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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2005

OR

For the transition period from              to             

Commission file number 000-23084

Integrated Silicon Solution, Inc.

(Exact name of registrant as specified in its charter)

(408) 969-6600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

The number of outstanding shares of the registrant’s Common Stock as of April 29, 2005 was 36,832,885.

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References in this Report on Form 10-Q to “we,” “us,” “our” and “ISSI” mean Integrated Silicon Solution, Inc. and all entities owned or controlled by Integrated Silicon Solution, Inc.

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Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share data)

See accompanying notes to condensed consolidated financial statements.

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Integrated Silicon Solution, Inc.

Condensed Consolidated Balance Sheets

(In thousands)

See accompanying notes to condensed consolidated financial statements.

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Integrated Silicon Solution, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

See accompanying notes to condensed consolidated financial statements.

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed financial statements include the accounts of Integrated Silicon Solution, Inc. (the “Company”) and its consolidated majority owned subsidiaries, after elimination of all significant intercompany accounts and transactions and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included.

Operating results for the three and six months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending September 30, 2005 or for any other period. The financial statements included herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2004.

2. Stock-based Compensation

The Company applies the intrinsic-value method prescribed in APB Opinion No. 25, “Accounting for Stock issued to Employees,” in accounting for employee stock options. Accordingly compensation expense is generally recognized only when options are granted with an exercise price less than fair value on the date of grant. Any resulting compensation expense would be recognized ratably over the associated service period, which is generally the option vesting term.

The Company has determined pro forma net income (loss) and net income (loss) per share information as if the fair value method described in SFAS No. 123, “Accounting for Stock Based Compensation,” had been applied to its employee stock-based compensation. The proforma effect on net income (loss) and net income (loss) per share is as follows for the three and six month periods ending March 31, 2005 and 2004 (in thousands, except per share data):

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

3. Concentrations

Sales to ATM Electronic Corporation accounted for approximately 10% of total net sales for the three months ended March 31, 2005. Revenue recognized for Arrow Electronics accounted for approximately 10% and 11% of total net sales for the three and six months ended March 31, 2005, respectively. Sales to Asian Information Technology Inc. accounted for approximately 12% and 10% of total net sales for the three and six months ended March 31, 2004, respectively. Sales to ATM Electronic Corporation accounted for approximately 10% and 9% of total net sales for the three months and six months ended March 31, 2004, respectively.

4. Cash, Cash Equivalents, Restricted Cash and Short-term Investments

Cash, cash equivalents, restricted cash, and short-term investments consisted of the following:

All debt securities held at March 31, 2005 are due in less than one year.

5. Inventories

The following is a summary of inventories by major category:

During the three and six months ended March 31, 2005, the Company recorded inventory write-downs of $1.3 million and $10.9 million, respectively. The inventory write-downs primarily related to valuing inventory at the lower-of-cost-or-market and to adjust inventory valuation for certain excess and obsolete products.

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

6. Other Assets

Other assets consisted of the following:

The market value of the Company’s investment in the common stock and convertible debentures of ICSI at March 31, 2005 was approximately $39.8 million and $3.8 million, respectively, based on quoted market prices. Since ICSI is accounted for under the equity method of accounting, the carrying value of the Company’s investment in ICSI’s common stock differs from the market value. The Company’s total carrying value for ICSI common stock as of March 31, 2005 was approximately $22.0 million of which approximately $4.8 million is included in other comprehensive income as an accumulated foreign currency translation adjustment in the equity portion of the balance sheet.

On March 17, 2004, SMIC completed an initial public offering (“IPO”). SMIC’s ordinary shares are traded on the Hong Kong Stock Exchange and SMIC American Depository Receipts (“ADR”) are traded on the New York Stock Exchange. Each SMIC ADR represents fifty (50) ordinary shares. The Company sold certain shares of its SMIC stock in the IPO, and recorded gross proceeds of approximately $13.2 million in the March 2004 quarter resulting in a pre-tax gain of approximately $8.8 million. In the September 2004 quarter, the Company sold additional shares of SMIC and recorded gross proceeds of approximately $5.0 million and a pre-tax gain of approximately $2.1 million. In the December 2004 quarter, the Company sold additional shares of SMIC and recorded gross proceeds of approximately $4.5 million and a pre-tax gain of approximately $2.4 million. In the March 2005 quarter, the Company sold additional shares of SMIC and recorded gross proceeds of approximately $1.1 million and a pre-tax gain of approximately $0.5 million. Since SMIC’s IPO, the Company accounts for its shares in SMIC under the provisions of FASB 115 and has marked its investment to the market value as of March 31, 2005 by increasing other assets and by increasing accumulated comprehensive income in the equity section of the balance sheet. The cost basis of the Company’s remaining shares in SMIC is approximately $31.9 million and the market value at March 31, 2005 was approximately $54.0 million. The market value of SMIC shares is subject to fluctuation and the Company’s carrying value will be subject to adjustments to reflect the current market value. The Company’s shares in SMIC are subject to certain lockup restrictions and therefore all of such shares are not freely tradable. These lockup restrictions generally lapse at the rate of 15% of the Company’s pre-offering shares every 180 days following the IPO. Thus all of the Company’s shares in SMIC will be freely tradable 3 years and 180 days following the IPO.

In the fourth quarter of fiscal 2004, the Company recorded approximately a $0.3 million impairment loss on one of its equity investments accounted for under the cost method.

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

7. Comprehensive Income (Loss)

Comprehensive income (loss) includes net income (loss) as well as other comprehensive income (loss). The Company’s other comprehensive income (loss) consists of changes in cumulative translation adjustment and unrealized gains and losses on investments.

Comprehensive income (loss), net of taxes, was as follows:

The accumulated comprehensive income (loss) component within the stockholders’ equity section of the Company’s balance sheet is comprised of foreign currency translation adjustments and unrealized gains and losses on investments.

The components of accumulated other comprehensive income, net of tax, were as follows:

8. Income Taxes

The provision for income taxes for the three month and six month periods ended March 31, 2005 of $16,000 and $17,000, respectively, consists solely of foreign withholding taxes. The Company has a full valuation allowance against its deferred tax assets due to its operating loss history and has not recorded any tax benefit for its deferred tax assets for the three month and six month periods ended March 31, 2005. The provision for income taxes for the three month and six month periods ended March 31, 2004 of $366,000 and $378,000, respectively, consists of alternative minimum taxes.

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

9. Per Share Data

The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share amounts):

The above diluted calculation for the three months ended March 31, 2005 and March 31, 2004 does not include approximately 3,907,000 shares and 394,000 shares attributable to options as of March 31, 2005 and 2004, respectively, as their impact would be anti-dilutive. The above diluted calculation for the six months ended March 31, 2005 and 2004, does not include approximately 3,479,000 shares and 414,000 shares attributable to options as of March 31, 2005 and 2004, respectively, as their impact would be anti-dilutive. Of the 3,907,000 shares and 3,479,000 shares excluded from the three and six month ended March 31, 2005 calculation, approximately 907,000 shares and 1,111,000 shares, respectively, had exercise prices less than the daily average closing price of the Company’s stock during the period but were excluded under the treasury stock method solely because the Company had a net loss for that period.

10. Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and such differences, may be material to the financial statements.

11. Impact of Recently Issued Accounting Standards

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) and supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. On April 14, 2005, the Securities and Exchange Commission (SEC) announced a delay in the effective date of the option-expensing requirements of SFAS 123R. The Company is now required and plans to adopt SFAS 123R in the first quarter of fiscal 2006, beginning October 1, 2005. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The Company is evaluating the requirements of SFAS 123R and expects that the adoption of SFAS 123R will have a material impact on the Company’s consolidated results of operations and earnings per share. The Company has not yet determined the method of adoption or the effect of adopting SFAS 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.

12. Commitments and Contingencies

Commitments to Wafer Fabrication Facilities and Contract Manufacturers

The Company issues purchase orders for wafers to various wafer foundries. These purchase orders are generally considered to be cancelable. However, to the degree that the wafers have entered into work-in-process, as a matter of practice it becomes increasingly difficult to cancel the purchase order. As of March 31, 2005, the Company had approximately $1.3 million of purchase orders for which the related wafers had been entered into wafer work-in-process (i.e., manufacturing had begun). In addition, the Company had noncancelable purchase commitments of approximately $3.7 million to ICSI for certain finished goods inventories for which ICSI is providing contract manufacturing services.

Write-off of Excess Facility Space

In the three months ended March 31, 2005, the Company recorded a $1.1 million write-off of excess facility space in its Santa Clara headquarters.

13. Geographic and Segment Information

The Company has one operating segment, which is to design, develop, and market high-performance SRAM, DRAM, and other memory and non-memory semiconductor products. The following table summarizes the Company’s operations in different geographic areas:

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

14. Related Party Transactions

The Company sells and licenses memory products to ICSI. At March 31, 2005, the Company had approximately a 41% ownership interest in ICSI. The Company’s Chairman and Chief Executive Officer (“CEO”), Jimmy S.M. Lee, is a director of ICSI.

The Company purchases goods and contract manufacturing services from ICSI. For the six months ended March 31, 2005 and March 31, 2004, purchases of goods and services were approximately $786,000 and $2,332,000, respectively. The Company also pays ICSI for certain product development costs, license fees and royalties. For the six months ended March 31, 2005 and March 31, 2004, these charges totaled approximately $156,000 and $570,000, respectively.

The Company sold memory products to Marubun USA Corporation (“Marubun USA”) in the first quarter of fiscal 2004. Hide L. Tanigami, a director of the Company, is the president and chief executive officer of Marubun USA. Effective January 1, 2004, the Company no longer sells products to Marubun USA.

The Company purchases goods from SMIC in which the Company has less than a 2% ownership interest. The Company’s Chairman and CEO, Jimmy S.M. Lee, was a director of SMIC until March 2004. Lip-Bu Tan, a director of the Company, has been a director of SMIC since January 2002. For the six months ended March 31, 2005 and March 31, 2004, purchases of goods from SMIC were approximately $29,021,000 and $16,907,000, respectively.

The Company sells memory products to Flextronics. Lip-Bu Tan, a director of the Company, has been a director of Flextronics since April 3, 2003. The Company had been doing business with Flextronics prior to Mr. Tan joining the board of directors of Flextronics.

The Company provides manufacturing support services to Signia Technologies (“Signia”). The Company had less a than 50% ownership interest through November 2004. In December 2004, the Company acquired a majority ownership interest in Signia at which time the Company began consolidating Signia’s results of operations. At March 31, 2005, the Company had approximately a 68% ownership interest in Signia. The Company’s Chairman and CEO, Jimmy S.M. Lee, is a director of Signia. For the two months ended November 30, 2004 and the six months ended March 31, 2004, the Company provided services of approximately $382,000 and $1,863,000, respectively, to Signia.

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Accounts receivable from related parties consisted of the following:

The following table shows net sales to related parties:

Accounts payable to related parties consisted of the following:

15. Investment in Integrated Circuit Solution Inc.

The following summarizes financial information for ICSI, an equity investee.

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

In the June 2002 quarter, the Company invested approximately $3.2 million in convertible debentures issued by ICSI. As a result of changes in ICSI’s convertible debenture price, the Company has recorded an accumulated unrealized gain of approximately $733,000 related to the ICSI convertible debentures. The unrealized gain is included in accumulated other comprehensive loss. In addition, in the six months ended March 31, 2005, the Company recorded a charge of approximately $21,000 related to the decline in the fair value of an embedded derivative associated with the ICSI convertible debenture. The charge associated with the embedded derivative is included in other income (expense). The market value of the Company’s convertible debentures at March 31, 2005 was approximately $3.8 million.

On January 25, 2005, ISSI announced the execution on such date of a Merger Agreement (the “Merger Agreement”) between Integrated Silicon Solution (Taiwan), Inc. (“ISSI-Taiwan”) and ICSI. ISSI-Taiwan is incorporated under the laws of the Republic of China and is a wholly-owned subsidiary of ISSI. ICSI is incorporated under the laws of the Republic of China and its common stock is publicly traded in Taiwan. Prior to the transaction, ISSI owned approximately 29.1% of the outstanding shares of ICSI and approximately $3.8 million of convertible debentures of ICSI. In the quarter ended March 31, 2005, the Company purchased additional shares of ICSI on the open market for approximately $11.8 million increasing its ownership percentage to approximately 41% at March 31, 2005. These shares were recorded at their acquisition cost. The Company will account for its purchase these shares as part of a step-acquisition. The purchase price accounting will be recorded upon the consolidation of ICSI. The additional consideration to be paid by the Company in connection with the merger is cash in the aggregate amount of approximately $58 million (excluding the value of the shares of ICSI held by the Company at March 31, 2005). The Merger Agreement has been approved by the boards of directors of ISSI, ISSI-Taiwan and ICSI and the shareholders of ICSI, and is subject to customary closing conditions. The Company currently anticipates this transaction will be completed in the September 2005 quarter.

The Company accounts for investments in 50% or less owned companies over which it has the ability to exercise significant influence using the equity method of accounting. The Company periodically reviews these investments for other-than-temporary declines in market value and writes these investments to their fair value when an other-than-temporary decline has occurred.

16. Acquisition of Signia Technologies Inc.

In December 2004, the Company acquired a majority ownership interest in Signia. Signia is a privately held wireless chipset company based in Taipei, Taiwan. Signia has focused on RF chipsets for the consumer electronics market. Signia has a family of Bluetooth ^™ compliant, 2.4G RF devices and also proprietary 2.4G RF devices. One element of ISSI’s strategy is to diversify into non-memory products. Increasing its stake in Signia furthers this strategy.

ISSI has increased its ownership to approximately 68% by buying common shares from other shareholders. The cost of this additional investment was approximately $8.1 million in cash which includes $0.4 million in estimated transaction costs. Prior to this increase, the Company owned approximately 15% of the outstanding equity of Signia and accounted for its investment on the cost basis. Since the Company increased its ownership to 68%, beginning from December 1, 2004 the Company will consolidate Signia’s financial statements with its own. The total purchase price, including the previous investment of $1.1 million, is $9.2 million.

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INTEGRATED SILICON SOLUTION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

In the December 2004 quarter, the Company consolidated Signia based on preliminary valuation data. During the March 2005 quarter, the valuation data was refined and the Company’s best estimate has been presented as of March 31, 2005. Management is continuing to assess the valuation of the acquisition and potential adjustments could be made in the June 2005 quarter. The allocation of the purchase price of Signia includes both tangible assets and acquired intangibles including both developed technology as well as in-process research and development (“IPR&D”). The amounts allocated to IPR&D were expensed in the Company’s quarter ending March 31, 2005, as it was deemed to have no future value.

The estimated purchase price allocation is as follows (in thousands):

The developed technology is being amortized over five years.

17. Subsequent Event

Effective May 1, 2005, the Company’s Chairman and Chief Executive Officer, Jimmy Lee, was appointed Chairman of ICSI and the ICSI board formally elected Mr. Lee as Chairman on May 6, 2005. The Company also agreed to loan $15.0 million to ICSI under loan documents executed on April 28, 2005, of which $13.0 million had been funded as of May 9, 2005. ICSI agreed to collateralize the loan with a mortgage on its building in Taiwan and the lien documents were effective on April 28, 2005. As a result of these events, and changes in the management reporting structure of ICSI (which were effective as of May 1, 2005), the Company will begin consolidating the financial results of ICSI with its results as of May 1, 2005 in accordance with generally accepted accounting principles.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

We have made forward-looking statements in this report that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of our operations. Also, when we use words such as “believes,” “expects,” “anticipates” or similar expressions, we are making forward-looking statements. You should note that an investment in our securities involves certain risks and uncertainties that could affect our future financial results. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in “Certain Factors Which May Affect Our Business or Future Operating Results” and elsewhere in this report.

We believe it is important to communicate our expectations to our investors. However, there may be events in the future that we are not able to predict accurately or over which we have no control. The risks described in “Certain Factors Which May Affect Our Business or Future Operating Results” included in this report, as well as any cautionary language in this report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements.

All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth in this report. Except as required by federal securities laws, we are under no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise.

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

Overview

We are a fabless semiconductor company that designs and markets high performance integrated circuits for the following key markets: (i) digital consumer electronics, (ii) networking, (iii) mobile communications and (iv) automotive electronics. Our primary products are high speed and low power SRAM and low and medium density DRAM. We were founded in October 1988 and initially focused on high performance, low cost SRAM for PC cache memory applications. In 1997, we introduced our first low and medium density DRAM products. Historically, our SRAM product family generated most of our revenue. However, in the year 2001, the high-end networking and telecom markets slowed and this impacted our SRAM revenue. During this period, we increased our focus on the digital consumer electronics, mobile communications and automotive electronics markets. As a result of our success in the digital consumer electronics market, sales of our low and medium density DRAM products have increased significantly and represented a majority of our net sales in fiscal 2004 and the three and six months ended March 31, 2005.

In order to limit and control our operating expenses, in recent years, we have reduced our headcount in the U.S. and transferred various functions to our subsidiary in Taiwan and our subsidiary in China. We believe this has enabled us to limit our operating expenses while simultaneously locating these functions closer to our manufacturing partners and our customers. As a result of these efforts, we currently have more employees in Asia than we do in the U.S. Part of our outsourcing strategy includes licensing product designs. To control our R&D expenses, we regularly license some of our SRAM and DRAM designs from Integrated Circuit Solution Inc. (ICSI), other companies or our foundries. We also license our own designs to ICSI or other companies. We intend to continue these strategies going forward.

As a fabless semiconductor company, our business model is less capital intensive because we rely on third parties to manufacture, assemble and test our products. Because of our dependence on third-party wafer foundries, our ability to increase our unit sales volumes depends on our ability to increase our wafer capacity allocation from current foundries, add additional foundries and improve yields of die per wafer.

Although average selling prices of our SRAM and DRAM products have generally declined over time, the selling prices are very sensitive to supply and demand conditions in our target markets. While the average selling prices for certain of our products increased during the first three quarters of fiscal 2004, the average selling prices for our products declined significantly in the fourth quarter of fiscal 2004. We experienced further declines in the average selling

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prices for certain of our products in the first two quarters of fiscal 2005. We expect average selling prices for our products to decline in the future, principally due to increased market competition and an increased supply of competitive products in the market. Any future decreases in our average selling prices would have an adverse impact on our revenue growth rate, gross margins and operating margins. Our ability to maintain or increase revenues will be highly dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in quantities sufficient to compensate for the anticipated declines in average selling prices of existing products. Declining average selling prices will adversely affect gross margins unless we are able to offset such declines with commensurate reductions in per unit costs or changes in product mix in favor of higher margin products.

Revenue from product sales to our direct customers is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed and determinable, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations. A portion of our sales is made to distributors under agreements that provide the possibility of certain sales price rebates and limited product return privileges. Given the uncertainties associated with the levels of returns and other credits that will be issued to these distributors, we defer recognition of such sales until our products are sold by the distributors to their end customers. Revenue from sales to distributors who do not have sales price rebates or product return privileges is recognized at the time our products are sold by us to the distributors.

We market and sell our products in Asia, the U.S. and Europe through our direct sales force, distributors and sales representatives. The percentage of our revenues shipped outside the U.S. was approximately 81%, 87%, 87% and 87% in the first six months of fiscal 2005, the first six months of fiscal 2004, fiscal 2004 and fiscal 2003, respectively. We measure revenue location by the shipping destination, even if the customer is headquartered in the U.S. The increase in our revenues from Asia is due to our success in the digital consumer electronics market. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. The percentages of our revenues by region are set forth in the following table:

Our sales are generally made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog is not a good indicator of our future sales. Cancellations of customer orders or changes in product specifications could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses.

Since a significant portion of our revenue is from the digital consumer electronics market, our business may be subject to seasonality, with increased revenues in the third and fourth calendar quarters of each year, when customers place orders to meet year-end holiday demand. However, broad fluctuations in our overall business in the past several years makes it difficult for us to assess the impact of seasonal factors on our business.

We hold equity interests in a number of other companies. We acquired these interests for strategic reasons, such as developing a strong relationship with a third-party wafer foundry we rely on to manufacture our products. Our financial results for the first six months of fiscal 2005 and fiscal 2004 reflect accounting for ICSI on the equity basis and include our percentage share of the results of ICSI’s operations. Our financial results for fiscal 2004 and fiscal 2005 through the period ended November 30, 2004 reflect accounting for Signia Technologies Inc. (Signia) on the cost basis. Effective December 2004, our ownership of Signia became greater than 50% and we began consolidating the results of Signia. Our financial results for the first six months of fiscal 2005 and fiscal 2004 reflect accounting for E-CMOS Technology Corporation (E-CMOS), GetSilicon, and NexFlash Technologies (NexFlash) on the cost basis. Our financial results for fiscal 2004 until their IPO in March 2004, reflect accounting for Semiconductor Manufacturing International

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Corporation (SMIC) on the cost basis. Since SMIC’s IPO, we account for our shares in SMIC under the provisions of FASB 115 and have marked our investment to the market value as of March 31, 2005 by increasing other assets and by increasing accumulated comprehensive income in the equity section of the balance sheet. ICSI is a Taiwan-based fabless memory supplier, E-CMOS is a Taiwan-based peripherals interface device company, GetSilicon is a semiconductor supply chain management software company, NexFlash is a Flash memory supplier, Signia Technologies is a developer of wireless semiconductors, and SMIC is a China-based semiconductor foundry. At March 31, 2005, we owned approximately 41% of ICSI, approximately 11% of E-CMOS, approximately 14% of NexFlash, approximately 68% of Signia Technologies and less than 2% of SMIC.

On January 25, 2005, we announced the execution on such date of a Merger Agreement (the “Merger Agreement”) between Integrated Silicon Solution (Taiwan), Inc. (“ISSI-Taiwan”) and ICSI. ISSI-Taiwan is incorporated under the laws of the Republic of China and is a wholly-owned subsidiary of ISSI. ICSI is incorporated under the laws of the Republic of China and its common stock is publicly traded in Taiwan. Prior to the transaction, we owned approximately 29.1% of the outstanding shares of ICSI and approximately $3.8 million of convertible debentures of ICSI. In the quarter ended March 31, 2005, we purchased additional shares of ICSI on the open market for approximately $11.8 million increasing our ownership percentage to approximately 41% at March 31, 2005. The additional consideration to be paid by the us in connection with the merger is cash in the aggregate amount of approximately $58 million (excluding the value of the shares of ICSI held by us at March 31, 2005). The Merger Agreement has been approved by the boards of directors of ISSI, ISSI-Taiwan and ICSI and the shareholders of ICSI, and is subject to customary closing conditions. We currently expect the merger to close in the September 2005 quarter. Prior to the closing of the merger, we may purchase additional shares of ICSI on the open market. Effective May 1, 2005, our Chairman and Chief Executive Officer, Jimmy Lee, was appointed Chairman of ICSI and the ICSI board formally elected Mr. Lee as Chairman on May 6, 2005. We also agreed to loan $15.0 million to ICSI under loan documents executed on April 28, 2005, of which $13.0 million had been funded as of May 9, 2005. ICSI agreed to collateralize the loan with a mortgage on its building in Taiwan and the lien documents were effective on April 28, 2005. As a result of these events and changes in the management reporting structure of ICSI (which were effective as of May 1, 2005), we will begin consolidating the financial results of ICSI with our results as of May 1, 2005 in accordance with generally accepted accounting principles.

We are subject to the risks of conducting business internationally, including economic conditions in Asia, particularly Taiwan and China, changes in trade policy and regulatory requirements, duties, tariffs and other trade barriers and restrictions, the burdens of complying with foreign laws and, possibly, political instability. All of our foundries and assembly and test subcontractors are located in Asia. Although we transact business predominately in U.S. dollars, we do have some transactions in New Taiwan dollars, in Hong Kong dollars and in China Renminbi. Such transactions expose us to the risk of exchange rate fluctuations. We monitor our exposure to foreign currency fluctuations, but have not to date adopted any hedging strategy. There can be no assurance that exchange rate fluctuations will not harm our business and operating results in the future.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make difficult and subjective estimates, judgments and assumptions. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. The estimates and judgments that we use in applying our accounting policies have a significant impact on the results we report in our financial statements. We base our estimates and judgments on our historical experience combined with knowledge of current conditions and our beliefs of what could occur in the future, considering the information available at the time. Actual results could differ from those estimates and such differences may be material to our financial statements. We reevaluate our estimates and judgments on an ongoing basis.

Our critical accounting policies which are impacted by our estimates are: (i) the valuation of our inventory, which impacts cost of goods sold and gross profit; (ii) the valuation of our allowance for sales returns and allowances, which impacts net sales; (iii) the valuation of our allowance for doubtful accounts, which impacts general and administrative expense; and (iv) the valuation of our non-marketable equity securities, which impacts gains and losses on equity securities when we record impairments. Each of these policies is described in more detail below. We also have

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other key accounting policies that may not require us to make estimates and judgments that are as subjective or difficult, for instance, our policies with regard to revenue recognition, including the deferral of revenues on sales to distributors with sales price rebates and product return privileges. These policies are described in the notes to our financial statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2004.

Valuation of inventory. Our inventories are stated at the lower of cost or market value. Determining market value requires us to project unit prices and volumes for future periods in which we expect to sell inventory on hand as of the balance sheet date. As a result of these estimates, we may record a charge to cost of goods sold, which decreases our gross profit, in advance of when the inventory is actually sold to reflect market values that are below our manufacturing and sales commission costs. Conversely, if we sell inventory that has previously been written down to the lower of cost or market at more favorable prices than we had forecasted at the time of the write-down, our gross profit may be higher. In addition to lower of cost or market write-downs, we also analyze inventory to determine whether any of it is excess, obsolete or defective. We write down to zero dollars (which is a charge to cost of goods sold) the carrying value of inventory on hand in excess of six months’ historical sales volumes to cover estimated excess and obsolete exposures, unless adjustments are made based on our judgments for newer products, end of life products or planned inventory increases. In making such judgments to write down inventory, we take into account the product life cycles which can range from six to 30 months, the stage in the life cycle of the product, and the impact of competitors’ announcements and product introductions on our products.

Valuation of allowance for sales returns and allowances. Net sales consist principally of total product sales less estimated sales returns. To estimate sales returns and allowances, we analyze potential customer specific product application issues, potential quality and reliability issues and historical returns. We evaluate quarterly the adequacy of the reserve for sales returns and allowances. This reserve is reflected as a reduction to accounts receivable in our consolidated balance sheets. Increases to the reserve are recorded as a reduction to net sales. Because the reserve for sales returns and allowances is based on our judgments and estimates, particularly as to product application, quality and reliability issues, our reserves may not be adequate to cover actual sales returns and other allowances. If our reserves are not adequate, our net sales could be adversely affected.

Valuation of allowance for doubtful accounts. We maintain an allowance for doubtful accounts for losses that we estimate will arise from our customers’ inability to make required payments for goods and services purchased from us. We make our estimates of the uncollectibility of our accounts receivable by analyzing historical bad debts, specific customer creditworthiness and current economic trends. Once an account is deemed unlikely to be fully collected, we write down the carrying value of the receivable to the estimated recoverable value, which results in a charge to general and administrative expense, which decreases our profitability.

Valuation of non-marketable securities. Our ability to recover our strategic investments in equity securities that are non-marketable and to earn a return on these investments is largely dependent on financial market conditions and the occurrence of liquidity events, such as initial public offerings, mergers or acquisitions, and private equity transactions. The timing of when any of these events may occur is uncertain and very difficult to predict. In addition, under our accounting policy, we are required to periodically review all of our investments for impairment. In the case of non-marketable equity securities, this requires significant judgment on our part, including an assessment of the investees’ financial condition, the existence of subsequent rounds of financing and the impact of any relevant equity preferences, as well as the investees’ historical results of operations and projected results and cash flows. If the actual outcomes for the investees’ are significantly different from their forecasts, the carrying value of our non-marketable equity securities may be overstated, and we may incur additional charges in future periods, which will decrease our profitability. At March 31, 2005, our strategic investments in non-marketable securities totaled $3.3 million.

Impact of Recently Issued Accounting Standards

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS 123, no longer will be an alternative to financial statement recognition. On April 14, 2005, the Securities and Exchange Commission (SEC) announced a delay in the

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effective date of the option-expensing requirements of SFAS 123R. We are now required and plan to adopt SFAS 123R in the first quarter of fiscal 2006, beginning October 1, 2005. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. We are evaluating the requirements of SFAS 123R and we expect that the adoption of SFAS 123R will have a material impact on our consolidated results of operations and earnings per share. We have not yet determined the method of adoption or the effect of adopting SFAS 123R, and we have not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.

Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004

Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales decreased by 31% to $35.7 million in the three months ended March 31, 2005 from $51.5 million in the three months ended March 31, 2004. The decrease in sales was principally due to a decrease in the average selling prices of our DRAM products, specifically our 64 and 128 Mb devices, in the three months ended March 31, 2005 compared to the three months ended March 31, 2004. In addition, both the average selling prices and unit shipments of our 16 Mb DRAM products declined in the three months ended March 31, 2005 compared to the three months ended March 31, 2004. The decline in unit shipments of our SRAM products in the three months ended March 31, 2005 for such products compared to the three months ended March 31, 2004, more than offset the increase in the average selling prices resulting in an overall decrease in SRAM revenue. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for certain products. In this regard, we anticipate a decline in the average selling prices for our DRAM and certain of our SRAM products in the June 2005 quarter compared to the March 2005 quarter. There can be no assurance that any future price declines will be offset by higher volumes or by higher prices on newer products.

Sales to ATM Electronic Corporation (ATM) accounted for approximately 10% of total net sales for the three months ended March 31, 2005. Revenue recognized for Arrow Electronics accounted for approximately 10% of total net sales for the three months ended March 31, 2005. Sales to Asian Information Technology Inc. and ATM accounted for approximately 12% and 10%, respectively, of our total net sales for the three months ended March 31, 2004. As sales to these customers are executed pursuant to purchase orders and no purchasing contract exists, these customers can cease doing business with us at any time.

Gross Profit. Cost of sales includes die cost from the wafers acquired from foundries, subcontracted package, assembly and test costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit decreased by $7.4 million to $4.5 million in the three months ended March 31, 2005 from $11.9 million in the three months ended March 31, 2004. Our gross margin decreased to 12.7% in the three months ended March 31, 2005 from 23.1% in the three months ended March 31, 2004. Our gross margin for the three months ended March 31, 2005 included inventory write-downs of $1.3 million predominately as a result of applying our lower-of-cost-or-market inventory valuation policy. The decrease in gross profit was principally due to a decrease in the average selling prices of our DRAM products, specifically our 64 and 128 Mb products, in the three months ended March 31, 2005 compared to the three months ended March 31, 2004. In addition, declines in the average selling prices of our DRAM products more than offset declines in the cost of our DRAM products in three months ended March 31, 2005 compared to three months ended March 31, 2004 resulting in a decline in our DRAM gross margin. Decreases in the units shipments of our SRAM products more than offset increases in the average selling prices of such products in the three months ended March 31, 2005 compared to the three months ended March 31, 2004 resulting in a decrease in gross profit. However, increases in the average selling prices of our SRAM products more than offset any increases in product costs resulting in higher gross margins for our SRAM products in three months ended March 31, 2005 compared to three months ended March 31, 2004. We believe that the average selling prices of our products will decline over time and, unless we are able to reduce our cost per unit to the extent necessary to offset such declines, the decline in average selling prices will result in a material decline in our gross margin. In addition, product unit costs could increase if our suppliers raise prices, which

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could result in a material decline in our gross margin. In the past, foundries have raised wafer prices when demand for end products increases. Although we have product cost reduction programs in place that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. We do not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our products or the level of service provided by us.

Research and Development. Research and development expenses decreased by 14% to $4.6 million in the three months ended March 31, 2005 compared to $5.4 million in the three months ended March 31, 2004. As a percentage of net sales, research and development expenses increased to 13.0% in the three months ended March 31, 2005 from 10.4% in the three months ended March 31, 2004. The decrease in absolute dollars was primarily the result of a reduction in mask expenses as we limited the focus of our development efforts. In addition, depreciation expense decreased in the three months ended March 31, 2005 compared to the three months ended March 31, 2004. This was partially offset by an increase in research and development expenses attributable to our consolidation of Signia beginning in December 2004 (see In-Process Research and Development below). Our research and development expenses could increase in absolute dollars in future periods due to increased costs associated with the development of new products.

Selling, General and Administrative. Selling, general and administrative expenses increased by 29% to $5.4 million in the three months ended March 31, 2005 from $4.2 million in the three months ended March 31, 2004. As a percentage of net sales, selling, general and administrative expenses increased to 15.1% in the three months ended March 31, 2005 from 8.1% in the three months ended March 31, 2004. The increase in selling, general and administrative expenses was primarily due to the $1.1 million write-off of excess facility space in our Santa Clara headquarters. In addition, there was an increase in selling, general and administrative expenses attributable to our consolidation of Signia beginning in December 2004. This was partially offset by decreased selling commissions associated with lower revenues in the three months ended March 31, 2005 compared to the three months ended March 31, 2004. Changes in corporate governance rules, in particular, complying with the internal control requirements of the Sarbanes-Oxley Act of 2002 Section 404, have had and will continue to result in increased internal efforts, significantly higher fees from our independent accounting firm and significantly higher fees from third party contractors. As a result, excluding the impact of the $1.1 million write-off in the March 2005 quarter, we expect our selling, general and administrative expenses will increase in absolute dollars in future quarters, although such expenses may fluctuate as a percentage of net sales.

In-process Research and Development. In December 2004, we acquired a majority ownership in Signia. Signia is a privately held wireless chipset company based in Taipei, Taiwan. Signia has focused on RF chipsets for the consumer electronics market. Signia has a family of Bluetooth ^™ compliant, 2.4G RF devices and also proprietary 2.4G RF devices. As of March 31, 2005, we had increased our ownership to approximately 68% by buying common shares from other shareholders. The cost of this additional investment was approximately $8.1 million in cash which includes $0.4 million in estimated transaction costs. Prior to this increase, we owned approximately 15% of the outstanding equity of Signia and accounted for our investment on the cost basis. Since we increased our ownership to 68%, beginning from December 1, 2004 we consolidate Signia’s financial statements with our own. The total purchase price, including our previous investment of $1.1 million, is $9.2 million. In the December 2004 quarter, we consolidated Signia based on preliminary valuation data. During the March 2005 quarter, the valuation data was refined and our best estimate has been presented as of March 31, 2005. Management is continuing to assess the valuation of the acquisition and potential adjustments could be made in the June 2005 quarter. The estimated allocation of the purchase price of Signia includes both tangible assets and acquired intangibles including both developed technology as well as in-process research and development (“IPR&D”). The $0.4 million allocated to IPR&D was expensed in our quarter ending March 31, 2005, as it was deemed to have no future value.

Other income, net. Other income, net was $0.8 million in the three months ended March 31, 2005 compared to $0.9 million in the three months ended March 31, 2004. In the three months ended March 31, 2005, interest income increased by approximately $0.3 million compared to the three months ended March 31, 2004 as the result of higher interest rates. In the three months ended March 31, 2005, we recorded a gain of approximately $0.3 million from the sale of fixed assets. In the three months ended March 31, 2004, we recorded a gain of approximately $0.3 million related to the increase in the fair value of the embedded derivative associated with the ICSI convertible debenture. In addition, in the three months ended March 31, 2004, we recorded a gain of approximately $0.3 million in connection with the completion of the liquidation of our subsidiary D2Code in Korea.

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Gain on sale of investments. In the three months ended March 31, 2005, we sold shares of SMIC for approximately $1.1 million which resulted in a pre-tax gain of $0.5 million. On March 17, 2004, SMIC completed an Initial Public Offering (“IPO”). SMIC’s ordinary shares are traded on the Hong Kong Stock Exchange and SMIC American Depository Receipts (“ADR”) are traded on the New York Stock Exchange. Each SMIC ADR represents fifty (50) ordinary shares. As a result of our sale of certain shares of SMIC in the IPO, we recorded gross proceeds of approximately $13.2 million in the March 2004 quarter resulting in a pre-tax gain of approximately $8.7 million.

Provision for income taxes. The provision for income taxes for the three month period ended March 31, 2005 of $16,000 consists solely of foreign withholding taxes. We have a full valuation allowance against our deferred tax assets due to our operating loss history and have not recorded any tax benefit for our deferred tax assets for the three month period ended March 31, 2005. The provision for income taxes for the three month period ended March 31, 2004 of $366,000 consists of alternative minimum taxes.

Minority interest in net loss of consolidated subsidiary. In December 2004, we increased our ownership in Signia to approximately 68% of the outstanding shares from 15% at September 30, 2004. The cost of this additional investment was approximately $8.1 million in cash. The results of Signia’s operations are included in our consolidated financial statements as of December 2004. The minority interest in net loss of consolidated subsidiary represents the minority shareholders’ proportionate share of the net loss of Signia for the three months ended March 31, 2005.

Equity in net income (loss) of affiliated companies. Equity in net income (loss) of affiliated companies was a $9.3 million loss in the three months ended March 31, 2005 compared to $0.9 million income in the three months ended March 31, 2004. This primarily reflects a decline in ICSI’s financial results as a result of inventory write-downs in the three months ended March 31, 2005 compared to the three months ended March 31, 2004. In addition, in the three months ended March 31, 2005, we increased our ownership percentage in ICSI to approximately 41% from 29%.

Six Months Ended March 31, 2005 Compared to Six Months Ended March 31, 2004

Net Sales. Net sales decreased by 28% to $66.2 million in the six months ended March 31, 2005 from $91.8 million in the six months ended March 31, 2004. The decrease in sales was principally due to a decrease in the average selling prices of our DRAM products, specifically our 64 and 128 Mb devices, in the six months ended March 31, 2005 compared to the six months ended March 31, 2004. In addition, both the average selling prices and unit shipments of our 16 Mb DRAM products declined in the six months ended March 31, 2005 compared to the six months ended March 31, 2004. The decline in unit shipments of our SRAM products in the six months ended March 31, 2005 compared to the six months ended March 31, 2004, more than offset the increase in the average selling prices resulting in an overall decrease in SRAM revenue. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for certain products. There can be no assurance that any future price declines will be offset by higher volumes or by higher prices on newer products.

Revenue recognized for Arrow Electronics accounted for approximately 11% of total net sales for the six months ended March 31, 2005. Sales to Asian Information Technology Inc. accounted for approximately 10% of our total net sales for the six months ended March 31, 2004. As sales to these customers are executed pursuant to purchase orders and no purchasing contract exists, these customers can cease doing business with us at any time.

Gross Profit (loss). Gross profit decreased by $22.1 million to a $1.3 million gross loss in the six months ended March 31, 2005 from a $20.8 million gross profit in the six months ended March 31, 2004. Gross margin decreased to (1.9)% in the six months ended March 31, 2005 from 22.7% in the six months ended March 31, 2004. Our gross margin for the six months ended March 31, 2005 included inventory write-downs of $10.9 million predominately as a result of applying our lower-of-cost-or-market inventory valuation policy. Excluding the inventory write-downs in the six months ended March 31, 2005, the decrease in gross profit was principally due to a decrease in the average selling prices of our DRAM products, specifically our 16, 64 and 128 Mb devices, in the six months ended March 31, 2005 compared to the six months ended March 31, 2004. In addition, declines in the average selling prices of our DRAM products more than offset declines in the cost of our DRAM products in six months ended March 31, 2005 compared to six months ended March 31, 2004 resulting in a decline in our DRAM gross margin. Decreases in the unit shipments of our SRAM products more than offset increases in the average selling prices in the six months ended March 31, 2005 compared to the

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six months ended March 31, 2004 resulting in a decrease in gross profit. However, increases in the average selling prices of our SRAM products more than offset any increases in product costs resulting in higher gross margins for our SRAM products in six months ended March 31, 2005 compared to six months ended March 31, 2004. We believe that the average selling prices of our products will decline over time and, unless we are able to reduce our cost per unit to the extent necessary to offset such declines, the decline in average selling prices will result in a material decline in our gross margin. In addition, product unit costs could increase if our suppliers raise prices, which could result in a material decline in our gross margin. In the past, foundries have raised wafer prices when demand for end products increases. Although we have product cost reduction programs in place that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. We do not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our products or the level of service provided by us.

Research and Development. Research and development expenses decreased by 2% to $9.7 million in the six months ended March 31, 2005 from $9.9 million in the six months ended March 31, 2004. As a percentage of net sales, research and development expenses increased to 14.7% in the six months ended March 31, 2005 from 10.8% in the six months ended March 31, 2004. The decrease in absolute dollars was primarily the result of a reduction in expenses associated with new product development as we limited the focus of our development efforts resulting in a reduction in mask costs. In addition, depreciation expense decreased in the six months ended March 31, 2005 compared to the six months ended March 31, 2004. This was partially offset by an increase in research and development expenses attributable to our consolidation of Signia beginning in December 2004 (see In-process Research and Development below).

Selling, General and Administrative. Selling, general and administrative expenses increased by 19% to $9.6 million in the six months ended March 31, 2005 from $8.1 million in the six months ended March 31, 2004. As a percentage of net sales, selling, general and administrative expenses increased to 14.5% in the six months ended March 31, 2005, from 8.8% in the six months ended March 31, 2004. The increase in absolute dollars was primarily due to the $1.1 million write-off of excess facility space in our Santa Clara headquarters. In addition, there was an increase in selling, general and administrative expenses attributable to our consolidation of Signia beginning in December 2004. This was partially offset by decreased selling commissions associated with lower revenues in the six months ended March 31, 2005 compared to the six months ended March 31, 2004.

In-process Research and Development. In December 2004, we acquired a majority ownership in Signia. As of March 31, 2005, we had increased our ownership to approximately 68% by buying common shares from other shareholders. The cost of this additional investment was approximately $8.1 million in cash which includes $0.4 million in estimated transaction costs. Prior to this increase, we owned approximately 15% of the outstanding equity of Signia and accounted for our investment on the cost basis. Since we increased our ownership to 68%, beginning from December 1, 2004 we consolidate Signia’s financial statements with our own. The total purchase price, including our previous investment of $1.1 million, is $9.2 million. In the December 2004 quarter, we consolidated Signia based on preliminary valuation data. During the March 2005 quarter, the valuation data was refined and our best estimate has been presented as of March 31, 2005. Management is continuing to assess the valuation of the acquisition and potential adjustments could be made in the June 2005 quarter. The estimated allocation of the purchase price of Signia includes both tangible assets and acquired intangibles including both developed technology as well as in-process research and development (“IPR&D”). The $0.4 million allocated to IPR&D was expensed in our quarter ending March 31, 2005, as it was deemed to have no future value.

Other income, net. Other income, net was $1.4 million in the six months ended March 31, 2005 compared to $1.0 million in the six months ended March 31, 2004. In the six months ended March 31, 2005, interest income increased by approximately $0.8 million compared to the six months ended March 31, 2004 as the result of higher cash balances and interest rates. In the three months ended March 31, 2005, we recorded a gain of approximately $0.3 million from the sale of fixed assets. In the six months ended March 31, 2004, we recorded a gain of approximately $0.4 million related to the increase in the fair value of the embedded derivative associated with the ICSI convertible debenture. In addition, in the six months ended March 31, 2004, we recorded a gain of approximately $0.3 million in connection with the completion of the liquidation of our subsidiary D2Code in Korea.

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Gain on sale of investments. In the six months ended March 31, 2005, we sold shares of SMIC for approximately $5.6 million which resulted in a pre-tax gain of $2.9 million. On March 17, 2004, SMIC completed its IPO. As a result of our sale of shares of SMIC in the IPO, we recorded gross proceeds of approximately $13.2 million in the March 2004 quarter resulting in a pre-tax gain of approximately $8.7 million.

Provision for Income Taxes. The provision for income taxes for the six month period ended March 31, 2005 of $17,000 consists solely of foreign withholding taxes. We have a full valuation allowance against our deferred tax assets due to our operating loss history and have not recorded any tax benefit for our deferred tax assets for the six month period ended March 31, 2005. The provision for income taxes for the six month period ended March 31, 2004 of $378,000 consists of alternative minimum taxes.

Minority interest in net loss of consolidated subsidiary. In December 2004, we increased our ownership in Signia to approximately 68% of the outstanding shares from 15% at September 30, 2004. The cost of this additional investment was approximately $8.1 million in cash. The results of Signia’s operations are included in our consolidated financial statements as of December 2004. The minority interest in net loss of consolidated subsidiary represents the minority shareholders’ proportionate share of the net loss of Signia for the four months ended March 31, 2005.

Equity in net income (loss) of affiliated companies. Equity in net income (loss) of affiliated companies was a $10.6 million loss in the six months ended March 31, 2005 compared to $1.2 million income in the six months ended March 31, 2004. This primarily reflects a decline in ICSI’s financial results as a result of inventory write-downs in the six months ended March 31, 2005 compared to the six months ended March 31, 2004. In addition, in the three months ended March 31, 2005, we increased our ownership percentage in ICSI to approximately 41% from 29%.

Liquidity and Capital Resources

As of March 31, 2005, our principal sources of liquidity included cash, cash equivalents, restricted cash and short-term investments of approximately $114.1 million. During the six months ended March 31, 2005, operating activities used cash of approximately $12.3 million compared to $9.9 million used in the six months ended March 31, 2004. The principle uses of cash during the six months ended March 31, 2005 were our net loss of $27.2 million adjusted for non-cash items of $9.8 million (the gain on the sale of SMIC shares of $2.9 million, equity in net loss of affiliated companies of $10.6 million, depreciation of $1.4 million, in-process research and development charge of $0.4 million, other non-cash items of $0.3 million) and decreases in accounts payable of $10.8 million. These uses were partially offset by decreases in inventories of $10.2 million, decreases in accounts receivables of $4.4 million, decreases in other assets of $0.4 million and increases in accrued expenses of $0.9 million.

In the six months ended March 31, 2005, we generated $30.5 million from investing activities compared to $81.7 million used in the six months ended March 31, 2004. The cash generated from investing activities in the six months ended March 31, 2005 primarily resulted from net sales of available-for-sale securities of $44.8 million. In addition, in the six months ended March 31, 2005, we generated approximately $5.6 million from the sale of additional shares of SMIC, resulting in a pre-tax gain of approximately $2.9 million. We used approximately $6.8 million, net of cash receipts, for our additional investment in Signia which is comprised of cash used for the purchase of Signia shares of $7.7 million less cash acquired as a result of our consolidation of Signia of $0.9 million. In the three months ended March 31, 2005, we used approximately $11.8 million for the purchase of additional shares of ICSI and approximately $0.5 million for the purchase of additional shares of NexFlash. The cash used for investing activities in the six months ended March 31, 2004 primarily resulted from net purchases of available-for-sale securities of $94.7 million. We generated approximately $13.2 million from our sale of shares in the SMIC IPO in March 2004.

In the six months ended March 31, 2005, we made capital expenditures of approximately $0.8 million for test equipment and engineering tools. We expect to spend approximately $2.0 million to $5.0 million to purchase capital equipment during the next twelve months, principally for the purchase of design and engineering tools, additional test equipment, and computer software and hardware. We expect to fund our capital expenditures from our existing cash and cash equivalent balances.

We generated $2.9 million from financing activities during the six months ended March 31, 2005 compared to $99.1 million in the six months ended March 31, 2004. The source of financing for the six months ended March 31,

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2005, was proceeds from the issuance of common stock of $1.7 million from stock option exercises and sales under our employee stock purchase plan and a decrease in restricted cash of $1.2 million. In the three months ended March 31, 2004, we completed a follow-on public offering of our Common Stock whereby we sold 6,025,000 shares at a public offering price of $16.50 per share. Proceeds from this offering, net of commissions, discounts and expenses, were $93.5 million. In addition, in the six months ended March 31, 2004, we generated $5.6 million from the issuance of common stock from option exercises and sales under our employee stock purchase plan.

We lease our facilities including our headquarters in Santa Clara, California, our field sales offices in the U.S. and Europe, and sales and engineering offices in Asia. Our leases expire at various dates through 2007. Our outstanding commitments under these leases are approximately $3.2 million.

We generally warrant our products against defects in materials and workmanship for a period of 12 months. Liability for a stated warranty period is usually limited to replacement of defective items or return of amounts paid. Warranty expense has historically been immaterial to our financial statements.

On January 25, 2005, we announced the execution on such date of a Merger Agreement between ISSI-Taiwan (our wholly owned subsidiary) and ICSI. Prior to the transaction, we owned approximately 29.1% of the outstanding shares of ICSI and approximately $3.8 million of convertible debentures of ICSI. In the March 2005 quarter, we purchased additional shares of ICSI for approximately $11.8 million increasing our ownership percentage to approximately 41%. The additional consideration to be paid by us in connection with the merger is cash in the aggregate amount of approximately $58 million (excluding the value of the shares of ICSI held by us at March 31, 2005). The Merger Agreement has been approved by the boards of directors of ISSI, ISSI-Taiwan and ICSI and the shareholders of ICSI, and is subject to regulatory approvals and customary closing conditions. We anticipate that the merger will be completed in the September 2005 quarter. Prior to the closing of the merger, we may purchase additional shares of ICSI on the open market. We also agreed to loan $15.0 million to ICSI under loan documents executed on April 28, 2005, of which $13.0 million had been funded as of May 9, 2005. ICSI agreed to collateralize the loan with a mortgage on its building in Taiwan and the lien documents were effective on April 28, 2005.

Our contractual cash obligations at March 31, 2005 are outlined in the table below:

We believe our existing funds will satisfy our anticipated working capital and other cash requirements through at least the next 12 months. We may from time to time take actions to further increase our cash position through equity or debt financings, sales of shares of investments, bank borrowings, or the disposition of certain assets. From time to time, we may also evaluate potential acquisitions or equity investments including strategic investments in wafer fabrication foundries or assembly and test subcontractors. To the extent we pursue such transactions, any such transaction could require us to seek additional equity or debt financing to fund such activities. There can be no assurance that any such additional financing could be obtained on terms acceptable to us, if at all.

Off-Balance Sheet Arrangements

As of March 31, 2005, we did not have any significant off-balance sheet arrangements, as defined in Item 303 (a)(4)(ii) of SEC Regulation S-K.

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Certain Factors Which May Affect Our Business or Future Operating Results

We have incurred significant losses in certain recent periods, and there can be no assurance that we will be able to achieve or sustain profitability in the future.

We incurred losses of $27.2 million in the first six months of fiscal 2005, which included inventory write-downs of $10.9 million and charges of $10.6 million related to our equity interest in ICSI. Though we were profitable in the first three quarters of fiscal 2004, we incurred a loss of $15.6 million in the fourth quarter of fiscal 2004, which included an inventory write-down of $12.1 million. We incurred losses in the ten consecutive quarters ended September 30, 2003 totaling $124.0 million. We expect to incur a loss in the June 2005 quarter and may incur losses in subsequent quarters. Our ability to achieve and maintain profitability on a quarterly or fiscal year basis in the future will depend on a variety of factors, including the need for future inventory write-downs, our ability to increase net sales, maintain or expand gross margins, introduce new products on a timely basis, secure sufficient wafer fabrication capacity and control operating expenses. Adverse developments with respect to these or other factors could result in quarterly or annual operating losses in the future.

Our operating results are expected to continue to fluctuate and may not meet our financial guidance or published analyst forecasts. This may cause the price of our common stock to decline significantly.

Our future quarterly and annual operating results are subject to fluctuations due to a wide variety of factors, including: