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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended March 31, 2003

OR

Commission File No. 0-14225

EXAR CORPORATION

(Exact Name of registrant as specified in its charter)

48720 Kato Road, Fremont, CA 94538

(Address of principal executive offices, Zip Code)

Registrant’s telephone number, including area code: (510) 668-7000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK

(Title of Class)

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

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

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

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of September 30, 2002 was $456,902,927 based on the last sales price reported for such date as reported on The Nasdaq Stock Market, Inc.

The number of shares outstanding of the Registrant’s Common Stock was 40,379,536 as of May 31, 2003, net of treasury shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company’s Definitive Proxy Statement to be filed not later than 120 days after the close of the fiscal year are incorporated by reference into Part III, Items 10, 11, 12 and 13 of this Report.

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EXAR CORPORATION AND SUBSIDIARIES

INDEX TO

ANNUAL REPORT ON FORM 10-K

FOR YEAR ENDED MARCH 31, 2003

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PART I

This Annual Report on Form 10-K (the “Annual Report”) contains certain forward-looking statements within the meaning of section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements as a result of various factors. These risks, uncertainties and other factors include, among others, those identified under “Risk Factors.” Forward-looking statements are generally written in the future tense and/or are preceded by words such as “will,” “may,” “should,” “could,” “expect,” “suggest,” “believe,” “anticipate,” “intend,” “plan,” or other similar words. Forward-looking statements contained in this Annual Report include, among others, statements made in “Financial Outlook” and elsewhere regarding (1) the Company’s net sales, (2) the Company’s gross margins, (3) the Company’s ability to control and/or reduce operating expenses, (4) the Company’s research and development efforts, (5) customer acceptance of the Company’s new products, (6) the Company’s ability to maintain positive operating cash flows to fund future operations, (7) the sufficiency of the Company’s capital resources, (8) the Company’s capital expenditures, (9) competitive pressures and (10) the general market and economic outlook. Factors that could cause actual results to differ materially from those included herein include, but are not limited to, the information contained under the captions “Part I, Item 1. Business,” and “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and, in particular, “Risk Factors.” The Company disclaims any obligation to update information in any forward-looking statement.

ITEM 1.     BUSINESS

Overview

Exar Corporation (“Exar” or the “Company”) designs, develops and markets high-performance, analog and mixed-signal silicon solutions for the worldwide communications infrastructure. Leveraging its industry-proven analog design expertise, system-level knowledge and standard process technologies, Exar provides OEMs with innovative, highly integrated ICs that facilitate the transport and aggregation of signals in access, metro and wide area networks. The Company’s physical layer silicon solutions address transmission standards such as T/E carrier, ATM and SONET/SDH. Additionally, Exar offers ICs for both the serial communications and the video and imaging markets. Exar’s customers include, among others, Alcatel, Cisco Systems, Inc., Digi International, Inc., Hewlett-Packard Company (“Hewlett-Packard”), Huawei Technologies Company, LTD., Logitech International S.A., NEC Corporation, Nokia Corporation, Plantronics, Inc. and Tellabs, Inc. Exar’s common stock trades on The Nasdaq Stock Market, Inc. under the symbol “EXAR” and is included in the S&P 600 SmallCap Index.

Industry Background

Communications technology has evolved from simple analog voice signals transmitted over networks of copper telephone lines to complex analog and digital voice and data signals transmitted over hybrid networks of media, such as copper, coaxial and fiber optic cables. This evolution has been driven by large increases in the number of users and the complexity and variety of the data transmitted over networks resulting from:

The majority of installed communications systems were designed to transmit only voice communications, and, therefore, are inadequate for the high-bandwidth transmission of both voice and data. Access to the public network is typically based on asynchronous technologies, such as T/E carrier over copper wire. The demand for

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greater bandwidth is driving a migration from lower-speed T1/E1, to higher-speed T3/E3 transmission rates. The T1/E1 standard permits the transmission of data at 1.5 Mbps/2.0 Mbps, and the T3/E3 standard permits the transmission of data at 45 Mbps/34 Mbps. The backbone of the public network is built on an optical fiber transmission medium that employs synchronous technologies such as SONET/SDH. Similar to the utilization of faster transmission rates over copper wire, SONET/SDH protocols such as OC–3 (1.554 Mbps) are being upgraded to OC-12 (622 Mbps) and OC-48 (2.5 Gbps) to increase the bandwidth over a single optical fiber.

The market dynamics of the communications industry have changed significantly since 2000. Many carriers that spent billions of dollars building out their networks in 2000 and prior years were not successful in executing their business models, and consequently, were sold or declared bankruptcy. Incumbent telephone companies (such as AT&T Corp., Sprint Corporation and MCI WORLDCOM, Inc.) and regional bell operating companies (such as BellSouth Corporation, Verizon Communications Inc. and SBC Communications Inc.) have substantially reduced their capital expenditures in line with current revenues. This dynamic has severely impacted Exar’s customers, communications equipment OEMs, or original equipment manufacturers, many of which have undergone or are undergoing extensive restructuring to eliminate excess inventory and to reduce expenses by significantly downsizing their organizations. At the same time, the Company’s OEM customers are and will continue to come under tremendous pressure to develop new products for access and MAN markets that will enable carriers to leverage their current network infrastructure.

To address these evolving requirements of the communications industry, OEMs must develop and introduce increasingly sophisticated systems with fewer engineering resources. To achieve the performance and functionality required of these systems, communications OEMs are using increasingly complex communications ICs, which now account for a significant portion of the value-added proprietary content of these systems. As a result of the need for new equipment introductions, coupled with the reduction in their technical staff, the proliferation of transmission standards and the difficulty of designing and producing communications ICs, equipment suppliers are increasingly outsourcing the design and production of the ICs incorporated into their systems.

The key ICs contained in a typical communications system include physical-interface, access control, network processor, traffic manager and switch fabric devices. The physical-interface device consists of a transmitter and receiver that, when integrated, is called a transceiver. Transceivers interface with the physical transmission media, such as copper wire or optical fiber. Most of these high-speed, mixed-signal ICs convert parallel digital signals into a single analog bit stream that is up to 32 times faster than the original signal. Transceivers therefore serve as a bridge between analog transmission media and the digital devices that process data. Access control circuits are digital ICs that format, or frame, the data, perform error checking and in some applications aggregate signals by mapping multiple lower-speed data streams to a single higher-speed stream. The traffic manager manages the transfer of data between the network processor and the switch fabric, which work together to shape, route and control the data.

Because physical-interface and access control ICs interface with the transmission media and are critical to increasing bandwidth, these ICs must offer high-speed and robust performance. Therefore, communications equipment OEMs seek IC suppliers that possess extensive analog and digital expertise to provide high-speed, mixed-signal solutions to bridge the analog physical world and the digital computing environment. This must be coupled with system-level expertise so that a supplier can quickly bring to market high-performance, highly reliable ICs with optimal feature sets.

The Exar Solution

Exar designs, develops and markets high-performance, high-bandwidth mixed-signal ICs for use in the worldwide communications infrastructure. The Company’s analog and digital design expertise, combined with its systems understanding, enables the Company to provide physical-interface and access control solutions for Access, MAN, and WAN communications equipment. Exar offers ICs based on the T/E carrier, ATM and

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SONET/SDH transmission standards. In addition, the Company provides solutions for the serial communications market and the video and imaging markets. Exar believes its products offer its customers the following benefits:

Key elements of the Company’s solution include:

Leading Analog and Mixed-Signal Design Expertise.    Exar has over 30 years of experience in developing analog and mixed-signal ICs. As a result, the Company has developed a significant base of knowledge in these areas and a library of design elements. For example, the Company believes that it has particularly strong expertise in the design of high-speed, low-jitter phase lock loops, which are key elements in Exar’s mixed-signal transceiver, jitter attenuator and data aggregation mapper products. As a result, Exar can provide its customers with solutions that typically exceed standard specifications and allow them flexibility in designing other parts of their systems.

Broad Product Offerings.    Exar offers a variety of physical-interface and access control products based on the T1/E1, T3/E3, ATM and SONET/SDH transmission standards. Exar’s broad portfolio of multiple channel products for various transmission standards enables its customers to minimize board space and overall cost in multi-port applications.

Comprehensive Solutions to Enhance System Integration.    The combination of Exar’s design and system level expertise allows it to provide a solution that encompasses hardware, software and applications support. Exar believes that, by using its solutions, OEMs can efficiently integrate the Company’s devices into their systems, better leverage their development resources and reduce their time to market.

Compelling Price/Performance Solutions.    The Company uses its systems expertise and its analog, digital and mixed-signal design techniques to architect high-performance products based on standard CMOS process technologies. Exar believes that these CMOS processes are proven, stable, predictable and able to meet its customers’ application speed and power/performance requirements at a lower price point than other semiconductor manufacturing processes.

Strategy

Exar’s objective is to be the leading provider of high-performance, high-bandwidth IC solutions for the worldwide communications infrastructure. To achieve this objective, Exar employs the following strategies:

Focus on Growing Market Share within the Communications Markets.    Exar targets communications markets, including T/E carrier, ATM and SONET/SDH. The Company has built substantial expertise in the areas of analog and digital design, systems architecture and applications support. Exar believes that the integration of these capabilities enables the Company to develop solutions addressing the high-bandwidth requirements of communications systems OEMs. The Company’s broad product offerings support differentiated features, which the Company believes, will enable it to increase its market share.

Leverage Analog and Mixed-Signal Design Expertise to Provide Integrated System Level Solutions.    Utilizing Exar’s strong analog and mixed-signal design expertise, the Company integrates mixed-signal physical-interface devices with digital access control devices. The Company offers products that integrate transceivers with jitter attenuators and framers/ATM UNIs on a single IC. The Company’s data aggregation devices leverage its T/E carrier

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and SONET/SDH expertise, mapping multiple T3 data streams into a SONET/SDH stream. These configurations enable OEMs to use less board space and reduce their overall system cost.

Expand the Company’s Revenue Content Per System.    Exar’s analog and mixed-signal design expertise enabled the Company to build what it believes to be a technological lead and a strong market position in T3/E3 transceivers. The Company intends to leverage this lead and its established customer relationships to capture design wins for its access control products, thereby increasing the Company’s overall revenue content per system.

Strengthen and Expand Strategic OEM Relationships.    Exar’s customers include Alcatel, Cisco Systems, Inc., Digi International, Inc., Hewlett-Packard Company (“Hewlett-Packard”), Huawei Technologies Company, LTD., Logitech International S.A., NEC Corporation, Nokia Corporation, Plantronics, Inc. and Tellabs, Inc. To promote the early adoption of its solutions, the Company actively seeks collaborative relationships with strategic OEMs during product development. The Company believes that OEMs recognize the value of Exar’s early involvement because designing their system products in parallel with the Company’s development can accelerate time to market for their end products. In addition, Exar believes that collaborative relationships help the Company to obtain early design wins and to reduce the market acceptance risk of its new products.

Leverage Broad Product Portfolio to Accelerate Communications Product Development.    Exar believes it has developed a strong presence in the serial communications market, where the Company has leading industry customers and proven technological capabilities. The Company’s design expertise has enabled it to offer a diverse portfolio of both industry standard and proprietary serial communications products. Additionally, the Company offers what it believes is a strong product portfolio for the video and imaging markets. The Company has established important customer relationships for its high-performance, low-power video and imaging products and continues to support key customers such as Hewlett-Packard with its imaging products.

Use Standard CMOS Process Technologies to Provide Compelling Price/Performance Solutions.    Exar designs its products to be manufactured using standard CMOS processes. The Company believes that these processes are proven, stable and predictable and benefit from the extensive semiconductor-manufacturing infrastructure devoted to CMOS processes. Therefore, the Company believes that it can achieve a higher level of performance at a lower cost than competitors that use alternative processes.

Leverage Fabless Semiconductor Model.    Exar has long-standing relationships with world-class third-party assembly, test and wafer foundries to manufacture the Company’s ICs. The Company’s fabless approach allows it to avoid substantial capital spending, obtain competitive pricing, reduce time to market, reduce technology and product risks, and facilitate the migration of the Company’s products to new process technologies, which reduce costs and optimize performance. By leveraging the fabless model, Exar can focus on its core competencies of IC design and product development.

Products

Exar designs, develops and markets high-performance, high-bandwidth physical-interface and access control solutions for the worldwide communications infrastructure. The Company’s current IC products for the communications market are designed to respond to the growing demand for cost effective line card solutions based on transmission standards such as T/E carrier, ATM and SONET/SDH. The Company also designs, develops and markets IC products that address the needs of the serial communications market and the video and imaging markets. Exar uses its design methodologies to develop products ranging from ASSPs, for industry-wide applications, to semi-custom solutions, for specific customer applications.

Communications

Exar’s products for T/E carrier, ATM and SONET/SDH applications include high-speed analog, digital and mixed-signal physical-interface and access control ICs. The physical-interface IC consists of a transmitter and

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receiver that, when integrated, is called a transceiver. Transceivers interface with the physical transmission media. Most of these high-speed, mixed-signal ICs convert parallel digital inputs into a single analog bit stream that is up to 32 times faster than the original signal. Access control circuits are digital circuits that format, or frame, the data, perform error checking and in some applications aggregate signals by mapping multiple lower-speed data streams to a single higher speed stream. The figure below illustrates where the Company’s products are employed within networking equipment.

Types of Communications ICs Used in Networking Equipment

Exar’s communications products include transmitters and receivers, transceivers, PHYs, jitter attenuators, framers, ATM UNIs and data aggregation mappers. These products are used in networking equipment such as SONET/SDH multiplexers, PBX, central office switches, digital cross connects and multiservice provisioning platforms. The Company enhanced its TE/E3 physical-interface solution in 1999 with an integrated single chip transceiver and now offers two, three, four, six and twelve-channel versions, with or without integrated jitter attenuation, that meet the same performance levels, while requiring less board space and lower overall power in multi-port applications. Extending its jitter attenuation capabilities, Exar incorporates desynchronization in its transceivers and data aggregation mappers to solve complex timing issues associated with mapping/demapping from SONET/SDH (synchronous) to T3/E3 (asynchronous) environments. Exar’s data aggregation mapper solutions leverage the Company’s expertise in T/E carrier with SONET/SDH enabling the Company to provide unique solutions to the SONET/SDH market place. In addition to integrating SONET PHY capability into its data aggregation mappers, the Company also introduced its first OC-48 PHY with integrated Forward Error Correction, or FEC. The Company plans to compliment this product with OC-48 data aggregation solutions currently under development. Exar’s access control products include framers and ATM UNIs, in addition to its data aggregation mappers. The Company also supplies a family of V.35 transceiver products used for high-speed data transmission, primarily in networking equipment such as routers and bridges.

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The following table describes some of the Company’s key communications products:

The Company expects to introduce a number of new communications ICs in the fiscal year ending March 31, 2004 to provide an expanded line of T/E carrier products as well as SONET/SDH products. The T/E carrier products are expected to include multi-channel, multi-function ICs that integrate transceivers, jitter attenuators, framers and ATM UNIs. SONET/SDH product introductions are expected to focus on data aggregation, combining OC-3 (155 Mbps) capability with OC-12 (622 Mbps) or OC-48 (2.5 Gbps) functions.

Serial Communications

UARTs convert data streams from parallel to serial, enabling a serial data stream to communicate with a central processing unit, or CPU. Exar sells its UART products to the remote access, data collection, industrial automation and handheld/mobile markets. Many of these products include high-performance features, such as automated flow control and large First-In First-Out, or FIFO, buffers. The Company has designed highly integrated quad (four channel) and octal (eight channel) UARTs with FIFO circuitry, which the Company believes are the de-facto industry standard for multi-channel FIFO UARTs used in multi-port networking applications.

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The following table describes the Company’s key serial communications products:

During the current fiscal year, the Company expects to expand its family of PCI products.

Video and Imaging

Exar supplies high-performance analog-to-digital converters, or ADCs, and integrated analog front ends, or AFEs, for products such as digital copiers and scanners, digital still cameras, or DSCs, and multifunctional peripherals, or MFPs, which incorporate scanning, faxing, copying and printing functions in a single integrated system. The Company uses advanced design techniques and process technologies to integrate low-power converter architectures with surrounding analog functions, thereby reducing system costs.

The following table describes some of the Company’s key video and imaging products:

Sales and Customers

Exar markets its products in the Americas through 23 independent, non-exclusive sales representatives and two independent, non-exclusive distributors, as well as through the Company’s own direct sales force. The Company currently has sales support offices in or near Atlanta, Boston, Chicago, Dallas, Los Angeles and Fremont, California. The Company is represented internationally by 22 independent, non-exclusive sales representatives and distributors. In addition, the Company is represented in Europe by its wholly owned subsidiaries, Exar Ltd. and EXAR SARL, and in Japan by its wholly owned subsidiary, Exar Japan.

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The Company’s customers include the following, among others:

For the fiscal year ended March 31, 2003, one customer, Hewlett-Packard, accounted for 26.4% of the Company’s net sales. No other customer accounted for more than 10% of the Company’s net sales during this period. Sales to the domestic distribution channel accounted for 17.5% of net sales.

Manufacturing

Exar out-sources all of its fabrication and assembly, as well as the majority of its testing operations. This fabless manufacturing model allows the Company to focus on its core competencies of product design and development.

The majority of the Company’s current products are implemented in standard CMOS. The Company uses CMOS manufacturing processes to take advantage of that technology’s lower power consumption, cost-effectiveness, foundry availability and ever-increasing speed. Currently, all of the Company’s new product development is being implemented in CMOS. Chartered Semiconductor Manufacturing (“Chartered”) and Taiwan Semiconductor Manufacturing Company, (“TSMC”) manufacture all of the Company’s CMOS products. In addition, Chartered manufactures all of the Company’s BiCMOS products, which combine bipolar and CMOS processes. The Company does not have long term supply agreements with Chartered or TSMC. Chartered has announced that it intends to transfer production from its foundry which utilizes six-inch wafer manufacturing technologies to a facility that is based on eight-inch wafer manufacturing technologies. Chartered has indicated that it intends to close the older foundry concurrently with the transfer of manufacturing operations to the newer facility by March 2004. The transfer of many of the Company’s existing products to the new foundry entails certain risks and uncertainties. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors.”

Most semiconductor wafers are usually shipped to the Company’s subcontractors in Asia for wafer test and assembly, where they are cut into individual die and packaged. Independent contractors in Hong Kong, Indonesia and Singapore perform most of the Company’s assembly work. Following assembly, final test and quality assurance are performed either at the Company’s Fremont, California facility or at its subcontractors’ facilities in Asia. The combination of various functions makes the test process for analog and mixed-signal devices particularly difficult. Test operations require the programming, maintenance and use of sophisticated computer-based test systems and complex automatic handling systems.

Research and Development

Exar believes that the continued introduction of new products in its target markets is essential to its growth. Exar’s research and development is focused on developing high-performance analog, digital and mixed-signal solutions addressing the high-bandwidth requirements of communications systems OEMs. Exar has made significant investments in advanced design tools and high-performance standard cell libraries. By utilizing these tools, the Company has developed design methodologies that are optimized for reducing design-cycle time and increasing chances of first-time success. In order to support high pin-count devices, the Company continues to

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develop high-performance packages for its new products in collaboration with packaging suppliers. As of March 31, 2003, the Company’s research and development staff consisted of 137 employees, 53 of whom hold advanced degrees.

Competition

The semiconductor industry is intensely competitive and is characterized by rapid technological change and a history of price reductions as production efficiencies are achieved in successive generations of products. Although the market for analog and mixed-signal integrated circuits is generally characterized by longer product life cycles and less dramatic price reductions than the market for digital integrated circuits, the Company faces substantial competition in each market in which it participates. Competition in the Company’s markets is based principally on technical innovation, product features, timely introduction of new products, quality and reliability, performance, price, technical support and service. The Company believes that it competes favorably in all of these areas.

Because the IC markets are highly fragmented, the Company generally encounters different competitors in its various market areas. Competitors with respect to the Company’s communications products include Applied Micro Circuits Corporation, Mindspeed Technologies, a division of Conexant Systems, Inc., PMC-Sierra, Inc., and TranSwitch Corporation. Competitors in the Company’s serial communications and video and imaging markets include Analog Devices Inc., Philips Electronics, Texas Instruments Incorporated and Wolfson Microelectronics LTD.

Backlog

Exar defines backlog to include OEM orders and distributor orders for which a delivery schedule has been specified for product shipment occurring primarily during the succeeding six months.

At March 31, 2003, Exar’s backlog was $9.4 million, compared to $15.1 million at March 31, 2002. Exar believes that the decrease in the Company’s backlog was due to a reduction in carrier capital expenditures by the Company’s communications customers. Additionally, the decrease in backlog resulted from the shortened order-to-shipment time for the Company’s products. Over the past 18 to 24 months, the Company has experienced an increased percentage of orders received that shipped in the same quarter. If this practice of short order-to-delivery times continues, the Company’s backlog may be less than in previous years and a less reliable indicator of future revenue.

Sales are made pursuant to either purchase orders for current delivery of standard items or agreements covering purchases over a period of time, which are frequently subject to revision and cancellation. Lead times for the release of purchase orders depend on the scheduling practices of the individual customer, and the Company’s rate of bookings varies from month-to-month. In addition, Exar’s domestic distributor agreements generally permit the return of up to 10% of purchases of the preceding quarter for purposes of stock rotation and also provide for credits to distributors in the event that Exar reduces the price of any product. Because of the possibility of changes in delivery schedules, quantities actually purchased, cancellations of orders, distributor returns or price reductions, Exar’s backlog as of any particular date may not be representative of actual sales for any succeeding six-month period. Customers can cancel a significant portion, if not all, of their backlog at their discretion without substantial penalty.

Intellectual Property Rights

The Company has 108 patents issued and 29 patent applications pending in the U.S. The Company has 12 patents issued and 33 patent applications pending in various foreign countries. None of the Company’s key domestic and foreign patents that have been issued will expire in the near future unless the Company chooses not to pay renewal fees. To protect its intellectual property, the Company also relies on a combination of mask work

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registrations, trademarks, copyrights, trade secrets, employee and third party nondisclosure agreements and licensing arrangements. The Company may enter into license agreements or other agreements to gain access to externally developed products or technologies.

The Company may fail to adequately protect its intellectual property. Others may gain access to the Company’s trade secrets or disclose such trade secrets to third parties. Some or all of the Company’s pending and future patent applications may not result in issued patents that provide it with a competitive advantage. Even if issued, such patents, as well as its existing patents, may be challenged and later determined to be invalid or unenforceable. In addition, others may develop similar or superior products without access to or without infringing upon its intellectual property, including intellectual property that is protected by trade secret and patent rights.

The Company cannot be sure that its products or technologies do not infringe patents that may be granted in the future pursuant to pending patent applications or that the Company’s products do not infringe any patents or proprietary rights of third parties. Occasionally, the Company is informed by third parties of alleged patent infringement. In the event that any relevant claims of third-party patents are found to be valid and enforceable, the Company may be required to:

If the Company were required to take any of the actions described above or defend against any claims from third parties, its business, financial condition and results of operations could be harmed.

Employees

As of March 31, 2003, the Company employed 265 full-time employees, with 137 in engineering and product development, 37 in operations, 49 in marketing and sales and 42 in administration. Of the 137 engineering and product development employees, 53 hold advanced degrees. The Company’s ability to attract, motivate and retain qualified personnel is essential to its continued success. None of the Company’s employees is represented by a collective bargaining agreement, nor has the Company ever experienced a work stoppage due to labor issues. The Company believes its employee relations are good.

GLOSSARY:    Exar uses a number of terms in this Annual Report which are familiar to industry participants but which some investors may not recognize. The Company has provided a glossary of some of these terms below.

Access:

Refers to the part of the network between a home or business and the public network.

Access Control Circuits:

An IC that formats or frames the data, performs error checking and in some applications aggregates signals by mapping multiple lower rate data streams to a single higher speed data stream.

Analog-to-Digital Converters (“ADCs”):

Convert an analog signal to a digital signal.

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Add/Drop Multiplexer (“ADM”):

A device at an intermediate point on a transmission line that enables new signals to come in and existing signals to go out.

Analog Front Ends (“AFEs”):

An IC that conditions the analog signal received from a sensor and performs an analog-to-digital conversion.

Analog Integrated Circuits:

These semiconductor devices are used to electronically shape continuous real-world phenomena, such as sound waves, motion, heat, light and pressure. The electronic signals from analog ICs are typically translated into digital form and later converted back into analog forms that provide visual, auditory and tactile sensory stimuli.

Application-Specific Standard Product (“ASSP”):

A device tailored for a specific application that is sold on the open market to multiple customers with similar requirements. Customers will often differentiate their end product with unique software and hardware features.

Asynchronous Transfer Mode (“ATM”):

A fast packet switching protocol by which short packets or cells containing data, voice or video signals are moved over networks at high-speed. This high-speed switching technology is used as a backbone technology in carrier networks and large enterprises. ATM is designed to take advantage of high-speed transmission media such as T3/E3 and SONET.

ATM User Network Interfaces (“ATM UNIs”):

A device that provides the ATM Physical Layer (Physical Medium Dependent and Transmission Convergence sub-layers) interface for the public and private networks.

Asynchronous Transmission:

Describes digital signals that are transmitted without precise clocking.

Backbone:

Backplane or bus which makes up the skeleton of a network.

Bandwidth:

Commonly defined as the volume of data that a transmission line can carry, measured in bits per second (“bps”). Traditional copper lines have the lowest bandwidth potential, while fiber optic lines have the highest.

A range of signal frequencies, measured in cycles per seconds or Hertz (“Hz”). Also refers to the speed at which data is transmitted, measured in bits per second (“bps”).

Broadband Communications:

Data transmission at speeds of equal to or greater than 1.5 Mbps.

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Central Office (“CO”):

The main switching facility for a telephone company where larger telephone trunks are provisioned out in smaller lines to customers. Where fiber is connected to copper and vice versa.

Central Processing Unit (“CPU”):

The computational and control unit of a computer; the device that interprets and executes instructions. By definition, the CPU is the chip that functions as the “brain” of the computer.

Complementary Metal Oxide Semiconductor (“CMOS”):

Process technology used to manufacture silicon integrated circuits.

Carrier:

An organization that provides communications services.

Copper:

Usually small gauge where two wires are twisted together, “twisted pair.” Limited in the amount of information it can carry. Typically associated with “last mile” transport.

Design Win:

Exar defines as a minimum order of 100 units which signifies acceptance of a device by an OEM for use in their end product.

Digital Cross Connect:

An electronic switching system that routes digital signals among multiple paths without demultiplexing them.

Digital ICs:

Within these devices, transistors are used to switch discrete digital signals that are represented in two states: on or off, or “1” or “0”. With today’s process technologies, millions of transistors can be integrated on a single chip, resulting in enormous computing power.

Frame Relay:

A packet-switching technology used to route frames of information within a network. Instead of leasing dedicated lines between all remote sites, frame relay allows virtual private networks to be established in which remote sites are connected to a central carrier, which routes data accordingly.

Gigabit (“Gbps”):

One billion bits per second.

Integrated Circuit (“IC”):

A single electronic device that contains previously separate (discrete) electronic components. An IC is produced on a small slice of silicon semiconductor material.

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Jitter Attenuation:

Reduces jitter (noise, distortion) so that data transmission is clean and error free.

Kilobit (“Kbps”):

One thousand bits per second.

Local Area Network (“LAN”):

A shared, private data communications network linking a variety of data devices such as workstations, computers and printers within an office or home environment, usually confined to a single building or cluster of buildings.

Megabit (“Mbps”):

One million bits per second.

Metropolitan Area Network (“MAN”):

A communications network that covers a geographic area, such as a city or suburb, or a series of LANs at multiple sites often interconnected by public facilities.

Mixed-Signal ICs:

Integrated circuits that combine analog and digital functions. Mixed-signal ICs are difficult to design because the analog and digital parts of the chip operate differently.

Multiplexing (“Multiplexer” or “MUX”):

An electronic or optical process that combines a large number of low-speed transmission lines into one high-speed line by splitting the total available bandwidth of the high-speed line into narrower channels. Demultiplexing is the reverse of multiplexing.

Network Processor:

An IC that executes programmed instructions, performs arithmetic and logical operations on signals, and controls input/output functions.

OC-3, OC-12, OC-48, OC-192:

Optical carrier, designating SONET speed (155 Mbps, 622 Mbps, 2.5 Gbps, 10 Gbps, respectively).

Peripheral Component Interconnect (“PCI”)

PCI provides high speed, auto configuring interconnections between the cards in a PC or a system.

Packet:

Any logical block of data sent over a network. It contains a header consisting of control information such as sender, receiver, and error-control data, as well as the message itself. May be fixed or variable length.

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Phase Lock Loop (“PLL”):

Analog or digital function that regulates the critical timing function in telecommunication and computer ICs.

Physical Layer:

Level 1 on the Open Space Interconnect (“OSI”) Model. The connection layer, or where the “wire” connects to the equipment.

Physical Interface (“PHY”):

An IC that receives analog signals from transmission media and converts it to a digital signal for further processing for incoming signals. It converts digital signals to analog for transmission across the transmission media for outgoing signals.

Private Branch Exchanges (“PBX”):

A PBX is a switching system that provides telecommunications services on the premises or campus, (e.g. internal calling and other services), and access to public and private telecommunications networks.

Router:

A device that connects multiple LANs, or the bridge between a LAN and the public network.

Synchronous Digital Hierarchy (“SDH”):

An international standard for high-speed synchronous data transmission over fiber; SDH was adapted from SONET, which is employed in North America.

Synchronous Optical Network (“SONET”):

The North America standard for high-speed synchronous data transmission over optical fiber. Rates are measured in optical carrier (“OC”) units. For example, OC-3 corresponds to 155 Mbps, OC-12 corresponds to 622 Mbps and OC-48 corresponds to 2.5 Gbps. SONET backbones are widely used to aggregate lower-speed T1 and T3 lines. The international equivalent is SDH.

Synchronous Transport Signal (“STS-x”):

Electronic equivalent of SONET—OC-level, x designating the speed.

Switch Fabric Devices:

An IC that incorporates a series of point to point interconnections that are used to overcome bandwidth bottlenecks in traditional bus structures. Connection end points are joined through a cross-connected switching matrix resembling a woven piece of cloth, hence the name fabric. Any point may be combined with any other point to produce a powerful combination of switched end points.

T1/E1:

T1 is a dedicated digital transmission link with a capacity of 1.554 Mbps provided by telephone companies. Widely used for private networks as well as interconnections between an organization’s PBX or LAN and

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telephone companies. A T1 line can normally accommodate 24 voice conversations (channels), each one digitized at 64 Kbps and one 8 Kbps channel for signaling and control. E1 is the European designation for T1 and has a capacity of approximately 2 Mbps.

T3/E3:

A digital transmission link capable of transmission speeds of 45 Mbps. A T3 line can normally accommodate 672 voice conversations. E3 is the European designation for T3.

Traffic Manager:

An IC which manages the transfer of data among numerous channels and elements such as the network processor and switch fabric, which work together to shape, route and control the data.

Transmission Media:

The physical transmission path along which a signal propagates, such as a twisted copper pair, coaxial cable or optical fiber cable.

Universal Asynchronous Receiver Transmitter (“UART”)

UARTs convert data streams from parallel to serial, enabling a serial data stream to communicate with a CPU.

Wide Area Network (“WAN”):

A shared network of computers and data devices that spans a large geographical area, such as the Internet, transporting long distance between MANs.

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MANAGEMENT

The names of the Company’s executive officers and directors, and their ages as of May 31, 2003, are as follows:

Donald L. Ciffone, Jr. joined the Company as President and Chief Executive Officer in October 1996 and was appointed a Director at that time. Mr. Ciffone was appointed Chairman of the Board in April 2002. From August 1996 to October 1996, Mr. Ciffone was Executive Vice President of Toshiba America, the U.S. semiconductor subsidiary of Toshiba Semiconductor. Prior to joining Toshiba, he served from 1991 to 1996 in a variety of senior management positions, including Senior Vice President of the VLSI Product Divisions, at VLSI Technology, Inc. From 1978 to 1991, Mr. Ciffone held a variety of marketing and operations positions at National Semiconductor, Inc. Mr. Ciffone holds a B.A. from San Jose State University and an M.B.A. from Santa Clara University.

Michael Class joined the Company as Director of Western Area Sales in 1997. In January 1998, he was promoted to the position of Vice President, North American/European Sales and was promoted to Vice President, Worldwide Sales in July 1999. Mr. Class has over 21 years of experience in the semiconductor industry, including employment with IC Works, Inc. as Area Sales Manager for the Western U.S. and Canada. Prior to joining IC Works, Mr. Class held various sales management positions with Intel Corporation and VLSI from 1979 to 1995. He holds a B.S. in Electrical Engineering from Lehigh University and an M.B.A. from LaSalle University.

Mir Bahram Ghaderi joined the Company in March 1995 as Director of Engineering, Startech Division, when the Company acquired Startech Semiconductor, Inc., where he served as Vice President of Engineering. He was promoted to Divisional Vice President of Engineering, Communications Division in September 2001, and to his current position as Vice President and General Manager, Network and Transmission Products Division, in April 2003. Prior to joining Startech in 1994, he was Director of Engineering, Modem/Clock Products, at Sierra Semiconductor, Inc. Dr. Ghaderi has 22 years of product development experience in the semiconductor industry and received a M.S.E.E. and Ph.D. in Electrical Engineering from the University of California at Los Angeles, as well as a M.S.E.E. from Tehran University.

Roubik Gregorian joined the Company in March 1995 as Vice President, Startech Division, when the Company acquired Startech Semiconductor, Inc., where he served as President. He was appointed Chief Technology Officer and Vice President of the Communications Division in June 1996, and Chief Technology Officer, Senior Vice President/General Manager, Communications Division, in June 1998. Dr. Gregorian was promoted to Executive Vice President/General Manager, Communications Division in May 2002 and to Chief

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Operating Officer in April 2003. Prior to joining Startech in 1994, Dr. Gregorian was Vice President of Research and Development and Chief Technology Officer for Sierra Semiconductor, Inc. Dr. Gregorian has been issued 25 patents, authored two textbooks and received his M.S.E.E. and Ph.D. in Electrical Engineering from the University of California at Los Angeles, as well as a M.S.E.E. from Tehran University.

Ronald W. Guire joined the Company in July 1984 and has been a Director since June 1985. He has served as Chief Financial Officer since May 1985, and Executive Vice President since July 1995. Mr. Guire was a partner in the certified public accounting firm of Graubart & Co. from 1979 until he joined Exar in July 1984. Mr. Guire holds a B.S. in Accounting from California College of Commerce.

Susan J. Hardman joined the Company in February 1997 and became Vice President / General Manager of the Company’s interface products division in April 2003. Prior to this, she served as Vice President, Corporate Marketing and has served as Director of Marketing for the Company’s communications products. Ms. Hardman has 20 years experience in the semiconductor industry. From 1989 to 1997, Ms. Hardman was with VLSI Technology (VLSI) in a variety of management positions, most recently as Director of Product Marketing for VLSI’s networking products division. From 1983 to 1989, she was with Motorola holding a variety of engineering roles. Ms. Hardman holds a B.S. in Chemical Engineering from Purdue University and an M.B.A. from the University of Phoenix.

Thomas R. Melendrez joined the Company in April 1986 as Corporate Attorney. He was promoted to Director, Legal Affairs in July 1991, and again to Corporate Vice President, Legal Affairs in March 1993. In March 1996, Mr. Melendrez was promoted to Corporate Vice President, General Counsel. In June 2001, Mr. Melendrez was appointed Secretary of the Company. In April 2003, Mr. Melendrez assumed the responsibilities of Vice President, Business Development. Mr. Melendrez has over 21 years legal experience in the semiconductor and related industries. He received a B.A. from the University of Notre Dame, a J.D. from the University of San Francisco, and an M.B.A. from Pepperdine University.

Stephen W. Michael joined Exar as Vice President New Market Development in September 1992. In July 1995, he was appointed Vice President Operations, and in May 2001, he was appointed to his current position of Vice President, Operations and Reliability & Quality Assurance. Mr. Michael has 30 years of semiconductor industry experience, most recently as Vice President and General Manager, Analog and Custom Products with Catalyst Semiconductor. He joined Catalyst in 1987 and served in various senior positions. He holds a B.S. in Electrical Engineering from the University of California at Davis.

Raimon L. Conlisk joined the Company as a Director in August 1985, was appointed Vice Chairman of the Board in August 1990, served as Chairman of the Board from August 1994 to April 2002, and is currently serving as Vice Chairman. Mr. Conlisk has also served as a director since 1991, and in December 1997 was appointed Chairman of the Board of SBE, Inc., a manufacturer of communications and computer products. From 1977 to 1999, Mr. Conlisk was President of Conlisk Associates, a management consulting firm serving high-technology companies in the United States and foreign countries. From 1991 to 1998, Mr. Conlisk served as a Director of Xetel Corporation, a contract manufacturer of electronic equipment. Mr. Conlisk was also President from 1984 to 1989, a Director from 1970, and Chairman from 1989 until retirement in June 1990, of Quantic Industries, Inc., a privately held manufacturer of electronic systems. From 1970 to 1973, and from 1987 to 1990, Mr. Conlisk served as a Director of the American Electronics Association.

Frank P. Carrubba joined the Company as a Director in August 1998. Dr. Carrubba served as Executive Vice President and Chief Technical Officer of Philips Electronics, headquartered in Eindhoven, The Netherlands, from 1991 to 1997. From 1982 to 1991, Dr. Carrubba was with Hewlett-Packard Company, where he was a member of the Group Management Committee and was Director of Hewlett-Packard Laboratories. Prior to joining Hewlett- Packard, he spent 22 years as a member of the technical staff at IBM Corporation’s Thomas J. Watson Research Laboratory in Yorktown Heights, New York. Dr. Carrubba was one of the original designers of the RISC Architecture, for which he was named “Inventor of the Year” by the Intellectual Property Owners in

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Washington, D.C. in 1992. Dr. Carrubba is also a Director of Coherent, Inc., a global leader in the design, manufacture and sale of lasers, and Gyration, Inc., creators of in-air cordless mice and controllers for games, presentations and virtual reality. In June 2002, Dr. Carrubba was appointed Chairman of the Board of Accerra Corporation, a provider of secure online services for business communications located in Santa Rosa, California.

James E. Dykes joined the Company as a Director in May 1994. Mr. Dykes served as President and CEO of the Signetics division of North American Philips Corporation, a manufacturer of industrial and consumer electronics, from 1989 to 1993, and from 1987 to 1988, as President and CEO of TSMC, a semiconductor foundry in Taiwan. Prior to joining TSMC, Mr. Dykes held various management positions with other semiconductor and related companies, including General Electric Company, a diversified international manufacturer of defense, electrical and other products, and Harris Semiconductor, Inc., a manufacturer of semiconductors and integrated circuits. Mr. Dykes also is a Director of the Thomas Group, Inc., a management services company, and CREE Research, Inc., a silicon carbide materials and electronics company.

Richard Previte joined the Company as a Director in October 1999. He was a Director of Advanced Micro Devices, or AMD, from 1990 to April 2000, and Vice Chairman from 1999 to April 2000. Additionally, Mr. Previte served as Chairman of the Board of Vantis Corporation, a subsidiary of AMD, from 1997 to June 1999, and acted as Chief Executive Officer from February 1999 to June 1999. Mr. Previte served as President of AMD from 1990 to 1999, Executive Vice President and Chief Operating Officer from 1989 to 1990, and Chief Financial Officer and Treasurer from 1969 to 1989. Most recently he was Chief Executive Officer and Chairman of the Board of MarketFusion, Inc., from January 2000 to April 2002.

ITEM 2.     PROPERTIES

Exar’s executive offices, marketing and sales, research and development, manufacturing, test and engineering operations are located in Fremont, California in two buildings that the Company owns, which consist of approximately 151,000 square feet. Additionally, the Company owns approximately 5.3 acres of undeveloped property adjacent to its headquarters, which is presently being held for future office expansion. The Company leases additional space for sales offices in or near Atlanta; Boston; Chicago; Dallas; Kawasaki, Japan; and Valauris, France.

ITEM 3.     LEGAL PROCEEDINGS

The Company is not currently a party to any material legal proceedings.

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

During the fourth quarter of fiscal year 2003, no matter was submitted to a vote of security holders through the solicitation of proxies or otherwise.

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PART II

The common stock of Exar is traded on The Nasdaq Stock Market, Inc. under the symbol “EXAR.” The following table sets forth the range of high and low sales prices of the Company’s common stock for the periods indicated, as reported by Nasdaq. The listed quotations represent inter-dealer prices without retail markups, markdowns or commissions.

The Company has never paid cash dividends on its common stock and presently intends to continue this policy in order to retain earnings for use in its business. The Company had approximately 208 stockholders on record as of May 31, 2003. The Company believes it has in excess of 6,772 beneficial stockholders. The last sales price for Exar’s common stock, as reported by Nasdaq on May 31, 2003 was $16.24 per share.

Information relating to securities authorized for issuance under equity compensation plans under this item is hereby incorporated by reference from the Company’s Definitive Proxy Statement under the caption “Equity Compensation Plan Summary.”

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ITEM 6.     SELECTED CONSOLIDATED FINANCIAL DATA

The following selected financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Report. Historical periods have been restated to reflect the three-for-two stock split effected on February 15, 2000 and the two-for-one stock split effected on October 19, 2000.

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The following Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained in “Risk Factors” below and elsewhere in this Annual Report on Form 10-K (the “Annual Report”) under the caption “Part I, Item 1. Business,” contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements as a result of various factors. These risks, uncertainties and other factors include, among others, those identified under “Risk Factors.” Forward-looking statements are generally written in the future tense and/or are preceded by words such as “will,” “may,” “should,” “could,” “expect,” “suggest,” “believe,” “anticipate,” “intend,” “plan,” or other similar words. Forward-looking statements contained in this Annual Report include, among others, statements made in “Financial Outlook” and elsewhere regarding (1) the Company’s net sales, (2) the Company’s gross margins, (3) the Company’s ability to control and/or reduce operating expenses, (4) the Company’s research and development efforts, (5) customer acceptance of the Company’s new products, (6) the Company’s ability to maintain positive operating cash flows to fund future operations, (7) the sufficiency of the Company’s capital resources, (8) the Company’s capital expenditures, (9) competitive pressures and (10) the general market and economic outlook. The Company disclaims any obligation to update information in any forward-looking statement.

Overview

Exar designs, develops and markets high-performance, high-bandwidth physical-interface and access control solutions for the worldwide communications infrastructure. The Company’s current IC products for the communications market are designed to respond to the growing demand for cost effective line card solutions based on transmission standards such as T/E carrier, ATM and SONET/SDH. The Company also designs, develops and markets IC products that address the needs of the serial communications market and the video and imaging markets. Exar uses its design methodologies to develop products ranging from ASSPs, designed for industry-wide applications, to semi-custom solutions for specific customer applications. These complementary products enable the Company to offer a range of solutions for its customers’ applications. Exar’s products provide the following benefits to its users:

The Company’s customers include, among others, Alcatel, Cisco Systems, Inc., Digi International, Inc., Hewlett-Packard Company (“Hewlett-Packard”), Huawei Technologies Company, LTD., Logitech International S.A., NEC Corporation, Nokia Corporation, Plantronics, Inc. and Tellabs, Inc. For the fiscal year ended March 31, 2003, one customer, Hewlett-Packard, accounted for 26.4% of the Company’s net sales. No other customer accounted for more than 10% of the Company’s net sales during this period.

Over the past several years, the Company has actively refocused its business on products for the communications market. In the 1970’s, the Company designed, manufactured and marketed custom and general-purpose analog circuits supporting many different applications. In the 1980’s, the Company transitioned its products to analog and mixed-signal application specific standard products, or ASSPs, focusing on telecommunications, data communications, computer peripherals and consumer electronics. Through the mid-1990’s, the Company continued this product transition through internal development and strategic acquisitions and moved to a fabless semiconductor business model. In 1997, the Company leveraged its analog expertise by beginning to focus its product strategy and development efforts predominantly on the communications markets.

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For the fiscal year ended March 31, 2003, the Company’s communications product sales represented 59.1% of its net sales.

The Company markets its products in the Americas through independent non-exclusive sales representatives and independent non-exclusive distributors as well as the Company’s own direct sales organization. Additionally, the Company is represented in Europe and Asia/Pacific Region by its wholly owned subsidiaries. The Company’s international sales represented 58.6%, 47.4% and 38.5% of net sales for the years ended March 31, 2003, 2002 and 2001, respectively. These international sales consist primarily of export sales from the United States that are denominated in United States dollars. Such international sales and operations expose the Company to fluctuations in currency exchange rates because the Company’s foreign operating expenses are denominated in foreign currency while its sales are denominated in United States Dollars. The Company has adopted a set of practices to minimize its foreign currency risk, which include the occasional use of foreign currency exchange contracts to hedge the operating results of its foreign subsidiaries against this currency exchange risk. Although foreign sales within certain countries or foreign sales comprised of certain products may subject the Company to tariffs, the Company’s profit margin on international sales of ICs, adjusted for differences in product mix, is not significantly different from that realized on the Company’s sales to domestic customers. The Company’s operating results are subject to quarterly and annual fluctuations as a result of several factors that could materially and adversely affect the Company’s future profitability, as described below in “Risk Factors.”

To date, inflation has not had a significant impact on the Company’s operating results.

Financial Outlook for Fiscal Year 2004

The Company believes that further capital expenditure reductions and reduced enterprise spending by communications carriers in calendar year 2003 will put further downward pressure on demand for equipment and products sold by Exar’s customers. As a consequence, Exar continues to experience limited visibility with respect to customer demand for its communications products. The Company expects that long-term video, imaging and other revenue will decline further due to anticipated decreases in imaging product sales resulting from Hewlett-Packard’s product transitions, seasonality and competing sources. The Company may not be able to sustain or grow its communications revenue sufficiently to offset the anticipated decline in its video, imaging and other revenue, thus the Company’s future results of operations and financial condition may be negatively impacted. The Company believes that these factors may be offset, in part, by the improved operational efficiencies resulting from the cost containment measures undertaken by Exar commencing in fiscal year 2002 through fiscal year 2003.

The Company has continued to witness the design of its communication devices into several of its customers’ new and enhanced networking equipment, contributing to the Company’s belief that it is positioned for growth as market conditions improve. In addition, the Company’s serial communication devices achieved record-level design wins in fiscal year 2003. However, if the Company’s assumptions prove to be inaccurate, the design wins fail to result in significant revenue or the Company experiences pressure on its bookings and backlog as a result of competition or unfavorable market conditions, the Company’s future results of operations and financial condition may be negatively impacted.

The Company anticipates that interest income will continue to be under pressure as interest rates remain at historical lows. The Company plans to continue exchanging some of its shorter-termed marketable securities for longer-termed marketable securities in order to capitalize on higher yields offered by longer-termed securities. However, if the Company consumes cash in excess of future cash receipts, resulting in decreased average cash balances available for earning interest, the Company’s results of operations and financial condition may be negatively impacted.

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Critical Accounting Policies and Use of Estimates

The U.S. Securities and Exchange Commission (the “SEC”) has released FR-60 “Cautionary Advice Regarding Disclosure About Critical Accounting Policies,” which encourages companies to disclose critical accounting policies, judgments and uncertainties affecting the application of those policies and the likelihood that materially different financial results would be reported under different conditions or with the use of different assumptions. Such critical accounting policies, as defined by the SEC, are those that are both most significant to the depiction of a company’s financial condition and results and require the use of difficult, subjective and complex judgment by management, often as a result of the need to make estimates about the effect of matters that are uncertain.

The Company’s financial statements and accompanying disclosures, which are prepared in conformity with the accounting principles generally accepted in the United States, require that management use estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period for which they are determined to be necessary.

Exar’s most critical accounting policies relate to: (1) net sales; (2) reserves for excess inventories; (3) income taxes and (4) investments in non-public entities. These accounting policies, the basis for the underlying estimates and the potential impact on the Company’s consolidated financial statements, should any of the estimates prove to be inaccurate, are further described below:

Net Sales

Net sales are comprised of product deliveries principally to OEMs or their contract manufacturers and non-exclusive domestic distributors. For the fiscal year ended March 31, 2003, 82.5% and 17.5% of net sales were derived from product sales to OEMs and non-exclusive domestic distributors, respectively. For the fiscal year ended March 31, 2002, 72.4% and 27.6% of net sales were derived from product sales to OEMs and non-exclusive domestic distributors, respectively. The Company recognizes product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable and collection is reasonably assured. The Company has agreements with its non-exclusive domestic distributors, which provide for returns and allowances to these distributors. The Company records an allowance, at the time of delivery to such distributors, based on authorized and historical patterns of returns and other concessions. The following is a description of the provisions of the agreements allowing the distributors certain volume-based discounts and rights of return.

As of March 31, 2003, the Company had $942,000 of allowances for future volume discounts and stock rotation related to sales that were recorded during the fiscal year ended March 31, 2003. The Company has

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estimated volume discounts and stock rotation required by its distributors. However, the Company’s actual experience could differ from its original estimated allowances, therefore requiring adjustments to revenues in the relevant period.

Inventories

The Company’s policy is to establish accruals against inventory supply in excess of approximately six months of forecasted demand, unless there are other factors indicating that the inventory will be sold at a profit after six months. Such factors include, among others, known backlog of orders, projected sales and marketing forecasts, shipment activity, inventory-on-hand at the Company’s distributors, past and current market conditions, anticipated demand for the Company’s products and current business conditions when determining if a provision for excess inventory is required. The Company’s net inventories at March 31, 2003 were $2.9 million, compared with $7.3 million at March 31, 2002. The decrease of $4.4 million was primarily the result of the $2.3 million write-off of inventory in fiscal year 2003. Should management’s assumptions used in estimating the provision for excess inventory differ from actual future demand or should market conditions become less favorable than those projected by management, additional inventory write-downs may be required, which would impact the results of operations.

Deferred Income Tax Assets

Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, operating losses and tax credit carryforwards. Changes in tax rates affect the deferred income tax assets and liabilities and are recognized in the period in which the tax rates are enacted. In the event that the Company is unable to generate sufficient operating income in future periods, the deferred tax assets including the operating loss and credit carryforward components of the deferred tax assets would not be realized, which would result in a write-down of the deferred tax assets and a reduction of net income or an increase in net loss.

Investments in Non-Public Entities

Internet Machines Corporation

In July 2001, Exar invested $40.3 million in the Series C Preferred Stock financing for a 16% equity interest in Internet Machines Corporation (“IMC”), a pre-revenue, privately-held company which has developed a family of highly-integrated communications ICs designed to provide protocol-independent network processing, switch fabric and traffic management solutions for high-speed optical, MAN and Internet infrastructure equipment.

Because IMC is a non-public company, determining the market value of this investment is judgmental in nature and depends on management’s assessment of IMC’s performance, among other factors. Management must assess, among other matters, the possibility of successful introduction of IMC’s new products at a point in time when there is market demand for this new technology. This investment is subject to risks, including the risks that a suitable market for such technology may not exist as IMC markets it products, or that a competitor may develop a similar or superior product, or that the new products may fail to meet market demand, or that market demand fails to develop for IMC’s new products. Should any of these or other risks materialize, this asset would become impaired. In such case, the Company would be required to write-down the asset and record the related expense in the same period.

During the three months ended September 30, 2002, the Company became aware of a potential decline in the value of its 16% equity investment in IMC. As a result, the Company retained an independent third party to assist in determining the fair market value of its investment. As a consequence, the Company recorded against its earnings an investment impairment charge of $35.3 million, reducing its equity investment from $40.3 million to $5.0 million. If the Company’s assessed value of its investment were to fall below the carrying value, the Company would be required to recognize additional impairment to the investment, resulting in additional expense in the Company’s Consolidated Statements of Operations.

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TechFarm Ventures

As of March 31, 2003, the Company had invested $4.0 million in TechFarm Ventures (Q), L.P. (the “TechFarm Fund”). Exar became a limited partner in the TechFarm Fund in May 2001. This partnership is a venture capital fund, managed by TechFarm Ventures Management L.L.C., the general partner of the TechFarm Fund, a Delaware Limited Partnership, and focuses its investment activities on seed and early-stage technology companies. The Company’s capital commitment to the fund was $8.0 million, 10% of the total fund’s committed capital. The Company had accounted for this investment in accordance with EITF D-46, “Accounting for Limited Partnership Investments,” through May 31, 2002. Effective May 31, 2002, in connection with the amendment of the partnership agreement, the Company and TechFarm Ventures Management L.L.C. agreed to reduce the Company’s capital commitment in the TechFarm Fund to $4.0 million, or approximately 5% of the TechFarm Fund’s total committed capital. Additionally, the Company and TechFarm Ventures Management L.L.C. agreed to change the Company’s status from a limited partner to that of an assignee having less rights and status than a limited partner. Because of these modifications, the Company changed its method of accounting for this investment from the equity method to the cost basis method as of May 31, 2002. The Company has fulfilled its capital contribution commitment and, therefore, will not be required to fund additional amounts. If the Company’s assessed value of its investment falls below the carrying value, the Company would be required to recognize impairment to the asset, resulting in additional expense on the Company’s Consolidated Statement of Operations.

For the fiscal year ended March 31, 2003, Exar recorded charges against its earnings totaling $513,000, representing Exar’s portion of total losses in the TechFarm Fund and expenses through May 31, 2002. In the fiscal year ended March 31, 2002, the Company recorded a $680,000 charge against its earnings for its proportionate share of the TechFarm Fund losses and expenses. At March 31, 2003, the investment amount represents Exar’s total contributed capital of $4.0 million less an investment write-down of $1.2 million, netting to the $2.8 million reflected on the Company’s Consolidated Balance Sheet. If the Company’s assessed value of its investment were to fall below the carrying value on the Company’s Consolidated Balance Sheet, the Company would be required to recognize impairment to the asset, which would result in additional expense in the Company’s Consolidated Statements of Operation.

Skypoint Telecom

As of March 31, 2003, the Company had invested approximately $944,000 in Skypoint Telecom Fund II (US), L.P. (the “Skypoint Fund”), a venture capital fund, including funded capital and capitalized expenses. The investment is carried at cost on the Company’s Consolidated Balance Sheet. Exar is obligated to fund a total of $5.0 million, which represents approximately 5% of the fund’s total capital commitments. Of the $5.0 million obligation, Exar had funded $925,000 as of March 31, 2003, which reflects the return to the Company of $750,000 of previously funded capital in the three months ended September 30, 2002. As of March 31, 2003, the Company’s remaining capital contribution obligation was $4.1 million. The Company reviews the fund’s investments periodically to determine if there has been a temporary or permanent decline in the market value of the investments below the value at which the Company is carrying them on the Company’s Consolidated Balance Sheet. In assessing the potential of an impairment to the investment, the Company considers the fund performance information provided by the fund’s general partner together with other independent market information and makes an estimate of the future market potential of the venture capital fund. If the Company’s assessed value of its investment were to fall below the carrying value, the Company would be required to recognize impairment to the asset, resulting in additional expense on the Company’s Consolidated Statements of Operations.

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Results of Operations

The following table sets forth for the periods indicated the percentage relationship to net sales of certain cost, expense and income items. The table and subsequent discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto.

Product Line Sales as a Percentage of Net Sales

The following table sets forth product line revenue information as a percentage of net sales. The table and subsequent discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto.

Fiscal Year Ended March 31, 2003 Compared to Fiscal Year Ended March 31, 2002

Net Sales

Net sales for the fiscal year ended March 31, 2003 increased by 21.9% to $67.0 million compared to $55.0 million for the fiscal year ended March 31, 2002. The increase in net sales during fiscal year 2003 resulted from a 62.6% increase in video, imaging and other product sales, primarily as a result of sales to Hewlett-Packard. For the fiscal years ended March 31, 2003 and 2002, sales to Hewlett-Packard represented 26.4% and 13.8%, respectively of net sales, consisting of shipments of the Company’s imaging products to support Hewlett-Packard’s multifunction products.

The Company expects that long-term video, imaging and other revenue will decline further due to anticipated decreases in imaging product sales resulting from Hewlett-Packard’s product transitions, seasonality and competing sources. Although the Company anticipates an increase in communications product sales, this increase may not be sufficient to offset the estimated decline in video and imaging product sales. If communications product sales do not increase to offset such anticipated decline, the Company’s financial condition and results of operations will likely be adversely impacted.

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In the fiscal year ended March 31, 2003, sales to North American customers remained relatively stable as compared with fiscal year 2002. International sales increased by 49.8% to $38.7 million, as compared to $25.8 million for the prior fiscal year, primarily the result of increased imaging product sales to Hewlett-Packard.

Gross Profit

Gross profit represents net sales less cost of sales. Cost of sales includes:

Included in the cost of sales for the fiscal year ended March 31, 2003 is a $2.3 million charge taken by the Company during the three months ended September 30, 2002 to write-down inventory the Company determined to be excess.

Gross profit as a percentage of net sales for the fiscal year ended March 31, 2003, including the inventory write-down of $2.3 million, was 54.9% compared to 56.3% for the fiscal year ended March 31, 2002. The decrease in gross profit as a percentage of net sales was primarily due to the inventory write-down of $2.3 million, partially offset by the Company’s ability to achieve manufacturing efficiencies resulting from increased production volumes. Such efficiencies were modestly offset by the increase in imaging and video product sales, which typically have lower margins than the Company’s communications products, for the fiscal year ended March 31, 2003, when compared to the same period a year ago. The Company anticipates that gross profit will continue to fluctuate as a percentage of net sales due to future fluctuations in net sales, fluctuations in manufacturing costs, competitive pricing strategies, changes in product mix and other factors.

Research and Development

Research and development (“R&D”) costs consist primarily of:

R&D expenses for the fiscal year ended March 31, 2003 were $22.3 million, or 33.2% of net sales, compared to $21.9 million, or 39.8% of net sales, for the fiscal year ended March 31, 2002.

As a continuation of the cost containment measures undertaken by the Company in the fiscal year ended March 31, 2002, the Company implemented an approximate 10% workforce reduction effected on October 21, 2002 to further align the Company’s expenses with anticipated revenue (the “October Workforce Reduction”). In connection with the October Workforce Reduction, the Company reduced the number of engineering employees engaged in R&D. The Company began to realize the cost benefits associated with these measures were realized in the quarter ended March 31, 2003. The Company anticipates that the impact of these cost benefits will be partially offset by increased spending on product development.

Some aspects of the Company’s research and development efforts require significant short-term expenditures, the timing of which may cause significant fluctuations in the Company’s expenses. The Company expects that R&D expenses as a percentage of net sales will continue to fluctuate in the future because of the timing of expenditures and changes in the level of net sales. The Company believes that technological innovation is critical to its long-term success, and it intends to continue to make substantial investments to enhance its product offerings to meet the current and future technological requirements of its customers and markets.

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Selling, General and Administrative

Selling, general and administrative (“SG&A”) expenses consist primarily of:

SG&A expenses for the fiscal year ended March 31, 2003 were $18.7 million, or 28.0% of net sales, compared to $18.0 million, or 32.6% of net sales, for the fiscal year ended March 31, 2002. The increase in SG&A spending in absolute dollars was primarily the result of increased professional fees and sales commissions.

In connection with the October Workforce Reduction, the Company reduced the number of employees engaged in selling, marketing and administration. The cost benefits associated with the October Workforce Reduction began to be realized in the quarter ended March 31, 2003. However, it is possible that future SG&A expenses will increase in absolute dollars as a result of possible future expansion of the Company’s infrastructure to support potential acquisition and integration activities, and a general expansion of the Company’s operations. The Company continues to assess its cost structure and other programs to improve operational efficiencies. In the short term, many of the SG&A expenses are fixed, which results in a decline in SG&A expense as a percentage of net sales in periods of increasing net sales and an increase as a percentage of net sales when net sales decrease.

Other Income (Loss), Net

Other income (loss), net primarily consists of:

For the fiscal year ended March 31, 2003, other income (loss), net decreased to a loss of $26.8 million from income of $14.6 million for the prior fiscal year. This decrease resulted principally from a $35.3 million loss on long-term investments resulting from impairment charges.

During the quarter ended September 30, 2002, the Company became aware of a potential decline in the value of its 16% equity investment in IMC. As a result, the Company retained an independent third party to assist in determining the fair market value of its investment. As a consequence, the Company recorded an impairment charge of $35.3 million reported as a loss on other long-term investments.

Also reported within loss on other long-term investments in other income (expense), net for the fiscal years ended March 31, 2003 and 2002 are charges of $513,000 and $680,000, respectively, recorded for the Company’s equity investment portion of the loss experienced by the TechFarm Fund during those periods. In connection with the amendment of the partnership agreement effective May 31, 2002, the Company and TechFarm Ventures Management L.L.C. agreed to reduce the Company’s capital commitment in the fund to approximately $4.0 million, or approximately 5% of the TechFarm Fund’s total committed capital. The Company has fulfilled its capital contribution commitment. Additionally, the Company and TechFarm Ventures Management L.L.C. agreed to change the Company’s status from a limited partner to that of an assignee, having less rights and status than a limited partner. Because of these modifications, the Company changed its method of accounting for this investment from the equity method to the cost basis method as of May 31, 2002. The Company does not anticipate that it will take additional charges against earnings for losses incurred by the fund.

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However, if the Company’s assessed value of its investment were to fall below the carrying value reported on the Company’s Consolidated Balance Sheet, the Company would be required to recognize an impairment charge, resulting in additional expense in the Company’s Consolidated Statement of Operations.

The decrease in other income (loss), net, was primarily due to the impairment charge coupled with lower interest-related earnings on cash and marketable securities. The Company expects that its interest income will continue to be adversely affected by continued downward pressure on interest rates and current economic conditions.

The Company may report additional losses in connection with its investment in the TechFarm Fund or its investment in IMC, which would negatively affect the Company’s future other income (loss), net. See “Investments in Non-Public Companies” in the Critical Accounting Policies Section of this Report.

Net realized gains on investments were $101,000 for the fiscal year ended March 31, 2003, as compared to $882,000 for the fiscal year ended March 31, 2002. The decrease resulted from greater sales of marketable securities in fiscal year 2002 relative to fiscal year 2003.

Provision for Income Taxes

The provision for income taxes for the year ended March 31, 2003 differs from the amount computed by applying the statutory federal rate. This difference is principally due to the Company’s decision not to recognize a tax benefit for the $35.3 million IMC asset impairment charge. This decision resulted from the Company’s uncertainty regarding whether it will earn sufficient future capital gains to offset this capital loss after the loss is recognized for tax purposes.

The effective tax rate for fiscal year 2003, excluding the asset impairment charge, was 30%, which is the same as the income tax rate recorded by the Company in fiscal year 2002, compared with the federal statutory rate of 35%. The difference is due primarily to tax-exempt interest and the use of income tax credits, partially offset by state income taxes.

Fiscal Year Ended March 31, 2002 Compared to Fiscal Year Ended March 31, 2001

Net Sales

Net sales for the fiscal year ended March 31, 2002 decreased by 51.3% to $55.0 million compared to $112.9 million for the fiscal year ended March 31, 2001. The Company believes that this significant revenue decrease was largely due to adverse telecommunications industry-wide economic conditions that led to a reduction in purchases by the Company’s customers. This resulted in decreased shipments of the Company’s products to communications equipment OEMs. Price changes did not have a material effect on net sales.

In the fiscal year ended March 31, 2002, sales to North American customers decreased by 58.6% to $29.2 million, as compared to $70.4 million for the prior fiscal year. International sales decreased by 39.3% to $25.8 million, as compared to $42.5 million for the prior fiscal year. Sales to North American customers represented 53.0% of net sales for the fiscal year ended March 31, 2002 compared to 62.3% for the prior fiscal year.

Gross Profit

Gross profit as a percentage of net sales for the fiscal year ended March 31, 2002 decreased to approximately 56.3%, compared to 59.3% for the fiscal year ended March 31, 2001. The decrease in gross margins in fiscal year 2002 from fiscal year 2001 levels was primarily the result of reduced shipment volumes without an equivalent decrease in manufacturing overhead costs, coupled with a shift in the Company’s product sales mix to lower-margin video and imaging products.

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Research and Development

R&D expenses for the fiscal year ended March 31, 2002 were $21.9 million, or 39.8% of net sales, compared to $23.8 million, or 21.1% of net sales, for the fiscal year ended March 31, 2001. The decrease in R&D spending was due to labor cost reductions in fiscal year 2002 resulting from cost control measures undertaken by the Company.

Selling, General and Administrative

SG&A expenses for the fiscal year ended March 31, 2002 were $18.0 million, or 32.6% of net sales, compared to $25.0 million, or 22.1% of net sales, for the fiscal year ended March 31, 2001. The decrease in SG&A spending was primarily the result of cost control measures undertaken by the Company coupled with reduced sales commissions as a result of the decrease in net sales for the fiscal year ended March 31, 2002.

Other Income (Loss), Net

For the fiscal year ended March 31, 2002, other income (loss), net decreased by 44.5% to $14.6 million, as compared to $26.4 million for the prior fiscal year. Interest income, net for the fiscal year ended March 31, 2002 decreased to $14.4 million from $26.1 million for the prior fiscal year. This decrease resulted from a decline in interest rates.

Realized gains on investments were $882,000 for the fiscal year ended March 31, 2002, as compared to $59,000 for the fiscal year ended March 31, 2001. The increase resulted from greater sales of marketable securities in fiscal year 2002 relative to fiscal 2001. Declining interest rates allowed the Company to realize investment gains at the time of sale of these securities, but reduced the Company’s interest income.

The Company recorded losses of $680,000 for the fiscal year ended March 31, 2002 on its investment in the TechFarm Fund resulting from losses incurred by the fund on investments made during fiscal year 2002.

Provision for Income Taxes

The provision for income taxes is based on income before income taxes. The effective tax rate for fiscal year 2002 was 30.0% compared with the federal statutory rate of 35.0%. The difference is due primarily to the use of income tax credits, offset in part by state income taxes. The effective tax rate for fiscal 2001 was approximately 36.1% compared to the federal statutory rate of 35.0%. The difference was primarily due to state income taxes partially offset by the use of tax credits.

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Quarterly Results

The following table contains selected unaudited quarterly financial data for the eight quarters ended March 31, 2003, both in absolute dollars as well as in terms of percentage of net sales. In the opinion of management, this unaudited information has been prepared on the same basis as the audited information and includes all adjustments, consisting only of normal and recurring adjustments necessary to present fairly the information set forth therein. Results for a given quarter are not necessarily indicative of results for any subsequent quarter.

Commencing with the three months ended March 31, 2001, the Company’s gross margins have fluctuated through fiscal year 2003. Excluding the inventory write-down of $2.3 million recorded in the three months ended September 30, 2002 for excess communications product inventory, the Company would have reported quarterly gross margins for fiscal year 2003 that were flat to slightly greater than those reported in fiscal year 2002. The Company’s ability to achieve manufacturing efficiencies resulting from increased production volumes also

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contributed to the improved gross margins reported by the Company in fiscal year 2003 excluding the inventory write-down. Such efficiencies were modestly offset by the increase in imaging and video product sales, which typically have lower margins than the Company’s communications products.

The Company’s operating results for fiscal year 2003 improved from those reported in fiscal year 2002, excluding the asset impairment charge of $35.3 million related to the decline in the fair market value of the Company’s 16% equity investment in IMC. The improvement in operating results was primarily due to higher sales and cost containment measures implemented by the Company in fiscal year 2002 and sustained through fiscal year 2003.

Liquidity and Capital Resources

The Company does not have any off balance-sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. Additionally, the Company is not a party to any derivative contracts, nor does it have any synthetic leases. Due to the strength of its financial position, the Company elected not to renew a credit facility agreement with a domestic bank under which it had been permitted to execute up to $15.0 million in foreign currency transactions. At March 31, 2003, the Company had no foreign currency contracts outstanding.

The Company’s principal source of liquidity in fiscal years 2003 and 2002 were cash and cash equivalents, short-term marketable securities and long-term marketable securities which increased by $17.9 million to $422.1 million at March 31, 2003 from $404.2 million at March 31, 2002. Cash and cash equivalents decreased from $317.4 million at March 31, 2002 to $231.0 million at March 31, 2003. The decrease was due to net cash used in investing activities of $110.2 million, partially offset by net cash provided by operating activities of $16.4 million and net cash provided by financing activities of $7.3 million.

The Company generated cash flows from operating activities of $16.4 million in the fiscal year ended March 31, 2003 as compared to $16.0 million in the fiscal year ended March 31, 2002. The positive cash flow from operations in fiscal year 2003 was attributable, in part, to a $4.7 million refund from the Internal Revenue Service resulting from favorable tax law changes under the 2002 Federal Economic Stimulus Bill, which enabled companies to apply any 2001 net operating tax losses to taxable income realized in the previous five years. Also contributing to the positive operating cash flow for the fiscal year ended March 31, 2003 were $44.9 million in additional adjustments to the $32.3 million net loss for depreciation and amortization, loss on other long-term investments, provision for doubtful accounts and inventory write-down and a $2.1 million decrease in inventories. These amounts were slightly offset by increases in accounts receivable and prepaid expenses. The Company generated cash from operating activities of $16.0 million during the fiscal year ended March 31, 2002. Adjustments to net income of $4.0 million for that year included $12.0 million of non-cash charges and changes in working capital.

Net cash used in investing activities totaled $110.2 million in the fiscal year ended March 31, 2003 as compared to $92.0 million in the fiscal year ended March 31, 2002. During the fiscal year ended March 31, 2003, the Company’s investing activities included proceeds from the maturity of $61.6 million and $109.8 million of short-term and long-term marketable securities, respectively. For the same period, purchases of both short-term and long-term securities were $168.1 million and $107.3 million, respectively. Purchases of manufacturing test equipment, computer equipment, software and hardware used for product development amounted to $6.0 million for the fiscal year ended March 31, 2003. Included in purchases of property and equipment were progress payments totaling $3.5 million related to the on-site power generation project that the Company has undertaken in order to produce its own electricity for its Fremont headquarters. The Company expects that the total on-site power generation project costs, net of an approximate $926,000 refund to be issued by the California Energy Commission, will be approximately $2.8 million. The on-site power generation project is expected to be completed and to become operational by June 30, 2003.

As of March 31, 2003, the Company had funded $925,000 of its $5.0 million committed capital in the Skypoint Fund. As of June 30, 2002, the Company had funded $1.5 million of its committed capital. However,

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during the quarter ended September 30, 2002, the Skypoint Fund refunded $750,000 of the Company’s previous capital contribution. The Company is obligated to contribute its remaining committed capital of approximately $4.1 million as needed. To meet its capital commitment to the fund, the Company may need to use its existing cash, cash equivalents and marketable securities.

Effective May 31, 2002, the Company and TechFarm Ventures Management L.L.C. agreed to, among other matters, reduce the Company’s capital commitment in the TechFarm Fund to approximately $4.0 million, or approximately 5% of the TechFarm Fund’s total committed capital. As of June 1, 2002, the Company had satisfied its capital contribution obligation through the final capital contribution of $801,517.

Net cash provided by financing activities totaled $7.3 million in the fiscal year ended March 31, 2003 as compared to $3.9 million in the fiscal year ended March 31, 2002 representing proceeds from the issuance of common stock. During fiscal year 2003, the Company received $7.3 million from the issuance of approximately 961,000 shares of common stock upon the exercise of stock options under the Company’s stock option plans and the purchase of shares of common stock under the Company’s employee stock purchase plan.

In March 2001, the Board of Directors authorized a stock repurchase program to acquire outstanding common stock in the open market. Under this program, the Board of Directors authorized the acquisition of up to $40.0 million of Exar’s common stock. During the fiscal year ended March 31, 2001, the Company acquired 245,000 shares of its common stock for $4.6 million. Although the Company did not repurchase any of its outstanding shares during fiscal years 2002 and 2003, the Company may utilize this program in the future, which would reduce cash, cash equivalents and/or marketable securities available to fund future operations and meet other liquidity requirements.

The Company places purchase orders with wafer foundries and other vendors as part of its normal course of business. As of March 31, 2003, the Company had approximately $4.4 million of outstanding purchase commitments with several suppliers for the purchase of wafers, capital equipment and various service contracts. The Company expects to receive and pay for the wafers and capital equipment within the next six months and pay for its various service contracts over the next twelve months from its existing cash balances.

The following table summarizes the Company’s contractual payment obligations and commitments as of March 31, 2003 (in thousands):

The Company anticipates that it will continue to finance its operations with cash flows from operations, existing cash and investment balances, and some combination of long-term debt and/or lease financing and additional sales of equity securities. The combination and sources of capital will be determined by management based on the Company’s needs and prevailing market conditions. The Company believes that its cash and cash equivalents, short-term marketable securities, long-term marketable securities and cash flows from operations will be sufficient to satisfy working capital requirements and capital equipment needs for at least the next

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12 months. However, should the demand for the Company’s products decrease in the future, the availability of cash flows from operations may be limited, thus possibly having a material adverse effect on the Company’s financial condition or results of operations. From time to time, the Company evaluates potential acquisitions and equity investments complementary to its design expertise and market strategy, which may include investments in wafer fabrication foundries. To the extent that the Company pursues or positions itself to pursue these transactions, the Company could choose to seek additional equity or debt financing. There can be no assurance that additional financing could be obtained on terms acceptable to the Company. The sale of additional equity or convertible debt could result in dilution to the Company’s stockholders.

Recently Issued Accounting Pronouncements

In May 2002, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No.145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections” (“SFAS 145”). Among other things, SFAS 145 rescinds various pronouncements regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the provisions of Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” are met. SFAS 145 provisions regarding early extinguishment of debt are generally effective for fiscal years beginning after May 15, 2002. The adoption of this statement did not have any effect on the Company’s financial statements.

In July 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” (“SFAS 146”). This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This Statement requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The Company adopted SFAS 146 effective January 1, 2003. The adoption of SFAS 146 did not have a material impact on its financial position or results of operations, although SFAS 146 may impact the timing of recognition of costs associated with future restructuring, exit or disposal activities.

In November 2002, FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34.” FIN 45 clarifies the requirements of FASB Statement No. 5, “Accounting for Contingencies,” relating to the guarantor’s accounting for and disclosure of the issuance of certain types of guarantees. The disclosure provisions of the Interpretation are effective for financial statements of interim or annual reports that end after December 15, 2002. However, the provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002, irrespective of the guarantor’s year-end. The adoption of FIN 45 did not have a material impact on the Company’s financial position or results of operations.

In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, (“EITF 00-21”). EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company believes that adoption of EITF 00-21 will have no material impact on its financial position or results of operations.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—An Amendment of FASB Statement No. 123,” (“SFAS 148”). SFAS 148 requires companies to provide alternative methods of transition for a voluntary change to the fair value based method of

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accounting for stock-based employee compensation. SFAS 148 amends the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”), to require prominent disclosures both in annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has included the disclosures required by SFAS 148 in Note 8—“Stockholders’ Equity.” The Company does not intend to adopt the accounting provisions of SFAS 123 for employee compensation.

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” (“FIN 46”). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company is currently evaluating the impact that the adoption of this standard will have on its financial position and results of operations.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” (“SFAS 150”). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not believe the adoption of this standard will have a material impact on its financial position or results of operations.

RISK FACTORS

The Company is subject to a number of risks. Some of these risks are endemic to the fabless semiconductor industry and are the same or similar to those disclosed in the Company’s previous SEC filings, and some risks may arise in the future. You should carefully consider all of these risks and the other information in this Report before investing in the Company. The fact that certain risks are endemic to the industry does not lessen the significance of these risks.

As a result of these risks, the Company’s business, financial condition or operating results could be materially and adversely affected. This could cause the trading price of the Company’s common stock to decline, and stockholders might lose some or all of their investment.

IF THE COMPANY IS UNABLE TO GENERATE ADDITIONAL REVENUE FROM THE SALE OF ITS COMMUNICATIONS PRODUCTS, OR ITS REVENUE FROM THESE PRODUCTS DECLINES, THE COMPANY’S BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS WILL BE MATERIALLY AND ADVERSELY IMPACTED.

Although communications revenue is expected to grow in the long term, it may not grow fast enough to offset the expected decline in revenue from non-communications products. If communications revenue does not increase in the future, the Company’s financial condition and results of operations will be materially and adversely impacted.

The Company is continuing to focus a significant portion of its research and sales resources on the communications market. As a result, the Company’s dependence on this market, as compared to Exar’s dependence on other markets, such as video and imaging, is increasing. Given the Company’s increasing dependence on the communications market to support revenue growth, the Company must continue to generate

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additional sales from this market, either by taking market share from competitors or by maintaining market share while in a growing market. If the Company is not able to generate additional revenue in the communications market, the Company’s business, financial condition and results of operations will be materially and adversely impacted.

THE SLOWDOWN AND UNCERTAINTY IN THE U.S. AND GLOBAL ECONOMIES MAY CONTINUE TO ADVERSELY AFFECT THE COMPANY’S BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Decreased consumer confidence, reduced corporate profits, lower capital spending, the impact of the Iraq war, the outbreak of the Severe Acute Respiratory Syndrome (“SARS”) and other geopolitical factors have had, and continue to have, a negative impact on the U.S. and global economies. Many of the Company’s customers continue to experience significant declines in demand for their products as a result of continued uncertainty regarding future capital spending by the communications service providers. This uncertainty regarding capital spending is based upon the weak operating results of these service providers, which, in turn, have hindered their ability to obtain additional capital from the public markets in order to continue to build their networks. Communications service providers continue to face significant financial challenges and, therefore, may continue to delay or further reduce their spending on the Company’s customers’ products. These challenges have been exacerbated by disclosures of accounting irregularities by communications service providers and other large public companies. If the Company’s customers delay or cancel their orders for the Company’s products, the Company’s revenues and results of operations may be negatively impacted.

The extent and severity of this economic downturn, in conjunction with the uncertainty of the geopolitical environment, have made it difficult for the Company to predict when and if demand for its products will increase. Additionally, the Company does not expect the trend of lower capital spending among service providers to reverse itself in the near future. Therefore, the Company does not know when or how quickly its customers will place new orders. Furthermore, the Company’s revenues may decline in the future, which could materially and adversely impact the Company’s business, financial condition and results of operations.

IF THE COMPANY FAILS TO DEVELOP AND INTRODUCE NEW PRODUCTS THAT MEET THE EVOLVING NEEDS OF ITS CUSTOMERS, THE COMPANY’S BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY IMPACTED.

The markets for the Company’s products are characterized by: