SILICON LABORATORIES INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 28, 2002
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or

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

For the transition period from to
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Commission file number:
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SILICON LABORATORIES INC.
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(Exact name of registrant as specified in its charter)

Delaware 74-2793174
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(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification No.)

4635 Boston Lane, Austin, Texas 78735
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(Address of principal executive offices) (Zip Code)

(512) 416-8500
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(Registrant's telephone number, including area code)

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(Former name, former address and former fiscal year,
if changed since last report)

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court. |_| Yes |_| No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. As of October 9, 2002,
48,792,338 shares of common stock of Silicon Laboratories Inc. were outstanding.
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2

PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SILICON LABORATORIES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

3

SILICON LABORATORIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

4

SILICON LABORATORIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)

5

SILICON LABORATORIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 28, 2002

1. SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The condensed consolidated financial statements, other than the condensed
consolidated balance sheet as of December 29, 2001, included herein are
unaudited; however, they contain all normal recurring accruals and adjustments
which, in the opinion of management, are necessary to present fairly the
consolidated financial position of Silicon Laboratories Inc. and its
subsidiaries (collectively, the "Company") at September 28, 2002, the
consolidated results of its operations for the three and nine months ended
September 28, 2002 and September 29, 2001 and the consolidated statements of
cash flows for the nine months ended September 28, 2002 and September 29, 2001.
All intercompany accounts and transactions have been eliminated. The results of
operations for the three and nine months ended September 28, 2002 are not
necessarily indicative of the results to be expected for the full year.

The accompanying unaudited condensed consolidated financial statements do
not include certain footnotes and financial presentations normally required
under accounting principles generally accepted in the United States. Therefore,
these financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year ended
December 29, 2001, included in the Company's Form 10-K filed with the Securities
and Exchange Commission on January 22, 2002.

INVENTORIES

Inventories are stated at the lower of cost, determined using the first-in,
first-out method, or market. Inventories consist of the following (in
thousands):

EQUITY METHOD INVESTMENTS

Where the Company has investments in affiliated companies in which it has
the ability to exercise significant influence over operating and financial
policies, but not control, these investments are accounted for using the equity
method. When special conditions warrant, for example when the Company is the
sole funding source for an affiliated company and the affiliated company has not
generated sufficient cash flows to sustain its operations, the Company
determines equity income measurement by using the Hypothetical Liquidation at
Book Value (HLBV) method. The HLBV method is a balance-sheet oriented approach
to equity method accounting and is calculated as the amount that the Company
would receive or be obligated to pay if the affiliated company were to liquidate
all of its assets at recorded amounts and distribute the cash to creditors and
investors in accordance with their respective priorities.

The Company records investment loss under the caption "equity investment
loss" in its condensed consolidated statement of operations.

OTHER COMPREHENSIVE INCOME

There were no material differences between net income (loss) and
comprehensive income (loss) during any of the periods presented.

6

SILICON LABORATORIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) Nos. 141 and 142, BUSINESS
COMBINATIONS and GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS No. 141 replaces
Accounting Principles Board Opinion (APB) No. 16 and eliminates
pooling-of-interests accounting prospectively. It also provides guidance on
purchase accounting related to the recognition of intangible assets and
accounting for negative goodwill. SFAS No. 142 changes the accounting for
goodwill from an amortization method to an impairment-only approach. Under SFAS
No. 142, goodwill will be tested annually and whenever events or circumstances
occur indicating that goodwill might be impaired. SFAS No. 141 and SFAS No. 142
are effective for all business combinations completed after June 30, 2001. Upon
a company's adoption of SFAS No. 142, a company ceases to amortize goodwill
recorded for business combinations consummated prior to July 1, 2001, and
intangible assets acquired prior to July 1, 2001 that do not meet the criteria
for recognition under SFAS No. 141 are reclassified to goodwill. Companies are
required to adopt SFAS No. 142 for fiscal years beginning after December 15,
2001. The Company adopted SFAS No. 142 on December 30, 2001, the beginning of
fiscal 2002. In connection with the adoption of SFAS No. 142, the Company has
performed a transitional goodwill impairment assessment. The adoption of SFAS
No. 141 and SFAS No. 142 did not have a material impact on the Company's results
of operations and financial position since the Company's existing balances of
goodwill and other intangible assets were not significant.

In October 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS, which supersedes SFAS No. 121, ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF;
however, it retains the fundamental provisions of that statement related to the
recognition and measurement of the impairment of long-lived assets to be "held
and used." In addition, the Statement provides more guidance on estimating cash
flows when performing a recoverability test, requires that a long-lived asset to
be disposed of other than by sale be classified as "held and used" until it is
disposed of, and establishes more restrictive criteria to classify an asset as
"held for sale." The Company adopted SFAS No. 144 on December 30, 2001. The
adoption did not have a material impact on the results of operations or
financial position of the Company.

7

SILICON LABORATORIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

EARNINGS (LOSS) PER SHARE

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

Approximately 3,782,000 and 4,120,000 common shares have been excluded from
the diluted loss per share calculation for the three and nine months ended
September 29, 2001, respectively, as their impact would have been anti-dilutive.

2. SEGMENT REPORTING

The Company has one operating segment, mixed-signal communication integrated
circuits (ICs), consisting of eight product lines. The Company's chief operating
decision maker is considered to be the Chief Executive Officer and Chairman of
the Board. The chief operating decision maker allocates resources and assesses
performance of the business and other activities at the operating segment level.

3. EQUITY INVESTMENT IN A NON-PUBLICLY TRADED COMPANY

On June 14, 2002, the Company made an equity investment in a start-up
venture, ASIC Design Services, Inc. (ADS), with an initial investment of
$1.3 million in the form of convertible-preferred stock. ADS is engaged in the
design and development of proprietary integrated circuits (ICs) used in
networking devices.

The Company has a contingent obligation to make two additional
convertible-preferred stock investments in ADS totaling $2.7 million based on
ADS' achievement of certain milestones and the satisfaction of other conditions.
Additionally, the Company has an exclusive right, but not the obligation, to
purchase ADS for $15 million in cash or common stock in connection with the
occurrence of certain events.

8

SILICON LABORATORIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

At September 28, 2002, the Company's voting interest in ADS was less than
20% of the total ownership of ADS. However, the Company determined, based on APB
Opinion No. 18 "THE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS IN COMMON STOCK"
and other relevant guidance that it has the ability to exercise significant
influence, but not control, over the management of ADS as a result of its
contractual rights, rights as an equity stockholder and ability to designate a
member of ADS' Board of Directors, which the Company has done. Therefore, the
Company has accounted for its investment in ADS using the HLBV method under the
equity method of accounting. The Company is using the HLBV method to determine
its equity investment loss because the Company believes that it is unlikely that
the other stockholders could bear their proportionate share of ADS' loss. Under
this method, the Company's loss is equivalent to ADS' cash expenditures for the
period.

For the three months ended September 28, 2002, the Company recorded an
equity investment loss of $0.3 million from its investment in ADS.

4. COMMITMENTS AND CONTINGENCIES

The Company is involved in various legal proceedings that have arisen in the
normal course of business. While the ultimate results of these matters cannot be
predicted with certainty, management does not expect them to have a material
adverse effect on the consolidated financial position or results of operations.

On August 7, 2001, TDK Semiconductor Corporation commenced a lawsuit against
the Company for alleged willful infringement by its direct access arrangement
(DAA) products of a TDK-held patent. TDK's complaint seeks unspecified treble
damages, costs and attorneys' fees, and an injunction. On September 27, 2001,
the Company served and filed an answer to TDK's complaint, in which the Company
denied infringement and asserted that TDK's patent is invalid. On March 27,
2002, the Company filed an amended answer and counterclaims in which the Company
claimed that the TDK-held patent is unenforceable due to inequitable conduct and
asserted counterclaims seeking a declaration that the TDK-held patent is
invalid, not infringed and unenforceable. We are currently in the discovery
phase of this litigation. This lawsuit has involved, and may continue to
involve, significant expense and may also divert management's time and attention
from other aspects of the Company's business. The Company intends to vigorously
contest this case, however, the Company is unable at this time to determine
whether the outcome of the litigation will have a material impact on its results
of operations or financial condition in any future period.

On December 6, 2001, a class action complaint for violations of U.S. federal
securities laws was filed in the United States District Court, Southern District
of New York against the Company, four of its officers individually and the three
investment banking firms who served as representatives of the underwriters in
connection with the Company's initial public offering of common stock which
became effective on March 23, 2000. On April 19, 2002, a consolidated amended
complaint was filed in the same court. The action is being coordinated with over
300 other nearly identical actions filed against other companies. These claims
are premised on allegations that the registration statement and prospectus for
the Company's initial public offering did not disclose that (1) the underwriters
solicited and received additional, excessive and undisclosed commissions from
certain investors, and (2) the underwriters had agreed to allocate shares of the
offering in exchange for a commitment from the customers to purchase additional
shares in the aftermarket at pre-determined higher prices. A court order dated
October 9, 2002 dismissed without prejudice numerous individual defendants,
including the four officers of the Company who had been named individually. The
Company intends to vigorously contest this case, however, the Company is unable
at this time to determine whether the outcome of the litigation will have a
material impact on its results of operations or financial condition in any
future period.

9

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES THERETO INCLUDED ELSEWHERE
IN THIS QUARTERLY REPORT ON FORM 10-Q AND OUR ANNUAL REPORT ON FORM 10-K FILED
JANUARY 22, 2002. EXCEPT FOR THE HISTORICAL FINANCIAL INFORMATION CONTAINED
HEREIN, THE MATTERS DISCUSSED IN THIS QUARTERLY REPORT ON FORM 10-Q MAY BE
CONSIDERED "FORWARD-LOOKING" STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED. SUCH STATEMENTS INCLUDE DECLARATIONS REGARDING THE
INTENT, BELIEF OR CURRENT EXPECTATIONS OF OUR COMPANY AND MANAGEMENT AND MAY BE
SIGNIFIED BY THE WORDS "EXPECTS," "ANTICIPATES," "INTENDS," "BELIEVES" OR
SIMILAR LANGUAGE. PROSPECTIVE INVESTORS ARE CAUTIONED THAT ANY SUCH
FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE
A NUMBER OF RISKS AND UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED BELOW, AS WELL AS THOSE
DISCUSSED IN OUR ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION ON JANUARY 22, 2002. OUR FISCAL YEAR-END FINANCIAL REPORTING
PERIODS ARE A 52- OR 53- WEEK YEAR ENDING ON THE SATURDAY CLOSEST TO DECEMBER
31ST. OUR THIRD QUARTER OF FISCAL YEAR 2002 ENDED SEPTEMBER 28, 2002. OUR THIRD
QUARTER OF FISCAL YEAR 2001 ENDED SEPTEMBER 29, 2001. ALL OF THE QUARTERLY
PERIODS REPORTED IN THIS QUARTERLY REPORT ON FORM 10-Q HAD THIRTEEN WEEKS.

OVERVIEW

We design and develop proprietary, analog-intensive, mixed-signal integrated
circuits (ICs) for the communications industry. Our innovative ICs can
dramatically reduce the cost, size and system power requirements of the products
that our customers sell to consumers. We currently offer ICs that can be
incorporated into communications devices, such as wireless phones and modems, as
well as cable and satellite set-top boxes, residential communication gateways
for cable or DSL, and optical network equipment. Customers during the first nine
months of fiscal 2002 or fiscal 2001 included 3Com, Agere Systems, Ambit,
Echostar, PC-TEL, Samsung, Sendo, Smart Link, Solectron, Sony, Texas
Instruments, Thomson and Wavecom.

Our company was founded in 1996. As of September 28, 2002 we had 343
employees, up from 279 at the end of fiscal 2001, 256 at the end of fiscal 2000
and 148 at the end of fiscal 1999. As a "fabless" semiconductor company, we rely
on third-party semiconductor fabricators to manufacture the silicon wafers that
reflect our IC designs. Each wafer contains numerous die, which are cut from the
wafer to create a chip for an IC. We also rely on third-party assemblers to
assemble and package these die prior to final product testing and shipping.

We offer numerous mixed-signal communication ICs across eight product lines.
We commenced research and development for our first IC product, the DAA, in
October 1996. We introduced our DAA product in the first quarter of fiscal 1998,
and first received acceptance of this product for inclusion in a customer's
device, which we refer to as a "design win", in March 1998. The first commercial
shipment of our DAA product was made in April 1998. Based on the success of our
family of DAA products, we achieved profitability in the fourth quarter of
fiscal 1998. In 1999, we introduced a voice codec product, an ISOmodem product
and our RF synthesizer product. In 2000, we introduced our ProSLIC product and a
clock and data recovery product suitable for SONET physical layer applications.
In 2001, we introduced several products, including a GSM transceiver chipset, a
digital subscriber line analog front end and added several new optical
networking products. During the first nine months of 2002, our wireless products
were responsible for almost half of our revenues. We have made significant
progress in our revenue diversity. However, except for quarterly fluctuations,
we expect to become more dependent on our wireless products for our future sales
as, and to the extent, those products become more widely adopted by GSM handset
manufacturers.

10

Many of our customers purchase products indirectly from us through
distributors and contract manufacturers. A customer purchasing through a
contract manufacturer typically instructs such contract manufacturer to obtain
our products and incorporate such products with other components for sale by
such contract manufacturer to the customer. Although we actually sell the
products to, and are paid by, the distributors and contract manufacturers, we
refer to such end customer as our customer. During the first nine months of
2002, two customers in aggregate, represented, 26% of our revenues. Samsung,
purchasing primarily through Uniquest, represented 15% of revenues, and Wavecom,
purchasing through Solectron and other contract manufacturers, represented 11%
of revenues. No other single customer accounted for more than 10% of our
revenues during the first nine months of 2002. Uniquest, a distributor selling
product to Samsung and several other customers, represented 19% of our total
revenues. Edom Technology, a distributor selling products to several customers
in Asia, represented 13% of our revenues.

The percentage of our revenues to customers located outside of the United
States was 78% in the nine months ended September 28, 2002, 66% in fiscal 2001,
21% in fiscal 2000 and 7% in fiscal 1999. All of our revenues to date have been
denominated in U.S. dollars. We believe that a large percentage of our revenues
will continue to be made to customers outside of the United States as our
products receive acceptance in international markets.

The sales cycle for the test and evaluation of our ICs can range from
1 month to 12 months or more. An additional 3 to 6 months or more may be
required before a customer ships a significant volume of devices that
incorporate our ICs. Due to this lengthy sales cycle, we may experience a
significant delay between incurring expenses for research and development and
selling, general and administrative efforts, and the generation of corresponding
sales, if any. Consequently, if sales in any quarter do not occur when expected,
expenses and inventory levels could be disproportionately high, and our
operating results for that quarter and, potentially, future quarters would be
adversely affected. Moreover, the amount of time between initial research and
development and commercialization of a product, if ever, generally is
substantially longer than the sales cycle for the product. Accordingly, if we
incur substantial research and development costs without developing a
commercially successful product, our operating results, as well as our growth
prospects, could be adversely affected.

Our limited operating history and rapid growth across our product lines
makes it difficult for us to assess the impact of seasonal factors on our
business. Because many of our ICs are designed for use in consumer products such
as PCs and wireless telephones, we expect that the demand for our products will
be subject to seasonal demand resulting in increased sales in the third and
fourth quarters of each year when customers place orders to meet holiday demand.

The following describes the line items set forth in our consolidated
statements of operations:

REVENUES. Revenues are generated principally by sales of our ICs. We
recognize revenue upon the transfer of title, which generally occurs upon
shipment to our customers. Revenues are deferred on shipments to distributors
until they are resold by such distributors. Our products typically carry a
one-year replacement warranty. Our revenues are subject to variation from period
to period due to the volume of shipments made within a period and the prices we
charge for our products. The vast majority of our revenues were negotiated at
prices that reflect a discount from the list prices for our products. These
discounts are made for a variety of reasons, including to establish a
relationship with a new customer, as an incentive for customers to purchase
products in larger volumes, to provide profit margin to our distributors who
resell our products or in response to competition. In addition, as a product
matures, we expect that the average selling price for our products will decline
due to the greater availability of competing products. The sales of our wireless
products into the highly competitive GSM handset market are expected to comprise
a larger percentage of our revenue, resulting in increased downward pressure on
our average selling prices. Our ability to increase revenues in the future is
dependent on increased demand for our established products and our ability to
ship larger volumes of those products in response to such demand, as well as our
ability to develop new products and subsequently achieve customer acceptance of
newly introduced products.

11

COST OF REVENUES. Cost of revenues includes the cost of purchasing finished
silicon wafers processed by independent foundries; costs associated with
assembly, test and shipping of those products; costs of personnel and equipment
associated with manufacturing support, logistics and quality assurance; costs of
software royalties and amortization of software license costs associated with
certain products; an allocated portion of our occupancy costs; and allocable
depreciation of testing equipment and leasehold improvements. Generally, we
depreciate equipment over four years on a straight line basis. We also
depreciate our leasehold improvements over the shorter of the estimated useful
life or the applicable lease term. Recently introduced products tend to have
higher cost of revenues per unit due to initially low production volumes
required by our customers and higher costs associated with new package
variations. Generally, as production volumes for a product increase, unit
production costs tend to decrease as our semiconductor fabricators and
assemblers, and our internal test operation, achieve greater economies of scale
for that product. Additionally, the cost of wafer procurement, which is a
significant component of cost of goods sold, varies cyclically with overall
demand for semiconductors and availability of supply from our subcontractors and
foundries.

RESEARCH AND DEVELOPMENT. Research and development expense consists
primarily of compensation and related costs of employees engaged in research and
development activities and the related new product mask and wafer costs, as well
as an allocated portion of our occupancy costs for such operations. We
depreciate our research and development equipment over four years and amortize
our purchased software from computer-aided design tool vendors over four years.
Development activities include the design of new products and creation of new
product masks and wafers and test methodologies to assure compliance with
required specifications.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expense consists primarily of personnel-related expenses, related allocable
portion of our occupancy costs, sales commissions to independent sales
representatives, professional fees, directors' and officers' liability
insurance, patent litigation legal fees, other promotional and marketing
expenses, and reserves for bad debt. Write offs of uncollectible accounts have
been insignificant to date.

GOODWILL AMORTIZATION. Goodwill amortization through December 2001 includes
the amortization of goodwill purchased in connection with our acquisitions of
Krypton Isolation, Inc. (Krypton) in August 2000 and SNR Semiconductor
Incorporated (SNR) in October 2000. Goodwill was amortized over four to five
years using the straight line method. We adopted SFAS No. 142, GOODWILL AND
OTHER INTANGIBLE ASSETS, at the end of December 2001 and accordingly have ceased
amortization of its goodwill.

IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE ASSETS. Impairment of goodwill
and other intangible assets reflects the charge to write-down that portion of
the carrying value of goodwill and other intangible assets that are in excess of
their fair market value.

AMORTIZATION OF DEFERRED STOCK COMPENSATION. In connection with the grant
of stock options and direct issuances of stock to our employees, we recorded
deferred stock compensation, representing, for accounting purposes, the
difference between the exercise price of option grants, or the issuance price of
direct issuances of stock, as the case may be, and the deemed fair value of our
common stock at the time of such grants or issuances. The deferred stock
compensation is amortized over the vesting period of the applicable options or
shares, generally five to eight years. The amortization of deferred stock
compensation is recorded as an operating expense.

INTEREST AND OTHER INCOME. Interest and other income reflects interest
earned on average cash, cash equivalents and investment balances and the gain
on the sale of fixed assets. We may from time to time elect to invest in
tax-advantaged short-term investments yielding lower nominal interest proceeds.

INTEREST EXPENSE. Interest expense consists of interest on our long-term
debt and capital lease obligations.

EQUITY INVESTMENT LOSS. Equity investment loss reflects our share of losses
in our equity investment, ASIC Design Services, Inc. (ADS).

PROVISION (BENEFIT) FOR INCOME TAXES. We accrue a provision (benefit) for
federal and state income tax at the applicable statutory rates adjusted for
non-deductible expenses, research and development tax credits and interest
income from tax-advantaged short-term investments.

12

RESULTS OF OPERATIONS

The following table sets forth our statement of operations data as a
percentage of revenues for the periods indicated:

COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 28, 2002 TO THE THREE
AND NINE MONTHS ENDED SEPTEMBER 29, 2001.

REVENUES. Revenues for the three months ended September 28, 2002 were
$51.8 million, an increase of $31.9 million, or 160%, from revenues of
$19.9 million in the three months ended September 29, 2001. Revenues for the
nine months ended September 28, 2002 were $121.8 million, an increase of
$71.3 million, or 141%, from revenues of $50.5 million in the nine months ended
September 29, 2001. The increases were primarily due to a significant growth in
the sales of our non-DAA products, such as the Aero Transceiver, the RF
Synthesizer, the ISOmodem and the ProSLIC, reflecting the growing market
acceptance for those products.

GROSS PROFIT. Gross profit for the three months ended September 28, 2002
was $29.0 million, or 56.1% of revenues, an increase of $17.6 million, as
compared with gross profit of $11.4 million, or 57.3% of revenues, in the three
months ended September 29, 2001. Gross profit for the nine months ended
September 28, 2002 was $67.7 million, or 55.6% of revenues, an increase of
$39.6 million, as compared with gross profit of $28.1 million, or 55.6% of
revenues, in the nine months ended September 29, 2001. The increases in gross
profit dollars were primarily due to the substantial increase in sales volume
and increased utilization of our testing capacity. The decrease in gross margin
in the most recent quarter was primarily due to a greater portion of our sales
being comprised of our lower margin wireless products. We anticipate that gross
margins may fluctuate significantly in the future due to the effect of many
factors including our ability to sell existing inventory on hand, our ability to
successfully introduce and sell new products, market forces that impact the
selling prices for existing and new products, the extent to which our
competitors introduce new products to market, the revenue mix of products,
variations in manufacturing production yields and future product cost
considerations with our vendors. During fiscal 2002, the sales of our wireless
products into the highly competitive GSM handset market have comprised a larger
percentage of our revenues, resulting in increased downward pressure on our
average selling prices and gross margins.

13

RESEARCH AND DEVELOPMENT. Research and development expense for the three
months ended September 28, 2002 was $7.4 million, or 14.3% of revenues, which
reflected a decrease of $0.3 million, or 3.9%, as compared with research and
development expense of $7.7 million, or 38.7% of revenues, for the three months
ended September 29, 2001. Research and development expense for the nine months
ended September 28, 2002 was $23.6 million, or 19.4% of revenues, which
reflected an increase of $2.3 million, or 10.8%, as compared with research and
development expense of $21.3 million, or 42.2% of revenues, for the nine months
ended September 29, 2001. The decrease in dollar amount for the three month
period ended September 28, 2002 was principally due to lower spending for
engineering masks and wafers which was caused by the timing of our development
cycle for new ICs. The increase in the dollar amount of research and development
expense for the nine month period ended September 28, 2002 was principally due
to continued product development activities, significant increases in new
product development initiatives in wireless and moderate increases in spending
in optical networking product development opportunities, usage of more expensive
advanced silicon complementary metal oxide semiconductor (CMOS) processes, and
increased spending to develop test methodologies for new products. As a
percentage of revenues, research and development expense decreased significantly
due to the substantial increase in revenues for the three and nine months ended
September 28, 2002. We expect that research and development expense will
increase in absolute dollars in future periods as we develop new ICs, and may
fluctuate as a percentage of revenues due to changes in sales volume and new
product development initiatives.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expense for the three months ended September 28, 2002 was $8.7 million, or 16.7%
of revenues, which reflected an increase of $3.3 million, or 61.1%, as compared
to selling, general and administrative expense of $5.4 million, or 27.1% of
revenues, in the three months ended September 29, 2001. Selling, general and
administrative expense for the nine months ended September 28, 2002 was
$23.6 million, or 19.4% of revenues, which reflected an increase of
$9.4 million, or 66.2%, as compared to selling, general and administrative
expense of $14.2 million, or 28.1% of revenues, in the nine months ended
September 29, 2001. The increases in the dollar amount of selling, general and
administrative expense were principally attributable to increased staffing and
legal fees incurred during patent litigation. We expect to continue to incur
significant legal expenses, fluctuating with case activity, for at least the
remainder of this fiscal year as a result of the ongoing infringement lawsuit
filed against us by TDK Semiconductor Corporation in August 2001. We expect that
selling, general and administrative expense will increase in absolute dollars in
future periods as we expand our sales channels, marketing efforts and
administrative infrastructure. In addition, we expect selling, general and
administrative expense to fluctuate as a percentage of revenues because of
(1) the likelihood that indirect sales distribution channels, which typically
entail the payment of commissions, will account for a larger portion of our
revenues in future periods and, therefore, increase our selling, general and
administrative expense relative to a direct sales force performing at
satisfactory levels of productivity; (2) fluctuating usage of advertising to
promote our products and, in particular, our newly introduced products; and
(3) potential significant variability in our future sales volume.

GOODWILL AMORTIZATION. We did not incur goodwill amortization in the three
or nine months ended September 28, 2002 due to the adoption of SFAS No. 142.
Goodwill amortization for the three and nine months ended September 29, 2001 was
zero and $4.2 million, respectively. During the three months ended
September 29, 2001, we wrote off our goodwill balances after determining that
they were permanently impaired.

IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE ASSETS. During fiscal 2001, we
performed an assessment of the carrying value of the Company's long-lived assets
recorded in connection with our acquisitions of Krypton and SNR. As a result of
this assessment, we concluded that the value of these assets had become
permanently impaired and recorded charges of $33.3 million to write off related
goodwill and $1.6 million to reduce the carrying value of related intangible
assets to their fair value. There was no impairment of goodwill and other
intangible assets for the three and nine months ended September 28, 2002.

AMORTIZATION OF DEFERRED STOCK COMPENSATION. We recorded deferred stock
compensation for the difference between the exercise price of option grants or
the issuance price of direct issuances of stock, as the case may be, and the
deemed fair value of our common stock at the time of such grants or issuances.
We are amortizing this amount over the vesting periods of the applicable options
or restricted stock, which resulted in amortization expense of $1.3 million and
$3.9 million for the three and nine months ended September 28, 2002,
respectively, as compared to $1.3 million and $4.0 million for the three and
nine months ended September 29, 2001, respectively.

14

INTEREST AND OTHER INCOME. Interest income for the three and nine months
ended September 28, 2002 was $0.4 million and $1.2 million, respectively, as
compared to $0.9 million and $2.9 million for the three and nine months ended
September 29, 2001, respectively. The decreases were primarily due to lower
interest rates on cash and short-term investments balances during the recent
three and nine month periods.

INTEREST EXPENSE. Interest expense for the three and nine months ended
September 28, 2002 was $0.2 million and $0.5 million, respectively, as compared
to $0.2 million and $0.6 million for the three and nine months ended
September 29, 2001, respectively. The decrease for the nine month period ended
September 28, 2002 was due to lower debt and lease payable balances during the
recent period.

EQUITY INVESTMENT LOSS. Equity investment loss for the three and nine
months ended September 28, 2002 was $0.3 million with respect to our investment
in ADS. We did not have any equity investments, and therefore no corresponding
losses, during the three and nine month periods ending September 29, 2001.

PROVISION (BENEFIT) FOR INCOME TAXES. Our effective tax provision rate,
excluding the impact of goodwill amortization, impairment of goodwill and other
intangible assets, and deferred stock compensation amortization, was 29.0% in
the nine months ended September 28, 2002, as compared to our effective tax
benefit rate of 40.5% in the nine months ended September 29, 2001. The current
period's tax provision rate was lower than the prior comparable tax benefit rate
primarily due to the current period's decreased tax benefit from the estimated
research and development tax credit in proportion to the amount of the current
period's pre-tax income.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of liquidity as of September 28, 2002 consisted of
$104.3 million in cash, cash equivalents and short-term investments, in addition
to our bank credit facility. Our bank credit facility is a revolving line of
credit available for borrowings and letters of credit of up to the lesser of
$5.0 million or 80% of eligible accounts receivable at the bank's prime lending
rate, which was 4.75% as of September 28, 2002. At September 28, 2002, a letter
of credit for $0.4 million related to a building lease was outstanding under the
revolving line of credit and $4.0 million was available for new borrowings or
letters of credit.

The bank facility is secured by our accounts receivable, inventories,
capital equipment and all other unsecured assets (excluding intellectual
property). The line of credit prohibits the payment of cash dividends and
requires the maintenance of tangible net worth and compliance with financial
ratios which measure our immediate liquidity and our ongoing ability to pay back
our outstanding obligations. We believe we were in compliance with all covenants
at September 28, 2002.

We also have agreements with three institutional lenders for equipment
financing to purchase or lease equipment, leasehold improvements and software.
At September 28, 2002, the amount outstanding under these agreements was
$1.9 million. This indebtedness bears effective interest rates (including
end-of-term interest payments of $1.2 million) ranging from 12.5% to 14.6% per
annum, is secured by certain equipment, and is repayable over approximately the
next two years. Based on available liquidity, we anticipate that we may retire
these obligations before their scheduled maturities.

During the nine months ended September 28, 2002, cash provided by operating
activities was $21.3 million, as compared to cash provided by operating
activities of $4.9 million during the nine months ended September 29, 2001. This
increase in cash flow was primarily due to the net income generated during the
period as a result of increased sales volume.

Due to the nature of our business, we experience working capital needs in
the area of accounts receivable. Typically, we bill our customers, or their
contract manufacturers, on an open account basis with net 30 day payment terms
or other specific terms and conditions that may vary from account to account as
individually negotiated with customers. As of September 28, 2002, we had a net
accounts receivable balance of $29.0 million. The recent increase in our
accounts receivable balance is attributable primarily to increased sales levels
rather than to customers delaying their payments.

15

We also experience working capital needs in the area of inventory. We
believe that in order to maintain an adequate supply of product for our
customers, we must carry a certain level of inventory. This inventory level may
vary based principally upon either orders received from customers or our
forecast of demand for our products. Other factors influencing inventory levels
may include the product life cycle stage of our products, customer demands for
consignment inventory arrangements, and competitive situations in the
marketplace. To address the difficult, subjective and complex area of judgment
in determining appropriate inventory valuation in a consistent manner, we apply
a set of methods, assumptions and estimates to arrive at the net inventory
amount by completing the following procedures which collectively comprise a
critical accounting policy. First, we identify any inventory that has been
previously reserved in prior periods. This inventory remains reserved until
sold, destroyed or otherwise disposed of. Second, we examine the inventory line
items that may have some form of obsolescence due to non-conformance with
electrical and mechanical standards as identified by our quality assurance
personnel. Third, the remaining inventory not otherwise identified to be
reserved is compared to an assessment of product history and forecasted demand,
typically over the next six months, or actual firm backlog on hand. Finally, an
analysis of the result of this methodology is compared against the product life
cycle and competitive situations in the marketplace driving the outlook for the
consumption of the inventory and the appropriateness of the resulting inventory
levels. As of September 28, 2002, we had a net inventory balance of
$13.0 million, up from $5.2 million as of December 29, 2001. The recent increase
in our inventory balance is attributable primarily to increased levels to
fulfill customer purchase orders and maintain an adequate supply based on our
forecast of future customer demand.

Capital expenditures increased by $12.6 million to $17.5 million for the
nine months ended September 28, 2002 from $4.9 million for the nine months ended
September 29, 2001. This increase in capital expenditures was primarily due to
the purchase of additional semiconductor test equipment for wireless products
for GSM mobile handsets. We anticipate additional capital expenditures of
approximately $2.5 million during fiscal 2002, primarily to fund additional test
floor capabilities and new product development activities.

In June 2002, we entered into agreements with a newly-formed, privately-held
company, ASIC Design Services, Inc. (ADS). These agreements cover (i) an initial
equity investment by us in ADS of $1.3 million; (ii) a contingent commitment by
us to make additional equity investments in increments cumulatively totaling
$2.7 million based on ADS' achievement of certain milestones and the
satisfaction of other conditions; (iii) ADS' grant to us of certain
manufacturing, sales and marketing rights during ADS' early revenue phase, and;
(iv) the right, but not the obligation, to acquire ADS in its entirety at a
total acquisition value of $15 million in cash or our common stock in connection
with the occurrence of certain events.

The use of this structure provides us visibility and significant influence,
but not control, over the direction of research and development activities of
ADS. If we find the results of their development efforts to be desirable or
advisable for full ownership, then we could exercise our right to acquire ADS.
If we elect not to exercise our right to acquire ADS, we would still hold our
preferred stock investment.

Our future capital requirements will depend on many factors, including the
rate of sales growth, market acceptance of our products, the timing and extent
of research and development projects and the expansion of our sales and
marketing activities. We believe our existing cash balances and credit
facilities are sufficient to meet our capital requirements through at least the
next 12 months, although we could be required, or could elect, to seek
additional funding prior to that time. We may enter into acquisitions or
strategic arrangements in the future which also could require us to seek
additional equity or debt financing. There can be no assurances that additional
equity or debt financing, if required, will be available to us on acceptable
terms or at all.

16

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the FASB issued SFAS Nos. 141 and 142, BUSINESS COMBINATIONS
and GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS No. 141 replaced APB No. 16 and
eliminates pooling-of-interests accounting. It also provides guidance on
purchase accounting related to the recognition of intangible assets and
accounting for negative goodwill. SFAS No. 142 changes the accounting for
goodwill from an amortization method to an impairment-only approach. Under SFAS
No. 142, goodwill will be tested annually and whenever events or circumstances
occur indicating that goodwill might be impaired. SFAS No. 141 and SFAS No. 142
are effective for all business combinations completed after June 30, 2001. Upon
a company's adoption of SFAS No. 142, a company ceases to amortize goodwill
recorded for business combinations consummated prior to July 1, 2001, and
intangible assets acquired prior to July 1, 2001 that do not meet the criteria
for recognition under SFAS No. 141 are reclassified to goodwill. Companies are
required to adopt SFAS No. 142 for fiscal years beginning after December 15,
2001. We adopted SFAS No. 142 on December 30, 2001, the beginning of fiscal
2002. In connection with the adoption of SFAS No. 142, we performed a
transitional goodwill impairment assessment. The adoption of SFAS No. 141 and
SFAS No. 142 did not have a material impact on our results of operations or
financial position.

In October 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS, which supersedes SFAS No. 121, ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF;
however, it retains the fundamental provisions of that statement related to the
recognition and measurement of the impairment of long-lived assets to be "held
and used." In addition, the Statement provides more guidance on estimating cash
flows when performing a recoverability test, requires that a long-lived asset to
be disposed of other than by sale be classified as "held and used" until it is
disposed of, and establishes more restrictive criteria to classify an asset as
"held for sale." The Company adopted SFAS No. 144 on December 30, 2001, but the
adoption did not have a material impact on our results of operations or
financial position.

QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

Our interest income is sensitive to changes in the general level of U.S.
interest rates, particularly since the majority of our investments are in
short-term instruments. Due to the nature of our short-term investments, we have
concluded that there is no material market risk exposure.

FACTORS AFFECTING OUR FUTURE OPERATING RESULTS

RISKS RELATED TO OUR BUSINESS

WE MAY NOT BE ABLE TO MAINTAIN OUR HISTORICAL GROWTH RATE AND MAY EXPERIENCE
SIGNIFICANT PERIOD-TO-PERIOD FLUCTUATIONS IN OUR REVENUES AND OPERATING RESULTS,
WHICH MAY RESULT IN VOLATILITY IN OUR STOCK PRICE

Although we have experienced revenue and earnings growth in our two most
recent quarterly periods, we may not be able to sustain these growth rates. We
may also experience significant period-to-period fluctuations in our revenues
and operating results in the future due to a number of factors, and any such
variations may cause our stock price to fluctuate. It is likely that in some
future period our operating results will be below the expectations of public
market analysts or investors. If this occurs, our stock price may drop, perhaps
significantly.

A number of factors, in addition to those cited in other risk factors
applicable to our business, may contribute to fluctuations in our revenues and
operating results, including:

- the timing and volume of orders received from our customers;

- the rate of acceptance of our products by our customers, including the
acceptance of new products we may develop for integration in the products
manufactured by such customers, which we refer to as "design wins";

- the time lag between "design wins" and production orders;

17

- the demand for, and life cycles of, the products incorporating our ICs;

- the rate of adoption of mixed-signal ICs in the markets we target;

- deferrals of customer orders in anticipation of new products or product
enhancements from us or our competitors or other providers of ICs;

- changes in product mix; and

- the rate at which new markets emerge for products we are currently
developing or for which our design expertise can be utilized to develop
products for these new markets.

The mobile telephone market is characterized by rapid fluctuations in demand
which results in corresponding fluctuations in the demand for our wireless
products that are incorporated in mobile telephones. Additionally, the rate of
technology acceptance by our customers results in fluctuating demand for our
products as customers are reluctant to incorporate a new IC into their products
until the new IC has achieved market acceptance. Once a new IC achieves market
acceptance, demand for the new IC can quickly accelerate to a point and then
level off such that rapid historical growth in sales of a product should not be
viewed as indicative of continued future growth. In addition, demand can quickly
decline for a product when a new IC product is introduced and receives market
acceptance. Accordingly, you should not rely on the results of any prior
quarterly or annual periods as an indication of our future operating
performance.

OUR INABILITY TO MANAGE GROWTH COULD MATERIALLY AND ADVERSELY AFFECT OUR
BUSINESS

In recent periods, we have significantly increased the scope of our
operations and expanded our workforce from 42 employees at January 2, 1999 to
343 employees at September 28, 2002. This growth has placed, and any future
growth of our operations will continue to place, a significant strain on our
management personnel, systems and resources. We anticipate that we will need to
implement a variety of new and upgraded operational and financial systems,
procedures and controls, including the improvement of our accounting and other
internal management systems. We also expect that we will need to continue to
expand, train, manage and motivate our workforce. All of these endeavors will
require substantial management effort. If we are unable to effectively manage
our expanding operations, our business could be materially and adversely
affected.

IF WE ARE UNABLE TO DEVELOP NEW AND ENHANCED PRODUCTS THAT ACHIEVE MARKET
ACCEPTANCE IN A TIMELY MANNER, OUR OPERATING RESULTS AND COMPETITIVE POSITION
COULD BE HARMED

Our future success will depend on our ability to reduce our dependence on a
few products by developing new ICs and product enhancements that achieve market
acceptance in a timely and cost-effective manner. The development of
mixed-signal ICs is highly complex, and we occasionally have experienced delays
in completing the development and introduction of new products and product
enhancements. Successful product development and market acceptance of our
products depend on a number of factors, including:

- changing requirements of customers within the communications markets;

- accurate prediction of market requirements;

- timely completion and introduction of new designs;

- timely qualification and certification of our ICs for use in our
customers' products;

- commercial acceptance and volume production of the products into which
our ICs will be incorporated;

- availability of foundry, assembly, and test capacity;

- achievement of high manufacturing yields;

- quality, price, performance, power use and size of our products;

18

- availability, quality, price and performance of competing products and
technologies;

- our customer service and support capabilities and responsiveness;

- successful development of our relationships with existing and potential
customers;

- changes in technology, industry standards or end-user preferences; and

- cooperation of software partners and semiconductor partners to support
our chips within a system.

We cannot provide any assurance that products which we recently have
developed or may develop in the future will achieve market acceptance. We have
introduced to market or are in development of many ICs including:

- a new generation of direct access arrangement (DAA) products, which
provide enhanced computer modem functionality;

- a family of RF synthesizers, which are used to generate high frequency
signals that are used in wireless communications systems to select a
particular radio channel;

- an Aero Transceiver chipset, providing a highly integrated radio
communication section of a GSM wireless handset with versatile interfaces
to other electronic sections of the handset;

- an ISOmodem, which is a miniaturized modem that can be embedded in
electronic devices with low-speed transmission requirements, such as
credit card verification devices, to provide quick network access;

- a family of higher speed ISOmodem products to serve additional embedded
modem markets where faster transmission is required such as next
generation set-top boxes;

- a family of ProSLIC products, which provides dial tone, busy tone,
caller ID and ring signal functions at the source end of the telephone
line addressing long-haul and short-haul applications;

- a Digital Subscriber Line, or DSL, Analog Front End providing a highly
integrated interface for DSL; and

- a family of optical networking products, which features highly
integrated physical layer and clock circuits designed for SONET/ATM
routers, multiplexers, digital cross connects and optical transceiver
modules.

We also are actively developing other ICs. If our recently introduced or
other ICs fail to achieve market acceptance, our growth prospects, operating
results and competitive position could be adversely affected.

WE HAVE INCREASED OUR INTERNATIONAL SALES ACTIVITIES SIGNIFICANTLY AND PLAN TO
CONTINUE SUCH EFFORTS, WHICH SUBJECTS US TO ADDITIONAL BUSINESS RISKS INCLUDING
INCREASED LOGISTICAL COMPLEXITY, POLITICAL INSTABILITY AND CURRENCY FLUCTUATIONS

We have opened additional sales offices in international markets to expand
our international sales activities in Europe and the Pacific Rim region and
intend to increase our staffing in international sales. The percentage of our
revenues to customers located outside of the United States was 78% in the nine
months ended September 28, 2002, 66% in fiscal 2001, 21% in fiscal 2000 and 7%
in fiscal 1999. Our planned international sales growth will be limited if we are
unable to hire additional personnel and develop relationships with international
distributors. We may not be able to maintain or increase international market
demand for our products. Our international operations are subject to a number of
risks, including:

- increased complexity and costs of managing international operations;

19

- protectionist laws and business practices that favor local competition
in some countries;

- multiple, conflicting and changing laws, regulations and tax schemes;

- longer sales cycles;

- greater difficulty in accounts receivable collection and longer
collection periods;

- high levels of distributor inventory subject to rights of return to us;
and

- political and economic instability.

To date, all of our sales to international customers and purchases of
components from international suppliers have been denominated in U.S. dollars.
As a result, an increase in the value of the U.S. dollar relative to foreign
currencies could make our products more expensive for our international
customers to purchase, thus rendering them less competitive.

WE ARE SUBJECT TO CREDIT RISKS RELATED TO OUR ACCOUNTS RECEIVABLE, ESPECIALLY
WHEN CUSTOMERS PURCHASE PRODUCTS THROUGH DISTRIBUTORS AND CONTRACT
MANUFACTURERS.

We do not generally obtain letters of credit or other security for payment
from customers, distributors or contract manufacturers. Accordingly, we are not
protected against accounts receivable default or bankruptcy by these entities.
If we are unable to collect our accounts receivable, our operating results could
be materially harmed. A significant and increasing portion of our revenues are
realized through indirect channels such as distributors and contract
manufacturers. At September 28, 2002, gross receivable balances from
distributors and contract manufacturers totaled $21.8 million versus
$5.9 million at December 29, 2001. Distributors and contract manufacturers are
frequently thinly capitalized and operate at very low profit margins, and are
accordingly subject to a greater risk of insolvency. Typically, distributors and
contract manufacturers are dependent on receiving payment from the ultimate
customers for the resources necessary to pay us. None of our shipments to
distributors and contract manufacturers are guaranteed by the ultimate customer.
If for any reason a customer does not pay the distributor or contract
manufacturer, there are no assurances that our direct contractual customers will
have adequate working capital to enable the collection of our accounts
receivable. We continue to monitor the credit worthiness and payment practice of
each of the distributors or contract manufacturers, and to date have not had any
significant write offs of receivable balances from them.

WE ARE SUBJECT TO INCREASED INVENTORY RISKS AND COSTS BECAUSE WE BUILD OUR
PRODUCTS BASED ON FORECASTS PROVIDED BY CUSTOMERS BEFORE RECEIVING PURCHASE
ORDERS FOR THE PRODUCTS

In order to assure availability of our products for some of our largest
customers, we start the manufacturing of our products in advance of receiving
purchase orders based on forecasts provided by these customers. However, these
forecasts do not represent binding purchase commitments and we do not recognize
sales for these products until they are shipped to the customer. As a result, we
incur inventory and manufacturing costs in advance of anticipated sales. Because
demand for our products may not materialize, manufacturing based on forecasts
subjects us to increased risks of high inventory carrying costs and increased
obsolescence and may increase our operating costs. These inventory risks are
exacerbated when our customers purchase indirectly through contract
manufacturers because we have less direct interaction with such contract
manufacturers, and less visibility regarding their accumulated levels of
inventory.

WE RELY ON THIRD PARTIES TO MANUFACTURE, ASSEMBLE AND TEST OUR PRODUCTS AND
THE FAILURE TO SUCCESSFULLY MANAGE OUR RELATIONSHIPS WITH OUR MANUFACTURERS AND
ASSEMBLERS WOULD NEGATIVELY IMPACT OUR ABILITY TO SELL OUR PRODUCTS

We do not have our own wafer fab manufacturing facilities. Therefore, we
must rely on third-party vendors to manufacture the ICs we design. We also
currently rely principally on two third-party assembly contractors, Advanced
Semiconductor Engineering and Amkor, to assemble and package the silicon chips
provided by the wafers for use in final products. Additionally, we rely on
third-party vendors for a portion of the testing requirements of our products
prior to shipping.

20

There are significant risks associated with relying on these third-party
contractors, including:

- failure by us, our customers or their end customers to qualify a
selected supplier;

- capacity shortages during periods of high demand;

- potential insolvency of the third-party contractors;

- reduced control over delivery schedules and quality;

- limited warranties on wafers or products supplied to us;

- potential increases in prices;

- their inability to supply or support new or changing packaging
technologies; and

- low test yields.

We currently do not have long-term supply contracts with any of our
third-party vendors, and, therefore, they are not obligated to perform services
or supply products to us for any specific period, or in any specific quantities,
except as may be provided in a particular purchase order. Although we believe
that other semiconductor foundries or assembly contractors can adequately
address our needs, we expect that it would take approximately two to nine months
to transition performance of these services from our current providers to new
providers. Such a transition may also require a qualification process by our
customers or their end customers. We generally place orders for products with
some of our suppliers approximately four months prior to the anticipated
delivery date, with order volumes based on our forecasts of demand from our
customers. Accordingly, if we do not accurately forecast demand for our
products, we may be unable to obtain adequate foundry or assembly capacity from
our third-party contractors to meet our customers' delivery requirements, or we
may accumulate excess inventories. On occasion, we have been unable to
adequately respond to unexpected increases in customer purchase orders, and,
therefore, were unable to benefit from this incremental demand. None of our
third-party foundry or assembly contractors have provided assurances to us that
adequate capacity will be available to us within the time required to meet
additional demand for our products.

Since our inception, substantially all of the silicon wafers for the
products that we have shipped were manufactured either by Taiwan Semiconductor
Manufacturing Co. or its affiliates. Our customers typically complete their own
qualification process. If we fail to properly balance customer demand across the
existing semiconductor fabrication facilities that we utilize or are required by
our foundry partners to increase, or otherwise change the number of fab lines
that we utilize for our production, we might not be able to fulfill demand for
our products and may need to divert our engineering resources away from new
product development initiatives to support the fab line transition, which would
adversely affect our operating results. Additionally, a resulting write off of
unusable or excess inventories would contribute to a decline in earnings.

THE SEMICONDUCTOR MANUFACTURING PROCESS IS HIGHLY COMPLEX AND, FROM TIME TO
TIME, MANUFACTURING YIELDS MAY FALL BELOW OUR EXPECTATIONS, WHICH COULD RESULT
IN OUR INABILITY TO TIMELY SATISFY DEMAND FOR OUR PRODUCTS.

The manufacture of silicon wafers for our products is a highly complex and
technologically demanding process. Although we work closely with our foundries
to minimize the likelihood of reduced manufacturing yields, our foundries from
time to time have experienced lower than anticipated manufacturing yields.
Changes in manufacturing processes or the inadvertent use of defective or
contaminated materials by our foundries could result in lower than anticipated
manufacturing yields or unacceptable performance deficiencies. If our foundries
fail to deliver fabricated silicon wafers of satisfactory quality in a timely
manner, we will be unable to meet our customers' demand for our products in a
timely manner, which would adversely affect our operating results and damage our
customer relationships.

21

OUR CURRENT MANUFACTURERS, ASSEMBLERS, TEST SERVICE PROVIDERS, AND CUSTOMERS ARE
CONCENTRATED IN THE SAME GEOGRAPHIC REGION WHICH INCREASES THE RISK THAT A
NATURAL DISASTER, LABOR STRIKE, WAR OR POLITICAL UNREST COULD DISRUPT OUR
OPERATIONS OR SALES

Our current semiconductor manufacturers are located in the same region
within Taiwan and our assembly contractors are located in the Pacific Rim
region. In addition, many of our customers, particularly mobile telephone
manufacturers, are located in the Pacific Rim region. The risk of earthquakes in
Taiwan and the Pacific Rim region is significant due to the proximity of major
earthquake fault lines in the area. We are not currently covered by insurance
against business disruption caused by earthquakes as such insurance is not
currently available on terms that we believe are commercially reasonable.
Earthquakes, fire, flooding or other natural disasters in Taiwan or the Pacific
Rim region, or political unrest, war, labor strikes or work stoppages in
countries where our semiconductor manufacturers' and assemblers' facilities are
located, likely would result in the disruption of our foundry or assembly
capacity. Any disruption resulting from these events could cause significant
delays in shipments of our products until we are able to shift our manufacturing
or assembling from the affected contractor to another third-party vendor. There
can be no assurance that such alternate capacity could be obtained on favorable
terms, if at all. In addition, a natural disaster, labor strike, war or
political unrest where our customers' facilities are located would likely reduce
our sales to such customers.

A SUBSTANTIAL PORTION OF THE FINAL TESTING OF OUR PRODUCTS IS PERFORMED
INTERNALLY BY US, WHICH INCREASES OUR FIXED COSTS

In fiscal 2001, substantially all of our test operations were performed
in-house. During the first nine months of 2002, we significantly expanded our
internal test capabilities to support our wireless products. However, during
this same period we also outsourced a portion of test operations to our contract
manufacturers or other third parties. While we expect that performing a
substantial portion of testing in-house provides us with advantages in terms of
quality control and shorter time required to bring a product to market, we may
encounter difficulties and delays in maintaining or expanding our internal test
capabilities. In addition, final testing of complex semiconductors requires
substantial resources to acquire state-of-the-art testing equipment and hiring
additional qualified personnel, which has increased our fixed costs. If demand
for our products does not support the effective utilization of these employees
and additional equipment, we may not realize any benefit from performing the
final testing internally. Any decrease in the demand for our products could
result in the underutilization of our testing equipment and personnel. If our
internal test operations are underused or mismanaged, we may incur significant
costs that could adversely affect our operating results.

WE HAVE DEPENDED ON OUR WIRELESS FAMILY OF PRODUCTS FOR A SIGNIFICANT AMOUNT OF
OUR REVENUES IN FISCAL 2002, AND SUBSTANTIAL REDUCTIONS IN ORDERS FOR WIRELESS
PRODUCTS WOULD SIGNIFICANTLY REDUCE OUR REVENUES

During the first nine months of 2002, a significant amount of our sales were
derived from sales of our wireless family of ICs. This product family, in turn,
is highly dependent on sales to the GSM segment of the wireless phone industry.
Continued diversification of our sales through the introduction and commercial
acceptance of products other than wireless products will be required to reduce
our reliance on sales of our wireless products. A decline in overall demand for
wireless phones or the introduction by our competitors of products with superior
price/performance characteristics could significantly reduce our sales. In
addition, substantially all of our wireless products that we have sold include
technology related to one or more of our issued U.S. patents. If these patents
are found to be invalid or unenforceable, our competitors could introduce
competitive products that could reduce both the volume and price per unit of our
products.

22

WE HAVE DEPENDED ON OUR DAA FAMILY OF PRODUCTS FOR A SIGNIFICANT AMOUNT OF OUR
REVENUES IN FISCAL 2002, AND SUBSTANTIAL REDUCTIONS IN ORDERS FOR DAA PRODUCTS
WOULD SIGNIFICANTLY REDUCE OUR REVENUES

During the first nine months of 2002, a significant amount of our sales were
derived from sales of our DAA family of ICs. This product family, in turn, is
highly dependent on sales to the personal computer industry. Continued
diversification of our sales through the introduction and commercial acceptance
of products other than DAA products will be required to reduce our reliance on
sales of our DAA products. A decline in overall demand for personal computers or
the introduction by our competitors of products with superior price/performance
characteristics could significantly reduce our sales. In addition, substantially
all of our DAA products that we have sold include technology related to one or
more of our issued U.S. patents. If these patents are found to be invalid or
unenforceable, our competitors could introduce competitive products that could
reduce both the volume and price per unit of our products.

In August 2001, TDK Semiconductor Corporation filed suit against us alleging
that certain of our DAA products infringe a TDK-held patent. We have filed a
response denying the alleged infringement. If our DAA products are found to
infringe TDK's patent, our future operating results and financial condition
could be substantially adversely affected. For further information regarding
this litigation, please see "Part II, Item 1. Legal Proceedings."

WE DEPEND ON A LIMITED NUMBER OF CUSTOMERS FOR A SUBSTANTIAL PORTION OF OUR
REVENUES, AND THE LOSS OF, OR A SIGNIFICANT REDUCTION IN ORDERS FROM, ANY KEY
CUSTOMER COULD SIGNIFICANTLY REDUCE OUR REVENUES

The loss of any of our key customers, or a significant reduction in sales to
any one of them, would significantly reduce our revenues and adversely affect
our business. During the first nine months of 2002, two customers, in aggregate
represented 26% of our revenues. Samsung, purchasing primarily through Uniquest,
represented 15% of revenues and Wavecom, purchasing through Solectron and other
contract manufacturers, represented 11% of revenues. No other single customer
accounted for more than 10% of our revenues during the first nine months of
2002. Uniquest, a distributor selling products to Samsung and several customers,
represented 19% of our revenues. Edom Technology, a distributor selling products
to several customers in Asia, represented 13% of our revenues. Most of the
markets for our products are dominated by a small number of potential customers.
Therefore, our operating results in the foreseeable future will continue to
depend on our ability to affect sales to these dominant customers, as well as
the ability of these customers to sell products that incorporate our IC
products. In the future, these customers may decide not to purchase our ICs at
all, purchase fewer ICs than they did in the past or alter their purchasing
patterns, particularly because:

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

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

- some of our customers have sought or are seeking relationships with
current or potential competitors which may affect our customers'
purchasing decisions.

While we have been the sole supplier of the direct access arrangement, or
DAA, ICs used in many of our customers' soft modem DAA products, we anticipate
that our customers will regularly evaluate alternative sources of supply in the
future in order to diversify their supplier base, which would increase their
negotiating leverage with us and protect their ability to secure DAA components.
We believe that any second source of DAA ICs for our customers could have an
adverse effect on the prices we are able to charge our customers and the volume
of DAA ICs that we sell to our customers, which would negatively affect our
revenues and operating results.

23

DUE TO OUR LIMITED OPERATING HISTORY, WE MAY HAVE DIFFICULTY BOTH IN ACCURATELY
PREDICTING OUR FUTURE SALES AND APPROPRIATELY BUDGETING FOR OUR EXPENSES

We were incorporated in 1996, did not begin generating revenues until the
second quarter of 1998 and have rapidly expanded our product lines in recent
years. As a result, we have only a short history from which to predict future
revenues. This limited operating experience, combined with the rapidly evolving
nature of the markets in which we sell our products and other factors which are
beyond our control, reduce our ability to accurately forecast quarterly or
annual revenues. Additionally, because most of our expenses are fixed in the
short term or incurred in advance of anticipated revenues, we may not be able to
decrease our expenses in a timely manner to offset any shortfall of revenues.

OUR RESEARCH AND DEVELOPMENT EFFORTS ARE FOCUSED ON A LIMITED NUMBER OF NEW
TECHNOLOGIES AND PRODUCTS, AND ANY DELAY IN THE DEVELOPMENT, OR ABANDONMENT, OF
THESE TECHNOLOGIES OR PRODUCTS BY INDUSTRY PARTICIPANTS, OR THEIR FAILURE TO
ACHIEVE MARKET ACCEPTANCE, COULD COMPROMISE OUR COMPETITIVE POSITION

Our ICs are used as components in communications devices in various markets.
As a result, we have devoted and expect to continue to devote a large amount of
resources to develop products based on new and emerging technologies and
standards that will be commercially introduced in the future. For the nine
months ended September 28, 2002, our research and development expense was $23.6
million, which represented 19.4% of our revenues, compared to $21.3 million, or
42.2% of our revenues, for the nine months ended September 29, 2001. A number of
large companies in the communications industry are actively involved in the
development of these new technologies and standards. Should any of these
companies delay or abandon their efforts to develop commercially available
products based on new technologies and standards, our research and development
efforts with respect to these technologies and standards likely would have no
appreciable value. In addition, if we do not correctly anticipate new
technologies and standards, or if the products that we develop based on these
new technologies and standards fail to achieve market acceptance, our
competitors may be better able to address market demand than would we.
Furthermore, if markets for these new technologies and standards develop later
than we anticipate, or do not develop at all, demand for our products that are
currently in development would suffer, resulting in lower sales of these
products than we currently anticipate. For example, we have introduced to market
a RF synthesizer product for use in wireless phones operating on the GSM
standard. The RF synthesizer is also compatible with GPRS standard, which we
believe is the emerging data communications protocol for GSM based wireless
phones. We cannot be certain whether these standards will not change, thereby
making our products unsuitable or impractical. Additionally, despite the
published GSM/GPRS specifications, mobile phone network operators may demand
increased performance beyond specifications for this highly competitive market.
In the area of optical networking, our clock and data recovery integrated
circuit operates within stringent specifications for high speed communications
systems known as SONET. Changes to this standard could make our products
uncompetitive or unsuitable to changing system requirements and result in our
inability to sell these products.

WE DEPEND ON OUR CUSTOMERS TO SUPPORT OUR PRODUCTS

Our products are currently used by our customers to produce modems,
telephony equipment, mobile telephones, various wireless devices and optical
networking equipment. We rely on our customers to provide hardware, software,
intellectual property indemnification and other technical support for the
devices that use our products. If our customers do not provide the required
functionality or if our customers do not provide satisfactory support for their
products, the demand for these devices that incorporate our products may
diminish. Any reduction in the demand for these devices would significantly
reduce our revenues.

ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR FINANCIAL
CONDITION

As part of our growth strategy, we will continue to evaluate opportunities
to acquire other businesses or technologies that would complement our current
offerings, expand the breadth of our markets or enhance our technical
capabilities. Acquisitions that we may potentially make in the future entail a

24

number of risks that could materially and adversely affect our business and
operating results, including:

- problems integrating the acquired operations, technologies or products
with our existing business and products;

- diversion of management's time and attention from our core business;

- difficulties in retaining business relationships with suppliers and
customers of the acquired company;

- risks associated with entering markets in which we lack prior
experience; and

- potential loss of key employees of the acquired company.

WE ARE A RELATIVELY SMALL COMPANY WITH LIMITED RESOURCES COMPARED TO SOME OF OUR
CURRENT AND POTENTIAL COMPETITORS AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY
AND INCREASE MARKET SHARE

Some of our current and potential competitors have longer operating
histories, significantly greater resources and name recognition and a larger
base of customers than we have. As a result, these competitors may have greater
credibility with our existing and potential customers. They also may be able to
adopt more aggressive pricing policies and devote greater resources to the
development, promotion and sale of their products than we can to ours. In
addition, some of our current and potential competitors have already established
supplier or joint development relationships with the decision makers at our
current or potential customers. These competitors may be able to leverage their
existing relationships to discourage their customers from purchasing products
from us or persuade them to replace our products with their products. Our
competitors may also offer bundled chipset kit arrangements offering a more
complete product despite the technical merits or advantages of our products.
These competitors may elect not to support our products which could complicate
our sales efforts.

In addition, our largest competitors may restructure their operations to
create separate companies that are more focused on providing the types of
products we produce. For example, Conexant is a significant competitor of ours
across multiple product lines. In June 2002, Conexant completed the spin-out of
a new company named Skyworks Solutions, Inc., resulting from the combination of
Conexant's wireless business merged with Alpha Industries, Inc. Conexant has
also re-affirmed their intention to spin-out their Mindspeed entity which is
principally focused on optical networking semiconductor components. In
July 2000, Lucent Technologies spun off its microelectronics business, which
included its optoelectronics components and integrated circuits division, into a
separate company named Agere Systems in order to accelerate the growth of the
business and alleviate strategic conflicts with Lucent's competitors.
Additionally, Siemens spun off its semiconductor business in 1999 to create a
more focused company named Infineon Technologies. Increased competition could
decrease our prices, reduce our sales, lower our margins or decrease our market
share. These and other competitive pressures may prevent us from competing
successfully against current or future competitors, and may materially harm our
business.

WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY
CHANGING MARKET, AND IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL AND HIRE
ADDITIONAL PERSONNEL, OUR ABILITY TO DEVELOP AND SUCCESSFULLY MARKET OUR
PRODUCTS COULD BE HARMED

25

We believe our future success will depend in large part upon our ability to
attract and retain highly skilled managerial, engineering, sales and marketing
personnel. Specifically, we believe that our future success is highly dependent
on Navdeep Sooch, our co-founder, Chief Executive Officer and Chairman of the
Board, Daniel Artusi, our Chief Operating Officer, Jeffrey Scott, our co-founder
and Vice President, and David Welland, our co-founder and Vice President. There
is currently a shortage of qualified personnel with significant experience in
the design, development, manufacturing, marketing and sales of analog and mixed-
signal communications ICs. In particular, there is a shortage of engineers who
are familiar with the intricacies of the design and manufacturability of analog
elements, and competition for such personnel is intense. Our key technical
personnel represent a significant asset and serve as the primary source for our
technological and product innovations. We may not be successful in attracting
and retaining sufficient numbers of technical personnel to support our
anticipated growth. The loss of any of our key employees or the inability to
attract or retain qualified personnel, including engineers and sales and
marketing personnel, could delay the development and introduction of, and
negatively impact our ability to sell, our products.

OUR PRODUCTS ARE COMPLEX AND MAY REQUIRE MODIFICATIONS TO RESOLVE UNDETECTED
ERRORS WHICH COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR
REVENUES

Our products are complex and may contain errors when first introduced or as
new versions are released. We rely primarily on our in-house testing personnel
to design test operations and procedures to detect any errors prior to delivery
of our products to our customers. Because our products are manufactured by third
parties, should problems occur in the operation or performance of our ICs, we
may experience delays in meeting key introduction dates or scheduled delivery
dates to our customers. These errors also could cause us to incur significant
re-engineering costs, divert the attention of our engineering personnel from our
product development efforts and cause significant customer relations and
business reputation problems.

THE PERFORMANCE OF OUR DIRECT ACCESS ARRANGEMENT PRODUCTS MAY BE ADVERSELY
AFFECTED BY SEVERE ENVIRONMENTAL CONDITIONS THAT MAY REQUIRE MODIFICATIONS,
WHICH COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR REVENUES

Although our DAA products are compliant with published specifications, these
established specifications might not adequately address all conditions that must
be satisfied in order to operate in harsh environments. This includes
environments where there are wide variations in electrical quality, telephone
line quality, static electricity and operating temperatures or that may be
affected by lightning or improper handling by customers and end users. Our
products have had a limited period of time in the field under operation, and
these environmental factors may result in unanticipated returns of our products.
Any necessary modifications could cause us to incur significant re-engineering
costs, divert the attention of our engineering personnel from our product
development efforts and cause significant customer relations and business
reputation problems.

We have a large installed base of DAA products in the field. As part of our
ongoing support of this product line, we verify the performance of our products
through regulatory agency qualifications, customer acceptance procedures,
evaluation of end customer technical support information, and analysis of field
returns. Certain customer modem implementations of our direct access arrangement
products have been identified to be susceptible to a particular class of
electrical surges originating from lightning strikes that are not adequately
described in regulatory agency qualifications. We have provided application
guidelines to our customers to enhance their implementation of the modem
function to protect our devices from these lightning strike electrical surges.

Damage from these electrical surges could result in product liability claims
against our customers that produce these modems or against us. Our customers may
seek indemnification or other compensation from us with respect to any liability
that they incur. Even if our DAA product is not the source of the problem and we
are not contractually liable for such indemnification, we may incur costs in an
effort to maintain good relations with our customers. If we are held liable for
these claims or incur other costs in order to maintain good relations, this
problem could adversely affect our operating results.

WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH WOULD NEGATIVELY
AFFECT OUR ABILITY TO COMPETE

26

Our products rely on our proprietary technology, and we expect that future
technological advances made by us will be critical to sustain market acceptance
of our products. Therefore, we believe that the protection of our intellectual
property rights is and will continue to be important to the success of our
business. We rely on a combination of patent, copyright, trademark and trade
secret laws and restrictions on disclosure to protect our intellectual property
rights. We also enter into confidentiality or license agreements with our
employees, consultants and business partners, and control access to and
distribution of our documentation and other proprietary information. Despite
these efforts, unauthorized parties may attempt to copy or otherwise obtain and
use our proprietary technology. Monitoring unauthorized use of our technology is
difficult, and we cannot be certain that the steps we have taken will prevent
unauthorized use of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as in the United States. We
cannot be certain that patents will be issued as a result of our pending
applications nor can we be certain that any issued patents would protect or
benefit us or give us adequate protection from competing products. For example,
issued patents may be circumvented or challenged and declared invalid or
unenforceable. We also cannot be certain that others will not develop effective
competing technologies on their own.

SIGNIFICANT LITIGATION OVER INTELLECTUAL PROPERTY IN OUR INDUSTRY MAY CAUSE US
TO BECOME INVOLVED IN COSTLY AND LENGTHY LITIGATION WHICH COULD SERIOUSLY HARM
OUR BUSINESS

In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. From time to time, we
receive letters from various industry participants alleging infringement of
patents, trademarks or misappropriation of trade secrets. The exploratory nature
of these inquiries has become relatively common in the semiconductor industry.
We typically respond when appropriate and as advised by legal counsel. We have
been involved in litigation to protect our intellectual property rights in the
past and may become involved in such litigation again in the future. In the
future, we may become involved in litigation to defend allegations of
infringement asserted by others, both directly and indirectly as a result of
certain industry-standard indemnities we may offer to our customers. Legal
proceedings could subject us to significant liability for damages or invalidate
our proprietary rights. Legal proceedings initiated by us to protect our
intellectual property rights could also result in counterclaims or countersuits
against us. Any litigation, regardless of its outcome, would likely be time
consuming and expensive to resolve and would divert our management's time and
attention. Any intellectual property litigation also could force us to take
specific actions, including:

- cease selling products that use the challenged intellectual property;

- obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on reasonable terms, or at all;

- redesign those products that use infringing intellectual property; or

- pursue legal remedies with third parties to enforce our indemnification
rights, which may not adequately protect our interests.

In August 2001, TDK Semiconductor Corporation commenced a lawsuit against us
for alleged willful infringement by our DAA products of a TDK-held patent. TDK's
complaint seeks unspecified treble damages, costs and attorneys' fees, and an
injunction. In September 2001, we served and filed an answer to TDK's complaint,
in which we denied the alleged infringement and asserted that their patent is
invalid. On March 27, 2002, we filed an amended answer and counterclaims in
which we claimed that the TDK-held patent is unenforceable due to inequitable
conduct and asserted counterclaims seeking a declaration that the TDK-held
patent is invalid, not infringed and unenforceable. This lawsuit may involve
significant expense and may also divert our management's time and attention from
other aspects of our business. Due to the inherent uncertainties of litigation,
we are unable to predict the outcome of this matter. For further information
regarding this litigation, please see "Part II, Item 1. Legal Proceedings."

27

FAILURE TO MANAGE OUR DISTRIBUTION CHANNEL RELATIONSHIPS COULD IMPEDE OUR FUTURE
GROWTH

The future growth of our business will depend in part on our ability to
manage our relationships with current and future distributors and sales
representatives, develop additional channels for the distribution and sale of
our products and manage these relationships. As we execute our indirect sales
strategy, we will need to manage the potential conflicts that may arise with our
direct sales efforts. The inability to successfully execute or manage a
multi-channel sales strategy could impede our future growth.

RISKS RELATED TO OUR INDUSTRY

COMPETITION WITHIN THE NUMEROUS MARKETS WE TARGET MAY REDUCE SALES OF OUR
PRODUCTS AND REDUCE MARKET SHARE

The markets for semiconductors in general, and for mixed-signal ICs in
particular, are intensely competitive. We expect that the market for our
products will continually evolve and will be subject to rapid technological
change. In addition, as we target and supply products to numerous markets and
applications, we face competition from a relatively large number of competitors.
Across all of our product areas, we compete with Agere Systems, AMCC, Analog
Devices, Broadcom, Conexant, Cypress, ESS, Fujitsu, Hitachi, Infineon
Technologies, Legerity (formerly the Advanced Micro Devices telecom division),
Maxim Integrated Products, National Semiconductor, Philips, Semtech, Skyworks
Solutions Inc. (the combination of Conexant's wireless business and Alpha
Industries), Texas Instruments, Vitesse Semiconductor Corp, and others. We
expect to face competition in the future from our current competitors, other
manufacturers and designers of semiconductors, and innovative start-up
semiconductor design companies. Some of our customers, such as Agere Systems,
Intel, Motorola, Samsung and Texas Instruments, are also large, established
semiconductor suppliers. Our sales to and support of these customers may enable
them to become a source of competition to us, despite our efforts to protect our
intellectual property rights. As the markets for communications products grow,
we also may face competition from traditional communications device companies.
These companies may enter the mixed-signal semiconductor market by introducing
their own ICs or by entering into strategic relationships with or acquiring
other existing providers of semiconductor products. The sales of our wireless
products into the highly competitive GSM handset market are expected to comprise
a larger percentage of our future revenues resulting an increasingly competitive
marketplace for our aggregate product revenue.

THE AVERAGE SELLING PRICES OF OUR PRODUCTS COULD DECREASE RAPIDLY WHICH MAY
NEGATIVELY IMPACT OUR GROSS MARGINS AND REVENUES

We may experience substantial period-to-period fluctuations in future
operating results due to the erosion of our average selling prices. We have
reduced the average unit price of our products in anticipation of future
competitive pricing pressures, new product introductions by us or our
competitors and other factors. The highly competitive GSM handset market is
extremely cost sensitive due to the potentially very high volumes and stringent
expectations placed on consumer electronics component suppliers for aggressive
and sustained price reductions which would result in declining average selling
prices. We expect that these factors will create downward pressure on our
average selling prices and gross margins. If we are unable to offset any such
reductions in our average selling prices by increasing our sales volumes, our
gross profits and revenues will suffer. To maintain gross margins, we will need
to develop and introduce new products and product enhancements on a timely basis
and continually reduce our costs. Our failure to do so would cause our revenues
and gross margins to decline.

WE ARE SUBJECT TO THE CYCLICAL NATURE OF THE SEMICONDUCTOR INDUSTRY

28

The semiconductor industry is highly cyclical and is characterized by
constant and rapid technological change, rapid product obsolescence and price
erosion, evolving standards, short product life cycles and wide fluctuations in
product supply and demand. The industry has experienced significant downturns,
often connected with, or in anticipation of, maturing product cycles of both
semiconductor companies' and their customers' products and declines in general
economic conditions. These downturns have been characterized by diminished
product demand, production overcapacity, high inventory levels and accelerated
erosion of average selling prices. Specific areas of the communications markets
have contributed to the overall decline and volatility of the semiconductor
industry. For example, the semiconductor industry has suffered a downturn due to
reductions in the actual unit sales of personal computers and wireless phones as
compared to previous robust forecasts, and forecasts of excess capacity in the
fiber optic networks. Additionally, changing and competing technical standards
in airwave interfaces such as GSM and CDMA for mobile handsets, migration to
higher speed communication protocols in the optical space and the return to
prominence of the traditional bell regional operating companies compared to the
competitive local exchange companies all have contributed to the volatility in
the communications area of the semiconductor industry. This downturn has
resulted in a material adverse effect on our business and operating results. The
severity and duration of these industry-wide trends are currently unclear and
the material adverse effect on our business may continue in the future.

Due to the cyclical nature of the semiconductor industry, any upturn in
business could result in increased competition for access to third-party foundry
and assembly capacity. We are dependent on the availability of such capacity to
manufacture and assemble our ICs. None of our third-party foundry or assembly
contractors have provided assurances that adequate capacity will be available to
us.

OUR CUSTOMERS REQUIRE OUR PRODUCTS TO UNDERGO A LENGTHY AND EXPENSIVE
QUALIFICATION PROCESS WHICH DOES NOT ASSURE PRODUCT SALES

Prior to purchasing our products, our customers require that our products
undergo an extensive qualification process, which involves testing of the
products in the customer's system as well as rigorous reliability testing. This
qualification process may continue for six months or longer. However,
qualification of a product by a customer does not assure any sales of the
product to that customer. Even after successful qualification and sales of a
product to a customer, a subsequent revision to the IC, changes in its
manufacturing process or the selection of a new supplier by us may require a new
qualification process, which may result in delays and in us holding excess or
obsolete inventory. After our products are qualified, it can take an additional
six months or more before the customer commences volume production of components
or devices that incorporate our products. Despite these uncertainties, we devote
substantial resources, including design, engineering, sales, marketing and
management efforts, toward qualifying our products with customers in
anticipation of sales. If we are unsuccessful or delayed in qualifying any of
our products with a customer, such failure or delay would preclude or delay
sales of such product to the customer, which may impede our growth and cause our
business to suffer.

OUR PRODUCTS MUST CONFORM TO INDUSTRY STANDARDS IN ORDER TO BE ACCEPTED BY END
USERS IN OUR MARKETS

Generally, our products comprise only a part of a communications device. All
components of such devices must uniformly comply with industry standards in
order to operate efficiently together. We depend on companies that provide other
components of the devices to support prevailing industry standards. Many of
these companies are significantly larger and more influential in affecting
industry standards than we are. Some industry standards may not be widely
adopted or implemented uniformly, and competing standards may emerge that may be
preferred by our customers or end users. If larger companies do not support the
same industry standards that we do, or if competing standards emerge, market
acceptance of our products could be adversely affected which would harm our
business.

29

Products for communications applications are based on industry standards
that are continually evolving. Our ability to compete in the future will depend
on our ability to identify and ensure compliance with these evolving industry
standards. The emergence of new industry standards could render our products
incompatible with products developed by other suppliers. As a result, we could
be required to invest significant time and effort and to incur significant
expense to redesign our products to ensure compliance with relevant standards.
If our products are not in compliance with prevailing industry standards for a
significant period of time, we could miss opportunities to achieve crucial
design wins. We may not be successful in developing or using new technologies or
in developing new products or product enhancements that achieve market
acceptance. Our pursuit of necessary technological advances may require
substantial time and expense.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Information related to quantitative and qualitative disclosures regarding
market risk is set forth in Management's Discussion and Analysis of Financial
Condition and Results of Operations and the risk factors under Item 2 above.
Such information is incorporated by reference herein.

ITEM 4. CONTROLS AND PROCEDURES

We performed an evaluation under the supervision and with the participation
of our management, including our Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), of the effectiveness of the design and operation of
our disclosure controls and procedures. Based on that evaluation, our
management, including our CEO and CFO, concluded that our disclosure controls
and procedures were effective as of September 28, 2002. There have been no
significant changes in our internal controls or other factors that could
significantly affect internal controls subsequent to September 28, 2002.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

PATENT INFRINGEMENT LITIGATION

On August 7, 2001, TDK Semiconductor Corporation (TDK) commenced a lawsuit
in the United States District Court for the Central District of California
against us for alleged infringement of TDK's United States Patent
No. 5,654,984. TDK's complaint asserts that we have infringed TDK's '984 patent
by making, using and selling in the United States certain DAA semiconductor
chipsets, including our Si3035 and Si3044 products, and that the infringement
was and continues to be willful. TDK's complaint seeks unspecified treble
damages, costs and attorneys' fees, and an injunction.

On September 27, 2001, we served and filed an answer to TDK's complaint, in
which we denied infringement and asserted that TDK's '984 patent is invalid.

On March 27, 2002, we filed an amended answer and counterclaims in which we
claimed that the TDK-held patent is unenforceable due to inequitable conduct and
asserted counterclaims seeking a declaration that the TDK-held patent is
invalid, not infringed and unenforceable. We are currently in the discovery
phase of this litigation.

We intend to vigorously contest this case, and are unable at this time to
determine whether the outcome of the litigation will have a material impact on
our results of operations or financial condition in any future period. For a
description of risks associated with this pending lawsuit, please see "Risk
Factors--Significant litigation over intellectual property in our industry may
cause us to become involved in costly and lengthy litigation which could
seriously harm our business."

30

SECURITIES LITIGATION

On December 6, 2001, a class action complaint for violations of U.S. federal
securities laws was filed in the United States District Court, Southern District
of New York against us, four officers individually and the three investment
banking firms who served as representatives of the underwriters in connection
with our initial public offering of common stock which became effective on
March 23, 2000. On April 19, 2002, a consolidated amended complaint was filed in
the same court. The action is being coordinated with over 300 other nearly
identical actions filed against other companies. These claims are premised on
allegations that the registration statement and prospectus for our initial
public offering did not disclose that (1) the underwriters solicited and
received additional, excessive and undisclosed commissions from certain
investors, and (2) the underwriters had agreed to allocate shares of the
offering in exchange for a commitment from the customers to purchase additional
shares in the aftermarket at pre-determined higher prices. A court order dated
October 9, 2002 dismissed without prejudice numerous individual defendants,
including the four officers of our company who had been named individually. We
intend to vigorously contest this case, and are unable at this time to determine
whether the outcome of the litigation will have a material impact on our results
of operations or financial condition in any future period.

We are not currently involved in any other material legal proceedings.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Our registration statement (Registration No. 333-94853) under the Securities
Act of 1933, as amended, relating to our initial public offering of our common
stock became effective on March 23, 2000. A total of 3,680,000 shares of common
stock were registered. We sold a total of 3,200,000 shares of our common stock
and selling stockholders sold a total of 480,000 shares to an underwriting
syndicate. The managing underwriters were Morgan Stanley & Co. Incorporated,
Lehman Brothers Inc., and Salomon Smith Barney Inc. The offering commenced and
was completed on March 24, 2000, at a price to the public of $31.00 per share.
The initial public offering resulted in net proceeds to us of $90.6 million,
after deducting underwriting commissions of $6.9 million and offering expenses
of $1.6 million. We used $15 million of the proceeds as part of the
consideration paid in the acquisition of Krypton Isolation, Inc. on August 9,
2000. Another $4.3 million was used to pay off equipment loans provided by
Imperial Bank. We used another $1.0 million of the proceeds as part of the
consideration paid in the acquisition of SNR Semiconductor Incorporated on
October 2, 2000. As of September 28, 2002, the remaining proceeds were invested
in short-term, investment-grade, interest bearing instruments.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable

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

Not applicable

ITEM 5. OTHER INFORMATION

Not applicable

31

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) The following exhibits are filed as part of this report:

Exhibit
Number
-------
3.1* Form of Fourth Amended and Restated Certificate of Incorporation of
Silicon Laboratories Inc. filed as Exhibit 3.1 to the Registrant's
Registration Statement on Form S-1 (SEC File No. 333-94853 (the "IPO
Registration Statement")).

3.2* Form of Amended and Restated Bylaws of Silicon Laboratories Inc.
(filed as Exhibit 3.2 to the IPO Registration Statement).

4.1* Specimen certificate for shares of common stock (filed as
Exhibit 4.1 to the IPO Registration Statement).
- ---------------
* Incorporated herein by reference to the indicated filing.

(b) During the three months ended September 28, 2002, we filed the following
Current Reports on Form 8-K:

We filed a Form 8-K on September 12, 2002 (Item 5) announcing the
appointment of Russell J. Brennan as chief financial officer.

32

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

SILICON LABORATORIES INC.
(Registrant)

October 22, 2002 /s/ Navdeep S. Sooch
- ---------------------------- --------------------------------------
Date Navdeep S. Sooch
CHAIRMAN AND
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)

October 22, 2002 /s/ Russell J. Brennan
- ---------------------------- --------------------------------------
Date Russell J. Brennan
VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING OFFICER)

33

CERTIFICATIONS

I, Navdeep S. Sooch, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Silicon
Laboratories Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons fulfilling the
equivalent functions):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls;

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: October 22, 2002

/s/ Navdeep S. Sooch
- -------------------------------
Navdeep S. Sooch
CHAIRMAN AND
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)

34

CERTIFICATIONS

I, Russell J. Brennan, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Silicon
Laboratories Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons fulfilling the
equivalent functions):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls;

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: October 22, 2002

/s/ Russell J. Brennan
- ------------------------------------
Russell J. Brennan
VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING OFFICER)

35