Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market value. We typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. The value of our inventory is dependent on our estimate of future average selling prices, and, if our projected average selling prices are over estimated, we may be required to adjust our inventory value to reflect the lower of cost or market. Due to the large number of units in our inventory, even a small change in average selling prices could result in a significant adjustment and have a significant impact on our financial position and results of operations. Our inventories include high technology parts and components that are specialized in nature or subject to rapid technological obsolescence. Some of our customers have requested that we ship them product that has a finished goods date of manufacture that is less than one or two years old. In the event that this becomes a common requirement, it may be necessary for us to provide for an additional allowance for our on hand finished goods inventory with a date of manufacture of greater than one or two years, which could result in a significant adjustment and could harm our financial results. While we have programs to minimize the required inventories on hand and we consider technological obsolescence when estimating allowances for potentially excess and obsolete inventories and those required to reduce recorded amounts to market values, it is reasonably possible that such estimates could change in the near term. Such changes in estimates could have a significant impact on our financial position and results of operations.

                                                           December 31,  September 30,
                                                              2001          2002
                                                           -----------   -----------
Accrued compensation and related items                    $     4,372   $     3,975
Accrued liabilities-related parties                               764           378
Accrued warranty                                                2,883           916
Other accrued liabilities                                       8,371         6,361
                                                           -----------   -----------
                                                          $    16,390   $    11,630
                                                           ===========   ===========

In December 2000, we committed, subject to certain business conditions, to prepay $50.0 million to a vendor to secure increased wafer capacity in 2002 and 2003. The prepayment will be applied against inventory material purchases. As of September 30, 2002, we had prepaid a total of $5.0 million towards this commitment, which is included in other current assets on the balance sheet. Under the agreement, we have a remaining commitment of $45.0 million. However, at this time we are in the process of renegotiating this agreement and expect that this commitment will no longer be required. In addition, as of September 30, 2002, we had outstanding purchase commitments with our foundry vendors of approximately $25.7 million for delivery in 2002.

The following table shows our product revenues and gross profit (loss) for each segment (in thousands):

11

                                                  Three Months Ended            Three Months Ended
                                                  September 30, 2001            September 30, 2002
                                              -------------------------     -------------------------
                                                              Gross                         Gross
                                               Revenues     Profit (Loss)    Revenues       Profit
                                              -----------  ------------     -----------  ------------
SMPG                                         $    36,164  $    (35,989)    $    42,251  $      2,956
ASPG                                              25,945         9,655          15,481         6,159
SPG                                                3,054          (742)          1,713           930
Technology Licensing                               9,034         9,034           8,311         8,311
                                              -----------  ------------     -----------  ------------
                                             $    74,197  $    (18,042)    $    67,756  $     18,356
                                              ===========  ============     ===========  ============



                                                Nine Months Ended             Nine Months Ended
                                                  September 30, 2001            September 30, 2002
                                              -------------------------     -------------------------
                                                              Gross                         Gross
                                               Revenues    Profit (Loss)     Revenues       Profit
                                              -----------  ------------     -----------  ------------
SMPG                                         $   115,908  $    (27,630)    $   130,248  $     15,803
ASPG                                              75,483        37,054          52,517        19,481
SPG                                                6,598           931           4,455         1,799
Technology Licensing                              25,221        25,221          24,595        24,595
                                              -----------  ------------     -----------  ------------
                                             $   223,210  $     35,576     $   211,815  $     61,678
                                              ===========  ============     ===========  ============

                                                Three Months Ended            Nine Months Ended
                                                   September 30,                September 30,
                                            ------------------------     ------------------------
                                               2001         2002            2001         2002
                                            -----------  -----------     -----------  -----------
Net loss                                   $   (26,482) $    (4,768)    $   (19,911) $    (7,432)

Other comprehensive income:
   Change in net unrealized gains
      on investments, net of tax                    85           95             170           56
                                            -----------  -----------     -----------  -----------
Total comprehensive loss                   $   (26,397) $    (4,673)    $   (19,741) $    (7,376)
                                            ===========  ===========     ===========  ===========

                                                        December 31, September 30,
                                                           2001          2002
                                                       ------------  ------------
Net unrealized gains on investments, net of tax       $        225  $        281
                                                       ============  ============

The following table is a summary of our related party revenues and purchases for the quarter and nine months ended September 30, 2002, and our related party accounts receivable and payable balances as of September 30, 2002 (in thousands):

12

                                                  Three Months Ended             Nine Months Ended
                                                  September 30, 2002            September 30, 2002
                                              -------------------------     -------------------------
                                               Revenues      Purchases       Revenues      Purchases
                                              -----------  ------------     -----------  ------------
Silicon Technology Co., Ltd.                 $       392  $         --     $     1,348  $         --
Acer and related entities (1)                         45           232             891           721
Apacer Technology, Inc.                              229           321             656           467
Professional Computer Technology Limited              --            --             141            --
Silicon Professional Technology Ltd.              37,067            --         103,219            --
King Yuan Electronics Company, Limited                --         4,111              --        13,677
Powertech Technology, Incorporated                    --         1,399              --         6,151
                                              -----------  ------------     -----------  ------------
                                             $    37,733  $      6,063     $   106,255  $     21,016
                                              ===========  ============     ===========  ============


                                                   September 30, 2002
                                              -------------------------
                                                             Accounts
                                               Accounts    Payable and
                                              Receivable     Accruals
                                              -----------  ------------
Silicon Technology Co., Ltd.                 $       221  $         --
Acer and related entities (1)                         45           217
Apacer Technology, Inc.                              132           140
Professional Computer Technology Limited              --           132
Silicon Professional Technology Ltd.              25,048           991
King Yuan Electronics Company, Limited                --         4,639
Powertech Technology, Incorporated                    --         1,971
                                              -----------  ------------
                                             $    25,446  $      8,090
                                              ===========  ============

(1) Excludes Apacer Technology, Inc. balances

The following table is a summary of our related party revenues and purchases for the quarter and nine months ended September 30, 2002, and our related party accounts receivable and payable balances as of September 30, 2002 (in thousands). For a description of our relationship with these parties please see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Related Party Transactions" in our Annual Report on Form 10-K for the year ended December 31, 2001.

                                                  Three Months Ended             Nine Months Ended
                                                  September 30, 2002            September 30, 2002
                                              -------------------------     -------------------------
                                               Revenues      Purchases       Revenues      Purchases
                                              -----------  ------------     -----------  ------------
Silicon Technology Co., Ltd.                 $       392  $         --     $     1,348  $         --
Acer and related entities (1)                         45           232             891           721
Apacer Technology, Inc.                              229           321             656           467
Professional Computer Technology Limited              --            --             141            --
Silicon Professional Technology Ltd.              37,067            --         103,219            --
King Yuan Electronics Company, Limited                --         4,111              --        13,677
Powertech Technology, Incorporated                    --         1,399              --         6,151
                                              -----------  ------------     -----------  ------------
                                             $    37,733  $      6,063     $   106,255  $     21,016
                                              ===========  ============     ===========  ============


                                                   September 30, 2002
                                              -------------------------
                                                             Accounts
                                               Accounts    Payable and
                                              Receivable     Accruals
                                              -----------  ------------
Silicon Technology Co., Ltd.                 $       221  $         --
Acer and related entities (1)                         45           217
Apacer Technology, Inc.                              132           140
Professional Computer Technology Limited              --           132
Silicon Professional Technology Ltd.              25,048           991
King Yuan Electronics Company, Limited                --         4,639
Powertech Technology, Incorporated                    --         1,971
                                              -----------  ------------
                                             $    25,446  $      8,090
                                              ===========  ============

(1) Excludes Apacer Technology, Inc. balances

19

PCT continues to earn commissions for point-of-sales transactions to its customers. PCT's commissions are paid at the same rate as all of our other manufacturer's representatives in Asia. In addition, we continue to pay SPT a fee for providing logistics center functions. This fee is based on a percentage of revenue for each product shipped through SPT to our end customers. The fee paid to SPT covers the costs of warehousing and insuring our inventory and accounts receivable, personnel costs required to maintain logistics and information technology functions and the costs to perform billing and collection of accounts receivable.

In August 2002, we made an additional investment of $181,000 in Apacer. At the end of the third quarter of 2002, we determined that a continued and significant decline in Apacer's price per share was other than temporary, and accordingly, in the third quarter of 2002, we recorded a period charge to other expense of approximately $7.8 million to write down our investment in Apacer to $4.4 million which was determined using the price per share paid for the additional investment in August 2002. As of September 30, 2002, we owned approximately 9.8% of Apacer's outstanding shares.

For information related to our revenue recognition and other critical accounting policies, please refer to the "Critical Accounting Policies" section of our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2001, as filed with the Securities and Exchange Commission.

In July 2001, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 142, "Goodwill and Other Intangible Assets," which is effective for fiscal years beginning after December 15, 2001. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. We adopted SFAS No. 142 during the quarter ended March 31, 2002. The adoption of SFAS No. 142 did not have a significant impact on our financial position or results of operations and goodwill amortization recorded in prior periods was not material.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS No. 144 applies to all long-lived assets, including discontinued operations, and consequently amends the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Division of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale and requires the measurement to be at the lower of book value or fair value less cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. We adopted SFAS No. 144 during the quarter ended March 31, 2002. The adoption of SFAS No. 144 to date has not had a significant impact on our financial position or results of operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal Activities." SFAS No. 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for under EITF No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The scope of SFAS No. 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS No. 146 will be effective for exit or disposal activities that are initiated after December 31, 2002 and early application is encouraged. We will adopt SFAS No. 146 during the quarter ending March 31, 2003. The provisions of EITF No. 94-3 shall continue to apply for an exit activity initiated under an exit plan that met the criteria of EITF No. 94-3 prior to the adoption of SFAS No. 146. The effect on adoption of SFAS No. 146 will change on a prospective basis the timing of when restructuring charges are recorded from a commitment date approach to when the liability is incurred.

20

Operating activities. Our operating activities generated cash of $22.2 million for the nine months ended September 30, 2002 as compared to using cash of $54.7 million for the nine months ended September 30, 2001. The cash provided by operating activities for the nine months ended September 30, 2002 related primarily to non-cash adjustments of $32.3 million, primarily relating to provision for doubtful accounts receivable of $3.2 million, provision for excess and obsolete inventories and lower of cost or market of $6.8 million, provision for sales returns of $1.3 million, other expense of $7.8 million, deferred income taxes of $5.8 million and depreciation and amortization of $7.5 million, decreases in inventory of $8.5 million and accounts receivable from unrelated parties of $778,000 and increases in trade accounts payable from related and unrelated parties of $6.5 million. Cash provided by operating activities was reduced by our net loss of $7.4 million for the nine months ended September 30, 2002, an increase of $4.7 million in trade accounts receivable from related parties, an increase of $7.0 million in other current and non-current assets and decreases in accrued expenses and other liabilities of $4.9 million and deferred revenue of $1.8 million. The cash used in operating activities for the nine months ended September 30, 2001 related primarily to net loss of $19.9 million, increases in inventory of $119.2 million, accounts receivable from related parties of $9.2 million, deferred income taxes of $14.3 million and other assets of $1.0 million and decreases in trade accounts payable from related and unrelated parties of $14.5 million, accrued expenses of $15.4 million and deferred revenue of $1.5 million. Cash used in operating activities was reduced by a decrease in trade accounts receivable from unrelated parties of $47.2 million and non-cash adjustments of $78.9 million, primarily relating to depreciation and amortization, inventory write-downs and increased provisions for doubtful accounts receivable and sales returns.

Investing activities. Our investing activities used cash of $11.8 million for the nine months ended September 30, 2002 as compared to using cash of $3.7 million for the nine months ended September 30, 2001. Investing activities in the nine months ended September 30, 2002 were primarily related to capital expenditures of approximately $3.4 million and net purchases of available-for-sale investments and restricted cash of $7.1 million. In addition, in the nine months ended September 30, 2002, we invested $964,000 in Insyde Software Corporation, a privately held Taiwanese company, and made additional investments of $179,000 in PCT and $181,000 in Apacer. In the nine months ended September 30, 2001, investing activities were primarily related to a $50.0 million equity investment in Grace Semiconductor Manufacturing Corporation, a Cayman Islands company with operations in China, a $2.1 million investment in a production subcontractor and approximately $12.6 million spent in capital expenditures, offset by net sales and maturities of available-for-sale investments of approximately $60.9 million.

Financing activities. Our financing activities provided cash of approximately $3.6 million during the nine months ended September 30, 2002 as compared to $4.9 million for the nine months ended September 30, 2001. For the nine months ended September 30, 2002, the cash provided was primarily from $4.0 million of common stock issued under the employee stock purchase plan and the exercise of employee stock options, offset by $234,000 in loan repayments. The cash provided for the first nine months of 2001 was primarily from the issuance of common stock for $3.4 million and $1.8 million related to a loan from a landlord, offset by $187,000 in loan repayments.

We terminated our line of credit on July 12, 2002.

In July 2002, we posted a bond in the amount of $36.5 million for the Atmel litigation. In connection with the bond, we have pledged cash, cash equivalents and available-for-sale investments in the amount of $36.5 million. As of September 30, 2002, this amount is included in restricted cash, cash equivalents and available-for-sale investments in our balance sheet.

Principal sources of liquidity as of September 30, 2002 consisted of $151.1 million of cash, cash equivalents, short and long-term available-for-sale investments.

Purchase Commitments. In December 2000, we committed, subject to certain business conditions, to prepay $50.0 million to a vendor to secure increased wafer capacity in 2002 and 2003. The prepayment will be applied against inventory material purchases. As of September 30, 2002, we had prepaid a total of $5.0 million towards this commitment, which is included in other current assets on the balance sheet. Under the agreement, we have a remaining commitment of $45.0 million. However, at this time we are in the process of renegotiating this agreement and expect that this commitment will no longer be required. In addition, as of September 30, 2002, we had outstanding purchase commitments with our foundry vendors of approximately $25.7 million for delivery in 2002.

Lease Commitments. We have long-term, non-cancelable building lease commitments. We are currently seeking subtenants for our unused office space. We may be unable to secure subtenants, for this space, due to the recent decrease in demand for commercial rental space in Silicon Valley. See also "Business Risks - If we are not successful in subleasing our unused office space, we may be required to take a period charge for the difference between the total future sublease income and our lease cost."

21

Future payments due under building lease and purchase commitments as of September 30, 2002 (in thousands):

                                               Building     Purchase
                                                 Lease     Commitments      Total
                                              -----------  -----------   -----------
2002                                         $     1,248  $    70,712   $    71,960
2003                                               5,102           --         5,102
2004                                               5,221           --         5,221
2005                                               3,624           --         3,624
2006                                               2,468           --         2,468
Thereafter                                         8,647           --         8,647
                                              -----------  -----------   -----------
                                             $    26,310  $    70,712   $    97,022
                                              ===========  ===========   ===========

Stock Purchase Plan. In September 2001, our board of directors authorized the purchase of an aggregate of up to $15.0 million of our common stock. The purchases may be made in the open market at prevailing market prices or in negotiated transactions off the market, subject to compliance with applicable provisions of the California Corporations Code and in accordance with applicable federal and state securities laws and regulations. The stock purchase program was recently extended until October 31, 2003 and will stay in effect unless earlier revoked by our board of directors. As of September 30, 2002, no shares had been purchased under this program.

Operating Capital Requirements. We believe that our cash balances, together with the funds we expect to be generated from operations, will be sufficient to meet our projected working capital and other cash requirements through at least the next twelve months. However, there can be no assurance that future events will not require us to seek additional borrowings or capital and, if so required, that such borrowing or capital will be available on acceptable terms. Factors that could affect our cash used or generated from operations and as a result, our need to seek additional borrowings or capital include:

• the average selling prices of our products;
• customer demand for our products;
• the need to secure future wafer production capacity from our suppliers;
• the timing of significant orders and of license and royalty revenue; and
• unanticipated research and development expenses associated with new product introductions.

For more information, please also see "Business Risks - Our operating results fluctuate significantly, and an unanticipated decline in revenues may disappoint securities analyst or investors and result in a decline in our stock price."

In addition, on May 7, 2002, the Court entered judgment against us in Atmel's lawsuit against us in the total amount of $36.5 million. In the event our appeal of this lawsuit is unsuccessful, we may have to pay this amount to Atmel. For more information, please also see "Business Risks - If we are accused of infringing the intellectual property rights of other parties we may become subject to time-consuming and costly litigation. If we lose, we could suffer a significant impact on our business and be forced to pay damages."

Although we were profitable in 2000 and in the first quarter of 2002, we incurred net losses for 1998, 1999, 2001 and in the second and third quarters of 2002. Our operating results have fluctuated significantly and our past financial performance should not be used to predict future operating results. Our recent quarterly and annual operating results have fluctuated, and may continue to fluctuate, due to the following factors, all of which are difficult to forecast and many of which are out of our control:

22

As recent experience confirms, a downturn in the market for products such as personal computers and cellular telephones that incorporate our products can also harm our operating results.

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

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

In addition, political or economic events beyond our control can suddenly result in increased operating costs. For example, the terrorist attacks on September 11, 2001 has resulted in a substantial increase to our business insurance costs. In addition, there is considerable public debate as to whether to require companies to record compensation expense on stock option grants. Such requirements, if enacted, would substantially increase our operating costs and impact our earnings per share.

We typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. The value of our inventory is dependent on our estimate of future average selling prices, and, if our projected average selling prices are over estimated, we may be required to adjust our inventory value to reflect the lower of cost or market. As of September 30, 2002, we had $92.9 million of inventory on hand, a decrease of $15.3 million, or 14.2%, from December 31, 2001. Total valuation adjustments to inventory were $72.2 million in 2001. Due to the large number of units in our inventory, even a small change in average selling prices could result in a significant adjustment and could harm our financial results. Some of our customers have requested that we ship them product that has a finished goods date of manufacture that is less than one or two years old. In the event that this becomes a common requirement, it may be necessary for us to provide for an additional allowance for our on hand finished goods inventory with a date of manufacture of greater than one or two years, which could result in a significant adjustment and could harm our financial results.

23

Due to possible customer changes in delivery schedules and cancellations of orders, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. A reduction of backlog during any particular period, or the failure of our backlog to result in future revenue, could harm our business. We began to experience a sharp downturn in several of our markets late in the fourth quarter of 2000, as our customers reacted to weakening demand for their products. Although we had improvements in total units shipped for the first nine months of 2002 from the first nine months of 2001, our revenues declined in the first nine months of 2002 when compared to the first nine months of 2001 due to decreased average selling prices. Our business could be harmed by industry-wide fluctuations in the future.

During 2000, 2001 and first nine months of 2002, our export product and licensing revenues accounted for approximately 84.3%, 90.3% and 92.1% of our net revenues, respectively. Our international business activities are subject to a number of risks, each of which could impose unexpected costs on us that would harm our operating results. These risks include:

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

In addition, we have made equity investments in companies with operations in China, Japan and Taiwan. The value of our investments is subject to the economic and political conditions particular to their industry, their countries and to foreign exchange rates and the global economy. If we determine that a change in the recorded value of an investment is other than temporary, we will adjust the value of the investment. Such an expense could have a negative impact on our operating results. For example, in the third quarter of 2002, we determined that a decline in the value of our investment in Apacer was other than temporary and we wrote down the value of our investment by $7.8 million.

We derived 77.6%, 80.7% and 88.5% of our net product revenues from Asia during 2000, 2001 and the first nine months of 2002, respectively. Additionally, substantially all of our wafer suppliers and packaging and testing subcontractors are located in Asia. Any kind of economic, political or environmental instability in this region of the world can have a severe negative impact on our operating results due to the large concentration of our production and sales activities in this region. For example, during 1997 and 1998, several Asian countries where we do business, such as Japan, Taiwan and Korea, experienced severe currency fluctuation and economic deflation, which negatively impacted our revenues and also negatively impacted our ability to collect payments from customers. During this period, the lack of capital in the financial sectors of these countries made it difficult for our customers to open letters of credit or other financial instruments that are guaranteed by foreign banks. Finally, the economic situation during this period exacerbated a decline in selling prices for our products as our competitors reduced product prices to generate needed cash.

It should also be noted that we may be impacted by political, economic and military conditions in Taiwan. Taiwan and China are continuously engaged in political disputes and both countries have continued to conduct military exercises in or near the other's territorial waters and airspace. Such disputes may continue and even escalate, resulting in an economic embargo, a disruption in shipping or even military hostilities. Additionally, we believe the economic uncertainty fueled by the September 11, 2001 terrorist attacks in the United States has caused our customer base to become more cautious. Any of these events could delay production or shipment of our products. Any kind of activity of this nature or even rumors of such activity could harm our operations, revenues, operating results, and stock price.

We do not typically enter into long-term contracts with our customers. In addition, we cannot be certain as to future order levels from our customers. In the past, when we have entered into a long-term contract, the contract has generally been terminable at the convenience of the customer.

24

We rely on stocking representatives, distributors and our logistics center to establish and maintain customer relationships and to sell our products. These stocking representatives, distributors and our logistics center could discontinue their relationship with us or discontinue selling our products at any time. The majority of our stocking representatives and our logistics center are located in Asia.

Since March 2001, we have been out-sourcing our customer service logistics in Taiwan and other parts of Asia to Silicon Professional Technology Ltd., or SPT. SPT is a wholly owned subsidiary of one of our stocking representatives in Taiwan, Professional Computer Technology Limited, or PCT. SPT provides planning, warehousing, delivery, billing, collection and other logistic functions for us in Taiwan. SPT now services substantially all of our end customers based in Taiwan, China and selected end customers throughout Asia. Products shipped to SPT are accounted for as consigned inventory, and revenue is recognized when the products have been delivered and are considered as a sale to our end customers by SPT. For the year ended December 31, 2001 and the nine months ended September 30, 2002, SPT serviced end customer sales accounting for 30.3% and 55.1% of our net product revenues recognized, respectively.

Product shipments to Asia accounted for 77.6%, 80.7% and 88.5% of net product revenues for 2000, 2001 and the nine months ended September 30, 2002, respectively. For further description of our relationships with PCT and SPT, please refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Related Party Transactions" in our Annual Report on Form 10-K for the year ended December 31, 2001.

We ship to, and have accounts receivable from, OEMs, ODMs, CEMs, stocking representatives, distributors, and our logistics center. Our logistics center, stocking representatives and distributors reship our products to our end customers, including OEMs, ODMs, CEMs and end users. No stocking representative or distributor serviced more than 10.0% of our net product revenues in 2000, 2001 or the nine months ended September 30, 2002.

No single customer, which we define as an OEM, ODM, CEM, or end user that purchases product directly from us or through our logistics center, represented 10.0% or more of our net product revenues during 2000, 2001 or the nine months ended September 30, 2002.

We do not have any long-term contracts with SPT or PCT, and SPT or PCT may cease providing services to us at any time. If SPT or PCT were to terminate their relationship with us we would experience a delay in reestablishing warehousing, logistics and distribution functions, which would harm our business.

The loss of our relationship with any stocking representative, logistics center or distributor could harm our operating results by impairing our ability to sell our products to our end customers.

We outsource substantially all of our manufacturing and testing activities. We currently buy all of our wafers and sorted die from a limited number of suppliers. Substantially all of our products are manufactured by four foundries, TSMC in Taiwan, Sanyo and Seiko-Epson in Japan, and Samsung in Korea. We anticipate that these foundries, together with Nanya and Vanguard in Taiwan and Oki in Japan, will manufacture the majority of our products in 2002. On March 6, 2001, we invested $50.0 million in GSMC, a Cayman Islands company, for a wafer foundry project located in Shanghai, China. We anticipate that GSMC will begin to manufacture some of our products in 2003. If these suppliers fail to satisfy our requirements on a timely basis at competitive prices we could suffer manufacturing delays, a possible loss of revenues or higher than anticipated costs of revenues, any of which could harm our operating results.

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

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In order to grow, we need to increase our present manufacturing capacity. We currently believe that the existing capacity available to us will be sufficient through 2003. However, events that we have not foreseen could arise which would limit our capacity. We have a remaining commitment to prepay a total of $45.0 million, subject to certain economic and business conditions, to secure increased wafer capacity in 2002 and 2003. However, at this time we are in the process of renegotiating this agreement and expect that this commitment will no longer be required. Similar to our $50.0 million investment in GSMC, we may determine that it is necessary to invest substantial capital in order to secure appropriate production capacity commitments. If we cannot secure additional manufacturing capacity on acceptable terms, our ability to grow will be impaired and our operating results will be harmed.

We have long-term, non-cancelable building lease commitments. We are currently in the process of locating subtenants for our unused office space. We may be unable to secure subtenants, for this space, due to the recent decrease in demand for commercial rental space in Silicon Valley. During the third quarter of 2001, we recorded a period charge to other operating expense of approximately $756,000 relating to an operating lease for an abandoned building. This charge represented the estimated difference between the total non-discounted future sublease income and our non-discounted lease commitments relating to this building. The charge was an estimate and may be adjusted if we obtain a sublease for the building and the actual sublease income is significantly different from the estimate. If we are unable to secure subtenants, we may be required to take additional period charges for the balance of the future lease cost, and this will harm our operating results.

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

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

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

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

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

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

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

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

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

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

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

The markets for our products are characterized by:

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

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

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

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

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

We rely on a combination of patent, trade secrets, copyrights, mask work rights, nondisclosure agreements and other contractual provisions and technical measures to protect our intellectual property rights. Policing unauthorized use of our products, however, is difficult, especially in foreign countries. Litigation may continue to be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Litigation could result in substantial costs and diversion of resources and could harm our business, operating results and financial condition regardless of the outcome of the litigation. We own 54 patents in the United States relating to our products and processes, and have filed for several more. In addition, we hold several patents in Europe and Canada, and have filed several foreign patent applications in Europe, Japan, Korea, Taiwan and Canada. We cannot assure you that any pending patent application will be granted. Our operating results could be harmed by the failure to protect our intellectual property.

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

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

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

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

Our litigation may be expensive, may be protracted and confidential information may be compromised. Whether or not we are successful in our lawsuit with Atmel, we expect this litigation to continue to consume substantial amounts of our financial and managerial resources. A jury recently found that we willfully infringed Atmel's '811 and '829 patents, and awarded Atmel $20.0 million in actual damages. On May 7, 2002, the Court entered judgment in the total amount of $36.5 million, which includes the original $20.0 million. The '811 and '829 patents expired in February 2002. Therefore, there will not be any impact on our ability to sell any of our products. We believe that there were significant errors in both the infringement and the damages verdicts, and filed a Notice of Appeal on July 16, 2002. On October 7, 2002 we filed our opening brief in that appeal. Briefing is scheduled to conclude by the end of 2002 with a decision expected sometime in mid-to-late 2003. Atmel has agreed to stay its enforcement of this judgment pending our appeal. In July 2002, we posted a bond in the amount of $36.5 million pending the appeal. We have incurred certain amounts associated with defending this matter, and at any time Atmel may file additional claims against us, which could increase the risk, expense and duration of the litigation. Further, because of the substantial amount of discovery required in connection with this type of litigation, there is a risk that some of our confidential information could be compromised by disclosure. For more information with respect to our litigation, please also see "Part II, Item 1- Legal Proceedings."

Our corporate headquarters are located in California near major earthquake faults. In addition, some of our suppliers are located near fault lines. In the event of a major earthquake or other natural disaster near our headquarters, our operations could be harmed. Similarly, a major earthquake or other natural disaster such as typhoon near one or more of our major suppliers, like the earthquake in September 1999 or the typhoon in September 2001 that occurred in Taiwan could potentially disrupt the operations of those suppliers, which could then limit the supply of our products and harm our business.

Our design and process research and development facilities and our corporate offices are located in California, which in the past has been susceptible to power outages and shortages as well as increased energy costs. To limit this exposure, all corporate computer systems at our main California facilities are on battery back-up. In addition, all of our engineering and back-up servers and selected corporate servers are on generator back-up. While the majority of our production facilities are not located in California, more extensive power shortages in the state could delay our design and process research and development as well as increase our operating costs.

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

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

The semiconductor industry has historically been cyclical, characterized by wide fluctuations in product supply and demand. From time to time, the industry has also experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles and declines in general economic conditions. Downturns of this type occurred in 1997 and 1998, and more recently in late 2000 through the first nine months of 2002. These downturns are characterized by diminished product demand, production over-capacity and accelerated decline of average selling prices, and in some cases have lasted for more than a year. Our business could be harmed by industry-wide fluctuations in the future. The flash memory products portion of the semiconductor industry, from which we derive substantially all of our revenues suffered from excess capacity in 1996, 1997 and 1998, which resulted in greater than normal declines in our markets, which unfavorably impacted our revenues, gross margins and profitability. While these conditions improved in 1999 and 2000, deteriorating market conditions at the end of 2000 and continuing through the first nine months of 2002 have resulted in the decline of our selling prices and harmed our operating results.

Sales of our products in the consumer electronics applications market are subject to seasonality. As a result, sales of these products are impacted by seasonal purchasing patterns with higher sales generally occurring in the second half of each year. If we fail to continue to introduce new products, our business may suffer and the seasonality of a portion of our sales may become more pronounced.

We are exposed to risks associated with foreign exchange rate fluctuations due to our international manufacturing and sales activities. These exposures may change over time as business practices evolve and could negatively impact our operating results and financial condition. All of our sales are denominated in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and therefore reduce the demand for our products. Such a decline in the demand could reduce revenues and/or result in operating losses. In addition, a downturn in the economies of China, Japan or Taiwan could impair the value of our equity investments in companies with operations in these countries. If we consider the value of these companies to be impaired, we will write off, or expense, some or all of our investments. In the fourth quarter of 2001, we wrote down our investment in KYE by $3.3 million due to an other than temporary decline in its market value. As of September 30, 2002, the recorded value of our KYE investment was approximately $1.7 million, which represented the fair market value as of the balance sheet date. In the third quarter of 2002, we wrote down our investment in Apacer, a privately held memory module manufacturer located in Taiwan, by $7.8 million due to an other than temporary decline in its value. As of September 30, 2002, the recorded value of our Apacer investment was approximately $4.4 million. We also have equity investments in companies with operations in China, Japan and Taiwan with recorded values as of September 30, 2002 of approximately $50.0 million, $0.9 million and $9.7 million, respectively.

At any time, fluctuations in interest rates could effect interest earnings on our cash, cash equivalents and available-for-sale investments, or the fair value of our investment portfolio. We believe that the effect, if any, of reasonably possible near term changes in interest rates on our financial position, results of operations, and cash flows would not be material. Currently, we do not hedge these interest rate exposures. As of September 30, 2002, the carrying value of our available-for-sale investments approximated fair value. The table below presents the carrying value and related weighted average interest rates for our unrestricted and restricted cash, cash equivalents and available-for-sale investments as of September 30, 2002 (in thousands):

Our management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

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

On two of the six patents, the District Court ruled by summary judgment that we did not infringe. Two of the other patents were invalidated by another U.S. District Court in a proceeding to which we were not a party, but this decision was later reversed by the Federal Circuit Court of Appeals. As discussed below, as the result of a ruling in another case, Atmel has withdrawn its allegations as to another patent ("the '747 patent"). At this point, three patents remain at issue in Atmel's District Court case against us ("the '811, '829 and '903 patents"). All of these patents have expired, so Atmel can no longer obtain an injunction against the sale of our products.

On February 17, 1997, Atmel filed an action with the International Trade Commission, or ITC, against two suppliers of our parts, involving four of the six patents that Atmel alleged that we infringed in the District Court case above. We intervened as a party to that investigation.

On October 16, 2000, the ITC found the '903 patent valid and infringed, and ruled that we could not import into the United States certain products that use the claimed circuit made by one of our suppliers. The ITC also ruled that we do not infringe the '811 and '829 patents. We appealed from the Limited Exclusion Order, and in August 2001 the Court of Appeals for the Federal Circuit issued an opinion giving its reasons for denying that appeal. The '903 patent and the ITC's Limited Exclusion Order expired on September 14, 2001.

On January 14, 2002, the court in Atmel Corp. v. Macronix America, Inc. denied Atmel's motion to correct the '747 patent. We intervened as a party in the Macronix case for purposes of opposing that motion. As a result of the Court's decision, Atmel withdrew its claims against us based on the '747 patent.

A jury trial on the '811 and '829 patents began on April 8, 2002. The jury found that we willfully infringed those patents, and awarded Atmel $20.0 million in actual damages. On May 7, 2002, the Court entered judgment in the total amount of $36.5 million, which includes the original $20.0 million. The '811 and '829 patents expired in February 2002. Therefore, there will not be any impact on our ability to sell any of our products. We believe that there were significant errors in both the infringement and the damages verdicts, and filed a Notice of Appeal on July 16, 2002. On October 7, 2002 we filed our opening brief in that appeal. Briefing is scheduled to conclude by the end of 2002 with a decision expected sometime in mid-to-late 2003. Atmel has agreed to stay its enforcement of this judgment pending our appeal. In July 2002, we posted a bond in the amount of $36.5 million pending the appeal. In connection with the bond, we have pledged cash, cash equivalents and available-for-sale investments in the amount of $36.5 million. As of September 30, 2002, this amount is included in restricted cash, cash equivalents and available-for-sale investments in our balance sheet.

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Trial on the '903 patent was severed and heard before a jury beginning on July 29, 2002. The jury was unable to unanimously decide whether the `903 patent is valid, and a mistrial was declared. Atmel has not yet indicated whether it will seek another trial. The Court has ruled that we infringed that patent, so if the jury finds the patent valid, it will assess what, if any, damages are due Atmel.

From time to time, we are also involved in other legal actions arising in the ordinary course of business. We have incurred certain amounts associated with defending these matters. There can be no assurance the Atmel complaint or other third party assertions will be resolved without costly litigation, in a manner that is not adverse to our financial position, results of operations or cash flows or without requiring royalty payments in the future which may adversely impact gross margins. No estimate can be made of the possible loss or possible range of loss associated with the resolution of these contingencies. As a result, no losses have been accrued in our financial statements as of September 30, 2002.

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