscal 1999. The growth in other income
of $849,000 in fiscal 1999, as compared with fiscal 1998, reflects a full year
of interest income from investments in fiscal 1999 as compared to a partial year
in fiscal 1998, since the Company invested proceeds from an initial public
offering and secondary public offering completed in February 1998 and April
1998, respectively. The increased other

17
18

income also reflects higher interest income earned as a result of the Company's
decision to move from tax-exempt investments in fiscal 1998 to taxable
investments early in fiscal 1999.

CHANGE CHANGE
2000 INC /(DEC) 1999 INC /(DEC) 1998
------ ---------- ------ ---------- ------
(DOLLARS IN THOUSANDS)

Provision (benefit) for Income
Taxes........................ $ 533 N/A $ (858) N/A $ 923

The income tax provision was $533,000 in fiscal 2000. The income tax
benefit was $858,000 in fiscal 1999 and the income tax provision in fiscal 1998
was $923,000. The effective tax rate was 33.0% in fiscal 2000 and 28.4% in 1998.
The tax provisions in fiscal 2000 and 1998 were due to the taxable operating
income in fiscal 2000 and fiscal 1998. The tax benefit in fiscal 1999 was due to
the operating loss in that year. The difference between the statutory and
effective rates of income tax is due to the impact of state taxes and tax-free
interest income and tax credits.

LIQUIDITY AND CAPITAL RESOURCES

The Company has funded its operations primarily from revenue received from
inception to September 30, 2000, 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.

The Company's operating activities provided net cash of $3.6 million, $2.3
million and $2.1 million in fiscal 2000, 1999 and 1998, respectively. Net cash
provided by operating activities in fiscal 2000 was primarily due to net income
plus depreciation and amortization and changes in accounts payable and other
liabilities and deferred revenue offset by deferred taxes. Net cash provided by
operating activities in fiscal 1999 was due to deferred revenue, depreciation
and amortization and accounts payable and other liabilities, offset by contract
receivables, deferred taxes and the Company's net loss. Net cash provided by
operating activities in fiscal 1998 was primarily due to net income plus
depreciation and amortization offset by contract receivables, prepaid expenses
and other assets.

Net cash provided by investing activities was $11.0 million in fiscal 2000
and net cash used in investing activities was $25.2 million in fiscal 1999 and
$10.2 million in fiscal 1998. Investing activities in fiscal 2000 consisted
primarily of net sales of marketable securities and purchase of property and
equipment. Investing activities in fiscal 1999 and 1998 consisted primarily of
net purchases of marketable securities offset by purchases of property and
equipment. See Notes 5 and 6 of the Notes to Consolidated Financial Statements.

Net cash provided by financing activities was $3.5 million, $1.6 million
and $43.6 million in fiscal 2000, 1999 and 1998, respectively. In fiscal 2000
and 1999, financing activities consisted of proceeds from issuance of Common
Stock to employees upon the exercise of stock options or in connection with the
Company's 1997 employee stock purchase plan. In fiscal 1998, financing
activities consisted primarily of sales of the Company's Common Stock in its
initial public offering and secondary public offering.

As of September 30, 2000, the Company had cash, cash equivalents and
current marketable securities of $54.0 million. As of September 30, 2000, the
Company had retained earnings of $3.8 million and working capital of $57.1
million that includes the current portion of deferred revenue of $4.6 million.
The Company anticipates spending approximately $4.0 million in capital
expenditures over the next 12 months.

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 and royalty
revenue, available borrowings under line of credit arrangements and other
factors. The Company believes that its current cash and investment balances and
any

18
19

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 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.

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB
No. 101 summarizes certain of the SEC's views in applying generally accepted
accounting principles to revenue recognition in financial statements. In March
2000, the SEC issued SAB No. 101A to defer for one quarter, and in June 2000
issued SAB No. 101B to defer for an additional two quarters, the effective date
of implementing SAB No. 101, with earlier application encouraged. The adoption
of SAB No. 101 is required in the first quarter of fiscal 2001. The Company does
not expect the adoption of SAB No. 101 to have a material effect on its
financial position or results of operations.

In March 2000, the FASB issued Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation -- an
interpretation of APB Opinion No. 25." FIN 44 clarifies, among other issues (a)
the definition of employee for purposes of applying APB Opinion No. 25, (b) the
criteria for determining whether a plan qualifies as a non compensatory plan,
(c) the accounting consequence of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. This interpretation has
provisions that are effective on staggered dates, some of which began after
December 15, 1998 and January 15, 2000, and others that became effective after
June 30, 2000. The adoption of this interpretation did not have a material
impact on the Company's financial statements.

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

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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 which 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 September 30, 2000 and 1999. All investments mature
in one year or less.

CARRYING AVERAGE RATE CARRYING AVERAGE RATE
VALUE AT OF RETURN AT VALUE AT OF RETURN AT
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2000 2000 1999 1999
-------------- ------------- -------------- -------------
(IN THOUSANDS) (ANNUALIZED) (IN THOUSANDS) (ANNUALIZED)

INVESTMENT SECURITIES:
Cash equivalents -- variable rate..... $ 4,544 5.8% $ 1,619 4.7%
Money market funds -- variable rate... 618 6.3% 678 5.2%
Cash equivalents -- fixed rate........ 28,116 6.6% 12,936 5.3%
Short-term investments -- fixed
rate................................ 20,738 6.7% 32,948 5.6%
------- -------
Total investment
securities................ $54,016 $48,181
======= =======

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.

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.

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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 has, in the past, experienced periods of negative growth
as well as declines in the rate of growth of its revenue as compared with prior
periods. There can be no assurance that the Company will experience stable or
increasing revenues 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, some of the Company's older 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. See
"-- Results of Operations."

Dependence on License Fee-and Royalty-Based Business Model

The Company has historically generated revenue from license fees only.
Beginning in late fiscal 1996, the Company implemented a 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. A portion of these payments is credited back to the customer's
account for use as payment of license fees for future orders to be placed with
the Company. The remaining portion of the royalty is reported as net royalty
revenue. In the third quarter of fiscal 1999, the Company received its first
royalty revenue. The Company's success will depend, in part, on its ability to
generate royalty revenue from a substantially larger number of designs and on
many of these designs achieving large manufacturing volumes. The Company's
ability to generate such royalty revenue will in turn depend in part on its
ability to negotiate, structure, monitor and enforce agreements for the
determination and payment of royalties. 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."

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

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ability to forecast royalty revenue is limited by factors that are beyond the
Company's ability to control or assess in advance. Royalties are recognized in
the quarter in which the Company receives a royalty report from its customers
and are dependent upon fluctuating sales volumes. In addition, under the
royalty-based business model, the Company's revenue is 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 also
faces risks relating to the accuracy and completeness of the royalty collection
process. The Company has only limited experience and systems in place to conduct
reviews of the accuracy of the royalty reports it receives from its licensees.
The Company has the right to audit its licensee's records to ensure the
integrity of their royalty reporting systems; however, such audits may only be
conducted periodically and are at the Company's expense in the event that no
material errors in reported royalties are found. The Company does not have
internal systems or staff dedicated to monitoring the royalty obligations of its
customers, and if it were to implement such systems and hire such staff in the
short term, the costs of those systems and staff could largely offset the
revenue the Company receives in the form of royalties. See "-- Results of
Operations."

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. System-on-a-Chip ICs are
characterized by rapid technological change and competition from an increasing
number of alternate design strategies such as multi-chip system-on-package and
chip size packaging designs. 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

Within the merchant segment of the IP component market, the Company
primarily competes against Avant!, Nurlogic, the Silicon Architects division of
Synopsys, Virage and Virtual Silicon. 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
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.

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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. See "Business -- Competition."

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. Demand for the Company's
products may also be affected by mergers in the semiconductor and systems
industries, which may reduce the aggregate level of purchases of the Company's
products and services by the combined companies. Faltering growth in the
semiconductor and systems industries, a reduced number of designs starts, shifts
in the types of integrated circuits manufactured, tightening of customers'
operating budgets or consolidation among the Company's customers could have a
material adverse effect on the Company's business, financial condition and
results of operations.

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.

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
composing this group have changed from time to time. In fiscal

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2000, TSMC, Sharp and NEC accounted for 35%, 12% and 10% of total revenue,
respectively. In fiscal 1999, NEC, TSMC, Conexant and UMC accounted for 25%,
19%, 14% and 13% of revenue, respectively. In fiscal 1998, TSMC, OKI and UMC
accounted for 14%, 11% and 11% of total 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" and
"Business -- Customers."

Product Concentration

While net royalty revenue accounted for 16% of total revenue in fiscal
2000, the Company derives substantially all of its revenue from license fees
associated with sales products, including support and maintenance, that together
accounted for 84%, 95% and 100% of total revenue in fiscal 2000, 1999 and 1998,
respectively. Although the percent of revenue represented by license revenue has
declined, the Company expects that 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
license revenue and a decline in license revenue 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 "Results of Operations."

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

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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.

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 total revenue has been
international revenue. In fiscal 2000, 1999 and 1998, international revenue,
primarily in Asia and Europe, represented 86%, 67% and 84%, respectively, of the
Company's total revenue. The Company anticipates that international revenue will
remain a substantial portion of its total 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. See "-- Results of Operations" and
"Business -- Sales, Marketing and Distribution."

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. See
"Business -- Product Development."

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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. See
"Business -- Employees."

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 September 30, 1996 to September 30, 2000, the
Company grew from 28 to 108 employees and 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
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. See "Business -- Employees."

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. There can be no assurance that
the Company's pending patent applications will be approved, that any issued
patents will protect the Company's intellectual property or will not be
challenged by third parties or that the patents of others will not have an
adverse effect on the Company's ability to do business. 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

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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.

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 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. See "Business -- Patents and
Intellectual Property Protection."

Future Capital Needs; Uncertainty of Additional Funding

The Comp