Back to GetFilings.com

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

  For the fiscal year ended December 31, 2002

OR

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

  For the transition period from ______________ to _______________

Commission File Number 0-25996

TRANSWITCH CORPORATION

(Exact name of Registrant as Specified in its Charter)

Three Enterprise Drive

Shelton, Connecticut 06484

(Address of principal executive offices, including zip code)

Telephone (203) 929-8810

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes  ¨  No  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

The aggregate market value of the outstanding common stock, other than shares held by persons who may be deemed affiliates of the Registrant, as of the last business day of the Registrant’s most recently completed second fiscal quarter was approximately $57.6 million. At March 12, 2003, as reported on the Nasdaq SmallCap Market, there were 90,133,689 shares of common stock, par value $.001 per share, of the Registrant outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the following document are incorporated by reference in Part III of this Form 10-K Report:

(1)  Proxy Statement for the Registrant’s 2003 Annual Meeting of Shareholders—Items 10, 11, 12 and 13.

Item 1.    Business.

The following description of our business should be read in conjunction with the information included elsewhere in this document. The description contains certain forward-looking statements that involve risks and uncertainties. When used in this document, the word “intend”, “believe”, “estimate”, “plan”, and “expect” and similar expressions as they relate to us are included to identify forward-looking statements. Our actual results could differ materially from the results discussed in the forward-looking statements as a result of certain risk factors set forth elsewhere in this document. See also, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Certain Factors That May Affect Future Results.”

General

TranSwitch is a Delaware corporation incorporated on April 26, 1988. We design, develop and market highly integrated semiconductor devices that provide core functionality in voice and data communications network equipment deployed in the global network infrastructure. In addition to their high degree of functionality, our products incorporate digital and mixed-signal (analog and digital) processing capabilities, providing comprehensive system-on-a-chip (SOC) solutions to our customers.

Our products are compliant with all of the relevant network standards including Asynchronous/Plesiochronous Digital Hierarchy (Asynchronous/PDH), Synchronous Optical Network/Synchronous Digital Hierarchy (SONET/SDH) and Asynchronous Transfer Mode/Internet Protocol (ATM/IP). We offer several products that combine multi-protocol capabilities on a single chip, enabling our customers to develop network equipment for multi-service (voice, data and video) applications. A key attribute of our products is their inherent flexibility. Many of our products incorporate embedded programmable processors, enabling us to rapidly accommodate new customer requirements or evolving network standards.

We bring value to our customers through our communications systems expertise, very large scale integration (VLSI) design skills and commitment to excellence in customer support. Our innovative skills and technical capabilities enable us to define and develop products that permit our customers to achieve faster time-to-market, and to produce communications systems that offer a host of benefits such as greater functionality, improved performance, lower power dissipation, reduced system size and cost and greater reliability.

Our principal customers are the telecommunications and data communications equipment Original Equipment Manufacturers (OEMs) that serve three market segments:

We have sold our VLSI devices to more than 400 customers worldwide since shipping our first product in 1990. Our products are sold through a worldwide direct sales force and a worldwide network of independent distributors and sales representatives.

Products and Applications

We supply high-speed, broadband VLSI semiconductor devices to network systems OEMs that serve three market segments: the worldwide public network infrastructure that supports both voice and data communications, the Internet infrastructure that supports the World Wide Web and other data services and corporate WANs. As a system-on-a-chip innovation leader, our core competencies include:

2

Our products comply with all relevant industry standards and provide functionality in three key areas:

a)  SONET/SDH used in high speed (optical) networks;

b)  Asynchronous/PDH for lower speed (metallic wire) networks; and

c)  ATM and IP data networking protocols.

We believe that our chip-set approach and broad product coverage in all three product lines positions us as a “one-stop source” for broadband communications VLSI products. Network equipment OEMs can mix and match our VLSI devices to optimally configure their specific systems. Our product lines can be combined to provide a cost-effective communication systems solution with increased functional integration and features while providing seamless integration of SONET/SDH, Asynchronous/PDH and ATM/IP for broadband network applications. In 2002, the prices for our products ranged from approximately $10 to $500 per device, depending on technology, volume, complexity and functionality.

In 2002 we extended our product offerings in two important areas by introducing the EtherMap^® family of products that enable the transport of Ethernet over SONET/SDH networks and the OMNI^® family of products that provide an unparalleled solution for multi-service metropolitan area network switching applications.

Asynchronous/PDH Products

Our Asynchronous/PDH products provide high-bandwidth connections and are used to configure transmission equipment for use in the public network. This equipment is used to increase the capacity of the copper-based public network. Our Asynchronous/PDH VLSI products also enable customer premise equipment (CPE), such as hubs and routers used in WANs and local area networks (LANs), to access the public network for voice and data communications with similar products in other locations.

Our Asynchronous/PDH products provide high levels of integration, as well as cost, power and performance benefits relative to discrete and competing integrated circuit solutions. Our Asynchronous/PDH VLSI products include devices that provide solutions for DS-0 through DS-3 and E-1 through E-3 transmission lines. This product line includes line interfaces, multiplexers, which combine multiple low-speed lines to form a higher speed line, as well as demultiplexers, which perform the reverse function. In addition, we offer framers, which are devices that identify the starting points of defined bit streams and enable systems to recognize the remaining bits.

SONET/SDH Products

In the SONET/SDH area, we offer devices that provide a direct interface for fiber optic transmission in North America, Europe and Asia. Our mappers bridge the interconnections between SONET/SDH equipment and asynchronous equipment, allowing DS-series and E-series transmission lines to be connected with SONET/SDH lines. These mappers transparently transport Asynchronous/PDH signals across the SONET/SDH network.

Our recently introduced EtherMap family of products constitutes a major extension of our SONET/SDH product line. These products comply with recently introduced industry standards for efficient and flexible transport of Ethernet over SONET/SDH networks. Ethernet is universally deployed in enterprise LANs, while SONET/SDH is equally ubiquitous in optical WANs. Our EtherMap products enable our customers to rapidly enhance their existing systems or to develop new systems that provide Ethernet transport capabilities. This in

3

turn provides value to their customers, the service providers, by enabling service providers to leverage their existing investment in SONET/SDH networks to provide new revenue generating services.

Our SONET/SDH products have traditionally been used to build access equipment, add/drop multiplexers, digital cross connects and other telecommunication and data communications equipment. This equipment is configured for use in both domestic and international fiber-based public networks. Our SONET/SDH products also have applications in CPE, such as routers and hubs, and in central offices, adding integrated fiber optic transmission capability to telephone switches.

With the introduction of our OMNI multi-service switching family of products, we have extended the reach of SONET/SDH products from the access networks into the metro networking space. The product family consists of highly integrated SONET/SDH Transport Processor and a Switch Element device that enables our customers to build highly scalable switch fabrics with improved performance in the areas of switching granularity and versatility of simultaneously supporting multiple data types.

ATM/IP Products

Our ATM/IP products provide the key functions of ATM/IP-based multi-service access multiplexer systems. CellBus^® is a system architecture invented by TranSwitch for implementing ATM/IP access multiplexers and ATM/IP switching systems. The products incorporating our CellBus technology include the CUBIT^® and ASPEN^® families of VLSI devices. Our CellBus technology provides single-chip ATM/IP switching capability in access equipment. These products have been designed into many network system OEMs’ solutions since late 1995, establishing CellBus as a significant technology in the global broadband network access market. Our ATM/IP products also include VLSI semiconductor devices for line interfacing and service adaptation functions, including the mapping of these data protocols into SONET/SDH.

Technology

We believe that one of our core competencies is our knowledge of the telecommunications and data communications landscape. Specifically, our systems engineering personnel possess substantial telecommunications and data communications design experience, as well as extensive knowledge of the relevant standards. This includes not only a thorough understanding of the actual written standards, but also an awareness of and appreciation for, the nuances associated with these standards necessary for assuring that device designs are fully compliant. To date, we have been very successful in delivering VLSI devices that are standards compliant as we have insignificant warranty claims.

Complementing our communications industry expertise is our VLSI design competence. Our VLSI design personnel have extensive experience in designing high-speed digital and mixed-signal devices for communications applications. These designs require a sophisticated understanding of complex technology, as well as the specifics of the deep sub-micron manufacturing processes and their resulting impact on device performance. We have developed a large number of VLSI blocks and intellectual property (IP) cores that operate under the demanding requirements of the telecommunications and data communications industries. These blocks and IP cores have been designed using standard VLSI-oriented programming languages such as Visic Hardware Descriptive Language (VHDL) and Verilog and have been verified with standard verification tools.

We have developed proprietary tool sets, called “Test Benches”, that facilitate rapid development of VLSI products and help assure that our products are standards compliant and meet customer requirements. These Test Benches consist of behavioral models of all applicable functions in a high-level design environment and also include test signal generators and analyzers such as models of SONET/SDH signals. Systems engineers use Test Benches to test new architectural concepts, while VLSI designers use Test Benches to ensure that the device conforms to product specifications.

4

In addition to the extensive hardware functionality, many of our products utilize embedded processors that are software programmable. This approach enables us to develop products with higher levels of functionality and flexibility than are possible with purely hardware based solutions.

The newly introduced EtherMap and OMNI product families are multi-million gate devices, which will be implemented in 0.18, 0.15 and 0.13 micron complementary metal oxide semiconductor (CMOS) silicon technologies. They incorporate high speed mixed signal circuitry, and many of them are equipped with embedded processors that provide added functionality through software.

Other products that incorporate programmability are the ASPEN family of ATM processors, and the PHAST series of products that target simultaneous mapping and transport of ATM/point-to-point protocol (PPP) and time division multiplex (TDM) services over fiber optic networks. In addition, we have introduced a family of devices which provide a high degree of granularity for access networks. The T3BwP and TEPro VLSI devices support both data and management planes with an on-chip Reduced Instruction Set Computing (RISC) processor supporting full standards based management and performance monitoring.

We have enhanced our internal chip layout capabilities through the acquisition of experienced personnel through standard hiring practices and enhanced our design for test capability through the acquisition of Horizon Semiconductors, Inc., in 2001, both of which have resulted in significant improvements in silicon efficiency and time-to-market. Our system-on-a-chip (SOC) definition, architecture, verification expertise and design methodology ensure that hardware and software architectural trade-offs yield desired performance testing from our VLSI solutions. The system-on-a-chip performance, simulation, emulation, verification and stress testing, using Test Benches and test equipment, ensures that our products meet carrier class quality, performance and reliability requirements.

The expertise of our personnel, our rigorous design methodology and our investment in state-of-the-art tools enable us to develop the complex and innovative products our customers demand.

Marketing and Sales

Our marketing strategy focuses on key customer relationships to promote early adoption of our VLSI devices in the products of market-leading communications equipment OEMs. Through our customer sponsorship program, OEMs collaborate on product specifications and applications while participating in product testing in parallel with our own certification process. This approach accelerates our customers’ time-to-market delivery while enabling us to achieve early design wins for our products and obtain non-recurring engineering expense support and volume forecasts for specific products from these sponsors.

Our sales strategy focuses on worldwide suppliers of high-speed communications and communications-oriented equipment. These customers include telecommunications, data communications, Internet, customer premise, computing, process control and defense equipment vendors. In addition, we target emerging technology leaders in the communications equipment market that are developing next generation solutions for the telecommunications and data communications markets. We identify and address sales opportunities through our worldwide direct sales force and our worldwide network of independent distributors and sales representatives.

Our worldwide direct sales force, technical support personnel and key engineers work together in teams to support our customers. We have technical support capabilities located in key geographical locations throughout the world as well as a technical support team at our headquarters as a backup to the field applications engineers.

We have established foreign distributors and sales representative relationships in Australia, Belgium, Brazil, Canada, China, Germany, India, Ireland, Israel, Italy, Japan, Korea, Luxemburg, Mexico, Spain, Switzerland, Taiwan, Turkey and the United Kingdom. We also sell our products through domestic distributors and a network of domestic sales representatives. We have regional sales and technical support capabilities in Boston,

5

Massachusetts; Chicago, Illinois; San Jose, California; Morristown, New Jersey; Raleigh/Durham, North Carolina; Dallas, Texas; Ottawa, Ontario; Stockholm, Sweden; Paris, France; Rome, Italy; Berkshire, England; Hilversum, Netherlands; Brussels, Belgium; Tel Aviv, Israel; New Delhi, India; and Taipei, Taiwan, as well as at our headquarters facility in Shelton, Connecticut.

Customers

We have sold our products and services to over 400 customers since shipping our first product in 1990. Our customers include public network systems OEMs that incorporate our products into telecommunications systems, WAN and LAN equipment OEMs, Internet-oriented OEMs, communications test and performance measurement equipment OEMs and government, university and private laboratories that use our products in advanced public network and WAN and LAN developments. A small number of our customers have historically accounted for a substantial portion of our net revenues. The following tables set forth the percentage of net revenues attributable to our major distributors as well as the significant customers that had total purchases (either direct or through distributors) of greater than 10% of net revenues for the three years ended December 31, 2002:

Information on reportable operating segments for each of the last three years is located in Note 8 of the Notes to Consolidated Financial Statements in Item 8 of this report and incorporated herein by reference.

Research and Development

We believe that the continued introduction of new products in our target markets is essential to our growth. As of December 31, 2002, we had 260 full-time employees engaged in research and product development efforts. We employ designers who have the necessary engineering and systems qualifications and who are experienced in software, mixed-signal, high-speed digital, telecommunications and data communications technologies. See Item 2 “Properties”, for a listing of our design centers that are engaged in product development.

Research and development expenditures for the years 2002, 2001 and 2000 were $53.5 million, $49.3 million, and $24.2 million, respectively. In 2002, 2001 and 2000, we also expensed $2.0 million, $22.0 million

6

and $2.8 million of purchased in-process research and development related to the acquisitions of Systems On Silicon, Inc, Opal Acquisition Corporation (formerly known as Onex Communications Corporation) and TranSwitch Silicon Valley, Inc. (formerly known as Alacrity Communications, Inc.), respectively.

All development efforts are carried out using ISO 9001 certified design processes and our design tools and environment are continuously updated to improve design, fabrication and verification of products. From time to time, we subcontract design services and acquire products from third parties to enhance our product lines. Our internal research and development organization thoroughly reviews the external development processes and the design of these products as part of its quality assurance process.

Patents and Licenses

Through the end of 2002, TranSwitch has been issued or became an assignee of one hundred twenty-three (123) patents worldwide with one hundred three (103) patents pending worldwide. TranSwitch has been assigned forty-two (42) United States patents of which two are co-assigned (one with Siemens Telecommunications Systems, Ltd. and one with ECI Telecom Ltd.). One of the United States patents has been abandoned and is no longer in force. In addition there were twenty-nine (29) United States patents pending. Many of the United States issued and pending patents were filed internationally. As a result, TranSwitch has been issued eighty-two (82) international patents, which include the co-assigned patents from Siemens Telecommunications Systems, Ltd. and ECI Telecom Ltd., as of December 31, 2002. For one or more of its United States patents, TranSwitch has coverage in Canada, China, Taiwan, Israel, Japan, Korea, France, Germany, United Kingdom, Belgium, Italy, Sweden, Spain, Ireland, Denmark, The Netherlands, Portugal, Switzerland, Luxembourg and Liechtenstein. Internationally, there are fifty-three (53) patents pending in specific countries with an additional twenty-one (21) filed in the European Patent Office (EPO) or under the Patent Cooperative Treaty (PCT).

We cannot guarantee that our patents will not be challenged or circumvented by our competitors, and we cannot be sure that pending patent applications will ultimately be issued as patents. Under current law, patent applications in the United States filed before November 29, 2000 are maintained in secrecy until they are issued but applications filed after November 29, 2000 (and foreign applications) are generally published 18 months after their priority date, which is generally the filing date. The right to a patent in the United States is attributable to the first to invent, while in most jurisdictions the right to a patent is obtained by the first to file the patent application. We cannot be sure that our products or technologies do not infringe patents that may be granted in the future based upon currently pending non-published patent applications or that our products do not infringe any patents or proprietary rights of third parties. From time to time, we receive communications from third parties alleging patent infringement. If any relevant claims of third-party patents are upheld as valid and enforceable, we could be prevented from selling our products or could be required to obtain licenses from the owners of such patents or be required to redesign our products to avoid infringement. We cannot be assured that such licenses would be available or, if available, would be on terms acceptable to us or that we would be successful in any attempts to redesign our products or processes to avoid infringement. Our failure to obtain these licenses or to redesign our products would have a material adverse effect on our business.

We also have been granted registration of seventeen trade or service marks in the United States, and we have four more U.S. applications for trademarks awaiting approval. We have also obtained four trademark registrations under the European Community Trademark (ECT) procedure with one awaiting approval in the ECT and two awaiting approval in Canada.

Our ability to compete depends upon our ability to protect our proprietary information through various means, including ownership of patents, copyrights, mask work registrations and trademarks. While no intellectual property right of ours has been invalidated or declared unenforceable, we cannot assure that such rights will be upheld in the future. We believe that, in view of the rapid pace of technological change in the communication semiconductor industry, the technical experience and creative skills of our engineers and other personnel are the most important factors in determining our future technological success.

7

We have entered into various license agreements for product or technology exchange. The purpose of these licenses has, in general, been to obtain second sources for standard products or to convey or receive rights to certain proprietary or patented cores, cells or other technology.

We sell our products into the telecommunications and data communications industries, in which products are subject to various standards that are agreed upon by recognized industry standards committees. Where applicable, we design our products to be in conformity with these standards. We have received and expect to continue to receive, in the normal course of business, communications from third parties stating that if certain of our products meet a particular standard, these products may infringe one or more patents of that third party. We will review the circumstances of each communication, and, in our discretion and upon the advice of legal counsel, have taken or may take in the future one of the following courses of action: we may negotiate payment for a license under the patent or patents that may be infringed, we may use our technology and/or patents to negotiate a cross-license with the third party or we may decline to obtain a license on the basis that we do not infringe the claimant’s patent or patents, or that such patents are not valid, or other bases. We cannot assure that licenses for any of these patents will be available to us on reasonable terms or that we would prevail in any litigation seeking damages or expenses from us or to enjoin us from selling our products on the basis of any of the alleged infringements.

Manufacturing and Quality

Our manufacturing objective is to produce reliable, high-quality devices on a cost effective basis. To this end, we seek to differentiate ourselves by:

Established independent foundries manufacture all of our VLSI devices. This approach permits us to focus on our design strengths, minimize fixed costs and capital expenditures and access diverse manufacturing technologies. Currently, we utilize seven foundries to process our wafers, of which four of these relationships are governed by foundry agreements: Texas Instruments Incorporated (TI), LSI Logic Corporation, IBM Microelectronics (a division of IBM) and Taiwan Semiconductor Manufacturing Company Limited (TSMC). Foundries are required to have qualified and reliable processes. The selection of a foundry for a specific device is based on availability of the required process technology and the foundry’s capability to support the particular set of tools used by us for that device. Currently, TI manufactures all of our Bipolar Complementary Metal Oxide Semiconductor (BiCMOS) devices.

Various independent subcontractors and foundry suppliers perform assembly and testing functions. Additionally, certain testing and inspection functions are performed at our facility in Shelton, Connecticut.

TUV Rheinland of North America, Inc. registers us as complying with the requirements of ISO 9001.

8

Acquisitions

While some of the next generation products we introduce are based on technologies that we develop ourselves, we have filled some of our technology gaps through acquisitions. The following is a table that summarizes technology and skills we obtained through acquisitions of stand-alone companies during the three years ended December 31, 2002.

Investments in Non-Publicly Traded Companies

We will, from time-to-time, make investments (which include convertible bridge loans) in early stage venture-backed, start-up companies that develop technologies that are complementary to our product roadmap. In each case we have also entered into commercial agreements giving us the rights to resell products developed by these companies. The following is a table that summarizes the investments we have made and their related technologies during the three years ended December 31, 2002.

A description of each of these businesses, including their locations, follows. When determining the accounting method for these investments, we consider both direct (TranSwitch) ownership and indirect ownership, which is comprised of employees and directors of TranSwitch. We also consider other factors, such as our influence over the financial, technology and operating policies of these companies.

9

OptiX Networks, Inc. is a Delaware corporation with offices in Weston, Massachusetts and a research and development center in Kfar Saba, Israel. OptiX Networks is developing VLSI devices in advanced technologies for the broadband optical backbone, interoffice and metro area communications. Initial products will focus on 10 Gb/s and 40 Gb/s SONET/SDH framing. As of December 31, 2002, we have committed to provide up to $4.0 million in convertible debt financing to OptiX Networks, of which we have funded approximately $3.5 million. We have an obligation to fund the remaining $0.5 million of this convertible bridge loan subject to certain terms and conditions of the convertible bridge loan agreement. We account for this investment under the equity method.

Intellectual Capital for Integrated Circuits, Inc. (IC4IC) is a Delaware corporation with offices in Yokneam Illit, Israel. IC4IC specializes in the designing, developing and marketing of VLSI solutions serving the wireless Internet market segment for multi-access platform. We account for this investment under the cost method. Refer to Note 17—Subsequent Events of our Consolidated Financial Statements, which discuss a potential change in accounting method for this investment.

TeraOp (USA), Inc. is a Delaware corporation with a research and development center in Magshimim, Israel. TeraOp designs micro electro mechanical systems (MEMS) based optical crossbars for next generation core and metro storage switches and routers. We account for this investment under the cost method. Refer to Note 17—Subsequent Events of our Consolidated Financial Statements, which discuss a potential change in accounting method for this investment.

Accordion Networks, Inc. is a California corporation with offices in Milpitas, California. Accordion designs and supplies broadband services platforms designed to allow service providers to remotely activate, personalize and manage bandwidth-intensive applications. Accordion’s target market is metro area telecommunications and data communications providers. We account for this investment under the cost method.

Other than our commitment to OptiX Networks noted above, we do not have any further obligations to participate in future rounds of financing of the above companies, although we do have rights of first refusal to purchase additional securities offered by the above companies. We do not have any commitments to acquire or merge with any of the companies in which we have investments. Additionally, we do not have a right of first refusal to acquire these companies. Our rights are consistent with the rights of all holders of the class (or classes) of stock that we have purchased.

Investments in Venture Capital Funds

We have also invested in two venture capital funds as follows:

GTV Capital, L.P. (GTV), is a partnership in the business of making, supervising and disposing of capital investments in equity or equity-related securities in companies engaged in high-technology industries. The partnership focuses on seed and early-stage investments in communication infrastructure technology companies, including wireless and optical systems technology, storage and related semiconductor technology, and media convergence technology. We account for this investment under the equity method.

Neurone Ventures II, L.P. (Neurone), is a partnership in the business of making, supervising and disposing of privately negotiated equity and equity-related investments, principally in early-stage Israeli and Israeli-related high-technology companies. We account for this investment under the equity method. Neurone is also an investor in IC4IC and we are a 1% owner of Neurone.

Competition

The communication semiconductor industry is intensely competitive and is characterized by the following:

10

The telecommunications and data communications industries, which are our primary target markets, are also intensely competitive due to deregulation and heightened international competition.

Our competition consists of specialized semiconductor companies from the United States as well as other countries and semiconductor divisions of vertically integrated companies, such as IBM Corporation, Lucent Technologies, Inc., NEC Corporation and Siemens Corporation. New entrants are also likely to attempt to obtain a share of the market for our current and future products.

Our principal competitors in the Asynchronous/PDH and SONET/SDH areas are Applied Micro Circuits Corporation, Conexant Systems, Inc., Cirrus Logic, Inc., Infineon Technologies, Exar Corporation, Agere Systems, PMC-Sierra Inc., TriQuint Semiconductor, Inc., Vitesse Semiconductor Corporation and Broadcom Corporation. In addition, there are a number of ASIC vendors, including AMI Semiconductor, LSI Logic Corporation and STM Microelectronics Group, which compete with us by supplying customer-specific products to OEMs. In the ATM market, the principal competitors include all the vendors mentioned above and, in addition, Intel Corporation. Other domestic and international vendors have announced plans to enter into this market.

Backlog

As of December 31, 2002, our backlog was $2.2 million, as compared to $4.0 million as of December 31, 2001. Backlog represents firm orders anticipated to be shipped within the next 12 months. Our business and, to a large extent, that of the entire communication semiconductor industry, is characterized by short-term order and shipment schedules. Since orders constituting our current backlog are subject to changes in delivery schedules or to cancellation at the option of the purchaser without significant penalty, backlog is not necessarily an indication of future revenues. During 2002 and 2001, many of our customers experienced decreased demand, order cancellations or postponements.

Employees

At December 31, 2002, we employed 366 full time employees, which included 260 in research and development, 68 in marketing and sales, 20 in operations and quality assurance, and 18 in administration. We have not entered into any collective bargaining agreements. We have never experienced any work stoppage and we believe our employee relations are good.

Subsequent to December 31, 2002, we announced a restructuring action aimed at reducing operating costs. This resulted in terminations of approximately 25% of our workforce. Refer to Note 17—Subsequent Events of our Consolidated Financial Statements for additional details.

Available Information

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports will be made available free of charge through the Investor Relations section of the Company’s Internet website (http://www.transwitch.com) as soon as practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. Our executive offices are located at Three Enterprise Drive, Shelton, CT 06484.

11

Item 2.    Properties

Our headquarters are located in a suburban office park in Shelton, Connecticut. We have additional sales offices and design centers located throughout the world. The following is a summary of our offices and locations for which we have lease commitments:

Notes

Refer to Note 15—Supplemental Cash Flow Information of our Consolidated Financial Statements for additional disclosures regarding our commitments under lease obligations. Also, refer to Note 13—Restructuring and Asset Impairment Charges of our Consolidated Financial Statements regarding our restructuring charges during fiscal years 2002 and 2001 as we have recorded charges for future rent payments relating to excess office space.

Item 3.    Legal Proceedings

We are not party to any material litigation proceedings. However, we are currently prosecuting civil action number 03-10228NG in U.S. District Court in Massachusetts, entitled TranSwitch Corp. v. Galazar Networks, Inc., and are responsible for litigation costs there from. We are asserting that Galazar Networks, Inc. (Galazar) infringes three of our United States patents. In that action Galazar has alleged that those three patents are not infringed, are invalid and are unenforceable. There can be no assurances that we will be successful in our suit against Galazar or that Galazar will be unsuccessful in its allegations.

Item 4.    Submission of Matters to a Vote of Security-Holders

We did not submit any matters to a vote of our security-holders during the three months ended December 31, 2002.

12

PART II

Item 5.     Market for Registrants’ Common Equity and Related Stockholder Matters

Our common stock is traded under the symbol “TXCC” on the Nasdaq SmallCap Market. The following table sets forth, for the periods indicated, the range of high and low closing prices for our common stock on the Nasdaq National Market until October 14, 2002, at which time we began trading on Nasdaq SmallCap Market. The prices set forth below reflect a 3-for-2 stock split in the form of a dividend effected on June 8, 1999, a 3-for-2 stock split in the form of a dividend effected on January 11, 2000, and 2-for-1 stock split in the form of a dividend effected on August 10, 2000.

As of March 12, 2003 there were approximately 615 holders of record and approximately 36,335 beneficial shareholders of our common stock.

We have never paid cash dividends on our common stock. We currently do not anticipate paying any cash dividend in the foreseeable future. Any future declaration and payment of dividends will be subject to the discretion of our Board of Directors, will be subject to applicable law and will depend upon our results of operations, earnings, financial condition, contractual limitations, cash requirements, future prospects and any other factors deemed relevant by our Board of Directors.

We also have securities authorized for issuance under equity compensation plans. This information is incorporated herein by reference to the information in the section entitled “Equity Compensation Plan Information” contained in our definitive proxy statement to be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year ended December 31, 2002.

13

Item 6.    Selected Financial Data

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 7 of this Form 10-K. The selected statement of operations data as well as the selected balance sheet data presented below are derived from our consolidated financial statements, which have been audited by KPMG LLP, our independent auditors, and together with their report thereon are included in Item 8 of this Form 10-K. Historical periods have been restated to reflect the share-for-share exchange accounted for as a pooling of interests with Easics N.V. in May 2000. Historical periods have also been restated to reflect the change in accounting principle from the cost to the equity method for our investment in OptiX Networks, Inc.

14

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Conditions and Results of Operations (MD&A) is provided as a supplement to the accompanying consolidated financial statements and footnotes (Item 8) to help provide an understanding of our financial condition, changes in our financial condition and results of operations. The MD&A is organized as follows:

Caution concerning forward-looking statements.    This section discusses how certain forward-looking statements made by us throughout the MD&A are based on management’s present expectations about future events and are inherently susceptible to uncertainty and changes in circumstances.

Overview.    This section provides a general description of our business.

Critical accounting policies and use of estimates.    This section discusses those accounting policies that are both considered important to our financial condition and operating results and require significant judgment and estimates on the part of management in their application.

Restatements of prior period results.    During fiscal 2002, we restated 2001 and 2000 results due to a change in accounting principle related to an investment in a non-publicly traded company. This is further described in this section.

Results of operations.    This section provides an analysis of our results of operations for the years ended December 31, 2002, 2001 and 2000. In addition, a brief description is provided of transactions and events that impact the comparability of the results being analyzed.

Liquidity and capital resources.    This section provides an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements. In this section, we also summarize related party transactions, subsequent events and recent accounting pronouncements.

Certain factors that may affect future results.    In this section, we detail certain risk factors that affect our quarterly and annual results, but which are difficult to predict.

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. When used in this report, the words, “intend”, “anticipate”, “believe”, “estimate”, “plan”, “expect” and similar expressions as they relate to us are included to identify forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS” and elsewhere in this report. You should read this discussion in conjunction with the consolidated financial statements and the notes thereto included in this report.

OVERVIEW

TranSwitch is a Delaware corporation incorporated on April 26, 1988. We design, develop and market highly integrated semiconductor devices that provide core functionality in voice and data communications network equipment deployed in the global network infrastructure. In addition to their high degree of functionality, our products incorporate digital and mixed-signal (analog and digital) processing capabilities, providing comprehensive system-on-a-chip (SOC) solutions to our customers.

Our products are compliant with all of the relevant network standards including Asynchronous/Plesiochronous Digital Hierarchy (Asynchronous/PDH), Synchronous Optical Network/Synchronous Digital Hierarchy (SONET/SDH) and Asynchronous Transfer Mode/Internet Protocol (ATM/IP). We offer several products that combine multi-protocol capabilities on a single chip, enabling our customers to develop network equipment for multi-service (voice, data and video) applications. A key attribute of our products is their inherent flexibility. Many of our products incorporate embedded programmable processors, enabling us to rapidly accommodate new customer requirements or evolving network standards.

15

We bring value to our customers through our communications systems expertise, VLSI design skills and commitment to excellence in customer support. Our innovative skills and technical capabilities enable us to define and develop products that permit our customers to achieve faster time-to-market and to produce communications systems that offer a host of benefits such as greater functionality, improved performance, lower power dissipation, reduced system size and cost and greater reliability.

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

Our consolidated financial statements and related disclosures, which are prepared to conform with accounting principles generally accepted in the United States of America (U.S. GAAP), require us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the period reported. We are also required to disclose amounts of contingent assets and liabilities at the date of the consolidated financial statements. Our actual results in future periods could differ from those estimates. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.

We consider the most critical accounting policies and uses of estimates in our Consolidated Financial Statements to be those surrounding:

(1) revenues, cost of revenues and gross profit;

(2) estimated excess inventories;

(3) valuation of deferred tax assets;

(4) valuation and impairment of goodwill;

(5) estimated restructuring reserves; and

(6) valuation of investments in non-public companies.

These accounting policies, the basis for these estimates and their potential impact to our consolidated financial statements, should any of these estimates change, are further described as follows:

Revenues, Cost of Revenues and Gross Profit.    Net revenues are primarily comprised of product shipments, principally to domestic and international telecommunications and data communications OEMs and to distributors. Net revenues from product sales are recognized at the time of product shipment when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) title and risk of loss transfers to the customer; (3) the selling price is fixed or determinable; and (4) collectibility is reasonably assured. Agreements with certain distributors provide price protection and return and allowance rights. With respect to recognizing revenues from our distributors: (1) the prices are fixed at the date of shipment from our facilities; (2) payment is not contractually or otherwise excused until the product is resold; (3) we do not have any obligations for future performance relating to the resale of the product; and (4) the amount of future returns, allowances, refunds and costs to be incurred can be reasonably estimated and are accrued at the time of shipment. Service revenues are recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) we have performed a service in accordance with our contractual obligations; (3) the fee is fixed or determinable, and (4) collectibility is reasonably assured.

At the time of shipment, we record an expense (and related liability) against our gross product revenues for future price protection and sales allowances. This liability is established based on historical experience, contractually agreed to provisions and future shipment forecasts. We had established liabilities totaling $1.0 million and $1.9 million as of December 31, 2002 and 2001, respectively, for price protection and sales allowances related to shipments that were recorded as revenue during the preceding 12 months. Should our actual experience differ from our estimated liabilities, there could be adjustments (either favorable or unfavorable) to our net revenues, cost of revenues and gross profits.

We also record, at the time of shipment, an expense (and related liability) against our gross product revenues and an inventory asset against product cost of revenues in order to establish a provision for the

16

We warranty our products for up to one year from the date of shipment. A liability is recorded for estimated claims to be incurred under product warranties and is based primarily on historical experience. Estimated warranty expense is recorded as cost of product revenues when products are shipped. As of December 31, 2002 and 2001, we had a warranty liability established in the amounts of $0.2 million and $0.2 million, respectively, which is included in accrued expenses on the consolidated balance sheets. We had no material warranty claims during the year ended December 31, 2002. Should future warranty claims differ from our estimated current liability, there could be adjustments (either favorable or unfavorable) to our cost of revenues. Any adjustments to cost of revenues could also impact future gross profits.

Estimated Excess Inventories.     We periodically review our inventory levels to determine if inventory is stated at the lower of cost or net realizable value. The telecommunications and data communications industries have experienced a significant downturn during the past few years and, as a result, we have had to evaluate our inventory position based on known backlog of orders, projected sales and marketing forecasts, shipment activity and inventory held at our significant distributors. During the year ended December 31, 2002, as a result of current and anticipated business conditions, as well as lower than anticipated demand, we recorded a charge for excess inventories of approximately $4.8 million. During the year ended December 31, 2001 we recorded a charge for excess inventories of approximately $39.2 million. Most of these products have not been disposed of and remain in inventory at an adjusted cost basis of zero.

During fiscal 2002, we recorded net product revenues of approximately $4.8 million on shipments of excess inventory that had previously been written down to their estimated net realizable value of zero. This resulted in 100% gross margin on these product revenues. Had these products been sold at our historical average cost basis, a 51% gross margin would have been recorded. We currently do not anticipate that a significant amount of the excess inventories subject to the write-downs described above will be used in the future based upon our current demand forecast. Should our actual future demand exceed the estimates that we used in writing down our excess inventories, we will recognize a favorable impact to cost of revenues and gross profits. Should demand fall below our current expectations, we may record additional inventory write-downs which will result in a negative impact to cost of revenues and gross profits.

Valuation of Deferred Tax Assets.    Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

We continually evaluate our deferred tax assets as to whether it is “more likely than not” that the deferred tax assets will be realized. In assessing the realizability of our deferred tax assets, we consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies. Based on this assessment, we believe that significant uncertainty exists surrounding the recoverability of the deferred tax assets and we have accordingly recorded a valuation allowance for all of our deferred tax assets. As a result of recording the valuation allowance, $61.4 million was charged to income tax expense in the consolidated statement of operations during the year ended December 31, 2002.

At December 31, 2002, we had deferred income tax assets, net of valuation allowances, of zero compared to $68.6 million as of December 31, 2001. Deferred income tax assets decreased during fiscal 2002 due to the establishment of the valuation allowance described above.

17

Valuation and Impairment of Goodwill.    We review goodwill for impairment under SFAS 142, which states that goodwill impairment is deemed to exist if the net asset value of a reporting unit exceeds its estimated fair value. We operate within a single reporting unit; therefore no goodwill is allocated. We are required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. When measuring the potential impairment of goodwill, we determine the fair value of our reporting unit and compare this fair value against the carrying value of the goodwill. If the fair value of the reporting unit exceeds that of the goodwill and intangible assets, then no impairment exists. If the fair value of the reporting unit is less than that of the carrying value of our goodwill and intangible assets, then these assets will be written down by the difference. We use a quarterly average of our historical quoted common stock price when assessing a reporting unit’s fair value. As a result, impairment of our goodwill could occur if our common stock trades below the carrying value of these assets for an extended period of time.

We performed an impairment review of our goodwill in accordance with SFAS 142 and, as a result, recorded a goodwill impairment charge of $59.9 million during the year ended December 31, 2002 to reduce the carrying value of goodwill to zero. The amount of goodwill impairment primarily reflects the decline in our stock price during 2002 and related market capitalization as of December 31, 2002. Our total goodwill balance was zero and $54.4 million on our consolidated balance sheets as of December 31, 2002 and 2001, respectively.

Estimated Restructuring Reserves.    During the fiscal year ended December 31, 2002, we recorded restructuring charges and asset impairments totaling $3.9 million related to employee termination benefits and costs to exit certain facilities, net of sub-lease benefits. During the fiscal year ended December 31, 2001, we recorded restructuring charges and asset impairments totaling $32.5 million related to employee termination benefits and costs to exit certain facilities. At December 31, 2002, the restructuring liabilities that remain total $27.5 million on our consolidated balance sheets, compared to $29.9 million as of December 31, 2001. The decrease of $2.4 million during the year ended December 31, 2002 was related to cash payments for severance and lease costs on excess facilities and a non-cash reduction to the remaining restructuring liability as we entered into a new sub-lease arrangement with a third party to rent a portion of our excess space, offset by the restructuring charges taken in the third quarter of fiscal 2002. Certain assumptions are used by management to derive this estimate, including future maintenance costs, price escalation and sublease income derived from these facilities. Should we negotiate additional sublease rental income agreements or reach a settlement with our lessors to be released from our existing obligations, we could realize a favorable benefit to our results of future operations. Should future lease, maintenance or other costs related to these facilities exceed our estimates, we could incur additional expenses in future periods.

Valuation of Investments in Non-Public Companies.    Since 1999, we have been making strategic equity investments in non-public companies that develop technologies that are complementary to our product road map. Depending on our level of ownership and whether or not we have the ability to exercise significant influence, we account for these investments on either the cost or equity method, and they are reviewed periodically for impairment. The appropriate reductions in carrying values are recorded when, and if, necessary. The process of assessing whether a particular investment’s net realizable value is less than its carrying cost requires a significant amount of judgment. In making this judgment, we carefully consider the investee’s cash position, projected cash flows (both short and long-term), financing needs, most recent valuation data, the current investing environment, management / ownership changes, and competition. This evaluation process is based on information that we request from these privately-held companies. This information is not subject to the same disclosure and audit requirements as the reports required of U.S. public companies, and as such, the reliability and accuracy of the data may vary. Based on our evaluations, we recorded impairment charges related to our investments in non-publicly traded companies of $8.7 million during the year ended December 31, 2002. We used the modified equity method of accounting to determine the impairment loss for certain investments, as it was determined that no better current evidence of the value of our cost method investments existed and we believe that this gives us the best basis for our estimate given the negative cash flows of these companies. The modified equity method of accounting results in recording an impairment loss on a cost method investment equal to the investor’s proportionate

18

There were no impairment charges in the year ended December 31, 2001. Refer also to Note 5—Investments in Non-Publicly Traded Companies in our Consolidated Financial Statements for additional details. The total investment in non-public companies was $2.0 million and $9.8 million as of December 31, 2002 and 2001, respectively on the consolidated balance sheets.

RESTATEMENTS OF PRIOR PERIOD RESULTS

United States Generally Accepted Accounting Principles (U.S. GAAP) requires retroactive restatement where an equity investment previously accounted for under the cost method of accounting qualifies for use of the equity method. We have restated prior period results to reflect the change from the cost to the equity method of accounting for our investment in OptiX Networks, Inc. (OptiX) as we have obtained the ability to significantly influence the operating and financial policies of OptiX during the third quarter of fiscal 2002 through our investments in convertible preferred stock and a bridge loan. This restatement reduced the investment balance in OptiX (included in investments in non-publicly traded companies on the consolidated balance sheets), as if accounted for on the equity method since inception and we reflected our pro-rata share of equity in net losses of OptiX. The amounts reflecting equity in net losses of affiliates were recorded on the consolidated statement of operations for the prior periods reported. Refer also to Note 5—Investments in Non-Publicly Traded Companies in our Consolidated Financial Statements.

RESULTS OF OPERATIONS

The results of operations that follow should be read in conjunction with our critical accounting policies and estimates summarized above as well as our consolidated financial statements and notes thereof contained in Item 8 of this report. The following table sets forth certain consolidated statements of operations data as a percentage of net revenues for the periods indicated.

19

Comparison of Fiscal Years 2002 and 2001

Net Revenues.    The following tables summarizes our net product revenue mix by product line for the years ended December 31, 2002 and 2001 (dollar amounts in thousands):

Total net product revenues for the year ended December 31, 2002 decreased by $42.5 million compared to the year ended December 31, 2001. This represents a 73% decline. During fiscal 2002, we began shipping products under our new Omni product line that we are classifying as Multi Service/Switching products. We expect this product line to grow in the future as we complete development and gain customer acceptance for this family of products. We continued to experience very difficult market conditions and decreased revenues in the SONET/SDH, the Asynchronous/PDH and ATM/IP product lines during the year ended December 31, 2002 compared to the comparable prior year period. SONET/SDH had the largest period over period percentage decrease. These decreases were primarily related to a decline in volumes shipped over the prior comparable period that we attribute to an overall economic downturn and significant excess capacity in the telecommunications and data communications industries.

Although our volumes are down significantly, we continue to retain the majority of our customer base. Our current product mix percentage is not consistent with historical trends as the market is in a severe downturn and we are also introducing new product lines. Given the lack of visibility in the current market, we cannot predict when, and to the extent that, historical product mix percentages will return, if at all.

Included in total net revenues were service revenues consisting of design services performed for third parties on a short-term contract basis. Service revenues for the year ended December 31, 2002 increased by $0.4 million, or 91%, from the prior year. Service revenues are not our primary strategic focus and, as such, will fluctuate up or down from period to period, depending on business priorities. Approximately 37% of service revenues during fiscal 2002 were from OptiX Networks, Inc. (OptiX), a related party. We obtained significant influence over the financial and operating policies of OptiX during the quarter ended September 30, 2002. As a result we have switched to the equity method of accounting for this investment and did not recognize revenue on any services performed for OptiX after March 30, 2002. Refer also to Note 5—Investments in Non-Publicly Traded Companies of our Consolidated Financial Statements.

International net revenues represented approximately 59% of net revenues for the year ended December 31, 2002 compared with approximately 69% of net revenues for the year ended December 31, 2001. The decrease in international revenues as a percent of total revenues in fiscal 2002 is due to a greater marketing focus on domestic customers than international during the fiscal year. We do not consider this decrease in international revenues a trend given our low shipment levels and the modest ordering patterns that currently exist throughout the industry. Refer also to Note 8—Segment Information and Major Customers in our Consolidated Financial Statements, which summarizes revenue by country.

20

Gross Profit.    The following tables present the impact to gross profit (loss) of the excess inventory charges and benefits for the years ended December 31, 2002 and 2001:

Total gross profit for the year ended December 31, 2002 increased by $7.7 million, or 426%, from the prior year. This increase is due in large part to charges that we took against cost of revenues in fiscal 2001 for excess inventories ($39.2 million) versus much lower charges taken during fiscal 2002 ($4.8 million). Excluding these charges for excess inventories as well as the benefit from sales of previously written down inventory in fiscal 2002, gross profit for the period decreased by $28.9 million, or 77%. The decrease in gross profit dollars for the year ended December 31, 2002 is the result of lower total net revenues and volumes of product shipments. Gross profit percentage (excluding excess inventory charges and benefits) for the year ended December 31, 2002 was 51% compared to 64% for the year ended December 31, 2001. This decrease is due to the change in product mix over the prior year and the excess capacity absorption due to lower product volumes causing our average inventory cost to increase compared to the prior year.

We anticipate that gross profit will continue to fluctuate due the impact of product mix at current revenue levels and the continued impact of fixed cost absorption of our production operations.

Research and Development.    Research and development expenses for the year ended December 31, 2002 increased by $4.2 million, or 9%, over the prior year. This increase in absolute dollars is the result of acquisitions during the first quarter of 2002 and the second half of 2001 and continued investment in personnel, electronic design automation software tools and intellectual property cores, as well as fabrication costs and depreciation expense in connection with developing next generation telecommunication and data communication products. As a percentage of total net revenues, our research and development costs increased as we continued investing in the design and development of future products notwithstanding the fact that current product shipments have declined due to adverse industry conditions. We have monitored our known and forecasted revenue demand and operating expense run rates closely and, as a result, took two restructuring actions in fiscal 2001 and one during fiscal 2002. We will continue to closely monitor both our costs and our revenue expectations in future periods and will take actions as market conditions dictate.

Subsequent to December 31, 2002, we announced another restructuring action; refer to Note 17—Subsequent Events of our Consolidated Financial Statements for additional details.

Marketing and Sales.    Marketing and sales expenses for the year ended December 31, 2002 decreased by $8.9 million, or 40%, compared to the year ended December 31, 2001. This decrease in expense is primarily

21

because of a decrease in commissions due to the decrease in revenues over the same period last year. Also contributing to this decrease is a reduction in our allowance for doubtful customer accounts by approximately $1.1 million for the year ended December 31, 2002. During fiscal 2002, we experienced improved collections on certain customer accounts receivables that we had previously reserved. We have monitored our known and forecasted revenue demand and operating expense run rates closely and, as a result, took two restructuring actions in fiscal 2001 and one during fiscal 2002. We will continue to closely monitor both our costs and our revenue expectations in future periods and will take actions as market conditions dictate.

Subsequent to December 31, 2002, we announced another restructuring action; refer to Note 17—Subsequent Events of our Consolidated Financial Statements for additional details.

General and Administrative.    General and administrative expenses for year ended December 31, 2002 decreased by $1.7 million, or 19%, compared to the year ended December 31, 2001. This decrease is primarily due to lower professional fees and savings realized from restructuring actions. As a percentage of total net revenues, our general and administrative costs increased since the fixed components of these costs do not fluctuate with total net revenues, which decreased by 73% during the year. We have monitored our known and forecasted revenue demand and operating expense run rates closely and, as a result, took two restructuring actions in fiscal 2001 and one during fiscal 2002. We will continue to closely monitor both our costs and our revenue expectations in future periods and will take actions as market conditions dictate.

Subsequent to December 31, 2002, we announced another restructuring action; refer to Note 17—Subsequent Events of our Consolidated Financial Statements for additional details.

Amortization of Goodwill.    Amortization of goodwill for the year ended December 31, 2002 decreased $2.5 million, or 100%, compared to the year ended December 31, 2001. This decrease in expense is related to our adoption of SFAS 141 on July 1, 2001 and SFAS 142 on January 1, 2002, at which time all future amortization of goodwill ceased.

Impairment of Goodwill.    As required by SFAS 142, we performed an initial impairment review of our goodwill balance as of January 1, 2002 upon the adoption of SFAS 142. Under SFAS 142, goodwill impairment is deemed to exist if the net asset value of a reporting unit exceeds its estimated fair value. This impairment analysis determined that as of January 1, 2002, there was no impairment to the carrying value of goodwill. We operate within a single reporting unit; therefore no goodwill is allocated.

We are also required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. As a result of industry conditions, we determined that there were indicators of impairment to the carrying value of goodwill during the quarter ended September 30, 2002. Accordingly, we performed an impairment review of our goodwill in accordance with SFAS 142 and, as a result, recorded a goodwill impairment charge of $59.9 million during the quarter ended September 30, 2002 to reduce the carrying value of goodwill to zero. The amount of goodwill impairment primarily reflects the decline in the Company’s stock price during 2002 and related market capitalization. There were no impairments of goodwill in the prior year.

Restructuring Charges and Asset Impairments.    During the year ended December 31, 2002, we announced a restructuring plan due to current and anticipated business conditions. As a result of this plan, we eliminated fifty-six positions and announced the closing of our design centers in Milpitas, CA and Raleigh, NC. In conjunction with this restructuring, we are discontinuing the AsTriX and Sertopia product lines and are strategically refocusing our research and development efforts. This plan resulted in employee termination benefits of $2.4 million and costs to exit facilities of $3.1 million for a total restructuring expense of approximately $5.5 million recorded on the Consolidated Statement of Operations. Restructuring charges for the year ended December 31, 2002 were $3.9 million as we recognized a restructuring benefit of approximately $1.6 million related to the sublease of a portion of our unused excess facilities. We expect to realize approximately $5 million in annual operating expense savings and $4 million in annual cash savings as a result of this workforce reduction and facility consolidation.

22

During the year ended December 31, 2001 we announced two restructuring plans due to current and anticipated business conditions. As a result of these plans, we eliminated seventy-seven positions and announced the closing of our design centers and certain facilities in Connecticut and Massachusetts. These plans resulted in employee termination benefits of $3.3 million, costs to exit facilities of $28.6 million and asset impairments of $0.6 million for a total restructuring and asset impairment expense of approximately $32.5 million.

We will continue to closely monitor both our costs and our revenue expectations in future periods and will take actions as market conditions dictate. Subsequent to December 31, 2002, we announced another restructuring action; refer to Note 17 – Subsequent Events of our Consolidated Financial Statements for additional disclosure.

In-Process Research and Development.    During the year ended December 31, 2002, we recorded a charge for In-Process Research and Development (IPR&D) of $2.0 million related to our purchase of Systems On Silicon, Inc. (SOSi) on March 27, 2002. This transaction was recorded in the first quarter of fiscal 2002.

At the time of acquisition, SOSi was in the process of developing the Intelligent Integrated Access Device (IAD) chip. The project was started concurrently with SOSi’s inception in 1999 and was scheduled to be released in the first quarter of 2003. Subsequent to December 31, 2002, the Company announced a restructuring plan that included a workforce reduction and facility closings. Included in this plan is the closing of the SOSi design center. In addition, we have postponed the completion of the IAD product line and archived the intellectual property until the market returns, if ever. Refer to Note 17 – Subsequent Events in the Consolidated Financial Statements for additional disclosure regarding subsequent events.

The IAD chip was intended to be the enabling solution to service the last mile in voice and data access. The IAD chip provides a system on a chip (SOC) solution. The IAD chip was intended to serve the need for existing incumbent local exchange carrier (ILEC) legacy networks. Its telephone features would have included voice activity detection, silence suppression and comfort noise generation.

The $2.0 million allocated to IPR&D was determined through an independent valuation using established valuation techniques in the telecommunications and data communications industries. The value allocated to IPR&D was based upon the forecasted operating after-tax cash flows from the technology acquired, giving effect to the stage of completion at the acquisition date. Future cash flows were adjusted for the value contributed by any core technology and development efforts expected to be completed post acquisition. These forecasted cash flows were then discounted at rates commensurate with the risks involved in completing the acquired technologies, taking into consideration the characteristics and applications of each product, the inherent uncertainties in achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets. A project’s risk is the highest at its inception. As the project progresses, the risk of a project generally decreases. As of the acquisition date, the IAD chip was still in the initial stages of development. After considering these factors, the risk adjusted discount rate for the IAD chip product was determined to be 65%. The acquired technology that had not yet reached technological feasibility and had no alternative future uses was expensed upon acquisition in accordance with SFAS No. 2, “Accounting for Research and Development Costs”.

During the third quarter of fiscal 2001, we recorded a charge for in-process research and development of $22.0 million related to our purchase of Onex Communications Corporation in September 2001.

Impairment of Investments in Non-Publicly Traded Companies.    As a result of industry conditions, we determined that there were indicators of impairment to the carrying value of our investments in OptiX Networks, Inc. (OptiX), TeraOp (USA), Inc. (TeraOp), Intellectual Capital for Integrated Circuits, Inc. (IC4IC), and Accordion Networks (Accordion) during the year ended December 31, 2002. The process of assessing whether a particular investment’s net realizable value is less than its carrying cost requires a significant amount of judgment. In making this judgment, we carefully consider the investee’s cash position, projected cash flows (both short and long-term), financing needs, most recent valuation data, the current investing environment,

23

management/ownership changes, and competition. This evaluation process is based on information that we request from these privately held companies. This information is not subject to the same disclosure and audit requirements as the reports required of U.S. public companies, and as such, the reliability and accuracy of the data may vary. During fiscal 2002, we used the modified equity method of accounting to measure the impairment loss for TeraOp, IC4IC and Accordion as we determined that no better current evidence of the value of our cost method investments existed and we believe that this gives us the best basis for our estimate given the negative cash flows of these companies. The modified equity method of accounting results in recording an impairment loss on a cost method investment equal to the investor’s proportionate share of the investee’s losses as its contributed capital is consumed to fund operating losses of the investee from the inception of the investor’s investment.

In addition, we also evaluated all outstanding bridge loans under SFAS 114, “Accounting by Creditors for Impairment of a Loan” (SFAS 114) that we had not already impaired under the modified equity method of accounting. Under SFAS 114, a loan is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.

The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral.

During 2002, we reduced the carrying value of our investments (including bridge loans) in non-publicly traded companies as follows (in thousands):

There were no impairments of investments in non-publicly traded companies during the year ended December 31, 2001. We will continue to periodically review all of our investments in non-publicly traded companies for impairment in future periods. There can be no assurances that future impairment charges will not be necessary.

Equity in Net Losses of Affiliates.    We account for our investments in GTV Capital, L.P. (GTV), Neurone Ventures II, L.P. (Neurone) and OptiX under the equity method of accounting. Under the equity method, our pro-rata share of the net income or losses from the investee companies are recorded on the consolidated statement of operations and, accordingly, the investment’s carrying value is adjusted on the consolidated balance sheet.

Prior to June 30, 2002, we had been accounting for our investment in OptiX under the cost method. However, during the third quarter of fiscal 2002, in connection with a bridge loan of $4.0 million that is convertible to convertible preferred stock upon OptiX closing its anticipated round of financing, we obtained the ability to exercise significant influence over the financial and operating policies of OptiX. Approximately $3.5 million of this $4.0 million bridge loan was drawn upon as of December 31, 2002. All prior period financial information has been retroactively restated to reflect this change in reporting entity (refer also to Note 1—Summary of Significant Accounting Policies of our Consolidated Financial Statements for additional disclosure).

24

Our pro-rata share of equity losses in GTV, Neurone, and OptiX were $3.4 million for the year ended December 31, 2002, respectively, compared with $2.0 million for year ended December 31, 2001. The increase in equity losses is due to our increased investment in OptiX and an increase in OptiX losses in fiscal 2002. Equity in net losses of affiliates will continue to be a component of our other income and expense in future periods and amounts will fluctuate depending on the business results of the investee companies.

Interest Income (Expense).    Interest income (expense), net for the year ended December 31, 2002 decreased by $4.4 million, or 167%, compared to the year ended December 31, 2001. The decrease in interest income (expense), net is due to a lower average cash balance and lower interest rates during fiscal 2002 compared to fiscal 2001. The decrease in interest income has been partially offset by lower interest expense because we repurchased approximately $200 million face value of our 4½% Convertible Notes due 2005 during the first quarter of 2002. At December 31, 2002 and 2001, the effective interest rate on our interest-bearing securities was approximately 2.15% and 3.52%, respectively.

Income Tax Expense (Benefit).    For the year ended December 31, 2002, the income tax expense was $49.8 million compared to a benefit of $38.9 million for the year ended December 31, 2001. The increase in tax expense was due to the recording of an additional valuation allowance of $61.4 million during the quarter ended September 30, 2002 to reduce the carrying value of deferred tax assets. We continually evaluate our deferred tax assets as to whether it is “more likely than not” that the deferred tax assets will be realized. In the evaluation of the realizability of deferred tax assets, we consider projections of future taxable income, the reversal of temporary differences and tax planning strategies. We have evaluated and determined that it is not “more likely than not” that all of the deferred tax assets will be realized. Accordingly, a valuation reserve has been recorded against substantially all of our net deferred tax assets. In future periods, we will not recognize a deferred tax benefit and will maintain deferred tax valuation allowance until the Company achieves sustained taxable income.

The following table summarizes the differences between the U.S. federal statutory rate and our effective tax rate on continuing operations for financial statement purposes for the years ended December 31, 2002 and 2001:

Extraordinary Gain on the Repurchase of Convertible Notes.    For the year ended December 31, 2002, we recognized an extraordinary gain, net of income taxes, of $32.5 million compared to an extraordinary gain, net of income taxes, of $22.1 million for the year ended December 31, 2001. This increase in extraordinary gain is due to the Company repurchasing a higher face value of convertible notes ($199.9 million) during 2002 than the face value of convertible notes ($145.9 million) repurchased 2001.

The timing and amount of any additional repurchases of our convertible notes will depend on many factors, including, but not limited to, the prevailing market price of the notes and overall market conditions. We intend to fund additional repurchases of the notes, if any, from available cash, cash equivalents and investments.

25

Comparison of Fiscal Years 2001 and 2000

Net Revenues.    The following table summarizes our revenue mix by product line for the two years ended December 31, 2001 and 2000:

Net revenues for the year ended December 31, 2001 decreased by $96.4 million, or 62%, over fiscal 2000. The decrease in absolute dollars was distributed across all three of our product lines. The decrease in SONET/SDH was not as significant as the decrease in Asynchronous/PDH and ATM/IP product lines. These decreases were primarily related to a decline in volumes shipped over prior comparable periods. The significant decline in revenues was part of an industry wide condition where end-users of our products (telecommunications and data communications OEMs) found themselves with too much inventory during a time of declining demand and depressed market conditions.

International net revenues represented approximately 69% of net revenues for fiscal 2001, compared with approximately 46% in fiscal 2000. The increase in the percentage of international net revenues to total net revenues during fiscal 2001 was due to the fact that the telecommunication and data communications markets have experienced a more significant decline in the United States than in international markets. Refer also to Note 8—Segment Information and Major Customers in our Consolidated Financial Statements which summarizes revenue by country.

Gross Profit.    Gross profit for the year ended December 31, 2001 decreased by $110.7 million, or 102%, over the prior year. The decrease of gross profit dollars and the percentage of net revenues is the result of lower net revenues for the comparable period, shift in product mix and the provision for excess inventories of $39.2 million which was recorded in 2001. Our gross profit, excluding the excess inventory provision, was $37.4 million, or a 64% gross margin, for fiscal 2001 compared to $108.9 million, or 70% gross margin, for fiscal 2000. The decrease in gross margin percentage was due to a change in product mix sold during 2001 over the previous year.

Research and Development.    Research and development expenses for the year ended December 31, 2001 increased by $25.1 million, or 104%, over the prior year from $24.2 million to $49.3 million. This increase in absolute dollars was the result of acquisitions during 2001 and continued investment in personnel, depreciation, software and related tools to develop next generation telecommunication and data communication products. As a percentage of net revenues, our research and development costs increased as we continued investing in the design and development of future products notwithstanding the fact that current product shipments have declined due to industry conditions.

Marketing and Sales.    Marketing and sales expenses for the year ended December 31, 2001 increased by $1.7 million, or 8%, over the prior year from $20.5 million to $22.2 million. This increase includes increased provisions for doubtful customer accounts by approximately $1.0 million during the fiscal year 2001 as we specifically identified customer collection risks that existed in light of the general economic weakness in the communication semiconductor in our markets. We also added sales and marketing personnel and infrastructure during fiscal 2001.

26

General and Administrative.    General and administrative expenses for the year ended December 31, 2001 increased by $3.4 million, or 60%, over the prior year from $5.6 million to $9.0 million. The increase in absolute dollars was the result of acquisitions, and increases in personnel, legal and professional fees and our continued infrastructure investment in the general and administrative area. As a percentage of net revenues, our general and administrative costs increased since the fixed components of these costs do not fluctuate with net revenues which decreased during fiscal 2001.

Amortization of Goodwill and Purchased Intangible Assets.    Amortization of goodwill and purchased intangible assets for the year ended December 31, 2001 increased by $2.1 million, or 545%, over the prior year. This expense is related to business combinations of Alacrity Communications, ADV Engineering and Horizon Semiconductors accounted for as purchases in August 2000, January 2001 and February 2001, respectively. For the comparable period of the prior year the only amortization was that of Alacrity which was acquired in August 2000. The increase as a percentage of net revenues for the year ended December 31, 2001, compared to fiscal 2000, is due to the increase of goodwill and purchased intangibles during fiscal 2001 and the decline in net revenues compared to the prior year.

Purchased In-Process Research and Development.    During the year ended December 31, 2001, we recorded a charge for in-process research and development (IPR&D) of $22.0 million related to our purchase of Onex Communications Corporation in September 2001. During the year ended December 31, 2000, we recorded a charge for in-process research and development of $2.8 million related to our purchase of Alacrity Communications in August 2000.

Restructuring Charges, Asset Impairments and Merger Costs.    During fiscal 2001 we announced two restructuring plans due to current and anticipated business conditions. These plans resulted in 77 positions being eliminated in North America and the closing of four locations. These plans consisted of employee termination benefits of approximately $3.2 million and excess facility costs of approximately $28.6 million. In addition, we recorded impairment charges to reduce the carrying value of certain assets including; excess furniture, leasehold improvements, equipment and a technology license, totaling approximately $3.4 million in conjunction with these restructuring plans. There were no such comparable costs for the year ended December 31, 2000.

Equity in Net Losses of Affiliates.    Our pro-rata share of equity losses in GTV and OptiX were $1.9 million for the year ended December 31, 2001, compared with $0.4 million for year ended December 31, 2000. The increase in equity losses is due to our initial investment in GTV during 2001 as well as increased investment in OptiX and an increase in OptiX losses in fiscal 2001.

Interest Income (Expense).    Interest income, net of interest expense, for year ended December 31, 2001 decreased 69% from the prior year. Our 4½% Convertible Notes due 2005 were issued in September of 2000, thus we recorded less than four months of interest expense associated with these notes for the year ended December 31, 2000. These notes were outstanding during the entire year ended December 31, 2001 which resulted in an additional eight and a half months interest expense partially offset by lower convertible note balances compared to the same period in the prior year. During fiscal 2001, we experienced declining interest income due to lower cash balances and lower interest rates. At December 31, 2001 and 2000, the effective interest rate on our interest-bearing securities was approximately 3.52%, and 5.60%, respectively.

Income Tax Expense (Benefit).     Our effective income tax (benefit) rate, before extraordinary items, for the year ended December 31, 2001 was a benefit of 28.1%, compared to an effective income tax rate expense of approximately 38.9% for the year ended December 31, 2000. Excluding the write-off of purchased in-process research and development, for which there is no income tax benefit, the effective income tax benefit would have been 33.7% for the year ended December 31, 2001. The income tax benefit for the year ended December 31, 2001 differed from statutory rates primarily due to the non tax deductible write-off of purchased in-process research and development of $22.0 million and a valuation allowance of $3.2 million taken against certain tax credits which we expect will expire unutilized. The following table summarizes the differences between the U.S.

27

federal statutory rate and our effective tax (benefit) rate on continuing operations for financial statement purposes for the years ended December 31, 2001 and 2000:

In addition to the tax benefit recorded during the year ended December 31, 2001, we recorded income tax expense of $13.2 million on the extraordinary gain from the repurchase of a portion of the 4 ½% Convertible Notes due 2005.

Extraordinary Gain from Repurchase of 4½% Convertible Notes due 2005.    In April 2001, we announced a repurchase program for our 4½% Convertible Notes due 2005. During the year ended December 31, 2001, we have repurchased $145.9 million face value of our outstanding convertible notes for $106.1 million, including a write-off of deferred financing fees of $4.4 million, realizing a pre-tax gain of $35.3 million. Net of income taxes, this extraordinary gain was $22.1 million for the year ended December 31 2001. There were no repurchases during the year ended December 31, 2000.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2002, we had total cash, cash equivalents and investments (marketable securities) of approximately $205.5 million. This is our primary source of liquidity as we are not currently generating positive cash flow from our operations. Details of our cash inflows and outflows for the year ended December 31, 2002 as well as a summary of our cash, cash equivalents and investments and future commitments are detailed as follows:

Cash Inflows and Outflows

During the year ended December 31, 2002, the net decrease in cash and cash equivalents was $219.7 million compared to a net decrease of $137.3 million during the year ended December 31, 2001. As reported on our consolidated statements of cash flows, our decrease in cash and cash equivalents during the years ended December 31, 2002 and 2001 is summarized as follows (in thousands):

28

Details of our cash inflows and outflows are as follows during the year ended December 31, 2002:

Operating Activities:      During the year ended December 31, 2002, we used $65.6 million in cash, which consists of the following:

Investing Activities:    During the year ended December 31, 2002, we invested approximately $12.2 million in capital equipment and product licenses. We also paid $5.0 million to satisfy a purchase price contingency related to ADV Engineering S.A. which we acquired in January 2001, and $0.8 million to purchase all of the outstanding securities not already owned by us, of Systems On Silicon, Inc., which we acquired in March 2002. We invested approximately $5.0 million in non-publicly traded companies during the year ended December 31, 2002. These investments were offset by net proceeds of held-to-maturity short and long-term investments totaling $11.0 million, which resulted in a total use of cash totaling $12.0 million from investing activities.

Financing Activities:    During the year ended December 31, 2002, we used $142.6 million in financing activities, which consisted primarily of $143.2 million used to repurchase our 4½% Convertible Notes due 2005, partially offset by proceeds from the exercise of stock options and purchases of shares in our employee stock purchase plan of $0.6 million.

Effect of Exchange Rates and Inflation:    Exchange rates and inflation have not had a significant impact on our operations or cash flows.

29

In addition to the use of $219.7 million of cash and cash equivalents during the year ended December 31, 2002, we also used $11.0 million of matured short and long-term investments. Thus, the total use of cash, cash equivalents, short and long term investments during the year ended December 31, 2002 was $230.7 million.

Cash, Cash Equivalents and Investments

We have financed our operations and have met our capital requirements since incorporation in 1988 primarily through private and public issuances of equity securities, convertible notes, bank borrowings and cash generated from operations. Our principal sources of liquidity as of December 31, 2002 consisted of $150.5 million in cash and cash equivalents, $33.1 million in short-term investments and $21.8 million in long-term investments in marketable securities for a total cash and investment balance of $205.5 million. Cash equivalents are instruments with maturities of less than 90 days, short-term investments have maturities of greater then 90 days but less than one year and long-term investments have maturities of greater than one year. Our cash equivalents and investments consist of U.S. Treasury Bills, corporate debt, taxable municipal securities, money market instruments, overnight repurchase investments and commercial paper.

We believe that our existing cash, cash equivalents and investments will be sufficient to fund operating losses, capital expenditures and provide adequate working capital for at least the next twelve months. However, there can be no assurance that events in the future will not require us to seek additional capital and, if so required, that capital will be available on terms favorable or acceptable to us, if at all.

Commitments and Significant Contractual Obligations

We have existing commitments to make future interest payments on our existing 4½% Convertible Notes due 2005 and also to redeem these notes in September 2005. Over the remaining life of the outstanding notes, we expect to accrue and pay approximately $13.9 million in interest to the holders.

We have outstanding operating lease commitments of $50.4 million, payable over the next fifteen years. Some of these commitments are for space that was not being utilized and, as a result, we recorded restructuring charges of $3.1 million and $28.6 million during fiscal 2002 and fiscal 2001, respectively, for excess facilities. During fiscal 2002, we sublet a portion of our excess space and, as a result, we reduced our restructuring liability and recorded a restructuring benefit of $1.6 million. We are in the process of trying to sublease additional excess space but it is unlikely that any sublease income generated will offset the entire future commitment. As of December 31, 2002 we have sub-lease agreements totaling $11.4 million in place to rent portions of our excess facilities over the next seven years. We currently believe that we can fund these lease commitments in the future; however, there can be no assurances that we will not be required to seek additional capital or provide additional guarantees or collateral on these obligations.

A summary of our significant future contractual obligations and their payments by fiscal year is summarized as follows (in thousands):

30

We also have pledged approximately $1.4 million in available cash and cash equivalents as collateral for stand-by letters of credit that guarantee certain long-term property lease obligations totaling approximately $1.9 million.

Related Party Transactions

On a limited basis, we conduct certain related party transactions with the companies in which we have equity investments. During 2002 we recognized revenue of approximately $0.3 million related to design services performed for OptiX Networks, Inc. (OptiX). We obtained significant influence over the financial and operating policies of OptiX during the quarter ended September 30, 2002 and, as a result, we have switched to the equity method of accounting for this investment and are no longer recognizing revenue on services performed for OptiX. Also during 2002, we made additional investments into OptiX, TeraOp (USA), Inc. (TeraOp), and Intellectual Capital for Integrated Circuits, Inc. (IC4IC). Refer also to Note 5 – Investments in Non-Publicly Traded Companies of our Consolidated Financial Statements.

As of December 31, 2002, we have a $4.0 million convertible bridge loan outstanding with OptiX Networks, of which we have funded approximately $3.5 million. Our obligation to fund the remaining $0.5 million of this bridge loan is subject to certain terms and conditions of the bridge loan agreement.

Other than our obligation to OptiX mentioned above, we do not have any obligation to participate in future rounds of financing in the companies which we have an equity ownership interest in, although we do have a right of first refusal to purchase additional securities offered by the above companies. We do not have any commitments to acquire or merge with any of the companies that we have investments in. Additionally, we do not have a right of first refusal to acquire these companies. Our rights are consistent with the rights of all shareholders in the class of stock that we have purchased.

Subsequent Events

In January 2003, we announced a restructuring plan in order to lower our operating expense run-rate due to current and anticipated business conditions. This plan resulted in a work-force reduction of approximately 25% of existing personnel. We are also closing our South Brunswick, NJ (SOSi) design center, and reducing staff in Boston, MA, and Shelton, CT. This workforce reduction will also impact our Switzerland and Belgium locations. In addition, we have postponed the completion of the SOSi IAD product line and have archived the intellectual property until the market returns, if ever. It is currently estimated that we will incur between $3.0 million to $5.0 million in charges to operations in the first and second quarters of 2003 in conjunction with this plan.

Subsequent to December 31, 2002 we made additional convertible bridge loan investments into TeraOp and IC4IC totaling approximately $0.3 million (as of February 28, 2003). As we are currently providing substantially all of the funding required by these two companies to operate, it is likely that we now have significant influence which could require either a change to the equity method of accounting for these investments or consolidation of these companies’ financial statements going forward. This could result in us having to restate prior period results to reflect this change in accounting. We are currently evaluating the accounting for these transactions as well as the future business plans and funding alternatives for TeraOp and IC4IC and will make additional disclosures when the results for the quarter ending March 31, 2003 are reported.

In February 2003, we terminated our limited partnership agreement with GTV Capital, L.P. and were paid $0.9 million, which was the balance of our investment.

In March of 2003, we received notification from the Nasdaq informing us that our stock price had traded below the minimum $1.00 per share requirement for continued inclusion under Marketplace Rule 4310(c)(4). Therefore, in accordance with Marketplace Rule 4310(c)(8)(D) we have been provided with 180 calendar days, or until September 2, 2003 to regain compliance. In order to regain compliance, our bid price must close at $1.00

31

per share or more for a minimum of 10 consecutive trading days. If compliance is not regained, we may be granted an additional 180 calendar day grace period, should we meet certain other listing criteria for the Nasdaq SmallCap Market. If we do not meet this listing criteria, or if we are granted this additional 180 day grace period and our stock does not trade at or above $1.00 for 10 consecutive trading days, then Nasdaq will provide notification that our securities will be delisted. We have the right to appeal any delisting notification.

Recent Accounting Pronouncements

In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. SFAS No. 145 requires that certain gains and losses on extinguishments of debt be classified as income or loss from continuing operations rather than as extraordinary items as previously required under SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt”. This statement also amends SFAS No. 13, “Accounting for Leases”, to require certain modifications to capital leases be treated as a sale-leaseback and modifies the accounting for sub-leases when the original lessee remains a secondary obligor (or guarantor). In addition, SFAS No. 145 rescinded SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers”, which addressed the accounting for intangible assets of motor carriers and made numerous technical corrections to various FASB pronouncements. We will be required to adopt SFAS No. 145 on January 1, 2003, and will reclassify extraordinary gains from the redemption of our 4½% Convertible Notes due 2005 to continuing operations.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). SFAS 146 will spread out the reporting of expenses related to restructurings initiated after 2002, because commitment to a plan to exit an activity or dispose of long-lived assets will no longer be sufficient to record a liability for the anticipated costs. Instead, companies will record exit and disposal costs when they are “incurred” and can be measured at fair value, and they will subsequently adjust the recorded liability for changes in estimated cash flows. The provisions of SFAS 146 are effective for exit and disposal activities that are initiated after December 31, 2002. We are currently reviewing the provisions of SFAS 146 to determine the standard’s impact upon adoption.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (SFAS 148). SFAS 148 amends SFAS No. 123 “Accounting for Stock-Based Compensation” (SFAS 123) to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, FAS 148 amends the disclosure requirements of SFAS 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The additional disclosure requirements of SFAS 148 are effective for fiscal years ending after December 15, 2002. As of December 31, 2002, we have elected to continue to follow the intrinsic value method of accounting as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for employee stock options. We have complied with the disclosure requirements of SFAS 148 in the “Stock Based Compensation” paragraph above. Refer also to Note 11 – Employee Benefit Plans in our Consolidated Financial Statements for additional disclosures of our employee benefit plans.

In November 2002, FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” was issued. The interpretation provides guidance on the guarantor’s accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others. We have adopted the disclosure requirements of the interpretation as of December 31, 2002. The accounting guidelines are applicable to guarantees issued after December 31, 2002 and require that we record a liability for the fair value of such guarantees in the balance sheet. We are reviewing FIN No. 45 to determine its impact, if any, on future reporting periods.

In January 2003, FIN No. 46, “Consolidation of Variable Interest Entities” was issued. The interpretation provides guidance on consolidating variable interest entities and applies immediately to variable interests created

32

after January 31, 2003. The guidelines of the interpretation will become applicable for us in the third quarter of 2003 for variable interest entities created before February 1, 2003. The interpretation requires variable interest entities to be consolidated if the equity investment at risk is not sufficient to permit an entity to finance its activities without support from other parties, or the equity investors lack certain specified characteristics. We are reviewing FIN No. 46 to determine its impact, if any, on future reporting periods.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

From time to time, information provided by us, statements made by our employees or information included in our filings with the Securities and Exchange Commission (including this Form 10-K) may contain statements that are not historical facts, so-called “forward-looking statements”, which involve risks and uncertainties. Such forward-looking statements are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended. These statements can be identified by the use of forward-looking terminology such as “may”, “should”, “could”, “will”, “expect”, “anticipate”, “estimate”, “continue”, “believe” or the negative of these terms or other similar words. These statements discuss future expectations, contain projections of results of operations or of financial condition or state other forward-looking information. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this Form 10-K.

Our actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below. Each of these factors, and others, are discussed from time to time in our filings with the Securities and Exchange Commission.

Our operating results may fluctuate because of a number of factors, many of which are beyond our control. If our operating results are below the expectations of public market analysts or investors, then the market price of our common stock could decline. Some of the factors that affect our quarterly and annual results, but which are difficult to control or predict, are:

There has been a significant decline in our net revenues.

Our net revenues have declined substantially during the twelve months ended December 31, 2002, to $16.6 million, from $58.7 million in during the twelve months ended December 31, 2001 and from $155.1 million during the twelve months ended December 31, 2000. Due to declining current economic conditions and slowdowns in purchases of VLSI semiconductor devices, it has become increasingly difficult for us to predict the purchasing activities of our customers and we expect that our net revenues will fluctuate substantially in the future.

We are using our available cash and investments each quarter to fund our operating activities.

During the year ended December 31, 2002, we used $219.7 million of our available cash and cash equivalents to fund our operating, investing and financing activities and redeemed $11 million of short and long-term investments for a total cash and investment usage of $230.7 million. This significant use of cash included approximately $143.2 million to repurchase some of our convertible notes (including transaction fees) through a tender offer. We anticipate that we will use approximately $19 million to $22.0 million in cash, cash equivalents and investments during the first quarter of 2003 to fund our operations, investments and financing activities. We believe that we will continue to use our available cash, cash equivalents and investments in the future although we believe that we have sufficient cash for our needs for at least the next twelve months. We will continue to experience losses and use our cash, cash equivalents and investments if we do not receive sufficient product orders and our costs are not reduced to offset the decline in revenue.

33

We continue to have substantial indebtedness after the completion of our tender offer for some of our convertible notes.

In the third quarter of 2000, we sold in a private placement $460.0 million of 4½% Convertible Notes due 2005. As a result, we incurred $460.0 million of additional indebtedness, substantially increasing our ratio of debt to total capitalization. In April 2001, we adopted a repurchase program for our convertible notes through which we repurchased some of the convertible notes from time to time at varying prices. In fiscal 2002, we repurchased, through a tender offer, approximately $199.9 million of face value of our convertible notes bringing total repurchases to approximately $346.0 million. As of December 31, 2002, we had approximately $114.1 million in face value of indebtedness outstanding. We may repurchase additional 4½% Convertible Notes due 2005 in the future. We funded repurchases of the convertible notes and will fund any additional repurchases of the convertible notes, if any, from available cash, cash equivalents and short-term investments.

We may incur substantial additional indebtedness in the future. The level of our indebtedness, among other things, could:

There can be no assurance that we will be able to meet our debt service obligations, including our obligations under the convertible notes.

We may not be able to pay our debt and other obligations.

If our cash, cash equivalent, investments and operating cash flows are inadequate to meet our obligations, we could face substantial liquidity problems. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments on the 4½% Convertible Notes due 2005 or our other obligations, we would be in default under the terms thereof, which would permit the holders of the notes to accelerate the maturity of the 4½% Convertible Notes due 2005 and also could cause defaults under future indebtedness we may incur. Any such default could have a material adverse effect on our business, prospects, financial condition and operating results. In addition, we cannot be sure that we would be able to repay amounts due in respect of the 4½% Convertible Notes due 2005 if payment of the notes were to be accelerated following the occurrence of an event of default as defined in the indenture.

We expect that our operating results will fluctuate in the future due to reduced demand in our markets.

Our business is characterized by short-term orders and shipment schedules, and customer orders typically can be cancelled or rescheduled without significant penalty to our customers. Because we do not have substantial non-cancelable backlog, we typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. Future fluctuations to our operating results may also be caused by a number of factors, many of which are beyond our control.

In response to anticipated long lead times to obtain inventory and materials from our foundries, we may order in advance of anticipated customer demand, which might result in excess inventory levels if the expected orders fail to materialize. As a result, we cannot predict the timing and amount of shipments to our customers, and any significant downturn in customer demand for our products would reduce our quarterly and our annual operating results. As a result of these conditions, in 2002 and 2001, we recorded a write down for excess inventories totaling $4.8 million and $39.2 million, respectively.

34

We may have to further restructure our business.

During fiscal 2002, we announced a restructuring plan due to continued weakness in our business and the industry. As a result of this plan, we eliminated 56 positions and announced the closing of design centers in Milpitas, CA and Raleigh, NC. In conjunction with this restructuring, we are also discontinuing certain product lines and strategically refocusing our research and development efforts. As a result of these plans, we incurred restructuring charges and asset impairments of approximately $5.5 million.

During fiscal 2001, we announced restructuring plans as a result of then current and anticipated business conditions. As a result of those plans, we incurred restructuring charges and asset impairments of approximately $32.5 million related to workforce reductions of 77 positions throughout our Company and the related consolidation of several of our leased facilities.

Subsequent to year-end, we announced another restructuring plan reducing headcount by an additional 25% and closing additional design centers (refer to Note 17—Subsequent events of our Consolidated Financial Statements). We cannot be sure that these measures will be sufficient to offset lower total net revenues, and if they are not, our operating results will be adversely affected.

We face possible delisting from The Nasdaq SmallCap Market which would result in a limited public market for our common stock and make obtaining future debt or equity financing more difficult for us.

On July 19, 2002, we received notification from Nasdaq regarding noncompliance with the listing requirements for The Nasdaq National Market, on which our common stock was traded. This was due to our bid price closing below $1.00 for a period of thirty consecutive trading days. As a result, we applied for listing on the Nasdaq SmallCap Market. On October 14, 2002 our common stock began trading on the Nasdaq SmallCap Market after having been transferred from The Nasdaq National Market. On December 19, 2002, we received a letter from The Nasdaq SmallCap Market stating that we were no longer out of compliance with Marketplace Rule 4310(c)(4), which requires issuers to maintain a minimum bid price per share of $1.00. Our closing common stock price on December 31, 2002 was $0.69.

In March of 2003, we received notification from Nasdaq informing us that our stock price had traded below the minimum $1.00 per share requirement for continued inclusion under Marketplace Rule 4310(c)(4). Therefore, in accordance with Marketplace Rule 4310(c)(8)(D) we have been provided with 180 calendar days, or until September 2, 2003, to regain compliance. In order to regain compliance, our bid price must close at $1.00 per share or more for a minimum of 10 consecutive trading days. If compliance is not regained, we may be granted an additional 180 calendar day grace period, should we meet certain other listing criteria for the Nasdaq SmallCap Market. If we do not meet this listing criteria, or if we are granted this additional 180 day grace period and our stock does not trade at or above $1.00 for 10 consecutive trading days, then Nasdaq will provide notification that our securities will be delisted. We have the right to appeal any delisting notification.

Such delisting from the Nasdaq SmallCap Market or further declines in our stock price could also greatly impair our ability to raise additional necessary capital through equity or debt financing, and significantly increase the ownership dilution to stockholders caused by our issuing equity in financing or other transactions.

We anticipate that shipments of our products to relatively few customers will continue to account for a significant portion of our total net revenues.

Historically, a relatively small number of customers have accounted for a significant portion of our total net revenues in any particular period. For the year ended December 31, 2002, shipments to our top five customers, including sales to distributors, accounted for approximately 70% of our total net revenues. For the year ended December 31, 2001, sales to our top five customers, including sales to distributors, accounted for approximately 64% of our total net revenues. We expect that a limited number of customers may account for a substantial portion of our total net revenues for the foreseeable future.

35

Some of the following may reduce our total net revenues or adversely affect our business:

We cannot be certain that our current customers will continue to place orders with us, that orders by existing customers will return to the levels of previous periods or that we will be able to obtain orders from new customers. We have no long-term volume purchase commitments from any of our significant customers. The following tables set forth the percentage of net revenues attributable to our major distributors as well as the significant customers that had total purchases (either direct or through distributors) of greater than 10% of net revenues for the three years ended December 31, 2002:

The cyclical nature of the communication semiconductor industry affects our business and we are currently and for the past two years have been experiencing a significant downturn.

We provide semiconductor devices to the telecommunications and data communications markets. The semiconductor industry is highly cyclical and currently is experiencing a significant contraction of the market. These downturns are characterized by:

We may experience substantial fluctuations in future operating results due to general semiconductor industry conditions, overall economic conditions, seasonality of customers’ buying patterns and other factors. We

36

are currently and for the past two years have been experiencing a significant slowdown in the communication semiconductor industry.

Our international business operations expose us to a variety of business risks.

Foreign markets are a significant part of our net revenues. In the year ended December 31, 2002, foreign shipments accounted for 59% of our total net revenues. We expect foreign markets to continue to account for a significant percentage of our total net revenues. A significant portion of our total net revenues will, therefore, be subject to risks associated with foreign markets, including the following: