10-Q 1 a10-q.txt 10-Q (18 PAGES) SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________. Commission file number 0-13244 GATEFIELD CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 41-1404495 (State of incorporation) (I.R.S. Employer Identification No.) 47436 FREMONT BLVD. FREMONT, CALIFORNIA 94538 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (510) 623-4400 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. TITLE OF EACH CLASS OUTSTANDING AT AUGUST 7, 2000 ------------------- ----------------------------- Common stock, par value $0.10 per share 6,177,163 GATEFIELD CORPORATION INDEX

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS GATEFIELD CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

See Accompanying Notes To Condensed Consolidated Financial Statements. 3 GATEFIELD CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (UNAUDITED)

See Accompanying Notes to Condensed Consolidated Financial Statements. 4 GATEFIELD CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

See Accompanying Notes to Condensed Consolidated Financial Statements. 5 GATEFIELD CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JUNE 30, 2000 1. BASIS OF PRESENTATION The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during the quarters ended June 30, 2000 and 1999, GateField Corporation, ("GateField" or the "Company") incurred net losses of approximately $2,561,000 and $2,847,000, respectively. Additionally, the Company had stockholders' deficits of approximately $2,998,000 at June 30, 2000 and $10,297,000 at December 31, 1999, and is highly dependent on obtaining additional financing in order to fund the current and planned operating levels. These factors among others raise substantial doubt about the ability of the Company to continue as a going concern for a reasonable period of time. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to obtain additional financing to complete its new product development and begin commercial sales, and ultimately obtain sufficient customer demand to attain profitable operations. No assurance can be given that the Company will be successful in these efforts. Interim results of operations are not necessarily indicative of the results to be expected for the full year. The Company's interim fiscal quarter ended on June 30, 2000 and 1999, respectively. In the opinion of the Company, all adjustments (consisting only of normal, recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows at June 30, 2000, and for all periods presented, have been made. These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's December 31, 1999 Annual Report on Form 10-K. 2. MERGER AGREEMENT On May 24, 2000 GateField and Actel Corporation ("Actel") signed an Agreement and Plan of Merger, which was amended and restated on May 31, 2000 (the "Merger Agreement"). In the proposed merger, GateField will merge into a wholly-owned subsidiary of Actel and each GateField stockholder will receive cash consideration of $5.25 per share of outstanding common stock held by such stockholder (the "Merger"). The Merger is subject to approval by GateField stockholders at a special meeting that the Company anticipates will be held in September 2000. Under the Merger Agreement Actel converted its $8.0 million Convertible Promissory Note and Actel and Idanta Partners, Inc. converted their GateField preferred stock into GateField common stock. Both parties agreed to vote their shares of common stock for approval of the Merger and the Merger Agreement. In the event of a termination of the Merger Agreement by either GateField or Actel, the terminating party must either loan or sell the non-terminating party a $3.0 million convertible promissory note at an effective conversion rate of $5.25 per share of common stock, at an interest rate equal to 100% of the applicable federal rate. A preliminary proxy statement describing the Merger and setting forth the date of the special meeting is under review by the Securities and Exchange Commission (the "Commission") and will be mailed to stockholders as soon as the Commission has completed its review. 3. CONVERTIBLE PROMISSORY NOTES In May 2000, the Company issued a convertible promissory note in the aggregate principal amount of $1.0 million (the May 2000 Note). The May 2000 Note accrues interest at 6.25% per annum, has a five-year term and is secured by a 6 lien against all the assets of the Company. The May 2000 Note is convertible into 35,000 shares of the Company's Series C-2 convertible preferred stock. The Series C-2 convertible preferred stock is in turn convertible into 190,476 shares of the Company's common stock, at the equivalent price of $5.25 per share of common stock. The May 2000 Note is convertible at the option of the noteholder. In August 2000, the Company issued a convertible promissory note in the aggregate principal amount of $2.75 million (the August Note). The August Note accrues interest at 6.25% per annum, has a five-year term and is secured by a lien against all the assets of the Company. The August Note is convertible into 96,250 shares of the Company's Series C-2 convertible preferred stock. The Series C-2 convertible preferred stock is in turn convertible into 523,809 shares of the Company's common stock, at the equivalent price of $5.25 per share of common stock. The May 2000 Note is convertible at the option of the noteholder. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE DISCUSSION IN THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, INCLUDING STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "FACTORS AFFECTING FUTURE RESULTS" AS WELL AS THOSE DISCUSSED IN THIS SECTION AND ELSEWHERE IN THIS REPORT, AND THE RISKS DISCUSSED IN THE COMPANY'S SECURITIES AND EXCHANGE COMMISSION FILINGS. RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2000 AND 1999 REVENUES Total revenues for the quarters ended June 30, 2000 and 1999 were $312,000 and $662,000, respectively, a decrease of 53%. Total ProASIC product revenues for the second quarter of 2000 decreased to $312,000 from $482,000 in the second quarter of 1999. ProASIC product revenues in 2000 consisted entirely of deferred revenue from license fees from Rohm Co. Ltd that were collected in fiscal 1998. ProASIC revenue in the second quarter of 1999 consisted of $312,000 in deferred revenue from license fees and $170,000 in hardware sales of its 0.72-micron product that was terminated in 1999. Revenues in the year 2000, if any, will come from the Company's anticipated introduction of its 0.25-micron products. The Company began sampling its 0.25-micron product to initial customers in the first quarter of 1999 and began shipping engineering samples in limited volumes in the fourth quarter of 1999. The Company does not expect to begin shipment of pre-production quality parts for this family until the third quarter of 2000 and does not expect sales to reach a volume that could generate operating cash flow break-even in fiscal year 2000. While the Company expects to have the capacity to produce pre-production parts in volume in the third quarter of 2000 there can be no assurance that sales will indeed begin at that time, if at all. Nor can there be any assurance how many products will be introduced in 2000 or in what packages or volumes those products will ship or that units sold will be at prices that generate a positive gross margin. In addition, it is impossible to anticipate the degree of market acceptance of this new technology, or whether it will be accepted at all. Therefore neither revenues nor margins associated with the new 0.25-micron product can be predicted with any degree of accuracy. The Company's failure to introduce its 0.25-micron products on a timely basis and to achieve market acceptance of such products would have a material adverse effect on its business, financial condition and result of operations. Service revenues for the quarters ended June 30, 2000 and 1999 were $nil and $180,000, respectively. Service revenues in 1999 represent the Company's portion of a profit sharing agreement with the purchaser of the verification assets that were sold in 1997. The Company does not expect revenues from services in fiscal 2000. Total revenue for the six months ended June 30, 2000 decreased to $625,000 from $1,114,000 for the same period last year. Product revenue for the six months ended June 30, 2000 and 1999 was $625,000 and $624,000 respectively and for both periods, is derived solely from the amortization of deferred revenue. Service revenue was zero for the six months ended June 30, 2000; compared to $490,000 for the same period last year. The decline service revenue represents termination of the profit sharing arrangement with the purchaser of those assets. 7 GROSS PROFIT Gross profit for the quarters ended June 30, 2000 and 1999 was $237,000, and $330,000, respectively. Gross profit as a percentage of total revenues was 76% in the second quarter of 2000 and 50% in the second quarter of 1999. Gross profit from ProASIC product revenues for the quarter ended June 30, 2000 was $237,000, as compared to a gross profit of $150,000 at June 30, 1999. The increase in margin reflects slightly lower overhead costs required to maintain the company's manufacturing capabilities until product sales begin. The 0.25-micron product has not yet been manufactured in commercial quantities and commercial sales have not yet begun, therefore the gross profit from ProASIC products for the quarter does not in any way represent expected margins on this product family. Accordingly, the Company cannot predict its margins for the year 2000 with any degree of certainty. Gross profit from service revenues was $180,000 in the quarter ended June 30, 1999 and relates to maintenance contracts on the verification systems. The verification maintenance revenues and, hence, the related gross profits ceased in 1999 and, therefore, the Company does not expect any gross margin contribution from this source in fiscal 2000. Gross profit for the six-month period ended June 30, 2000 was $472,000 compared to $407,000 for the same period last year. The gross profit from product revenues was $472,000 or 76% of revenues, as compared to a gross profit of $55,000 for the same period last year. The costs incurred for the six-month period ended June 30, 2000 represents the overhead costs of maintaining the manufacturing function applied against the amortization of deferred revenue during the period. During the same period last year the company had higher overhead costs resulting in the lower margins. Gross profit from service revenues was zero for the six months ended June 30, 2000 compared to $352,000, or 72%, for the same period last year. SALES AND MARKETING Sales and marketing expenses were $67,000 for the quarter ended June 30, 2000 and $197,000 for the quarter ended June 30, 1999. Expenses incurred in the second quarters of 2000 and 1999 related to the Company's efforts to support strategic initiatives and product designs and the 66% decline represents reduced headcount and expenses associated with new designs in 1999. RESEARCH AND DEVELOPMENT Research and development expenses for the quarter ended June 30, 2000 were $1,812,000 as compared to $1,079,000 for the quarter ended June 30, 1999. The increase in quarterly expenses is due to an increase in the number of engineering lots produced in order to resolve process related issues encountered in commercializing the manufacturing process for the 0.25-micron product. The Company expects quarterly research and development expenses to increase slightly over the remaining half of the year due to a continuation of the Company's efforts to stabilize and improve the current 0.25-micron product manufacturing process, the development of new products and the migration to smaller geometries. GENERAL AND ADMINISTRATIVE General and administrative expenses for the three months ended June 30, 2000 and 1999 were $904,000 and $693,000, respectively. The increase in the second quarter of 2000 is due to increased legal, investment banking and accounting fees as well as directors and officers insurance expenses incurred in connection with the Merger. G&A expenses could experience significant increases in future quarters due to additional legal and accounting expenses related to the Merger. OTHER INCOME AND EXPENSES Other expenses for the quarter ended June 30, 2000 were $15,000 as compared to other expenses of $1,208,000 for the quarter ended June 30, 1999. The reduction in other expenses for the current quarter reflect lower interest expense due to the conversion of a $8.0 million convertible promissory note into common stock in May 2000, as more fully described in Note 2 above. LIQUIDITY AND CAPITAL RESOURCES At June 30, 2000, the Company had cash and cash equivalents of approximately $879,000 and a working capital deficit of $3.4 million. During the quarters ended June 30, 2000, and 1999, GateField incurred net losses of approximately $2.6 million and $2.8 million, respectively. The Company expects to continue to generate such losses for at least the remainder of 2000. In August 2000, the Company entered into a $2.75 million convertible promissory note that the 8 Company expects will cover its cash flow requirements through September 30, 2000. However, the Company estimates it will have exhausted all of its currently available capital resources on or about September 30, 2000. Thus the Company will be unable to continue as a going concern if sufficient funding is not arranged before September 30, 2000. Cash used in operations was $5.3 million in the first six months of 2000 compared to the same amount of $5.3 million for the first six months of 1999. Net cash used by investing activities during the six-month period ended June 30, 2000 was $139,000 for acquisition of equipment. GateField expects it would need to invest a minimum of $700,000 and possibly as much as $1.5 million in mask sets for its new 0.25-micron and smaller geometries product in 2000, but does not anticipate any other significant capital asset acquisitions. Net cash provided by financing activities was $920,000 for the six months ended June 30, 2000, which represents the net proceeds of a $1.0 million convertible promissory note issued in May 2000 partially offset by the payment of long term obligations. Net cash provided by financing activities in the first six months of 1999 was $7.9 million and represents the net proceeds of an $8.0 million convertible promissory note issued in May 1999. The Company currently anticipates that capital in the aggregate principal amount of $3.0 million to $6.0 million would meet the Company's capital requirements through 2000 and an additional $6.0 million to $10.0 million would be needed through 2001. However, the Company's capital requirements may be greater than anticipated. There can be no assurance that such amounts, if available to the Company, will be sufficient to meet the Company's capital requirements. FACTORS AFFECTING FUTURE RESULTS IMMEDIATE NEED FOR ADDITIONAL FUNDING At June 30, 2000, the Company had cash and cash equivalents of approximately $879,000 and a working capital deficit of $3.4 million. During the six-month periods ended June 30, 2000 and 1999, the Company incurred net losses of approximately $3.9 million and $5.1 million, respectively. The Company has not reported an operating profit since fiscal 1995. In addition, a substantial number of parts will have to be sold on a quarterly basis before the Company can achieve quarterly profitability. Several factors, including gross margins, market acceptance and competitive factors, make it impossible to predict with any degree of assurance when or whether the Company will attain profitability. Accordingly, GateField cannot predict how long it will continue to experience significant or increasing operating and net losses, or whether or if it will become profitable. The Company expects to continue to generate such losses for at least the remainder of 2000. The Company expects that it will have utilized all of its currently available assets on or about September 30, 2000. If sufficient funding is not then available, the Company will be unable to continue as a going concern. NO ASSURANCE OF FUTURE FUNDING GateField must continue to make significant investments in research and development to bring its technology to market and to remain competitive. Our future capital requirements will depend on many factors, including, among others: product development expense levels, investments in working capital, and the amount of income generated by operations, including royalty income and income deriving from the Actel relationship. To the extent that the Merger does not occur and existing resources and future earnings are insufficient to fund the Company's operations, GateField will need to raise additional funds through public or private debt or equity financings. If additional funds are raised through the issuance of equity securities, the percentage ownership of current stockholders could be significantly reduced and such equity securities may have rights, preferences or privileges senior to those of the holders of the Company's common stock. The Company has historically funded its operations primarily through private equity and debt financings, sale and leaseback arrangements and bank financing and credit lines. If the Merger is not successful or adequate funds are not available, the Company would be required to delay, limit or eliminate some or all of its proposed operations and indeed may be required to cease operations and seek bankruptcy protection. (See "Liquidity and Capital Resources"). Unless the Merger is consummated or the Company obtains additional funding, the Company will have utilized all its currently available resources on or about September 30, 2000. 9 The Company currently anticipates that capital in the aggregate principal amount of $3.0 million to $6.0 million would meet the Company's capital requirements through 2000 and an additional amount of $6.0 million to $10.0 million would be needed through 2001. However, the Company's capital requirements may be greater than anticipated. There can be no assurance that such amounts, even if available to the Company, will be sufficient to meet the Company's capital requirements. DEPENDENCE ON THE SUCCESSFUL DEVELOPMENT OF 0.25-MICRON PRODUCTS GateField's success is highly dependent upon the timely completion and introduction of new products at competitive price and performance levels, especially the timely introduction of its of 0.25-micron generation products. GateField is currently completing testing of its 0.25-micron products and related software. The joint Actel/GateField marketing team began sampling initial customers in the first quarter of 1999 and began limited shipments of engineering samples to select customers in the fourth quarter of 1999. The Company currently believes it has a design capable of yielding pre-production parts however it has experienced significant lot-to-lot variation and has to date been unable to qualify its parts for production status and begin volume shipments to customers. No assurance can be given that the Company's design and manufacturing process issues can be resolved nor can the Company ensure introduction schedules for such products will be met. Moreover, there can be no assurances that, even if such products are introduced into the market on a timely basis, that they will achieve market acceptance. To the extent that the Company's development and commercialization efforts with respect to the 0.25-micron products are unsuccessful or if these products do not achieve market acceptance, the Company's business, financial condition and results of operations would be materially adversely affected. The Company's 0.25-micron products are highly complex and may contain undetected or unresolved defects when first introduced or as new versions are released. There can be no assurance that, despite testing by the Company, defects will not be found in new products, including the Company's 0.25-micron products, or new versions of such products following commercial release. This could result in loss of market share, delay in or loss of market acceptance or product recall. Any such occurrence could have a material adverse effect upon the Company's business, financial condition and results of operations. DEPENDENCE ON INDEPENDENT WAFER MANUFACTURERS GateField does not manufacture any of the wafers used in the production of its products, including its 0.25-micron ProASIC products. This dependence on independent wafer manufacturers puts GateField at risk should its suppliers be unable or unwilling to produce GateField's products. Currently, Infineon manufactures GateField's 0.25-micron ProASIC products at their wafer fabrication facility located in Dresden, Germany. This dependence on a single foundry subjects the Company to risks associated with an interruption of supply from a single source. GateField plans to initially produce its 0.25-micron products in relatively low volumes. Still, it will be competing with Infineon's internal requirements for production capacity and the attention of Infineon's process engineers. The company's reliance on Infineon to fabricate its 0.25-micron products involves significant risks, such as technical difficulties or damage to production facilities that could limit production and reduce yields, lack of control over capacity allocation and lack of control over delivery schedules. Also, these risks are increased by the fact that GateField does not have second source suppliers for any of its wafer products. GateField is working to bring up a second source but there can be no assurance that its efforts will be successful or that other factors will not interrupt supply. GateField has in the past experienced delays in obtaining wafers from its foundries, and there can be no assurance that the Company will not experience similar or more severe delays in the future. Although GateField has supply agreements with Infineon, a shortage of raw materials or production capacity could lead Infineon to allocate available capacity to customers other than GateField or internal uses could delay manufacture of GateField products and interrupt GateField's capability to meet its product delivery obligations. Any inability or unwillingness of GateField's independent wafer manufacturers to provide adequate quantities of finished wafers to satisfy GateField's needs in a timely manner would delay production and product shipments and could have a material adverse effect on GateField's business, financial 10 condition and results of operations. These risks are particularly pronounced with respect to the Company's current reliance on Infineon as the only manufacturer of the Company's 0.25-micron products. If GateField's independent wafer manufacturers were unable or unwilling to manufacture GateField's products as required, the Company would have to identify and qualify additional foundries. The development and qualification process typically takes one year or longer. No assurance can be given that any additional qualified wafer foundries would become available or be able to satisfy GateField's requirements on a timely basis. In particular, the Company has invested significant amounts of time and resources in working with Infineon to develop and improve the manufacturing processes relating to GateField's 0.25-micron product family. If Infineon were unable or unwilling to manufacture such products as anticipated by GateField, GateField would be unable to introduce such products to market on a timely basis, which would have a material adverse effect on the Company's business, financial condition and results on operations. RELIANCE ON ACTEL RELATIONSHIP In August 1998, GateField entered into a strategic relationship with Actel Corporation. In a product marketing agreement, Actel acquired the exclusive right to distribute GateField's standard ProASIC products based on 0.25-micron and smaller geometries. In connection with the formation of the alliance, GateField terminated its entire sales force and does not anticipate creating a new sales force in the foreseeable future. Consequently, GateField is highly dependent on Actel's sales efforts and the success of its sales force in marketing GateField's 0.25-micron products. In the event the Merger does not occur, Actel will continue to market its own products, including products that are competitive with GateField's products. Accordingly, there is a risk that Actel may give higher priority to the Actel products, thus reducing its efforts to sell GateField's products. In addition, GateField's agreement with Actel is terminable by Actel under a variety of circumstances, including GateField's material breach of the product marketing agreement. As GateField would require significant amounts of time and resources to rebuild its sales force, reduction in sales efforts by Actel or a termination of its agreement with GateField would have a material adverse effect on GateField's business, financial condition and results of operations. In addition, if Actel's sales and marketing efforts do not achieve anticipated growth rates, GateField would be forced to reduce the amount of product that is manufactured. As a result, the Company's profit margins on future sales of higher cost products would be reduced because GateField would be unable to take full advantage of Infineon's manufacturing cost reductions. The product marketing agreement with Actel contains certain GateField milestones relating to the development schedule and manufacturing costs of the 0.25-micron product family. The agreement also contains Actel milestones with respect to the marketing and sale of the 0.25-micron products (including certain revenue targets). If GateField fails to achieve such cost milestones, it must notify Actel and seek their consent to its corrective action. GateField has so notified Actel and the two companies are jointly working on corrective measures. Should Actel decide it is not in their best interest to support these corrective actions it may take GateField longer to resolve the delays. Loss of cooperation and support from Actel could divert resources from other GateField development efforts and disrupt the Company's development efforts with respect to the 0.25-micron product family. The delays in meeting GateField's milestones relieve Actel from its milestones as set forth in the Product Marketing Agreement. Such consequences of GateField's failure to achieve its milestones could have a material adverse effect on GateField's business, financial condition and results of operations. COMPETITION The semiconductor industry is intensely competitive and is characterized by rapid rates of technological change, product obsolescence, and price erosion. GateField's existing competitors include suppliers of conventional gate arrays, complex programmable logic devices ("CPLDs") and FPGAs. The Company's two principal competitors are Xilinx, a supplier of FPGAs based on SRAM technology, and Altera, a supplier principally of CPLDs. GateField also faces competition in the future from major domestic and international semiconductor suppliers and suppliers of logic products based on new or emerging technologies. Given the intensity of the competition and the research and development being done, no assurance can be given that GateField's technology--or patents--will remain competitive. Important competitive factors in GateField's market are: price, performance, number of usable gates, ease of use 11 and functionality of development system software, installed base of development systems, adaptability of products to specific applications, length of development cycle (including reductions to finer micron design rules), number of I/Os, reliability, adequate wafer fabrication capacity and sources of raw materials, protection of products by effective utilization of intellectual property laws and technical service and support. Failure of GateField to compete successfully in any of these or other areas could have a material adverse effect on its business, financial condition and results of operations. Furthermore, if there was a downturn in the market for CPLDs and FPGAs, GateField believes companies that have broader product lines and longer standing customer relationships may be in a stronger competitive position than GateField. Many of the Company's current and potential competitors offer broader product lines and have significantly greater financial, technical, manufacturing and marketing resources than GateField has. DEPENDENCE ON KEY PERSONNEL GateField's success is dependent in large part on the continued service of its key management, engineering, marketing and support employees. Competition for qualified personnel, particularly skilled IC engineers, is intense in the semiconductor industry. The loss of GateField's current key employees, or the inability of the Company to attract other qualified personnel, could have a material adverse effect on GateField. The Company does not have employment agreements with any of its key employees, but it does have standard non-disclosure agreements with all technical and management employees and it does have indemnity agreements with Dr. Timothy Saxe, its chief executive officer, president and chief operating officer, and James B. Boyd, its chief financial officer. PRICE EROSION The semiconductor industry is characterized by intense competition. Historically, average selling prices in the semiconductor industry in general, and for GateField's products in particular; have declined significantly over the life of each product. Moreover, GateField is highly dependent on Actel for the marketing of the Company's next generation of ProASIC products. While GateField expects that the average selling prices of its products will be reduced over time as the Company achieves manufacturing cost reductions, GateField may from time to time be required by competitive pressures to reduce the prices of its products more quickly than such cost reductions can be achieved. In addition, GateField occasionally approves price reductions on specific sales to meet competition. If these reductions are not offset by reductions in manufacturing costs or by a shift in the mix of products sold toward higher-margin products, declines in the average selling prices of GateField's products will reduce gross margins and could have a material adverse effect on the Company's business, financial condition and results of operations. MANUFACTURING YIELDS GateField depends upon its independent wafer manufacturers to produce wafers with acceptable yields and to deliver them to GateField in a timely manner. Currently, substantially all of the Company's revenues are derived from products based on GateField's proprietary ProASIC technology. Successful implementation of ProASIC technology requires a high degree of coordination between GateField and its independent wafer manufacturers. In particular, with respect to the manufacture of GateField's 0.25-micron products, Infineon will require significant lead-time to reach volume production on new processes. Accordingly, no assurance can be given that volume production or acceptable yields with respect to GateField's new 0.25-micron product family will be achieved on a timely basis or at all. The manufacture of high-performance ProASIC products is a complex process that requires a high degree of technical skill, state-of-the-art equipment and effective cooperation between the wafer supplier and the circuit designer to produce acceptable yields. Minute impurities, errors in any step of the fabrication process, defects in the masks used to print circuits on a wafer and other factors can cause a substantial percentage of wafers to be rejected or numerous die on each wafer to be nonfunctional. As is common in the semiconductor industry, GateField has from time to time experienced in the past, and expects that it will experience in the future, production yield problems and delivery delays. Any prolonged inability to obtain adequate yields or deliveries of the 0.25-micron products would adversely affect GateField's business, financial condition and results of operations. 12 SEMICONDUCTOR INDUSTRY RISKS The semiconductor industry has historically been cyclical and periodically subject to significant economic downturns, which are characterized by rapid technological change, product obsolescence, diminished product demand, accelerated price erosion and overcapacity. These downturns often occur in connection with, or in anticipation of, maturing product cycles (of both the semiconductor companies and their "end customers") and declines in general economic conditions. Some of these downturns have lasted for more than a year. Also, during such periods, customers of semiconductor manufacturers benefiting from shorter lead times may delay some purchases of semiconductors into future periods. GateField has experienced in the past, and may experience again in the future, substantial period-to-period fluctuations in business and results of operations. This can adversely affect the market price of the Company's common stock. The main factors affecting these fluctuations is the performance of the semiconductor industry, overall economic conditions, or other factors, including legislation and regulations governing the import or export of semiconductor products. DEPENDENCE ON DESIGN WINS For GateField to sell its ProASIC products to a customer, the customer must incorporate the Company's ProASIC technology into the customer's product in the design phase. GateField is highly dependent on Actel's sales marketing and Field Application Engineer ("FAE") team, in conjunction with the support of GateField resources, to persuade potential customers to incorporate the Company's standard ProASIC product into new or updated products. These efforts may precede by many months (and sometimes a year or more) the generation of volume sales, if any, by the customer. The value of any design win, moreover, will depend in large part upon the ultimate success of the customer's product. No assurance can be given that GateField will win sufficient designs or that any design win will result in significant revenues. In addition, there are some costs associated with marketing the Company's licensing of its ProASIC technology for embedded applications. Such costs would not be recovered if GateField were unable to win additional licenses. DEPENDENCE ON INDEPENDENT ASSEMBLY SUBCONTRACTORS GateField relies primarily on foreign subcontractors for the assembly and packaging of its products and, to a lesser extent, for the testing of its finished products. The Company generally relies on a few key subcontractors to provide particular services and has from time to time experienced difficulties with the timeliness and quality of product deliveries. GateField has no long-term contracts with its subcontractors, and certain of those subcontractors are currently operating at or near full capacity. There can be no assurance that these subcontractors will continue to be able and willing to meet GateField's requirements for components or services. Any significant disruption in supplies from, or degradation in the quality of components or services supplied by, these subcontractors could delay shipments and result in the loss of customers or revenues or otherwise have a material adverse effect on GateField's business, financial condition and results of operations. SUPPLY PROBLEMS In a typical semiconductor manufacturing process, silicon wafers produced by a foundry are sorted and cut into individual die, which are then assembled into individual packages and tested for performance. The manufacture, assembly and testing of semiconductor products are highly complex and subject to a wide variety of risks, including contaminants in materials, contaminants in the environment and performance failures by personnel and equipment. Any of these conditions could have a material adverse effect on GateField's business, financial condition and results of operations. It is common in the semiconductor industry for independent wafer suppliers to experience lower than anticipated yields of usable die. For example, GateField experienced a yield problem at one of its independent wafer manufacturers in fiscal years 1997 and 1998 that was severe enough to have a material adverse effect on GateField's operating results. To the extent yields of usable die decrease, the average cost to GateField of each usable die increases, which reduces or eliminates gross 13 margin. Wafer yields can decline without warning and may take substantial time to analyze and correct, particularly for a Company such as GateField that does not operate its own manufacturing facility, but instead relies upon a single independent wafer manufacturer. Yield problems may also increase the time-to-market for GateField's products and create inventory shortages and dissatisfied customers. In 1999 and 2000 GateField experienced process problems at Infineon that caused the introduction of its 0.25-micron product family to be significantly delayed. Once production of commercially acceptable product begins GateField anticipates that yields for such products will initially be low. If such yields do not improve over time, the Company's business, financial condition and results of operations would be adversely affected. Although GateField has overcome such difficulties in the past, no assurance can be given that it will be able to do so with respect to its 0.25-micron product family. Nor can any assurance be given that GateField will not experience wafer supply problems in the future, or that any such problem would not have a material adverse effect on GateField's business, financial condition and results of operations. See "Dependence on Independent Wafer Manufacturer." PATENT INFRINGEMENT Although GateField has obtained patents covering aspects of its ProASIC and related technologies, no assurance can be given that GateField's patents will be determined to be valid or that any assertions of infringement or invalidity by other parties (or claims for indemnity from customers resulting from any infringement claims) will not be successful. Although the Company is not currently a party to any material litigation, the semiconductor industry is characterized by frequent claims regarding patent and other intellectual property rights. As is typical in the semiconductor industry, the Company from time to time receives communications from third parties asserting patents on certain of the Company's technologies. In the event any third party were to make a valid claim against the Company, the Company could be required to discontinue the use of certain processes or cease the use, import and sale of infringing products, to pay substantial damages and to develop non-infringing technologies or to acquire licenses to the alleged infringed technology. The Company's business, financial condition and results of operations could be materially and adversely affected by such developments. Litigation, which could result in substantial cost to and diversion of resources of the Company, may also be necessary to enforce patents or other intellectual property rights of the Company or to defend the Company against claimed infringement of the rights of others. The failure to obtain necessary licenses or the occurrence of litigation relating to patent infringement or other intellectual property matters could have a material adverse effect on the Company's business, financial condition and results of operations. PROTECTION OF INTELLECTUAL PROPERTY GateField has historically devoted significant resources to research and development. It believes that the intellectual property derived from research and development is a valuable asset that has been and will continue to be important to the success of the Company's business. GateField relies primarily on a combination of nondisclosure agreements, other contractual provisions, and patent and copyright laws to protect its proprietary rights. No assurance can be given that the steps taken by GateField will be adequate to protect its proprietary rights. In addition, the laws of certain territories in which GateField's products are or may be developed, manufactured or sold, including Asia and Europe, may not protect the Company's products and intellectual property rights to the same extent as the laws of the United States. Failure of GateField to enforce its patents or copyrights or to protect its trade secrets could have a material adverse effect on the Company's business, financial condition and results of operations. RELIANCE ON INTERNATIONAL SALES GateField expects that revenues indirectly derived from international sales will represent a significant portion of the Company's total revenues received through its marketing relationship with Actel. Further, such foreign sales are denominated in U.S. dollars. Therefore, GateField's products become less price competitive in countries with currencies that are declining in value against the dollar. International sales are subject to a variety of risks, including longer payment cycles, greater difficulty in accounts receivable collection, currency restrictions, tariffs, trade barriers, taxes, export license requirements and the impact of recessionary environments in economies outside the United States. 14 DEPENDENCE ON NEW PRODUCT DEVELOPMENT; RAPID TECHNOLOGICAL CHANGE The market for GateField's products is characterized by rapidly changing technology, frequent new product introductions, and declining average selling prices over product life cycles. All of these factors make the timely introduction of new products a critical objective of the Company. GateField's future success is highly dependent upon the timely completion and introduction of new products at competitive price and performance levels, including the timely introduction of its 0.25-micron ProASIC products. In evaluating new product decisions, GateField must anticipate well in advance both the future demand and the technology that will be available to supply such demand. Failure to anticipate customer demand, delays in developing new products with anticipated technological advances and failure to coordinate the design and development of silicon and associated software products each could have a material adverse effect on GateField's business, financial condition and results of operation. In addition, there are greater technological and operational risks associated with new products. Several factors could have a material adverse effect on GateField's business, financial condition and results of operations: the inability of Infineon to produce GateField's 0.25-micron products; delays in commencing or maintaining volume shipments of new products; the discovery of product, process, software or programming failures; and any related product returns. No assurance can be given that any other new products will gain market acceptance or that GateField will respond effectively to new technological changes or new product announcements by others. Any failure of GateField or its strategic partners to successfully define, develop, market, manufacture, assemble or test competitive new products could have a material adverse effect on its business, financial condition and results of operations. DEPENDENCE ON INTERNATIONAL OPERATIONS GateField buys all of its wafers from foreign foundries and has most of its commercial products assembled, packaged and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with international business operations, including trade barriers and other restrictions, changes in trade policies, foreign governmental regulations, currency exchange fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in political or economic conditions and other disruptions or delays in production or shipments, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. "BLANK CHECK" PREFERRED STOCK GateField's Certificate of Incorporation authorizes the issuance of up to 2,000,000 shares of "blank check" preferred stock (of which (1,261,997) shares remain available for issuance), with such designations, rights and preferences as may be determined from time to time by the GateField Board of Directors. Accordingly, the board is empowered, without approval by holders of the Company's common stock, to issue preferred stock with dividend, liquidation, redemption, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of the common stock. Issuance of the preferred stock could be used as a method of discouraging, delaying or preventing a change in control of GateField. In addition, such issuance could adversely affect the market price of GateField's common stock. In order to raise capital, the Company may issue additional shares of its preferred stock in the future. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The GateField Corporation is exposed to a variety of risks, including changes in interest rates affecting the return on its investments and foreign currency fluctuations. The Company has established policies and procedures to manage its exposure to fluctuations in interest rates and foreign currency exchanged. INTEREST RATE RISK. GateField maintains its funds in money market and Certificate of Deposit accounts at banks. The Company's exposure to market risk due to fluctuations in interest rates relates primarily to its interest earnings on its cash deposits. These securities are subject to interest rate risk inasmuch as their fair value will fall if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from the levels prevailing at 15 December 31, 1999, the fair value of the portfolio would not decline by a material amount. GateField does not use derivative financial instruments to mitigate risks. However, it does have an investment policy that would allow it to invest in short-term investments such as money market instruments and corporate debt securities. The Company's policy does attempt to reduce such risks by typically limiting the maturity date of such securities to no more than eighteen months with a maximum average maturity to its whole portfolio of such investments at six months, placing its investments with high credit quality issuers and limiting the amount of credit exposure with any one issuer. FOREIGN CURRENCY EXCHANGE RATE RISK. GateField's exposure to market risk due to fluctuations in foreign currency exchange rates relates primarily to the intercompany balances with its UK, German and Japanese subsidiaries. The Company closed these subsidiaries in 1999 and only has some insignificant cash balances remaining in these countries. Although the Company transacts business in various foreign countries, settlement amounts are usually based on U.S. currency. Transaction gains or losses have not been significant in the past, and there is no hedging activity on the pound, mark, yen or other currencies. The Company would not experience a material foreign exchange loss based on a hypothetical 10% adverse change in the price of the pound, mark or yen against the U.S. dollar. Consequently, GateField does not expect that a reduction in the value of such accounts denominated in foreign currencies resulting from even a sudden or significant fluctuation in foreign exchange rates would have a direct material impact on the Company's financial position, results of operations or cash flows. Notwithstanding the foregoing analysis of the direct effects of interest rate and foreign currency exchange rate fluctuations on the value of certain of GateField's investments and accounts, the indirect effects of such fluctuations could have a material adverse effect on the Company's business, financial condition and results of operations. For example, international demand for GateField's products is affected by foreign currency exchange rates. In addition, interest rate fluctuations may affect the buying patterns of the Company's customers. Furthermore, interest rate and currency exchange rate fluctuations have broad influence on the general condition of the U.S., foreign and global economics, which could materially adversely affect the Company. 16 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1* Amended and Restated Agreement and Plan of Merger, dated May 31, 2000 10.2 Convertible Promissory Note--$1.0 million, dated May 25, 2000 10.3 Security Agreement, dated May 25, 2000 27.1 Financial Data Schedule (b) Reports on Form 8-K None ----------- * Exhibit 10.1 is incorporated herein by reference to the Company's amended and revised Schedule 14A, filed on August 17, 2000. 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: August 21, 2000 GATEFIELD CORPORATION /s/ Timothy Saxe ------------------------------------- Timothy Saxe President and Chief Executive Officer /s/ James B. Boyd ------------------------------------- James B. Boyd Chief Financial Officer 18

GATEFIELD CORP 10-Q