Com21, Inc., or the Company, is a leading global supplier of system solutions for the broadband access market. Our ATM and DOCSIS-based products enable cable operators and service providers to deliver high-speed, cost-effective Internet and telephony applications to corporate telecommuters, small businesses, home offices, and residential users. To date, we have shipped over 1.8 million cable modems and over 1,850 headend controllers worldwide.

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.

We believe the broadband industry, which in its most basic form is identified with an always-on internet connection characterized by data transfer rates significantly faster than dial-up services, is poised to offer much more than faster web surfing. With a significant upgrade to the cable and telecommunication networks over the past several years, operators are now in a position to utilize the power of broadband networks to deliver much more than just data. Previously, service providers (both telecommunication and cable companies) could deliver only one or two out of the three basic service types by which most communications can be categorized: data, voice, and video. With newly upgraded networks and advanced equipment to service the networks, broadband service providers are in a position to take advantage of the full power of broadband and deliver all three services over a single unified network. In the process, we believe broadband is driving the next wave of technology innovation and investment, as the increase in bandwidth is also driving the pace of innovation in software applications, computers, communications equipment, semiconductors, and other similar devices.

Although the broadband industry is moving rapidly to capture the rewards of offering data, voice, video over a single network, broadband still remains in relative infancy, with much of the growth still ahead of it. As broadband rollout becomes more widespread, we believe these integrated services will drive an accelerated demand for transmission equipment, cable and DSL modems, digital set-top boxes, and voice gateways. Of all the broadcast mediums, we believe in cable given its capability to deliver digital video, data, voice, and other two- way services such as pay per view, or PPV, video-on-demand, or VOD, and subscription video-on-demand, or sVOD, all over the same network. Cable will be the access platform of choice in carrying out the full service vision of the broadband service providers. In spite of a challenging macroeconomic environment, cable has continued to be a steady source of demand for broadband equipment. If the economy improves, and acceptance of integrated services accelerates, we believe cable will be a strong driver of growth for broadband equipment providers focused on equipment to facilitate digital service delivery from the cable headend to a customer premise.

Building upon the solutions that the Company has pioneered to date for the cable data industry, Com21 is focused on delivering system solutions that allow cable operators to realize the full potential of their digital networks. As we have demonstrated with our ComUNITY Access^® System, which comprised of the ComCONTROLLER^® line of headends (over 1850 shipped to date), ComPORT^® modems (over 1.1 million units shipped worldwide), and network management and provisioning system, or NMAPS, (over 400 copies installed, covering over a million subscribers worldwide), end-to-end product solutions are a key strength for Com21. Leveraging on this core competency, the following are some key elements of Com21's business strategy:

During March 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 common stock at a price of $3.1227 per share and a warrant to acquire up to an additional 3,505,981 shares of the Company's common stock at $9.0951 per share.

During December 2001, Com21 entered into a new revolving line of credit agreement, which allows Com21 to borrow up to the lesser of $10.0 million or 75% of Com21's eligible domestic and foreign accounts receivable. At December 31, 2001, $6.0 million was outstanding under the line of credit and there was no availability for additional borrowings.

During 2001, Com21 announced a number of programs to reduce operating expenses. These programs were designed to prioritize our initiatives around high-growth areas of the business, focus on profit contribution, and reduce expenses and capital spending. These restructuring programs included workforce reductions, reorganization and closure of certain business functions, and consolidation of facilities. As a result of the restructuring efforts, we recorded restructuring charges of $69.3 million for the year ended December 31, 2001.

Workforce Reduction - The restructuring programs resulted in the reduction of approximately 143 employees across all business functions and operating units, including employees of the wireless business unit, Maryland development center and corporate headquarters.

Closure of the Wireless Business Unit - In April 2001, we ceased development in our wireless business unit to focus our efforts on projects with shorter development cycles. All wireless employees were terminated and the facility located in Long Island, New York was closed in May 2001.

Sale of the Voice Systems Division (formerly known as GADline) - In June 2001, Com21 sold the voice systems division to the division's management team. The division's goodwill and purchased intangible assets were impaired. The impairment amount was equal to the amount by which the carrying amount exceeded the present value of the estimated future cash flows for goodwill and purchased intangible assets.

Closure of Excess Facilities - In the second quarter 2001, Com21 exited the wireless business unit facility in Long Island, New York; the Maryland development center in Germantown, Maryland; and a building in Milpitas, California.

The programs noted above reduced recurring operating expenditures during 2001 while allowing us to focus our development efforts on our core ATM and DOCSIS products, including our recently announced DOXcontroller^™ XB System.

For purposes of segment reporting, Com21 aggregates operating segments that have similar economic characteristics and meet the aggregation criteria of Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information." Based on such criteria, there are three operating and reportable segments: ATM Products, DOCSIS Products, and Voice Products. The ATM Products segment develops, manufactures, and markets the proprietary cable modems, ATM headend equipment and network management software. The DOCSIS Products segment develops, manufactures, and markets DOCSIS cable modems for both home and office. The Voice Products segment, based primarily in Israel, developed, manufactured, and marketed voice over Internet cable modems, and was, as noted above, sold during 2001.

ATM Segment - The ATM-based ComUNITY Access^® System is an end-to-end system solution including our headend, cable modem, and management software, all based on our proprietary technology. The market and customers for the segment are similar to the market and customers for our DOCSIS segment and are discussed in the "Markets" and "Customers" sections below. For financial information related to the ATM segment, see Note 15 in the Consolidated Financial Statements.

The ATM-based ComUNITY Access System consists of the following products:

DOCSIS Segment - The DOCSIS-based DOXport family of modems are Com21's standards-based solution that combines the advantages of interoperability while leveraging our technological leadership and modem expertise. The market and customers for the segment are similar to the market and customers for our ATM segment and are discussed in the "Markets" and "Customers" sections below. For financial information related to the DOCSIS segment, see Note 15 in the Consolidated Financial Statements.

The DOCSIS-based DOXport family of modems is based on the DOXport 1110:

Com21 currently has under development the following DOCSIS- based products:

Voice Segment - The ANEXT 1 product provided an analog circuit switching voice solution for cable networks that included a Public Switch Telephone Network, or PSTN, gateway using V5.2 and subscriber equipment. Both Plain Old Telephone Service (POTS) RJ11 phones and Integrated Service Digital Network, or ISDN devices are supported in the customer premise device. Com21 sold this segment during 2001 in connection with our restructuring activities.

CUSTOMERS

In North America, we generally sell directly to cable operators. Internationally, we sell primarily to system integrators, who in turn sell to cable operators. In 1999, 2000 and 2001 revenues attributable to international customers constituted 47%, 67% and 77%, respectively.

In 1999, revenues attributable to AT&T, Philips and Siemens accounted for 20%, 18% and 12% of net revenues, respectively. In 2000, revenues attributable to Siemens, Telindus, and Comcast Communications accounted for 12%, 11%, and 10% respectively. In 2001, revenues attributable to Telindus and Comcast Communications accounted for 25% and 10% of net revenues, respectively.

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

Residential consumer Internet users. Residential consumer Internet users generally only require a connection to their Internet service provider, or ISP, without the same level of security and reliability required by business and small office/home office, or SOHO users. Frequent users desire high-speed access to the Internet for Web browsing, gaming and downloading of multimedia applications and files.

Corporate telecommuter and remote office users. Corporate telecommuters and remote office business users need available, high-speed access to corporate intranets and corporate local area networks, or LANs. These users also must interconnect the LANs among their various offices. Such offices may be collocated or widely dispersed. Connections to a central telephone Private Branch Exchange, or PBX, rapid two-way transfer of large data files, desktop video conferencing, security, and reliability exemplify the services that business users may require.

Small office/home office, or SOHO users. SOHO users increasingly find the Internet an efficient means of communicating and processing transactions with customers and suppliers. Com21 believes these businesses require 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.

MANUFACTURING

Com21 tests and assembles its ComCONTROLLER headend equipment in its Milpitas, California facility. We outsource printed circuit board assemblies on a turnkey basis and perform final integration and burn-in at our Milpitas facility. We configure 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 with facilities in Mexico and Malaysia. In addition, we are in the process of finalizing an agreement with a new third party contract manufacturer to build our DOCSIS modems. With these contract manufacturers, we have and are currently developing and implementing a series of product test methodologies, quality standards, and process control parameters. We believe that employing turnkey manufacturers enables us to meet anticipated manufacturing needs and reduces the cost of product procurement.

We believe our current manufacturing capabilities can accommodate our requirements through the end of 2002 provided we are able to successfully begin and sustain production of our DOCSIS modems at our new contract manufacturer. Warranty and repair support is performed at third party repair facilities in Europe and the United States. Com21 received ISO 9001 certification in December 1998 and continues to maintain its certification.

MARKETING AND SALES

Marketing. Domestically, we have targeted our marketing efforts primarily at cable operators. We seek to work with local cable operators to promote Com21's products and accelerate cable modem service penetration. Internationally, we have focused our marketing efforts on supporting our systems integration partners' marketing programs.

RESEARCH AND DEVELOPMENT

We have focused our research and development efforts to prioritize initiatives around high-growth areas of the business and with a focus on profit contribution. We rely on our research and development programs for the development of new products and improvement of existing products in line with our goal of maximizing profit contribution.

Our research and development expenditures were $29.8 million in 1999, $48.6 million in 2000, and $24.9 million in 2001. 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, 2001, Com21 had a team of 84 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 and Cork, Ireland.

CUSTOMER SERVICE AND TECHNICAL SUPPORT

We believe that successful long-term relationships with our customers require a service organization committed to customer satisfaction. As of December 31, 2001, Com21 had 10 technical support employees. Com21 makes available to all new customers a five-day training course prior to receiving and installing a ComUNITY Access System.

In North America, Com21 provides direct support by telephone and at the customers' locations. Com21 supplies support 24 hours a day, seven days a week. Internationally, systems integrators provide first level support, and Com21 provides second level support. Com21 maintains a customer call tracking system that captures and monitors service activities. Com21 is able to identify problems with a customer's ComUNITY Access System through a dialup analog modem connection and a web-based management interface.

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 Motorola, Scientific-Atlanta, Inc., Toshiba America, Inc., Thomson, Samsung Electronics Company, Terayon Communication Systems, and Cisco Systems, Inc.

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

As of December 31, 2001, Com21 had 180 full-time employees. Of the total number of employees, 84 were in research and development, 18 in marketing and technical support, 26 in operations, 24 in sales, and 28 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.

You should carefully consider the risks described below before making a decision to invest in Com21. You may lose all or part of your investment. The risks and uncertainties described below are not the only ones facing Com21.

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 revenues and gross margins.

Revenues for any future quarter are difficult to predict. Delays in the product distribution schedule of one or more of our cable operator customers would likely reduce our operating results for a particular period.

Factors that could cause our revenues to fluctuate include:

• pressure to reduce prices;
• variations in the timing of orders and shipments of our products;
• variations in the size of orders by our customers;
• new product introductions by us or by competitors;
• delays in obtaining certification for our standards-based products;
• general economic conditions and economic conditions specific to the cable and electronic data transmission industries;
• cable operators' financial ability to purchase our products; and
• delays in obtaining regulatory approvals necessary to sell our products.

We cannot assure you that any additional financing will be available to us on acceptable terms, or at all, when required. As previously announced, we are currently evaluating alternative forms of financing. These alternatives may include the sale of additional stock, additional lines of credit, and the additional divestiture of certain business assets. If issuing equity securities raises additional funds, significant dilution to existing stockholders may result given the current price of our common 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.

In light of our current financial situation and our history of operating losses, we expect such financing to be available but it may be at less favorable terms than our present financing arrangement. Further alternative forms of financing may also restrict Com21's operations or limit our ability to respond quickly to changes in the marketplace.

At December 31, 2001, we had an accumulated deficit of approximately $241.3 million. If we do not increase revenues, improve gross margins, and reduce operating expenses, we may also incur net losses during future quarters. Because of a decline in our revenues in the fourth quarter of 2000, we introduced measures to reduce operating expenses that resulted in restructuring charges of $69.3 million in the twelve months ended December 31, 2001. In January 2002, we had an additional work force reduction due to the reorganization of Com21 from a divisional structure centered on multiple product lines to a single functional organization. We continue to monitor market conditions to assess the need to take further action, if necessary. Any subsequent actions may result in additional workforce reductions, restructuring charges, discontinuation of product lines, and provisions for impairment of long-lived assets, which could harm our financial position, results of operations and stock price.

We contract for the manufacture of cable modems and integrated circuit boards on a turnkey basis. Our future success will depend, in significant part, on our ability to have others manufacture our products cost-effectively, in sufficient volumes and to meet production and delivery schedules. Dependence on third-party manufacturers presents a number of risks, including:

In the fourth quarter of 2001, we entered into a contract with a new contract manufacturer for the manufacture of ATM cable modems. If the transition from the existing third-party manufacturers to this new contract manufacturer does not occur on a timely basis, or if the new contract manufacturer is not able to produce our product to our quality standards, or at a volume large enough to fulfill our orders then our revenues and margins could be harmed.

We are in the process of entering into a contract with a new contract manufacturer for the manufacture of DOCSIS cable modems and expect to finalize the contract by April 2002. If the transition from existing third-party manufacturer to this new contract manufacturer does not occur on a timely basis, or if the new contract manufacturer is not able to produce our product to our quality standards, or at a volume large enough to fulfill our orders then our revenues and margins could be harmed.

Any manufacturing disruption could impair our ability to fulfill orders. We have arrangements with any of our vendors that guarantee product availability, the continuation of particular payment terms, or the extension of credit limits. We may experience manufacturing or supply problems in the future. We are dependent on our manufacturers to secure components at favorable prices, and in sufficient volume. If our contract manufacturers fail to perform in any of these areas, it could harm our relationships with customers. Failure to obtain these components and supply our customers with our products would decrease our revenues.

Our operating results are impacted significantly by our ability to improve and sustain gross margins. The factors which impact gross margins and cause them to fluctuate from quarter to quarter include:

• pressures to reduce prices;
• write-off of excess inventory;
• changes in the cost of inventory;
• the sales mix within a product group, especially between proprietary ATM and standards-based DOCSIS modems;
• component prices we secure from our vendors;
• the average selling prices of our products;
• the effectiveness of our cost reduction efforts;
• the sales mix between our headend equipment and cable modems;
• the ability of the new contract manufacturers to produce quality products; and
• the volume of products manufactured.

Additionally, our inability to reduce inventory levels may result in substantial inventory-related charges including marking component inventory to current market prices because of falling component prices, carrying charges from our contract manufacturers, and significant write-offs of excess and obsolete inventory that would not be utilized.

A reduction in gross margins would harm our operating results and reduce the amount of cash flow generated from our operations. Additionally, if operating results did not satisfy the expectations of analysts or investors, the trading price of our common stock would likely decline.

In March 2002, Com21 cancelled all outstanding purchase orders with our two primary contract manufacturers. In connection with the cancellation, we signed promissory notes for existing payables to the vendors and for excess component inventory materials held by the vendors. These notes total approximately $22.5 million, bear interest at an average rate ranging from 8% to 10% and mature in December 2003 and May 2004. The approximate $9.3 million of materials held by the vendors will likely be of no future use to Com21 as a result of the new DOCSIS contract manufacturing arrangement we entered into with a new third party in March 2002. Accordingly, the materials with no future use will be written off during the first quarter of 2002. Our provision for excess and obsolete inventory at December 31, 2001 did not contain provisions for this inventory held by the vendors. In addition to the notes, Com21 granted warrants to the vendors to purchase a total of 350,000 shares of common stock. For additional information see Note 17 to the financial statements.

We may not be able to maintain our listing on the national market.

Our common stock is currently listed on the Nasdaq National Market. We must satisfy a number of requirements to maintain our listing on the Nasdaq National Market, including maintaining a minimum bid price for our common stock of $1.00 per share. As of March 27, 2002, the price of our common stock was $1.34. If the common stock loses its Nasdaq National Market status, it would likely trade on the Over the Counter Bulletin Board maintained by Nasdaq, which is viewed by most investors as a less desirable, less liquid marketplace.

Some of our competitors have assets and annual revenues that far exceed ours and because of their financial status, greater product portfolio, and higher volume sales are able to offer cable modem products at lower prices than we can. As headend equipment becomes more widely distributed, the price of cable modems and related equipment will continue to decrease. In particular, the adoption of the DOCSIS standard has caused increased price competition for cable modems. To remain competitive, we may have to lower the price of 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 to secure component parts at a low enough cost to enable us to lower our modem prices to compete effectively. 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 we are unable to continue to reduce the manufacturing costs of our cable modems, our gross margin and operating results could be harmed.

We have not made a profit, and we expect to continue to operate at a loss through the first half of 2002. To achieve and subsequently maintain profitable operations, we must successfully design, develop, test, manufacture, introduce, market and distribute products on a broad commercial basis and secure higher revenues and gross profits and contain our operating expenses. Our future revenues will depend on a number of factors, many of which are beyond our control. These factors include our ability to:

• reduce prices;
• manufacture products at acceptable quality standards;
• have product available when our customers need it;
• meet industry standards;
• respond to technological change; and
• have a strong competitive advantage.

Due to these factors, we cannot forecast with a degree of accuracy what our revenues will be or how quickly cable operators will adopt our systems and buy our cable modems. If we do not generate sufficient revenues and gross margins, we may not achieve, or be able to sustain, profitability.

A relatively small number of customers have accounted for a large part of our revenues, and we expect that this trend will continue. For the year ended December 31, 2001, our top five customers accounted for 54% of total revenues. We expect that our largest customers in the future could be different from our largest customers today due to a variety of factors, including customers' distribution schedules and budget considerations. Additionally, some of our systems integrators could develop and manufacture products that compete with our products and choose not to distribute our products. Because a limited number of companies account for a majority of our prospective customers, our future success will depend upon our ability to establish and maintain relationships with these companies. We may not be able to retain our current accounts or to obtain additional accounts. Both in the U.S. and internationally, a substantial majority of households passed by cable access are controlled by a relatively small number of companies. The loss of one or more of our customers or our inability to successfully develop relationships with other significant cable operators could cause our business to suffer.

The market for cable modem systems and products is characterized by rapidly changing technologies and short product life cycles. Our future success will depend in large part upon our ability to:

• identify and respond to emerging technological trends in the market;
• develop and maintain competitive products;
• enhance our products by adding innovative features that differentiate our 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.

The technological innovations required for us to remain competitive are inherently complex, require long development cycles, are dependent in some cases on sole source suppliers and require us, in some cases, to license technology from others. If our product development and enhancements take longer than planned, the availability of products would be delayed. We must continue to invest in research and development to attempt to maintain and enhance our existing technologies and products, but we may not have the funds available to do so. Even if we have sufficient funds, these investments may not serve the needs of our customers or be compatible with changing technological requirements or standards. Most costs must be incurred before we can determine the technological feasibility or commercial viability. In addition, revenues from future products or product enhancements may not be sufficient to recover the development costs incurred by these products or enhancements.

We may not be successful in managing the transition from our current products to our new and enhanced products. Product transitions contain a number of inherent risks, including obsolescence of product inventory, unavailability of product as inventory of existing product is exhausted before availability of new product, market acceptance of new products, undetected defects in new products, and availability of components and parts in new products. If we are unable to successfully manage the risks of the release and transition of new and enhanced products, our revenues could be reduced.

There are many different methods of getting high speed Internet access to the end customers. These methods include:

• Regular dial up connection-using a telephone line and the average 28K or 56K modem;
• Digital subscriber line/asymmetric digital subscriber line-a digital high- speed modem connection offered by telephone companies, also known as DSL or ADSL;
• Cable modems-high-speed modem connections offered by cable television companies;
• Wireless-high-speed wireless local loop connections that work similar to cell phones. Digital subscriber line/asymmetric digital subscriber line and cable modems can operate in a wireless environment; and
• Fiber optics-strands of very pure glass capable of carrying enormous volumes of data and voice traffic.

Because of the widespread reach of telephone networks and the financial resources of telephone companies, competition from telephone-based solutions is expected to be intense. Cable modem technology may not be able to compete effectively against wireline or wireless technologies. Significant market acceptance of alternative solutions for high-speed data transmission could decrease the demand for our 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. Our competitors include Motorola, Inc., Scientific-Atlanta, Inc., Toshiba America, Inc., Thomson, Samsung Electronics Company, Terayon Communication Systems, and Cisco Systems, Inc.

We believe that our business is affected by the following competitive factors:

• costs;
• ease of installation;
• technical support and service;
• breadth of product line;
• conformity to industry standards; and
• implementation of additional product features and enhancements.

Many of our existing 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 we do. 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 we do. Some competitors may sell their modems at below cost to reduce excess inventories, causing severe price competition.

Our customers have increasingly been requiring us to ship product upon ordering instead of submitting purchase orders far in advance of expected shipment dates. This practice requires us to keep inventory on hand for immediate shipment. Any significant cancellations or deferrals could adversely affect our business by slowing our growth and decreasing our revenues. Additionally, cancellations or deferrals could cause us to hold excess inventory, which could reduce our profit margins and restrict our ability to fund our operations. In particular, increases in inventory could cause a harmful effect on operations if this inventory is not used or becomes obsolete. This risk could be realized in inventory write-offs in any given period.

Our products are complex and may contain undetected defects, errors, design deficiencies, or may have been manufactured incorrectly. Our products have contained errors in the past and may contain errors in the future. Defects, errors, or failures in our products could result in delayed shipments, returned products, and loss or delay of market acceptance of our products. We could incur costs or losses in excess of amounts that we have reserved for these events. Although we have not experienced any product liability claims, due to the highly technical nature of our products, such a risk exists. A successful product liability claim brought against us could impair our business, operating results, and financial condition by forcing us to use cash and personnel resources. This would limit our ability to grow the company and would decrease our revenues.

The trading price of our common stock has fluctuated significantly since our initial public offering in May 1998. The common stock price has fluctuated between $3.03 per share and $0.43 per share in the last 12-month period. The price of our common stock could continue to be subject to wide fluctuations in response to a variety of factors including:

• variations in quarterly earnings;
• announcements of technological innovations or new products by us or our competitors;
• announcements by certification and standards bodies;
• the state of Com21's patents or proprietary rights; and
• changes in financial estimates by securities analysts.

Additionally, the stock market is volatile. This volatility has particularly affected the stock prices of equity securities of many high technology companies and, often, has been unrelated or disproportionate to the operating performance of these companies. Our stock price has declined significantly and our stock price may continue to decline because of these broad market and industry factors, regardless of our actual operating performance. These broad market fluctuations may lower the market price of Com21 common stock. Additionally, Com21 may choose to structure acquisitions or other financing transactions by issuing additional Com21 common stock, or warrants or options to purchase Com21 common stock that would dilute common stock outstanding. Although Com21's management believes these types of transactions will increase the overall long- term value of Com21, these transactions may initially decrease the market price of our common stock.

Competition for these personnel is intense; however, there is less competition for these skilled workers in other countries. In June 2001 we completed, the transfer of the research and development, product management, and marketing functions for the proprietary ComUNITY Access System product line to our facility in Cork, Ireland. We made this transition to take advantage of the greater availability of qualified personnel in Cork to support this product line. However, the loss of any key Cork employee with technical, marketing or support knowledge may affect our ability to provide timely development and support activities for the ComUNITY Access System product line.

Our standard credit terms are net 30 days from the date of shipment, and we generally do not require collateral or other security to support customer receivables. Starting with third quarter 2001, we offered certain customers a 2% discount for payment received within 10 days of the invoice date. We may require letters of credit from a customer before shipping an order if we determine that the customer has not proven to be creditworthy.

We rely on contract manufacturers for the production of our products. Contract manufacturers generally require revenue forecasts in order to manage component inventories to meet customer demand. Accordingly, our contract manufacturers may order substantial amounts of inventory to meet our revenue forecasts. If our future shipments do not utilize the committed inventory, these contract manufacturers would have the right to charge us for inventory carrying costs and to bill us for any excess component and finished goods inventory. We would be required to fulfill these obligations even if demand for our products were lower than we anticipate, which could reduce our working capital and have a negative impact on our financial position.

Early cable modem equipment was not interoperable, meaning cable modem products from different cable modem developers would not work together. For different companies' products to work together, each company must meet an established standard. For each standard, a certification body is established to certify that a product does meet the standard. Cable operators are demanding certified standards-based cable modem products for two primary reasons. First, a certified product has proven to have the functionality they want. Second, certified interoperable products give cable operators the freedom to buy products from a variety of cable modem manufacturers, creating increased competition and driving down prices.

The widespread adoption of DOCSIS, EuroDOCSIS or other standards could cause aggressive competition in the cable modem market and result in lower sales of Com21's proprietary products not design to these standards. As cable operators move to standards-based products, sales of Com21's proprietary headend products, and revenues from licensing of our network management software could decrease if our products do not meet the appropriate standards. This could reduce our gross margin and our operating results.

As we research and introduce new products and services such as the DOXcontroller XB System, we may encounter risks not present in our current business. We must anticipate and manage these risks, which may include new regulations, competition, technological requirements and our own ability to deliver or maintain reliable services to our customers or partners. Failure to do so may result in unrecovered costs, loss of market share or adverse publicity.

Today, cable operators and systems integrators purchase cable modems from vendors through direct and indirect sales channels. We anticipate that the North American cable modem market may at some point shift to a consumer purchase model. If this occurs, we will likely sell more of our cable modems directly through consumer sales channels. Our success will be dependent on our ability to market effectively to end users, to establish brand awareness, to set up the required channels of distribution and to have cable operators' reference sell our products. We have begun to establish new distribution channels for our cable modems. We may not have the capital required or the necessary personnel or expertise to develop these distribution channels, which could harm our business, operating results, and financial condition. As large consumer electronics companies enter the cable modem market, their well-established retail distribution capabilities and brands would provide them with a significant competitive advantage.

We depend on our proprietary technology. To protect our intellectual property rights we rely on a combination of patent, copyright and trademark laws, and trade secrets, confidentiality provisions and contractual provisions to protect our proprietary rights. However, any of our intellectual proprietary rights could be challenged by third parties. Our means of protecting our proprietary rights in the U.S. or abroad may not be adequate. An unauthorized party may attempt to copy aspects of our products or to obtain and use trade secrets or other proprietary information. Additionally, 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 we do not enforce and protect our intellectual property, our business will be harmed.

Third parties may claim that we are infringing on their intellectual property. Even if we do not believe that our products are infringing third parties' intellectual property rights, these claims can be time-consuming, costly to defend, and divert management's attention and resources away from our business. Claims of intellectual property infringement might also require us to enter into costly royalty or license agreements. If we cannot or do not license the infringed technology or substitute similar technology from another source, our business could suffer. We may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Litigation to determine the validity of any claims, whether or not the litigation is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel from productive tasks. If there is an adverse ruling against us in any litigation, we may be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology, or obtain licenses to infringing technology. Our failure to develop or license a substitute technology could prevent us from selling our products.

To drive costs out of our business and improve our operating efficiencies, we may 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 our core technologies and;
• effectively manage multiple relationships with our customers, suppliers, and other third parties.

Additionally, we must continue to recruit and retain personnel, and failure to do so would prevent us from achieving our operational goals. Also, our management team may not be able to achieve the rapid execution necessary to fully exploit the market for our products and services. In the future, we may experience difficulties meeting the demand for our products and services. We cannot assure you that our systems, procedures, or controls will be adequate to support the anticipated growth in our operations or that we will be able to achieve the operational efficiencies needed to be competitive. Any failure could materially cause us not to meet our operating revenues and cost objectives and weaken our financial position.

Our business strategy relies to a significant extent on strategic relationships with other companies. These relationships include:

• software license arrangements for our network management system;
• technology licensing agreements;
• development arrangements and agreements with original equipment manufacturers 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 our cable modems with these suppliers' products.

The failure to maintain and develop these relationships, or replace them if any of these relationships are terminated and to renew or extend any license agreements with a third party may harm our business.

Our business is subject to the effects of general economic conditions in the United States and globally, and, in particular, market conditions in the communications and networking industries. In recent quarters, our operating results have been adversely affected by unfavorable economic conditions and reduced capital spending in the United States, Europe and Asia. In particular, sales to North America, and the manufacturing industry in the United States were materially affected during fiscal 2001. If the economic conditions in the United States and globally do not improve, or if we experience a worsening in the global economic slowdown, we may continue to experience negative impacts on our business, operating results, and financial condition.

For the year ended December 31, 2001, international sales accounted for 77% of revenues. We intend to enter new international markets, and we expect that a significant portion of our sales will continue to be in international markets. Because we sell primarily through systems integrators, a successful expansion of our international operations and sales may require us to develop relationships with new international systems integrators and distributors. If we are unable to identify, attract or retain suitable international systems integrators or distributors, we may not be able to successfully expand our international operations. To increase revenues in international markets, we will need to continue to establish foreign operations, to hire additional personnel to run these operations and to maintain good relations with our foreign systems integrators and distributors. If we are unable to successfully do so, our growth in international sales will be limited, which would reduce our operating results. Additionally, international operations involve a number of risks not typically present in domestic operations, including:

• changes in regulatory requirements;
• the possibility of difficult accounts receivable collections;
• costs and risks of distributing 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;
• the imposition of legislation and regulations on the import and export of high technology products; and
• fluctuations in foreign currency especially with the increasing use of Euro as common currency for members of European union, this could have an impact on foreign exchange exposure.

There has been a trend toward industry consolidation for several years, which is expected to continue through 2002. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry. We believe that industry consolidation may produce increasingly stronger competitors that are better able to compete. This could lead to more variability in operating results as we compete to be a vendor solution and could harm our business, operating results, and financial condition. We believe that industry consolidation may lead to fewer possible customers. If we are unable to maintain our current customers or secure additional customers, our business could be harmed.

Our business operations may be impacted by the California energy crisis.

Our principal executive offices are located in the Silicon Valley in Northern California. In 2001, California experienced an energy crisis that resulted in disruptions in power supply and increased utility costs to consumers and businesses throughout the State. Should the energy crisis continue, Com21, together with many other Silicon Valley companies, may experience power interruptions and shortages and be subject to significantly higher costs of energy. Although we have not experienced any material disruption to our business to date, if the energy crisis continues and power interruptions or shortages occur in the future, they may cause a decline in our business.

Com21's corporate headquarters, including some of its research and development operations and our 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 halt our business, weaken our financial condition and create disappointing operating results.

A dispute has arisen with one of the Company's significant shareholders regarding the terms of a March 6, 2001 private placement of securities. To date, this investor has not resorted to litigation and we believe that this dispute can be resolved amicably, and without any material impact on the Company's results of operations, liquidity, and financial condition. Nevertheless, should litigation ensue, the Company will be required to expend management time and financial resources to defend the action. We believe that any potential claims arising from this dispute are without merit, and we will vigorously defend them. However, failure to successfully defend any such action could negatively affect our results of operation, liquidity, or financial position.

Com21's common stock is traded on the Nasdaq National Market under the symbol "CMTO". There are 263 holders of record as of February 28, 2002.

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, and we do not intend to declare or pay dividends in the near future.

On March 6, 2001, the Company entered into a definitive agreement to complete a $7.7 million private equity financing with Fletcher International Limited (Fletcher). Pursuant to a subscription agreement, dated February 28, 2001, the Company sold 2,450,000 shares of unregistered common stock at a price of $3.1227 per share and a warrant to acquire up to an additional 2,450,000 shares of the Company's common stock at $9.0951 per share. The offer and sale of these shares were not registered under the Securities Act of 1933, as amended, at the time of issuance pursuant to the exemption provided by Regulation D. These shares were subsequently registered. The warrant is exercisable for a period of seven years from the date of issuance. In accordance with the agreement terms, Com21 amended the warrant to Fletcher to provide that an additional 1,055,981 shares of common stock were issuable under the warrant since the common stock sold in the financing was not registered by June 5, 2001. There are 553,731 shares of common stock issuable under the warrant which have not yet been registered.

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, 2001, and the consolidated balance sheet data at December 31, 2000 and 2001, 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, 1997 and 1998 and the consolidated balance sheet data as of December 31, 1997, 1998 and 1999 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):

                                                   Years Ended December 31,
                                     -----------------------------------------------------
                                       1997       1998       1999       2000       2001
                                     ---------  ---------  ---------  ---------  ---------
Consolidated Statement of
  Operations Data:
Net revenues....................... $  15,649  $  48,114  $  95,743  $ 193,983  $ 122,761
Cost of net revenues...............     8,372     29,573     60,918    151,319    116,826
                                     ---------  ---------  ---------  ---------  ---------
  Gross profit.....................     7,277     18,541     34,825     42,664      5,935
                                     ---------  ---------  ---------  ---------  ---------
Operating expenses:
  Research and development.........    13,481     19,936     29,821     48,556     24,867
  Sales and marketing..............     5,277     10,273     16,250     29,145     19,490
  General and administrative.......     1,782      3,871      4,120     16,167     18,488
  Restructuring charges............        --         --         --         --     69,320
  In-process research and
     development...................        --         --         --      8,823         --
                                     ---------  ---------  ---------  ---------  ---------
    Total operating expenses.......    20,540     34,080     50,191    102,691    132,165
                                     ---------  ---------  ---------  ---------  ---------
Loss from operations...............   (13,263)   (15,539)   (15,366)   (60,027)  (126,230)
Total other income (expense), net..       229      2,190      5,104      3,993         (3)
                                     ---------  ---------  ---------  ---------  ---------
Loss before income taxes...........   (13,034)   (13,349)   (10,262)   (56,034)  (126,233)
Income taxes.......................        21         14         55         22         19
                                     ---------  ---------  ---------  ---------  ---------
    Net loss....................... $ (13,055) $ (13,363) $ (10,317) $ (56,056) $(126,252)
                                     =========  =========  =========  =========  =========

Net loss per share, basic
  and diluted...................... $   (6.15) $   (1.10) $   (0.49) $   (2.42) $   (4.67)
                                     =========  =========  =========  =========  =========
Shares used in computation,
  basic and diluted................     2,124     12,150     20,932     23,123     27,031
                                     =========  =========  =========  =========  =========


                                                          December 31,
                                     -----------------------------------------------------
                                       1997       1998       1999       2000       2001
                                     ---------  ---------  ---------  ---------  ---------
Consolidated Balance Sheet Data:
Cash, cash equivalents, restricted
  cash and short-term investments.. $  17,980  $  65,744  $ 106,023  $  45,914  $  29,735
Working capital....................    19,523     68,084    112,233     63,483     21,524
Total assets.......................    31,573     82,948    141,166    214,365     84,975
Long-term debt obligations.........     1,508        936        345          9        198
Total stockholders' equity......... $  23,283  $  73,366  $ 120,078  $ 142,638  $  31,206

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 revenues 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.

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Our preparation of these consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets and liabilities, 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. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from such estimates under different assumptions or conditions. The following summarizes our critical accounting policies and significant estimates used in preparing our consolidated financial statements:

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 intended use. Gains and losses on sales of investments are determined on a specific identification basis. We perform periodic reviews of their investments for impairment. Investments in publicly held companies are generally considered impaired when a decline in the fair value of an investment as measured by quoted market prices is less than its carrying value and such decline is not considered temporary. Investments in privately held companies are considered impaired when a review of the investee's operations and other indicators indicate that the carrying value of the investment is not likely to be recoverable. Such indicators used to evaluate impairment include, but are not limited to, capital resources, prospects of receiving additional financing, and prospects for liquidity of the related securities. If our estimates of fair value change in the future, we may be required to record additional impairment charges.

Inventories - Inventories consist of networking equipment, modems and sub- assemblies stated at the lower of cost (first-in, first-out method) or market. We write-down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additionally inventory write-downs may be required.

As of December 31, 2001, we also have made future commitments of approximately $12.1 million in purchase commitments to our two primary contract manufacturers. If our future shipments do not utilize the committed inventory, these contract manufacturers have the right to charge us for inventory carrying costs and to bill us for any excess components and finished goods inventory. We also had a $10.4 million non-cancelable purchase order with a major chip supplier at December 31, 2001.

In March 2002, Com21 cancelled all outstanding purchase orders with its two primary contract manufacturers. In connection with the cancellation, we signed promissory notes for existing payables to the vendors and for certain materials held by the vendors. These notes total approximately $22.5 million, bear interest at an average rate ranging from 8% to 10% and mature in December 2003 and May 2004. The approximate $9.3 million of materials held by the vendors will likely be of no future use to Com21 as a result of the new DOCSIS contract manufacturing arrangement we are in the process of entering into with a new third party in 2002. Accordingly, the materials with no future use will be written off during the first quarter of 2002. Our provision for excess and obsolete inventory at December 31, 2001 did not contain provisions for this inventory held by the vendors. In addition to the notes, Com21 granted warrants to the vendors to purchase a total of 350,000 shares of common stock. For additional information see Note 17 to the financial statements.

In March 2002, Com21 also signed a letter agreement with our major chip supplier to cancel the purchase order of $10.4 million in exchange for an exclusive relationship on certain components over a two-year period with no specified volume commitment.

Closure of Excess Facilities Restructuring Accrual - In calculating the charge related to our facilities consolidation, certain estimates were used, sublease terms upon the negotiation of future subleases, broker commissions, tenant improvements and operating costs. In developing our estimates, we obtained information from third party leasing agents to calculate anticipated third party sublease income and the vacancy period prior to finding a sub lessee. In calculating the undiscounted value of ongoing lease commitments for unused facilities, we considered ongoing facilities needs and the sublease rate. Market conditions will affect our ability to sublease facilities on terms consistent with our estimates. Management re-evaluates these estimates quarterly, based on the availability of more recent information and makes adjustments to the facilities charges accordingly. Our ability to sublease facilities ahead of schedule or the negotiation of lease terms resulting in higher or lower sublease income than estimated will affect our accrual and the related restructuring charge. Difference between estimates of related broker commissions, tenant improvements and operating costs may increase or decrease the accrual upon final negotiation. The restructuring accrual for closure of excess facilities at December 31, 2001 was $5.1 million, which is comprised of $9.6 million of future rent obligations offset by $4.5 million of estimated future sublease income, net of costs.

We are a leading global supplier of system solutions for the broadband access market. Our products enable domestic and international cable operators to provide high-speed, cost-effective Internet access, reduce operating costs, and maximize revenues opportunities in a variety of subscriber markets - including residential, corporate telecommuters, and small businesses. We develop, manufacture and sell headend equipment, subscriber cable modems, and network management software, all designed to support Asynchronous Transfer Mode, or ATM, Data Over Cable System Interface Specification, or DOCSIS, and Euro-DOCSIS industry standards. In the North American market, we primarily sell directly to cable operators and systems integrators. Internationally, we sell primarily to systems integrators, who in turn sell to cable operators.

During March 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 $3.1227 per share and a warrant to acquire up to an additional 3,505,981 shares of the Company's common stock at $9.0951 per share.

During December 2001, Com21 entered into a new revolving line of credit agreement, which allows Com21 to borrow up to the lesser of $10.0 million or 75% of Com21's eligible domestic and foreign accounts receivable. At December 31, 2001, $6.0 million was outstanding under the line and there was no availability for additional borrowings.

During 2001, Com21 announced a number of programs to reduce operating expenses. These programs were designed to prioritize our initiatives around high-growth areas of the business, focus on profit contribution, and reduce expenses and capital spending. These restructuring programs included workforce reductions, reorganization and closure of certain business functions, and consolidation of facilities. As a result of the restructuring efforts, we recorded restructuring charges of $69.3 million for the year ended December 31, 2001.

Workforce Reduction - The restructuring programs resulted in the reduction of approximately 143 employees across all business functions and operating units, including employees of the wireless business unit, Maryland development center and corporate headquarters.

Closure of the Wireless Business Unit - In April 2001, we ceased development in our wireless business unit to focus our efforts on projects with shorter development cycles. All wireless employees were terminated and the facility located in Long Island, New York was closed in May 2001.

Sale of the Voice Systems Division (formerly known as GADline) - In June 2001, Com21 sold the voice systems division to the division's management team. This division's goodwill and purchased intangible assets were impaired, measured as the amount by which the carrying amount exceeded the present value of the estimated future cash flows for goodwill and purchased intangible assets.

Closure of Excess Facilities - In the second quarter 2001, Com21 exited the wireless business unit facility in Long Island, New York; the Maryland development center in Germantown, Maryland; and a building in Milpitas, California.

The programs noted above reduced recurring operating expenditures during 2001 while focused our development efforts on our core ATM and DOCSIS products, including our recently announced DOXcontroller^™ XB System.

Results of Operations - Years Ended December 31, 1999, 2000, and 2001

Net Revenues. Net revenues in 2001 decreased by 36.7% to $122.8 million as compared to $194.0 million in 2000. Unit sales of all our cable modem products decreased 14.8% from 2000, and unit sales of our headend products decreased 26.1% from 2000. The decrease in revenues is due to the economic slowdown, which has affected and continues to affect our customers' purchases and the rebalancing of their inventory levels. The decrease in revenues is also due to a shift in product mix to include higher unit volumes of the lower priced DOCSIS modems coupled with a decline in the average selling price of DOCSIS cable modems from the third quarter of 2000 due to heavy price competition.

Total revenues increased by 102.6% to $194.0 million in 2000 as compared to $95.7 million in 1999. Our revenues growth was principally due to the growth in cable modem revenues over the prior year. Cable modem sales accounted for 85.4% of net revenues in 2000 as compared to 78.1% of net revenues in 1999. The average sales price of our cable modems declined during 2000, as expected. Our prices decreased primarily 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 continued pricing pressure on our cable modems and headend equipment, and declines in the average selling price of our ATM and DOCSIS cable modems and headend equipment.

Gross Margins. Gross margins decreased to 4.8% in 2001 from 22.0% in 2000. The decrease in margins is primarily due to the following factors:

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

• The sale of more DOCSIS modems, which have lower gross margins than our proprietary ATM modems. DOCSIS modem shipments increased from 49.8% of total Com21 modems shipped in 2000 to 55.3% of total Com21 modems shipped in 2001. The adoption of the DOCSIS-based standard has caused considerable price pressure due to the number of competitors in the marketplace.
• Carrying charges resulting from excess inventory at our contract manufacturers.
• Write off of our obsolete component and finished goods inventory.
• Sales of high cost OEM DOCSIS modems and first generation DOCSIS modems at clearance prices resulting in negative gross margins.
• Amortization of intangible assets acquired core and existing technologies as a result of the GADline acquisition.

During 2002 we anticipate continued pressure on margins due to the following:

• In March 2002, Com21 cancelled all outstanding purchase orders with its two primary contract manufacturers. In connection with the cancellation, we signed promissory notes for existing payables to the vendors and for certain materials held by the vendors. These notes total approximately $22.5 million, bear interest at an average rate ranging from 8% to 10% and mature in December 2003 and May 2004. The approximate $9.3 million of materials held by the vendors will likely be of no future use to Com21 as a result of the new DOCSIS contract manufacturing arrangement we are in the process of entering into with a new third party in March 2002. Accordingly, the materials with no future use will be written off during the first quarter of 2002. Our provision for excess and obsolete inventory at December 31, 2001 did not contain provisions for this inventory held by the vendors. In addition to the notes, Com21 granted warrants to the vendors to purchase 350,000 shares of common stock. For additional information see Note 17 to the financial statements.
• Increased sales of our DOCSIS modems. If the mix of shipments shifts to the lower margin DOCSIS modems from ATM modems, then our total margin percentage will decline.

• Continuing price pressure due to competitive pricing offered by our competitors to move inventory and increase market share.

We are taking steps to counter the impact of this price erosion by continuing modem cost reduction programs.

As noted above, cable modem sales accounted for 83.9% of revenues in 2001 and 85.4% in 2000. Additionally, revenues from our DOCSIS modems have become a more significant portion of our total cable modem revenues. Cable modems have lower margins than our headend products and our DOCSIS cable modems currently have lower margins than our proprietary ATM modems.

Gross margin decreased to 22.0% in 2000 from 36.4% in 1999. The decrease in margins was 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 10.0% of total Com21 modem shipments in 1999 to 393,000 units or 49.8% 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 market place.

Research and Development. Research and development expenses consist primarily of personnel costs, as well as prototype material expenditures and equipment and supplies required to develop and to enhance our products. Research and development expenses decreased 48.8% to $24.9 million in 2001 from $48.6 million in 2000. The decrease in research and development expenses is due to our efforts to reduce expenses. These efforts involved workforce reductions, elimination of certain development programs, and closure and consolidation of research and development facilities, as we refocus our development efforts on key technology initiatives. In 2002, we anticipate that research and development expenses will be less than the 2001 level by $8.0 million to $11.0 million. The decline is likely to result from the 2001 personnel reductions as well as the continuing effort to reduce expenses and future work force reductions.

Research and development expenses increased 62.8% to $48.6 million in 2000 from $29.8 million in 1999. The increase in 2000 was 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, a charge of $1.3 million was incurred in 2000 due to the amortization of intangibles associated with these acquisitions.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries and commissions for sales personnel, marketing and support personnel and costs related to trade shows, consulting and travel. Sales and marketing expenses decreased 33.1% to $19.5 million in 2001 from $29.1 million in 2000. This decline is due to our efforts to reduce costs which involved workforce reductions and a decrease in spending on marketing programs. In 2002, we anticipate that sales and marketing expenses will be less than the 2001 level by $8.0 million to $10.0 million. The decline is likely to result from the 2001 personnel reductions as well as the continuing effort to reduce expenses and future work force reductions.

Sales and marketing expenses increased 79.4% to $29.1 million in 2000 from $16.3 million in 1999. The increase in 2000 was 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.

General and Administrative. General and administrative expenses primarily consist of salary and benefits for administrative officers and support personnel, travel expenses, legal, accounting and consulting fees. General and administrative expenses increased 14.4% to $18.5 million in 2001 from $16.2 million in 2000. This increase is related to higher personnel related costs, increased rent, inclusion of expenses of our GADline acquisition, professional fees, and insurance costs. In 2002, we anticipate that sales and marketing expenses will be less than the 2001 level by $7.0 million to $9.0 million. The decline is likely to result from the 2001 personnel reductions as well as the continuing effort to reduce expenses and future work force reductions.

General and administrative expenses increased 292.4% 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.

Restructuring Charges. Restructuring charges of $69.3 millions resulted from the measures Com21 introduced during 2001 to reduce operating expenses. This included reductions in workforce, reorganization and closure of certain business functions, and consolidation of excess facilities.

In-Process Research and Development. Com21 recorded a one-time charge associated with the GADline acquisition 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. Management believes that the in-process research and development had no alternative future use.

Total Other Income (Expense), Net. Total other income (expense), net decreased to a $3,000 expense in 2001 from $4.0 million in income in 2000. This decrease was attributable to lower interest income on a declining cash and investments balance during 2001 coupled with $867,000 in interest expenses charged by the line of credit and term loan, and $769,000 of recognized unrealized loss on a current investment.

Total other income (expense), 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.

Income Taxes. Income tax expense for all years consisted solely of state franchise taxes. We have not recorded any income tax 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, 2001, we had cash, cash equivalents and short-term investments of $29.7 million of which $10.0 million is restricted for use under a stand-by letter of credit. The stand-by letter of credit was issued to our primary contract manufacturer, Celestica, to provide financial support for our manufacturing plans during 2000.

Net cash used in operating activities was $18.0 million in 2001. Cash used in operating activities primarily resulted from outflows due to: a net loss of $126.3 million which included restructuring charges of $65.7 million; a decrease in accounts payable of $10.4 million; a decrease in accrued compensation and related benefits of $2.0 million; and a decrease in other current liabilities of $2.9 million. The cash outflows were offset by a decrease in total accounts receivable of $27.4 million; a decrease in inventory of $13.5 million; and a decrease in prepaid and other assets of $2.7 million.

Net cash provided by investing activities was $8.6 million in 2001. Cash provided by investing activities was primarily attributable to net proceeds from the sales and maturities of investments of $9.7 million offset by purchases of property and equipment of $1.1 million.

Net cash provided by financing activities was $3.8 million. Cash provided by financing activities consisted primarily of net proceeds from the issuance of debt obligations of $6.0 million and net proceeds from the equity financing of $6.9 million offset by repayment on the line of credit of $10.5 million.

At December 31,2000, we had cash, cash equivalents and short-term investments of $45.9 million compared to $106.0 million at December 31, 1999, a decrease of $60.1 million. The decrease is primarily a result of net cash used in operating activities of $55.3 million and cash used for investing in purchases of property and equipment of $11.9 million partially offset by cash provided by financing activities.

During 1999, 2000 and 2001 we generated net losses of approximately $10.3 million, $56.1 million and $126.3 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, February, 2001, April, 2001 and October 2001. Management continues to monitor market conditions to assess the need to take further action. 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.

At December 31, 2001, we had outstanding borrowing of $6.0 million under our line of credit, which expires November 30, 2002. The borrowing was paid off in February 2002. At February 28, 2002, we have $3.2 million available for borrowing needs, and we are required to maintain a minimum tangible net worth of $24.0 million at each quarterly reporting period. The following table depicts our contractual obligations as of December 31, 2001:

                                            Contractual Obligations
                                      -----------------------------------
                                                 Less Than   Greater Than
                                        Total      1 Year       1 Year
                                      ---------  ----------  ------------
                                                 (in thousands)

Line of Credit...................... $   6,000  $    6,000  $         --
Inventory Purchase Commitments (*)..    22,406      22,406            --
Capital Lease Obligations...........       376         178           198
Operating Lease Obligations.........    14,847       3,888        10,959
                                      ---------  ----------  ------------
Total Contractual Cash Obligations.. $  43,629  $   32,472  $     11,157
                                      =========  ==========  ============

(*) See Note 9 to the consolidated financial statements

We also have available $10.0 million in a letter of credit facility to be utilized for contract manufacturer security. Any letter of credit commitments requires 100% cash collateral by Com21.

Com21 subleases certain of its office to third parties. If the subleasees fail to make the payments, Com21 would be liable for $893,000 over the next four years.

We believe that our cash, cash equivalents, short-term investments and available borrowings under our credit facilities at December 31, 2001 coupled with the continuing cost reduction programs, will be sufficient to meet our working capital requirements through December 31, 2002.

New Accounting Standards

On January 1, 2001, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. 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 adoption of SFAS No. 133 did not have an impact on the Company's consolidated financial position, results of operations or cash flows.

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will be tested at least annually for impairment. The Company will adopt SFAS No. 142 for its fiscal year beginning January 1, 2002. Upon adoption of SFAS No. 142, the Company ceases the amortization of intangible assets with indefinite lives (goodwill) with a net carrying value of $3.6 million at December 31, 2001. The Company recognized annual amortization of $1.5 million for the year ended December 31, 2001. The Company has evaluated goodwill under SFAS No. 142 and has determined that the adoption of this statement will not result in an impairment.

In August 2001, the FASB issued SFAS No 144, Accounting for Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement is effective for the Company on January 1, 2002. Management believes the adoption of this statement will not have an impact on the consolidated financial position, results of operations or cash flows of the Company.

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, 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. We had no such investments at December 31, 2001.

Com21 is also subject to interest rate risk as of December 31, 2001, related to variable rate debt obligations totaling $6,000,000. 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 rates were to increase immediately and uniformly by 10 percent from levels at December 31, 2001, the fair value of the repayment obligation would increase by $65,000.

Com21 has fixed rate debt obligations of $291,000 and $376,000 at December 31, 2000 and 2001, respectively, that have no interest rate risk. The fixed rates on such obligations ranged from 7% to 12% in 2000 and ranged from 8% to 11% in 2001, and matures on various dates through 2004.

Market Price Risk. Com21 is also exposed to market price risk through investments 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 $2,714,000 and $1,019,000 decrease in the fair value of the investment in the marketable equity security as of December 31, 2000 and 2001, 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. The functional currency of our subsidiary in Ireland is the U.S. dollar; however, the local accounts are maintained in Irish pounds subjecting us 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.