UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number: 0-20784

TRIDENT MICROSYSTEMS, INC.

1090 East 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.

Yes  [X]  No [   ]

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

Yes  [X]  No [   ]

The number of shares of the registrant’s Common Stock, $0.001 par value, outstanding at September 30, 2004 was 22,955,508.

TRIDENT MICROSYSTEMS, INC.

INDEX

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TRIDENT MICROSYSTEMS, INC.

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

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TRIDENT MICROSYSTEMS, INC.

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

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TRIDENT MICROSYSTEMS, INC.

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

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TRIDENT MICROSYSTEMS, INC.

Note 1. The Company

     Trident Microsystems, Inc. and its subsidiaries (collectively the “Company”) designs, develops and markets integrated circuits for videographics, multimedia and digitally processed television products for the consumer television market and the PC market. Our digital media operations are primarily conducted by our majority-owned subsidiary, Trident Technologies, Inc. (“TTI”).

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 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, 2004 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, 2005.

Note 3. Revenue Recognition

     Revenue from product sales is generally recognized upon shipment when persuasive evidence of an arrangement exists, title and risk of loss pass to the customer, 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 products are shipped to end customers by the distributors.

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Note 4. Inventories

     Inventories consisted of the following (in thousands):

Note 5. Net income Per Share

     Basic net income per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income per share is calculated adjusting the net income by the potential minority interests and using the weighted average number of outstanding shares of common stock plus potential common stock shares. The calculation of diluted net income 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 income per share calculations are as follows:

Note 6. Stock-based compensation

     Stock-based compensation expense for the three months ended September 30, 2004 represents the intrinsic value of stock options issued by TTI to employees of TTI and certain employees of TMI. The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of APB No. 25, “Accounting for Stock Issued to Employees” and complies with the disclosure provisions of Statements of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” Under APB No. 25, compensation cost is generally recognized based on the difference, if any, between the quoted market price of the Company’s stock on the date of grant and the amount an employee must pay to acquire the stock.

     Had the Company recorded compensation based on the estimated grant date fair value, as defined by SFAS No. 123, for awards granted under its stock option plans and stock purchase plan, the net income and net income per share would have been changed to the pro forma amounts below for the three months ended September 30, 2004 and 2003:

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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 20%, 15%, 15%, 4.01% and 8% stock dividends payable to shareholders of record as of May 2000, July 2001, August 2002, July 2003 and August 2004, respectively. As of September 30, 2004, the Company owned approximately 75.1 million shares of UMC, which represents about 0.5% of the outstanding stock of UMC. Shares of the Company’s UMC investment are listed on the Taiwan Stock Exchange. In accordance with SFAS No. 115, as of September 30, 2004, 75.1 million shares are treated as available-for-sale securities and are classified as short-term investments.

     An increase in the market value of UMC’s stock price from July 1, 2003 to June 30, 2004 resulted in an increase in accumulated other comprehensive income of $6.1 million which was recorded as of September 30, 2004 in equity as “accumulated other comprehensive income” in accordance with SFAS No. 130, “Reporting Comprehensive Income”. The $6.1 million was equal to a $8.8 million increase in market value of the Company’s short-term investment in UMC from July 1, 2003 to June 30, 2004, less deferred income taxes of $2.7 million relating to the unrealized gain.

     Due to a decrease in the market value of UMC’s stock price from July 1, 2004 to September 30, 2004, a decrease in accumulated other comprehensive income of $3.9 million was recorded in equity as “accumulated other comprehensive income” in accordance with SFAS No. 130, “Reporting Comprehensive Income”. The $3.9 million is equal to a $6.5 million decrease in market value of the Company’s short-term investment in UMC from July 1, 2004 to September 30, 2004, less deferred income taxes of $2.6 million relating to the unrealized gain.

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Note 8. Gain on investments, net

     During the quarter ended September 30, 2004, the Company recognized a net gain on investments totaling $401,000 as follows:

     During the quarter ended September 30, 2004 the Company sold 330,000 shares of its subsidiary Trident Technology, Inc. (TTI) for cash of $877,000 resulting in a gain of $694,000. The Company’s percentage ownership interest in its TTI subsidiary was approximately 80% as of September 30, 2004.

     During the quarter ended September 30, 2004, the Company received additional cash of $22,000 for an ADSL company which had been previously liquidated.

     In March 2000, the Company invested $550,000 in a private company engaged in broadband server technology. In the quarter ended June 30, 2002, the Company determined that the product outlook and future cash position for this company was unfavorable. Therefore, the Company assessed the estimated fair value of the investment held and concluded that the estimated shortfall was an other-than-temporary impairment. Accordingly, $275,000 of the investment was written off against earnings in accordance with APB No. 18. In the quarter ended September 30, 2004, the Company determined that the product outlook and future cash position for this company had deteriorated further, and the remaining $275,000 investment was written off against earnings in accordance with APB No. 18.

     In January 2004, the Company invested $40,000 in a private company engaged in integrated circuit design. In the quarter ended September 30, 2004, the Company determined that the prospects for recovery of the investment were unfavorable given the deteriorating cash position of the company and the company’s operating losses. Accordingly, all of the investment was written off against earnings in accordance with APB No. 18.

     During the quarter ended September 30, 2003, the Company recognized a net gain on investments totaling $7.2 million as follows:

     On June 12, 2003, the Company announced that it would transfer its Graphics Division in Sunnyvale, California to XGI Technology, Inc. (“XGI”), a newly formed company incorporated in Taiwan, in exchange for stock in XGI. Silicon Integrated Systems Corporation, a company incorporated in Taiwan and unrelated to the Company, also transferred its graphics business to XGI. The transactions were structured to simultaneously close, with the Company receiving cash for the assets of the Graphics Division in one transaction, and simultaneously using the cash to acquire a 30% equity interest in XGI.

     The above transactions closed on July 25, 2003. In addition, on September 30, 2003, the

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Company sold one third of its investment in XGI to a third party for cash of $7.5 million. The above transactions resulted in a gain of approximately $6.6 million being recognized in the third quarter of 2003. Because XGI is a new company that is merging two businesses with an uncertain future and its equity securities are not traded on a quoted exchange, the Company recognized a gain on the above transactions based on the actual cash received and retained by the Company and no value was attributed to the Company’s remaining 20% equity interest in XGI.

     During the quarter ended September 30, 2003, the Company sold approximately 6.8% of its holding in TTI to a venture fund and its affiliates for cash of approximately of $2.8 million which resulted in a gain of approximately $1.0 million. The venture fund is an affiliate of UMC, a key business partner of the Company, and was the largest independent shareholder of TTI.

     In March 2000, the Company invested $287,000 in a private company engaged in software development. In the quarter ended March 31, 2003, the Company determined that revenue growth had not been achieved and the investee company’s financial position had deteriorated significantly. Therefore, the Company assessed the fair value of its investment based on the investee company’s latest financial position and concluded that the impairment was other-than-temporary. Accordingly, $110,000 of the investment was written off against earnings in accordance with APB No. 18. In the quarter ended September 30, 2003, due to further deterioration in the financial position of the investee company, the Company concluded that the remaining investment of $177,000 was impaired and was written off against earnings in accordance with APB No. 18.

     In May 2000, the Company invested $750,000 in a private company engaged in development of an 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 the quarter ended September 30, 2003, due to further deterioration in the financial position of the investee company, the Company concluded that the remaining investment of $272,000 was impaired and was written off against earnings in accordance with APB No. 18.

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, 2004 and June 30, 2004 related to unrealized gain (loss), net of tax, on its investments in UMC.

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Note 10. Segment information and concentration of credit risk.

     Subsequent to the transfer of its graphics division to XGI in July 2003, the Company operates in only one reportable segment: digital media. Accordingly, certain comparative amounts were reclassified to conform with current period presentation.

The following is a summary of the Company’s segment information (in thousands):

As of September 30, 2004, 67.3 million shares and options to purchase 11.9 million options were outstanding for TTI. The options vested over a period of four years from the grant date. During the quarter ended September 30, 2004 the Company sold 330,000 shares of TTI stock for proceeds of $0.9 million and realized a gain on the sale of $0.7 million and certain options granted became vested and were exercised. As a result, the Company held 80% of the outstanding shares of TTI as of September 30, 2004. Further dilution of interest would result upon exercise of stock options by the employees or if the Company determines to sell further interests in TTI in the future.

The following is a summary of the Company’s geographic operations:

Revenues are attributed to countries based on delivery locations. Long-lived assets comprise property and equipment.

Three customers accounted for 37%, 18% and 11% of accounts receivables as of September 30, 2004, respectively.

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Note 11. Contingencies

     On December 14, 1998, NeoMagic Corporation (“NeoMagic”) filed a patent infringement action against the Company in the United States District Court for the District of Delaware, Case No. 98-CV-699. After years of litigation, the Federal Circuit issued a unanimous decision on August 4, 2004 which affirmed summary judgment in the Company’s favor on the remaining claim against the Company. Trident’s counterclaim against NeoMagic for violation of Section 2 of the Sherman Act, attempted monopolization arising out of NeoMagic’s prosecution of the patent infringement action against Trident, remains pending in Delaware federal district court.

     From time to time, the Company may be involved in litigation in the normal course of business. The results of any litigation matters are inherently uncertain. In the event of an adverse decision in the described legal actions or disputes, or any other related litigation with third parties that could arise in the future with respect to patents or other intellectual property rights relevant to the Company’s products, the Company could be required to pay damages and other expenses, to cease the manufacture, use and sale of infringing products, to expend significant resources to develop non-infringing technology or to obtain licenses to the infringing technology. The Company cannot make any assurance that these matters will not materially and adversely affect the Company’s business, financial condition, operating results, or cash flows.

Note 12. Recent Accounting Pronouncements

     In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, which codifies, revises and rescinds certain sections of SAB No. 101, Revenue Recognition in Financial Statements, in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material impact on the Company’s consolidated results of operations, consolidated financial position or consolidated cash flows.

     In April 2004, the Emerging Issues Task Force issued Statement No. 03-06, Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share, (“EITF 03-06”). EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for fiscal periods beginning after March 31, 2004. The Company adopted this EITF during the quarter ended June 30, 2004. The adoption of EITF 03-06 did not have any material impact on the Company’s consolidated financial statements.

     At its November 2003 meeting, the EITF reached a consensus on disclosure guidance previously discussed under EITF 03-01,“The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The consensus provided for certain disclosure requirements that were effective for fiscal years ending after December 15, 2003. At its March 2004 meeting, the EITF reached a consensus on recognition and measurement guidance previously discussed under EITF 03-01. The consensus clarifies the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investments accounted for under the cost method or the equity method. The implementation of the recognition and measurement guidance provisions has been delayed. The disclosure requirement are effective for annual financial statements for fiscal years ending after June 30, 2004. The Company will evaluate the effect of adopting EITF 03-01 on its results of operations when the final guidance is issued.

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Item 2:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)

Special Note Regarding Forward-Looking Statements

     When used in this report the words “expects,” “anticipates,” “estimates” and similar expressions are intended to identify forward-looking statements. Such statements include our expectations and beliefs concerning:

•

our expectations regarding future revenues,

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future prospects for the digital television industry in general,

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our product development plans,

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future gross margin levels and our strategy to maintain and improve gross margins,

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trends in average selling prices,

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our expectations and plans regarding TTI and our ownership thereof,

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maintenance of majority ownership in our subsidiaries,

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the sufficiency of our financial resources over the next twelve months,

•

denomination of our international revenues and exposure to interest rate risk,

•

the adequacy of our internal controls over financial reporting,

•

future investments and/or acquisitions.

We are subject to risks and uncertainties, including those set forth below under “Factors That May Affect Our Results” and elsewhere in this report, that could cause actual results to differ materially from those projected. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based.

     The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto.

Overview of Business

     We design, develop and market integrated circuits for digital media applications, such as digital television, liquid crystal display (LCD) television and digital set-top boxes. Our system-on-chip semiconductors provide the “intelligence” for these new types of displays by processing and optimizing video and computer graphic signals to produce high-quality and realistic images. Many of the world’s leading manufacturers of consumer electronics and computer display products utilize our technology to enhance image quality and ease of use of their products. Our goal is to provide the best image quality enhanced digital media integrated circuits at competitive prices to users.

     We sell our products primarily to digital television original equipment manufacturers in China, Korea, Taiwan and Japan. Historically, significant portions of our revenue have been generated by sales to a relatively small number of customers. Our top five customers accounted for 74% of our total revenue for the fiscal quarter ended September 30, 2004. Substantially all of our revenue to date has been denominated in U.S. dollars. Our products are manufactured primarily by United Microelectronics Corporation (UMC), a semiconductor manufacturer located in Taiwan, which also owns a minority interest in our subsidiary TTI.

     Many of our customers sell their end products, digitally enhanced televisions, in Asian and European markets, so the health of these economies and consumer spending trends are indirectly important to our business. For instance, the recent credit tightening in China is something that may indirectly affect our business. While most television purchases are made with cash in China, any resulting slowdown in construction of new homes is thought likely to have somewhat of a dampening affect on the growth of television sales in China. The basis for our comment is anecdotal and cannot be easily quantified. However, this is a situation we continue to monitor.

     We operate primarily through subsidiaries and offices located in California, Taiwan and China. Trident Microsystems, Inc. (TMI), located in Sunnyvale, California, acts as an administrative home office,

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operating through our 80% owned subsidiary, Trident Technology, Inc. (TTI), located in Taipei, Taiwan, TTI’s US Branch located in Sunnyvale, California and our 100% owned subsidiary, Trident Multimedia Technologies (Shanghai) Co., Ltd. (TMT), located in Shanghai, China. Our net income is determined after taking a charge for the share of income relating to the minority interest in TTI. In general our executives are focused on revenue growth and developing new integrated circuits that garners as many high volume future design wins with customers as possible to continue to fuel that revenue growth. Management believes that the Company is operating in what will be a very high growth market over the next 5 years and that success will be measured by companies that seize a “first mover” advantage early in the market’s growth cycle and continue to deliver new innovative products that will hold and grow the Company’s share of the market. Our executives also focus on trends in average selling price erosion as well as gross margin, operating income and cash flow from operations.

     References to “we,” “Trident,” or the “Company” in this report refer to Trident Microsystems, Inc. and its subsidiaries, including TTI which was 83% owned by TMI as of June 30, 2004, and is approximately 80% owned by TMI as of September 30, 2004.

Recent Developments

     Our Board of Directors has authorized management to develop and present a proposal for acquiring the minority interests in our subsidiary TTI. The development of a proposal will require us to address a number of issues and may require negotiation with holders of minority interests. We will need to obtain valuation advice and address structural issues including the most expedient approach to acquiring all or substantially all of the minority interests, and the Board will need to evaluate any proposal and determine whether to proceed with any such proposal. We have not presented a proposal and cannot predict the likelihood or timing of such a transaction. However, we believe that it will be at least several months before any transaction could be proposed reviewed, negotiated and finalized.

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Results of Operations

     The following table sets forth the results of operations expressed as percentages of revenues for the three months ended September 30, 2004 and 2003:

     The following table provides statement of operations data and the percentage change from the prior year (in thousands):