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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark one)

or

TRIDENT MICROSYSTEMS, INC.

1090 E. Arques Avenue, Sunnyvale, California 94085

(408) 991-8800

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.

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

The number of shares of the registrant’s $0.001 par value Common Stock outstanding at December 31, 2002 was 13,696,166.

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TRIDENT MICROSYSTEMS, INC.

INDEX

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TRIDENT MICROSYSTEMS, INC.

ASSETS

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

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TRIDENT MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

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

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TRIDENT MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

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

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TRIDENT MICROSYSTEMS, INC.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

Note 1. The Company

     Trident Microsystems, Inc. (the “Company”) designs, develops and markets integrated circuits for videographics, multimedia and digitally processed television products for the desktop and notebook PC market and consumer television market.

Note 2. Basis of Presentation

     The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts; actual results could differ from those estimates.

     In the opinion of the Company, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the financial position, operating results and cash flows for those periods presented. The unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and are not audited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended June 30, 2002 included in the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission.

     The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for any other period or for the entire fiscal year which ends June 30, 2003.

Note 3. Revenue Recognition

     Revenue from product sales is generally recognized upon shipment when persuasive evidence of an arrangement exists, the price is fixed or determinable, shipment is made and collectibility is reasonably assured. Provision is made for expected future sales returns and allowances when revenue is recognized. The Company has no obligation to provide any modification or customization upgrades, enhancements or other post-sale customer support. The Company grants certain distributors limited rights of return and price protection on unsold products. Product revenue on shipments to distributors with such rights is deferred until the Company is notified by the distributors that the products are shipped to end customers by the distributors.

     The Company’s license revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and the collectibility is reasonably assured. The Company’s license revenue does not require significant production,modification or customization of software. Royalty revenue is recognized when the Company is informed that the related products have been sold provided that collectibility is reasonably assured.

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Note 4. Recent Accounting Pronouncements

     In July 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” The principal difference between SFAS No. 146 and EITF Issue No. 94-3 relates to SFAS No.146’s timing for recognition of a liability for a cost associated with an exit or disposal activity. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue No. 94-3 a liability for an exit cost as generally defined in EITF Issue No. 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. SFAS No. 146 is applied prospectively upon adoption and, as a result, would not have any impact on the Company’s current financial position or results of operations.

     In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee and further requires a guarantor to provide additional disclosures regarding guarantees. The Interpretation’s provisions for initial recognition and measurement should be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of periods that end after December 15, 2002. The adoption of this Interpretation did not have any effect on the Company’s consolidated financial statements.

Note 5. Inventories

     Inventories consisted of the following (in thousands):

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Note 6. Loss Per Share

     Basic net loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income per share is calculated using the weighted average number of outstanding shares of common stock plus potential common stock shares. The calculation of diluted net loss per share excludes potential common stock if the effect is antidilutive. Potential common stock shares consist of common stock options, computed using the treasury stock method based on the average stock price for the period.

     Reconciliations of the numerators and denominators of the basic and diluted net loss per share calculations are as follows:

Note 7. Investment in UMC

     In August 1995, the Company made an investment of $49.3 million in United Integrated Circuits Corporation (“UICC”). On January 3, 2000, United Microelectronics Corporation (“UMC”) acquired UICC and, as a result of this merger, the Company received approximately 46.5 million shares of UMC. Subsequently, UMC announced a 20% stock dividend paid to shareholders of record on May 16, 2000, a 15% stock dividend paid to shareholders of record on July 21, 2001 and a 15% stock dividend paid to shareholders of record on August 22, 2002. The only change in the number of shares in UMC held by the Company from January 3, 2000 to December 31, 2002 was the increase resulting from the stock dividends. As of December 31, 2002, the Company owned approximately 73.8 million shares of UMC which represents about 0.5% of the outstanding stock of UMC.

     On January 3, 2000, the Company recognized a pre-tax gain of $117.0 million upon the receipt of UMC shares in exchange for the UICC shares. In the quarter ended March 31, 2001, based on the decline of UMC’s stock price, the decline in stock prices of publicly traded semiconductor companies and the unfavorable outlook regarding the demand and operating environment of the semiconductor industry, the Company concluded that the decline in the investment value in UMC had become other-than-temporary. Accordingly, the difference of $76.4 million between the carrying value on January 3, 2000 and the quoted fair value on March 31, 2001 was written off and included in earnings as impairment loss on investments in accordance with SFAS No. 115 and APB No. 18 for the short-term and long-term portions of investments, respectively.

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     In the quarter ended September 30, 2001, the Company concluded that due to a substantial decline in the market value of UMC’s stock price from March 31, 2001 to September 30, 2001, the continued decline in stock prices of publicly traded semiconductor companies and the continuing unfavorable outlook for the semiconductor industry, the decline in the investment value in UMC had become other-than-temporary. Accordingly, the difference of $40.0 million between the carrying value on March 31, 2001 and the quoted fair value on September 30, 2001, was written off against earnings as an impairment loss on investments in accordance with SFAS No. 115 and APB No. 18, for the short-term and long-term portions of investments, respectively.

     Due to a decrease in the market value of UMC’s stock price from October 1, 2001 to December 31, 2002, an unrealized loss of $4.5 million was recorded in equity as “accumulated other comprehensive loss” in accordance with SFAS No. 130, “Reporting Comprehensive Income.” The $4.5 million is equal to a $4.5 million decrease in market value of our short-term investment in UMC from October 1, 2001 to December 31, 2002.

     In order to preserve the 12.5% wafer capacity guarantee of the UICC facility, which guarantees a maximum of approximately 3,000 wafers per month, there are certain limitations on the Company’s ability to sell the UMC shares. If the Company’s total shareholdings fall below one-half of the initial percentage of shares held in UMC, the Company’s production capacity will be reduced by at least 50%, and depending on the interpretation of the foundry capacity agreement between the parties, the Company’s production capacity could be reduced by substantially more than 50%. In addition, one-third of the shares are subject to a two-year lock-up period in accordance with an investment agreement entered into with UMC on January 3, 2000. After a two-year period, one-fifth of the shares will be available for sale from the lock-up portion every six months. As of December 31, 2002, approximately 64.1 million shares with a carrying value of $39.1 million were included as short-term investments. As of December 31, 2002, approximately 9.7 million shares with a carrying value of $6.6 million are subject to this lock-up restriction. These shares are accounted for as long-term investments using the cost method in accordance with APB No. 18.

     Shares of the Company’s UMC investment are listed on the Taiwan Stock Exchange. In accordance with SFAS No. 115, the 64.1 million unrestricted shares are treated as available-for-sale securities and are classified as short-term investments. These unrestricted shares had a market value of $39.1 million as of December 31 2002. Unrestricted shares include shares that may need to be held by the Company to retain wafer capacity, as described in the prior paragraph.

Note 8. Investments in other companies

     During the six months ended December 31, 2002, the Company recognized impairment losses on investments totaling $1,966,000 as follows:

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     In May 2000, the Company invested $750,000 in a private company engaged in optical applications technology. In June 2001, an additional $509,000 was invested in the company. In the quarter ended December 31, 2002, the Company determined that the fair value of the shares had decreased significantly. Therefore, the Company assessed the fair value of its investment based on the latest financing transaction and concluded that the impairment was other-than-temporary. Accordingly, an amount of the investment of $987,000 was written off against earnings in accordance with APB No. 18.

     In June 2000, the Company invested $500,000 in a private company engaged in fiber optic technology. In the quarter ended June 30, 2002, the Company recorded an other than-temporary impairment of $349,000. In the quarter ended December 31, 2002, the Company further determined that the prospects for recovery of the investment were unfavorable given the market position of the company and the company’s operating losses. Therefore, the Company concluded that the impairment was other-than-temporary. Accordingly, the remaining investment of $151,000 was written off against earnings in accordance with APB No. 18.

     From December 1999 to October 2000, the Company invested $1,400,000 in a venture capital fund. In the quarter ended December 31, 2002, substantial losses were recorded by the fund. Accordingly, the company recorded an other-than-temporary impairment of $200,000 based on the latest financial statements available.

     In February 2000, the Company invested $500,000 in a private company engaged in integrated circuit design. In the quarter ended December 31, 2002, the Company determined that the prospects for recovery of the investment were unfavorable given the poor cash position of the company and the company’s operating losses. Therefore, the Company concluded that the impairment was other-than-temporary. Accordingly, 50% of its investment of $250,000 was written off against earnings in accordance with APB No. 18.

     In May 2000 to May 2002, the Company invested $753,000 in a private company engaged in analog integrated circuit design. In the quarter ended December 31, 2002, the Company determined that the cash position of the company was poor and there was reasonable doubt the company may not be able to raise additional funds. Therefore, the Company concluded that the impairment was other-than-temporary. Accordingly, 50% of its investment of $378,000 was written off against earnings in accordance with APB No. 18.

     During the six months ended December 31, 2001, the Company also recognized impairment losses on investments other than UMC totaling $1,936,000 as follows:

     In September 1999, the Company invested $909,000 in an ADSL company for 227,250 shares of preferred stock which were then converted into the same number of common stock shares upon the company’s initial public offering in August 2000. On March 31, 2001 the fair value of these shares as

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quoted was $498,000. Because the company experienced declining earnings in relation to its competitors in the ADSL market and erosion of its market share, the decline in value was considered other-than-temporary. Accordingly, the difference between the carrying value and the quoted fair value on March 31, 2001 was written off against earnings in accordance with SFAS No. 115. On September 30, 2001 due to deteriorating industry outlook and decreasing value in the company’s shares, the difference between the carrying value and the quoted fair value on September 30, 2001 of $270,000 was considered an other-than-temporary impairment and was written off against earnings in accordance with SFAS No. 115. Due to an increase in the market value of the ADSL company’s stock price from October 1, 2001 to December 31, 2001, an unrealized gain of $103,000 was recorded in equity as “accumulated other comprehensive gain” in accordance with SFAS No. 130, “Reporting Comprehensive Income.” The $103,000 is equal to a $170,000 increase in market value of the short-term investment for the three months ended December 31, 2001, less deferred taxes relating to the unrealized gain of $67,000.

     In June 2000, the Company invested $600,000 in a communications company which was subsequently acquired by a listed company. On March 31, 2001, the fair value of the shares of the listed company owned by the Company was $221,000. Because of the significant losses incurred by this company, the Company concluded that the decline in value was other-than-temporary. Accordingly, the difference between the carrying value and the quoted fair value on March 31, 2001 was written off against earnings in accordance with SFAS No. 115. On September 30, 2001 due to the deteriorating industry outlook and decreasing value in the company’s shares, the difference between the carrying value and the quoted fair value on September 30, 2001 of $66,000 was considered an other-than-temporary impairment and was written off against earnings in accordance with SFAS No. 115. Due to an increase in the market value of the communications company’s stock price from October 1, 2001 to December 31, 2001, an unrealized gain of $94,000 was recorded in equity as “accumulated other comprehensive gain” in accordance with SFAS No. 130, “Reporting Comprehensive Income.” The $94,000 is equal to a $157,000 increase in market value of the short-term investment for the three months ended December 31, 2001, less deferred taxes relating to the unrealized gain of $63,000.

     In April 2000, the Company invested $650,000 in a private company engaged in broadband communication technology. In June 2000, an additional $100,000 was invested in the company. In the quarter ended September 30, 2001, the Company determined that the prospects for recovery of the investment were unfavorable given the market position of the company and the company’s operating losses. Therefore, the Company concluded that the impairment was other-than-temporary. Accordingly, the full investment of $750,000 was written off against earnings in accordance with APB No. 18.

     In September 2000, the Company invested $1,500,000 in a private company engaged in “voice over DSL” communication technology. In the quarter ended September 30, 2001, the Company determined that this communications company was in a product reengineering process. It was considered likely that the company would cease operations. The Company assessed the estimated cash recoverable from this investment and concluded that the estimated shortfall was an other-than-temporary impairment. Accordingly, $1,000,000 of the investment was written off against earnings in accordance with APB No. 18. In December 2001, this investment was sold for $650,000 and a gain of $150,000 was recognized as “Gain on investments” for the three months ended December 31, 2001.

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Note 9. Comprehensive Income (Loss)

     Under SFAS No. 130, “Reporting Comprehensive Income” any unrealized gains or losses on the short-term investments which are classified as available-for-sale equity securities are to be reported as a separate adjustment to equity. The components of accumulated other comprehensive income (loss) as of September 30, 2002 and June 30, 2002 are as follows (in thousands):