PC TEL INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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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)

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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.
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PCTEL, INC.

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

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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.

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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.

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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.

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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.

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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

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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

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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.

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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

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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

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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 shortage in the supply of power within the
state. In anticipation of continuing power shortages, the electric utility
industry in California has warned power consumers to expect rolling blackouts
throughout the state, particularly during the summer months when power usage
peaks. We currently do not have backup generators or alternate sources of power
in the event of a blackout, and our current insurance does not provide coverage
for any damages we or our customers may suffer as a result of any interruption
in our power supply. Although the blackouts we have experienced to date have not
materially impacted our business, an increase in the frequency or length of the
blackouts could damage our reputation, harm our ability to retain existing
customers and to obtain new customers, and could result in lost revenue, any of
which could substantially harm our business and results of operations.
Furthermore, the deregulation of the energy industry has caused power prices to
increase. If wholesale prices continue to increase, our operating expenses will
likely increase, as the majority of our facilities are located in California.

27

RISKS RELATED TO OUR COMMON STOCK

OUR STOCK PRICE MAY BE VOLATILE BASED ON A NUMBER OF FACTORS, SOME OF WHICH ARE
NOT IN OUR CONTROL.

The trading price of our common stock has been highly volatile. Our stock
price could be subject to wide fluctuations in response to a variety of factors,
many of which are out of our control, including:

- actual or anticipated variations in quarterly operating results,

- announcements of technological innovations,

- new products or services offered by us or our competitors,

- changes in financial estimates by securities analysts,

- conditions or trends in our industry,

- our announcement of significant acquisitions, strategic partnerships,
joint ventures or capital commitments,

- additions or departures of key personnel,

- mergers and acquisitions, and

- sales of common stock by us or our stockholders.

In addition, the Nasdaq National Market, where many publicly held
telecommunications companies, including our company, are traded, often
experiences extreme price and volume fluctuations. These fluctuations often have
been unrelated or disproportionate to the operating performance of these
companies. In the past, following periods of volatility in the market price of
an individual company's securities, securities class action litigation often has
been instituted against that company. This type of litigation, if instituted,
could result in substantial costs and a diversion of management's attention and
resources.

PROVISIONS IN OUR CHARTER DOCUMENTS MAY INHIBIT A CHANGE OF CONTROL OR A CHANGE
OF MANAGEMENT WHICH MAY CAUSE THE MARKET PRICE FOR OUR COMMON STOCK TO FALL AND
MAY INHIBIT A TAKEOVER OR CHANGE IN OUR CONTROL THAT A STOCKHOLDER MAY CONSIDER
FAVORABLE.

Provisions in our charter documents could discourage potential acquisition
proposals and could delay or prevent a change in control transaction that our
stockholders may favor. These provisions could have the effect of discouraging
others from making tender offers for our shares, and as a result, these
provisions may prevent the market price of our common stock from reflecting the
effects of actual or rumored takeover attempts and may prevent stockholders from
reselling their shares at or above the price at which they purchased their
shares. These provisions may also prevent changes in our management that our
stockholders may favor. Our charter documents do not permit stockholders to act
by written consent, do not permit stockholders to call a stockholders meeting
and provide for a classified board of directors, which means stockholders can
only elect, or remove, a limited number of our directors in any given year.

Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock in one or more series. The board of directors can fix the price,
rights, preferences, privileges and restrictions of this preferred stock without
any further vote or action by our stockholders. The rights of the holders of our
common stock will be affected by, and may be adversely affected by, the rights
of the holders of any preferred stock that may be issued in the future. Further,
the issuance of shares of preferred stock may delay or prevent a change in
control transaction without further action by our stockholders. As a result, the
market price of our common stock may drop. The board of directors has not
elected to issue additional shares of preferred stock since the initial public
offering on October 19, 1999.

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to minimal market risks. We manage the sensitivity of our
results of operations to these risks by maintaining a conservative investment
portfolio, which is comprised solely of highly-rated, short-term

28

investments. We do not hold or issue derivative, derivative commodity
instruments or other financial instruments for trading purposes. We are exposed
to currency fluctuations, as we sell our products internationally. We manage the
sensitivity of our international sales by denominating all transactions in U.S.
dollars.

We may be exposed to interest rate risks, as we may use additional
financing to fund additional acquisitions and fund other capital expenditures.
The interest rate that we may be able to obtain on financings will depend on
market conditions at that time and may differ from the rates we have secured in
the past.

29

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

PCTEL, INC.

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

30

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To PCTEL, Inc.:

We have audited the accompanying consolidated balance sheets of PCTEL, Inc.
(a Delaware corporation) and subsidiaries as of December 31, 2001 and 2000 and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2001. These
financial statements and the schedule referred to below are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of PCTEL, Inc. and subsidiaries
as of December 31, 2001 and 2000, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States of
America.

Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in Item 14(a)2 is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits of
the basic consolidated financial statements and, in our opinion, fairly states
in all material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.

ARTHUR ANDERSEN LLP

San Jose, California
January 22, 2002
(except with respect to the matters
discussed in Note 11, as to which
the date is March 27, 2002)

31

PCTEL, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

The accompanying notes are an integral part of these consolidated financial
statements.
32

PCTEL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying notes are an integral part of these consolidated financial
statements.
33

PCTEL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial
statements.
34

PCTEL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial
statements.
35

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEAR ENDED: DECEMBER 31, 2001

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND OPERATIONS OF THE COMPANY

We were originally incorporated in California in February 1994 and in July
1998, we reincorporated in Delaware. We are a leading provider of software-based
high speed connectivity solutions to individuals and businesses worldwide. We
design, develop, produce and market advanced high performance, low cost modems
that are flexible and upgradable, with functionality that can include data/fax
transmission at various speeds, and telephony features. Our soft modem products
consist of a hardware chipset containing a proprietary host signal processing
software architecture which utilizes 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.

We are subject to certain risks including the impact of the recent economic
slowdown, concentration of sales among a limited number of customers,
concentration of sales in Asia, the Company's ability to develop and
successfully introduce new and enhanced products, the outcome of ongoing and
potential litigation involving intellectual property, competition from larger,
more established companies and dependence on key suppliers.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the periods
reported. Actual results could differ from those estimates.

CONSOLIDATION AND FOREIGN CURRENCY TRANSLATION

We use the United States dollar for our financial statements, even for our
subsidiaries in foreign countries with the exception of our Japanese subsidiary
where the functional currency is Japanese Yen. All gains and losses resulting
from transactions originally in foreign currencies and then translated into US
dollars are included in net income. Assets and liabilities of our Japanese
operations are translated to U.S. dollars at the exchange rate in effect at the
applicable balance sheet date, and revenues and expenses are translated using
average exchange rates prevailing during that period. Operations and translation
adjustments have not been material to date. As of December 31, 2001, we had
subsidiaries in the Cayman Islands, Japan and Taiwan. These consolidated
financial statements include the accounts of PCTEL and our subsidiaries after
eliminating intercompany accounts and transactions.

CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

We divide our financial instruments into two different classifications.

Cash equivalents: are debt instruments that mature within three
months after we purchase them.

Short-term
investments: are marketable debt instruments that generally
mature between three months and two years from
the date we purchase them. All of our short-term
investments are classified as current assets and
available-

36

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

for-sale because they are marketable and we have
the option to sell them before they mature.

As of December 31, 2001, short-term investments
consisted of high-grade corporate securities with
maturity dates of approximately five months to
two years.

These investments are recorded at market price
and any unrealized holding gains and losses
(based on the difference between market price and
book value) are reflected as other comprehensive
income/loss in the stockholders' equity section
of the balance sheet. We have accumulated a
$812,000 unrealized holding gain as of December
31, 2001. Realized gains and losses and declines
in value of securities judged to be other than
temporary are included in interest income and
have not been significant to date. Interest and
dividends of all securities are included in
interest income.

CONCENTRATIONS AND RISKS

Financial instruments that potentially subject us to concentration and
credit risk consist primarily of short-term investments and trade receivables.

To mitigate credit risk related to short-term investments, we have an
investment policy to preserve the value of capital and generate interest income
from these investments without undue exposure to risk. Market risk is the
potential loss due to the change in value of a financial instrument due to
interest rates or equity prices. We try to moderate this risk in two ways.
First, our investment portfolio is divided between Banc of America Securities
and Salomon Smith Barney. By using two independent investment banking firms, we
believe we have improved market visibility. Secondly, we independently review
market pricing on a periodic basis based upon directly managing a limited amount
of funds we use for operations which are not managed by our funds' managers.

For trade receivables, credit risk is the potential for a loss due to a
customer not meeting its payment obligations. Estimates are used in determining
an allowance for amounts which we may not be able to collect based on current
trends, the length of time receivables are past due and historical collection
experience. We moderate this risk by establishing and reviewing credit limits,
monitoring those limits and making updates as required. Provisions for and
recovery of bad debts are recorded against revenue in our consolidated
statements of operations.

Our customers are concentrated in the personal computer industry and modem
board manufacturer industry segment and in certain geographic locations. We
actively market and sell products in Asia. We perform ongoing evaluations of our
customers' financial condition and generally require no collateral. As of
December 31, 2001, approximately 89% of gross accounts receivable were
concentrated with five customers. As of December 31, 2000, approximately 64% of
gross accounts receivable were concentrated with four customers.

For the years ended December 31, 2001, 2000 and 1999, we purchased
integrated circuits from a limited number of vendors. If these vendors are
unable to provide integrated circuits in a timely manner and we are unable to
find alternative vendors, our business, operating results and financial
condition could be adversely affected.

The majority of our revenues are derived from a limited number of products
utilizing host signal processing technology. The market for these products is
characterized by frequent transitions in which

37

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

products rapidly incorporate new features and performance standards. A failure
to develop products with required feature sets or performance standards or a
delay in bringing a new product to market could adversely affect our operating
results.

INVENTORIES

Inventories are stated at the lower of cost or market and include material,
labor and overhead costs. Inventories as of December 31, 2001 and 2000 were
composed of finished goods only. We regularly monitor inventory quantities on
hand and, based on our current estimated requirements, it was determined that
there was excess inventory and those excess amounts were fully reserved as of
December 31, 2001 and 2000. Due to competitive pressures and technological
innovation, it is possible that these estimates could change in the near term.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives (three to seven years) of
the assets. Leasehold improvements are amortized over the corresponding lease
term.

Property and equipment consists of the following (in thousands):

SOFTWARE DEVELOPMENT COSTS

We account for software development costs in accordance with SFAS No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed." Our products include a software component. To date, we have expensed
all software development costs because these costs were incurred prior to the
products reaching technological feasibility.

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,

38

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

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.

INCOME TAXES

We provide for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes". SFAS No. 109 requires an asset and liability
based approach in accounting for income taxes. Deferred income tax assets and
liabilities are recorded based on the differences between the financial
statement and tax bases of assets and liabilities using enacted tax rates.
Valuation allowances are provided against assets which are not likely to be
realized. As of December 31, 2001, we have deferred tax assets, net of valuation
allowances, of $400,000.

STOCK-BASED COMPENSATION

We account for stock-based awards to employees in accordance with the
Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to
Employees". We have adopted the disclosure-only alternative of SFAS No. 123,
"Accounting for Stock-Based Compensation". Under APB No. 25, if the exercise
price of our employee stock options equals or exceeds the market value of the
underlying stock on the date of grant, no compensation expense is recorded.
However, if the stock option price is less than market value, a stock based
compensation charge is required. We have included the pro forma disclosures
required under SFAS No. 123 in Note 9. 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.

EARNINGS PER SHARE

We compute earnings per share in accordance with SFAS No. 128, "Earnings
Per Share". SFAS No. 128 requires companies to compute net income per share
under two different methods, basic and diluted, and present per share data for
all periods in which statements of operations are presented. Basic earnings per
share is computed by dividing net income by the weighted average number of
shares of common stock outstanding, less shares subject to repurchase. Diluted
earnings per share is computed by dividing net income by the weighted average
number of common stock and common stock equivalents outstanding. Common stock
equivalents consist of preferred stock using the "if converted" method and stock
options and warrants using the treasury stock method. Preferred stock, common
stock options and warrants are excluded from the computation of diluted earnings
per share if their effect is anti-dilutive. The weighted average common stock
option grants excluded from the calculations of diluted net loss per share were
200,000 for the year ended December 31, 2001.

39

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

The following table provides a reconciliation of the numerators and
denominators used in calculating basic and diluted earnings per share for the
years ended December 31, 2001, 2000 and 1999, respectively (in thousands, except
per share data):

GOODWILL AND INTANGIBLE ASSETS

Goodwill and intangible assets are amortized using the straight-line method
over useful lives of 2 to 5 years. As of December 31, 2001 and 2000, accumulated
amortization of goodwill and intangible assets was $48,000 and $7.0 million,
respectively.

ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS

We assess the need to record impairment losses on long-lived assets used in
operations when indicators of impairment are present such as a significant
industry downturn, significant decline in the market value of the Company or
significant reductions in projected future cash flows. On an on-going basis, we
review the value and period of amortization or depreciation of long-lived
assets. During this review, the significant assumptions used in determining the
original cost of long-lived assets are reevaluated. We then determine whether
there has been a permanent impairment of the value of long-lived assets by
comparing future estimated undiscounted cash flows to the asset's carrying
value. If the carrying value of the asset exceeds the estimated future
undiscounted cash flows, a loss is recorded as the excess of the asset's
carrying value over fair value. Long-lived assets to be disposed of are reported
at the lower of carrying amount or fair value less costs to sell.

Due to the recent economic downturn, we determined that a portion of the
remaining goodwill from the CSD acquisition and all of the remaining goodwill
and intangibles from the Voyager and BlueCom acquisitions have been impaired. As
such, an impairment charge of $16.8 million was recorded in fiscal 2001. See
Note 5 for further discussions.

40

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

COMPREHENSIVE INCOME

The following table provides the calculation of other comprehensive income
for the years ended December 31, 2001, 2000 and 1999 (in thousands):

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the FASB issued 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.

RECLASSIFICATIONS

Certain amounts in prior years have been reclassified to conform with the
current period presentation.

2. SHORT-TERM INVESTMENTS

We invest in high quality, short-term investments, which we classify as
available-for-sale. There were no significant differences between amortized cost
and estimated fair value of these short-term investments at December 31, 2001
and 2000. The following table presents the estimated fair value breakdown of
investment securities by major security type (in thousands):

41

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

As of December 31, 2001, $25.6 million of the short-term investments have
maturity dates of less than one year and $61.6 million have maturity dates of
one to five years. All of our short-term investments are classified as current
assets because they are marketable and we have the option to sell them before
they mature.

3. ACQUISITIONS

BLUECOM TECHNOLOGY CORP.

On December 14, 2000, we completed the acquisition of BlueCom, a Taiwanese
Company specializing in the innovation, development and marketing of MMX Signal
Processing (MSP) technology. Under the terms of the agreement, the former
shareholders of BlueCom received 11,245 shares of our common stock and
$1,557,770 of cash in exchange for all shares of BlueCom common stock.

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 following table summarizes the components of the total purchase price
and the allocation (in thousands).

Cash........................................................ $1,557
Fair value of 11,245 shares of our common stock............. 322
Acquisition costs........................................... 71
------
Total purchase price.............................. 1,950
Less: Net assets acquired................................... (170)
------
Acquired intangibles and goodwill................. $1,780
======

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 Note 5). We have included the results of BlueCom from the
date of acquisition in the consolidated statements of operations.

VOYAGER TECHNOLOGIES, INC.

On February 24, 2000, we completed the acquisition of Voyager, a provider
of personal connectivity and Internet access technology. Under the terms of the
Agreement and Plan of Reorganization (the "Merger Agreement"), the former
shareholders of Voyager received 237,272 shares of our common stock and
$2,065,331 of cash in exchange for all shares of Voyager common stock. In
addition, 645,157 vested and unvested options to purchase shares of Voyager
common stock were converted into 49,056 options to purchase our common stock at
the exchange ratio of 0.07604. Included in the 237,272 shares are 82,419
restricted shares of common stock issued to a Voyager shareholder. These shares
are not subject to forfeiture under any circumstances and, thus, were considered
in the determination of the purchase price at the date of acquisition.

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 following table summarizes the components of the total purchase price
and the allocation (in thousands).

42

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

Fair value of 237,272 shares of our common stock............ $11,814
Fair value of options for 49,056 shares of our common
stock..................................................... 2,504
Cash........................................................ 2,065
Settlement of outstanding claim............................. 1,500
Acquisition costs........................................... 687
-------
Total purchase price.............................. 18,570
Less: Net assets acquired................................... (762)
-------
Acquired intangibles and goodwill................. $17,808
=======

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 Note 5). We have included the results of Voyager from
the date of acquisition in the consolidated statements of operations.

In addition to the 237,272 shares of our common stock issued to the
shareholders of Voyager, 30,415 additional shares of common stock were held in
an escrow account pending resolution of an outstanding claim. These shares had
been treated as contingent consideration and were not initially recognized as
purchase price due to the uncertainty of how the claim would be resolved. In May
2000, the outstanding claim was settled for $1.5 million which resulted in the
return of the stock held in escrow to us. No amount was initially recorded for
the now-unissued stock while in escrow, however, the $1.5 million outstanding
claim settlement was recognized as additional purchase price in the quarter
ended June 30, 2000.

As part of the acquisition, we granted 49,056 vested and unvested options
to purchase our common stock upon conversion of the outstanding Voyager options,
based on the exchange ratio of 0.07604. The fair value of these options was
determined using the Black-Scholes option pricing model and the following
assumptions: risk-free interest rate of 5.50%; dividend yields of zero; an
estimated volatility factor of the market price of our common stock of 75%; and
an expected life between three to six months after vest date. The
weighted-average estimated fair value of these options was $51.05 per share.

Upon completion of the Voyager acquisition, 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 revenue 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
43

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

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.

The unaudited pro forma financial information for the years ended December
31, 2000 and 1999 is presented below (in thousands except per share information)
as if Voyager and BlueCom had been acquired on January 1. The pro forma
information does not purport to be indicative of what would have occurred had
the acquisitions been made as of those dates or of results that may occur in the
future. Pro forma net income excludes the write-off of acquired in-process
research and development of $1.6 million.

4. INVENTORY LOSSES

Due to the changing market conditions, recent economic downturn and
estimated future requirements, inventory valuation charges of $10.9 million were
recorded in the second half of 2001. Of the $10.9 million, $2.3 million related
to firm purchase order commitments with our major suppliers and the remaining

44

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

$8.6 million related to excess inventory on hand or disposed. As of December 31,
2001 and 2000, the allowance for obsolete inventory was $1.4 million and $2.5
million, respectively.

5. IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS

On December 22, 1998, we acquired substantially all of the assets and
assumed certain of the liabilities of CSD, a division of General DataComm, Inc.,
for a total purchase price of approximately $17 million. Of the excess purchase
price of $16.8 million, we attributed $10.7 million as goodwill and other
intangible assets.

On February 24, 2000, we completed the acquisition of Voyager, a provider
of personal connectivity and Internet access technology, for a total purchase
price of approximately $18.6 million. Of the excess purchase price of $17.8
million, we attributed $16.2 million as goodwill and other intangible assets.

On December 14, 2000, we completed the acquisition of BlueCom, one of
Taiwan's industry leaders in the innovation, development and marketing of MSP
technology, for a total purchase price of approximately $1.9 million. The excess
purchase price of $1.8 million was attributed to goodwill and other 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 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.

6. 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 for 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 charges
for the year ended December 31, 2001, consisting of severance and employment
related

45

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

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. The following analysis sets forth
the significant components of this charge:

Total severance and employment related costs of $2.5 million consisted of
termination compensation and related benefits. Total costs for closure of excess
facilities of $1.3 million consisted of future minimum lease payments and
related costs on the excess and unused facilities as a result of our down
sizing. We are in the process of locating a tenant to sublease the excess
facilities for the remainder of the lease term. As of December 31, 2001,
approximately $1.9 million of termination compensation and related benefits had
been paid to terminated employees. The remaining accrual balance of $579,000
will be paid on various dates extending through October 2002. As of December 31,
2001, approximately $324,000 of lease payments and related costs had been paid
to the landlord for the excess facilities. The remaining accrual balance of
$988,000 will be paid monthly through February 2003.

7. INCOME TAXES

We utilize the liability method of accounting for income taxes in
accordance with SFAS No. 109 "Accounting for Income Taxes". Under this method,
deferred taxes are determined based on the differences between the financial
statement and tax bases of assets and liabilities using enacted tax rates.

The domestic and foreign components of our income (loss) before provision
for income taxes and extraordinary loss were as follows (in thousands):

46

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

Our provision for income taxes consisted of the following (in thousands):

A reconciliation of the provision for income taxes at the Federal statutory
rate compared to our effective tax rate is as follows (in thousands):

47

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Our net deferred tax
asset consists of the following (in thousands):

As of December 31, 2001, we have federal and California net operating loss
carryforwards of approximately $4 million and $2 million, respectively, to
offset future taxable income. These carryforwards expire on various dates
through 2021.

Other cumulative temporary differences consist of items currently
deductible for financial reporting purposes, but not for tax purposes. These
items are primarily estimated reserves and accruals. The realization of the
deferred tax asset is dependent on generating sufficient taxable income in
future years. During the third quarter of 2001, we recorded $5.3 million of
provision for income taxes to establish valuation allowances against deferred
tax assets as a result of uncertainties regarding realizability. After the
establishment of the valuation allowances, we have $400,000 in net deferred tax
assets as of December 31, 2001.

8. PREFERRED STOCK

Following the closing of our IPO in October 1999, 4,635,548 shares of
Series A convertible preferred stock, 3,250,000 shares of Series B convertible
preferred stock and 625,200 shares of Series C convertible preferred stock were
automatically converted into 8,510,748 shares of common stock. We are authorized
to issue up to 5,000,000 shares of preferred stock in one or more series, each
with a par value of $0.001 per share. As of December 31, 2001 and 2000, no
shares of preferred stock were outstanding.

9. COMMON STOCK

INITIAL AND SECONDARY PUBLIC OFFERINGS

On October 19, 1999, we completed our IPO of common stock. A total of
5,290,000 shares were sold at a price of $17.00 per share (including the
exercise of the underwriters' over-allotment option of 690,000 shares). We
received net proceeds of approximately $82.5 million.

On April 11, 2000, we effected our secondary public offering of common
stock. A total of 2,750,000 shares were sold at a price of $46.50 per share;
650,000 shares were sold by us and 2,100,000 shares were sold by our selling
stockholders. The offering resulted in net proceeds to us and the selling
stockholders of approximately $28.0 million and $92.8 million, respectively, net
of an underwriting discount of $6.4 million and offering expenses of $0.7
million.

48

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

COMMON STOCK RESERVED FOR FUTURE ISSUANCE

As of December 31, 2001, we had reserved shares of common stock for future
issuance as follows:

1995, 1997 and 2001 Stock Option Plans...................... 6,150,428
1998 Director Option Plan................................... 200,000
Employee Stock Purchase Plan................................ 1,337,362
---------
Total shares reserved....................................... 7,687,790
=========

STOCK OPTION PLANS

1995 Plan, 1997 Plan, and 2001 Plan

In March 1995, the Board of Directors adopted and approved the 1995 Stock
Option Plan ("1995 Plan"). Under the 1995 Plan, the Board may grant to
employees, directors and consultants options to purchase our common stock at
terms and prices determined by the Board. No further options will be granted
under the 1995 Plan. However, all outstanding options under the 1995 Plan remain
in effect. The 1995 Plan will terminate in 2005. As of December 31, 2001, of the
total 3,200,000 shares authorized under the 1995 Plan, 156,032 shares remain
available for issuance.

In November 1996, the Board of Director adopted and approved the 1997 Stock
Option Plan ("1997 Plan"). Under the 1997 Plan, the Board may grant to
employees, directors and consultants options to purchase our common stock and/or
stock purchase rights at terms and prices determined by the Board. In August
1999, the Board of Directors and our stockholders approved an amendment and
restatement of the 1997 Plan that increased the number of authorized shares of
our common stock we may issue under the 1997 Plan to 5,500,000. We will further
increase annually the number of shares we are authorized to issue under the 1997
Plan by an amount equal to the lesser of (i) 700,000 shares, (ii) 4% of the
outstanding shares on such date or (iii) a lesser amount determined by the Board
of Directors. The exercise price of incentive stock options granted under the
1997 Plan may not be less than the fair market value of the common stock on the
grant date. Nonqualified stock options granted under the 1997 Plan must be at a
price equal to at least 85% of the fair market value of our common stock at the
date of grant. Options granted under the 1997 Plan may be exercised at any time
within ten years of the date of grant or within ninety days of termination of
employment, or such shorter time as may be provided in the related stock option
agreement. The 1997 Plan will terminate in 2007. As of December 31, 2001, of the
total 6,862,413 shares authorized under the 1997 Plan, 627,653 shares remain
available for issuance.

In August 2001, the Board of Directors adopted and approved the 2001
Nonstatutory Stock Option Plan ("2001 Plan"). Under the 2001 Plan, the Board may
grant to employees and consultants options to purchase our common stock at terms
and prices determined by the Board. The 2001 Plan does not apply to directors
and officers. Options granted under the 2001 Plan may be exercised at any time
within ten years from the date of grant or within ninety days of termination of
employment, or such shorter time as may be provided in the related stock option
agreement. The 2001 Plan will terminate in 2011. As of December 31, 2001, of the
total 750,000 shares authorized under the 2001 Plan, 419,648 remain available
for issuance.

49

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

The following table summarizes stock option activity under the 1995 Plan,
1997 Plan and 2001 Plan as of December 31, 2001:

In 2001, in connection with the hiring and appointment of two executive
officers of the Company, we granted an aggregate amount of 300,000 options at
$8.00 per share outside of any stock option plan, pursuant to individual stock
option agreements. As of December 31, 2001, all of the 300,000 options are
outstanding.

1998 Director Option Plan ("Directors Plan")

Our Directors Plan became effective following our IPO in October 1999. We
have reserved a total of 200,000 shares of common stock that we can issue under
our Directors Plan. Under our 1998 Directors Plan, any new non-employee director
elected to the Board of Directors automatically receives a grant of 15,000
shares of common stock. The 15,000 share options will vest one-third as of each
anniversary of its date of grant until the option is fully vested, provided that
the optionee continues to serve as a director on such dates. After the initial
15,000 share options are granted to the non-employee director, he or she shall
automatically be granted an option to purchase 7,500 shares each year on January
1, if on such date he or she shall have served on the Board of Directors for at
least six months. The 7,500 share options shall vest completely on the
anniversary of their date of grant, provided that the optionee continues to
serve as a director on such dates. The exercise price of all options shall be
100% of the fair market value per share of the common stock, generally
determined with reference to the closing price of the common stock as reported
on the Nasdaq National Market on the date of grant. All of the options granted
under our 1998 Directors Plan have a term of 10 years. As of December 31, 2001,
of the total 200,000 shares authorized for issuance, we have remaining 140,000
shares that we can grant under the Directors Plan. For the year ended December
31, 2000, we granted 22,500 options at a weighted average exercise price of
$59.00 under the Directors Plan and all 22,500 options were outstanding as of
December 31, 2000. For the year ended December 31, 2001, there were grants of

50

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

59,500 options at a weighted average exercise price of $8.46 and cancellations
of 15,000 options at a weighted average exercise price of $33.92 under the
Directors Plan. As of December 31, 2001, 60,000 options were outstanding at a
weighted average exercise price of $21.05.

The following table summarizes information about stock options outstanding
under the 1995 Plan, 1997 Plan, 2001 Plan, Directors Plan and Executive Options
at December 31, 2001:

As of December 31, 2000, there were 1,549,717 options exercisable at a
weighted average exercise price of $7.03 and as of December 31, 1999, there were
1,531,816 options exercisable at a weighted average exercise price of $3.82.

Employee Stock Purchase Plan ("Purchase Plan")

In May 1998, we reserved a total of 800,000 shares of common stock for
future issuance under our Purchase Plan, plus annual increases equal to the
lesser of (i) 350,000 shares (ii) 2% of the outstanding shares on such date or
(iii) a lesser amount determined by the Board of Directors. Our Purchase Plan
will enable eligible employees to purchase common stock at the lower of 85% of
the fair market value of our common stock on the first or last day of each
offering period. Each offering period is six months except for the first
offering period which began on October 19, 1999 following the initial public
offering and ended on February 14, 2000. The Purchase Plan will terminate in
2008. As of December 31, 2001, the number of authorized shares available for
issuance under the Purchase Plan was 1,481,207 and we have remaining 1,337,362
shares that we can issue under the Purchase Plan.

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 235,000 shares of restricted common stock
to employees in 2001 through our 1997 Plan, 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 three year
vesting period of the applicable shares.
51

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

Subsequent to the issuance of the restricted stock, employee terminations
resulted in the cancellation of 115,000 shares and reversal of $859,000 from
deferred stock compensation. Of the remaining 120,000 shares of restricted
common stock, 15,000 shares vest out of the repurchase option three years after
date of issuance, 52,500 shares vest out of the repurchase option on December
31, 2002 and the balance on December 31, 2003. As of December 31, 2001, all of
the remaining 120,000 shares are subject to repurchase by us. 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.

For the years ended December 31, 2001, 2000 and 1999, amortization of
deferred stock compensation (in thousands) relates to the following functional
categories:

Rescission of Stock Option Exercise

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.

Valuation of Stock Options

Under SFAS No. 123, we are required to present pro forma information
regarding net income and net income per share as if we had accounted for our
stock options under the fair value method. The fair value for the stock options
was estimated at the date of grant using the Black-Scholes option pricing model
with the following assumptions for fiscal years 2001, 2000 and 1999: risk-free
interest rates in the range of 2.2% to 6.5%; dividend yields of zero; an
estimated volatility factor of the market price of our common stock in the range
of 55% to 75%; and an expected life between three to six months after vest date.
The weighted-average estimated fair value of options granted during fiscal 2001,
2000 and 1999 was $4.11, $16.96 and $6.88 per share, respectively.

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility and expected option life. Because our employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in our opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of our employee stock
options.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the option vesting periods. Our pro forma
net income (loss) would have been approximately $(64.6) million, $(10.2) million
and $1.6 million for fiscal years 2001, 2000 and 1999, respectively. Pro forma
diluted net income (loss) per share would have been $(3.35), $(0.50) and $0.11
for fiscal years 2001, 2000 and 1999, respectively.

52

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

WARRANTS

In February 1998, in connection with the issuance of Series C preferred
stock, we issued warrants to purchase 2,417 shares of common stock at $8.00 per
share. In 1999, a portion of these warrants were exercised to purchase 1,354
shares of common stock. The remaining warrants were exercised in 2000. In
December 1998, in connection with the notes payable arrangement to acquire
Communications Systems Division ("CSD"), a division of General DataComm, Inc.,
we issued a warrant to purchase 200,000 shares of Series C preferred stock at
$8.00 per share which was converted to a warrant to purchase common stock at the
time of the IPO. This warrant was exercised in 2000 through a net exercise
settlement.

10. LEASE COMMITMENTS:

We entered into an operating lease for our facilities in Milpitas,
California in September 1999. The lease expires in February 2003. Additionally,
we have facilities in Waterbury, Connecticut, Japan, Taiwan, Korea and France.

We have non-cancelable operating leases for office facilities through 2003
and operating leases for equipment through 2005. Our future minimum rental
payments under these leases at December 31, 2001, are as follows (in thousands):

2002........................................................ $1,376
2003........................................................ 386
2004........................................................ 76
2005........................................................ 2
------
Future minimum lease payments............................... $1,840
======

Our rent expense under operating leases for the years ended December 31,
2001, 2000 and 1999 was approximately $1,166,000, $1,422,000, and $985,000,
respectively.

11. CONTINGENCIES:

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 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.

As of December 31, 2001 and 2000, we had accrued royalties of approximately
$12.3 million and $11.7 million, respectively. Of these amounts, approximately
$42,000 and $1.2 million represent amounts accrued based upon signed royalty
agreements as of December 31, 2001 and 2000, respectively. The remainder of
accrued royalties represents management's best estimate within a range of
possible settlement losses as of each date presented. While management is unable
to estimate the maximum amount of the range of possible settlement losses, it is
possible that actual losses could exceed the amounts accrued as of each date
presented.

We have 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,

53

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

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. Other than the ESS
Technology and Dr. Townshend lawsuits described below, no material lawsuits
relating to intellectual property are currently filed against us.

PCTEL, Inc. v. Brent Townshend

In September 1998 and May 1999, Dr. Brent 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. 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. 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 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 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.

54

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

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. 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.

12. INDUSTRY SEGMENT, CUSTOMER AND GEOGRAPHIC INFORMATION:

We are organized based upon the nature of the products we offer. Under this
organizational structure, we operate in one segment, that segment being
software-based modems using host signal processing technology. We market our
products worldwide through our sales personnel, independent sales
representatives and distributors.

Our sales to customers outside of the United States, as a percent of total
revenues, are as follows:

55

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

Sales to our major customers representing greater than 10% of total
revenues are as follows:

As of December 31, 2001, our long-lived assets were primarily located in
the United States. Our long-lived assets by geographic region as of December 31,
2001 and 2000 are as follows:

13. RELATED PARTY TRANSACTIONS:

Included in prepaid expenses and other assets as of December 31, 2000 are
amounts due from management. These promissory notes are due within a year and
bear interest at 8.0% per annum. The balance receivable as of December 31, 2001
and 2000 is $0 and $90,995, respectively.

For the year ended December 31, 2001, we paid a total of $210,000 to two of
our executive officers, prior to their appointment, for consulting services. One
of the executive officers served as a member of our Board of Directors during
the period in which consulting fees were paid to him.

14. 401(k) PLAN

Our 401(k) plan covers all of our employees beginning the first of the
month following the month of their employment. Under this plan, employees may
elect to contribute up to 15% of their current compensation to the 401(k) plan
up to the statutorily prescribed annual limit. We may make discretionary
contributions to the 401(k). We made $191,215 in employer contributions to the
401(k) plan for the year ended December 31, 2001. We made $224,969 in employer
contributions to the 401(k) plan for the year ended December 31, 2000.

56

PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED: DECEMBER 31, 2001

15. QUARTERLY DATA (UNAUDITED)

57

ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item concerning our directors is
incorporated by reference to the sections entitled "Proposal One -- Election of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance"
contained in our Proxy Statement related to our 2002 Annual Meeting of
Stockholders, to be filed with the Securities and Exchange Commission within 120
days of the end of our fiscal year pursuant to general instruction G(3) of Form
10-K (the "Proxy Statement"). Certain information required by this item
concerning executive officers is set forth in Item I of this Report in the
section captioned "Business -- Executive Officers".

ITEM 11: EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference to the
sections captioned "Executive Compensation and Other Matters" and "Report of the
Compensation Committee of the Board of Directors" contained in our Proxy
Statement.

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information concerning the security ownership of certain beneficial owners
and management is incorporated by reference to the section entitled "Information
Concerning Solicitation and Voting Security Ownership of Certain Beneficial
Owners and Management" contained in our Proxy Statement.

ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information concerning certain relationships is incorporated by reference
to the section entitled "Transactions with Related Parties and Insiders"
contained in our Proxy Statement.

PART IV

ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(A) (1) FINANCIAL STATEMENTS

Refer to the financial statements filed as a part of this Report under "Item
8 -- Financial Statements and Supplementary Data".

(2) FINANCIAL STATEMENT SCHEDULES

The following financial statement schedule is filed as a part of this Report
under "Schedule II" immediately preceding the signature page: Schedule
II -- Valuation and Qualifying Accounts for the three fiscal years ended
December 31, 2001. All other schedules called for by Form 10-K are omitted
because they are inapplicable or the required information is shown in the
financial statements, or notes thereto, included herein.

58

(3) EXHIBITS (NUMBERED IN ACCORDANCE WITH ITEM 601 OF REGULATION S-K)

59

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

(a) Filed herewith.

(b) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Registration Statement on Form S-1 (Registration Statement
No. 333-94707).

(c) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999.

(d) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Annual Report on Form 10-K for the year ended December 31,
2000.

(e) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Quarterly Report on Form 10-Q for the quarter ended March
31, 2001.

(f) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 2001.

(g) Incorporated by reference herein to the Registrant's Registration Statement
of Form S-8 filed on October 3, 2001 (Registration Statement No.333-70886).

(h) Incorporated by reference herein to the Registrant's Registration Statement
of Form S-8 filed on December 14, 2001 (Registration Statement
No.333-75204).

(B) REPORTS ON FORM 8-K

None.

(C) EXHIBITS

See Item 14(a)(3) above.

(D) FINANCIAL STATEMENT SCHEDULES

See Item 14(a)(2) above.

60

PCTEL, INC.

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

61

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.

PCTEL, Inc.
A Delaware Corporation
(Registrant)

/s/ MARTIN H. SINGER

--------------------------------------
Martin H. Singer
Chairman of the Board and
Chief Executive Officer

Dated: April 1, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

62

EXHIBIT INDEX

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

(a) Filed herewith.

(b) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Registration Statement on Form S-1 (Registration Statement
No. 333-94707).

(c) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999.

(d) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Annual Report on Form 10-K for the year ended December 31,
2000.

(e) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Quarterly Report on Form 10-Q for the quarter ended March
31, 2001.

(f) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 2001.

(g) Incorporated by reference herein to the Registrant's Registration Statement
of Form S-8 filed on October 3, 2001 (Registration Statement No.333-70886).

(h) Incorporated by reference herein to the Registrant's Registration Statement
of Form S-8 filed on December 14, 2001 (Registration Statement
No.333-75204).