Edgar Filing: SILICON STORAGE TECHNOLOGY INC

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934. For the quarterly period ended March 31, 2001.

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934. For the transition period from ________ to _________.

Commission File Number 0-26944

SILICON STORAGE TECHNOLOGY, INC.
(Exact name of Company as specified in its charter)

California 77-0225590
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification Number)

1171 Sonora Court, Sunnyvale, CA 94086
(Address of principal executive offices) (Zip code)

Company's telephone number, including area code: (408) 735-9110

----------

Indicate by check mark whether the Company (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 Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /

Number of shares outstanding of our Common Stock, no par value, as of the latest
practicable date, April 30, 2001: 90,932,640.

SILICON STORAGE TECHNOLOGY, INC.

FORM 10-Q: QUARTER ENDED MARCH 31, 2001
TABLE OF CONTENTS

Part I - FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Statements of Operations..............3
Condensed Consolidated Balance Sheets........................4
Condensed Consolidated Statements of Cash Flows..............5
Notes to Condensed Consolidated Financial Statements.........6

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.........................13

Item 3. Quantitative and Qualitative Disclosures About
Market Risk.................................................24

Part II - OTHER INFORMATION

Item 1. Legal Proceedings...........................................25

Item 6. Exhibits and Reports on Form 8-K............................26

PART I

Item 1. Condensed Consolidated Financial Statements

SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

Three months ended March 31,
--------------------------------
2000 2001
----------- -----------
(unaudited) (unaudited)

Net revenues:
Product revenues - unrelated parties $ 55,670 $ 68,075
Product revenues - related parties 6,143 11,854
License revenues 501 6,369
----------- -----------
Total net revenues 62,314 86,298
Cost of revenues 36,475 57,358
----------- -----------
Gross profit 25,839 28,940
----------- -----------

Operating expenses:
Research and development 8,076 12,286
Sales and marketing 4,627 6,344
General and administrative 2,639 4,808
----------- -----------

Total operating expenses 15,342 23,438
----------- -----------

Income from operations 10,497 5,502
Interest and other income 18 3,377
Interest expense (444) (99)
----------- -----------
Income before provision for income taxes 10,071 8,780
Provision for income taxes 427 3,336
----------- -----------
Net income $ 9,644 $ 5,444
=========== ===========

Net income per share - basic $ 0.13 $ 0.06
=========== ===========
Shares used in per share calculation 76,305 90,671
=========== ===========

Net income per share - diluted $ 0.11 $ 0.06
=========== ===========
Shares used in per share calculation 85,047 96,424
=========== ===========

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

SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

ASSETS
December 31, March 31,
2000 2001
------------ -----------
(unaudited) (unaudited)

Current assets:
Cash and cash equivalents $ 109,086 $ 44,764
Short-term investments 139,963 103,399
Trade accounts receivable-unrelated parties, net 106,258 71,966
Trade accounts receivable-related parties, net 20,000 31,060
Inventories 73,290 128,582
Deferred tax asset 9,491 8,609
Other current assets 14,835 20,586
------------ ------------
Total current assets 472,923 408,966

Equipment, furniture and fixtures, net 16,874 21,909
Long-term available-for-sale investments - 26,008
Equity investments 19,369 69,361
Other assets 3,424 3,910
------------ ------------
Total assets $ 512,590 $ 530,154
============ ============

LIABILITIES
Current liabilities:
Notes payable, current portion $ - $ 291
Trade accounts payable-unrelated parties 39,184 53,362
Trade accounts payable-related parties 7,339 7,289
Accrued expenses and other liabilities 33,879 18,303
Deferred revenue-unrelated parties 15,274 15,668
Deferred revenue-related parties - 9,638
------------ ------------
Total current liabilities 95,676 104,551

Other liabilities 279 1,698
------------ ------------
Total liabilities 95,955 106,249
------------ ------------

SHAREHOLDERS' EQUITY
Common stock 330,310 332,064
Accumulated other comprehensive income 132 204
Retained earnings 86,193 91,637
------------ ------------
Total shareholders' equity 416,635 423,905
------------ ------------
Total liabilities and shareholders' equity $ 512,590 $ 530,154
============ ============

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

SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Three months ended March 31,
---------------------------------
2000 2001
------------ ------------
(unaudited) (unaudited)

Cash flows from operating activities:
Net income $ 9,644 $ 5,444
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation /amortization 1,315 2,274
Provision for doubtful accounts receivable 25 84
Provision for excess and obsolete inventories and write down to market 1,593 5,890
Loss on sale of equipment 1 35
Changes in operating assets and liabilities:
Accounts receivable-unrelated parties (23,182) 34,208
Accounts receivable-related parties (464) (11,060)
Inventories (11,980) (61,182)
Other current and noncurrent assets (1,146) (5,738)
Trade accounts payable-unrelated parties 8,725 14,178
Trade accounts payable-related parties - (50)
Accrued expenses and other current liabilities 5,873 (15,700)
Deferred revenue-unrelated parties 4,833 394
Deferred revenue-related parties - 9,638
------------ ------------
Net cash provided by (used in) operating activities (4,763) (21,585)
------------ ------------

Cash flows from investing activities:
Investment in equity securities - (49,992)
Acquisition of equipment, furniture and fixtures (2,032) (6,961)
Purchases of available-for-sale investments - (27,508)
Sales and maturities of available-for-sale investments - 38,260
------------ ------------
Net cash provided by (used in) investing activities (2,032) (46,201)
------------ ------------

Cash flows from financing activities:
Borrowings 39,750 1,800
Repayments (59,037) (46)
Issuance of shares of common stock 223,410 1,754
Other - (44)
------------ ------------
Net cash provided by (used in) financing activities 204,123 3,464
------------ ------------
Net increase (decrease) in cash and cash equivalents 197,328 (64,322)
Cash and cash equivalents at beginning of period 1,223 109,086
------------ ------------
Cash and cash equivalents at end of period $ 198,551 $ 44,764
============ ============

Supplemental Disclosure of Cash Flow Information:
Cash received during the period for interest $ 17 $ 2,484
Cash paid during the period for interest $ 444 $ 99
Net cash paid during the period for income taxes $ 3 $ 9,995

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

SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AT MARCH 31, 2001
(UNAUDITED):

1. Basis of Presentation

In the opinion of management, the accompanying unaudited condensed interim
consolidated financial statements contain all adjustments (all of which are
normal and recurring in nature) necessary to fairly present our financial
position, results of operations and cash flows. The results of operations for
the interim periods presented are not necessarily indicative of the results that
may be expected for any future interim periods or for the full fiscal year.
These interim financial statements should be read in conjunction with the
financial statements in our Annual Report on Form 10-K, as amended, for the year
ended December 31, 2000.

The year-end balance sheet at December 31, 2000 was derived from audited
financial statements, but does not include all disclosures required by generally
accepted accounting principles.

Recent Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivatives and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. In July 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities-Deferral of the Effective Date of
FASB Statement No. 133," which deferred the effective date until the first
fiscal year beginning after June 15, 2000. In June 2000, the FASB issued SFAS
Statement No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities-an Amendment of SFAS 133." SFAS No. 138 amends certain terms
and conditions of SFAS 133. SFAS 133 requires that all derivative instruments be
recognized at fair value as either assets or liabilities in the statement of
financial position. The accounting for changes in the fair value (i.e., gains or
losses) of a derivative instrument depends on whether it has been designated and
qualifies as part of a hedging relationship and further, on the type of hedging
relationship. We adopted SFAS No. 133, as amended, in our quarter ending March
31, 2001. The adoption of SFAS No. 133 did not have a material impact on our
financial statements.

2. Computation of Net Income Per Share

We have computed and presented net income per share under two methods, basic and
diluted. Basic net income per share is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted net
income per share is computed by dividing net income by the sum of the weighted
average number of common shares outstanding and potential common shares (when
dilutive). A reconciliation of the numerator and the denominator of basic and
diluted net income per share is as follows (in thousands, except per share
amounts):

Three months ended March 31,
2000 2001
--------- ----------

Numerator - Basic
Net income $ 9,644 $ 5,444
======= =======
Denominator - Basic
Weighted average common stock outstanding 76,305 90,671
======= =======
Basic net income per share $0.13 $0.06
======= =======

Numerator - Diluted
Net income $ 9,644 $ 5,444
======= =======
Denominator - Diluted
Weighted average common stock outstanding 76,305 90,671
Dilutive potential of common stock equivalents:
Options 8,742 5,753
------- -------
85,047 96,424
======= =======

Diluted net income per share $0.11 $0.06
======= =======

Anti-dilutive stock options to purchase approximately 7,000 shares and 2,033,000
shares of common stock were excluded from the computation of diluted net income
per share for the three months ended March 31, 2000 and 2001, respectively,
because the exercise price of these options exceeded the average fair market
value of our common stock for the three months ended March 31, 2000 and 2001.

3. Marketable Securities

We consider cash and all highly liquid investments purchased with an original or
remaining maturity of less than three months at the date of purchase to be cash
equivalents. Substantially all of our cash and cash equivalents are in the
custody of three major financial institutions.

Our investments comprise federal, state, and municipal government obligations
and foreign and public corporate equity securities. Investments with maturities
of less than one year at the balance sheet date are considered short term and
investments with maturities greater than one year at the balance sheet date are
considered long term. All these investments are classified as
available-for-sale, and carried at fair value, based on quoted market prices,
with the unrealized gains or losses, net of tax, reported in shareholders'
equity as other comprehensive income. The cost of debt securities is adjusted
for amortization of premiums and accretion of discounts to maturity, both of
which are included in interest income. Realized gains and losses are recorded on
the specific identification method. Realized gains and realized losses for the
three months ended March 31, 2001 were not material.

3. Marketable Securities (continued):

The fair value of marketable securities as of March 31, 2001 were as follows (in
thousands):

Amortized Unrealized Fair
Cost Gain (Loss) Value
------------ ----------- -----------

Corporate bonds and notes $ 40,533 $ 13 $ 40,546
Government bonds and notes
120,659 315 120,974
------------ ----------- -----------
Total bonds and notes $ 161,192 $ 328 161,520
============ ===========
Less amounts classified as cash
equivalents (32,113)
-----------
Total long and short-term
marketable securities $ 129,407
===========
Contractual maturity dates
for investments:
Less than 1 year $ 103,399
1 to 5 years 26,008
-----------
$ 129,407
===========

The fair value of marketable securities as of December 31, 2000 were as follows
(in thousands):

Amortized Unrealized Fair
Cost Gain (Loss) Value
------------ ----------- -----------

Corporate bonds and notes $ 69,155 $ (20) $ 69,135
Government bonds and notes 141,523 152 141,675
------------ ----------- -----------
Total bonds and notes $ 210,678 $ 132 210,810
============ ===========

Less amounts classified as cash
equivalents (70,847)
------------
Total short-term marketable
securities $ 139,963
============

4. Balance Sheet Detail

Details of selected balance sheet accounts are as follows:

December 31, March 31,
---------------- -------------
2000 2001
---------------- -------------
Trade accounts receivable-unrelated parties $ 107,041 $ 72,519
Trade accounts receivable-related parties 20,000 31,375
Less allowance for doubtful accounts (783) (868)
---------------- -------------
$ 126,258 $ 103,026
================ =============

December 31, March 31,
---------------- -------------
2000 2001
---------------- -------------
Raw materials $ 29,025 $ 66,322
Work in process 17,631 13,151
Finished goods 26,634 49,109
---------------- -------------
$ 73,290 $ 128,582
================ =============

4. Balance Sheet Detail (continued):
December 31, March 31,
---------------- -------------
2000 2001
---------------- -------------
Equipment $ 13,389 $ 14,017
Design hardware 4,234 5,557
Software 5,781 6,414
Furniture and fixtures 2,269 2,819
---------------- -------------
25,673 28,807
Less accumulated depreciation 9,906 11,699
---------------- -------------
15,767 17,108
Construction in progress 1,107 4,801
---------------- -------------
$ 16,874 $ 21,909
================ =============

December 31, March 31,
---------------- -------------
2000 2001
---------------- -------------
Accrued compensation and related items $ 14,509 $ 3,555
Accrued income tax payable 11,292 4,758
Accrued liabilities-related parties 356 425
Other accrued liabilities 7,722 9,565
---------------- -------------
$ 33,879 $ 18,303
================ =============

5. Contingencies

On January 3, 1996, Atmel Corporation sued us in the U.S. District Court for the
Northern District of California. Atmel's complaint alleged that we willfully
infringe five U.S. patents owned by or exclusively licensed to Atmel. Atmel
later amended its complaint to allege infringement of a sixth patent. Regarding
each of these six patents, Atmel sought a judgment that we infringe the patent,
an injunction prohibiting future infringement, and treble damages, as well as
attorney's fees and expenses.

On two of the six patents, the District Court ruled by summary judgment that we
did not infringe. Two of the other patents were invalidated by another U.S.
District Court in a proceeding to which we were not a party, but this decision
was later reversed by the Federal Circuit Court of Appeals. Thus, four patents
remain at issue in Atmel's District Court case against us.

On February 17, 1997, Atmel filed an action with the International Trade
Commission, or ITC, against two suppliers of our parts, involving four of the
six patents that Atmel alleged that we infringed in the District Court case
above. We intervened as a party to that investigation. Pursuant to
indemnification agreements with these suppliers, we were obligated to indemnify
both to the extent provided in those agreements. As more fully described below,
the settlement with Winbond terminated our indemnity obligations to that
company.

As to one of these four patents, Atmel's claims were withdrawn because of the
summary judgment granted by the District Court, as described above. The
administrative law judge, or ALJ, who makes recommended determinations to the
ITC, ruled that we did not infringe the remaining three patents. As to one of
these patents, U.S. Patent No. 4,451,903 ("the `903 patent," also known as
"Silicon Signature"), the ALJ ruled on May 17, 2000 that it is invalid and
unenforceable because the patent did not name the proper inventors and because
Atmel intentionally misled the U.S. Patent Office. On October 16, 2000, the ITC
overturned the ALJ's recommendation on the `903 patent and ruled that we could
not import into the United States certain products that use this circuit. We
appealed the ITC ruling and in January 2001 the Federal Circuit Court issued an
order upholding the ITC's decision, but has not yet issued a written opinion
setting forth the basis of that order. The ITC also ruled that we do not
infringe the two other patents at issue ("the `811 and `829" patents). Atmel
appealed that determination but dropped the appeal. On May 8, 2001, we filed a
motion with the Commission to terminate the Limited Exclusion Order based on
newly discovered evidence. The motion is pending and we do not know when, and
what, the Commission's response will be.

5. Contingencies (continued):

The ITC action will not be dispositive in the pending lawsuit because Atmel and
SST can still pursue their claims in the District Court action. Atmel has filed
motions for summary judgment on the '811 and '829 patents as well as the `903
patent. On May 11, 2001 we filed our opposition papers with the court. A hearing
on Atmel's motion has been set for June 1, 2001. SST has recently learned of
evidence it believes renders the '903 patent invalid. The court has scheduled a
hearing for SST's summary judgement on that issue, and SST will file its motion
papers during the week of May 14, 2001. The District Court has scheduled a
status conference for December 15, 2001, to set a trial date, although Amtel and
SST are currently discussing an extension of that schedule.

On October 1, 2000, we announced a settlement in our lawsuit with Winbond
Electronics of Taiwan. We filed a lawsuit against Winbond in July 1998 in the
U.S. District Court in San Jose, California pursuant to the termination of our
SuperFlash technology licensing agreement with Winbond. As part of the
settlement, Winbond agreed to a consent judgment and will not contest the
validity and appropriateness of SST's termination of the licensing agreement in
June 1998. This settlement concludes all litigation between us and Winbond. We
received $10.4 million and $5.0 million in license fees during 2000 and for the
quarter ended March 31, 2001, respectively, as part of this settlement.

From time to time, we are also involved in other legal actions arising in the
ordinary course of business. While we have accrued certain amounts for the
estimated legal costs associated with defending these matters, there can be no
assurance the Atmel complaint or other third party assertions will be resolved
without costly litigation, in a manner that is not adverse to our financial
position, results of operations or cash flows or without requiring royalty
payments in the future which may adversely impact gross margins. No estimate can
be made of the possible loss or possible range of loss associated with the
resolution of these contingencies.

6. Line of Credit

As of March 31, 2001 we had no borrowings on our line of credit. However, we
continue to have access to this facility should we need it. As of March 31,
2001, our line of credit was for $35 million. This agreement expires September
2002. Borrowing is limited to 80.0% of eligible worldwide accounts receivable
and is also reduced by any letters of credit issued under a $35 million
sub-agreement to this line. Therefore, as of March 31, 2001 our actual credit
available under this line was approximately $4.1 million. The line bears
interest at a rate of the bank's reference rate (8.0% at March 31, 2001) plus
0.5%. There is a minimum interest rate of 6.0%. We are required to maintain
specified levels of tangible net worth. Under the agreement we are not permitted
to pay a dividend. We must pay an unused line fee at the annual rate of one
quarter of one percent on the unused portion. As of March 31, 2001 we were in
compliance with the covenants of this agreement.

7. Segment Information

Our operations involve the design, development, manufacturing, marketing and
technical support of our non-volatile memory products. We offer low and medium
density devices that target a broad range of existing and emerging applications
in the digital consumer, networking, wireless communications and Internet
computing markets. Our products are differentiated based upon attributes such as
density, voltage, access speed, package and predicted endurance. We also license
our technology for use in non-competing applications.

Previously we managed our business in two reportable segments: Flash products
and Technology Licensing. In January 2001, we introduced further granularity
into our management information systems which now allow us to segregate the
Flash products segment into three separate business units. These business units
are considered reportable segments. The new segments which comprise the former
Flash products segment are: the Standard Memory Product Group, or SMPG, the
Application Specific Product Group, or ASPG, and the Special Product Group, or
SPG. We make financial decisions and allocate resources based on the information
that we receive from this internal management system. We do not allocate
operating expenses, interest income or expense, other income, net or the
provision for income taxes to any of these segments for internal reporting
purposes, as we do not believe that allocating the expense is material in
evaluating a business unit's performance. Information for the prior period has
been restated to conform to the new presentation.

The following table shows our product revenues and gross profit at standard
margins for each segment:

Three months ended March 31, 2001:

Revenues Gross Profit
-------- ------------
SMPG $ 50,337 $ 6,663
ASPG 27,855 15,312
SPG 1,737 596
Technology Licensing 6,369 6,369
-------------------------------
$ 86,298 $ 28,940
===============================

Three months ended March 31, 2000:

Revenues Gross Profit
-------- ------------
SMPG $ 59,446 $ 24,816
ASPG 1,422 131
SPG 945 391
Technology Licensing 501 501
--------------------------------
$ 62,314 $ 25,839
================================

SMPG includes our three standard flash memory product families: the Small-Sector
Flash, or SSF, family, the Multi-Purpose Flash, or MPF, family, and the
Many-Time Programmable, or MTP, family and certain custom products based on
these standard flash memory families. These product families allow us to
produce products optimized for cost, quality and functionality to support the
broad range of applications that use nonvolatile memory products.

ASPG includes FlashBank, Concurrent SuperFlash, Serial Flash and Firmware Hub,
or FWH, and LPC flash products. These products are designed to address specific
applications such as cellular phones, pagers, PDAs, set-top boxes, hard disk
drives and PC BIOS applications. This business unit also includes our flash
embedded controllers and mass storage products such as the FlashFlex51, ADC,
ADM, and CompactFlash Card product families, to address the markets for digital
cameras, digital cellular phones, Internet appliances, PDAs, MP3 players,
Set-top boxes and other types of mass data storage applications.

SPG includes ComboMemory, ROM/RAM Combos and SRAM-related products.

7. Segment Information (continued):

Technology Licensing includes both up front license fees and royalties which are
recognized in accordance with our revenue recognition policy.

8. Comprehensive Income

The components of comprehensive income, net of tax, are as follows (in
thousands):

March 31, March 31,
------------------- -------------------
2000 2001
------------------- -------------------
Net income $ 9,644 $ 5,444
Other comprehensive income:
Change in net unrealized gains
on investments, net of tax - 72
------------------- -------------------
Total comprehensive income $ 9,644 $ 5,516
=================== ===================

9. Equity Investment

On March 6, 2001 we invested $50.0 million in Grace Semiconductor Manufacturing
Corporation (GSMC), a Cayman Islands company. The investment is for a wafer
foundry project located in Shanghai, P.R.C. As a result, we acquired a 5%
interest of the outstanding equity. This investment is carried at cost.

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.

The following discussion may be understood more fully by reference to the
condensed consolidated financial statements, notes to the condensed consolidated
financial statements, and management's discussion and analysis of financial
condition and results of operations contained in our Annual Report on Form 10-K,
as amended, for the year ended December 31, 2000, as filed with the Securities
and Exchange Commission.

The following discussion contains forward-looking statements, which involve risk
and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors
which are difficult to forecast and can materially affect our quarterly or
annual operating results. Fluctuations in revenues and operating results may
cause volatility in our stock price. Please refer to the section below entitled
"Business Risks".

Overview

We are a leading supplier of flash memory semiconductor devices for the
digital consumer, networking, wireless communications and Internet computing
markets.

The semiconductor industry has historically been cyclical,
characterized by wide fluctuations in product supply and demand. From time to
time, the industry has also experienced significant downturns, often in
connection with, or in anticipation of, maturing product cycles and declines in
general economic conditions. Downturns of this type occurred in 1996, 1997 and
1998. These downturns have been characterized by weakening product demand,
production over-capacity and accelerated decline of selling prices, and in some
cases have lasted for more than a year. We recently began to experience a sharp
downturn in several of our markets late in the fourth quarter of 2000, as our
customers reacted to weakening demand for their products. During the early
portion of the first quarter of 2001, market conditions had not improved and our
customers continued to return product, cancel backlog and/or push out shipments.
However, during the latter portion of the quarter, we began to see a slowing of
this activity and some of our customers have begun to place orders, primarily
in the personal computer segment. The networking and wireless communications
segments continue to be very weak. Our business could be harmed by industry-wide
fluctuations in the future.

We derived 77.6% and 72.1% of our product revenues during 2000 and the
three months ended March 31, 2001, respectively, from product shipments to Asia.
Additionally, all of our major wafer suppliers and packaging and testing
subcontractors are located in Asia.

Our product sales are made primarily using short-term cancelable
purchase orders. The quantities actually purchased by the customer, as well as
shipment schedules, are frequently revised to reflect changes in the customer's
needs and in our supply of product. Accordingly, our backlog of open purchase
orders at any given time is not a meaningful indicator of future sales. Changes
in the amount of our backlog do not necessarily reflect a corresponding change
in the level of actual or potential sales.

Sales to direct customers and foreign stocking representatives are
recognized upon shipment, net of an allowance for estimated returns. Sales to
distributors are made primarily under arrangements allowing price protection and
the right of stock rotation on merchandise unsold to customers. Because of the
uncertainty associated with pricing concessions and future returns, we defer
recognition of such revenues, related costs of revenues and related gross margin
until we are notified by the distributor that the merchandise is sold by the
distributor.

Most of our technology licenses provide for the payment of up-front
license fees and continuing royalties based on product sales. For license and
other arrangements for technology that we are continuing to enhance and refine
and under which we are obligated to provide unspecified enhancements, revenue is
recognized over the lesser of the estimated period we have historically enhanced
and developed refinements to the technology, generally three years, the upgrade
period, or the remaining portion of the upgrade period from the date of
delivery, provided all specified technology and documentation has been
delivered, the fee is fixed or determinable and collection of the fee is
reasonably assured. From time to time, we reexamine the estimated upgrade period
relating to licensed technology to determine if a change in the estimated update
period is needed. Revenues from license or other technology arrangements where
we are not continuing to enhance and refine the technology or are not obligated
to provide unspecified enhancements is recognized upon delivery, if the fee is
fixed or determinable and collection of the fee is reasonably assured.

We recognize royalties received under these arrangements during the
upgrade period as revenue based on the ratio of the elapsed portion of the
upgrade period to the estimated upgrade period. We recognize the remaining
portion of the royalties ratably over the remaining portion of the upgrade
period. We recognize royalties received after the upgrade period has elapsed
when reported to us, which generally coincides with the receipt of payment.

Results of Operations: Quarter Ended March 31, 2001

Net Revenues

Net revenues were $86.3 million for the three months ended March 31, 2001 as
compared to $161.0 million in the fourth quarter of 2000 and $62.3 million for
the three months ended March 31, 2000. Revenue increased compared to the first
quarter of last year due to increased shipment volume of new and existing
products and due to increased average selling prices. Revenue decreased compared
to the prior quarter due to the lower volume of units shipped as a result of a
deterioration in market conditions which began in the fourth quarter of 2000 and
continued into the first quarter of 2001. Our quarterly results are not
indicative of annual results, and we may not continue to experience recent rates
of growth on a year over year basis in revenues and earnings. Average selling
prices fluctuate due to a number of factors including the overall supply and
demand for our products in the marketplace, maturing product cycles and declines
in general economic conditions.

Product Revenues. Product revenues were $79.9 million in the first quarter of
2001 as compared to $149.1 million in the fourth quarter of 2000 and $61.8
million for the first quarter of 2000. Product revenue increased compared to the
first quarter of last year due to increased shipment volume of new and existing
products and due to increased average selling prices. Product revenue decreased
compared to the prior quarter due to the lower volume of units shipped as a
result of a deterioration in market conditions which began in the fourth quarter
of 2000 and continued into the first quarter of 2001. We anticipate shipping
volumes to continue to fluctuate due to overall industry supply and demands.

License Revenues. Revenues from license fees and royalties were $6.4 million
in the first quarter of 2001, as compared to $12.0 million in the fourth quarter
of 2000 and $501,000 in the first quarter of 2000. The increase from the first
quarter of 2000 to the first quarter of 2001 was primarily due to $5.0 million
in license fee received as part of our legal settlement with Winbond. In the
fourth quarter of 2001, the initial payment of $10.4 million in license fee was
received as a part of the same legal settlement, which is the primary reason for
the decrease from the fourth quarter of 2000 to the first quarter of 2001. We
anticipate an additional $5.0 million to be paid under this legal settlement in
each of the remaining quarters of 2001. We anticipate that license revenues will
fluctuate significantly in the future.

Gross Profit

Gross profit was $28.9 million or 33.5% of net revenues in the first quarter
of 2001 as compared to $80.5 million, or 50.0% of net revenues, in the fourth
quarter of 2000 and $25.8 million, or 41.5% of net revenues, in the first
quarter of 2000. Gross profit decreased as compared to the first quarter of 2000
and the fourth quarter of 2000 due primarily to write downs and allowances for
products in inventory.

Operating Expenses

Our operating expenses consist of research and development, sales and
marketing, and general and administrative expenses. Operating expenses were
$23.4 million, or 27.2% of net revenues, in the first quarter of 2001, as
compared to $29.9 million, or 18.6% of net revenues, in the fourth quarter of
2000, and $15.3 million, or 24.6% of net revenues, in the first quarter of 2000.
The increase from the comparable quarter last year was due primarily to hiring
additional personnel, annual salary increases and the development of new
products and infrastructure. The decrease in absolute dollars from the prior
quarter was primarily due to no profit sharing being accrued for the first
quarter of 2001 (a $5.8 million charge in the fourth quarter of 2000), no
in-process research and development charges in the first quarter of 2001 (a
$3.9 million in-process research and development charge was incurred due to the
acquisition of Agate Semiconductor, Inc. in December 2000), and decreased
commission costs due to lower revenue shipments during the first quarter of
2001. We anticipate that we will continue to devote substantial resources to
research and development, sales and marketing and to general and administrative,
and that these expenses will continue to increase in absolute dollar amounts.

Research and development. Research and development expenses include costs
associated with the development of new products, enhancements to existing
products, quality assurance activities and occupancy costs. These costs consist
primarily of employee salaries, benefits, mask tooling and the cost of outside
resources that supplement the internal development team. Research and
development expenses were $12.3 million, or 14.2% of net revenues, during the
first quarter of 2001, as compared to $12.3 million, or 7.6% of net revenues,
during the fourth quarter of 2000 and $8.1 million, or 13.0% of net revenues,
during the first quarter of 2000. Research and development expenses increased
52.1% from the first quarter of 2000 due primarily to expenses related to
increased engineering evaluation and mask costs, increased depreciation related
to purchases of new engineering equipment, increased engineering headcount and
occupancy costs. Research and development expenses remained flat from

the fourth quarter of 2000 because increased engineering evaluation and mask
costs, increased depreciation related to new engineering equipment purchases,
and increased engineering headcount and occupancy costs were offset by the
reduction of profit sharing costs related to the decrease in net revenues from
the fourth quarter of 2000 to the first quarter of 2001. We expect research and
development expenses to continue to increase in absolute dollars.

Sales and marketing. Sales and marketing expenses consist of personnel costs,
commissions to stocking representatives, travel and entertainment and
promotional expenses. Sales and marketing expenses were $6.3 million, or 7.4% of
net revenues, in the first quarter of 2001 as compared to $8.9 million, or 5.5%
of net revenues, in the fourth quarter of 2000 and $4.6 million, or 7.4% of net
revenues, during the first quarter of 2000. Sales and marketing expenses
increased 37.1% as compared to the first quarter of 2000 due to increased
commissions payable on higher product revenues in the first quarter of 2001,
increased headcount and occupancy costs and increased marketing costs. Sales and
marketing expenses decreased 28.8% from the fourth quarter of 2000 due to
decreased commissions and profit sharing costs related to the decrease in net
revenues from the fourth quarter of 2000 to the first quarter of 2001. We expect
sales and marketing expense to increase in absolute dollars as we continue to
expand our sales and marketing efforts.

General and administrative. General and administrative expenses consist of
salaries for administrative, executive and finance personnel, recruiting costs,
professional services and legal fees and allowances for doubtful accounts.
General and administrative expenses were $4.8 million, or 5.6% of net revenues,
in the first quarter of 2000, as compared to $4.8 million, or 3.0% of net
revenues, in the fourth quarter of 2000 and $2.6 million, or 4.2% of net
revenues, during the first quarter of 2000. Expenses increased from the first
quarter of 2000 due to increased legal, occupancy and headcount related costs,
as well as depreciation expense associated with new leasehold improvements on
additional leased office space. Our allowance for doubtful accounts increased
from the first quarter of 2000 due to the increase in our accounts receivable
during this period. Expenses remained flat from the fourth quarter of 2000 due
to increased legal, occupancy and headcount related costs, offset by the
reduction of profit sharing expenses and a fourth quarter charge for cancelled
offering costs. We anticipate that general and administrative expenses will
continue to increase in absolute dollar amount as we scale our facilities,
infrastructure, and head count to support our overall expected growth. We may
also incur additional expenses in connection with the Atmel litigation. For
further information on this litigation see "Legal Proceedings."

Interest and other income. Interest and other income was approximately $3.4
million, or 3.9% of net revenues, during the first quarter of 2001, as compared
to $4.2 million, or 2.6% of net revenues, during the fourth quarter of 2000 and
$18,000, or 0.0% of net revenues, during the first quarter of 2000. Interest
income increased from the first quarter of 2000 to the first quarter of 2001 due
to the receipt of cash proceeds from a follow-on public offering, which was
completed on April 13, 2000. Interest income decreased from the fourth quarter
of 2000 to the first quarter of 2001 due to a decrease in cash and cash
equivalent balances.

Interest Expense. Interest expense was approximately $99,000 for the first
quarter of 2001 as compared to $80,000 for the fourth quarter of 2000 and
$444,000 for the first quarter of 2000. Interest expense relates to interest and
fees under our line of credit. Interest expense decreased from the first quarter
of 2000 as we ceased to borrow against our line of credit. Fees will continue
and will fluctuate depending on our use of the line of credit facility.

Provision for Income Taxes

Our income tax provision of $3.3 million in the first quarter of 2001
consists of a 38.0% tax rate on income before taxes. This compares with a tax
provision of $17.5 million in the fourth quarter of 2000 which was a 31.9% tax
rate on income before taxes and a tax provision of $427,000 in the first quarter
of 2000 which was a 4.2% tax rate on income before taxes. The increase in the
effective tax rate during 2001 is a result of our continued profitability. All
of our prior year net operating losses were fully utilized by the end of the
second quarter of 2000. We expect our effective tax rate to be 38% for the
remainder of 2001. Our tax rate may change depending on our profitability and
the timing of the implementation of certain tax planning strategies which are
being designed to decrease the effective rate in future years.

Segment Reporting

Note 7 to the Condensed Consolidated Financial Statements for revenue and gross
profit information by reportable segment. Note that during 2000 we had different
reportable segments, and therefore the prior period information has been
restated to conform to the new presentation. Our analysis of the changes for
each segment is discussed below.

SMPG includes our three standard flash memory product families: the Small-Sector
Flash, or SSF, family, the Multi-Purpose Flash, or MPF, family, and the
Many-Time Programmable, or MTP, family and certain custom products based on
these standard flash memory families. These families allow us to produce
products optimized for cost and functionality to support the broad range of
applications that use nonvolatile memory products. Gross margin decreased from
41.7% to 13.2% between the first quarter of 2000 and the first quarter of 2001
for this segment due to the inventory write-down during the first quarter of
2001.

ASPG includes FlashBank, Concurrent SuperFlash, Serial Flash and Firmware Hub,
or FWH, and LPC flash products. These products are designed to address specific
applications such as cellular phones, pagers, PDAs, set-top boxes, hard disk
drives and PC BIOS applications. It also includes flash embedded controllers and
our mass storage products such as the FlashFlex51, ADC, ADM, and CompactFlash
Card product families, address digital cameras, digital cellular phones,
Internet appliances, PDAs, MP3 players, Set-top boxes and other types of mass
data storage applications. Gross margin increased from 9.2% to 55.0% between the
first quarter of 2000 and the first quarter of 2001 for this segment due to
units shipped of a new product, the Firmware Hub, which was introduced during
the second half of 2000.

SPG includes ComboMemory ROM/RAM Combos and SRAM-related products. Gross margin
decreased from 41.4% to 34.3% between the first quarter of 2000 and the first
quarter of 2001 for this segment due to changes in the mix of the types of
products sold between the two periods.

Revenue and gross profit related to Technology Licensing was $501,000 and
$6.4 million for the three months ended March 31, 2000 and 2001, respectively.

Recent Accounting Pronouncements

Liquidity and Capital Resources

Operating activities. Our operating activities used cash of $21.6 million for
the three month period ended March 31, 2001 as compared to using cash of $4.8
million for the three month period ended March 31, 2000. The cash used by
operating activities for the three month period ended March 31, 2001 related
primarily to increases in inventory of $61.2 million, accounts
receivable-related parties of $11.1 million and other assets of $5.7 million and
decreases in accrued expenses of $15.7 million. Cash used in operating
activities was reduced by net income of $5.4 million, a decrease in trade
accounts receivable-unrelated parties of $34.2 million and increases in trade
accounts payable of $14.2 million, and deferred revenues-related parties of $9.6
million and non-cash adjustments of $8.3 million, primarily relating to
depreciation and amortization and inventory write-down. Decreased accounts
receivable-unrelated parties relates to decreased shipment volume due to the
downturn in the economy. Increased accounts receivable-related parties and
increased deferred revenue-related parties relates to a new distribution
relationship with a company owned by one of our equity investments. The cash
used in operating activities for the three month period ended March 31, 2000
consisted of increases in accounts receivable and accounts receivable from
related parties of $23.6 million and increased in inventory of $12.0 million.
This cash use was partially offset by net income of $9.6 million, non-cash
adjustments of $2.4 million primarily relating to depreciation and amortization
of $1.3 million and provision for potential excess and obsolete inventory of
$1.6 million and increased trade accounts payable, accrued expenses and deferred
revenue of $19.4 million.

Investing activities. Our investing activities used cash of $46.2 million for
the three month period ended March 31, 2001, as compared to using cash of $2.0
million for the first three months of 2000. In the first quarter of 2001, we
made a $50 million equity investment in Grace Semiconductor Manufacturing
Corporation, a Cayman Islands company with operations in China, as a part of
multi-phased strategic plan to expand into China. Capital expenditures were $7.0
million for the current three month period as compared to $2.0 million in
capital expenditures for the same period of 2000. The expenditures for the three
month period ended March 31, 2001 include $3.9 million of leasehold improvements
on new building leases signed in 2000. Cash used in investing activities was
also reduced by the excess of sales and maturities of available for sale
investments over the purchases of such investments by $10.8 million.

Financing activities. Our financing activities provided cash of approximately
$3.5 million during the three month period ended March 31, 2001 as compared to
$204.1 million for the three month period ended March 31, 2000. For the current
three month period, the cash provided was from $1.8 million of common stock
issued under the employee stock purchase plan and the exercise of employee stock
options and $1.8 million related to a leasehold improvement loan as stipulated
by the lease agreement. The cash provided for the three month period ended March
31, 2000 was primarily from the issuance of common stock for $223.4 million and
primarily related to net proceeds from a follow-on public offering in which we
issued and sold 10.5 million shares of common stock, a private placement in
which we issued and sold 504,000 shares of common stock, and $3.9 million from
common stock issued under the employee stock purchase plan and the exercise of
employee stock options, offset by the repayment of our entire line of credit at
the end of March, 2000.

Principal sources of liquidity at March 31, 2001 consisted of $174.2 million
of cash, cash equivalents, short-term investments and long-term available for
sale investments and the line of credit. As of March 31, 2001 we had no
borrowings on our line of credit. However, we continue to have access to this
facility should we need it. As of March 31, 2001, our line of credit was for $35
million. This agreement expires September 2002. Borrowing is limited to 80.0% of
eligible worldwide accounts receivable and is also reduced by any letters of
credit issued under a $35 million sub-agreement to this line. Therefore, as of
March 31, 2001 our actual credit available under this line was approximately
$4.1 million. The line bears interest at a rate of the bank's reference rate
(8.0% at March 31, 2001) plus 0.5%. There is a minimum interest rate of 6.0%. We
are required to maintain specified levels of tangible net worth. Under the
agreement we are not permitted to pay a dividend. We must pay an unused line fee
at the annual rate of one quarter of one percent on the unused portion. As of
March 31, 2001 we were in compliance with the covenants of this agreement.

Purchase Commitments. We have committed to pay $50.0 million in 2001, subject
to certain economic and business conditions, to secure increased wafer
capacity in 2001 and 2002.

We believe that our cash balances, together with funds expected to be
generated from operations and the line of credit availability, will be
sufficient to meet our projected working capital and other cash requirements
through at least the next twelve months. However, there can be no assurance that
future events will not require us to seek additional borrowings or capital and,
if so required, that such borrowing or capital will be available on acceptable
terms.

Business Risks

Risks Related to Our Business

Our operating results fluctuate significantly, and an unanticipated decline in
revenues may disappoint securities analysts or investors and result in a decline
in our stock price.

Our recent growth may not be sustainable, and you should not use our past
financial performance to predict future operating results. Although we were
profitable in 2000 and the quarter ended March 31, 2001, we incurred net
losses in fiscal 1997, 1998 and 1999. Our recent quarterly and annual operating
results have fluctuated, and will continue to fluctuate, due to the following
factors, all of which are difficult to forecast and many of which are out of our
control:

o the availability, timely delivery and cost of wafers from our suppliers;
o competitive pricing pressures and related changes in selling prices;
o fluctuations in manufacturing yields and significant yield losses;
o new product announcements and introductions of competing products by us
or our competitors;
o product obsolescence;
o lower of cost or market inventory adjustments;
o changes in demand for, or in the mix of, our products;

o the gain or loss of significant customers;
o market acceptance of products utilizing our SuperFlash(Registered)
technology;
o changes in the channels through which our products are distributed and
the timeliness of receipt of distributor resale information;
o exchange rate fluctuations;
o general economic, political and environmental-related conditions, such as
natural disasters;
o difficulties in forecasting, planning and management of inventory levels;
o unanticipated research and development expenses associated with new product
introductions; and
o the timing of significant orders and of license and royalty revenue.

A downturn in the market for products such as personal computers and cellular
telephones that incorporate our products can also harm our operating results.

Our operating expenses are relatively fixed, and we order materials in advance
of anticipated customer demand. Therefore, we have limited ability to reduce
expenses quickly in response to any revenue shortfalls.

Our operating expenses are relatively fixed, and we therefore have limited
ability to reduce expenses quickly in response to any revenue shortfalls.
Consequently, our operating results will be harmed if our revenues do not meet
our revenue projections. We may experience revenue shortfalls for the following
reasons:

o sudden drops in consumer demand which causes customers to cancel backlog,
push out shipment schedules, or reduce new orders, possibly due to a
slowing economy or inventory corrections among our customers;
o significant declines in selling prices that occur because of competitive
price pressure during an over-supply market environment;
o sudden shortages of raw materials or fabrication, test or assembly capacity
constraints that lead our suppliers to allocate available supplies or
capacity to other customers which, in turn, harm our ability to meet our
sales obligations; and
o the reduction, rescheduling or cancellation of customer orders.

In addition, we typically plan our production and inventory levels based on
internal forecasts of customer demand, which are highly unpredictable and can
fluctuate substantially. From time to time, in response to anticipated long lead
times to obtain inventory and materials from our outside suppliers and
foundries, we may order materials in advance of anticipated customer demand.
This advance ordering may result in excess inventory levels or unanticipated
inventory write-downs if expected orders fail to materialize.

Cancellations or rescheduling of backlog may result in lower future revenue and
harm our business.

Due to possible customer changes in delivery schedules and cancellations of
orders, our backlog at any particular date is not necessarily indicative of
actual sales for any succeeding period. A reduction of backlog during any
particular period, or the failure of our backlog to result in future revenue,
could harm our business. We experienced a sharp downturn in several of our
markets late in the fourth quarter of 2000, as our customers reacted to
weakening demand for their products. To date, market conditions have not
improved during 2001 and our customers have continued to return product, cancel
backlog and/or push out shipments. Our business could be harmed by industry-wide
fluctuations in the future.

We depend on a limited number of foreign foundries to manufacture our products,
and these foundries may not be able to satisfy our manufacturing requirements,
which could cause our revenues to decline.

We outsource all of our manufacturing with the exception of limited testing
activities. We currently buy all of our wafers and sorted die from a limited
number of suppliers. Substantially all of our products are manufactured by four
foundries, Taiwan Semiconductor Manufacturing Co., Ltd., in Taiwan, Sanyo
Electric Co., Ltd., in Japan, Seiko-Epson Corp. in Japan, and Samsung
Electronics Ltd. in Korea. We anticipate that these foundries, together with
National Semiconductor Corporation in the United States and Nanya Technology
Corporation and Vanguard International Semiconductor Corporation in Taiwan, will
manufacture the majority of our products in 2001. On March 6, 2001, we invested
$50.0 million in Grace Semiconductor Manufacturing Corporation (GSMC), a Cayman
Islands company, for a wafer foundry project located in Shanghai, P.R.C. If
these suppliers fail to satisfy our requirements on a timely basis and at
competitive prices we could suffer manufacturing delays, a possible loss of
revenues or higher than anticipated costs of revenues, any of which could harm
our operating results.

Our revenues may be impacted by our ability to obtain adequate wafer supplies
from our foundries. The foundries with which we currently have arrangements,
together with any additional foundry at which capacity might be obtained, may
not be willing or able to satisfy all of our manufacturing requirements on a
timely basis at favorable prices. In addition, we have encountered delays in
qualifying new products and in ramping new product production and could
experience these delays in the future. We are also subject to the risks of
service disruptions, raw material shortages and price increases by the
foundries. Such disruptions, shortages and price increases could harm our
operating results.

If we are unable to increase our manufacturing capacity, our revenues may
decline.

In order to grow, we need to increase our present manufacturing capacity. Events
that we have not foreseen could arise which would limit our capacity. We have
committed to pay $50.0 million in 2001, subject to certain economic and business
conditions, to secure increased wafer capacity in 2001 and 2002. We are
continually engaged in attempting to secure additional manufacturing capacity to
support our long-term growth. In the longer term we may determine that it is
necessary to invest substantial capital in order to secure appropriate
production capacity commitments. If we cannot secure additional manufacturing
capacity on acceptable terms, our ability to grow will be impaired and our
operating results will be harmed.

Our cost of revenues may increase if we are required to purchase manufacturing
capacity in the future.

To obtain additional manufacturing capacity, we may be required to make
deposits, equipment purchases, loans, joint ventures, equity investments or
technology licenses in or with wafer fabrication companies. These transactions
could involve a commitment of substantial amounts of our capital and technology
licenses in return for production capacity. We may be required to seek
additional debt or equity financing if we need substantial capital in order to
secure this capacity and we cannot assure you that we will be able to obtain
such financing.

If our foundries fail to achieve acceptable wafer manufacturing yields, we will
experience higher costs of revenues and reduced product availability.

The fabrication of our products requires wafers to be produced in a highly
controlled and ultra-clean environment. Semiconductor companies that supply our
wafers sometimes have experienced problems achieving acceptable wafer
manufacturing yields. Semiconductor manufacturing yields are a function of both
our design technology and the foundry's manufacturing process technology. Low
yields may result from marginal design or manufacturing process drift. Yield
problems may not be identified until the wafers are well into the production
process, which often makes them difficult, time consuming and costly to correct.
Furthermore we rely on independent foreign foundries for our wafers which
increases the effort and time required to identify, communicate and resolve
manufacturing yield problems. If our foundries fail to achieve acceptable
manufacturing yields, we will experience higher costs of revenues and reduced
product availability, which would harm our operating results.

If our foundries discontinue the manufacturing processes needed to meet our
demands, or fail to upgrade the technologies needed to manufacture our products,
we may face production delays and lower revenues.

Our wafer and product requirements typically represent a small portion of the
total production of the foundries that manufacture our products. As a result, we
are subject to the risk that a foundry will cease production on an older or
lower-volume manufacturing process that it uses to produce our parts.
Additionally, we cannot be certain our foundries will continue to devote
resources to advance the process technologies on which the manufacturing of our
products is based. Each of these events could increase our costs and harm our
ability to deliver our products on time.

Our dependence on third-party subcontractors to assemble and test our products
subjects us to a number of risks, including an inadequate supply of products and
higher costs of materials.

We depend on independent subcontractors to assemble and test our products. Our
reliance on these subcontractors involves the following significant risks:

o reduced control over delivery schedules and quality;
o the potential lack of adequate capacity during periods of strong demand;
o difficulties selecting and integrating new subcontractors;
o limited warranties on products supplied to us;
o potential increases in prices due to capacity shortages and other factors;
and

o potential misappropriation of our intellectual property.

These risks may lead to increased costs, delayed product delivery or loss of
competitive advantage, which would harm our profitability and customer
relationships.

Because our flash memory products typically have lengthy sales cycles, we may
experience substantial delays between incurring expenses related to research and
development and the generation of revenues.

Due to the flash memory product cycle we usually require more than nine months
to realize volume shipments after we first contact a customer. We first work
with customers to achieve a design win, which may take three months or longer.
Our customers then complete the design, testing and evaluation process and begin
to ramp up production, a period which typically lasts an additional six months
or longer. As a result, a significant period of time may elapse between our
research and development efforts and our realization of revenue, if any, from
volume purchasing of our products by our customers.

We face intense competition from companies with significantly greater financial,
technical and marketing resources that could harm sales of our products.

We compete with major domestic and international semiconductor companies, many
of which have substantially greater financial, technical, marketing,
distribution, and other resources than we do. Many of our competitors have their
own facilities for the production of semiconductor memory components and have
recently added significant capacity for such production. Our memory products,
which presently account for substantially all of our revenues, compete
principally against products offered by Intel, Advanced Micro Devices, Atmel,
STMicroelectronics, Sanyo, Winbond Electronics and Macronix. If we are
successful in developing our high density products, these products will compete
principally with products offered by Intel, Advanced Micro Devices, Fujitsu,
Hitachi, Sharp, Samsung Semiconductor, SanDisk and Toshiba, as well as any new
entrants to the market.

In addition, we may in the future experience direct competition from our foundry
partners. We have licensed to our foundry partners the right to fabricate
products based on our technology and circuit design, and to sell such products
worldwide, subject to our receipt of royalty payments.

Competition may also come from alternative technologies such as ferroelectric
random access memory, or FRAM, or other developing technologies.

Our markets are subject to rapid technological change and, therefore, our
success depends on our ability to develop and introduce new products.

The markets for our products are characterized by:

o rapidly changing technologies;
o evolving and competing industry standards;
o changing customer needs;
o frequent new product introductions and enhancements;
o increased integration with other functions; and
o rapid product obsolescence.

To develop new products for our target markets, we must develop, gain access to
and use leading technologies in a cost-effective and timely manner and continue
to expand our technical and design expertise. In addition, we must have our
products designed into our customers' future products and maintain close working
relationships with key customers in order to develop new products that meet
their changing needs.

In addition, products for communications applications are based on continually
evolving industry standards. Our ability to compete will depend on our ability
to identify and ensure compliance with these industry standards. As a result, we
could be required to invest significant time and effort and incur significant
expense to redesign our products and ensure compliance with relevant standards.
We believe that products for these applications will encounter intense
competition and be highly price sensitive. While we are currently developing and
introducing new products for these applications, we cannot assure you that these
products will reach the market on time, will satisfactorily address customer
needs, will be sold in high volume, or will be sold at profitable margins.

We cannot assure you that we will be able to identify new product opportunities
successfully, develop and bring to market new products, achieve design wins or
respond effectively to new technological changes or product announcements by our
competitors. In addition, we may not be successful in developing or using new
technologies or in developing new products or product enhancements that achieve
market acceptance. Our pursuit of necessary technological advances may require
substantial time and expense. Failure in any of these areas could harm our
operating results.

Our future success depends in part on the continued service of our key design
engineering, sales, marketing and executive personnel and our ability to
identify, recruit and retain additional personnel.

We are highly dependent on Bing Yeh, our President and Chief Executive Officer,
as well as the other principal members of our management team and engineering
staff. There is intense competition for qualified personnel in the semiconductor
industry, in particular the highly skilled design, applications and test
engineers involved in the development of flash memory technology. Competition is
especially intense in Silicon Valley, where our corporate headquarters is
located. We may not be able to continue to attract and retain engineers or other
qualified personnel necessary for the development of our business or to replace
engineers or other qualified personnel who may leave our employ in the future.
Our anticipated growth is expected to place increased demands on our resources
and will likely require the addition of new management and engineering personnel
and the development of additional expertise by existing management personnel.
The failure to recruit and retain key design engineers or other technical and
management personnel could harm our business.

Our ability to compete successfully will depend, in part, on our ability to
protect our intellectual property rights.

We rely on a combination of patent, trade secrets, copyrights, mask work rights,
nondisclosure agreements and other contractual provisions and technical measures
to protect our intellectual property rights. Policing unauthorized use of our
products, however, is difficult, especially in foreign countries. Litigation may
continue to be necessary in the future to enforce our intellectual property
rights, to protect our trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Litigation could result in substantial costs and diversion of
resources and could harm our business, operating results and financial condition
regardless of the outcome of the litigation. We own 33 patents in the United
States relating to our products and processes, and have filed for several more.
In addition, we hold several patents in Europe and Canada, and have filed
several foreign patent applications in Europe, Japan, Korea, Taiwan and Canada.
We cannot assure you that any pending patent application will be granted. Our
operating results could be harmed by the failure to protect our intellectual
property.

If we are accused of infringing the intellectual property rights of other
parties we may become subject to time-consuming and costly litigation. If we
lose, we could suffer a significant impact on our business and be forced to pay
damages.

Third parties may assert that our products infringe their proprietary rights, or
may assert claims for indemnification resulting from infringement claims against
us. Any such claims may cause us to delay or cancel shipment of our products or
pay damages that could harm our business, financial condition and results of
operations. In addition, irrespective of the validity or the successful
assertion of such claims, we could incur significant costs in defending against
such claims.

Over the past three years we were sued both by Atmel Corporation and Intel
Corporation regarding patent infringement issues and sued Winbond Electronics
Corporation regarding our contractual relationship with them. Significant
management time and financial resources have been devoted to defending these
lawsuits. We settled with Intel in May 1999, with Winbond in October 2000, and
the Atmel litigation is ongoing.

In addition to the Atmel, Intel and Winbond actions, we receive from time to
time, letters or communications from other companies stating that such companies
have patent rights that involve our products. Since the design of all of our
products is based on SuperFlash technology, any legal finding that the use of
our SuperFlash technology infringes the patent of another company would have a
significantly negative effect on our entire product line and operating results.
Furthermore, if such a finding were made, there can be no assurance that we
could license the other company's technology on commercially reasonable terms or
that we could successfully operate without such technology. Moreover, if we are
found to infringe, we could be required to pay damages to the owner of the
protected technology and could be prohibited from making, using, selling, or
importing into the United States any products that infringe the protected
technology. In addition, the management attention consumed by and legal cost
associated with any litigation could harm our operating results.

Public announcements may hurt our stock price. During the course of lawsuits
there may be public announcements of the results of hearings, motions, and other
interim proceedings or developments in the litigation. If securities analysts or
investors perceive these results to be negative, it could harm the market price
of our stock.

Our litigation may be expensive, may be protracted and confidential information
may be compromised. Whether or not we are successful in our lawsuit with Atmel,
we expect this litigation to consume substantial amounts of our financial and
managerial resources. At any time Atmel may file additional claims against us,
which could increase the risk, expense and duration of the litigation. Further,
because of the substantial amount of discovery required in connection with this
type of litigation, there is a risk that some of our confidential information
could be compromised by disclosure.

Our business may suffer due to risks associated with international sales and
operations.

During 1998, 1999, 2000 and the three months ended March 31, 2001, our export
product and licensing revenues accounted for approximately 92.7%, 89.1%, 84.3%,
and 86.9% of our net revenues, respectively. Our international business
activities are subject to a number of risks, each of which could impose
unexpected costs on us that would harm our operating results. These risks
include:

o difficulties in complying with regulatory requirements and standards;
o tariffs and other trade barriers;
o costs and risks of localizing products for foreign countries;
o reliance on third parties to distribute our products;
o longer accounts receivable payment cycles;
o potentially adverse tax consequences;
o limits on repatriation of earnings; and
o burdens of complying with a wide variety of foreign laws.

In addition, we have made equity investments in several companies with
operations in Japan, Taiwan and China. The value of our investments is subject
to the economic and political conditions particular to our industry, these
countries and to the global economy. If we determine that a change in the
recorded value of an investment is other than temporary, we will adjust the
value of the investment and such an expense could have a negative impact on our
operating results.

We derived 80.8%, 77.6%, and 72.1% of our product revenue from Asia during
1999, 2000, and the three months ended March 31, 2001, respectively.
Additionally, our major wafer suppliers and assembly and packaging
subcontractors are all located in Asia. Any kind of economic, political or
environmental instability in this region of the world can have a severe negative
impact on our operating results due to the large concentration of our production
and sales activities in this region. For example, during 1997 and 1998, several
Asian countries where we do business, such as Japan, Taiwan and Korea,
experienced severe currency fluctuation and economic deflation, which negatively
impacted our total revenues and also negatively impacted our ability to collect
payments from these customers. During this period, the lack of capital in the
financial sectors of these countries made it difficult for our customers to open
letters of credit or other financial instruments that are guaranteed by foreign
banks. Finally, the economic situation in this period exacerbated a decline in
selling prices for our products as our competitors reduced product prices to
generate needed cash.

It should also be noted that we are greatly impacted by the political, economic
and military conditions in Taiwan. Taiwan and China are continuously engaged in
political disputes and both countries have continued to conduct military
exercises in or near the other's territorial waters and airspace. Such disputes
may continue and even escalate, resulting in an economic embargo, a disruption
in shipping or even military hostilities. Any of these events could delay
production or shipment of our products. Any kind of activity of this nature or
even rumors of such activity could harm our operations, revenues, operating
results, and stock price.

Because a small number of customer accounts are responsible for a substantial
portion of our revenues, our revenues could decline due to the loss of one of
these customer accounts.

In the past, more than half of our revenues have come from a small number of
customer accounts. For example, product sales to our top 10 customer accounts
represented approximately 62.8%, 53.6%, 43.0%, and 51.5% of our product
revenues for 1998, 1999, 2000 and the three months ended March 31, 2001,
respectively. During 2000, 7 of our top 10 accounts were stocking
representatives, two were domestic distributors and one was an OEM. In 1998, one
customer account represented 15.2% of product sales. Another customer account
represented 10.7% and 12.4% of product sales in 1998 and 1999, respectively. No
single customer account represented 10.0% or more of product revenues during
2000. One customer accounted for more than 10.0% of product revenues for the
three months ended March 31, 2001. If we were to lose any of these customer
accounts or experience any substantial reduction in orders from these customer
accounts, our revenues and operating results would suffer. In addition, the
composition of our major customer account base changes from year to year as the
market demand for our end customers' products change.

We do not typically enter into long-term contracts with our customers, and the
loss of a major customer could harm our business.

We do not typically enter into long-term contracts with our customers, and we
cannot be certain as to future order levels from our customers. When we do enter
into a long-term contract, the contract is generally terminable at the
convenience of the customer. An early termination by one of our major customers
would harm our financial results as it is unlikely that we would be able to
rapidly replace that revenue source.

If an earthquake or other natural disaster strikes our manufacturing facility or
those of our suppliers, we would be unable to manufacture our products for a
substantial amount of time and we would experience lost revenues.

Our corporate headquarters are located in California near major earthquake
faults. In addition, some of our suppliers are located near fault lines. In the
event of a major earthquake or other natural disaster near our headquarters, our
operations could be harmed. Similarly, a major earthquake or other natural
disaster near one or more of our major suppliers, like the one that occurred in
Taiwan in September 1999, could disrupt the operations of those suppliers, which
could limit the supply of our products and harm our business.

Prolonged electrical power outages or shortages, or increased costs of energy
could harm our business.

Our design and process research and development facilities and our corporate
offices are located in California, which is currently susceptible to power
outages and shortages as well as increased energy costs. To limit this exposure,
we are in the process of securing back-up generators and power supplies to our
main California facilities. While the majority of our production facilities are
not located in California, more extensive power shortages in the state could
delay our design and process research and development as well as increase our
operating costs.

We depend on stocking representatives and distributors to generate a majority of
our revenues.

We rely on stocking representatives and distributors to establish and maintain
customer relationships and, at times, to sell our products and these accounts
could discontinue their relationship with us or discontinue selling our products
at any time. Two of our stocking representatives are responsible for
relationships with customers which account for substantially all of our product
sales in Taiwan, which were 28.3%, 25.5%, and 26.2% of our net product revenues
during 1999, 2000, and the three months ended March 31, 2001. One stocking
representative was responsible for relationships with customers which accounted
for substantially all of our sales in China, including Hong Kong, during 1999
and 2000, which accounted for 24.3%, 19.1%, and 15.4% of our total product
revenues during 1999, 2000 and the three months ended March 31, 2001,
respectively. The loss of any of these stocking representatives, or any other
significant stocking representative or distributor could harm our operating
results by impairing our ability to sell our products to these customers.

Our growth continues to place a significant strain on our management systems and
resources and if we fail to manage our growth, our ability to market and sell
our products and develop new products may he harmed.

Our business is experiencing rapid growth which has strained our internal
systems and will require us to continuously develop sophisticated information
management systems in order to manage the business effectively. We are currently
implementing a supply-chain management system and a vendor electronic data
interface system. There is no guarantee that we will be able to implement these
new systems in a timely fashion, that in themselves they will be adequate to
address our expected growth, or that we will be able to foresee in a timely
manner other infrastructure needs before they arise. Our success depends on the
ability of our executive officers to effectively manage our growth. If we are
unable to manage our growth effectively, our results of operations will be
harmed. If we fail to successfully implement new management information systems,
our business may suffer severe inefficiencies that may harm the results of our
operations.

Risks Related to Our Industry

Our success is dependent on the growth and strength of the flash memory market.

All of our products, as well as all new products currently under design, are
stand-alone flash memory devices or devices embedded with flash memory. A memory
technology other than SuperFlash may be adopted as an industry standard. Our
competitors are generally in a better financial and marketing position than we
are from which to influence industry acceptance of a particular memory
technology. In particular, a primary source of competition may come from
alternative technologies such as FRAM devices if such technology is
commercialized for higher density applications. To the extent our competitors
are able to promote a technology other than SuperFlash as an industry standard,
our business will be seriously harmed.

The selling prices for our products are extremely volatile and have historically
declined during periods of over capacity or industry downturns. In addition, the
cyclical nature of the semiconductor industry could create fluctuations in our
operating results, as we experienced in 1997 and 1998.

The semiconductor industry has historically been cyclical, characterized by wide
fluctuations in product supply and demand. From time to time, the industry has
also experienced significant downturns, often in connection with, or in
anticipation of, maturing product cycles and declines in general economic
conditions. Downturns of this type occurred in 1997 and 1998. These downturns
have been characterized by diminished product demand, production over-capacity
and accelerated decline of average selling prices, and in some cases have lasted
for more than a year. Our business could be harmed by industry-wide fluctuations
in the future. The flash memory products portion of the semiconductor industry,
from which we derive substantially all of our revenues suffered from excess
capacity in 1996, 1997, and 1998, which resulted in greater than normal declines
in our markets, which unfavorably impacted our revenues, gross margins and
profitability. While these conditions improved in 1999 and 2000, deteriorating
market conditions at the end of 2000 and the first quarter of 2001 could
result in the eventual decline of our selling prices and, if such declines were
to resume, our growth and operating results would be harmed.

There is seasonality in our business and if we fail to continue to introduce new
products this seasonality may become more pronounced.

Sales of our products in the consumer electronics applications market are
subject to seasonality. As a result, sales of these products are impacted by
seasonal purchasing patterns with higher sales generally occurring in the second
half of each year. In 1999 and the first half of 2000, this seasonality was
partially offset by the introduction of new products as we continued to
diversify our product offerings. However, in the first quarter of 2001, this
seasonality again became pronounced as it was combined with deteriorating market
conditions, which together resulted in a decline in product revenues from the
fourth quarter of 2000 to the first quarter of 2001. If we fail to continue to
introduce new products, our business may suffer and the seasonality of a portion
of our sales may become more pronounced.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to risks associated with foreign exchange rate
fluctuations due to our international manufacturing and sales activities. These
exposures may change over time as business practices evolve and could negatively
impact our operating results and financial condition. All of our sales are
denominated in U.S. dollars. An increase in the value of the U.S. dollar
relative to foreign currencies could make our products more expensive and
therefore reduce the demand for our products. Such a decline in the demand could
reduce revenues and/or result in operating losses. In addition, a downturn in
the economies of Japan, Taiwan or China could impair the value of our equity
investments in companies with operations in these countries. If we consider the
value of these companies to be impaired, we would write off, or expense, some or
all of our investments. As of March 31, 2001 the value of our equity investments
in companies with operations in Japan, Taiwan and China was approximately $0.9
million, $18.4 million, and $50.0 million, respectively.

At any time, fluctuations in interest rates could effect interest
earnings on our cash, cash equivalents and short-term investments, any interest
expense owed on the line of credit facility, or the fair value of our investment
portfolio. We believe that the effect, if any, of reasonably possible near term
changes in interest rates on our financial position, results of operations, and
cash flows would not be material. Currently, we do not hedge these interest rate
exposures.

As of March 31, 2001, the carrying value approximated fair value. The
table below presents the carrying value and related weighted average interest
rates for our investments in marketable securities as of March 31, 2001.

Carrying Interest
Value Rate
-----------------------------
Investment securities:
Short-term investments - fixed rate $ 103,399 4.7%
Long-term investments - fixed rate 26,008 4.2%
---------
Total investment securities 129,407 4.6%
---------
Cash equivalents - variable rate 44,764 5.0%
---------
$ 174,171 4.7%
=========

PART II

Item 1. Legal Proceedings

On two of the six patents, the District Court ruled by summary judgment that
we did not infringe. Two of the other patents were invalidated by another U.S.
District Court in a proceeding to which we were not a party, but this decision
was later reversed by the Federal Circuit Court of Appeals. Thus, four patents
remain at issue in Atmel's District Court case against us.

The ITC action will not be dispositive in the pending lawsuit because Atmel
and SST can still pursue their claims in the District Court action. Atmel has
filed motions for summary judgment on the '811 and '829 patents as well as the
'903 patent. On May 11, 2001 we filed our opposition papers with the court. A
hearing on Atmel's motion has been set for June 1, 2001. SST has recently
learned of evidence it believes renders the '903 patent invalid. The court has
scheduled a hearing for SST's summary judgement on that issue, and SST will file
its motion papers during the week of May 14, 2001. The District Court has
scheduled a status conference for December 15, 2001, to set a trial date,
although Atmel and SST are currently discussing an extension of that schedule.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits. We incorporate by reference all exhibits filed in connection
with our annual report on Form 10-K, as amended, for the year ended
December 31, 2000.

(b) Reports on Form 8-K filed during the quarter ended March 31, 2001: None.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Sunnyvale, County of
Santa Clara, State of California, on the 15th day of May, 2001.

SILICON STORAGE TECHNOLOGY, INC.

By:

/s/ BING YEH
-----------------------------------------
Bing Yeh
President and Chief Executive Officer
(Principal Executive Officer)

/s/ JEFFREY L. GARON
-----------------------------------------
Jeffrey L. Garon
Vice President Finance & Administration,
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)