PC TEL INC - 10-K Annual Report

Back to GetFilings.com

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
---------------------
FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE YEAR ENDED DECEMBER 31, 2001

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 000-27115

PCTEL, INC.
(Exact Name of Business Issuer as Specified in Its Charter)

DELAWARE 77-0364943
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)

1331 CALIFORNIA CIRCLE, 95035
MILPITAS, CA (Zip Code)
(Address of Principal Executive Office)

(408) 965-2100
(Registrant's Telephone Number, Including Area Code)

---------------------

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $0.001 Par Value Per Share.

Indicate by checkmark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the past
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.

AS OF MARCH 22, 2002, THE AGGREGATE MARKET VALUE OF THE REGISTRANT'S COMMON
STOCK HELD BY NONAFFILIATES OF THE REGISTRANT WAS $160,623,019 BASED ON THE
CLOSING SALE PRICE AS REPORTED ON THE NASDAQ NATIONAL MARKET. THIS CALCULATION
DOES NOT REFLECT A DETERMINATION THAT CERTAIN PERSONS ARE AFFILIATES OF THE
REGISTRANT FOR ANY OTHER PURPOSES.

As of March 22, 2002, the number of shares of the Registrant's common stock
outstanding was 19,953,170.

Items 10, 11, 12 and 13 of Part III incorporate information by reference
from the definitive proxy statement for the Annual Meeting of Stockholders to be
held on May 29, 2002.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

PCTEL, INC.

FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2001

i

PART I

ITEM 1: BUSINESS

This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These statements include, among other things, statements
concerning our future operations, financial condition and prospects, and
business strategies. The words "believe," "expect," "anticipate" and other
similar expressions generally identify forward-looking statements. Investors in
our common stock are cautioned not to place undue reliance on these
forward-looking statements. These forward-looking statements are subject to
substantial risks and uncertainties that could cause our future business,
financial condition, or results of operations to differ materially from our
historical results or currently anticipated results. Investors should carefully
review the information contained under the caption "Factors That May Affect Our
Business, Financial Condition, and Future Operating Results," beginning on page
20 of the section of this report entitled "Management's Discussion and Analysis
of Financial Condition and Results of Operations," and elsewhere in, or
incorporated by reference into, this report.

OVERVIEW

We are a leading developer and supplier of cost-effective Internet access
solutions. Today our products enable high-speed Internet connections through
analog networks. Additionally, we are developing new technologies and products
to address wireless local area networks.

As a pioneer in developing HSP (host signal processing) technology, a
proprietary set of algorithms that enables cost-effective software-based digital
signal processing solutions, our solution utilizes the computational and
processing resources of a host central processing unit rather than requiring
additional special-purpose hardware. Based on our own research and testing, this
architecture can reduce space requirements by 50% and power requirements by 70%
compared to conventional hardware-based solutions. The first implementation of
our host signal processing technology was in a software modem, or soft modem, in
1995. Various original equipment manufacturers, including Compaq, Dell, Fujitsu,
Hewlett Packard, NEC and Samsung, have integrated our soft modems into their
products.

Our proprietary software architecture provides significant benefits over
traditional hardware-based solutions. Our software architecture:

- Reduces the hardware, space and power requirements of conventional
hardware-based connectivity devices, which reduces our customers'
manufacturing costs while offering superior or comparable performance;

- Minimizes the risk of technological obsolescence and enables an array of
communication solutions for PCs and alternative Internet access devices
that are easily upgradeable;

- Allows us to quickly and cost-effectively develop new products to
capitalize on rapidly growing market segments such as the developing
wireless local area network markets; and

- Is compatible with multiple operating systems, including but not limited
to Windows (3.1, 95, 98, 2000, NT, XP) and Linux.

CORPORATE BACKGROUND

We were incorporated in California in 1994 and reincorporated in Delaware
in 1998. Our principal executive offices are located at 1331 California Circle,
Milpitas, California 95035. Our telephone number at that address is (408)
965-2100.

1

PRODUCTS

CURRENT PRODUCTS

MicroModem(TM). The MicroModem integrates our host signal processing
technology with a micro form-factor, silicon DAA (data access arrangement). In
contrast to a conventional hardware modem, our soft architecture replaces the
memory chip, digital signal processing chip, universal asynchronous receiver and
transmitter, and controller chip with customized software that draws upon the
excess capacity of the host central processing unit. Our patented MicroModem
further reduces power and size requirements by replacing approximately 90
discrete hardware components with one or two silicon DAA chips. This integration
reduces the number of components in a conventional modem data access arrangement
by approximately 40%. The MicroModem is certified as being compatible with the
telecommunications standards of most industrialized countries, allowing original
equipment manufacturers to accomplish seamless global interoperability. The
MicroModem currently comes with standard interfaces to computers such as PCI,
ACR, Modem Riser and MDC.

Lansis(TM). In June 2001, we began to ship our Lansis product. Lansis is a
combination HSP modem and LAN (local area network) solution. It allows PC
original equipment manufacturers ("OEMs") to implement a solution for LAN
connectivity with the same performance as more expensive branded CardBus and
Personal Computer Memory Card International Association (PCMCIA) cards. Combined
with V.90 modem functionality, it provides a cost-effective alternative to
provide modem and network connectivity to the PC customer.

Solsis(TM). In the fourth quarter of 2000, we began to ship our Solsis
product line. Solsis is our first embedded solution for Internet access devices
that either do not use a central processing unit or lack the excess processing
capacity necessary to support our host signal processing solution. Solsis
operates on Texas Instruments DSPs (digital signal processing); targeted for
Internet appliances, such as set-top boxes, game consoles and other Internet
access devices. By offering reductions in size, cost and power consumption, we
believe that our embedded solution is also ideal for many of these
space-restricted mobile appliances.

Solsis II. In the fourth quarter of 2001, we began to ship the second
generation of our Solsis embedded solution that utilizes a two-chip solution
versus the previous five-chip version. This further reduces the cost and power
consumption for these non-PC Internet appliances. Solsis II utilizes the new TI
TMS320C54V90 DSP, integrating all modem functions into the DSP except the line
side DAA chip.

FUTURE PRODUCTS

Future products are intended to address the expanding market for wireless
LAN products intended for use directly by consumers. Further announcements are
anticipated during 2002.

INTELLECTUAL PROPERTY LICENSING

We offer our intellectual property through licensing and product royalty
arrangements. We have over 80 patents granted or pending addressing both
essential International Telecommunications Union (ITU) and non-essential
technologies. Our technology is licensed directly or indirectly by many
companies in the communications industry, such as Conexant, ESS Technology,
Smart Link and others, who use International Telecommunications Union standard
technology.

In addition, we are developing wireless spread spectrum intellectual
property technologies, which may be patentable. Once developed, we intend to
file patents covering such technologies.

CUSTOMERS

Our MicroModem and Lansis products are targeted for manufacturing
integration by PC OEMs, PC motherboard and modem card manufacturers. The Solsis
embedded modem products are typically integrated by non-PC Internet access
product manufacturers, such as set-top box makers. We sell directly to OEMs and
indirectly through a number of distributors.

2

For the year ended December 31, 2001, approximately 79% of our revenues
were generated by three of our customers, with Prewell International
representing 47% of revenues, GVC Corporation representing 22% and Askey
Computer representing 10% of revenues. For the year ended December 31, 2000,
approximately 60% of our revenues were generated by the same three customers,
with Prewell International representing 32% of revenues, GVC Corporation
representing 13% and Askey Computer representing 15%. No other customers
represented more than 10% of our product sales for these periods.

SALES, MARKETING AND SUPPORT

We sell our products directly to modem board and motherboard manufacturers
who assemble and distribute the end product directly to original equipment
manufacturers and systems integrators and indirectly through distributors. In
many cases, modems are manufactured by third parties on behalf of the final
brand name original equipment manufacturer. We focus on developing long-term
customer relationships with our direct and indirect customers. In many cases,
our indirect original equipment manufacturer customers specify our products be
included on their modem boards or motherboards purchased from board
manufacturers.

We employ a direct sales force with a thorough level of technical
expertise, product background and industry knowledge. Our sales force includes a
team of application engineers to assist customers in designing, testing and
qualifying system designs that incorporate our products. Our sales force also
supports the sales efforts of our distributors. We believe the depth and quality
of our sales support team is critical to:

- Achieving design wins,

- Improving customers' time to market,

- Maintaining a high level of customer satisfaction, and

- Engendering customer loyalty for our next generation of products.

Our marketing strategy is focused on further building market awareness and
acceptance of our new products. Our marketing organization also provides a wide
range of programs, materials and events to support the sales organization.

As of December 31, 2001, we employed 34 individuals in sales, marketing and
support and maintained regional sales support operations in Tokyo, Japan,
Taipei, Taiwan, Seoul, Korea and Paris, France.

BACKLOG

Sales of our products are generally made pursuant to standard purchase
orders, which are officially acknowledged by us according to our terms and
conditions. Due to industry practice, which allows customers to cancel or
reschedule orders with limited advance notice to us prior to shipment without
significant penalties, we believe that our backlog, while useful for scheduling
production, is not a meaningful indicator of future revenues.

RESEARCH AND DEVELOPMENT

We recognize that a strong technical base is essential to our long-term
success and have made a substantial investment in research and development. We
will continue to devote substantial resources to product development and patent
submissions. We monitor changing customer needs and work closely with our
customers, partners and market research organizations to track changes in the
marketplace, including emerging industry standards.

As of December 31, 2001, we employed 47 employees in research and
development. For the year ended December 31, 2001, total research and
development costs incurred were $11.6 million, compared to $14.1 million and
$10.3 million for 2000 and 1999, respectively.

3

MANUFACTURING

We procure DAA chips from Silicon Labs of Austin, Texas on a purchase order
basis. We have a limited guaranteed supply of data access arrangement chips
through a long-term business arrangement with Silicon Labs. We have no
guaranteed supply or long-term contract agreements with any other of our
suppliers.

LICENSES, PATENTS AND TRADEMARKS

We seek to protect our technology through a combination of patents,
copyrights, trade secret laws, trademark registrations, confidentiality
procedures and licensing arrangements. We have over 80 patents granted or
pending addressing both essential ITU and non-essential technologies. Because of
the fast pace of innovation and product development, our products are often
obsolete before the patents related to them expire. As a result, we believe that
the duration of the applicable patents is adequate relative to the expected
lives of our products.

We believe that our patent portfolio is one of the largest in the analog
modem market. To supplement our proprietary technology, we have licensed rights
to use patents held by third parties.

We have received communications from Agere Systems and 3Com, and may
receive communications from other third parties in the future, claiming to own
patent rights in technologies that are part of communications standards adopted
by the International Telecommunications Union, such as V.90, V.34, V.42bis and
V.32bis, and other common communications standards. These third parties claim
that our products utilize these patented technologies and have requested that we
enter into license agreements with them. We have also recently settled patent
infringement litigation against ESS Technology and Dr. Brent Townshend. Other
than the ESS Technology and Dr. Townshend lawsuits described below, no material
lawsuits relating to intellectual property are currently filed against us.

In addition, there are numerous risks that result from our reliance on our
proprietary technology in the conduct of our business. See "Risk Factors -- We
rely heavily on our intellectual property rights which offer only limited
protection against potential infringers. Unauthorized use of our technology may
result in development of products that compete with our products, which could
cause our market share and our revenues to be reduced."

COMPETITION

The Internet access device market is intensely competitive. Our current
competitors include Agere Systems, Broadcom, Conexant, ESS Technology and
SmartLink. We expect competition to increase in the future as current
competitors enhance their product offerings and new communication technologies
are introduced and deployed.

We may in the future also face competition from other suppliers of products
based on new or emerging communication technologies, which may render our
existing or future products obsolete or otherwise unmarketable. We believe that
these competitors may include 3Com, Alcatel, Analog Devices, GlobespanVirata,
Intersil, and Proxim.

We believe that the principal competitive factors required by users and
customers in the Internet access device market include compatibility with
industry standards, price, functionality, ease of use, customer service and
support. We believe that our products currently compete favorably in these
areas.

EMPLOYEES

As of December 31, 2001, we employed 112 people full-time, including 34 in
sales and marketing, 47 in research and development, and 31 in general and
administrative functions. None of our employees is represented by a labor union.
We consider our employee relations to be good.

4

EXECUTIVE OFFICERS

The following table sets forth information with respect to our executive
officers as of December 31, 2001:

Dr. Martin H. Singer has been our Chief Executive Officer and Chairman of
the Board since October 17, 2001. Prior to that, Dr. Singer has served as our
Non-Executive Chairman of the Board since February 2001 and a director for the
Company from August 1999. From October 2000 to May 2001, Dr. Singer served as
President and Chief Executive Officer of Ultra Fast Optical Systems, Inc. From
December 1997 to August 2000, Dr. Singer served as President and CEO of SAFCO
Technologies, Inc., a wireless communications company. He left SAFCO in August
2000 after its sale to Agilent Technologies. From September 1994 to December
1997, Dr. Singer served as Vice President and General Manager of the Wireless
Access Business Development Division for Motorola, Inc., a communications
equipment company. Prior to this period, Dr. Singer held senior management and
technical positions in Motorola Inc., Tellabs, Inc., AT&T and Bell Labs. Dr.
Singer holds a Bachelor of Arts in Psychology from the University of Michigan,
and a Master of Arts and a Ph.D. in Experimental Psychology from Vanderbilt
University.

Mr. John Schoen has been our Chief Operating Officer, Chief Financial
Officer and Secretary since November 12, 2001. Prior to that, Mr. Schoen was
Business Development Manager at Agilent Technologies. From May 1999 to July
2001, Mr. Schoen served as Chief Operating Officer and Chief Financial Officer
of SAFCO Technologies, Inc. before its acquisition by Agilent Technologies Inc.
Prior to this period, Mr. Schoen held various financial positions for over 19
years in Motorola Inc., including Controller of its Wireless Access Business
Development Division. Mr. Schoen received a Bachelor of Science in Accounting
from DePaul University and is a Certified Public Accountant.

Mr. Jeffrey A. Miller has been our Vice President of Engineering and
Development since November 7, 2001. Prior to that, Mr. Miller was Functional
Manager of Wireless Optimization Products at Wireless Network Test Division of
Agilent Technologies Inc. From January 1998 to July 2001, Mr. Miller served as
Vice President of Engineering of SAFCO Technologies, Inc. and led its Test and
Measurement Group before its acquisition by Agilent Technologies Inc. Prior to
this period, Mr. Miller held various technical positions in Motorola Inc.,
including its Cellular Infrastructure Group. Mr. Miller received a Bachelor of
Science in Computer Science from University of Illinois.

Mr. Mark Wilson has been our Vice President of Marketing since July 2000.
Before joining us, Mr. Wilson most recently served as director of product
management for privately-held NARUS, Inc., a leading provider of Internet
business infrastructure solutions. With more than twenty years of experience in
the industry, Mr. Wilson's portfolio of industry experience includes upper-level
management positions in firms such as Hewlett Packard, where he was charged with
market development and product management for the Internet Business Unit of the
VeriFone Division. While with Cirrus Logic, Inc., he served as Vice President of
Customer Marketing. Mr. Wilson also held the position of Vice President of OEM
Marketing at IBM Corporation's Storage Systems Division and was Vice President
of Marketing at Quantum Corporation. Mr. Wilson holds an MBA from Boston
University and an undergraduate degree in Electrical Engineering from the
University of Massachusetts.

ITEM 2: PROPERTIES

In September 1999, we entered into an operating lease for our new
headquarter facilities in Milpitas, California. This office building is 100,026
square feet and the lease expires February 2003. In addition, we have a
subsidiary office in Waterbury, Connecticut, an engineering office in Taipei,
Taiwan, and sales support

5

offices in Tokyo, Japan, Taipei, Taiwan, Seoul, Korea and Paris, France. We
believe that we have adequate space for our current needs.

As a result of the restructuring programs implemented in 2001, a portion of
our current headquarter facilities was closed and became available for rent. We
are currently actively marketing the excess facilities. As of December 31, 2001,
the idle space has not been subleased.

ITEM 3: LEGAL PROCEEDINGS

We record an accrual for estimated future royalty payments for relevant
technology of others used in our product offerings in accordance with SFAS No.
5, "Accounting for Contingencies." The estimated royalties accrual reflects
management's broader litigation and cost containment strategies, which may
include alternatives such as entering into cross-licensing agreements, cash
settlements and/or ongoing royalties based upon our judgment that such
negotiated settlements would allow management to focus more time and financial
resources on the ongoing business. We have accrued our best estimate of the
amount of royalties payable for royalty agreements already signed, agreements
that are in negotiation and unasserted but probable claims of others using
advice from third party technology advisors and historical settlements. Should
the final license agreements result in royalty rates significantly different
than our current estimates, our business, operating results and financial
condition could be materially and adversely affected.

PCTEL, Inc. v. Brent Townshend

In September 1998 and May 1999, Dr. Brent Townshend ("Townshend") alleged
by letter that our products infringe a number of patents owned by him and that
we owed him royalties. In May 2001, we filed a complaint against Townshend in
the U.S. District Court for the Northern District of California, contending that
Townshend's ITU-related patents are invalid, void, unenforceable and/or not
infringed ("Federal Court Action"). Our complaint also contends that Townshend's
patents are already licensed to us.

In September 2001, Townshend answered and filed a motion to dismiss the
complaint. Townshend also asserted counter-claims for patent infringement
against us seeking damages. Townshend sought exemplary and punitive damages and
asked that damages be increased three times the amount found or assessed,
alleging willful infringement. Townshend's answer also sought costs, fees,
interest and restitution. In January 2002, Townshend's motion to dismiss was
denied.

In September 2001, on behalf of ourselves and the general public, we filed
a complaint against Townshend and others in the California Superior Court for
unfair competition in the marketplace ("State Court Action"). This Superior
Court action was stayed, pending resolution of the U.S. District Court
litigation.

On March 19, 2002, Townshend entered into a settlement agreement with us,
which settled the Federal Court Action and State Court Action. Under the
Settlement Agreement, the terms of the settlement are confidential. The
Settlement Agreement required us to make a cash royalty payment on March 19,
2002 of $14.3 million related to past liability and prepayment of future
liabilities.

ESS Technology, Inc. v. PCTEL, Inc.

In April 1999, ESS Technology, Inc. ("ESS") filed a complaint against us in
the U.S. District Court for the Northern District of California, alleging that
we failed to grant licenses for some of our International Telecommunications
Union-related patents to ESS on fair, reasonable and non-discriminatory terms.
ESS's complaint includes claims based on antitrust law, patent misuse, breach of
contract and unfair competition. In its complaint, ESS also seeks a declaration
that some of our International Telecommunications Union-related patents are
unenforceable and that we should be ordered by the court to grant a license to
ESS on fair, reasonable and non-discriminatory terms.

We entered into a settlement agreement with ESS on February 5, 2002, which
settled this litigation matter and the litigation matter involving ESS pending
in the United States International Trade Commission

6

described below. The settlement required ESS to make an initial license payment
of $2.0 million and future royalty payments to us based on the terms under the
settlement agreement.

In the Matter of Certain HSP Modems, Software and Hardware Components Thereof,
and Products Containing the Same.

In September 2000, we filed a complaint under Section 337 of the Tariff Act
of 1930, as amended, with the United States International Trade Commission
("ITC"). Our complaint requested that the ITC commence an investigation into
whether Smart Link and ESS are engaged in unfair trade practices by selling for
importation into the United States, directly or indirectly importing into the
United States, or selling in the United States after importation devices which
infringe our patents.

Smart Link entered into a settlement agreement with us on May 17, 2001. The
settlement requires Smart Link to make royalty payments to us based on the terms
under the settlement agreement. The settlement did not have a material effect on
our financial position or operating results.

The hearing in this investigation against ESS took place from July 17, 2001
to July 27, 2001. In October 2001, the administrative law judge issued an
initial determination, which found that ESS infringes one of our key patents.

We entered into a settlement agreement and cross-license with ESS on
February 5, 2002, which settled this litigation matter and the litigation matter
between ESS and us pending in the United States District Court described above.
The settlement required ESS to make an initial license payment of $2.0 million
and future royalty payments to us based on the terms under the settlement
agreement. On February 22, 2002, ESS and us jointly filed a motion for
termination on the basis of the settlement agreement and on March 13, 2002, the
ITC granted the motion for termination.

Based on the settlements discussed above in the quarter ending March 31,
2002 and the settlement record within the modem industry, management has
re-evaluated its best estimate of accrued royalties, within a range of possible
settlement losses. We have concluded that these settlements do not have a
significant impact on our results of operations.

We are subject to various other claims which arise in the normal course of
business. In the opinion of management, the ultimate disposition of these claims
will not have a material adverse effect on our financial position, liquidity or
results of operations.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No stockholder votes took place during the fourth quarter of the year ended
December 31, 2001.

7

PART II

ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

PRICE RANGE OF COMMON STOCK

Our common stock has been traded on the Nasdaq National Market under the
symbol PCTI since our initial public offering on October 19, 1999. The following
table shows the high and low sale prices of our common stock as reported by the
Nasdaq National Market for the periods indicated.

The closing sale price of our common stock as reported on the Nasdaq
National Market on December 31, 2001, the last trading day of fiscal year 2001,
was $9.71 per share. As of that date there were 88 holders of record of our
common stock.

DIVIDENDS

We have never declared or paid cash dividends on our capital stock. We
currently intend to retain all of our earnings, if any, for use in our business
and do not anticipate paying any cash dividends in the foreseeable future. The
payment of any future dividends will be at the discretion of our Board of
Directors and will depend upon a number of factors, including future earnings,
the success of our business activities, regulatory capital requirements, the
general financial condition and our future prospects, general business
conditions and such other factors as the Board of Directors may deem relevant.

ITEM 6: SELECTED FINANCIAL DATA

The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," our Consolidated Financial Statements and related
notes and other financial information appearing elsewhere in this Form 10-K. The
statement of operations data for the years ended December 31, 2001, 2000 and
1999 and the balance sheet data as of December 31, 2001 and 2000 are derived
from audited financial statements included elsewhere in this Form 10-K. The
statement of operations data for the years ended December 31, 1998 and 1997 and
the balance sheet data as of December 31, 1999, 1998 and 1997 are derived from
audited financial statements not included in this Form 10-K. For the year ended
December 31, 2001, operating results include the $10.9 million provision for
inventory losses, the $3.8 million restructuring charges and the $16.8 million
impairment of goodwill and intangible assets related to our acquisitions of
Communications Systems Division ("CSD"), Voyager Technologies, Inc. ("Voyager")
and BlueCom Technology Corp. ("BlueCom"). The operating results for the year
ended December 31, 2000 include the $1.6 million write-off of in-process
research and development costs related to our acquisition of Voyager. For the
year ended December 31, 1998, operating results include the $6.1 million
write-off of in-process research and development costs related to our

8

acquisition of CSD. The operating results for the year ended December 31, 1999
include an extraordinary loss of $1.6 million related to the early
extinguishment of debt.

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

You should read the following discussion in conjunction with our
Consolidated Financial Statements and related notes appearing elsewhere in this
Form 10-K. Except for historical information, the following discussion contains
forward looking statements that involve risks and uncertainties, including
statements regarding our anticipated revenues, profits, costs and expenses and
revenue mix. These forward looking statements include, among others, those
statements including the words, "may," "will," "plans," "seeks," "expects,"
"anticipates," "intends," "believes" and words of similar import, constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. You should not place undue reliance on these
forward-looking statements. Our actual results could differ materially from
those anticipated in these forward-looking statements for many reasons,
including the risks faced by us described below and elsewhere in this Form 10-K,
and in other documents we file with the SEC. Factors that might cause future
results to differ materially from those discussed in the forward looking
statements include, but are not limited to, those discussed in "Business" and
elsewhere in this Form 10-K.

OVERVIEW

We provide cost-effective software-based communications solutions that
address high-speed Internet connectivity requirements for existing and emerging
technologies. Our communications products enable Internet access through PCs and
alternative Internet access devices. Our soft modem products consist of a
hardware chipset containing a proprietary host signal processing software
architecture which allows for the utilization of the computational and
processing resources of a host central processor, effectively replacing
special-purpose hardware required in conventional hardware-based modems.
Together, the combination of the chipset and software drivers are a component
part within a computer which allows for telecommunications connectivity. By
replacing hardware with a software solution, our host signal processing
technology lowers costs while enhancing capabilities.

From our inception in February 1994 through the end of 1995, we were a
development stage company primarily engaged in product development, product
testing and the establishment of strategic relationships with customers and
suppliers. From December 31, 1995 to December 31, 2000, our total headcount
increased from 18 to 198. In 2001, we reduced our headcount by 90 through
reductions in force. As of December 31, 2001, our total headcount was 112. We
first recognized revenue on product sales in the fourth quarter of 1995, and
became profitable in 1996, our first full year of product shipments. Revenues
increased from $24.0 million in 1997 to $33.0 million in 1998, $76.3 million in
1999 and $97.2 million in 2000. Since the fourth quarter of 2000, our customers,
primarily our PC motherboard and distribution manufacturers, were impacted by
significantly lower PC demand. As a result, our revenues decreased to $41.0
million in 2001. Because we expect PC demand to continue to be weak for the
foreseeable term, we expect our revenues and earnings to continue to be
negatively affected.

We sell soft modems to manufacturers and distributors principally in Asia
through our sales personnel, independent sales representatives and distributors.
Our sales to manufacturers and distributors in Asia were 91%, 91% and 99% of our
total sales for the years ended 2001, 2000 and 1999, respectively. The
predominance of our sales is in Asia because our customers are primarily
motherboard and modem manufacturers, and the

10

majority of these manufacturers are located in Asia. In many cases, our indirect
original equipment manufacturer customers specify that our products be included
on the modem boards or motherboards that they purchase from the board
manufacturers, and we sell our products directly to the board manufacturers for
resale to our indirect original equipment manufacturer customers, both in the
United States and internationally.

CRITICAL ACCOUNTING POLICIES

Our significant accounting policies are more fully described in Note 1 to
the consolidated financial statements included in this Form 10-K. The
preparation of our consolidated financial statements in accordance with
generally accepted accounting principles require us to make estimates and
judgments that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the period
reported. By their nature, these estimates and judgments are subject to an
inherent degree of uncertainty. Management bases its estimates and judgments on
historical experience, market trends, and other factors that are believed to be
reasonable under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions. Management believes the
following critical accounting policies affect its more significant judgments and
estimates used in the preparation of its consolidated financial statements.

REVENUE RECOGNITION

Revenues consist primarily of sales of products to OEMs and distributors.
Revenues from sales to customers are recognized upon shipment when title and
risk of loss passes to the customers, unless we have future obligations or have
to obtain customer acceptance, in which case revenue is not recorded until such
obligations have been satisfied or customer acceptance has been achieved. We
provide for estimated sales returns and customer rebates related to sales to
OEMs at the time of shipment. Customer rebates are recorded against receivables
to the extent that the gross amount has not been collected by the end customer.
Once the gross amount has been collected, the accrued customer rebate is then
reclassified to liabilities. As of December 31, 2001 and 2000, we have an
allowance for customer rebates against accounts receivable of $200,000 and $6.8
million, respectively, and accrued customer rebates of $2.1 million and $0,
respectively, presented as current liabilities on the balance sheet. Accrued
customer rebates will be paid to the customers, upon request, in the future
unless they are forfeited by the customer. Revenues from sales to distributors
are made under agreements allowing price protection and rights of return on
unsold products. We record revenue relating to sales to distributors only when
the distributors have sold the product to end-users. Customer payment terms
generally range from letters of credit collectible upon shipment to open
accounts payable 60 days after shipment.

We also generate revenues from engineering contracts. Revenues from
engineering contracts are recognized as contract milestones and customer
acceptance are achieved. Royalty revenue is recognized when confirmation of
royalties due to us is received from licensees. Furthermore, revenues from
technology licenses are recognized after delivery has occurred and the amount is
fixed and determinable, generally based upon the contract's nonrefundable
payment terms. To the extent there are extended payment terms on these
contracts, revenue is recognized as the payments become due and the cancellation
privilege lapses. To date, we have not offered post-contract customer support.

INVENTORY RESERVES

Due to the changing market conditions, recent economic downturn and
technological innovation, inventory valuation charges of $10.9 million were
recorded in the second half of 2001. Given the volatility of the market, the age
of the inventories on hand and the introduction of new products in 2002, we
wrote down excess inventories to net realizable value based on forecasted demand
and the firm purchase order commitments from our major suppliers. Of the $10.9
million inventory valuation charges recorded, $2.3 million is related to firm
purchase order commitments and the remaining $8.6 million is related to excess
inventories on hand or disposed. Actual demand may differ from forecasted demand
and such difference may have a material effect on our financial position and
results of operations. In addition to the reserve for excess

11

inventory, we also provide for an allowance against obsolete inventory. As of
December 31, 2001, there is an allowance for inventory obsolescence of $1.4
million.

ACCRUED ROYALTIES

We record an accrual for estimated future royalty payments for relevant
technology of others used in our product offerings in accordance with SFAS No.
5, "Accounting for Contingencies." The estimated royalties accrual reflects
management's broader litigation and cost containment strategies, which may
include alternatives such as entering into cross-licensing agreements, cash
settlements and/or ongoing royalties based upon our judgment that such
negotiated settlements would allow management to focus more time and financial
resources on the ongoing business. Accordingly, the royalties accrual reflects
estimated costs of settling claims rather than continuing to defend our legal
positions, and is not intended to be, nor should it be interpreted as, an
admission of infringement of intellectual property, valuation of damages
suffered by any third parties or any specific terms that management has
predetermined to agree to in the event of a settlement offer. We have accrued
our best estimate of the amount of royalties payable for royalty agreements
already signed, agreements that are in negotiation and unasserted but probable
claims of others using advice from third party technology advisors and
historical settlement rates.

As of December 31, 2001 and 2000, we had accrued royalties of approximately
$12.3 million and $11.7 million, respectively. However, the amounts accrued may
be inadequate and we will be required to take an immediate charge if royalty
payments are settled at a higher rate than expected, or if we do not prevail in
the litigation. In addition, settlement arrangements may require royalties for
both past and future sales of the associated products. If this is the case, in
addition to an immediate charge if our accrual is inadequate, our gross margins
will decrease on these future product sales. As a result of the litigation
settlement with Townshend, we made a cash royalty payment of $14.3 million
related to past liability and prepayment of future liabilities to Townshend in
March 2002. See discussion under "Contingencies" in Note 11 for the impact of
settlement on our financial position and results of operations.

INCOME TAXES

We currently operate with subsidiaries in the Cayman Islands and Japan as
well as branch offices in Taiwan, Korea and France. The complexities brought on
by operating in several different tax jurisdictions inevitably lead to an
increased exposure to worldwide tax challenges. Should the tax authorities
challenge us and the tax challenges result in unfavorable outcomes, our
operating results and financial position could be materially and adversely
affected.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(ALL AMOUNTS IN TABLES, OTHER THAN PERCENTAGES, ARE IN THOUSANDS)

REVENUES

Our revenues primarily consist of product sales of soft modems to board
manufacturers and distributors in Asia. Revenues decreased $56.2 million for the
year ended December 31, 2001 from 2000. The revenue decrease was primarily
attributable to 53% less unit shipments as a result of an abnormally poor PC
market due to poor economic conditions. Additionally, the decrease in sales
revenues was due to downward pressure on average selling prices commonly seen in
the industry. Our average selling prices decreased 9% from 2000 to 2001, mainly
due to the downward pricing pressure which is commonly seen in the industry.
Because we expect PC demand to continue to be weak for the foreseeable term, we
expect our revenues to continue to be negatively affected in 2002.

12

Revenues increased $20.9 million for the year ended December 31, 2000
compared to the same period in 1999. These increases were attributable to
increased units sold to tier-one OEMs such as Compaq Corporation, Intel
Corporation, Fujitsu Limited and NEC Corporation, and to a lesser extent,
increased license revenues recognized during fiscal year 2000. The increase in
sales volume was partly offset by downward pressure on average selling prices
and sales discounts to customers.

GROSS PROFIT

Cost of revenues consists primarily of chipsets we purchase from third
party manufacturers and also includes amortization of intangibles related to the
CSD acquisition, accrued intellectual property royalties, cost of operations,
provision for inventory obsolescence and distribution costs. Provision for
inventory losses are also included in the determination of gross profit.

Gross profit decreased $41.1 million for the year ended December 31, 2001
compared to the same period last year primarily due to decreased sales revenues
and the provision for inventory losses of $10.9 million recorded in the second
half of 2001. Gross margin as a percentage of revenue decreased from 44.5% for
the year ended December 31, 2000 to 5.3% for the year ended December 31, 2001
because of the provision for inventory losses and because average selling prices
decreased faster than the rate of cost reduction. In addition, the fixed portion
of our costs as a percentage of revenue increased due to the decrease in
revenues. We expect the gross profit and gross margin as a percentage of revenue
in 2002 to be higher than 2001 as we do not expect to record additional
provision for inventory losses in 2002 and licensing/royalty revenue as a
percentage of revenues will be higher in 2002 as a result of the ESS litigation
settlement, offset by the continuing pressure for price decreases.

Gross profit increased $6.4 million for the year ended December 31, 2000
compared to 1999 due to increased volume, partially offset by a decline in the
per-unit average gross profit. Gross profit as a percentage of revenue decreased
from 48.3% for the year ended December 31, 1999 to 44.5% for the year ended
December 31, 2000 because of a shift to higher volume, lower margin sales to
OEMs and, generally, average selling prices decreased faster than the rate of
cost reductions. On the other hand, higher-margin license revenues favorably
impacted gross margins during the year, partially offsetting the decrease from
average selling prices.

RESEARCH AND DEVELOPMENT

Research and development expenses include compensation costs for software
and hardware development, prototyping, certification and pre-production costs.
We expense all research and development costs as incurred.

Research and development expenses decreased $2.6 million for the year ended
December 31, 2001 compared to 2000 as a result of the completion of certain
projects and the reduction in headcount gradually through the year. As a
percentage of revenues, research and development increased for the year ended
December 31, 2001 because of lower revenues in 2001. Research and development
headcount decreased from 76 to 47 from December 31, 2000 to December 31, 2001.
We expect research and development expenses, as a percentage of revenues, to be
lower in 2002 because of lower average headcount. However, in the event that

13

we decide to pursue new research and development opportunities, research and
development expenses may increase in 2002.

Research and development expenses increased $3.8 million for the year ended
December 31, 2000 compared to 1999 as we continued to invest heavily in the
development of the G.DMT, wireless and embedded modems, as well as a V.92
upgrade.

SALES AND MARKETING

Sales and marketing expenses consist primarily of personnel costs, sales
commissions and marketing costs. Sales commissions payable to our distributors
are recognized when our products are "sold through" from the distributors to
end-users so that the commission expense is matched with related recognition of
revenues. Marketing costs include promotional costs, public relations and trade
shows.

Sales and marketing expenses decreased $3.4 million for the year ended
December 31, 2001 compared to 2000. The decrease in spending reflects the
reduction of sales and marketing personnel as a result of lower revenues and the
reduction in force in 2001. Sales and marketing headcount decreased from 75 to
34 from December 31, 2000 to December 31, 2001. We expect sales and marketing
expenses, as a percentage of revenues, to be lower in 2002 because of lower
average headcount.

Sales and marketing expenses increased $3.8 million for the year ended
December 31, 2000 compared to 1999. The increase reflects the increased costs to
support higher sales and the addition of sales and marketing personnel to
develop new accounts and drive new product development and product launches.
Public relation costs, trade shows, press tours, sales programs, the production
of collateral sales materials and travel costs also increased from 1999.

GENERAL AND ADMINISTRATIVE

General and administrative expenses include costs associated with our
general management and finance functions as well as professional service
charges, such as legal, tax and accounting fees. Other general expenses include
rent, insurance, utilities, travel and other operating expenses to the extent
not otherwise allocated to other functions.

General and administrative expenses increased $6.0 million for the year
ended December 31, 2001 compared to 2000. The increase was primarily due to the
increased legal costs associated with the patent infringement litigation against
Smart Link, ESS and Townshend. We expect that our general and administrative
expenses will be significantly lower in 2002 as a result of reaching a
settlement with Smart Link in 2001 and ESS and Townshend in early 2002. However,
should any new litigation arise in 2002, our legal costs and general and
administrative expenses could significantly increase.

General and administrative expenses increased $2.6 million for the year
ended December 31, 2000 compared to 1999. The increase was primarily due to our
increase in staffing and related infrastructure to support our growth and the
legal costs associated with the patent infringement litigation against Smart
Link and ESS.

14

ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT

Upon completion of the Voyager acquisition on February 24, 2000, we
immediately expensed $1.6 million representing purchased in-process technology
that had not yet reached technological feasibility and had no alternative future
use. The $1.6 million expensed as in-process research and development was
approximately 9% of the purchase price and was attributed and supported by a
discounted cash flow analysis that identified revenues and costs on a project by
project basis. The value assigned to purchased in-process technology, based on a
percentage of completion discounted cash flow method, was determined by
identifying research projects in areas for which technological feasibility has
not been established. The following in-process projects existed at Voyager as of
the acquisition date: Bluetooth, HomeRF, Direct Sequence Cordless,
Bluetooth/HomeRF Combo, Bluetooth/HomeRF/Direct Sequence, Wireless Gas Tank
Sensor, Wireless GPS and Wireless Industrial Garage Door Opener projects.

The value of in-process research and development was determined by
estimating the costs to develop the purchased in-process technology into
commercially viable products, estimating the resulting net cash flows from such
projects and discounting the net cash flows back to their present value. The
discount rate includes a risk adjusted discount rate to take into account the
uncertainty surrounding the successful development of the purchased in-process
technology. The risk-adjusted discount rate applied to the projects' cash flows
was 15% for existing technology and 20% for the in-process technology. Based
upon assessment of each in-process project's development stage, including
relative difficulty of remaining development milestones, it was determined that
application of a 20% discount rate was appropriate for all acquired in-process
projects. The valuation includes cash inflows from in-process technology through
2005 with revenues commencing in 2000 and increasing significantly in 2001
before declining in 2005. The projected total revenue of Voyager was broken down
to revenue attributable to the in-process technologies, existing technologies,
core technology and future technology. The revenue attributable to core
technology was determined based on the extent to which the in-process
technologies rely on the already developed intellectual property. The Bluetooth
and HomeRF projects were approximately 25% complete at the time of the valuation
and the expected timeframe for achieving these product releases was assumed to
be in the second half of 2000. The Direct Sequence Cordless project was
approximately 65% complete at the time of the valuation and the expected time
frame for achieving this product release was assumed to be in the second half of
2000. The Bluetooth/HomeRF Combo and Bluetooth/HomeRF/Direct Sequence projects
were approximately 10% complete at the time of the valuation and the expected
timeframe for achieving these product releases was assumed to be in the second
half of 2000 and the first half of 2000, respectively. The Wireless Gas Tank
Sensor and the Wireless Industrial Garage Door Opener projects were
approximately 70% complete at the time of the valuation and the expected time
frame for achieving these product releases was assumed to be 2001. The Wireless
GPS was approximately 50% complete at the time of the valuation and the expected
time frame for achieving this product release was assumed to be in the second
half of 2000. The percentage complete calculations for all projects were
estimated based on research and development expenses incurred to date and
management estimates of remaining development costs. Significant remaining
development efforts were to be completed in the next 6 to 18 months in order for
Voyager's projects to become implemented in a commercially viable timeframe.
Management's cash flow and other assumptions utilized at the time of acquisition
did not materially differ from historical pricing/licensing, margin, and expense
levels of the Voyager group prior to acquisition.

Approximately $0.5 million was attributed to core wireless technology and
royalty revenue associated with the Wireless Water Meter Reading Device project.

15

AMORTIZATION OF GOODWILL AND INTANGIBLE ASSETS

On December 14, 2000, we completed the acquisition of BlueCom. The purchase
price of BlueCom was allocated based upon the estimated fair value of the assets
acquired and liabilities assumed, which approximated book value. The acquisition
was accounted for under the purchase method of accounting. Under this method, if
the purchase price exceeds the net tangible assets acquired, the difference is
recorded as excess purchase price. In this circumstance, the difference was $1.8
million which was attributed to goodwill ($1,124,000) and a covenant not to
compete ($656,000). We classified this balance of $1.8 million as goodwill and
other intangible assets, net, in the accompanying consolidated balance sheets
and were amortizing it over useful lives of two to five years prior to the
impairment recorded in the quarter ended December 31, 2001 (see below).

On February 24, 2000, we completed the acquisition of Voyager. The purchase
price of Voyager was allocated based upon the estimated fair value of the assets
acquired and liabilities assumed, which approximated book value. The acquisition
was structured as a tax-free reorganization and was accounted for under the
purchase method of accounting. Under this method, if the purchase price exceeds
the net tangible assets acquired, the difference is recorded as excess purchase
price. In this circumstance, the difference was $17.8 million. We attributed
$1.6 million of the excess purchase price to in-process research and
development, which we expensed immediately, and the balance of $16.2 million was
attributed to intellectual property ($0.5 million), workforce ($0.3 million) and
goodwill ($15.4 million). We classified this balance of $16.2 million as
goodwill and other intangible assets, net, in the accompanying consolidated
balance sheets and were amortizing it over useful lives of five years prior to
the impairment recorded in the quarter ended September 30, 2001 (see below).

In July 2001, the Financial Accounting Standards Board issued SFAS No.'s
141 and 142, "Business Combinations" and "Goodwill and Other Intangibles". SFAS
No. 141 requires all business combinations initiated after June 30, 2001 to be
accounted for using the purchase method. Under SFAS No. 142, goodwill and
intangible assets with indefinite lives are not amortized but are subject to at
least an annual assessment for impairment applying a fair-value based test.
Effective January 1, 2002, existing goodwill will no longer be amortized.
Additionally, an acquired intangible asset should be separately recognized if
the benefit of the intangible asset is obtained through contractual or other
legal rights, or if the intangible asset can be sold, transferred, licensed,
rented, or exchanged, regardless of the acquirer's intent to do so. Upon
adoption of SFAS No. 142 on January 1, 2002, we will no longer amortize
goodwill, thereby eliminating annual goodwill amortization of approximately
$192,000, based on anticipated amortization for 2002.

IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS

In the second half of 2001, pursuant to SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," we
evaluated the recoverability of the long-lived assets, including intangibles,
acquired from CSD, Voyager and BlueCom, and recorded impairment charges totaling
$16.8 million. Due to the recent economic downturn, we determined that CSD's
estimated future undiscounted cash flows were below the carrying value of CSD's
long-lived assets. Accordingly, during the third quarter of 2001, we adjusted
the carrying value of CSD's long-lived assets, primarily goodwill, to their
estimated fair value of approximately $0.4 million, resulting in an impairment
charge of approximately $4.5 million. The estimated fair value was based on
anticipated future cash flows discounted at a rate commensurate with the risk
involved. In regards to the goodwill and intangible assets acquired from
Voyager, as a result of the recent corporate restructuring and reorganization,
we determined that there are no future

16

cash flows expected from this business. Accordingly, during the third quarter of
2001, we wrote off the carrying value of Voyager's long-lived assets, primarily
goodwill, resulting in an impairment charge of approximately $11.1 million. In
regards to the goodwill and intangible assets acquired from BlueCom, as a result
of the recent corporate restructuring and reorganization, we determined that
there are no future cash flows expected from this business. Accordingly, during
the fourth quarter of 2001, we wrote off the carrying value of BlueCom's
long-lived assets, resulting in an impairment charge of approximately $1.2
million.

RESTRUCTURING CHARGES

On February 8, 2001, we announced a series of actions to streamline support
for our voiceband business and sharpen our focus on emerging growth sectors.
These measures were part of a restructuring program to return the company to
profitability and operational effectiveness and included a reduction in
worldwide headcount of 7 research and development employees, 9 sales and
marketing employees and 6 general and administrative employees, a hiring freeze
and cost containment programs. On May 1, 2001, we announced a new business
structure to provide greater focus on our activities with a significantly
reduced workforce. 13 research and development, 12 sales and marketing and 17
general and administrative positions were eliminated as part of this
reorganization. In the fourth quarter of 2001, 7 research and development, 8
sales and marketing and 11 general and administrative positions were eliminated
to further focus our business. In total, 90 positions were eliminated during the
year ended December 31, 2001. The restructuring resulted in $3.8 million of
charges for the year ended December 31, 2001, consisting of severance and
employment related costs of $2.5 million and costs related to closure of excess
facilities of $1.3 million as a result of the reduction in force.

AMORTIZATION OF DEFERRED STOCK COMPENSATION

In connection with the grant of stock options to employees prior to our
initial public offering in 1999, we recorded deferred stock compensation of $5.4
million representing the difference between the exercise price and deemed fair
value of our common stock on the date these stock options were granted. Such
amount is presented as a reduction of stockholders' equity and is amortized
ratably over the vesting period of the applicable options. The amount of
deferred stock compensation expense to be recorded in future periods could
decrease if options for which accrued but unvested compensation has been
recorded are forfeited.

In connection with the grant of restricted stock to employees in 2001, we
recorded deferred stock compensation of $1.8 million representing the fair value
of our common stock on the date the restricted stock was granted. Such amount is
presented as a reduction of stockholders' equity and is amortized ratably over
the vesting period of the applicable shares. Subsequent to the issuance of the
restricted stock, employee terminations resulted in the reversal of $859,000
from deferred stock compensation. The amount of deferred stock compensation
expense to be recorded in future periods could decrease if options for which
accrued but unvested compensation has been recorded are forfeited.

The amortization of deferred stock compensation decreased $227,000 for the
year ended December 31, 2001 compared to 2000 primarily due to the termination
of employees in 2001 and the corresponding reversal of the remaining deferred
stock compensation balance, offset by the additional expense related to the
restricted stock grants in 2001. We expect the amortization of deferred stock
compensation to decrease to approximately $170,000 per quarter through 2003,
based on restricted stock grants and stock option grants through December 31,
2001.

17

The amortization of deferred stock compensation increased $518,000 for the
year ended December 31, 2000 compared to 1999 because 2000 reflected a full year
of amortization whereas 1999 reflected amortization from the date of grant, and
there were more grants in the second half of 1999.

In December 2000, an employee and the Company mutually agreed to rescind an
option exercise to purchase 30,000 shares of common stock which occurred in
January 2000. There was no effect on our financial position or results of
operations for the year ended December 31, 2000 as a result of this rescission.

OTHER INCOME, NET

Other income, net, consists of interest income, net of interest expense.
Interest income is expected to fluctuate over time, depending on future interest
rates. Other income, net, decreased $1.1 million for the year ended December 31,
2001 compared to 2000 primarily due to the decrease in interest rates in 2001.

Other income, net, increased $7.0 million for the year ended December 31,
2000 compared to 1999 primarily due to interest earned on the proceeds from our
initial and secondary public offerings and the elimination of interest expense
on the loan used to acquire Communications Systems Division.

PROVISION FOR INCOME TAXES

During the third quarter of 2001, we recorded $5.3 million of provision for
income taxes to establish valuation allowances against deferred tax assets in
accordance with the provisions of FASB No. 109, "Accounting for Income Taxes" as
a result of uncertainties regarding realizability. After the establishment of
the valuation allowances, we have $400,000 in remaining net deferred tax assets
as of December 31, 2001.

We had $5.7 million in deferred tax assets as of December 31, 2000. Our
effective tax rate was below the statutory tax rate of 35% due to international
sales and profits through our wholly owned subsidiaries, which are taxed at
rates below the statutory tax rate in the U.S.

EXTRAORDINARY ITEMS

On October 25, 1999, we retired $15.0 million of notes payable with
proceeds from the initial public offering. In connection with the early
retirement of debt, we incurred a $1.6 million, net of taxes, extraordinary loss
of prepayment penalties and the write-off of deferred debt charges.

LIQUIDITY AND CAPITAL RESOURCES

For the year ended December 31, 2001, net cash provided by operating
activities was $4.3 million, compared to net cash used in operating activities
of $5.2 million for the year ended December 31, 2000. The primary source of cash
provided by operating activities for the year ended December 31, 2001 was the
decrease in accounts receivable and inventories. Net cash provided by investing
activities for the year ended December 31, 2001 consisted of maturities and
sales of short-term investments of $82.1 million, offset by

18

purchases of property and equipment of $702,000 and purchases of short-term
investments of $75.8 million. Net cash provided by financing activities for the
year ended December 31, 2001 consisted of proceeds from issuance of common stock
from stock option exercises and shares issued through the employee stock
purchase plan.

As of December 31, 2001, we had $125.6 million in cash, cash equivalents
and short-term investments, and working capital of $104.5 million. Accounts
receivable, as measured in days sales outstanding ("DSO"), was 34 days at
December 31, 2001 compared to 130 days in December 31, 2000. The decrease in DSO
from December 31, 2000 to 2001 was primarily due to lower revenue in 2001 and
the increased cash collection efforts throughout 2001.

The decrease in net cash provided by operating activities for 2000 compared
to 1999 was primarily due to the increase in accounts receivable. Net cash used
in investing activities for 2000 consisted of the acquisition of Voyager
Technologies and BlueCom Technology of $5.1 million, purchases of property and
equipment of $3.0 million and purchases of short-term investments of $109.6
million, offset by maturities and sales of short-term investments of $70.6
million. Net cash provided by financing activities for 2000 consisted of
proceeds from issuance of common stock associated with the secondary public
offering and proceeds from stock option exercises and shares issued through the
employee stock purchase plan.

We believe that our existing sources of liquidity, consisting of cash,
short-term investments and cash from operations, will be sufficient to meet our
working capital for the foreseeable future, after the $14.3 million cash royalty
payment to Townshend discussed in Note 11. We will continue to evaluate
opportunities for development of new products and potential acquisitions of
technologies or businesses that could complement our business. We may use
available cash or other sources of funding for such purposes. However, possible
investments in or acquisitions of complementary businesses, products or
technologies, or cash settlements resulting from existing or new litigation, may
require us to use our existing working capital or to seek additional financing.
In addition, if the current economic downturn prolongs, we will need to continue
to expend our cash reserves to fund our operations. As of December 31, 2001, we
have outstanding firm inventory purchase order commitments with our major
suppliers of $3.0 million, of which $2.3 million was accrued as inventory
losses, and non-cancelable operating leases for office facilities of $1.8
million through 2005.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No.'s 141 and 142,
"Business Combinations" and "Goodwill and Other Intangible Assets". SFAS No. 141
requires all business combinations initiated after June 30, 2001 to be accounted
for using the purchase method. Under SFAS No. 142, goodwill and intangible
assets with indefinite lives are not amortized but are subject to at least an
annual assessment for impairment applying a fair-value based test. Effective
January 1, 2002, existing goodwill will no longer be amortized. Additionally, an
acquired intangible asset should be separately recognized if the benefit of the
intangible asset is obtained through contractual or other legal rights, or if
the intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so. Upon adoption of SFAS No. 142 on
January 1, 2002, we will no longer amortize goodwill, thereby eliminating annual
goodwill amortization of approximately $192,000, based on anticipated
amortization for 2002.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 supercedes SFAS No.
121 by requiring that one accounting model be used for long-lived assets to be
disposed of by sale, whether previously held and used or newly acquired and by
broadening the presentation of discontinued operations to include more disposal
transactions. The Statement will be effective for fiscal years beginning after
December 15, 2001. We do not expect that the adoption of SFAS No. 144 will have
a material impact on our financial position or results of operations.

19

FACTORS THAT MAY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND FUTURE OPERATING
RESULTS

This annual report on Form 10-K, including this Management's Discussion and
Analysis, contains forward-looking statements. These forward-looking statements
are subject to substantial risks and uncertainties that could cause our future
business, financial condition or results of operations to differ materially from
our historical results or currently anticipated results, including those set
forth below.

RISKS RELATED TO OUR BUSINESS

THE RECENT ECONOMIC SLOWDOWN, PARTICULARLY THE RAPID DETERIORATION IN PC DEMAND,
MAKES IT DIFFICULT TO FORECAST CUSTOMER DEMAND FOR OUR PRODUCTS, AND WILL LIKELY
RESULT IN EXCESSIVE OPERATING COSTS AND LOSS OF PRODUCT REVENUES.

Since the fourth quarter of 2000, our customers, primarily our PC
motherboard and distribution manufacturers, have been impacted by significantly
lower PC demand. As a result, our revenues and earnings in fiscal year of 2001
were negatively affected. Because we expect PC demand to continue to be weak for
the foreseeable term, we expect our revenues and earnings to continue to be
negatively affected.

In addition, the current economic environment also makes it extremely
difficult for us to forecast customer demand for our products. We must forecast
and place purchase orders for specialized semiconductor chips several months
before we receive purchase orders from our own customers. This forecasting and
order lead time requirement limits our ability to react to unexpected
fluctuations in demand for our products. These fluctuations can be unexpected
and may cause us to have excess inventory or a shortage of a particular product.
During the second half of 2001, due to the changing market conditions, recent
economic downturn and technological innovation, a provision for inventory losses
of $10.9 million was charged against operations. Given the volatility of the
market, the age of the inventories on hand and the introduction of a new
products in 2002, we wrote down inventories to net realizable value based on
forecasted demand and firm purchase order commitments from our major suppliers.
Of the $10.9 million inventory valuation charges recorded, $2.3 million is
related to firm purchase order commitments with our major suppliers and the
remaining $8.6 million is related to excess inventory on hand or disposed.
Actual demand may differ from forecasted demand and such difference may have a
material effect on our financial position and result of operations.

OUR SALES ARE CONCENTRATED AMONG A LIMITED NUMBER OF CUSTOMERS AND THE LOSS OF
ONE OR MORE OF THESE CUSTOMERS COULD CAUSE OUR REVENUES TO DECREASE.

Our sales are concentrated among a limited number of customers. If we were
to lose one or more of these customers, or if one or more of these customers
were to delay or reduce purchases of our products, our sales revenues may
decrease. For the year ended December 31, 2001, approximately 79% of our
revenues were generated by three of our customers, with one customer
representing 47% of revenues, another customer representing 22% and a third
customer representing 10% of revenues. These customers may in the future decide
not to purchase our products at all, purchase fewer products than they did in
the past or alter their purchasing patterns, because:

- we do not have any long-term purchase arrangements or contracts with
these or any of our other customers,

- our product sales to date have been made primarily on a purchase order
basis, which permits our customers to cancel, change or delay product
purchase commitments with little or no notice and without penalty, and

- many of our customers also have pre-existing relationships with current
or potential competitors which may affect our customers' purchasing
decisions.

We expect that a small number of customers will continue to account for a
substantial portion of our revenues for at least the next 12 to 18 months and
that a significant portion of our sales will continue to be

20

made on the basis of purchase orders. Our number of customers may be reduced in
the future through mergers in the PC OEM sector, such as HP and Compaq.

CONTINUING DECREASES IN THE AVERAGE SELLING PRICES OF OUR PRODUCTS COULD RESULT
IN DECREASED REVENUES.

Product sales in the connectivity industry have been characterized by
continuing erosion of average selling prices. Price erosion experienced by any
company can cause revenues and gross margins to decline. The average selling
price of our products has decreased by approximately 9% from fiscal year 2000 to
fiscal year 2001. We believe that the average selling price of our products is
likely to continue to decline in the future due principally to competition
pressure.

In addition, we believe that the widespread adoption of industry standards
in the soft modem industry is likely to further erode average selling prices,
particularly for analog modems. Adoption of industry standards is driven by the
market requirement to have interoperable modems. End-users need this
interoperability to ensure modems from different manufacturers communicate with
each other without problems. Historically, users have deferred purchasing modems
until these industry standards are adopted. However, once these standards are
accepted, it lowers the barriers to entry and price erosion results. Decreasing
average selling prices in our products could result in decreased revenues even
if the number of units that we sell increases. Therefore, we must continue to
develop and introduce next generation products with enhanced functionalities
that can be sold at higher gross margins. Our failure to do this could cause our
revenues and gross margin to decline.

OUR GROSS MARGINS MAY VARY BASED ON THE MIX OF SALES OF OUR PRODUCTS AND
SERVICES, AND THESE VARIATIONS MAY HURT OUR NET INCOME.

We derive a significant portion of our sales from our software-based
connectivity products. We expect margins on newly introduced products generally
to be higher than our existing products. However, due in part to the competitive
pricing pressures that affect our products and in part to increasing component
and manufacturing costs, we expect margins from both existing and future
products to decrease over time. In addition, licensing revenues from our
intellectual property historically have provided higher margins than our product
sales. Changes in the mix of products sold and the percentage of our sales in
any quarter attributable to products as compared to licensing revenues will
cause our quarterly results to vary and could result in a decrease in gross
margins and net income.

WE HAVE SIGNIFICANT SALES CONCENTRATED IN ASIA. CONTINUED POLITICAL AND ECONOMIC
INSTABILITY IN ASIA AND DIFFICULTY IN COLLECTING ACCOUNTS RECEIVABLE MAY MAKE IT
DIFFICULT FOR US TO MAINTAIN OR INCREASE MARKET DEMAND FOR OUR PRODUCTS.

Our sales to customers located in Asia accounted for 91% of our total
revenues for the year ended December 31, 2001. The predominance of our sales is
in Asia, mostly in Taiwan and China, because our customers are primarily
motherboard or modem manufacturers that are located there. In many cases, our
indirect original equipment manufacturer customers specify that our products be
included on the modem boards or motherboards, the main printed circuit board
containing the central processing unit of a computer system, that they purchase
from board manufacturers, and we sell our products directly to the board
manufacturers for resale to our indirect original equipment manufacturer
customers, both in the United States and internationally. Due to the industry
wide concentration of modem manufacturers in Asia, we believe that a high
percentage of our future sales will continue to be concentrated with Asian
customers. As a result, our future operating results could be uniquely affected
by a variety of factors outside of our control, including:

- delays in collecting accounts receivable, which we have experienced from
time to time,

- fluctuations in the value of Asian currencies relative to the U.S.
dollar, which may make it more costly for us to do business in Asia and
which may in turn make it difficult for us to maintain or increase our
revenues,

21

- changes in tariffs, quotas, import restrictions and other trade barriers
which may make our products more expensive compared to our competitors'
products, and

- political and economic instability.

OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP AND SUCCESSFULLY INTRODUCE
NEW AND ENHANCED PRODUCTS THAT MEET THE NEEDS OF OUR CUSTOMERS.

Our revenue depends on our ability to anticipate our customers' needs and
develop products that address those needs. In particular, our success will
depend on our ability to introduce new products for the wireless market.
Introduction of new products and product enhancements will require coordination
of our efforts with those of our suppliers to rapidly achieve volume production.
If we fail to coordinate these efforts, develop product enhancements or
introduce new products that meet the needs of our customers as scheduled, our
revenues may be reduced and our business may be harmed. We cannot assure you
that product introductions will meet the anticipated release schedules.

OUR REVENUES MAY FLUCTUATE EACH QUARTER DUE TO BOTH DOMESTIC AND INTERNATIONAL
SEASONAL TRENDS.

We have experienced and expect to continue to experience seasonality in
sales of our connectivity products. These seasonal trends materially affect our
quarter-to-quarter operating results. Our revenues are typically higher in the
third and fourth quarters due to the back-to-school and holiday as well as
purchasers of PCs making purchase decisions based on their calendar year-end
budgeting requirements.

We are currently expanding our sales in international markets, particularly
in Asia, Europe. To the extent that our revenues in Asia, Europe or other parts
of the world increase in future periods, we expect our period-to-period revenues
to reflect seasonal buying patterns in these markets.

ANY DELAYS IN OUR NORMALLY LENGTHY SALES CYCLES COULD RESULT IN CUSTOMERS
CANCELING PURCHASES OF OUR PRODUCTS.

Sales cycles for our products with major customers are lengthy, often
lasting nine months or longer. In addition, it can take an additional nine
months or more before a customer commences volume production of equipment that
incorporates our products. Sales cycles with our major customers are lengthy for
a number of reasons:

- our original equipment manufacturer customers usually complete a lengthy
technical evaluation of our products, over which we have no control,
before placing a purchase order,

- the commercial integration of our products by an original equipment
manufacturer is typically limited during the initial release to evaluate
product performance, and

- the development and commercial introduction of products incorporating new
technologies frequently are delayed.

A significant portion of our operating expenses is relatively fixed and is
based in large part on our forecasts of volume and timing of orders. The lengthy
sales cycles make forecasting the volume and timing of product orders difficult.
In addition, the delays inherent in lengthy sales cycles raise additional risks
of customer decisions to cancel or change product phases. If customer
cancellations or product changes were to occur, this could result in the loss of
anticipated sales without sufficient time for us to reduce our operating
expenses.

WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY RIGHTS WHICH OFFER ONLY LIMITED
PROTECTION AGAINST POTENTIAL INFRINGERS. UNAUTHORIZED USE OF OUR TECHNOLOGY MAY
RESULT IN DEVELOPMENT OF PRODUCTS THAT COMPETE WITH OUR PRODUCTS, WHICH COULD
CAUSE OUR MARKET SHARE AND OUR REVENUES TO BE REDUCED.

Our success is heavily dependent upon our proprietary technology. We rely
primarily on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights. These means of protecting our proprietary rights may not be
adequate. We have over 80 patents granted or pending addressing both essential
ITU and non-essential technologies. These

22

patents may never be issued. These patents, both issued and pending, may not
provide sufficiently broad protection against third party infringement lawsuits
or they may not prove enforceable in actions against alleged infringers.

Despite precautions that we take, it may be possible for unauthorized third
parties to copy aspects of our current or future products or to obtain and use
information that we regard as proprietary. We may provide our licensees with
access to our proprietary information underlying our licensed applications.
Additionally, our competitors may independently develop similar or superior
technology. Finally, policing unauthorized use of software is difficult, and
some foreign laws, including those of various countries in Asia, do not protect
our proprietary rights to the same extent as United States laws. Litigation may
be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. Litigation could result in substantial costs and
diversion of resources.

WE ARE SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY, WHICH HAS DIVERTED
MANAGEMENT ATTENTION, IS COSTLY TO DEFEND AND COULD PREVENT US FROM USING OR
SELLING THE CHALLENGED TECHNOLOGY.

From time to time, we have been subject to legal proceedings and claims
with respect to such matters as patents, product liabilities and other actions
arising out of the normal course of business.

We have recently settled two significant patent infringement lawsuits, as
described in more detail in Management's Discussion and Analysis of Financial
Condition and Results of Operations and Note 11 in this Form 10-K. We entered
into a settlement agreement with ESS on February 5, 2002. The settlement
requires ESS to make an initial license payment of $2.0 million and future
royalty payments to us based on the terms under the settlement agreement. On
March 19, 2002, Townshend entered into a settlement agreement with us, which
settled the Federal Court Action and State Court Action. Under the Settlement
Agreement, terms of the settlement are confidential. The Settlement Agreement
requires us to make a cash royalty payment of $14.3 million related to past
liability and prepayment of future liabilities to Townshend based on terms under
the Settlement Agreement. See discussion under "Contingencies" in Note 11 for
the impact of settlement on our financial position and results of operations.

We have also received communications from Agere Systems and 3Com, and may
receive communications from other third parties in the future, asserting that
our products infringe on their intellectual property rights, that our patents
are unenforceable or that we have inappropriately licensed our intellectual
property to third parties. These claims could affect our relationships with
existing customers and may prevent potential future customers from purchasing
our products or licensing our technology. Because we depend upon a limited
number of products, any claims of this kind, whether they are with or without
merit, could be time consuming, result in costly litigation, cause product
shipment delays or require us to enter into royalty or licensing agreements. In
the event that we do not prevail in litigation, we could be prevented from
selling our products or be required to enter into royalty or licensing
agreements on terms which may not be acceptable to us. We could also be
prevented from selling our products or be required to pay substantial monetary
damages. Should we cross license our intellectual property in order to obtain
licenses, we may no longer be able to offer a unique product. To date, we have
not obtained any licenses from Agere Systems and 3Com.

New patent applications may be currently pending or filed in the future by
third parties covering technology that we use currently or may use in the
future. Pending U.S. patent applications are confidential until patents are
issued, and thus it is impossible to ascertain all possible patent infringement
claims against us. We believe that several of our competitors, including Agere
Systems and Texas Instruments, may have a strategy of protecting their market
share by filing intellectual property claims against their competitors and may
assert claims against us in the future. The legal and other expenses and
diversion of resources associated with any such litigation could result in a
decrease in our revenues and cash.

In addition, some of our customer agreements include an indemnity clause
that obligates us to defend and pay all damages and costs finally awarded by a
court should third parties assert patent and/or copyright claims against our
customers. As a result, we may be held responsible for infringement claims
asserted against our customers.

23

WE HAVE ACCRUED FOR NEGOTIATED LICENSE FEES AND ESTIMATED ROYALTY SETTLEMENTS
RELATED TO EXISTING AND PROBABLE CLAIMS OF PATENT INFRINGEMENT. IF THE ACTUAL
SETTLEMENTS EXCEED THE AMOUNTS ACCRUED, ADDITIONAL LOSSES COULD BE SIGNIFICANT,
WHICH WOULD ADVERSELY AFFECT FUTURE OPERATING RESULTS.

We recorded an accrual for estimated future royalty payments for relevant
technology of others used in our product offerings in accordance with SFAS No.
5, "Accounting for Contingencies." The estimated royalties accrual reflects
management's broader litigation and cost containment strategies, which may
include alternatives such as entering into cross-licensing agreements, cash
settlements and/or ongoing royalties based upon our judgment that such
negotiated settlements would allow management to focus more time and financial
resources on the ongoing business. Accordingly, the royalties accrual reflects
estimated costs of settling claims rather than continuing to defend our legal
positions, and is not intended to be, nor should it be interpreted as, an
admission of infringement of intellectual property, valuation of damages
suffered by any third parties or any specific terms that management has
predetermined to agree to in the event of a settlement offer. We have accrued
our best estimate of the amount of royalties payable for royalty agreements
already signed, agreements that are in negotiation and unasserted but probable
claims of others using advice from third party technology advisors and
historical settlements. Should the final license agreements result in royalty
rates significantly higher than our current estimates, our business, operating
results and financial condition could be materially and adversely affected.

COMPETITION IN THE CONNECTIVITY MARKET IS INTENSE, AND IF WE ARE UNABLE TO
COMPETE EFFECTIVELY, THE DEMAND FOR OUR PRODUCTS MAY BE REDUCED.

The connectivity device market is intensely competitive. We may not be able
to compete successfully against current or potential competitors. Our current
competitors include Agere Systems, Boardcom, Conexant, ESS Technology and Smart
Link. We expect competition to increase in the future as current competitors
enhance their product offerings, new suppliers enter the connectivity device
market, new communication technologies are introduced and additional networks
are deployed.

We may in the future also face competition from other suppliers of products
based on broadband and/or wireless technologies or on emerging communication
technologies, which may render our existing or future products obsolete or
otherwise unmarketable. We believe that these competitors may include 3Com,
Alcatel, Analog Devices, GlobespanVirata, Intersil and Proxim.

We believe that the principal competitive factors required by users and
customers in the connectivity product market include compatibility with industry
standards, price, functionality, ease of use and customer service and support.
Although we believe that our products currently compete favorably with respect
to these factors, we may not be able to maintain our competitive position
against current and potential competitors.

IN ORDER FOR US TO OPERATE AT A PROFITABLE LEVEL AND CONTINUE TO INTRODUCE AND
DEVELOP NEW PRODUCTS FOR EMERGING MARKETS, WE MUST ATTRACT AND RETAIN OUR
EXECUTIVE OFFICERS AND QUALIFIED TECHNICAL, SALES, SUPPORT AND OTHER
ADMINISTRATIVE PERSONNEL.

Our past performance has been and our future performance is substantially
dependent on the performance of our current executive officers and certain key
engineering, sales, marketing, financial, technical and customer support
personnel. If we lose the services of one or more of our executives or key
employees, a replacement could be difficult to recruit and we may not be able to
grow our business.

Competition for personnel, especially qualified engineering personnel, is
intense. We are particularly dependent on our ability to identify, attract,
motivate and retain qualified engineers with the requisite education, background
and industry experience. As of December 31, 2001, we employed a total of 47
people in our engineering department. If we lose the services of one or more of
our key engineering personnel, our ability to continue to develop products and
technologies responsive to our markets will be impaired.

WE MAY HAVE TO CONTINUE TO REDUCE OUR HEADCOUNT, WHICH MAY HINDER OUR ABILITY TO
DEVELOP AND GROW OUR BUSINESS, WHICH MAY ULTIMATELY AFFECT OUR ABILITY TO BECOME
PROFITABLE.

24

In 2001, we reduced our workforce by 90 employees. If economic conditions
and the PC market do not improve, or if we decide to pursue new business
structures or focus on different sectors, we may need to reduce our workforce
even further. This may result in, as it has in the past, additional charges and
costs relating to severance and employment costs, as well as the closure of
excess facilities. If such an action is taken, it may temporarily inhibit our
ability to develop new products or become profitable.

FAILURE TO MANAGE OUR TECHNOLOGICAL AND PRODUCT GROWTH COULD STRAIN OUR
MANAGEMENT, FINANCIAL AND ADMINISTRATIVE RESOURCES.

Our ability to successfully sell our products and implement our business
plan in rapidly evolving markets requires an effective management planning
process. Future product expansion efforts could be expensive and put a strain on
our management by significantly increasing the scope of their responsibilities
and by increasing the demands on their management abilities during periods of
constrained spending. We are focusing on the wireless areas as well as placing
substantial effort on sustaining our leadership position in the analog modem
space. To effectively manage our growth in these new technologies, we must
enhance our marketing, sales, research and development areas. With revenues
either stabilizing or declining, these efforts will have to be accomplished with
limited funding. This will require management to effectively manage significant
technological advancement within reduced budgets.

WE RELY ON INDEPENDENT COMPANIES TO MANUFACTURE, ASSEMBLE AND TEST OUR PRODUCTS.
IF THESE COMPANIES DO NOT MEET THEIR COMMITMENTS TO US, OUR ABILITY TO SELL
PRODUCTS TO OUR CUSTOMERS WOULD BE IMPAIRED.

We do not have our own manufacturing, assembly or testing operations.
Instead, we rely on independent companies to manufacture, assemble and test the
semiconductor chips that are integral components of our products. Most of these
companies are located outside of the United States. There are many risks
associated with our relationships with these independent companies, including
reduced control over:

- delivery schedules,

- quality assurance,

- manufacturing costs,

- capacity during periods of excess demand, and

- access to process technologies.

In addition, the location of these independent parties outside of the
United States creates additional risks resulting from the foreign regulatory,
political and economic environments in which each of these companies exists.
Further, some of these companies are located near earthquake fault lines. While
we have not experienced any material problems to date, failures or delays by our
manufacturers to provide the semiconductor chips that we require for our
products, or any material change in the financial arrangements we have with
these companies, could have an adverse impact on our ability to meet our
customer product requirements.

We design, market and sell application specific integrated circuits and
outsource the manufacturing and assembly of the integrated circuits to third
party fabricators. The majority of our products and related components are
manufactured by four principal companies: Taiwan Semiconductor Manufacturing
Corporation, Kawasaki/LSI, ADMTek and Silicon Labs. We expect to continue to
rely upon these third parties for these services. Currently, the data access
arrangement chips used in our soft modem products are provided by a sole source,
Silicon Labs, on a purchase order basis, and we have only a limited guaranteed
supply of data access arrangement chips through a long-term business arrangement
with Silicon Labs. We have no guaranteed supply or long-term contract agreements
with any other of our suppliers. Although we believe that we would be able to
qualify an alternative manufacturing source for data access arrangement chips
within a relatively short period of time, this transition, if necessary, could
result in loss of purchase orders or customer relationships, which could result
in decreased revenues. As of December 31, 2001, we have outstanding firm
inventory purchase order commitments of $3.0 million with our major suppliers,
of which $2.3 million was accrued as inventory losses.

25

UNDETECTED SOFTWARE ERRORS OR FAILURES FOUND IN NEW PRODUCTS MAY RESULT IN LOSS
OF CUSTOMERS OR DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS.

Our products may contain undetected software errors or failures when first
introduced or as new versions are released. To date, we have not been made aware
of any significant software errors or failures in our products. However, despite
testing by us and by current and potential customers, errors may be found in new
products after commencement of commercial shipments, resulting in loss of
customers or delay in market acceptance.

CONNECTIVITY DEVICES GENERALLY REQUIRE INDIVIDUAL GOVERNMENT APPROVALS
THROUGHOUT THE WORLD TO OPERATE ON LOCAL TELEPHONE NETWORKS. THESE
CERTIFICATIONS COLLECTIVELY REFERRED TO AS HOMOLOGATION CAN DELAY OR IMPEDE THE
ACCEPTANCE OF OUR PRODUCTS ON A WORLDWIDE BASIS.

Connectivity products require extensive testing prior to receiving
certification by each government to be authorized to connect to their telephone
systems. This testing can delay the introduction or, in extreme cases, prohibit
the product usage in a particular country. International Telecommunications
Union standards seek to provide a worldwide standard to avoid these issues, but
they do not eliminate the need for testing in each country. In addition to these
government certifications, individual Internet Service Providers, or "ISPs", can
also have unique line conditions that must be addressed. Since most large PC
manufacturers want to be able to release their products on a worldwide basis,
this entire process can significantly slow the introduction of new products.

OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS CAN BE ADVERSELY AFFECTED IF
TAX AUTHORITIES CHALLENGE US AND THE TAX CHALLENGES RESULT IN UNFAVORABLE
OUTCOMES.

We currently operate with subsidiaries in the Cayman Islands and Japan as
well as branch offices in Taiwan, Korea and France. The complexities brought on
by operating in several different tax jurisdictions inevitably leads to an
increased exposure to worldwide tax challenges. Should the tax authorities
challenge us and the tax challenges result in unfavorable outcomes, our
operating results and financial position could be materially and adversely
affected.

RISKS RELATED TO OUR INDUSTRY

IF THE MARKET FOR PRODUCTS USING OUR HSP TECHNOLOGY DOES NOT GROW AS WE PLAN, OR
IF OUR PRODUCTS ARE NOT ACCEPTED IN THESE MARKETS, OUR REVENUES MAY BE ADVERSELY
AFFECTED.

Our success depends on market demand and growth patterns for products using
our HSP technology in soft analog modems. Market success for our products
depends primarily on cost and performance benefits relative to competing
solutions. Although we have shipped a significant number of soft modems since we
began commercial sales of these products, the current level of demand for soft
modems may not be sustained or may not grow. Further, the company's success in
the soft modem market is dependent on developing, selling and supporting next
generation products and applications. If these new products are not accepted in
the markets as they are introduced, our revenues and profitability will be
negatively affected.

In 2000, we introduced our Solsis(TM) modem for the embedded Internet
access market. We anticipate sales of this product to grow and become an
important component in our product mix. However, if the non-PC Internet
appliance market does not accept our product or if demand for embedded analog
modems is weaker than projected, our revenues can be adversely affected.

OUR INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGIES. IF WE ARE NOT
SUCCESSFUL IN RESPONSE TO RAPIDLY CHANGING TECHNOLOGIES, OUR PRODUCTS MAY BECOME
OBSOLETE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.

The Internet access business is characterized by rapidly changing
technologies, short product life cycles and frequent new product introductions.
To remain competitive, we have successfully introduced several new

26

products with advanced technologies since our company was founded. For example,
we introduced a 14.4 Kbps product in 1995, a 28.8 Kbps product in 1996, a 33.6
Kbps product in late 1996, a non-International Telecommunications Union standard
56 Kbps modem in the second half of 1997 and a V.90 International
Telecommunications Union standard 56 Kbps modem in early 1998. Starting in 2001
and continuing into 2002, we expect to see the introduction of additional
International Telecommunications Union standards, referred to as V.92 and V.44.
We continue to develop and sell advanced analog modem products in order to
remain competitive in our core business.

The market for high speed Internet connectivity is also characterized by
rapidly changing technologies and strong competition, such as broadband and
wireless solutions, which provide higher modem speeds and faster Internet
access. While these alternative technologies offer much faster data rates, they
are comparatively more costly than analog modems. They are also not as widely
available in the world markets. We will continue to evaluate, develop and
introduce technologically advanced products that will position the company for
possible growth in the Internet access market. If we are not successful in
response to rapidly changing technologies, our products may become obsolete and
we may not be able to compete effectively.

CHANGES IN LAWS OR REGULATIONS, IN PARTICULAR, FUTURE FCC REGULATIONS AFFECTING
THE BROADBAND MARKET, INTERNET SERVICE PROVIDERS, OR THE COMMUNICATIONS
INDUSTRY, COULD NEGATIVELY AFFECT OUR ABILITY TO DEVELOP NEW TECHNOLOGIES OR
SELL NEW PRODUCTS AND THEREFORE, REDUCE OUR PROFITABILITY.

The jurisdiction of the Federal Communications Commission, or FCC, extends
to the entire communications industry, including our customers and their
products and services that incorporate our products. Future FCC regulations
affecting the broadband access services industry, our customers or our products
may harm our business. For example, future FCC regulatory policies that affect
the availability of data and Internet services may impede our customers'
penetration into their markets or affect the prices that they are able to
charge. In addition, international regulatory bodies are beginning to adopt
standards for the communications industry. Although our business has not been
hurt by any regulations to date, in the future, delays caused by our compliance
with regulatory requirements may result in order cancellations or postponements
of product purchases by our customers, which would reduce our profitability.

WE RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OUR OPERATIONS, AND CALIFORNIA'S
CURRENT ENERGY CRISIS COULD DISRUPT OUR OPERATIONS AND INCREASE OUR EXPENSES.

Our business operations depend on our ability to maintain and protect our
facilities, computer systems and personnel, which are primarily located in or
near our principal headquarters in Milpitas, California. California has
experienced power outages due to a