At February 28, 2001, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $3,791,739, based on the last trade price as reported by The Nasdaq National Market. For purposes of this calculation, shares owned by officers, directors, and 10% stockholders known to the registrant have been excluded. Such exclusion is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant.

At February 28, 2001, there were 24,947,696 shares of the registrant's common stock, $0.001 par value, issued and outstanding.

This Form 10-K contains forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.

This Form 10-K contains forward-looking statements that have been made under the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections about our industry, our beliefs, and assumptions. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates" and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include those described in "Risk Factors" and elsewhere in this Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management's view only as of the date of this Form 10-K. We undertake no obligation to update these statements or publicly release the result of any revisions to the forward-looking statements that we may make to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events.

Com21, Inc., is a leading global supplier of broadband access solutions. Com21's products enable domestic and international cable operators to provide high-speed, cost-effective Internet access; reduce operating costs; and maximize revenue opportunities in a variety of subscriber markets - - - - including corporate telecommuters, small businesses, and private homes. We develop and sell headend equipment, subscriber cable modems, and network management software to support the Asynchronous Transfer Mode (ATM), Data Over Cable System Interface Specification (DOCSIS) and Digital Video Broadcasting (DVB) standards. In 2000, we shipped approximately 565 headends and 790,000 cable modems. In the North American market, we sell directly to cable operators such as AT&T, Charter Communications, Comcast, Cox Communications, and systems integrators such as HSA. Internationally, we sell primarily to systems integrators such as Siemens and Telindus, who in turn sell to cable operators.

During 2000, we completed the acquisition of two companies. On July 3, 2000, pursuant to a Share Purchase Agreement dated April 18, 2000, GADline, Ltd. (GADline), an Israeli company, was merged into Com21. GADline develops, manufactures and markets fully managed networking solutions that deliver high-speed data and telephony services over a hybrid fiber coaxial infrastructure. On July 6, 2000, pursuant to a Share Purchase Agreement dated June 22, 2000, BitCom, Inc. (BitCom), a Delaware company, with facilities in Germantown, Maryland was merged into Com21. BitCom is an engineering consulting and development organization specializing in wired and wireless telecommunications, satellite, and networking engineering.

Com21 was incorporated in Delaware in June 1992. Our principal executive offices are located at 750 Tasman Drive, Milpitas, California 95035 and our telephone number at that address is (408) 953-9100. We can also be reached at our Web site http://www.com21.com.

The Internet is a valuable communications tool for businesses and consumers as it facilitates global, real-time interactions. Because of its global reach, accessibility, use of open standards and ability to make real-time interaction, the Internet has become a valuable communication medium for both businesses and customers. The volume of data traffic across communications networks has significantly increased in recent years, due to the proliferation of network-based communications and electronic commerce.

In addition to the substantial increase in the sheer volume of Internet data users, both business and consumer users are intensifying demand for higher-caliber connections that can carry bandwidth-intensive information, such as voice and video. With the increasing importance of communications networks, the demand for bandwidth-sensitive information is also rising, so that the existing transmission speeds have become less tolerable and can negatively affect business productivity.

Typically, the limiting factor in overall data transmission performance is the last mile of the communications infrastructure between a service provider and a subscriber, known as the "last mile" problem. Cable provides a solution to this "last mile" problem, as cable is widely available to consumers, and cable infrastructure currently provides the highest available transmission speed, with peak data transmission speeds of 40 megabits per second and "always-on" availability providing instant access. These factors have led to the rapid growth in the deployment of Internet access over cable.

Com21's business strategy includes the following key elements:

Leverage the Cable Modem Platform. We offer a suite of products that leverage off our low cost cable modem platform. These products support a variety of service offerings, that enable cable operators to market service packages to different customer segments. Our products include a basic cable modem for Internet access, and modems which offer a combination of features, such as voice support, a range of security levels, Web content filtering, and virtual private network (VPN) support. Other products include a cable modem which services multi-dwelling units and residential gateways that transport voice, data and video to wired and wireless information appliances.

Provide Broadband Infrastructure Products and an Integrated End-to-End Solution. In time, cable operators will require an integrated software and hardware platform, a solution that we currently provide. In addition, we will provide solutions that can support the growing popularity of small node sizes, demonstrated by the increasing deployment of optical fiber in residential areas. We also want to fulfill the demand for broadband solutions that can manage data, voice and video. With our partner TdSoft, we have introduced a voice gateway to the public switched telephone network ComUNITY Vox. This addition allows cable operators to use our ComUNITY access system to offer voice services.

Lead Industry in Providing Enhanced Voice Solutions. Com21 is developing additional voice solutions using standards-based technology. The first solution, called ANEXT, is based on circuit-switched technology. The product was made available to our customers as a field trial in December 2000. It provides the operator the ability to support both Plain Old Telephone Service (POTS) and Integrated Service Digital Network (ISDN) telephony through the Hybrid Fiber/Coax (HFC), encompassing both headend and consumer equipment. The second solution called DOXphone, based on Voice Over IP (VoIP) technology, will be shipping in third quarter of 2001. DOXphone uses VoIP technology between the subscriber and the headend and the Public Switch Telephone Network (PSTN) via conventional E1/T1 links. By utilizing VoIP technology, the operator is able to provide enhanced services to the end user.

Leverage Technology Leadership. One of the factors of Com21's success has been our ability to supply end-to-end broadband communications system with features that support new, revenue generating opportunities for cable operators, and networking advantages. Technological developments in multi-service scheduling optimization, protocol simulation, and application specific integrated circuit (commonly referred to as an ASIC) integration, enable us to offer a scalable system to deliver tiered service levels, VPNs, and low-latency voice and video applications. Moreover, Com21's internal development of a network management system, and high performance, cost-effective radio frequency transmitters/receivers and fast radio frequency switching systems, lowers cable operators' cost of deploying and operating Com21's equipment.

Offer Standards-Based Cable Modems and Solutions. As the North American cable industry has embraced DOCSIS-compliant products, we have designed our cable modems to meet these specifications. In September 2000, our DOXport 1110 received DOCSIS 1.0 certification from CableLabs. Cable operators want to benefit from the interoperability, and lower product costs, associated with standardized parts. Com21 intends to continue to develop the DOCSIS products.

In Europe, the DVB standards are evolving. In late 2000, we introduced a DVB cable modem, the Comport II DVB cable modem. Additionally, as the EuroDOCSIS standard evolves, we believe we are well positioned to leverage our North American DOCSIS technology to the unique standards of the European market.

Be a Global Competitor. Our strategy is to be a worldwide supplier to the growing global market for cable modem systems. We have agreements with system integrators servicing markets in Europe, Japan, Latin America, South America and the Far East. Our business was approximately 67% international in 2000, 47% in 1999, and 52% in 1998. We have sales and support personnel in Japan, Singapore, Korea, Australia, China, Hong Kong, Latin America, Europe, Canada, and five domestic locations.

Integrate Toll-Quality Voice. An important market opportunity is the ability to offer products that can carry voice traffic over cable. Through our acquisition of GADline in July 2000, we are using their resources to develop voice over cable solutions.

We actively participate, and have been selected as a vendor author, in CableLabs' PacketCable cable telephony initiative. Com21's existing products have been designed with quality of service (QoS) capability to support toll-quality voice transmission over a cable plant. In late 2000, we have several customers evaluating our CommUnity voice solution, which is called CommUnity VoX.

Increase Cost Efficiencies. While we intend to continue to seek premium prices for our products, the cable modem market will be characterized by declining prices. As a result, we seek to reduce product costs, particularly with respect to end-user cable modems, with more efficient design, use of standardized components, and our continuous search for cost effective solutions.

PRODUCTS

Com21's current product offerings include DOCSIS standards-based products; ATM-based system; DVB standards-based cable modems; and Telephony products.

Com21 offers several DOCSIS standards-based products:

The Company currently has under development the following DOCSIS standards-based products:

The ATM-based ComUNITY Access system consists of the following:

Com21's DVB solution includes the following cable modem:

Our cable telephony product offerings include the following:

The Company currently has under development the following Cable Telephony Products:

CUSTOMERS

In 1998, revenues attributable to TCI (currently AT&T BIS/TCI), Philips Electronics and Siemens accounted for 24%, 15% and 14% of total revenues, respectively. In 1999, revenues attributable to AT&T BIS/TCI, Philips and Siemens accounted for 20%, 18% and 12% of total revenues, respectively. In 2000, revenues attributable to Siemens, Telindus, and Comcast Communications accounted for 12%, 11%, and 10% respectively.

Com21's products enable cable operators to serve three primary end-user markets, each of which have widely varying speed, service and pricing requirements.

Residential Consumer Internet Users. Residential consumer Internet users generally only require a connection to their Internet service provider (ISP), without the same level of security and reliability required by business and Small Office/Home Office (SOHO) users. Frequent users desire medium-to-high speed access to the Internet for Web browsing and downloading of multimedia applications and files. Occasional users require low-to-medium speed Internet access on a limited basis for Web browsing, e-mail and on-line services. Frequent users are generally willing to pay a slight premium for higher speed.

Corporate Telecommuter and Remote Office Users. Corporate telecommuters and remote office business users need highly available, high-speed access to corporate intranets and corporate local area networks. These users also must interconnect the local area networks among their various offices. Such offices may be collocated, in a large campus, for example, or widely dispersed, in the case of sales offices and telecommuters. Connections to a central telephone Private Branch Exchange (PBX), rapid two-way transfer of large data files, desktop video conferencing, security, and reliability exemplify the services that business users may require. Users in this segment of subscribers are generally willing to pay a premium for highly reliable, high-speed service with advanced features.

Small Office/Home Office (SOHO) Users. Small offices and home office businesses increasingly find the Internet an efficient and cost-effective means of communicating and processing transactions with customers and suppliers. Com21 believes these businesses require medium-to-high speed Internet access that is reliable and always available. SOHO users may have a local area network to connect to cable modem services, and may require routing in order to connect multiple terminals. These businesses may also require desktop video conferencing capability, and connectivity with other businesses. Because these requirements may be critical to running their business, there is population of SOHO users who are willing to pay more for higher-quality, secure, reliable service than are residential consumer Internet users.

MANUFACTURING

Com21 tests and assembles its ComUNITY headend controller equipment in its Milpitas, California facility. We outsource printed circuit board assemblies on a turnkey basis and perform final integration and burn-in on-site. Com21 configures the headend equipment and the network management and provisioning software prior to customer shipment.

Com21 outsources turnkey manufacturing of our cable modems to contract manufacturers in Mexico and Malaysia. With these contract manufacturers, Com21 has developed and implemented a series of product test methodologies, quality standards and process control parameters. These relationships have enabled us to ensure a continuous supply of modems, reducing susceptibility to plant disruption problems. We believe that employing turnkey manufacturers enables us to meet anticipated manufacturing needs and reduce the cost of product procurement.

We believe our current manufacturing capabilities can accommodate our requirements through the end of 2001. Warranty and repair support is performed at our Milpitas facility. Com21 received ISO 9001 certification in December 1998.

MARKETING AND SALES

Marketing. Domestically, we have targeted our marketing efforts primarily at cable operators. There are a limited number of cable operators in the domestic cable industry. A cable operator's internal technical experts typically influence purchasing decisions. The objective of our direct marketing activities is to reach these technical experts, raise product awareness and gain credibility for Com21's systems within the cable operator community. Activities with local cable operators are jointly managed to accelerate cable modem service penetration. Internationally, we have focused our marketing efforts on supporting our systems integration partners' marketing programs. We plan to increase our international marketing efforts in new markets in Asia, South America, and Europe, as certain markets become deregulated and the Internet usage grows in those regions.

RESEARCH AND DEVELOPMENT

Com21 has focused its research and development efforts on reducing the cable operator's cost of ownership, increasing the scalability and performance of its current products, enhancing value-added services for subscribers, reducing product costs, integrating voice capabilities into the cable modem and developing voice gateway and supporting emerging cable modem standards.

Our research and development expenditures were $19.9 million in 1998, $29.8 million in 1999, and $48.5 million in 2000. Research and development expenses primarily consist of salaries and related costs of employees and consultants engaged in ongoing research, design and development of our products and technology. As of December 31, 2000, Com21 had a team of 216 engineers with expertise in digital electronics design, encryption, radio frequency modulation and demodulation, networking, embedded software, and network management. The engineers are located in development centers in Milpitas, California; Germantown, Maryland; Cork, Ireland; and Jerusalem, Israel.

CUSTOMER SERVICE AND TECHNICAL SUPPORT

Com21 believes that successful long-term relationships with its customers require a service organization committed to customer satisfaction. As of December 31, 2000, Com21 had 56 technical support employees. Com21 makes available to all new customers a five-day training course prior to receiving and installing a ComUnity system.

COMPETITION

The markets for Com21's products are intensely competitive, rapidly evolving, and subject to rapid technological change. The principal competitive factors in these markets are likely to include product performance and features, reliability, technical support and service, relationships with cable operators and systems integrators, compliance with industry standards, interoperability with the products of other suppliers, sales and distribution capabilities, strength of brand name, price, long-term cost of ownership to cable operators and general industry and economic conditions. Com21's current and potential competitors include 3Com, Cisco Systems, Motorola, Nortel Networks, RCA/Thompson, Samsung Electronics Company, Terayon Communication Systems and Toshiba.

Com21 relies on a combination of patent, copyright and trademark laws, and on trade secrets, confidentiality provisions and other contractual provisions to protect its proprietary rights. These measures afford only limited protection. Com21 currently has eleven issued U.S. patents and several pending patent applications.

As of December 31, 2000, Com21 had a total of 525 full-time employees. Of the total number of employees, 216 were in research and development, 98 in marketing and technical support, 86 in operations, 42 in sales, and 83 in administration. Com21's employees are not represented by any collective bargaining agreement with respect to their employment by Com21, and Com21 has never experienced an organized work stoppage.

Certain of Com21's competitors' cable modems are priced lower than Com21's cable modems. As headend equipment becomes more widely deployed, the price of cable modems and related equipment will continue to decline. In particular, the adoption of industry standards, such as the DOCSIS standard in North America, has caused increased price competition for cable modems. In the future to remain competitive, we may have to forward price our modems in anticipation of planned product cost reductions of our DOCSIS modems. We may not be able to continually reduce the costs of manufacturing our cable modems or secure component parts at a low enough cost to enable us to lower our modem prices and compete effectively. In addition, as we perform on our cost reduction program, we may not be able to continue to certify our DOCSIS modems in a timely manner by various standards bodies including Cablelabs. If Com21 is unable to continue to reduce the manufacturing costs of its cable modems, Com21's gross margin and operating results could be harmed.

During 1999 and 2000, we generated net losses of approximately $10.3 million and $56.1 million, respectively. We may also incur net losses during future periods. Due to a decline in our sales in the fourth quarter 2000, we introduced measures to reduce operating expenses that included reductions in our workforce in December 2000 and February 2001. Management continues to monitor market conditions to assess the need to take further action if necessary. Any subsequent actions may result in restructuring charges, reductions in inventory carrying values, and provisions for impairment of long lived assets which could have a material adverse effect our results of operations and stock price.

Com21's products and those acquired from its acquisition of GADline are complex and may contain undetected defects, errors, design deficiencies, or may have been manufactured incorrectly. These errors have occurred in its products in the past and additional errors may be expected to occur in its products in the future. As part of our focus on customer support, we are currently evaluating a manufacturing problem related to the insertion of a component into our cable modem products which will include an appropriate failure analysis. Upon completion of this analysis, we may repair a number of units at a cost to be determined. If we are not successful in negotiating with our contract manufacturer regarding the cost, we may be subject to additional warranty charges in future periods. The occurrence of any other defects, errors, or failures could result in shipment delays, product returns with costs in excess of its warranty reserves and other losses to Com21 or to its cable operators or end-users. Any of these occurrences could also result in the loss of or delay in market acceptance of its products, which could have a material adverse effect on its business, operating results and financial condition. Com21 would have limited experience with the problems that could arise with any new products that it introduces. Although Com21 has not experienced any product liability claims to date, the sale and support of its products entail the risk of these claims. A successful product liability claim brought against Com21 could have a material adverse effect on its business, operating results and financial condition.

In addition, the stock markets in general, and the Nasdaq National Market and the market for broadband access services and technology companies in particular, have experienced extreme price and volume volatility and a significant cumulative decline in recent weeks and months. This volatility and decline has affected many companies irrespective of or disproportionately to the operating performance of these companies. Our stock price has declined significantly in recent weeks and months and these broad market and industry factors may materially adversely further affect the market price of our common stock, regardless of our actual operating performance.

Com21's operating results are likely to fluctuate significantly in the future on a quarterly and an annual basis due to a number of factors, many of which are outside Com21's control. Supply of components, delays in getting new products into high volume manufacturing, and manufacturing or testing constraints could result in delays in the delivery of products and impact gross margins and revenues. Factors that could cause Com21's revenues to fluctuate include the following: competitive pricing pressures; variations in the timing of orders and shipments of Com21's products; variations in the size of orders by Com21's customers; new product introductions by Com21 or by competitors; delays in introducing standards based products that are certified as meeting the specifications of various approval organizations; general economic conditions and economic conditions specific to the cable and electronic data transmission industries; variations in capital spending budgets of cable operators; and delays in obtaining Cable Labs and regulatory approval for commercial deployment of cable modem systems. The amount and timing of Com21's operating expenses generally will vary from quarter to quarter depending on the level of actual and anticipated business activities. Research and development expenses will vary based on decisions to develop new products or the deployment of resources on completed projects. Total revenues for any future quarter are difficult to predict. Delays in the product deployment schedule of one or more of Com21's cable operator customers would likely materially adversely affect Com21's operating results for a particular period.

A variety of factors affect Com21's gross margin, including the following: competitive pricing pressures; increases in inventory; the sales mix within a product group, especially between proprietary and DOCSIS modems; component prices Com21 secures from its vendors; the average selling prices of Com21's products; the effectiveness of Com21's cost reduction efforts; the sales mix between Com21's headend equipment and cable modems; and the volume of products manufactured. In addition, an inability to reduce inventory due to the industry slowdown or other reasons may result in substantial inventory-related charges including marking component inventory to current market prices and increased excess and obsolescence reserves.

Because of these factors, Com21's operating results in one or more future periods may not meet or exceed the expectations of securities analysts or investors. In that event, the trading price of Com21's common stock would likely decline.

Our standard credit terms are net 30 days from the date of shipment and we do not require collateral or other security to support customer receivables, but in certain instances we have required letters of credit from a customer before shipping an order. Due to the over all market decline during the second half of 2000, we have had difficulties in receiving payment in accordance with our payment terms resulting in a substantial increase in receivable balances during the six months ended December 31, 2000.

The market for cable modem systems and products is characterized by rapidly changing technologies and short product life cycles. Com21's future success will depend in large part upon its ability to: identify and respond to emerging technological trends in the market; develop and maintain competitive products; enhance its products by adding innovative features that differentiate its products from those of competitors; bring products to market on a timely basis at competitive prices; and respond effectively to new technological changes or new product announcements by others. If Com21's product development and enhancements take longer than planned, the availability of products would be delayed. The technical innovations required for Com21 to remain competitive are inherently complex, require long development cycles, are dependent in some cases on sole source suppliers and require it, in some cases, to license technology from others. Com21 must continue to invest in research and development to attempt to maintain and enhance its existing technologies and products, but it may not have the funds available to do so. Even if it has sufficient funds, these investments may not serve the needs of customers or be compatible with changing technological requirements or standards. Most expenses must be incurred before the technological feasibility or commercial viability can be ascertained. Revenues from future products or product enhancements may not be sufficient to recover the development costs associated with the products or enhancements.

Com21's future success will depend, to a significant extent, on the ability of its management to operate effectively, both individually and as a group. Com21 is dependent on its ability to retain and motivate high caliber personnel, in addition to attracting new personnel. Competition for qualified personnel in the cable networking equipment and telecommunications industries is extremely intense, especially in the San Francisco Bay Area, and Com21 may not be successful in attracting and retaining such personnel. There may be only a limited number of people with the requisite skills to serve in those positions and it may become increasingly difficult to hire these people. Com21 is actively searching for research and development engineers, who are in short supply. Com21's business will suffer if it encounters delays in hiring additional engineers. In response to the intense competition for qualified personnel in the San Francisco Bay Area, Com21 has development facilities in Long Island, New York, Germantown, Maryland, and Jerusalem, Israel, and a customer service center in The Netherlands and may set up additional centers in other locations. Competitors and others have in the past and may in the future attempt to recruit Com21's employees. Com21 does not have employment contracts with any of its key personnel. It is experiencing higher turnover than in earlier years due to increased competition for qualified personnel. It does not maintain key person life insurance on its key personnel. The loss of the services of any of its key personnel, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel, particularly engineers, could negatively affect Com21's business.

In July 2000, Com21 acquired GADline, Ltd. and BitCom, Inc. The process of integrating any acquired business into Com21's business and operations is risky and may create unforeseen operating difficulties and expenditures. The areas in which it may face difficulties include: assimilating the acquired operations and personnel; limits on Com21's ability to retain the acquired customers; risks of entering markets in which it has no or limited direct prior experience and where competitors in such markets have stronger market positions; disruption of ongoing business; limits on its ability to successfully incorporate acquired technology and rights into its service offerings and sell the acquired products; and implementation of controls, procedures and policies appropriate for a larger public group of companies that prior to acquisition had been smaller, private companies. Com21 has very limited experience in managing the integration process. Moreover, it may not be able to successfully overcome potential problems encountered with these acquisitions or other potential acquisitions. In addition, future acquisitions could materially adversely affect its operating results by diluting its stockholders' equity, causing Com21 to incur additional debt, incurring significant immediate expenses related to write-offs, or incurring amortization of acquisition expenses and acquired intangible assets.

Com21 has incurred net losses since inception and expects to continue to operate at a loss through at least the first half of fiscal year 2001. To achieve and subsequently maintain profitable operations, Com21 must successfully design, develop, test, manufacture, introduce, market and distribute its products on a broad commercial basis and secure higher revenues, gross profits and contain its operating expenses. Com21's ability to generate future revenues will depend on a number of factors, many of which are beyond its control. These factors include the following: the rate at which cable operators upgrade their cable plants; Com21's ability and the ability of cable operators to coordinate timely and effective marketing campaigns with the availability of upgrades; cable operators' success in marketing data-over-cable services and Com21's modems to subscribers; cable operators' success in setting prices for data transmission installation service; cable operators' success and timeliness in the installation of subscriber site equipment; and Com21's ability to meet competitive pricing pressures. Due to these factors, Com21 cannot forecast with any degree of accuracy what its revenues will be or how quickly cable operators will adopt its systems and buy its cable modems. Therefore, Com21 may not achieve, or be able to sustain, profitability.

The DOCSIS standard has achieved substantial market acceptance in North America. Conformance with the DOCSIS standard is being determined through certification tests performed by CableLabs. As Com21 continues to enhance current DOCSIS products and develop new products and as the evolution of the DOCSIS standard continues Com21 may incur additional costs associated with making its cable modems compliant with various versions of the DOCSIS standard. Additionally, Com21 cannot assure you that future enhancements or new DOCSIS product offerings will be CableLabs certified according to Com21's anticipated schedule, or that if certified, will meet with market acceptance. The emergence or evolution of industry standards, either through adoption by official standards committees or widespread use by cable operators or telephone companies could require Com21 to redesign current products. There is movement by some cable operators in Europe towards either a DVB or EuroDOCSIS standard. Com21 currently has DVB cable modems, but it cannot assure you that its DVB products will meet the evolving DVB specifications. Additionally, Com21 cannot assure you that if an EuroDOCSIS standard obtains widespread acceptance, Com21 will be able to produce its EuroDOCSIS modem to meet EuroDOCSIS specifications. The widespread adoption of DOCSIS, DVB, EuroDOCSIS or other standards outside North America could cause aggressive competition in the cable modem market and result in lower sales of Com21's proprietary headend products and lower revenues from licensing of its network management software. Any of these events would adversely affect Com21's gross margin and its operating results. The development of new competing technologies and standards increases the risk that current or new competitors could develop products that would reduce the competitiveness of Com21's products. If any of these new technologies or standards achieve widespread market acceptance, any failure by Com21 to develop new products or enhancements, or to address these new technologies or standards, could harm its business.

Today, cable operators and systems integrators purchase cable modems from vendors through direct and indirect sales channels. In North America, due to the DOCSIS standard achieving widespread market acceptance, Com21 anticipates that the North American cable modem market may at some point shift to a consumer purchase model. If this occurs, Com21 will sell more of its cable modems directly through consumer sales channels. Com21's success will be dependent on its ability to market effectively to end users, to establish brand awareness, to set up the required channels of distribution and to have cable operator's reference sell its products. Com21 has begun to establish new distribution channels for its cable modems. Com21 may not have the capital required or the necessary personnel, or expertise to develop these distribution channels, which could materially adversely affect its business, operating results and financial condition. To the extent that large consumer electronics companies enter the cable modem market, their well-established retail distribution capabilities would provide them with a significant competitive advantage.

The market for high-speed data transmission services has several competing technologies which offer alternative solutions. Technologies which compete with Com21's solution include the following: (i) telephone company-related wireline technologies such as: dial-up (analog modems); digital subscriber line, known as DSL, ADSL, among others; and integrated services digital network, known as ISDN; (ii) wireless technologies such as: local multipoint distribution service, known as LMDS; multi-channel multipoint distribution service, commonly known as MMDS; and direct satellite; and (iii) fiber optic technologies such as: fiber to a residence; and fiber to a multi-dwelling unit. Because of the widespread reach of telephone networks and the financial resources of telephone companies, competition from telephone company-related solutions is expected to be intense. Cable modem technology may not be able to compete effectively against wireline or wireless technologies. In addition, one of Com21's competitors has developed a commercially available alternative modulation technology. Significant market acceptance of alternative solutions for high-speed data transmission could decrease the demand for Com21's products if these alternatives are viewed as providing faster access, greater reliability, increased cost-effectiveness or other advantages.

The market for Com21's products is intensely competitive, rapidly evolving and subject to rapid technological change. Many of its current and potential competitors have been operating longer, have better name recognition, more established business relationships and significantly greater financial, technical, marketing and distribution resources than Com21 does. These competitors may undertake more extensive marketing campaigns, adopt more aggressive pricing policies, undertake more vendor financing programs or longer customer payment cycles and devote substantially more resources to developing new or enhanced products than Com21 does.

Com21 relies on a combination of patent, copyright and trademark laws, and on trade secrets and confidentiality provisions and other contractual provisions to protect its proprietary rights. These measures afford only limited protection. Com21's means of protecting its proprietary rights in the U.S. or abroad may not be adequate and competitors may independently develop similar technologies. Com21's future success will depend in part on its ability to protect its proprietary rights and the technologies used in its principal products. Despite Com21's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of its products or to obtain and use trade secrets or other information that Com21 regards as proprietary. In addition, the laws of some foreign countries do not protect Com21's proprietary rights as fully as do the laws of the U.S. Issued patents may not preserve Com21's proprietary position. Even if they do, competitors or others may develop technologies similar to or superior to those of Com21. If Com21 does not enforce and protect its intellectual property, its business will be harmed. From time to time, third parties, including Com21's competitors, have asserted patent, copyright and other intellectual property rights to technologies that are important to Com21. Com21 expects that it will increasingly be subject to infringement claims as the number of products and competitors in the cable modem market grows and the functionality of products overlaps. The results of any litigation matter are inherently uncertain. In the event of an adverse result in any litigation with third parties that could arise in the future, Com21 could be required to pay substantial damages, including treble damages if it is held to have willfully infringed, to halt the manufacture, use and sale of infringing products, to expend significant resources to develop non-infringing technology, or to obtain licenses to the infringing technology. Licenses may not be available from any third party that asserts intellectual property claims against Com21, on commercially reasonable terms, or at all. In addition, litigation frequently involves substantial expenditures and can require significant management attention, even if Com21 ultimately prevails. There can be no assurance that Com21 would be able to successfully resolve legal disputes in the future.

Com21 has rapidly and significantly expanded its operations and anticipate that further significant expansion will be required to address potential growth in its customer base and market opportunities. To manage the anticipated growth of its operations, Com21 will be required to: improve existing and implement new operational, financial and management information controls, reporting systems and procedures; hire, train and manage additional qualified personnel; expand and upgrade its core technologies; and effectively manage multiple relationships with its customers, suppliers and other third parties. Com21 competes for skilled personnel in a labor market where there is a shortage of qualified personnel and salary demands are above the norm. Com21 must be able to continue to recruit and retain personnel, and failure to do so would result in Com21 not meeting its anticipated growth goals. In addition, Com21's management team may not be able to achieve the rapid execution necessary to fully exploit the market for its products and services. Com21 may not be able to install enhanced management information and control systems in an efficient and timely manner, and its current or planned personnel, systems, procedures and controls may not be adequate to support its future operations. In the future, Com21 may experience difficulties meeting the demand for its products and services. Com21 cannot assure that its systems, procedures or controls will be adequate to support the anticipated growth in its operations. Any failure to manage growth effectively could materially adversely affect its business, operating results and financial condition.

Com21's business strategy relies to a significant extent on its strategic relationships with other companies. These relationships include: software license arrangements for its network management system; technology licensing agreements for certain products; development and OEM arrangements with certain suppliers for advanced products; marketing arrangements with system integrators, and others; and collaboration agreements with suppliers of routers and headend equipment to ensure the interoperability of Com21's cable modems with these suppliers. These relationships may not be successful because Com21 may not be able to continue to maintain, develop or replace them in the event any of these relationships are terminated. In addition, any failure to renew or extend any license agreements between any third party and Com21 may adversely affect Com21's business.

A relatively small number of customers (which include system integrators) have accounted for a large part of Com21's revenues, and Com21 expects that this trend will continue. Com21 expects that its largest customers in the future could be different from its largest customers today due to a variety of factors, including customers' deployment schedules and budget considerations. In addition, certain of Com21's system integrators could develop and manufacture products that compete with Com21 and therefore could no longer distribute its products. Because a limited number of cable operators account for a majority of Com21's prospective customers, its future success will depend upon its ability to establish and maintain relationships with these companies. Com21 may not be able to retain its current accounts or to obtain additional accounts. Both in the U.S. and internationally, a substantial majority of households passed are controlled by a relatively small number of cable operators. The loss of one or more of Com21's customers or its inability to successfully develop relationships with other significant cable operators could cause Com21's business to suffer.

Com21 expects that a significant portion of its sales will continue to be in international markets for the foreseeable future. Com21 has expanded operations in its existing international markets and intends to enter new international markets, which will demand management attention and financial commitment. In addition, a successful expansion of its international operations and sales in certain markets will require Com21 to develop relationships with international systems integrators and distributors. Com21 may not be able to identify, attract or retain suitable international systems integrators or distributors. Com21 may not be able to successfully expand its international operations. Furthermore, to increase revenues in international markets, Com21 will need to continue to establish foreign operations, to hire additional personnel to run these operations and to maintain good relations with its foreign systems integrators and distributors. To the extent that Com21 is unable to successfully do so, its growth in international sales will be limited and its operating results could be adversely affected. Com21's international sales to date have been denominated in U.S. dollars. Com21 does not currently engage in any foreign currency hedging transactions. A decrease in the value of foreign currencies relative to the U.S. dollar could make Com21's products more expensive in international markets. In addition to currency fluctuation risks, international operations involve a number of risks not typically present in domestic operations, including: changes in regulatory requirements; costs and risks of deploying systems in foreign countries; licenses, tariffs and other trade barriers; political and economic instability; difficulties in staffing and managing foreign operations; potentially adverse tax consequences; difficulties in obtaining governmental approvals for products; the burden of complying with a wide variety of complex foreign laws and treaties; and the possibility of difficult accounts receivable collections. Com21 is also subject to the risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. Com21 cannot predict whether charges or restrictions upon the importation or exportation of its products will be implemented by the U.S. or other countries. Future international activity may result in sales denominated in foreign currencies. Gains and losses on the conversion to U.S. dollars of accounts receivable, accounts payable and other monetary assets and liabilities arising from international operations may contribute to fluctuations in Com21's operating results. For the year ended December 31, 2000, Com21 has $628,000 of foreign exchange losses. Any of these factors could materially and adversely affect its business, operating results and financial condition.

There has been a trend toward industry consolidation for several years, which is expected to continue through 2001. Com21 expects this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry. Com21 believes that industry consolidation may provide increasingly stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in operating results as Com21 competes to be a single vendor solution and could have a material adverse effect on its business, operating results and financial condition. Additionally, Com21 believes that industry consolidation may lead to fewer possible customers. If Com21 is unable to maintain its current customers or secure additional customers its business could be adversely affected.

Com21's corporate headquarters, including some of its research and development operations and its in-house manufacturing facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity. A significant natural disaster in the Silicon Valley, such as an earthquake or power loss, could have a material adverse impact on Com21's business, financial condition and operating results.

On August 8, 2000, Telepoint, Inc. filed a demand for arbitration against the Company and BitCom, Inc., which the Company acquired in July 2000, with the American Arbitration Association (No. 72Y 181 812 00 HLT). Telepoint, a customer of BitCom, claims damages of $10 million and is seeking injunctive relief based on several causes of action. Telepoint's claims center around a development agreement between Telepoint and BitCom whereby BitCom was to develop a digital radio in exchange for payment of $180,000 (and royalties). The Company believes this claim is without merit and intends to defend it vigorously.

In September 2000, the Company issued a purchase order to Ambit Microsystems Corporation for purchase of OEM cable modems which was later canceled because delivery dates were not met. On February 27, 2001, the Company received notice of breach of contract by Ambit requesting the Company to submit a settlement proposal. The Company believes the basis for this request is without merit.

Com21's common stock is traded on the Nasdaq National Market under the symbol "CMTO".

The following table sets forth the high and low bid quotations of the Company's common stock for the periods indicated as reported by The Nasdaq National Market or NASD electronic bulletin board. Prices shown in the table represent inter-dealer quotations, without adjustment for retail markup, markdown, or commission, and do not necessarily represent actual transactions.

Com21 has never declared, or paid, any cash dividends on its common stock.

On March 7, 2001, the Company entered into a definitive agreement to complete a $7.7 million private equity financing. Pursuant to a subscription agreement, dated February 28, 2001, the Company sold 2,450,000 shares of unregistered common stock at a price of $3.12 per share and a warrant to acquire up to an additional 2,450,000 shares of the Company's common stock at $9.10 per share. The offer and sale of these shares were not registered under the Securities Act of 1933, as amended, pursuant to the exemption provided by Regulation D and these securities may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. The warrant is immediately exercisable and remains exercisable for a period of seven years from the date of issuance.

The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes to consolidated financial statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this Annual Report on Form 10-K. The consolidated statement of operations data for each of the years in the three-year period ended December 31, 2000, and the consolidated balance sheet data at December 31, 1999 and 2000, are derived from consolidated financial statements which are included in this Form 10-K. The consolidated statement of operations data set forth below for the fiscal years ended December 31, 1996 and 1997 and the consolidated balance sheet data as of December 31, 1996, 1997 and 1998 have been derived from our consolidated financial statements not included in this Form 10-K. The historical results are not necessarily indicative of the operating results to be expected in the future. (amounts in thousands, except per share data)

You should read the following discussion in conjunction with Com21's consolidated financial statements and notes to consolidated financial statements. The results described below are not necessarily indicative of the results to be expected in any future period. Certain statements in this discussion and analysis, including statements regarding our strategy, financial performance and revenue sources, are forward-looking statements based on current expectations and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements, including those described in "Risk Factors" and elsewhere in this Annual Report on Form 10-K.

During the first half of 2000, cable modem manufacturers experienced shortages and long lead times with respect to certain components such as flash memory and capacitors. Due to these shortages, the production of cable modems was constrained. Com21 placed substantial orders for component material to ensure we would meet our anticipated build plan, especially for our Doxport 1110 modem that we commenced shipping late in the third quarter of 2000. During the fourth quarter of 2000, the order rates and corresponding revenues dropped sharply resulting from lower demand from cable operators. This slow down in sales in the fourth quarter of 2000 caused our inventory levels to increase substantially. In addition, cable operators began to lengthen their accounts payable payments cycles as they more tightly managed their working capital. Although we believe that deployment of cable modems will continue to increase as subscriber growth for high speed access is forecasted to increase in 2001, some cable operators have delayed ordering new equipment in early 2001 in order to utilize the existing levels of inventory. Due to this oversupply of inventory by manufacturers, price competition has become more intense which has resulted in lower average selling prices and gross margin pressures. We expect the slow down in procurement by cable operators to continue at least through the first half of 2001. On a forward looking basis we believe these factors are likely to depress revenues, and are likely to cause inventory levels to remain higher than historical levels due to lower shipment rates. We anticipate that accounts receivable balance will remain at a relatively high level compared to historical levels as cable operators manage working capital tightly. With the slow down in shipments our contract manufactures have begun charging us for the carrying cost of inventory.

In January 2001, we announced a number of programs to reduce our operating expenses. These included the termination of a project to develop a DVB headend, the focusing of our engineering efforts on fewer projects and the elimination of certain marketing programs. This resulted in a reduction in personnel in these areas along with some administrative and support functions. We also transferred certain engineering and marketing efforts to lower cost development centers in Ireland and Maryland. In addition we announced that we had engaged a placement agent to help us spin out our wireless group into a separate minority owned subsidiary that would be separately funded. Furthermore, we were engaged in working with a European company on a joint venture development contract. Finally, we announced that we have engaged Dain Rauscher Wessels to assist us to evaluate working capital alternatives. In the future, we may continue to reduce operating expenses to accommodate decreased revenues or gross margins, or discontinue some development programs and product lines. This could result in the reductions in work force, restructuring charges, write downs of inventory carrying values or provisions for the impairment of long-lived assets. Any of these factors could affect our financial results of operations or stock price.

As described below, we made two acquisitions in 2000 to secure needed product development resources and expertise particularly in cable telephony products. As market dynamics change, resources become available locally, our ability to retain resources improves, and other product relationships with third parties evolve, we will continue to evaluate our ownership position. We may determine that the most cost effective means to secure these resources is a different relationship. This could result in accelerated amortization charges for intangible assets or provisions for the impairment of long-lived assets in future periods.

On March 7, 2001, the Company entered into a definitive agreement to complete a $7.7 million private equity financing. Pursuant to a subscription agreement, dated February 28, 2001, the Company sold 2,450,000 shares of unregistered common stock at a price of $3.12 per share and a warrant to acquire up to an additional 2,450,000 shares of the Company's common stock at $9.10 per share. The offer and sale of these shares were not registered under the Securities Act of 1933, as amended, pursuant to the exemption provided by Regulation D and these securities may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. The warrant is immediately exercisable and remains exercisable for a period of seven years from the date of issuance.

On July 3, 2000, pursuant to a Share Purchase Agreement (the "GADline Agreement") dated April 18, 2000 by Com21 and GADline, Ltd. (GADline), an Israeli company, GADline was merged with and into Com21. GADline develops, manufactures and markets fully managed networking solutions that deliver high-speed data and telephony services over a hybrid fiber coaxial infrastructure.

Pursuant to the GADline Agreement, the shareholders of GADline received an aggregate of 2,281,750 shares of Com21 common stock and all outstanding GADline options converted into options to purchase 168,193 shares of Com21 common stock. On January 9, 2001, GADline met certain milestones defined in the GADline Agreement which resulted in the issuance of an additional 175,124 shares of Com21 common stock valued on the measurement date at $963,000. This amount will be added to goodwill in the first quarter of 2001 and be amortized over the remaining useful life of the intangible asset. An additional 174,876 shares of Com21 common stock may be issued to GADline shareholders upon completion of predefined milestones. The fair value of the contingent shares will be measured upon achievement of the predefined milestones and will also be accounted for as additional purchase price. We also assumed certain operating assets and liabilities of GADline. The acquisition was treated as a purchase for accounting purposes. The total purchase price as of July 3, 2000 was allocated to the assets acquired and liabilities assumed based on their respective fair values as follows (in thousands):

We recorded a one-time charge of $8.8 million in the consolidated statement of operations and comprehensive loss for 2000 for purchased in-process technology related to a development project that had not reached technological feasibility, had no alternative future use, and for which successful development was uncertain. The in-process development project is an integrated network solution for data and voice over Internet protocol. At the time of acquisition, estimated costs to complete the development were $9.0 million. Management expects that product being developed will become available for sale in fiscal 2001; however, we can not assure that these products will become available by that time. To date, we have incurred expenses on the project of $10.6 million. Failure to reach successful completion of this project could result in impairment of the associated capitalized intangible assets and could require the Company to accelerate the time period over which the intangibles are being amortized, which could have a material adverse effect on the Company's business, financial condition or results of operations.

We utilized assumptions to determine the value of in-process technology included several factors, including the following. First, an income approach that focuses on the income producing capability of the acquired technology, and best represents the present value of the future economic benefits which we expected to derive from them. Second, we forecast net cash flows that we expected might result from the development effort, using projections prepared by Com21's management. Third, a discount rate of 25% was computed after analysis of the risk of an investment in GADline which considered the implied rate of the transaction and the weighted average cost of capital.

BitCom, Inc.

On July 6, 2000, pursuant to a Share Purchase Agreement (the "BitCom Agreement") dated June 22, 2000 by Com21 and BitCom, Inc. (BitCom), a Delaware company with facilities in Maryland, BitCom was merged with and into Com21. BitCom is an engineering consulting and development company specializing in the fields of wired and wireless telecommunications, satellite, and networking engineering.

Pursuant to the BitCom Agreement, the Company acquired all of the outstanding shares of BitCom for an aggregate purchase price of $4.0 million in cash. Additionally, the Company assumed 100,000 options to purchase BitCom stock. On January 3, 2001, certain milestones defined in the BitCom Agreement were met resulting in the issuance of an additional 50,000 shares of Com21 common stock valued on the measurement date at $263,000. This amount will be recorded as stock compensation in the first quarter of 2001. The Company also assumed certain operating assets and liabilities of BitCom. The acquisition was treated as a purchase for accounting purposes. The total purchase price as of July 6, 2000 was allocated to the assets acquired and liabilities assumed based on their respective fair values as follows (in thousands):

In connection with the BitCom acquisition, the Company granted 245,000 shares of restricted common stock to former BitCom employees who have executed Employment Agreements with Com21. The shares are released from restriction, in proportionate amounts, at each of the three anniversary dates of the acquisition. If an employee terminates prior to vesting, that employee's restricted shares are subject to forfeiture. As of December 31, 2000, all shares remained restricted. The Company recorded a deferred compensation charge of $6,049,000, as a separate component of stockholders' equity, for the fair value of the common shares on the issuance date and will amortize the amount, net of forfeitures, over the three-year vesting period. For the year ended December 31, 2000, $1,008,000 of compensation expense related to these awards was recorded in the accompanying consolidated statement of operations and comprehensive loss.

Results of Operations - - - - Years Ended December 31, 1998, 1999, and 2000

Total Revenues. Total revenues in 2000 increased by 103% to $194.0 million as compared to $95.7 million in 1999. Our revenue growth was principally due to growth in cable modem and headend revenues over the prior year. Unit sales of all our cable modem products increased 181% from 1999, as we experienced strong demand for our ATM and DOCSIS cable modems. Revenues associated with our headend products increased 38% as we experienced continued strong demand for these products especially in Europe. Cable modem sales accounted for 85% of total revenue in 2000 as compared to 78% of total revenues in 1999. Although we experienced growth in revenues, Com21 did experience a sharp decrease in sales during the fourth quarter of 2000 as compared to prior quarters due to an industry-wide downturn in broadband equipment purchases as cable operators balanced inventories. The average sales price of all cable modems declined during 2000. Our prices decreased due to planned price reductions to meet pricing pressures from competitors and due to the increased acceptance of our lower priced DOCSIS products. We anticipate that the average sales price of modems will continue to decline during 2001 due to competitive price pressures and the number of suppliers competing for market share.

Total revenues increased by 99% to $95.7 million in 1999 as compared to $48.1 million in 1998. Our revenue growth was principally due to the growth in cable modem revenue over the prior year. Cable modem sales accounted for 78% of total revenue in 1999 as compared to 56% of total revenue in 1998. The average sales price of our cable modems declined during 1999, as expected. Our prices decreased primarily due to increased price competition. The average sales price of our headend equipment increased moderately during 1999 primarily due to the mix of product sold.

Gross Margins. Gross margins decreased to 22% in 2000 from 36% in 1999. The decrease in margins is due primarily to the rapid acceptance of the DOCSIS cable modems especially in North America. DOCSIS cable modem shipments increased from 29,000 units or 10% of total Com21 modem shipments in 1999 to 393,000 units or 50% of total Com21 modems shipped in 2000. The adoption of the DOCSIS-based standard has caused considerable price pressure due to the number of competitors in the marketplace.

During 2001 we anticipate continued pressure on margins due to the following:

Gross margins decreased to 36% in 1999 from 39% in 1998. The decrease in gross margin in 1999 was primarily attributable to an increase in sales of cable modems as a percentage of total product sales and a shift away from our higher margin software products.

Research and Development. Research and development expenses increased 63% to $48.6 million in 2000 from $29.8 million in 1999. This increase in 2000 is primarily due to higher consulting expenses, increases in personnel related expenses in our Cork, Ireland development center, and a $2.5 million impairment charge related to a development project, and the addition of engineering headcount from our acquisitions of GADline and BitCom. In addition, $1.3 million was incurred in 2000 due to the amortization of intangibles associated with these acquisitions. In 2001, we anticipate that actual dollar amount of research and development expenses will decline from the 2000 level. This decline will be due to a reduced number of personnel and the elimination of certain development programs as we refocus our development efforts on key technology initiatives.

Com21 recorded a one-time charge of $8.8 million in the third quarter of 2000 for purchased in-process technology related to a development project that had not reached technological feasibility, had no alternative future use, and for which successful development was uncertain in connection with the acquisition of GADline. There were no acquisition related charges in 1999.

Research and development expenses increased 50% to $29.8 million in 1999 from $19.9 million in 1998. The increase in 1999 is primarily due to increased consulting and personnel related expenses related to product development.

Sales and Marketing. Sales and marketing expenses increased 79% to $29.1 million in 2000 from $16.3 million in 1999. The increase in 2000 is primarily due to higher costs associated with increased personnel in the sales, marketing, and service organizations. We increased sales personnel internationally strengthening our sales presence in Asia and Latin America. We also increased our customer service personnel to support the growth of our installed base of equipment and help manage our growing number of customers. Marketing headcount and expenses increased due to the acquisition of GADline in Israel, additional marketing and advertising investments related to the introduction of new products, and general corporate branding projects. In 2001, we anticipate that actual dollar amount of marketing expenses will decline from the 2000 level. This decline will be due to personnel reductions and a decrease in expenditures on marketing programs in connection with our effort to reduce operating expenses.

Sales and marketing expenses increased 58% to $16.3 million in 1999 from $10.3 million in 1998. The increase in 1999 is primarily due to higher costs associated with increased personnel in sales and marketing organizations. We increased sales personnel internationally strengthening our sales presence in Europe, Asia and Latin America, as well as domestically. We also increased our customer service personnel to support the growth of our installed base of equipment and help manage our growing number of customers. We added personnel to our marketing department as we expanded our marketing programs both domestically and internationally.

General and Administrative. General and administrative expenses increased 292% to $16.2 million in 2000 from $4.1 million in 1999. The increase in general and administrative expenses was primarily related to the addition of new personnel in Milpitas, the addition of administration headcount from our acquisition of GADline, and investments in infrastructure. General and administrative expenses included acquisition related charges of $5.0 million related to the amortization of goodwill, intangibles and deferred stock compensation. In 2001, we anticipate that actual dollar amount of general and administrative expense will decline from the 2000 level. This decline will be due to personnel reductions and general decrease in expenses in connection with our effort to reduce operating expenses.

General and administrative expenses increased 6% to $4.1 million in 1999 from $3.9 million in 1998. This increase is primarily attributable to increased personnel in our finance and administrative organization. This was offset by a decline in our legal fees associated with patent litigation, which was settled in January 1999.

Total Other Income, Net. Total other income, net decreased to $4.0 million in 2000 from $5.1 million in 1999. This decrease was attributable to lower interest income on a declining cash and investments balance during 2000 coupled with $628,000 in foreign exchange losses.

Total other income, net increased to $5.1 million in 1999 from $2.2 million in 1998. The increase was attributable to earnings on higher average cash and investment balances during 1999 resulting from the net cash received of $62.8 million from the initial public offering of common stock in May 1998 and the net cash received of $54.3 million from the secondary offering of common stock in February 1999.

Income Taxes. Income tax expense for all years consisted solely of state franchise taxes. We have not recorded any other income tax expense or benefit as we have not generated taxable income and as we have provided a full valuation allowance against our deferred tax assets based on our evaluation of the likelihood of realization of future tax benefits.

Liquidity and Capital Resources

At December 31, 2000, we had cash, cash equivalents and short-term investments of $45.9 million of which $11.3 million is restricted for use under two stand-by letters of credit. Of the restricted $11.3 million, $10.1 million was issued to our primary contract manufacturer, Celestica, in response to increased inventory levels and a reduction to our manufacturing build plan. The remaining $1.2 million was issued to a sole source component vendor.

Net cash used in operating activities was $55.3 million in 2000. Cash used in operating activities primarily resulted from outflows due to: a net loss of $56.1 million; an increase in accounts receivable of $30.0 million due to the decline in market conditions in the second half of 2000 which caused several major customers to delay payments; and an increase in inventory of $25.0 million which is a direct result of lower shipments in the fourth quarter of 2000 due to the slower procurement of equipment by customers. The cash outflows were offset by an increase in accounts payable of $33.8 million; and noncash activities including stock compensation of $2.9 million, in-process research and development of $8.8 million and a $2.5 million asset impairment charge.

Net cash provided by investing activities was $65.4 million in 2000. Cash provided by investing activities was primarily attributable to net proceeds from the sales and maturities of investments of $78.1 million offset by purchases property and equipment of $11.9 million.

Net cash used in financing activities was $1.4 million. Cash provided by financing activities consisted primarily of net proceeds from the issuance of debt obligations of $6.3 million and net proceeds from the issuance of common stock of $4.2 million. We used $11.3 million to support stand-by letters of credit.

During 1999 and 2000 we generated net losses of approximately $10.3 million and $56.1 million, respectively. We may also incur net losses during future periods. Due to a decline in our sales in the fourth quarter 2000, we introduced measures to reduce operating expenses that included reductions in our workforce in December, 2000 and February, 2001. Management continues to monitor market conditions to assess the need to take further action if necessary. Any subsequent actions may result in additional work force reductions, restructuring charges, reductions in inventory carrying values, discontinuation of product lines, and provisions for impairment of long-lived assets which could materially adversely affect our results of operations and stock price. We are currently evaluating several alternatives to improve liquidity and working capital as required. These alternatives include the sale of additional stock, additional lines of credit, and the divestiture of certain business assets. There can be no assurance, however, that any additional financing will be available to us on acceptable terms, or at all, when required.

If our financial resources are insufficient to fund our activities and repay our debts, additional funds will be required. If additional funds are raised by issuing equity securities, significant dilution to existing stockholders will result given the current price of our stock. If additional funds are not available, we may be required to delay, scale back, or eliminate one or more of our research and development or manufacturing programs. Accordingly, the inability to obtain such financing could have a material adverse effect on our business, financial condition, and results of operations.

We believe that our cash, cash equivalents, short-term investments and available borrowings under our credit facilities at December 31, 2000 coupled with the March 2001 equity financing and the cost reduction programs described under "Management's Discussion and Analysis of Financial Condition and Result of Operations - - - - Recent Developments" will be sufficient to meet our working capital requirements through December 31, 2001.

SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," is effective for all fiscal years beginning after June 15, 2000. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Under SFAS No. 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The Company will adopt SFAS No. 133 effective January 1, 2001. Management has concluded its analysis of the effects of adopting SFAS No. 133 and the adoption will not have an impact on the financial position, results of operations, or cash flows of the Company.

In December 1999, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements." This bulletin summarizes certain interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant of the SEC in administering the disclosure requirements of the Federal securities laws in applying accounting principles generally accepted in the United States of America to revenue recognition in financial statements. The adoption of SAB No. 101 in 2000 had no impact on the Company's financial position, results of operations or cash flows.

Interest Rate Sensitivity. Com21 maintains an investment portfolio of government and corporate debt obligations. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10 percent from levels at December 31, 1999 and 2000, the fair value of the portfolio would decline by an immaterial amount. We generally have the ability to hold our fixed income investments until maturity and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio.

Com21 is also subject to interest rate risk as of December 31, 2000, related to variable rate debt obligations totaling $11,030,000. The variable rates debt obligations are linked to the prime rate and the LIBOR rate and any increases in such market interest rates will increase the repayment obligation. If market rate were to increase immediately and uniformly by 10 percent from levels at December 31, 2000, the fair value of the repayment obligation would increase by $103,000.

Com21 has fixed rate debt obligations of $883,000 and $291,000 at December 31, 1999 and 2000, respectively, that have no interest rate risk. The fixed rates on such obligations was 13% in 1999 and ranged from 7% to 12% in 2000, and mature on various dates through 2002.

Market Price Risk. Com21 is also exposed to market price risk on investment in marketable equity securities held as available-for-sale investments. These investments are in publicly traded companies as well as private companies in the volatile high-technology industry sector. A 50% adverse change in the equity price would result in an approximate $586,000 and $2,714,000 decrease in the fair value of the investment in the marketable equity security as of December 31, 1999 and 2000, respectively.

Foreign Currency Risk. To date, our international sales have been dominated solely in U.S. dollars, and accordingly, we have not been exposed to foreign currency exchange rate fluctuations related to sales transactions. However, the functional currency of our subsidiaries in the Ireland and Israel is the U.S. dollar and as the local accounts are maintained in Irish pounds and Israeli new shekels, we are subject to foreign currency exchange rate fluctuations associated with remeasurement to U.S. dollars. A hypothetical change of 10% in the foreign currency exchange rates would not have a material impact on our consolidated financial positions or results of operation.

To the Board of Directors and Stockholders of

Com21, Inc.:

We have audited the accompanying consolidated balance sheets of Com21, Inc. and its subsidiaries (the Company) as of December 31, 1999 and 2000, and the related consolidated statements of operations and comprehensive loss, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Com21, Inc. and its subsidiaries as of December 31, 1999 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America.

DELOITTE & TOUCHE LLP

San Jose, California
March 26, 2001

Business - Com21, Inc. (the Company or Com21) was incorporated in Delaware in June 1992. The Company is a global supplier of broadband access solutions. The Company develops and sells headend equipment, subscriber cable modems and network management software to support the Asynchronous Transfer Mode (ATM), Data Over Cable System Interface Specification (DOCSIS) and Digital Video Broadcasting (DVB) standards. Such products enable domestic and international cable operators the ability to provide high-speed, cost-effective Internet access to a variety of subscriber markets including corporate telecommuters, small businesses and private homes.

Basis of Presentation - The consolidated financial statements include the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

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

Reclassifications - Certain prior year amounts in the accompanying consolidated financial statements have been reclassified to conform to current year presentation. These reclassifications had no effect on the consolidated financial position, results of operations or cash flows for any of the periods presented.

Cash Equivalents - The Company considers all highly liquid debt instruments with maturities at the date of purchase of three months or less to be cash equivalents.

Restricted Cash - As of December 31, 2000, $11,250,000 in cash held in a certificate of deposit is restricted for use as security on purchases from a third-party outsource manufacturer and a sole source component vendor.

Investments - Investments are stated at fair value based on quoted market prices obtained from an independent broker. Investments are classified as available-for-sale based on the Company's intended use. The difference between amortized cost and fair value representing unrealized holding gains or losses, net of deferred taxes, are recorded as a component of stockholders' equity as accumulated other comprehensive income (loss). Gains and losses on sales of investments are determined on a specific identification basis.

Other Accounts Receivable - Other accounts receivable consists of receivables due from third-party outsource manufacturers for the sale of component inventories used by the manufacturers in the production of the Company's product.

Inventories - Inventories consist of networking equipment, modems and sub-assemblies stated at the lower of cost (first-in, first-out method) or market.

Property and Equipment - Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally three to sixteen years. Amortization of leasehold improvements and assets recorded under capital lease agreements are computed using the straight-line method over the shorter of the lease term or the estimated useful lives of the related assets.

Intangible Assets - Intangibles assets, including goodwill, are amortized on a straight-line basis over useful lives of three to five years.

Long-Lived Assets - The Company evaluates long-lived assets for impairment using a discounted cash flows method whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

In June 2000, the Company entered into a 43 month development agreement with a third party for a cash payment of $2,250,000 which was recorded as an asset at the time the payment was made. In December 2000, in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets To Be Disposed Of," the Company recorded an impairment charge of $2,518,000 as research and development expense in the accompanying consolidated statement of operations and comprehensive loss for 2000. The amount consisted of the remaining net book value of the initial payment as well as noncancelable commitments to purchase materials for the development project. Such assets were determined to be impaired based on a comparison of the carrying amount of such assets to future discounted cash flows expected to be generated by the asset. As the development project was canceled with undeveloped product, there were no future discounted cash flows.

Income Taxes - The Company accounts for income taxes under an asset and liability approach. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and operating loss and tax credit carryforwards measured by applying currently enacted tax laws. Valuation allowances are provided when necessary to reduce net deferred tax assets to an amount that is more likely than not to be realized.

Certain Significant Risks and Uncertainties - The Company participates in a dynamic high technology industry and believes that changes in any of the following areas could have a material adverse effect on the Company''s future financial position, results of operations or cash flows: advances and trends in new technologies and industry standards; competitive pressures in the form of new products or price reductions on current products; changes in product mix; changes in the overall demand for products offered by the Company; changes in third-party manufacturers; changes in key suppliers; changes in certain strategic relationships or customer relationships; litigation or claims against the Company based on intellectual property, patent, product, regulatory or other factors; risks associated with changes in domestic and international economic and/or political conditions or regulations; availability of necessary components; the Company's ability to obtain additional capital to support operations; the Company's ability to integrate acquired businesses; and the Company's ability to attract and retain employees necessary to support its growth.

Since inception, the Company has incurred net losses and has an accumulated deficit of $115,072,000 at December 31, 2000. If profitability is not achieved in the near term, it could have a material adverse effect on the Company's financial position, results of operations or cash flows. Subsequent to December 31, 2000, the Company continued efforts to reduce operating expenses including reductions in its workforce; termination of a project to develop a DVB headend; refocusing of its engineering efforts on fewer projects; and the elimination of certain marketing programs. In addition, the Company had engaged Dain Rauscher Wessels to assist in the evaluation of working capital alternatives and raised $7,650,000 in an equity placement . If efforts to achieve profitable operations are not successful, additional funding will be required. If additional funds are not available, the Company may be required to continue to delay, scale back or eliminate one or more of its research and development, marketing or manufacturing programs.

Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments and accounts receivable. Cash and cash equivalents are held primarily with five financial institutions and consist primarily of commercial paper, short-term corporate and government obligations and cash in bank accounts. The Company's investment policy is to invest in instruments with minimum credit ratings of A-1/P-1 (Short-Term) or AA (Long-Term) and in strategic equity investments requiring Board of Directors approval. The Company sells its products primarily to cable operators in North America and primarily to systems integrators in Europe, Asia and South/Central America, and generally does not require its customers to provide collateral or other security to support accounts receivable. To reduce credit risk, management performs ongoing credit evaluations of its customers' financial condition. The Company maintains allowances for estimated potential bad debt losses. The recorded carrying amount of cash and cash equivalents, investments, accounts receivable, accounts payable and debt obligations approximate fair value.

The Company's customer base is highly concentrated. A relatively small number of customers have accounted for a significant portion of the Company's revenues and the Company expects that this trend will continue for the foreseeable future. For the years ended December 31, 1998, 1999 and 2000, the top five customers comprised 66%, 64% and 47%, respectively, of the Company's total revenues.

Revenue Recognition - The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. For product revenue, this generally occurs at the time of shipment. Estimated sales returns and warranty costs, based on historical experience by product, are recorded at the time the product revenue is recognized.

The Company accounts for revenue on software transactions under the principles of Statement of Position (SOP) 97-2, "Software Revenue Recognition," as amended, which requires, among other things, revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. Revenue for software licenses is recognized when SOP 97-2 criteria are met which is generally upon delivery provided that collection is probable. Software support and maintenance revenue are deferred and amortized over the maintenance period on a straight-line basis.

Software Development Costs - Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time certain development costs required to attain general production release would be capitalized. To date, the Company's software development has essentially been completed concurrent with the establishment of technological feasibility, and accordingly, no costs have been capitalized.

Stock-Based Compensation - The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees." The Company accounts for stock-based awards to non-employees in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation."

Foreign Currency - The functional currency of the Company's foreign subsidiaries is the U.S. dollar. Accordingly, all monetary assets and liabilities are translated at the current exchange rate as of the balance sheet date, nonmonetary assets and liabilities are translated at historical rates and revenues and expenses are translated at average exchange rates in effect during the period. Transaction gains and losses, which are included in other income (expense) - - - - net in the accompanying consolidated statements of operations and comprehensive loss, were not significant in 1998 and 1999 and was a loss of $628,000 in 2000.

Comprehensive Loss - In accordance with SFAS No. 130, "Reporting Comprehensive Income," the Company reports by major components and as a single total, the change in net assets during the period from nonowner sources in a consolidated statement of comprehensive loss which has been included with the consolidated statements of operations. Accumulated other comprehensive income (loss) in the accompanying consolidated balance sheets consists entirely of unrealized gains and losses on available-for-sale investments for all periods presented.

Net Loss Per Share - Basic earnings per share (EPS) excludes dilution and is computed by dividing net income attributable to common stockholders by the weighted average of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (convertible preferred stock, restricted stock, warrants to purchase convertible preferred stock and common stock options and warrants using the treasury stock method) were exercised or converted into common stock. Potential common shares in the diluted EPS computation are excluded in net loss periods as their effect would be antidilutive.

New Accounting Standards - SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," is effective for all fiscal years beginning after June 15, 2000. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Under SFAS No. 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The Company will adopt SFAS No. 133 effective January 1, 2001. Management has concluded its analysis of the effects of adopting SFAS No. 133 and the adoption will not have an impact on the financial position, results of operations or cash flows of the Company.

In December 1999, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements." This bulletin summarizes certain interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant of the SEC in administering the disclosure requirements of the Federal securities laws in applying accounting principles generally accepted in the United States of America to revenue recognition in financial statements. The adoption of SAB No. 101 in 2000 had no impact on the Company's financial position, results of operations or cash flows.

The amortized cost and the fair value of available-for-sale securities are presented in the tables below:

The contractual maturities of the Company's investments in debt securities at December 31, 2000 were all within one year.

Inventories consist of:

Accumulated amortization on capital leases as of December 31, 1999 and 2000 was $3,031,000 and $3,495,000, respectively.

Intangible assets consist of the following at December 31, 2000 (in thousands):

In December 2000, the Company entered into a revolving line of credit agreement, for working capital purposes, which allows the Company to borrow up to the lesser of $20,000,000 or 65% of the Company's eligible domestic and foreign accounts receivable. At December 31, 2000, the Company had $10,000,000 outstanding under the agreement. Borrowings under the line are secured by substantially all the assets of the Company and bears annual interest at the prime rate (9.25% at December 31, 2000) plus 0.25%, which is payable monthly. The line expires on November 30, 2001 at which time all outstanding borrowings and unpaid interest are due. The agreement requires the Company to comply with certain financial covenants. At December 31, 2000, the Company did not meet the minimum tangible effective net worth, the maximum debt-to-worth ratio, the maximum quarterly loss and minimum net liquidity covenants. A waiver for these violations was received on February 28, 2001.

The Company's Israeli subsidiary also has lines of credit with various financial institutions. As of December 31, 2000, the Company had outstanding borrowings of $1,030,000 which are denominated in Israeli New Shekels (ILS 4,165,000 at December 31, 2000). The Company has $39,000 available under the lines at December 31, 2000. The borrowings are secured by substantially all the assets of the Company's Israeli subsidiary and bear interest at rates ranging from 10% to 11% per annum. The lines expire in March 2001 at which time all outstanding borrowings and unpaid interest are due.

The Company leases its facilities and certain equipment under noncancelable capital and operating leases. The Company leases its primary facilities under a noncancelable operating lease which expires in August 2004.

In 2000, the Company's Irish subsidiary entered into two operating lease agreements for research and development facilities with terms of 20 years and 25 years. Under both leases, rental payments are subject to review and renegotiation every five years. The subsidiary can also terminate the leases, subject to penalty provisions, at the end of the tenth year on the 20-year lease and at the end of the fifth or tenth years on the 25-year lease.

Future minimum lease payments under capital and operating leases and the present value of minimum lease payments under capital leases as of December 31, 2000 are as follows:

Rent expense incurred under the operating leases was $867,000, $1,438,000 and $2,924,000 for the years ended December 31, 1998, 1999 and 2000, respectively. Rent expense under the facilities leases is recognized on a straight-line basis over the term of the leases. The difference between the amounts paid and the amounts expensed is classified as deferred rent in the accompanying consolidated balance sheets.

The Company is subject to various legal proceedings and claims which arise in the normal course of business. The Company does not believe that any current litigation or claims will have a material adverse effect on the Company's business, operating results or financial condition.

In May 1998, the Company completed its initial public offering of 5,750,000 shares (which includes the full exercise of the underwriters' over-allotment of 750,000 shares) which generated net proceeds to the Company of $62,791,000.

In February 1999, the Company completed a follow on offering of 2,480,000 shares which generated net proceeds to the Company of $54,330,000.

On April 22, 1998, holders of more than 50% of the Series D, E, F and G convertible preferred stock, voting as a single class, consented to the automatic conversion of all outstanding shares of Series D, E, F and G convertible preferred stock into common stock upon the completion of the initial public offering regardless of the offering price per share. Upon completion of the Company's initial public offering in May 1998, all shares of Series A, B, and C convertible preferred stock were converted to common stock in accordance with their existing terms and all shares of Series D, E, F and G convertible preferred stock were converted to common stock in accordance with the stockholders' consent. All shares were converted on a one-to-one basis.

Prior to the Company's initial public offering in May 1998, the Company issued warrants to purchase shares of various series of convertible preferred stock. Upon completion of the Company's initial public offering, the outstanding warrants to purchase 46,286 shares of convertible preferred stock were automatically converted into warrants to purchase 46,286 shares of common stock at the same exercise prices. All such warrants were outstanding at December 31, 1998 and were exercised in full during 1999.

During 2000, as consideration for services provided under two product development agreements, the Company issued warrants to purchase a total of 75,000 shares of common stock at a weighted average exercise price of $20.40 per share. The warrants are immediately exercisable until expiration (25,000 warrants in May 2001 and 50,000 warrants in January 2002). All such warrants were outstanding at December 31, 2000. During 2000, $832,000 related to these warrants was recognized as research and development expense in the accompanying consolidated statement of operations and comprehensive loss.

At December 31, 1999 and 2000, the Company had the right to repurchase 22,055 and 978 shares of common stock outstanding, respectively. The number of shares subject to repurchase is reduced over a two to four year vesting period. The Company has the right to repurchase these shares at the original issuance price.

The Company also has 245,000 shares of restricted common stock outstanding at December 31, 2000 which is subject to forfeiture by the holders if the holders' employment terminates prior to a three year cliff vesting term.

The following is a reconciliation of the numerators and denominators of the basic and diluted net loss per share computations: