CEVA INC - Quarter Report: 2003 March (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended: March 31, 2003

OR

For the transition period from                              to                        

Commission file number: 000-49842

ParthusCeva, Inc.

Exact Name of Registrant as Specified in Its Charter

2033 Gateway Place, Suite 150, San Jose, California 95110-1002

(Address of Principal Executive Offices) (Zip Code)

Registrant’s Telephone Number, Including Area Code: (408) 514-2900

Indicate by check whether the registrant: (1) has filed all reports 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  ¨  No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 18,079,119 shares of common stock, $0.001 par value, as of May 12, 2003.

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FORWARD-LOOKING STATEMENTS

This quarterly report includes forward-looking statements that are subject to a number of risks and uncertainties. All statements, other than statements of historical facts, included in this quarterly report regarding our strategy, future operations, financial position, estimated revenues, projected costs, prospects, plans, and objectives of management are forward-looking statements. The words “will”, “believe”, “anticipate”, “intend”, “estimate”, “expect”, “project”, and similar expressions are intended to identify forward-looking statements, although not all forward- looking statements in this report contain these identifying words. We cannot guarantee future results, levels of activity, performance or achievements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or strategic alliances. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including the risks described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That Could Affect Our Operating Results” and elsewhere in this quarterly report. We do not assume any obligations to update any of the forward-looking statements we make.

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ParthusCeva was formed through the combination of Parthus Technologies plc (‘Parthus’) and ParthusCeva (formerly known as Ceva, Inc.) on November 1, 2002. Unless otherwise indicated, the financial information in this quarterly report includes the results of the business of Parthus only for the periods following the combination on November 1, 2002.

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PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands, except share and per share data

The accompanying notes are an integral part of the interim consolidated financial statements.

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

U.S. dollars in thousands, except per share data

The accompanying notes are an integral part of the interim consolidated financial statements.

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INTERIM STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

AN RELATED COMPANY INVESTMENT

U.S. dollars in thousands (except share data)

The accompanying notes are an integral part of the interim consolidated financial statements.

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

U.S. dollars in thousands

The accompanying notes are an integral part of the interim consolidated financial statements.

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NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(U.S. dollars in thousands)

NOTE 1:- GENERAL

Background:

ParthusCeva, Inc. (formerly Ceva, Inc) (the “Company”) was a wholly-owned subsidiary of DSPG, Inc. (“DSPG”) until November 1, 2002. On November 1, 2002, DSPG, the Company and Parthus Technologies plc (“Parthus”) finalized the terms of the combination agreement dated April 4, 2002 (the “Combination Agreement”) pursuant to which the Company and Parthus agreed to effect a combination of their businesses. DSPG contributed the DSP cores licensing business and operations and the related assets and liabilities of such business and operations to the Company (the “Separation”); DSPG then spun-off the Company by distributing 9,040,851 shares of Common Stock of the Company to the existing stockholders of DSPG on a one-for-three basis (one share of the Company Common Stock for every three shares of DSPG Common Stock held); Parthus was acquired by the Company from the existing shareholders of Parthus in exchange for the issuance of 8,998,887 new shares of Common Stock of the Company (the “Combination”). The combined company was renamed ParthusCeva, Inc. (“ParthusCeva”).

The Company was incorporated in Delaware on November 22, 1999. The Company had no business or operations prior to the transfer of the DSP cores licensing business and operations from DSPG.

These financial statements give effect to the transfer by DSPG of the DSP cores licensing business and operations and the related assets and liabilities of such businesses to the Company for all periods presented and include the results of Parthus subsequent to the Combination on November 1, 2002.

ParthusCeva licenses to semiconductor companies and electronic equipment manufacturers (also known as original equipment manufacturers, or OEMs) complete, integrated intellectual property (IP) solutions that enable a wide variety of electronic devices. The Company’s programmable digital signal processing (DSP) cores and application-level IP platforms power handheld wireless devices, global positioning system (GPS) devices, consumer audio products, automotive applications and a range of other consumer products.

NOTE 2:- BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation:

The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial

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NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

(U.S. dollars in thousands)

NOTE 2:- BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)

information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, reference is made to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2002.

The consolidated financial statements incorporate the financial statements of the Company and all of its subsidiaries. All significant intercompany balances and transactions have been eliminated on consolidation.

For periods prior to November 1, 2002, the Company’s financial statements present the financial position, results of operations and cash flows of the licensing business and operations of DSPG, which have been carved out from the financial statements of DSPG using the historical results of operations and historical bases of the assets and liabilities of the DSPG business that it comprises. The consolidated financial statements reflect the assets, liabilities, results of operations, changes in stockholders’ equity and related company investment, and cash flows (the “Company’s Business”) as if the Company and its subsidiaries had been a separate entity for the periods presented.

Changes in related company investment represent the DSPG contribution of its net investment after giving effect to the net income of the Company plus net cash transfers to or from DSPG. Based on the Separation Agreement, DSPG and the Company jointly agreed the balance on the net investment account as of November 1, 2002 was $796.

The Company began accumulating its retained earnings on November 1, 2002, the date on which DSPG transferred to the Company all of the assets and liabilities relating to the Company’s Business.

The transfer of assets, liabilities and operations of the Company’s Business from DSPG is a reorganization of entities under common control and has been accounted for in a manner similar to a pooling of interests. Accordingly, the financial statements of the Company have been restated to include the Company’s Business as if it had always been operated as a separate entity.

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NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

(U.S. dollars in thousands)

NOTE 2:- BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)

The Company’s consolidated financial statements for the period prior to 1 November 2002 include:

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NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

(U.S. dollars in thousands)

NOTE 2:- BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)

Management believes that the foregoing allocations were made on a reasonable basis and would not have been materially different if the Company had operated as a stand-alone entity for all periods presented; however, the allocations of costs and expenses do not necessarily indicate the costs that would have been or will be incurred by the Company on a stand-alone basis.

The significant accounting policies applied in the annual consolidated financial statements of the Company as of December 31, 2002, contained in the Company’s Registration Statement on Form 10-K filed with the Securities and Exchange Commission on March 28, 2003 (File No. 000-49842), have been applied consistently in these financial statements.

NOTE 3:- GEOGRAPHIC INFORMATION AND MAJOR CUSTOMER DATA

The Company manages its business on a basis of one industry segment, licensing to semiconductor companies and electronic equipment manufacturers complete, integrated intellectual property solutions that enable a wide variety of electronic devices (see Note 1. for a brief description of the Company’s business) and follows the requirements of Statement of Financial Accounting Standard No. 131, “Disclosures About Segments of an Enterprise and Related Information” (“SFAS No. 131”).

The following is a summary of operations within geographic areas:

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NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

(U.S. dollars in thousands)

NOTE 3:- GEOGRAPHIC INFORMATION AND MAJOR CUSTOMER DATA (cont.)

Major customer data as a percentage of total revenues:

The following table sets forth the customers that represented 10% or more of the Company’s net revenue in each of the periods set forth below.

NOTE 4:- NET INCOME (LOSS) PER COMMON STOCK

Basic net income (loss) per share is computed based on the weighted average number of shares of Common Stock outstanding during each period. Diluted net income (loss) per share is computed based on the weighted average number of shares of Common Stock outstanding during each period, plus dilutive potential shares of Common Stock considered outstanding during the period, in accordance with Statement of Financial Standard No. 128, “Earnings Per Share”. All outstanding stock options were granted in 2002 and have been excluded from the calculation of the diluted net loss per common share because the effect of all such securities was anti-dilutive.

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NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

(U.S. dollars in thousands)

NOTE 5:- STOCK BASED COMPENSATION PLANS

We issue stock options to our employees and directors and provide employees the right to purchase our stock pursuant to approved stock option and employee stock purchase programs. We account for our stock-based compensation plans under the intrinsic value method of accounting as defined by Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees and related interpretations. No stock-based employee compensation cost is reflected in net income for the three months ended March 31, 2003 as all options granted under these plans had an exercise price equal to the fair market value of the underlying common stock on the date of grant. There were no options outstanding in the three months ended March 31, 2002.

Under SFAS No. 123, as amended by SFAS No. 148: pro forma information regarding net income (loss) and net earnings (loss) per share is required, and has been determined as if ParthusCeva had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Schloles option-pricing model with the following weighted-average assumptions:

Weighted average fair value of the options granted to the employees of the Company whose exercise price is equal to market price of the shares of the Company at the date of grant are as follows:

The following pro forma information includes the effect of the options granted to the Company’s employees to purchase shares.

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NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

(U.S. dollars in thousands)

NOTE 5:- STOCK BASED COMPENSATION PLANS (con’t)

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period.

There are no pro forma numbers for the first quarter of 2002 as ParthusCeva’s common stock has only been publicly trading since November 1, 2002. Refer to note 2 for further details.

NOTE 6:- REORGANIZATION AND SEVERANCE CHARGE

In the first quarter, the Company recorded a reorganization and severance charge of $1,380. This charge arose following the strategic initiative to strengthen the headquarters function in the U.S., including the planned hiring of a new chief executive officer and new chief financial officer to be based at our headquarters in San Jose, California, which involved the resignations of our Dublin, Ireland based chief executive officer and chief financial officer.

The major components of the fourth quarter 2002 restructuring charge and the first quarter 2003 reorganization charge are as follows:

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Item 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion together with the unaudited financial statements and related notes appearing elsewhere in this quarterly report. This discussion contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those indicated by such forward-looking statements. Factors which could cause actual results to differ materially include those set forth under “Factors That Could Affect Our Operating Results”, as well as those otherwise discussed in this section and elsewhere in this quarterly report. See “Forward-Looking Statements”.

INTRODUCTION

ParthusCeva was formed through the combination of Parthus Technologies plc and ParthusCeva (formerly known as Ceva, Inc.), a wholly owned subsidiary of DSP Group, Inc., on November 1, 2002. The transaction is described in detail in the Report on Form 8-K of ParthusCeva dated November 1, 2002, as amended. With respect to periods prior to November 1, 2002, the discussion below assumes that the separation of the DSP cores licensing business from DSP Group had been in effect throughout the relevant periods. Our financial statements show the DSP cores licensing business as an entity carved out from the consolidated financial statements of DSP Group using the historical results of operations and historical bases of assets and liabilities of this business. This information may not reflect what our financial position or results of operations actually would have been had we operated as a separate, stand-alone entity for the periods presented, and may not be indicative of our future financial position or results of operations. We have not made adjustments to our historical financial information for periods prior to November 1, 2002 to reflect the significant changes in our cost structure, funding and operations that have resulted from the separation of the DSP cores licensing business from DSP Group and our combination with Parthus. This discussion includes the results of the business of Parthus for the periods following the combination on November 1, 2002 only.

BUSINESS OVERVIEW

ParthusCeva licenses to semiconductor companies and electronic equipment manufacturers complete, integrated intellectual property solutions that enable a wide variety of electronic devices. Our programmable DSP cores and application-level IP platforms power wireless devices, handheld devices, consumer electronics products, GPS devices, consumer audio products and automotive applications. We develop and market our integrated portfolio of open-licensable IP in three distinct areas: DSP cores; system-on-a-chip sub-systems and application-specific platform IP.

Our strategy is to engage in licensing and royalty agreements with leading semiconductor manufacturers and OEMs that have a track record of successful adoption and deployment of key next-generation technologies. In addition, we derive a portion of our revenues from development work, which we refer to as IP Creation, and from the sale of our technology in module form, which we refer to as Hard IP.

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We seek to leverage our substantial investment to date in research and development and to utilize our experienced R&D staff to enhance our technology offerings and to drive future revenue growth by offering cutting-edge solutions.

RESULTS OF OPERATIONS

Total Revenues

Total revenues increased 115.9% to $8.8 million for the three-month period ended March 31, 2003 from $4.1 million for the comparable period in 2002. Licensing and royalty revenue increased by $3.8 million and Other revenues increased by $979,000 principally reflecting additional revenues from licensing and royalties on platform-level IP solutions, IP Creation and Hard IPas a result of the combination with Parthus on November 1, 2002.

Licensing and royalty revenues accounted for 78.9% of our total revenues for the three-month period ended March 31, 2003, compared with 78.4% of total revenues for the comparable period in 2002. Other revenues accounted for 21.1% of total revenues for the three-month period ended March 31, 2003, compared with 21.6% of total revenues for the comparable period in 2002. Revenues from two customers accounted for 22.6% and 10.4% of total revenues for the three-month period ended March 31, 2003. Revenues from five customers accounted for 29.3%, 14.4%, 12.7%, 10.4% and 10.0% of total revenues for the comparable period in 2002.

Licensing and Royalty Revenues

Licensing and royalty revenues increased 117.3% to $7.0 million for the three-month period ended March 31, 2003 from $3.2 million for the comparable period in 2002.

Licensing revenues increased 183.2% to $6.4 million for the three-month period ended March 31, 2003 from $2.3 million for the comparable period in 2002. The increase reflects the additional revenue generated following the combination with Parthus.

Unit and prepaid royalty revenues decreased 37.1% to $605,000 for the three-month period ended March 31, 2003, from $962,000 for the comparable period in 2002. The decrease in such revenues was primarily due to lower per-unit royalties from some license agreements due to volume pricing. We had 18 royalty-paying licensees for the three-month period ended March 31, 2003 and 11 for the comparable period in 2002. Royalty-generating licensees reported sales of 8.0 million chips incorporating our technology for the three-month period ended March 31, 2003, compared with 28.9 million chips for the comparable period in 2002. The primary reason for the reduction in volume shipped is the wind-down of 2G shipments of a key customer that is currently transitioning to 2.5G products.

Other Revenues

Other revenues increased 110.9 % to $1.9 million for the three-month period ended March 31, 2003 from $0.9 million for the comparable period in 2002. The increase was primarily due to revenues generated in IP Creation and Hard IP of $1.1 million following the combination with Parthus, offset by a small decrease in technical support revenues of $71,000.

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Geographic Revenue Analysis

For the three-month period ended March 31, 2003, revenues in the United States represented 63.0% of total revenues, while Europe, Middle East and Africa represented 23.4% and Asia represented 13.6%. For the comparable period in 2002, revenues in the United States represented 32.0% of total revenues, while Europe, Middle East and Africa represented 53.0% and Asia represented 15.0%.

Cost of Revenues

Cost of revenues was $1.6 million for the three-month period ended March 31, 2003, compared with $0.3 million for the comparable period in 2002. Cost of revenues accounted for 18.5% of total revenues for the three-month period ended March 31, 2003, compared with 7.6% for the comparable period in 2002. Gross profit decreased to 81.5% for the three-month period ended March 31, 2003 from 92.4% for the comparable period in 2002. The increase in total cost of revenues and decrease in gross profit were due primarily to the change in revenue mix in 2003. In 2003 a lower amount of revenues were derived from higher gross margin royalty revenues and additional lower margin revenues were generated from IP Creation and Hard IP following the combination with Parthus.

Research and Development Expenses, Net

Research and development expenses, net of related government research grants, increased by 145.4% to $4.1 million, or 45.8% of total revenues, for the three months ended March 31, 2003, from $1.7 million, or 40.3% of total revenues, for the comparable period in 2002. This increase reflects primarily higher labor and associated costs resulting from increased headcount and increased investment in design tools and sub-contract design following the combination with Parthus. The number of research and development personnel was 182 at March 31, 2003 compared with 45 at March 31, 2002.

Sales and Marketing Expenses

Sales and marketing expenses increased by 95.3% to $1.4 million for the three-month period ended March 31, 2003 from $0.7 million for the comparable period in 2002. The increase in absolute terms reflects the additional sales and marketing personnel following the combination with Parthus required to support our sales and marketing efforts in 2003. Sales and marketing expenses as a percentage of total revenues were 15.5% for the three-month period ended March 31, 2003, compared with 17.2% for the comparable period in 2002. The percentage decrease reflects higher revenues for the three-month period ended March 31, 2003 compared with the comparable period in 2002. The total number of sales and marketing personnel was 25 at March 31, 2003, compared with 5 at March 31, 2002.

General and Administrative Expenses

General and administrative expenses increased by 113.3% to $1.5 million for the three-month period ended March 31, 2003, compared with $0.7 million for the comparable period in 2002. General and administrative expenses as a percentage of total revenues were 16.7% for the three-month period ended March 31, 2003, compared with 16.9% for the comparable period in

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2002. The increase in absolute terms reflects the investment in a management and administrative structure to support our business going forward and increased facility costs following our combination with Parthus. The total number of general and administrative personnel was 30 for at March 31, 2003, compared with 7 at March 31, 2002.

Amortization of Intangibles

We recorded an expense of $284,000 for the three-month period ended March 31, 2003 in connection with the amortization of intangible assets acquired in the combination with Parthus.

Reorganization and Severance Charge

We incurred a reorganization and severance charge of $1.4 million as a result of the decision to strengthen our headquarters function in the U.S., including the planned hiring of a new chief executive officer and new chief financial officer to be based at our headquarters in San Jose, California, which involved the resignations of our Dublin, Ireland based chief executive officer and chief financial officer.

Financial income, net

Financial income, net, was $240,000 for the three-month period ended March 31, 2003, compared with $18,000 for the comparable period in 2002, reflecting the higher cash balances on hand following the combination with Parthus.

Operating Expenses

Total operating expenses for the three-month period ended March 31, 2003 were $8.6 million compared with $3.0 million for the comparable period in 2002. This increase reflects the combination with Parthus, as well as our continued investment, internally and by acquisition, in developing and licensing a strong portfolio of technology platforms. The investment has resulted in higher numbers of engineering staff, facility costs and depreciation charges together with additional sales and marketing and administrative costs required to support our investments following the combination with Parthus. In addition, as discussed above, we incurred a reorganization and severance charge of $1.4 million in the quarter.

Currency Translation Differences

We incurred foreign exchange losses of approximately $199,000 for the three-month period ended March 31, 2003 arising principally on euro liabilities as a result of the appreciation of the euro against the U.S. dollar.

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Provision for Income Taxes

There is no provision for income taxes for the three-month period ended March 31, 2003 as a result of losses incurred in the period. This compares with $242,000 for the comparable period in 2002, which was provided for domestic and foreign tax liabilities.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2003, we had approximately $68.5 million in cash and cash equivalents.

Net cash used in operating activities for the three-month period ended March 31, 2003 was $5.4 million, compared with $2.9 million of net cash used in operating activities for the comparable period in 2002. The net cash outflow from operating activities for the three-month period ended March 31, 2003 included the settlement of merger-related costs of approximately $3 million following the combination with Parthus and cash outflow in connection with restructuring costs incurred in November 2002 amounting to approximately $500,000. Cash used in operating activities for the comparable period in 2002 resulted from movements in taxes payable, trade payables and accruals. Cash flows from operating activities may vary significantly from quarter to quarter depending on the timing of our receipts and payments.

Cash outflows from capital equipment purchases amounted to approximately $86,000 for the three-month period ended March 31, 2003, compared with $56,000 for the comparable period in 2002. In addition we had proceeds from the sale of capital equipment of $38,000 for the three-month period ended March 31, 2003.

Net cash provided by financing activities of $81,000 reflects proceeds from the issuance of shares upon exercise of stock options and purchase of ESPP shares during the three-month period ended March 31, 2003. This compares with a capital contribution of approximately $3 million by DSP Group for the comparable period in 2002.

We believe that our current cash on hand will provide sufficient capital to fund our operations for at least the next 12 months. We cannot assure you, however, that the underlying assumed levels of revenues and expenses will prove to be accurate.

The table below presents the principal categories of our contractual obligations as of March 31, 2003:

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Capital lease obligations are principally on our leasehold properties located in the United States, Ireland, Israel and the United Kingdom.

Our operating lease obligations relate to license agreements entered into for design tools of $2,201,000 and obligations under motor vehicle leases of $375,000.

Purchase obligations consist of capital commitments of $2,811,000, principally for design tools, and operating purchase order commitments of $487,000.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND ASSUMPTIONS

The preparation of consolidated financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Management bases its estimates and judgments on historical experience and on other factors that are believed to be reasonable under current circumstances. Actual results may differ from these estimates if these assumptions prove to be incorrect or if conditions develop other than as assumed for purposes of such estimates. Our significant accounting policies and the basis of preparation of our unaudited financial statements are detailed in note 2 to our financial statements, which appear elsewhere in this quarterly report. The following is a brief discussion of those of our critical accounting policies that require significant estimates and judgments by management:

Revenue Recognition

Significant management judgments and estimates must be used and made in connection with the recognition of revenue in any accounting period. Material differences in the amount of revenue in any given period may result if these judgments or estimates prove to be incorrect or if management’s estimates change on the basis of development of the business or market conditions.

In recognizing revenue, we apply the provisions of Statement of Position No. 97-2, “Software Revenue Recognition,” as amended by Statement of Position No.98-4 and 98-9. A portion of our revenue is derived from license agreements that entail the customization of our application IP to the customer’s specific requirements. Revenues from initial license fees for such arrangements are recognized based on the percentage to completion method over the period from signing of the license through to customer acceptance, as such IP requires significant modification or customization that takes time to complete. The percentage to completion is measured by monitoring progress using records of actual time incurred to date in the project compared to the total estimated project requirement, which corresponds to the costs related to earned revenues. Estimates of total project requirements are based on prior experience of customization, delivery and acceptance of the same or similar technology and are reviewed and updated regularly by management. After delivery, if uncertainty exists about customer acceptance of the IP, license revenue is not recognized until acceptance. Estimated gross profit or loss from long-term contracts may change due to changes in estimates resulting from differences between actual performance and original forecasts. Such changes in estimated gross

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profit are recorded in results of operations when they are reasonably determinable by management, on a cumulative catch-up basis.

We believe that the use of the percentage of completion method is appropriate as we have the ability to make reasonably dependable estimates of the extent of progress towards completion, contract revenues and contract costs. In addition, contracts executed include provisions that clearly specify the enforceable rights regarding services to be provided and received by the parties to the contracts, the consideration to be exchanged and the manner and terms of settlement. In all cases we expect to perform our contractual obligations and our licensees are expected to satisfy their obligations under the contract.

If we do not accurately estimate the resources required or the scope of the work to be performed, or do not manage our projects properly within the planned periods of time or satisfy our obligations under the contracts, then future results may be significantly and negatively affected or losses on existing contracts may need to be recognized.

Acquired Intangibles

Intangible assets arising on acquisition are capitalized and amortized to the income statement over the period during which benefits are expected to accrue, currently estimated at five years. Where events and circumstances are present which indicate that the carrying value may not be recoverable, we will recognize an impairment loss. Factors we consider important, which could trigger impairment include:

Such impairment loss is measured by comparing the recoverable amount of the asset with its carrying value. The determination of the value of such intangible assets requires management to make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or the related assumptions change in the future, we could be required to record impairment charges. Any material change in our valuation of assets in the future and any consequent adjustment for impairment could have a material adverse impact on our future reported financial results.

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Goodwill

Goodwill associated with the excess purchase price over the fair value of assets acquired is currently reviewed for impairment annually or sooner if events or changes in circumstances indicate the carrying amount of goodwill may not be recoverable.

Factors considered important, which could trigger an interim impairment review, include the following:

Such impairment loss is measured by comparing the recoverable amount of goodwill with its carrying value. The determination of the value of goodwill requires management to make assumptions regarding estimated future cash flows and other factors to determine its fair value. If these estimates or the related assumptions change in the future, we could be required to record impairment charges. Any material change in our valuation of goodwill in the future and any consequent adjustment for impairment could have a material adverse impact on our future reported financial results.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses significant issues regarding the recognition, measurement, and reporting of costs associated with exit and disposal activities, including restructuring activities. SFAS No. 146 requires that costs associated with exit or disposal activities be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is effective for all exit or disposal activities initiated after December 31, 2002. The company adopted SFAS No. 146 during the three months ended March 31, 2003.

In November 2002, the FASB issued FASB Interpretation No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” (“FIN 45”). FIN 45 requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by it in issuing the guarantee. It also expands the disclosure requirements in the financial statements of the guarantor with respect to its obligations under certain guarantees that it has issued. The Company is required to adopt the initial recognition and initial measurement accounting provisions of this interpretation on a prospective basis to guarantees issued or modified after December 31, 2002.

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The Company does not anticipate that the adoption will have a material effect on the Company’s financial position, results of operations or cash flows The adoption of FIN 45 did not have any impact on the financial position, results of operations, cash flows of and disclosures by the Company.

In January 2003, the FASB issued FASB Interpretations No. 46, “Consolidation of Variable Interest Entities,” (“FIN 46”). This interpretation clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective February 1, 2003 for variable interest entities created after January 31, 2003, and July 31, 2003 for variable interest entities created prior to February 1, 2003. The adoption of FIN 46 did not have a material impact on the financial position, results of operations or cash flows of the Company.

FACTORS THAT COULD AFFECT OUR OPERATING RESULTS

We caution you that the following important factors, among others, could cause our actual future results to differ materially from those expressed in forward-looking statements made by or on behalf of us in filings with the Securities and Exchange Commission, press releases, communications with investors and oral statements. Any or all of our forward-looking statements in this quarterly report, and in any other public statements we make, may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in the discussion below will be important in determining future results. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make in our reports filed with the Securities and Exchange Commission.

RISKS RELATING TO OUR MARKETS AND OPERATIONS

The industries in which we license our technology are experiencing a challenging period of slow growth that has negatively impacted and could continue to negatively impact our business and operating results.

The primary customers for our products are semiconductor design and manufacturing companies, system OEMs and electronic equipment manufacturers, particularly in the telecommunications field. These industries are highly cyclical and have been subject to significant economic downturns at various times, particularly in recent periods. These downturns are characterized by production overcapacity and reduced revenues, which at times may encourage semiconductor companies or electronic product manufacturers to reduce their expenditure on our technology. During 2001, the semiconductor industry as a whole experienced the most severe contraction in its history, with total semiconductor sales worldwide declining by more than 30%, according to the Semiconductor Industry Association. The market for semiconductors used in mobile communications was particularly hard hit, with the overall decline in sales worldwide estimated by Gartner Dataquest to have been well above 30%. These

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adverse conditions stabilized but did not improve during the course of 2002. If the market does not recover during 2003, our business could be further materially and adversely affected.

The markets in which we operate are highly competitive, and as a result we could experience a loss of sales, lower prices and lower revenue.

The markets for the products in which our technology is used are highly competitive. Aggressive competition could result in substantial declines in the prices that we are able to charge for our intellectual property. It could also cause our existing customers to move their orders to our competitors. Many of our competitors are large companies that have significantly greater financial and other resources than we have.

In addition, we may face increased competition from smaller, niche semiconductor design companies in the future. Some of our customers may also decide to satisfy their needs through in-house design and production. We compete on the basis of price, product quality, design cycle time, reliability, performance, customer support, name recognition and reputation and financial strength. Our inability to compete effectively on these bases could have a material adverse effect on our business, results of operations and financial condition.

We have undertaken an effort to strengthen our headquarters functions in the U.S. and intend to hire a new CEO and CFO; this process may not be completed successfully and could be disruptive to our operations.

In the first quarter of 2002 we incurred a reorganization and severance charge of $1.4 million as a result of the decision to strengthen the headquarters function in the US. Although we believe that our announced goal to establish a U.S.-based management team will strengthen our sales and investor presence in the U.S., where most of our customers and stockholders are located, and will further advance the integration process arising from our combination with Parthus, we can provide no assurance that the anticipated benefits of this move will arise. Moreover, the transition to new management, including a new CEO and CFO, as well as a new independent chairman of the board of directors, may create operational difficulties that could hinder our ability to exploit our market opportunities. To the extent that this transition takes longer than planned, it could also delay our ability to implement our overall business strategy on a timely basis.

Our operating results fluctuate from quarter to quarter due to a variety of factors, including our lengthy sales cycle, and are not a meaningful indicator of future performance.

In some quarters our operating results could be below the expectations of securities analysts and investors, which could cause our stock price to fall. Factors that may affect our quarterly results of operations in the future include, among other things:

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Our corporate restructuring following the consummation of the combination resulted in a restructuring charge during the fourth quarter of 2002 of approximately $6.4 million. We expect that this restructuring will result in a short-term reduction in revenues. Our operating results will also be affected by general economic and other conditions affecting the timing of customer orders and capital spending. Unfavorable general economic conditions have harmed our business and the business of Parthus in the past and may harm our combined business in the future.

Our lengthy sales cycle may also cause our revenue and operating results to vary unpredictably from period to period. The period of time between our initial contact with a potential customer and the receipt of a request for a quote on an intellectual property license is generally at least 12 months, and the time from such a request to a binding contract is generally at least another four to six months. Due to the complexity of our technology and of the legal framework in which our industry operates, we must devote a substantial amount of time to negotiating the terms of our licensing arrangements with our customers. In addition, customers perform, and require us to perform, extensive process and product evaluation and testing before entering into purchase or licensing arrangements. Even after we enter into an agreement and provide a final product to a customer in the form of silicon or intellectual property, we expect that it will be at least six months more before the customer begins to sell its products incorporating our technology, and therefore even longer before we begin to receive royalty income. Many of the milestones along our sales cycle are beyond our control and difficult to predict. This fact makes it more difficult to forecast our quarterly results and can cause substantial variations in operating results from quarter to quarter that are unrelated to the long-term trends in our business. This lack of predictability and variability in our results could harm our stock price and could significantly affect it in particular periods.

We rely significantly on revenue derived from a limited number of licensees.

We expect that a limited number of licensees will account for a substantial portion of our revenues in any period. Moreover, license agreements for our DSP cores have not historically provided for substantial ongoing license payments, although they may provide for royalties based on product shipments. Significant portions of our anticipated future revenue, therefore, will likely depend upon our success in attracting new customers or expanding our relationships with existing customers. Our ability to attract new customers and expand our relationships with existing customers will depend on a variety of factors, including the performance, quality, breadth and depth of our current and future products. Our failure to obtain agreements with these customers will impede our future revenue growth.

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We depend on market acceptance of third-party semiconductor intellectual property (SIP).

Our future growth will depend on the level of acceptance by the market of our third-party, licensable intellectual property model and the variety of intellectual property offerings available on the market, which to a large extent are not in our control. If the market shifts and third-party SIP is no longer desired by our customers, our business, results of operations and financial condition could be materially harmed.

We depend on the success of our licensees to promote our solutions in the marketplace.

We do not sell our technology directly to end-users; we license our technology primarily to semiconductor companies and to electronic equipment manufacturers, who then incorporate our technology into the products they sell. Because we do not control the business practices of our licensees, we do not influence the degree to which they promote our technology or set the prices at which they sell products incorporating our technology. We cannot assure you that our licensees will devote satisfactory efforts to promote our solutions. In addition, our unit royalties from licenses are totally dependent upon the success of our licensees in introducing products incorporating our technology and the success of those products in the marketplace. If we do not retain our current licensees and continue to attract new licensees, our business may be harmed.

We depend on a limited number of key personnel who would be difficult to replace.

Our success depends to a significant extent upon our key employees and senior management; the loss of the service of these employees could materially harm us. Competition for skilled employees in our field is intense. We cannot assure you that we will be successful in attracting and retaining the required personnel.

RISKS RELATING TO

POLITICAL AND ECONOMIC DEVELOPMENTS

Terrorist attacks and threats, and war or the threat of war, could adversely affect our operating results and the price of our common stock.

Recent terrorist attacks, the response to those attacks, the war in Iraq, and the related decline in consumer confidence and continued economic weakness have had an adverse impact on our operations. Recent consumer reports indicate that consumer confidence has reached its lowest level in nearly a decade. If consumer confidence continues to decline or does not recover, our revenues and results of operations may continue to be adversely impacted in 2003 and beyond. Any escalation in these events, or similar future events, may disrupt our operations or those of our licensees. Any of these events could also increase volatility in the U.S. and worldwide financial markets and economy, which could harm our stock price and may limit the capital resources available to us and our licensees. This could have a significant impact on our operating results, revenues and costs and may result in increased volatility in the market price of our common stock and on the future price of our common stock.

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Potential political, economic and military instability in Israel may adversely affect our results of operations.

Some of our principal research and development facilities are located in, and some of our directors and executive officers are residents of, Israel. Although substantially all of our sales currently are being made to customers outside Israel, we are nonetheless directly influenced by the political, economic and military conditions affecting Israel. Any major hostilities involving Israel, or the interruption or curtailment of trade between Israel and its current trading partners, could significantly harm our business, operating results and financial condition.

In addition, certain of our officers and employees are currently obligated to perform annual reserve duty in the Israel Defense Forces and are subject to being called for active military duty at any time. Although we have operated effectively under these requirements since our inception, we cannot predict the effect of these obligations on the company in the future. Our operations could be disrupted by the absence, for a significant period, of one or more of our officers or key employees due to military service.

RISKS RELATING TO OUR

SEPARATION FROM DSP GROUP

We may have conflicts of interest with DSP Group with respect to our past and ongoing relationships and we may not be able to resolve these conflicts on terms that are most favorable to us.

The separation of our DSP cores licensing business from DSP Group was completed in November 2002. Immediately thereafter, we combined with Parthus Technologies plc. Prior to that time, we were a wholly owned subsidiary of DSP Group. Conflicts of interest may arise between DSP Group and us in a number of areas relating to our past and ongoing relationships, including labor, tax, employee benefit, indemnification, intellectual property, employee retention and recruiting, transitional services provided by DSP Group, and business opportunities that may be attractive to both DSP Group and us. We may not be able to resolve any of the potential conflicts of interest discussed above on favorable terms or at all.

We currently use some of DSP Group’s operational, administrative and technical infrastructure.

Although DSP Group is contractually obligated to provide us with operational, administrative and technical services pursuant to a transition services agreement, these services may not continue to be provided at the same level or quality as when we were part of DSP Group. If we are unable to obtain services of sufficient quality or replace any services that are not effectively provided, our business and results of operations could be harmed. We cannot assure you that DSP Group will continue to provide us with these services after the initial term of the transition services agreement, that the quality of services and level of responsiveness will meet our needs or that the cost of these services will not be significantly higher if we purchase them from other providers or employ staff to handle them internally. If we fail to find replacements for these services in a timely fashion, or if we are not able to replace them on favorable terms, our business, results of operations and financial condition could be harmed.

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Restrictions on our ability to issue stock and take certain other actions could inhibit our growth.

The agreement governing our separation from DSP Group contains restrictions on issuances of our capital stock and other specified actions by us during the one-year period following our spin-off from DSP Group, and on the liquidation, disposition or discontinuation of our DSP cores licensing business during the two-year period following our spin-off. These restrictions, as well as our agreement to indemnify DSP Group if we do not comply with these restrictions, could limit our ability to grow our business and compete effectively during the period following the distribution. In addition, these restrictions and indemnification obligations could make us a less attractive acquisition or merger candidate during this period.

We could be subject to joint and several liability for taxes of DSP Group.

As a former member of a group filing consolidated income tax returns with DSP Group, we could be liable for federal income taxes of DSP Group and other members of the consolidated group, including taxes, if any, incurred by DSP Group on the distribution of our stock to the stockholders of DSP Group. DSP Group has agreed to indemnify us against these taxes, other than taxes for which we have agreed to indemnify DSP Group pursuant to the terms of the tax indemnification and allocation agreement and separation agreement we entered into with DSP Group.

Our historical financial information may not be representative of our results as a separate company.

Our historical consolidated financial statements have been carved out from the consolidated financial statements of DSP Group using the historical results of operations and historical bases of the assets and liabilities of our business. Accordingly, this information does not necessarily reflect what our financial position, results of operations and cash flows would have been had our business operated as a separate, stand-alone entity during the periods presented. We have not made adjustments to the historical financial information for periods prior to November 1, 2002 to reflect the significant changes in the cost structure, funding and operations which resulted from the separation of the DSP cores licensing business from DSP Group and the combination with Parthus.

Some of our directors and executive officers may have conflicts of interest because of their ownership of DSP Group’s common stock or position with DSP Group.

Some of our directors and executive officers, including Eliyahu Ayalon, who serves as the Chairman of our board of directors and of the board of directors of DSP Group; Gideon Wertheizer, our Executive Vice President—Business Development and Chief Technology Officer; Issachar Ohana, our Vice President Sales and General Manager of the DSP Intellectual Property Licensing Division; and Bat-Sheva Ovadia, our Chief Scientist—DSP Technologies, hold a significant number of shares of DSP Group’s common stock and options to purchase shares of DSP Group’s common stock. Ownership of DSP Group’s common stock by certain of our directors and executive officers could create, or appear to create, conflicts of interest when they are faced with decisions that could have different implications for DSP Group and us.

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RISKS RELATING TO OUR

COMBINATION WITH PARTHUS

A number of factors could impair our ability to successfully complete the long-term integration of the combined businesses, and thereby harm our business, financial condition and operating results.

In November 2002, we combined our business with that of Parthus Technologies. Although we have made substantial progress in integrating our businesses, we cannot assure you that such integration will be completed in the most efficient, effective and timely manner or ultimately be successful over the long-term. We may encounter future difficulties in connection with the integration of these businesses, including:

In addition, the anticipated benefits of the combination may not be realized and its value may not prove to be accretive because our combined technology may not be as strong as anticipated, our business model may not be successful, or other unanticipated difficulties may be encountered. Further, we cannot assure you that our growth rate will equal the historical growth rates experienced by the two businesses separately.

ADDITIONAL RISKS RELATING TO OUR BUSINESS

Our success will depend on our ability to manage our geographically dispersed operations successfully.

Although we are headquartered in San Jose, California, most of our executives and employees are located in Dublin, Ireland and Herzeliya, Israel. Accordingly, our ability to compete successfully will depend in part on the ability of a limited number of key executives located in geographically dispersed offices to integrate management, address the needs of our customers and respond to changes in our markets. If we are unable to effectively manage our remote operations, our business may be harmed.

We may not be successful in licensing integrated, system-level solutions.

We offer our application-level IP platforms built around our DSP cores, and continue to offer our DSP cores and IP platforms on a stand-alone basis. We have limited experience in offering DSP cores and IP platforms as an integrated solution. Future licenses for these integrated solutions may be on terms less favorable than we currently anticipate.

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If we are unable to meet the changing needs of our end-users or to address evolving market demands, our business may be harmed.

The markets for programmable DSP cores and IP platforms are characterized by rapidly changing technology, emerging markets and new and developing end-user needs, requiring significant expenditure for research and development. We cannot assure you that we will be able to introduce systems and solutions that reflect prevailing industry standards on a timely basis, to meet the specific technical requirements of our end-users or to avoid significant losses due to rapid decreases in market prices of our products, and our failure to do so may seriously harm our business. In addition, the reduction in the number of our employees in connection with our recent restructuring efforts could adversely affect our ability to attract or retain customers who require certain R&D capabilities from their IP providers.

We may seek to expand our business through acquisitions that could result in diversion of resources and extra expenses.

We may pursue acquisitions of businesses, products and technologies, or establish joint venture arrangements in the future that could expand our business. The negotiation of potential acquisitions or joint ventures, as well as the integration of acquired or jointly developed businesses, technologies or products could cause diversion of management’s time and our resources. We may not be able to successfully integrate acquired businesses or joint ventures with our operations. If we were to make any acquisition or enter into a joint venture, we may not receive the intended benefits of the acquisition or joint venture. If future acquisitions or joint ventures disrupt our operations, or if we have difficulty integrating the businesses or technologies we acquire, our business, financial condition and results of operations could suffer.

We may not be able to adequately protect our intellectual property.

Our success and ability to compete depend in large part upon the protection of our proprietary technologies. We rely on a combination of patent, copyright, trademark, trade secret, mask work and other intellectual property rights, confidentiality procedures and licensing arrangements to establish and protect our proprietary rights. These agreements and measures may not be sufficient to protect our technology from third-party infringement, or to protect us from the claims of others. As a result, we face risks associated with our patent position, including the potential need to engage in significant legal proceedings to enforce our patents, the possibility that the validity or enforceability of our patents may be denied, the possibility that third parties will be able to compete against us without infringing our patents and the possibility that our products may infringe patent rights of third parties.

Our tradenames or trademarks may be registered or utilized by third parties in countries other than those in which we have registered them, impairing our ability to enter and compete in these markets. In the United States, the trademark SmartCore has been registered by an unrelated company. Although we have successfully co-existed with this other trademark holder,we cannot assure you that this state of affairs will continue. If we were forced to change any of our brand names, we could lose a significant amount of our brand equity.

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Our business will suffer if we are sued for infringement of the intellectual property rights of third parties or if we cannot obtain licenses to these rights on commercially acceptable terms.

Although we are not currently involved in any material litigation, we are subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of others. There are a large number of patents held by others, including our competitors, pertaining to the broad areas in which we are active. We have not, and cannot reasonably, investigate all such patents. From time to time, we have become aware of patents in our technology areas and have sought legal counsel regarding the validity of such patents and their impact on how we operate our business, and we will continue to seek such counsel when appropriate in the future. Claims against us may require us to enter into license arrangements or result in protracted and costly litigation, regardless of the merits of these claims. Any necessary licenses may not be available or, if available, may not be obtainable on commercially reasonable terms. If we cannot obtain necessary licenses on commercially reasonable terms, we may be forced to stop licensing our technology, and our business would be seriously harmed.

Our business depends on OEMs and their suppliers obtaining required complementary components.

Some of the raw materials, components and subassemblies included in the products manufactured by our OEM customers are obtained from a limited group of suppliers. Supply disruptions, shortages or termination of any of these sources could have an adverse effect on our business and results of operations due to the delay or discontinuance of orders for products containing our IP, especially our DSP cores, until those necessary components are available.

The future growth of our business depends in part on our ability to license to system OEMs and small-to-medium-sized semiconductor companies directly.

Historically a substantial portion of the revenues from the licensing of our DSP cores has been derived in any period from a relatively small number of licensees. Because of the high license fees we currently charge, only large semiconductor companies or vertically integrated system OEMs typically license our DSP core technologies. Part of our current growth strategy is to broaden our client base by offering tailored packages to small- and medium-sized semiconductor companies and other system OEMs to enable them to license our DSP core technologies. If we are unable to effectively develop and market our intellectual property through this model, our revenues will continue to be largely dependent on a smaller number of licensees and the failure to secure these types of relationships could harm our business and results of operations.

We utilize third-party foundries to produce the chips we sell, and any failure by them to deliver the chips we require on time could limit our ability to satisfy our customers’ demands.

Part of our revenues is generated from the sale of silicon chips embodying our intellectual property, which we refer to as Hard IP. Any interruption in our relationship with the third party foundries that produce these chips could harm our ability to develop this part of our business

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profitably. We do not have the ability to produce chips independently and thus depend on these foundries to:

ADDITIONAL RISKS RELATING TO OUR

INTERNATIONAL OPERATIONS

The Israeli tax benefits that we currently receive and the government programs in which we participate require us to meet certain conditions and may be terminated or reduced in the future, which could increase our costs.

We were assigned certain tax benefits in Israel from DSP Group, and have received others for our Israeli facilities, particularly as a result of the “Approved Enterprise” status of our facilities and programs. To maintain our eligibility for these tax benefits, we must continue to meet certain conditions, relating principally to adherence to the investment program filed with the Investment Center of the Israeli Ministry of Industry and Trade and to periodic reporting obligations. We believe that we will be able to continue to meet such conditions. Should we fail to meet such conditions in the future, however, these benefits would be cancelled and we would be subject to corporate tax in Israel at the standard rate of 36% and could be required to refund tax benefits already received. In addition, we cannot assure you that these grants and tax benefits will be continued in the future at their current levels or otherwise. The termination or reduction of certain programs and tax benefits (particularly benefits available to us as a result of the Approved Enterprise status of our facilities and programs) or a requirement to refund tax benefits already received may seriously harm our business, operating results and financial condition.

Our corporate tax rate may increase, which could adversely impact our cash flow, financial condition and results of operations.

We have significant operations in the Republic of Ireland and a substantial portion of our taxable income historically has been generated there. Currently, some of our Irish subsidiaries are taxed at rates substantially lower than U.S. tax rates. Although there is no expectation of any changes to Irish tax law, if our Irish subsidiaries were no longer to qualify for these lower tax rates or if the applicable tax laws were rescinded or changed, our operating results could be materially adversely affected. In addition, because our Irish and Israeli operations are owned by subsidiaries of a U.S. corporation, distributions to the U.S. corporation, and in certain circumstances undistributed income of the subsidiaries, may be subject to U.S. tax. Moreover, if U.S. or other foreign tax authorities were to change applicable foreign tax laws or successfully challenge the manner in which our subsidiaries’ profits are currently recognized, our overall taxes could increase, and our business, cash flow, financial condition and results of operations could be materially adversely affected.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

A majority of our revenues and a portion of our expenses are transacted in U.S. dollars and our assets and liabilities together with our cash holdings are predominately denominated in U.S. dollars. However, a portion of our expenses are denominated in currencies other than the U.S. dollar, principally the euro, the Israeli NIS and the British pound. Increases in the volatility of the exchange rates of the euro, NIS and pound versus the U.S. dollar could have an adverse effect on the expenses and liabilities that we incur when translated into U.S. dollars. We incurred foreign exchange losses of approximately $199,000 for the three-month period ended March 31, 2003 arising principally on euro liabilities as a result of the appreciation of the euro against the U.S. dollar. As a result of such currency fluctuations and the conversion to U.S. dollars for financial reporting purposes, we may experience fluctuations in our operating results on an annual and a quarterly basis going forward. We have not in the past, but may in the future, hedge against fluctuations in exchange rates. Future hedging transactions may not successfully mitigate losses caused by currency fluctuations. We expect to continue to experience the effect of exchange rate fluctuations on an annual and quarterly basis, and currency fluctuations could have a material adverse impact on our results of operations.

We are exposed to financial market risks, including changes in interest rates. We typically do not attempt to reduce or eliminate our market exposures on our investment securities because the majority of our investments are short-term. We do not have any derivative instruments.

The fair value of our investment portfolio or related income would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of our investment portfolio.

All the potential changes noted above are based on sensitivity analysis performed on our balances as of March 31, 2003.

Item 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Based on the evaluation of our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Exchange Act) as of a date within 90 days of the filing date of this quarterly report on Form 10-Q, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and are operating in an effective manner.

(b) Changes in internal controls. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the most recent evaluation.

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PART II. OTHER INFORMATION

Item 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

None.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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CERTIFICATIONS

I, Brian Long, certify that:

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CERTIFICATIONS

I, Elaine Coughlan, certify that:

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INDEX TO EXHIBITS

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