---



SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q



|x |  | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2003
|- |  | ------------------------------------------------------------------------------------------------------------------------------------



| ̈ |  | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- |  | ----------------------------------------------------------------------------------------



Commission file number: 000-31863



COMPUTER ACCESS TECHNOLOGY CORPORATION

(exact name of registrant as specified in its charter)



|Delaware                                                       |  | 77-0302527                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|2403 Walsh Avenue, Santa Clara California                      |  | 95051                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



(408) 727-6600

(Registrants telephone number, including area code)



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.



Yes  x     
No ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)



Yes ̈No  x



As of August 1, 2003, there were 19,381,026 shares of the registrants Common Stock outstanding.



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Part IFINANCIAL INFORMATION



Item 1.     Financial Statements



COMPUTER ACCESS TECHNOLOGY CORPORATION



CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands)



|                                     |  | June 30,2003 |        |   | December 31, 2002 |  
|------------------------------------ |  | ------------ | ------ | - | ----------------- | -
|ASSETS                               |  |              |        |   |                   |  
|Current assets:                      |  |              |        |   |                   |  
|Cash and cash equivalents            |  | $            | 30,698 |   |                   | $
|Short-term investments               |  |              | 12,135 |   |                   |  
|Trade accounts receivable, net       |  |              | 1,634  |   |                   |  
|Related party receivable             |  |              | 690    |   |                   |  
|Inventories                          |  |              | 826    |   |                   |  
|Other current assets                 |  |              | 1,552  |   |                   |  
|                                     |  |              |        |   |                   |  
|Total current assets                 |  |              | 47,535 |   |                   |  
|Property and equipment, net          |  |              | 872    |   |                   |  
|Purchased intangibles                |  |              | 236    |   |                   |  
|Other assets                         |  |              | 85     |   |                   |  
|                                     |  |              |        |   |                   |  
|                                     |  | $            | 48,728 |   |                   | $
|                                     |  |              |        |   |                   |  
|LIABILITIES AND STOCKHOLDERS EQUITY |  |              |        |   |                   |  
|Current liabilities:                 |  |              |        |   |                   |  
|Accounts payable                     |  | $            | 226    |   |                   | $
|Accrued expenses                     |  |              | 1,202  |   |                   |  
|Accrued restructuring                |  |              | 41     |   |                   |  
|Deferred revenue                     |  |              | 492    |   |                   |  
|                                     |  |              |        |   |                   |  
|Total current liabilities            |  |              | 1,961  |   |                   |  
|                                     |  |              |        |   |                   |  
|Stockholders equity:                |  |              |        |   |                   |  
|Common stock                         |  |              | 19     |   |                   |  
|Additional paid-in capital           |  |              | 52,941 |   |                   |  
|Deferred stock-based compensation    |  |              | (130   | ) |                   |  
|Accumulated deficit                  |  |              | (6,063 | ) |                   |  
|                                     |  |              |        |   |                   |  
|Total stockholders equity           |  |              | 46,767 |   |                   |  
|                                     |  |              |        |   |                   |  
|                                     |  | $            | 48,728 |   |                   | $
|                                     |  |              |        |   |                   |  



See accompanying
notes.



2



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COMPUTER ACCESS TECHNOLOGY CORPORATION



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share amounts)



|                                                                                                                                                                                                                                                                                   |  | Three Month PeriodEnded June 30, |        |   | Six Month PeriodEnded June 30, |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------ | -
|                                                                                                                                                                                                                                                                                   |  | 2003                             |        |   | 2002                           |  
|Revenue                                                                                                                                                                                                                                                                            |  | $                                | 3,856  |   |                                | $
|Cost of revenue (inclusive of amortization of deferred stock-based compensation of $15 and $31 in the three month period ended
June 30, 2003 and 2002, respectively, and of $18 and $80 in the six month period ended June 30, 2003 and 2002, respectively)                        |  |                                  | 791    |   |                                |  
|Amortization of acquired developed technology                                                                                                                                                                                                                                      |  |                                  | 9      |   |                                |  
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  
|Gross profit                                                                                                                                                                                                                                                                       |  |                                  | 3,056  |   |                                |  
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  
|Operating expenses:                                                                                                                                                                                                                                                                |  |                                  |        |   |                                |  
|Research and development (exclusive of amortization of deferred stock-based compensation (recovery) of $53 and $(229) in the three
month period ended June 30, 2003 and 2002, respectively, and of $85 and $70 in the six month period ended June 30, 2003 and 2002, respectively) |  |                                  | 1,249  |   |                                |  
|Sales and marketing (exclusive of amortization of deferred stock-based compensation (recovery) of $21 and $(32) in the three month
period ended June 30, 2003 and 2002, respectively, and of $40 and $(155) in the six month period ended June 30, 2003 and 2002, respectively)    |  |                                  | 1,193  |   |                                |  
|General and administrative (exclusive of amortization of deferred stock-based compensation of $7 and $59 in the three month period
ended June 30, 2003 and 2002, respectively, and of $15 and $191 in the six month period ended June 30, 2003 and 2002, respectively)             |  |                                  | 585    |   |                                |  
|Acquired in-process research and development                                                                                                                                                                                                                                       |  |                                  |       |   |                                |  
|Amortization of purchased intangibles                                                                                                                                                                                                                                              |  |                                  | 26     |   |                                |  
|Restructuring expenses                                                                                                                                                                                                                                                             |  |                                  |       |   |                                |  
|Amortization of deferred stock-based compensation                                                                                                                                                                                                                                  |  |                                  | 81     |   |                                |  
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  
|Total operating expenses                                                                                                                                                                                                                                                           |  |                                  | 3,134  |   |                                |  
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  
|Loss from operations                                                                                                                                                                                                                                                               |  |                                  | (78    | ) |                                |  
|Other income, net                                                                                                                                                                                                                                                                  |  |                                  | 198    |   |                                |  
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  
|Income (loss) before benefit from income taxes                                                                                                                                                                                                                                     |  |                                  | 120    |   |                                |  
|Benefit from income taxes                                                                                                                                                                                                                                                          |  |                                  |       |   |                                |  
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  
|Net income (loss)                                                                                                                                                                                                                                                                  |  | $                                | 120    |   |                                | $
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  
|Net income (loss) per share:                                                                                                                                                                                                                                                       |  |                                  |        |   |                                |  
|Basic and diluted                                                                                                                                                                                                                                                                  |  | $                                | 0.01   |   |                                | $
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  
|Weighted average shares outstanding:                                                                                                                                                                                                                                               |  |                                  |        |   |                                |  
|Basic                                                                                                                                                                                                                                                                              |  |                                  | 19,442 |   |                                |  
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  
|Diluted                                                                                                                                                                                                                                                                            |  |                                  | 19,980 |   |                                |  
|                                                                                                                                                                                                                                                                                   |  |                                  |        |   |                                |  



See accompanying notes.



3



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COMPUTER ACCESS TECHNOLOGY CORPORATION



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)



|                                                                            |  | Six Month PeriodEnded June 30, |       
|--------------------------------------------------------------------------- |  | ------------------------------ | ------
|                                                                            |  | 2003                           |       
|Cash flows from operating activities:                                       |  |                                |       
|Net loss                                                                    |  | $                              | (343  
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                |       
|Depreciation and amortization                                               |  |                                | 397   
|Provision for doubtful accounts                                             |  |                                |      
|Write-down of property and equipment in connection with restructuring       |  |                                |      
|Acquired in-process research and development                                |  |                                |      
|Amortization of acquired developed technology                               |  |                                | 18    
|Amortization of purchased intangibles                                       |  |                                | 52    
|Amortization of deferred stock-based compensation                           |  |                                | 158   
|Amortization of premium on short-term investments                           |  |                                | 262   
|Changes in assets and liabilities:                                          |  |                                |       
|Trade accounts and related party receivables                                |  |                                | (600  
|Inventories                                                                 |  |                                | 206   
|Deferred tax assets                                                         |  |                                |      
|Other assets                                                                |  |                                | 962   
|Accounts payable                                                            |  |                                | (1,100
|Accrued expenses                                                            |  |                                | (46   
|Accrued restructuring                                                       |  |                                | (229  
|Deferred revenue                                                            |  |                                | 7     
|Deferred rent                                                               |  |                                |      
|                                                                            |  |                                |       
|Net cash used in operating activities                                       |  |                                | (256  
|                                                                            |  |                                |       
|Cash flows from investing activities:                                       |  |                                |       
|Acquisition of property and equipment                                       |  |                                | (270  
|Other long-term assets                                                      |  |                                | 120   
|Purchase of short-term investments                                          |  |                                | (4,392
|Sale of short-term investments                                              |  |                                | 4,900 
|Acquisition of subsidiary, net of cash acquired                             |  |                                |      
|                                                                            |  |                                |       
|Net cash provided by (used in) investing activities                         |  |                                | 358   
|                                                                            |  |                                |       
|Cash flows from financing activities:                                       |  |                                |       
|Proceeds from exercise of stock options                                     |  |                                | 145   
|Proceeds from employee stock purchase plan                                  |  |                                | 70    
|Repurchases of common stock                                                 |  |                                | (465  
|                                                                            |  |                                |       
|Net cash provided by (used in) financing activities                         |  |                                | (250  
|                                                                            |  |                                |       
|Net decrease in cash and cash equivalents                                   |  |                                | (148  
|Cash and cash equivalents at beginning of period                            |  |                                | 30,846
|                                                                            |  |                                |       
|Cash and cash equivalents at end of period                                  |  | $                              | 30,698
|                                                                            |  |                                |       



See accompanying notes.



4



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NOTE 1  BUSINESS



Business



Computer Access Technology Corporation is a provider of advanced verification systems for existing and emerging digital communications standards. Our
products are used by semiconductor, computer systems, software, data storage, communications, automotive and aerospace companies at each phase of their products lifecycles from development through production and market deployment.



We have expertise in the Bluetooth, Ethernet, Fibre Channel, IEEE 1394,
InfiniBand, PCI Express, SCSI, Serial ATA, Serial Attached SCSI, and USB standards and are actively engaged with our customers throughout their development and production processes. Utilizing our easy to use, color-coded, expert analysis software,
the CATC Trace, our development products
generate, capture, filter and analyze high-speed communications traffic, allowing our customers to quickly discover and correct flaws in their product design. Our production products are used in manufacturing to ensure that products comply with
applicable standards and operate with other devices, as well as assist system manufacturers in downloading software onto new computers.



We have two reportable segments: development products and production products. Further segment and geographic information is included in Note 9 of the
Notes to Condensed Consolidated Financial Statements included in this report.



Computer Access Technology Corporation was incorporated in California in 1992 and reincorporated in Delaware in 2000. Our headquarters are located at 2403 Walsh Avenue, Santa Clara, California 95051. We maintain a
website at www.catc.com. The reference to this website address does not constitute incorporation by reference of the information contained therein.



Our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports, and the proxy statement
for our annual meeting of stockholders are made available, free of charge, on our website, www.catc.com, as soon as reasonably practicable after the reports have been filed with or furnished to the Securities and Exchange Commission
(SEC).



Interim Financial Information and Basis of Presentation



The accompanying unaudited condensed consolidated
financial statements as of June 30, 2003, and for the three and six month periods ended June 30, 2003 and 2002, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial
statements and pursuant to the rules and regulations of the SEC and include the accounts of Computer Access Technology Corporation and its wholly owned subsidiaries (collectively, Computer Access Technology Corporation or the
Company). Intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been condensed or omitted pursuant to SEC rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) necessary for a fair presentation of the condensed consolidated balance sheet at June 30, 2003, the condensed consolidated operating results for the three and six month periods ended June 30, 2003
and 2002, and the condensed consolidated cash flows for the six month periods ended June 30, 2003 and 2002. These unaudited condensed consolidated financial statements should be read in conjunction with the Companys audited consolidated
financial statements and notes thereto for the year ended December 31, 2002.



The unaudited condensed consolidated balance sheet at December 31, 2002 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes
required by generally accepted accounting principles in the United States of America for complete financial statements.



5



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Concentrations of credit risk



Revenue and accounts receivable from customers comprising more than 10% of revenue or receivables are summarized as follows:



|                     |  | Six Month Period Ended June 30,
|-------------------- |  | -------------------------------
|                     |  | 2003                           
|Revenue:             |  |                                
|Company A            |  | 18%                            
|Company B            |  | 17%                            
|                     |  |                                
|                     |  | June 30, 2003                  
|Accounts receivable: |  |                                
|Company A            |  | 18%                            
|Company B            |  | 9%                             



NOTE 2  COMPREHENSIVE
LOSS



Comprehensive loss is defined as
changes in equity of a company from transactions, other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners. There is no difference between net loss and comprehensive loss for the Company
in any of the periods presented.



NOTE 3  STOCK-BASED
COMPENSATION



Stock-based compensation



In connection with certain stock option grants in 2000, 1999 and 1998,
the Company recorded deferred stock-based compensation totaling $14,393,000 which represents the difference between the exercise price and the deemed fair value at the date of grant, which is being recognized over the vesting period of the related
options. Amortization of deferred stock-based compensation was $96,000 and $158,000 in the quarter ended June 30, 2003 and the six month period ended June 30, 2003, respectively, of which $15,000 and $18,000 was included in cost of revenue in the
quarter ended June 30, 2003 and the six month period ended June 30, 2003, respectively. Amortization (recovery) of deferred stock-based compensation was $(171,000) and $186,000 in the quarter ended June 30, 2002 and the six month period ended June
30, 2002, respectively, of which $31,000 and $80,000 was included in cost of revenue in the quarter ended June 30, 2002 and the six month period ended June 30, 2002, respectively. Amortization of deferred stock-based compensation on grants prior to
December 31, 2000 is estimated to be approximately $97,000 for the remainder of the year ending December 31, 2003 and $33,000 in the year ending December 31, 2004 and may change due to the granting of additional options or the cancellation of
existing grants in future periods.



Fair value disclosures



The Company has adopted the disclosure provisions of
Statement of Financial Accounting Standard (SFAS) No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure. This statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation and requires prominent disclosure in both the annual and interim financial statements of the method of
accounting used and the financial impact of stock-based compensation. As permitted by SFAS No. 123 the Company accounts for stock options granted as prescribed under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, which recognizes compensation cost based upon the intrinsic value of the award.



6



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The weighted-average fair value of options granted during the quarters ended June 30, 2003 and 2002, were
$2.01, $3.03 and for the six month periods ended June 30, 2003 and 2002, were $1.78, and $3.90. In determining the fair value of options granted in each of the periods, the Company used the Black Scholes option pricing model and assumed the
following:



|                         |  | Quarter Ended June 30, |  | Six Month Period Ended June 30,
|------------------------ |  | ---------------------- |  | -------------------------------
|                         |  |                       
|                         |  | 2003                   |  | 2002                           
|                         |  |                       
|Expected life (in years) |  | 5                      |  | 5                              
|Risk-free interest rate  |  | 2.63%                  |  | 4.17-5.11%                     
|Volatility               |  | 77%                    |  | 100%                           
|Dividend yield           |  | 0%                     |  | 0%                             



Had compensation costs
been determined based upon the fair value at the grant date for awards under the Plan, consistent with the methodology prescribed under SFAS No. 148, the Companys pro forma net loss and pro forma basic and diluted net loss per share under SFAS
No. 148 would have been (in thousands, except per share data):



|                                                                                                          |  | Quarter Ended June 30, |       |   | Six Month Period Ended June 30, |  
|--------------------------------------------------------------------------------------------------------- |  | ---------------------- | ----- | - | ------------------------------- | -
|                                                                                                          |  | 2003                   |       |   | 2002                            |  
|Net income (loss), as reported                                                                            |  | $                      | 120   |   |                                 | $
|Add: Amortization of deferred stock-based compensation included in as reported net loss                   |  |                        | 96    |   |                                 |  
|Deduct: Stock-based employee compensation expense determined under fair value based method for all grants |  |                        | (472  | ) |                                 |  
|                                                                                                          |  |                        |       |   |                                 |  
|Net loss, pro forma                                                                                       |  | $                      | (256  | ) |                                 | $
|                                                                                                          |  |                        |       |   |                                 |  
|Net income (loss) per share, as reported                                                                  |  |                        |       |   |                                 |  
|Basic and diluted                                                                                         |  | $                      | 0.01  |   |                                 | $
|                                                                                                          |  |                        |       |   |                                 |  
|Net loss per share, pro forma                                                                             |  |                        |       |   |                                 |  
|Basic and diluted                                                                                         |  | $                      | (0.01 | ) |                                 | $



NOTE 4  NET INCOME
(LOSS) PER SHARE



The Company computes net income (loss)
per share in accordance with SFAS No. 128, Earnings per Share, and SEC Staff Accounting Bulletin (SAB) No. 98. Under the provisions of SFAS No. 128 and SAB No. 98, basic net income (loss) per share is computed by dividing net
income (loss) for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net income (loss) per share excludes potential common stock if its effect is antidilutive. Potential
common stock consists of incremental common shares issuable upon the exercise of stock options.



7



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



|                                                                                                                                                    |  | Quarter EndedJune 30, |        |      | Six Month PeriodEnded June 30, |       
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | ------ | ---- | ------------------------------ | ------
|                                                                                                                                                    |  | 2003                  |        | 2002 |                                |       
|Numerator:                                                                                                                                          |  |                       |        |      |                                |       
|Net income (loss)                                                                                                                                   |  | $                     | 120    |      | $                              | (809  
|                                                                                                                                                    |  |                       |        |      |                                |       
|Denominator:                                                                                                                                        |  |                       |        |      |                                |       
|Weighted average shares outstanding                                                                                                                 |  |                       | 19,442 |      |                                | 19,083
|                                                                                                                                                    |  |                       |        |      |                                |       
|Denominator for basic calculation                                                                                                                   |  |                       | 19,442 |      |                                | 19,083
|Dilutive effect of stock options                                                                                                                    |  |                       | 538    |      |                                |      
|                                                                                                                                                    |  |                       |        |      |                                |       
|Denominator for diluted calculation                                                                                                                 |  |                       | 19,980 |      |                                | 19,083
|                                                                                                                                                    |  |                       |        |      |                                |       
|Net income (loss) per share:                                                                                                                        |  |                       |        |      |                                |       
|Basic                                                                                                                                               |  | $                     | 0.01   |      | $                              | (0.04 
|                                                                                                                                                    |  |                       |        |      |                                |       
|Diluted                                                                                                                                             |  | $                     | 0.01   |      | $                              | (0.04 
|                                                                                                                                                    |  |                       |        |      |                                |       
|Total common stock equivalents, related to options outstanding, excluded from the computation of earnings per share as their
effect is antidilutive |  |                       | 2,813  |      |                                | 4,052 
|                                                                                                                                                    |  |                       |        |      |                                |       



NOTE 5  INVENTORIES



Inventories consist of the following (in thousands):



|                 |  | June 30,2003 |     | December 31,2002
|---------------- |  | ------------ | --- | ----------------
|Raw materials    |  | $            | 319 |                 
|Work in progress |  |              | 192 |                 
|Finished goods   |  |              | 315 |                 
|                 |  |              |     |                 
|                 |  | $            | 826 |                 
|                 |  |              |     |                 



NOTE 6  RESTRUCTURING



During the quarters ended June 30, 2002 and December 31,
2002, the Company implemented two separate restructuring plans designed to consolidate operations and reduce costs. The Company had restructuring expenses of $443,000 for the quarter ended June 30, 2002 and $365,000 for the quarter ended December
31, 2002. The restructuring plans included the closure of our facilities in San Diego, California and Netanya, Israel and a reduction in staff by a total of 34 positions, primarily in research and development. Obligations related to subleasing may
continue until 2004 as estimated and accrued for as of June 30, 2003.



8



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The following table summarizes the components of the accrued restructuring (in thousands):



|                                                             |  | EmployeeSeverance |     | OfficeClosure |   | OtherCosts |  | Total
|------------------------------------------------------------ |  | ----------------- | --- | ------------- | - | ---------- |  | -----
|Accrued restructuring balance, December 31, 2002             |  | $                 | 197 |               | $ | 68         |  | $    
|Cash payments made during the six months ended June 30, 2003 |  |                   | 197 |               |   | 27         |  |      
|                                                             |  |                   |     |               |   |            |  |      
|Accrued restructuring balance, June 30, 2003                 |  | $                 |    |               | $ | 41         |  | $    
|                                                             |  |                   |     |               |   |            |  |      



NOTE 7  INCOME TAXES



The Companys effective tax rate decreased from
57.2% and 49.4% in the quarter ended March 31, 2002 and the six months ended June 30, 2002, respectively, to 0.0% in the quarter ended June 30, 2003 and the six months ended June 30, 2003 as the Company provided a full valuation allowance against
its net deferred tax assets in the quarters ended March 31, 2003 and June 30, 2003. As of June 30, 2003, the Company continued to carry a full valuation against its net deferred tax assets, as it has determined that it is more likely than not that
such amounts will not be realized through taxable income from future operations, or by carryback to prior years taxable income.



NOTE 8  STOCK REPURCHASE PROGRAM



On January 30, 2003, the Company announced that its Board of Directors had authorized a stock repurchase program under which up to 1 million shares of the
Companys outstanding Common Stock could be acquired in the open market. The Company has set up a Rule 10b5-1 plan for purchases of the shares that will allow the Company to repurchase shares at times when it would ordinarily not be in the
market because of self-imposed blackout periods. Repurchases will be effected by Needham & Company, Inc. Purchases under the program will be funded from available working capital. There is no guarantee as to the exact number of shares that will
be repurchased and the Company has the option to discontinue stock repurchases at any time.



During the six months ended June 30, 2003, the Company purchased approximately 164,000 shares under the stock repurchase program for approximately $465,000.



NOTE 9  REPORTABLE SEGMENTS AND GEOGRAPHIC INFORMATION



The Company has two reportable segments categorized by product type:
development products and production products. Prior to the quarter ended March 31, 2003, the Company had three reportable segments: development products, production products and connectivity products. For the quarter ended June 30, 2003,
connectivity product revenue and segment gross profit were $24,000 and $12,000, respectively. For the quarter ended June 30, 2002, connectivity product revenue and segment gross profit were $97,000 and $53,000, respectively. Connectivity products
are now included in the production products segment information below and under the caption Item 2, Managements Discussion and Analysis of Financial Condition and Results of Operations elsewhere in this report.



Development products are advanced verification systems that assist product
developers to efficiently design reliable and interoperable systems and devices. Production products are production verification systems and connectivity solutions designed to assist manufacturers in the volume production of reliable devices and
systems. The Company has no inter-segment revenue.



The Company
analyzes segment revenue and cost of revenue, but does not allocate operating expenses, including stock-based compensation, or assets to segments. Accordingly, the Company has presented only revenue and gross profit by segment.





9



---

Segment information (in thousands):



|                                        |  | DevelopmentProducts |       | ProductionProducts |   | UnallocatedStock-basedCompensationExpense |  |   | Total
|--------------------------------------- |  | ------------------- | ----- | ------------------ | - | ----------------------------------------- |  | - | -----
|Three Month Period Ended June 30, 2003  |  |                     |       |                    |   |                                           |  |   |      
|Segment revenue from external customers |  | $                   | 3,571 |                    | $ | 285                                       |  | $ |     
|Segment gross profit                    |  | $                   | 2,901 |                    | $ | 170                                       |  | $ | (15  
|                                        |  |                     |       |                   
|Three Month Period Ended June 30, 2002  |  |                     |       |                    |   |                                           |  |   |      
|Segment revenue from external customers |  | $                   | 2,960 |                    | $ | 533                                       |  | $ |     
|Segment gross profit                    |  | $                   | 2,507 |                    | $ | 348                                       |  | $ | (31  
|                                        |  |                     |       |                   
|Six Month Period Ended June 30, 2003    |  |                     |       |                    |   |                                           |  |   |      
|Segment revenue from external customers |  | $                   | 6,370 |                    | $ | 748                                       |  | $ |     
|Segment gross profit                    |  | $                   | 5,231 |                    | $ | 432                                       |  | $ | (18  
|                                        |  |                     |       |                   
|Six Month Period Ended June 30, 2002    |  |                     |       |                    |   |                                           |  |   |      
|Segment revenue from external customers |  | $                   | 5,837 |                    | $ | 1,078                                     |  | $ |     
|Segment gross profit                    |  | $                   | 4,954 |                    | $ | 688                                       |  | $ | (80  



Geographic information (in thousands):



|                                       |  | Revenue |       | Long-LivedAssets
|-------------------------------------- |  | ------- | ----- | ----------------
|Three Month Period Ended June 30, 2003 |  |         |       |                 
|North America                          |  | $       | 1,907 |                 
|Europe                                 |  |         | 525   |                 
|Asia                                   |  |         | 1,424 |                 
|Rest of world                          |  |         |      |                 
|                                       |  |         |       |                 
|Total                                  |  | $       | 3,856 |                 
|                                       |  |         |       |                 
|Three Month Period Ended June 30, 2002 |  |         |       |                 
|North America                          |  | $       | 1,481 |                 
|Europe                                 |  |         | 607   |                 
|Asia                                   |  |         | 1,403 |                 
|Rest of world                          |  |         | 2     |                 
|                                       |  |         |       |                 
|Total                                  |  | $       | 3,493 |                 
|                                       |  |         |       |                 
|Six Month Period Ended June 30, 2003   |  |         |       |                 
|North America                          |  | $       | 3,167 |                 
|Europe                                 |  |         | 965   |                 
|Asia                                   |  |         | 2,980 |                 
|Rest of world                          |  |         | 6     |                 
|                                       |  |         |       |                 
|Total                                  |  | $       | 7,118 |                 
|                                       |  |         |       |                 
|Six Month Period Ended June 30, 2002   |  |         |       |                 
|North America                          |  | $       | 2,881 |                 
|Europe                                 |  |         | 1,106 |                 
|Asia                                   |  |         | 2,898 |                 
|Rest of world                          |  |         | 30    |                 
|                                       |  |         |       |                 
|Total                                  |  | $       | 6,915 |                 
|                                       |  |         |       |                 



10



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Revenues are attributed to countries based on delivery locations. Sales to international customers accounted for 50.5%
and 57.6% of revenue during the quarters ended June 30, 2003 and 2002, respectively, and 55.5% and 58.3% for the six months ended June 30, 2003 and 2002, respectively.



NOTE 10  WARRANTIES



The Company offers warranties on certain products and records at time of shipment an estimate for the future costs associated with warranty claims. We
accrue these costs based upon our historical experience and our estimate of the level of future warranty costs. We assess the adequacy of our warranty reserve on a quarterly basis and make adjustments, if needed.



The following table reconciles the changes in our warranty reserve for the
six months ended June 30, 2003 (in thousands):



|Balance as of December 31, 2002                                                       |  | $ | 187  |  
|------------------------------------------------------------------------------------- |  | - | ---- | -
|Accrual for warranty reserve for sales made during the six months ended June 30, 2003 |  |   | 168  |  
|Warranty expirations during the six months ended June 30, 2003                        |  |   | (174 | )
|                                                                                      |  |   |      |  
|Total                                                                                 |  | $ | 181  |  
|                                                                                      |  |   |      |  



NOTE 11  RECENT ACCOUNTING
PRONOUNCEMENTS



In May 2003, the Financial Accounting
Standards Board (FASB)issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and
measures in its statement of financial position 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) because that financial instrument embodies an obligation of the issuer. 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, except for mandatorily redeemable financial instruments of nonpublic entities. For nonpublic entities, mandatorily redeemable financial instruments are subject to the provisions of this Statement for the
first period beginning after December 15, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the statement and still existing at the
beginning of the interim period of adoption. The Company believes that the adoption of SFAS 150 will not have a material impact on the consolidated financial position or results of the operations of the Company.



Item 2.    Managements Discussion and
Analysis of Financial Condition and Results of Operations



This Report on Form 10-Q contains forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements regarding our expectations, hopes, intentions,
beliefs or strategies regarding the future. Such forward-looking statements include, without limitation, our belief that the repurchase of Company stock will be funded out of working capital; our belief that emerging communications standards and
technological change are likely to continue to influence our revenues and results of operations; our belief that the rate and timing of customer orders may vary significantly from month to month; our belief that our current working capital
requirements will be met for at least the next twelve months; our expectation that revenue from USB products will continue to account for a substantial portion of our revenue for the foreseeable future; our expectation that revenue from
international operations will continue to represent a substantial portion of our revenue; and our belief that we have no material market risk exposure due to our short-term investments. Actual results could differ materially from those projected in
any forward-looking statements for the reasons noted under the sub-heading RISK FACTORS and in other sections of this Report on Form 10-Q. All forward-looking statements included in this Form 10-Q are based on information available to us
on the date of this Report on Form 10-Q, and we assume no obligation to update the forward-looking statements, or to update the reasons why actual results could differ from those projected in the forward-looking statements. See RISK
FACTORS below, as well as such other risks and uncertainties as are detailed in our Securities and Exchange Commission reports and filings



11



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for a discussion of the factors that could cause actual results to differ materially from the forward-looking
statements.



The following Managements
Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Item 1 of this report and
Managements Discussion and Analysis of Financial Condition and Results of Operations contained in our Form 10-K as filed with the Securities and Exchange Commission on March 21, 2003.



Critical Accounting Policies and Estimates



The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our consolidated financial statements in
conformity with generally accepted accounting principles requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We base our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We believe the following critical
accounting policies, among others, affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.



Due to the significant software content of our products, we have adopted Statement of Position (SOP), 97-2, Software Revenue
Recognition. Under SOP 97-2, we recognize revenue to distributors, resellers and end users upon shipment provided that there is persuasive evidence of an arrangement, the product has been delivered and title has passed, the fee is fixed or
determinable and collection of the resulting receivable is reasonably assured. We do not provide distributors, resellers or end-users price protection, and only provide limited rights of return or exchange. Generally, our distributors do not
maintain inventory; however, to the extent they do so, the Company has the right, but not the obligation, to repurchase inventory at the sales price pursuant to the distribution agreement. We review inventory levels held by distributors, if any, on
a quarterly basis to ensure that any potential returns in the event of termination are not material. When we have shipped products but some elements essential to the functionality of the products have not been completed, revenue and associated cost
of revenue are deferred until all remaining elements have been delivered. Software maintenance support revenue is deferred and recognized ratably over the maintenance support period. Provisions for warranty costs are recorded at the time products
are shipped.



Our cash equivalents and short-term investments
are placed in portfolios managed by two professional money management firms under investment guidelines we have established. These guidelines address the critical objectives of preservation of principal, avoiding inappropriate concentrations,
meeting liquidity requirements and maximize after-tax returns. We classify all highly liquid investments purchased with an original maturity of 90 days or less to be cash equivalents and those with a maturity greater than 90 days but less than one
year to be short-term investments. Our cash equivalents and short-term investments consist principally of investments in commercial paper, investment quality corporate and municipal bonds, money market funds, collateralized mortgage obligations, and
U.S. government agency securities.



We account for income taxes
under the liability method, which requires, among other things, that deferred income taxes account for temporary differences between the tax bases of our assets and liabilities and their financial statement reported amounts. In addition, deferred
tax assets are recorded for the future benefit of utilizing net operating losses and research and development credit carryforwards. A full valuation allowance is provided against deferred tax assets unless it is more likely than not that they will
be realized. In the quarter ended December 31, 2002, we provided a full valuation allowance for our net deferred tax assets. As of June 30, 2003, we continue to maintain a full valuation allowance against our net deferred tax assets as have
determined that it is more likely than not that such amounts will not be realized through taxable income from future operations, or by carryback to prior years taxable income.



Our purchased intangible assets total $236,000 as of June 30, 2003. We are required to make judgments about the
recoverability of these assets whenever events or changes in circumstances indicate that the carrying value



12



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of these assets may not be recoverable. In order to make such judgments, we are required to make assumptions about the
value of these assets in the future including future prospects for earnings and cash flows of the businesses underlying these investments. Judgments and assumptions about the future are complex, subjective and can be affected by a variety of factors
including industry and economic trends, our market position and the competitive environment in which we operate. Although we believe our judgments and assumptions are reasonable and appropriate, different judgments and assumptions could materially
impact our reported financial results.



Overview



We are a provider of advanced verification systems and
connectivity products for existing and emerging digital communications standards such as Bluetooth, Ethernet, Fibre Channel, IEEE 1394, InfiniBand, PCI Express, SCSI, Serial ATA, Serial Attached SCSI and USB.



Our products are used by semiconductor, computer systems, software, data
storage, communications, automotive and aerospace companies at each phase of their products lifecycles from development through production and market deployment. Our verification systems consist of development and production products that
accurately monitor communications traffic and diagnose operational problems to ensure that products comply with standards and operate with other devices as well as to assist system manufacturers in downloading software onto new computers. We
currently outsource most of the manufacturing of our verification systems so that we may concentrate our resources on the design, development and marketing of our existing and new products.



We report our revenue and gross profit in two business segments: development
and production products. In the quarter ended June 30, 2003, revenue from our development products was $3.6 million and revenue from our production products was $285,000. Historically, a predominant percentage of our revenue has been generated
across both segments from products addressing the USB standard.



We sell our products to technology, infrastructure and application companies through our direct sales force and indirectly through our distributors and manufacturers representatives. For the quarter ended June 30, 2003, Toyo, a holder
of our Common Stock and our primary distributor in Japan, accounted for 14.4% of our revenue. Historically, a substantial portion of our revenue has been derived from customers outside of North America. In the quarter ended June 30, 2003, 50.5% of
our revenue was derived from international customers, of which 14.6% was derived from customers in Japan, 22.3% was derived from customers in other parts of Asia, and 13.6% was derived from customers in Europe. All of our revenue and accounts
receivable are denominated in U.S. dollars. Although seasonality affects many of our target markets, to date our revenue and financial condition as a whole have not been materially impacted by seasonality.



The development of emerging communications standards and technological change
has influenced and is likely to continue to influence our quarterly and annual revenue and results of operations. Our product development and marketing strategies are focused on working closely with promoter companies and communications standards
groups to gain early access to new communications standards and technologies. We have invested significantly in the research, development and marketing of our products for emerging communications standards, often before these standards have gained
widespread industry acceptance and in advance of generating substantial revenue related to these investments. Additionally, the rate and timing of customer orders may vary significantly from month to month. Accordingly, if sales of our products do
not occur when we expect and we are unable to predict or adjust our expenses on a timely basis, our expenses may increase as a percentage of revenue.



Results of Operations



The following table presents selected consolidated financial data for the periods indicated as a percentage of revenue:



13



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|                                                  |  | Quarter EndedJune 30, |   |  | Six MonthPeriod EndedJune 30, |   
|------------------------------------------------- |  | --------------------- | - |  | ----------------------------- | --
|                                                  |  | 2003                  |   |  | 2002                          |   
|Consolidated Statement of Operations Data:        |  |                       |   |  |                               |   
|Revenue                                           |  | 100.0                 | % |  | 100.0                         | % 
|Cost of Revenue                                   |  | 20.5                  |   |  | 18.7                          |   
|Amortization of acquired developed technology     |  | 0.2                   |   |  | 0.5                           |   
|                                                  |  |                       |   |  |                               |   
|Gross profit                                      |  | 79.3                  |   |  | 80.8                          |   
|                                                  |  |                       |   |  |                               |   
|Operating expenses:                               |  |                       |   |  |                               |   
|Research and development                          |  | 32.4                  |   |  | 56.8                          |   
|Sales and marketing                               |  | 30.9                  |   |  | 34.8                          |   
|General and administrative                        |  | 15.2                  |   |  | 30.1                          |   
|Acquired in-process research and development      |  |                      |   |  | 11.7                          |   
|Amortization of purchased intangibles             |  | 0.7                   |   |  | 0.3                           |   
|Restructuring expenses                            |  |                      |   |  | 12.7                          |   
|Amortization of deferred stock-based compensation |  | 2.1                   |   |  | (5.8                          | ) 
|                                                  |  |                       |   |  |                               |   
|Total operating expenses                          |  | 81.3                  |   |  | 140.6                         |   
|                                                  |  |                       |   |  |                               |   
|Loss from operations                              |  | (2.0                  | ) |  | (59.8                         | ) 
|Other income, net                                 |  | 5.1                   |   |  | 5.7                           |   
|                                                  |  |                       |   |  |                               |   
|Income (loss) before benefit from income taxes    |  | 3.1                   |   |  | (54.1                         | ) 
|Benefit from income taxes                         |  |                      |   |  | (30.9                         | ) 
|                                                  |  |                       |   |  |                               |   
|Net income (loss)                                 |  | 3.1                   | % |  | (23.2                         | )%
|                                                  |  |                       |   |  |                               |   



Results of Operations in the
Quarters Ended June 30, 2003 and 2002



Revenue.    Our revenue was $3.9 million in the quarter ended June 30, 2003 compared to $3.5 million in the quarter ended June 30, 2002, an increase of 10.4%. The increase in revenue was due
primarily to increases in sales of new development products of $810,000, offset by a decrease in sales of certain existing development and production products of $197,000 and $250,000, respectively. The decrease in sales of existing development
products was primarily the result of reduced demand for Bluetooth products in advance of the markets transition to V1.2 of the Bluetooth standard and for production products primarily as a result of the SARS epidemic in key production areas of
Asia. Revenue from international customers represented 50.5% of our revenue in the quarter ended June 30, 2003 and 57.6 % of our revenue in the quarter ended June 30, 2002.



Cost of Revenue and Gross Profit.    Our gross profit was $3.1 million in the quarter ended
June 30, 2003 compared to $2.8 million in the quarter ended June 30, 2002, an increase of 8.2%. The increase in gross profit was primarily the result of an increase in unit sales of development products, partially offset by a decrease in
unit sales of production products. Our gross margin percentage was 79.3% in the quarter ended June 30, 2003 and 80.8% in the quarter ended June 30, 2002. The decrease in gross margin percentage was primarily due to reduced margins for our
development and production products, resulting from higher costs associated with components and manufacturing of new products, offset by increased development product sales as a percentage of total revenue. Our higher margin business segment,
development products, increased as a percentage of revenue by 7.9% in the quarter ended June 30, 2003, when compared to the quarter ended June 30, 2002.



Research and Development.    Our research and development expenses were $1.2 million in the quarter ended June 30,
2003 compared to $2.0 million in the quarter ended June 30, 2002, a decrease of 37.0%. Research and development expenses represented 32.4% of revenue in the quarter ended June 30, 2003 and 56.8% of revenue in the quarter ended
June 30, 2002. The decrease in expenses was primarily due to decreases in personnel and related costs of approximately $602,000. The percentage of revenue decrease for the quarter ended June 30, 2003



14



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was primarily due to the decrease in expenses noted in this paragraph and the impact of increased revenue when compared
to the quarter ended June 30, 2002.



Sales and
Marketing.    Our sales and marketing expenses were $1.2 million in the quarter ended June 30, 2003, the same as in the quarter ended June 30, 2002. Sales and marketing expenses represented 30.9% of revenue in
the quarter ended June 30, 2003 and 34.8% of revenue in the quarter ended June 30, 2002. The percentage of revenue decrease was primarily due to increased revenue as compared to the quarter ended June 30, 2002.



General and Administrative.    Our general and
administrative expenses were $585,000 in the quarter ended June 30, 2003 compared to $1.1 million in the quarter ended June 30, 2002, a decrease of 44.3%. General and administrative expenses represented 15.2% of revenue in the quarter
ended June 30, 2003 and 30.1% in the quarter ended June 30, 2002. The decrease was primarily due to a decrease in professional services of $389,000 and decreases in personnel and related costs of $91,000. The percentage of revenue decrease for the
quarter ended June 30, 2003 was primarily due to the decrease in costs noted in this paragraph and the impact of increased revenue when compared to the quarter ended June 30, 2002.



Acquired In-Process Research and
Development.    Our acquired in-process research and development expenses resulting from our purchase of Verisys were $410,000 in the quarter ended June 30, 2002, representing 11.7% of revenue in the quarter. There were no
comparable charges in the quarter ended June 30, 2003.



Amortization of Purchased Intangibles.    Our amortization of purchased intangibles resulting from our purchase of Verisys was $26,000 in the quarter ended June 30, 2003 compared to $12,000 in the quarter
ended June 30, 2002. Amortization of purchased intangibles represented 0.7% and 0.3% of revenue in the quarter ended June 30, 2003 and June 30, 2002, respectively.



Restructuring Expenses.    Restructuring expenses were $443,000 in the quarter ended
June 30, 2002, representing 12.7% of revenue in the quarter. There were no comparable charges in the quarter ended June 30, 2003. Restructuring expenses consist of severance payments in connection with our headcount reduction, other
expenses relating to office closures, write-down of fixed assets and other one-time charges relating to our restructuring plan implemented in the quarter ended June 30, 2002.



Amortization of Deferred Stock-based Compensation.    Amortization of deferred stock-based
compensation was $96,000 in the quarter ended June 30, 2003, of which $15,000 was included in cost of revenue. Amortization (recovery) of deferred stock-based compensation was $(171,000) in the quarter ended June 30, 2002, of which $49,000
was included in cost of revenue. This amount reflects the impact of option cancellations of approximately $520,000 due to employee terminations. Amortization of deferred stock-based compensation on grants prior to December 31, 2000 is estimated
to be approximately $97,000 for the remainder of the year ending December 31, 2003 and $33,000 in the year ending December 31, 2004, and may change due to the granting of additional options or the cancellation of existing grants in future periods.



Other Income.    Other income was
$198,000 in the quarter ended June 30, 2003 compared to $197,000 in the quarter ended June 30, 2002, an increase of 0.5%. This increase resulted primarily from interest income from income tax refunds of $60,000, offset by declining interest
income earned on the investment of excess cash balances. This decline was primarily the result of lower interest rates.



Benefit from Income Taxes.    We have incurred no provision for income taxes in the quarter ended June 30, 2003 compared
to a benefit from income taxes of $1.1 million in the quarter ended June 30, 2002, a decrease of 100.0%. Our effective tax rate decreased from 57.2% in the quarter ended June 30, 2002 to 0.0% in the quarter ended June 30, 2003. As of June 30,
2003, we continue to maintain a full valuation allowance against our net deferred tax assets as we have determined that it is more likely than not that such amounts will not be realized through taxable income from future operations, or by carryback
to prior years taxable income.



Results of Operations in the Six
Months Ended June 30, 2003 and 2002



Revenue.    Our revenue was $7.1 million in the six months ended June 30, 2003 compared to $6.9 million in the six months ended June 30, 2002, an increase of 2.9%. The increase in revenue was due
primarily to increases in



15



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sales of new development products of $1.3 million, partially offset by decreases in sales of certain existing
development and production products of $791,000 and $334,000, respectively. The decrease in sales of existing development products was primarily the result of reduced demand for Bluetooth products in advance of the markets transition to V1.2
of the Bluetooth standard and for production products primarily as a result of the SARS epidemic in key production areas of Asia. Revenue from international customers represented 55.5% of our revenue in the six months ended June 30, 2003 and 58.3 %
of our revenue in the six months ended June 30, 2002.



Cost of Revenue and Gross Profit.    Our gross profit was $5.6 million in the six months ended June 30, 2003 and in the six months ended June 30, 2002. Our gross margin percentage was 79.3% in the six
months ended June 30, 2003 and 80.4% in the six months ended June 30, 2002. The decrease in gross margin percentage was primarily due to reduced margins for our development production products, resulting from higher costs associated with
components and manufacturing of new products, offset by increased development product sales as a percentage of total revenue. Our higher margin business segment, development products, increased as a percentage of revenue by 5.1% in the six months
ended June 30, 2003 when compared to the six months ended June 30, 2002.



Research and Development.    Our research and development expenses were $2.6 million in the six months ended June 30, 2003 compared to $3.9 million in the six months ended
June 30, 2002, a decrease of 34.4%. Research and development expenses represented 35.9% of revenue in the six months ended June 30, 2003 and 56.3% of revenue in the six months ended June 30, 2002. The decrease in expenses was primarily due
to decreases in personnel and related costs of approximately $1.2 million. The percentage of revenue decrease for the six months ended June 30, 2003 was primarily due to the decrease in costs noted in this paragraph and the impact of increased
revenue when compared to the six months ended June 30, 2002.



Sales and Marketing.    Our sales and marketing expenses were $2.3 million in the six months ended June 30, 2003 compared to $2.5 million in the six months ended June 30, 2002, a decrease of 5.8%.
Sales and marketing expenses represented 32.8% of revenue in the six months ended June 30, 2003 and 35.9% of revenue in the six months ended June 30, 2002. The decrease in expenses was primarily due to a decrease in the commissions earned
by our manufacturers representatives of $125,000 and decreases in marketing programs of $78,000. The percentage of revenue decrease for the six months ended June 30, 2003 was primarily due to the decrease in costs noted in this paragraph
and the impact of increased revenue when compared to the six months ended June 30, 2002.



General and Administrative.    Our general and administrative expenses were $1.3 million in the six months ended June 30, 2003 compared to $2.2 million in the six months ended
June 30, 2002, a decrease of 42.0%. General and administrative expenses represented 17.7% of revenue in the six months ended June 30, 2003 and 31.4% in the six months ended June 30, 2002. The decrease was primarily due to a decrease
in professional services of $773,000 and decreases in personnel and related costs of $168,000. The percentage of revenue decrease for the six months ended June 30, 2003 was primarily due to the decrease in costs noted in this paragraph and the
impact of increased revenue when compared to the six months ended June 30, 2002.



Acquired In-Process Research and Development.    Our acquired in-process research and development expenses resulting from our purchase of Verisys were $410,000 in the six months ended June
30, 2002. There were no comparable charges in the six months ended June 30, 2003. Acquired in-process research and development expenses represented 5.9% of revenue in the six months ended June 30, 2002.



Amortization of Purchased Intangibles.    Our
amortization of purchased intangibles resulting from our purchase of Verisys was $52,000 in the six months ended June 30, 2003 compared to $12,000 in the six months ended June 30, 2002. Amortization of purchased intangibles represented 0.7% and
0.2% of revenue in the six months ended June 30, 2003 and June 30, 2002, respectively.



Restructuring Expenses.    Restructuring expenses were $443,000 in the six months ended June 30, 2002, representing 6.4% of
revenue in the six months ended June 30, 2002. There were no comparable charges in the six months ended June 30, 2003. Restructuring expenses consisted of severance payments in connection with our



16



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headcount reduction, other expenses relating to office closures, write-down of fixed assets and other one-time charges
relating to our restructuring plan implemented in the six months ended June 30, 2002.



Amortization of Deferred Stock-based Compensation.    Amortization of deferred stock-based compensation was $158,000 in the six months ended June 30, 2003, of which $18,000 was included in
cost of revenue. Amortization of deferred stock-based compensation was $186,000 in the six months ended June 30, 2002, of which $80,000 was included in cost of revenue. This amount reflects the impact of option cancellations of approximately
$761,000 due to employee terminations. Amortization of deferred stock-based compensation on grants prior to December 31, 2000 is estimated to be approximately $97,000 for the remainder of the year ending December 31, 2003 and $33,000 in the year
ending December 31, 2004, and may change due to the granting of additional options or the cancellation of existing grants in future periods.



Other Income.    Other income was $359,000 in the six months ended June 30, 2003 compared to $370,000 in the six months ended
June 30, 2002, a decrease of 3.0%. This decrease resulted primarily from declining interest income earned on the investment of excess cash balances, partially offset by interest on income tax refunds of $60,000. The declining interest income was
primarily the result of lower interest rates.



Benefit from
Income Taxes.    We have incurred no provision for income taxes in the six months ended June 30, 2003 compared to a benefit from income taxes of $1.8 million in the six months ended June 30, 2002, a decrease of 100.0%. Our
effective tax rate decreased from 49.4% in the six months ended June 30, 2002 to 0.0% in the six months ended June 30, 2003. As of June 30, 2003, we continue to maintain a full valuation allowance against our net deferred tax assets as we have
determined that it is more likely than not that such amounts will not be realized through taxable income from future operations, or by carryback to prior years taxable income.



Liquidity and Capital Resources



Our operating cash flow requirements have generally increased reflecting the expanding scope and level of our activities. Since our inception, we have
financed our operations primarily through cash flows from operating activities. In November 2000, we received net proceeds of $38.3 million from the initial public offering of our Common Stock.



In the six months ended June 30, 2003, cash used in operating activities of
$256,000 was primarily the result of our net loss of $343,000 and a decrease in related assets and liabilities for working capital purposes of $800,000 million, offset by non-cash expenses associated with depreciation expenses of $397,000,
amortization of premium on short-term investments, of $262,000, amortization of deferred stock-based compensation of $158,000, amortization of other purchased intangibles of $52,000 and the amortization of other acquired developed technology of
$18,000. Cash provided by investing activities was $358,000, related to the sale of short-term investments of $4.9 million, other long-term assets of $120,000, offset by the purchase of short-term investments of $4.4 million and capital expenditures
of $270,000. Cash used in financing activities was $250,000, consisting of the repurchases of common stock of $465,000, offset by the proceeds from the exercise of stock options of $145,000 and the sale of stock pursuant to our employee stock
purchase plan of $70,000.



In the six months ended June 30,
2002, cash used in operating activities of $1.3 million was primarily a result of our net loss of $1.8 million and a decrease in related assets and liabilities for working capital purposes of $566,000, offset by acquired in-process research and
development of $410,000, depreciation expenses of $304,000, amortization of deferred stock-based compensation of $186,000, write-down of property and equipment in connection with restructuring of $134,000, and amortization of other purchased
intangibles of $29,000. Cash used in investing activities was $9.4 million, related to the purchase of short-term investments of $10.9 million, acquisition of a subsidiary of $931,000, capital expenditures of $340,000, purchase of other long-term
assets of $188,000, offset by the proceeds from the sale of short-term investments of $3.0 million. Cash provided by financing activities was $315,000, consisting of the proceeds from the exercise of stock options of $199,000 and to the sale of
stock pursuant to our employee stock purchase plan of $116,000.



As of June 30, 2003, we had cash, cash equivalents and short-term investments of $42.8 million, working capital of $45.6 million and no debt. We currently have no capital lease obligations, and we had future minimum lease payments under our
operating leases of approximately $91,000. In order to meet our long term operating



17



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objections, however, it may become necessary for us in the future to commit to long term lease arrangements.



We believe that our current cash, cash equivalents and short-term
investments together with funds generated from operations will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. In the future, we may find it necessary to obtain additional equity or
debt financing. If we are required to raise additional funds, we may not be able to do so on acceptable terms or at all. In addition, if we issue new securities, stockholders might experience dilution and the holders of the new securities might have
rights, preferences or privileges senior to those of existing stockholders.



RISK FACTORS



Set forth below, elsewhere in
this Quarterly Report, and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. The
occurrence of any of the developments or risks identified below may make the occurrence of one or more of the other risk factors below more likely to occur.



We continue to face uncertainty relating to economic conditions affecting our customers.



We face uncertainty in the degree to which the current global economic
slowdown will continue to negatively affect growth and capital spending by our existing and potential customers. We continue to experience instances of customers delaying or deferring orders and longer lead times to close sales. If global economic
conditions do not improve, or if they worsen, our business, operating results and financial condition will continue to be adversely impacted.



Our future operating results are unpredictable and are likely to fluctuate from quarter to quarter. If we fail to meet the expectations of securities analysts or
investors, our stock price would likely decline significantly.



Our quarterly and annual operating results have fluctuated in the past and are likely to fluctuate significantly in the future due to a number of factors, some of which are wholly or partially outside our control. Several of these risks are
described in the risk factors below. Accordingly, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indications of future performance. Some of the factors that could cause
our quarterly or annual operating results to fluctuate include:



| |  |  | changes in the volume of our product sales and pricing concessions;
| | - |  | -------------------------------------------------------------------



| |  |  | changes in the average selling prices of our products;
| | - |  | ------------------------------------------------------



| |  |  | the timing, reduction, deferral or cancellation of customer orders or purchases;
| | - |  | --------------------------------------------------------------------------------



| |  |  | seasonality in some of our target markets;
| | - |  | ------------------------------------------



| |  |  | the amount and timing of our operating expenses and capital expenditures;
| | - |  | -------------------------------------------------------------------------



| |  |  | the effectiveness of our product cost reduction efforts;
| | - |  | --------------------------------------------------------



| |  |  | variability of our customers product lifecycles;
| | - |  | -------------------------------------------------



| |  |  | shifts in our sales toward lower-margin products; and
| | - |  | -----------------------------------------------------



| |  |  | cancellations, changes or delays of deliveries to us by our manufacturers and suppliers.
| | - |  | ----------------------------------------------------------------------------------------



If our operating results fall below the expectations of securities analysts or investors, the trading price of our Common
Stock would likely decline significantly.



We depend upon widespread market
acceptance of our USB products, and our revenue will decline if the market does not continue to accept these products.



A predominant percentage of our revenue derives from USB product sales and we expect that will continue for the foreseeable future. Factors that may
affect our USB product sales include the continued growth of markets for USB compliant devices, the performance and pricing of our USB products, and the availability, functionality and price of competing products. Companies must also modify their
products to support new versions of USB, such as USB 2.0. Many of these factors are beyond our control.



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If we fail to keep up with rapid technological change and evolving industry standards, our products could become less
competitive or obsolete.



The markets for our products are
characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. We may cease to be competitive if we fail to timely introduce new products or product enhancements
that address these factors. To continue to introduce new products or product enhancements on a timely basis, we must:



| |  |  | identify emerging technological trends in our target markets, including new communications standards;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | accurately define and design new products or product enhancements to meet market needs;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | develop or license the underlying core technologies necessary to create new products and product enhancements; and
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | respond effectively to technological changes and product introductions by our competitors.
| | - |  | ------------------------------------------------------------------------------------------



If we are unable to timely identify, develop, manufacture, market or support new or enhanced products successfully, our
competitors could gain market share or our new products or product enhancements might not gain market acceptance.



Delays in the development of new products or product enhancements could harm our operating results and our competitive position.



The development of new, technologically advanced products is a complex and
uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as accurate anticipation of technological and market trends. Consequently, product development delays are typical in our
industry. To the extent we do not timely introduce a product for an emerging standard or customers defer or cancel orders expecting the release of a new product or product enhancement, our operating results could suffer. Product development delays
may result from numerous factors, including:



| |  |  | changing product specifications and customer requirements;
| | - |  | ----------------------------------------------------------



| |  |  | unanticipated engineering complexities;
| | - |  | ---------------------------------------



| |  |  | difficulties with contract manufacturers or suppliers of key components or technologies;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | difficulties in allocating engineering resources and overcoming resource limitations; and
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | difficulties in hiring and retaining necessary technical personnel;
| | - |  | -------------------------------------------------------------------



If we devote resources to developing products for emerging communications standards that ultimately are not widely accepted, our business could be harmed.



Our future growth depends upon our ability to develop,
manufacture and sell in volume advanced verification systems for existing and emerging communications standards such as Bluetooth wireless technology, Ethernet, Fibre Channel, IEEE 1394, InfiniBand, PCI Express, SCSI, Serial ATA, Serial Attached
SCSI and USB and for new communications standards yet to be conceived. We have little or no control over the conception, development or adoption of new standards. Moreover, even as it relates to currently emerging standards, the markets are rapidly
evolving and we have virtually no ability to impact the adoption of those standards. As a result, there is significant uncertainty as to whether markets for new and emerging standards ultimately will develop at all or, if they do develop, their
potential size or future growth rate. We may incur significant expenses and dedicate significant time and resources to develop products for standards that fail to gain broad acceptance. For example, we spent four years from 1992 to 1995 developing
products for the ACCESS.bus technology, a standard designed to connect peripheral devices to computers, which did not gain market acceptance. The failure of a standard for which we devote resources to gain widespread acceptance would likely harm our
business.



If we fail to maintain and expand our relationships with the core
or promoter companies in our target markets, we may have difficulty developing and marketing our products.



It is important to our success to maintain and expand our relationships with technology and infrastructure companies that are leaders in developing
emerging communications standards in our target markets, as well as expand our relationships with leaders in new markets. We believe that we need to work closely with these companies to gain valuable insights into new product market demands, obtain
early access to such standards as they



19



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develop and help us design new products. Generally, we do not enter into formal contracts obligating these companies to
work or share their technology with us. Industry leaders could choose to work with other companies in the future. If we fail to maintain and expand our industry relationships, we could lose first-mover advantage with respect to emerging standards
and it would be more difficult for us to develop and market products that address these standards.



Increased competition, new product introductions by competitors, and our entry into new markets may decrease the average selling prices of our products, revenue and market share.



The markets for advanced verification products for emerging communications
standards are highly competitive. We compete with multiple companies in each of our various markets and we expect the number of competitors, some of which may be current customers, and the intensity of competition will continue to increase. Any of
these existing or future competitors may have substantially greater financial, technical, marketing and distribution resources and brand name recognition. If companies develop competing products or form alliances with or acquire companies offering
competing products, even if those products do not have capabilities comparable to our products, they could be significant competitors.



We continue to experience increased competition in our principal markets and, as we expand our product portfolio into other new and existing markets, we
expect to encounter similar competitive forces in those markets. Increased competition could result in significant price erosion, reduced revenue, lower margins and loss of market share, any of which would significantly harm our business. As a
result, we anticipate that the average selling prices of our products will decrease in the future in response to such things as product introductions or enhancements by us or our competitors, product discounting on volume purchase orders or
additional pricing pressures. We believe we must continue to develop and introduce on a timely basis new products that incorporate features that can be sold at higher average selling prices. Failure to do so would likely cause our revenue and gross
margins to decline.



Our executive officers, directors, Philips
Semiconductors and certain entities affiliated with them own a large percentage of our voting stock, which could have the effect of delaying or preventing a change in our control.



As of August 1, 2003, our executive officers, directors, Philips Semiconductors and certain entities affiliated with or
beneficially controlled by them owned approximately 13,032,245 shares or approximately 67.24% of the outstanding shares of our Common Stock. These stockholders, acting together, can control matters requiring stockholder approval, including the
election or removal of directors and the approval of mergers or other business combination transactions. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging potential
acquirers from attempting to obtain control, which in turn could have an adverse effect on the market price of our Common Stock or prevent our stockholders from realizing a premium over the market price for their shares of Common Stock. Our
repurchase of shares of our Common Stock pursuant to our stock repurchase program discussed under the separate caption in Part I, Item 1, Note 8 elsewhere in this Quarterly Report, may increase the control of these stockholders.



The interim status of our Chief Executive Officer and the transition to his successor may
cause substantial organizational disruptions and inefficiencies.



In October 2002, one of our co-founders, Dan Wilnai, returned to assume day-to-day management of the Company on an interim basis as our President and Chief Executive Officer. The future departure of Mr. Wilnai and any transitions under a
new President and CEO may cause significant operational disruptions and inefficiencies, the full impact of which we are currently unable to predict.



The loss of key management personnel, on whose knowledge, leadership and technical expertise we rely, would cause significant disruptions in our operations and harm
our ability to execute our business plan.



Our success
depends heavily upon the continued contributions of our key management personnel, whose knowledge, leadership and technical expertise may be difficult to replace. Moreover, all of our personnel, including our executive staff, are employed on an
at will basis. We maintain no key person insurance on any of our personnel. If we were to terminate or lose the services of any of our key personnel and were unable to hire qualified replacements, our ability to execute our business plan
would be harmed. Even if we were able to hire qualified replacements, we would expect to experience operational disruptions and inefficiencies. In addition, employees who leave our company may subsequently compete against us.



20



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Variations in our revenue may cause fluctuations in our operating results.



We may experience delays generating or recognizing revenue for a number of
reasons. Historically, we have had little backlog and our revenue in any quarter has depended upon orders booked and shipped in that quarter. Furthermore, our customers may delay scheduled delivery dates and cancel orders without significant
penalty. In addition, even if we ship orders, generally accepted accounting principles may require us to defer recognition of revenue until a later date. Because we budget our operating expenses on anticipated revenue trends and a high percentage of
our expenses are fixed in the short term, any delay in generating forecasted revenue could have a significant negative impact on our operating results.



Shifts in our product mix may result in declines in gross margins.



Our gross margins vary by product, with gross margins generally higher on our development products than our production products. Our overall gross margins
might fluctuate from period to period as a result of shifts in product mix, the channels through which we sell our products, the introduction of new products and product costs.



We depend on contract manufacturers for substantially all of our manufacturing requirements and if these manufacturers fail to provide us
with adequate supplies of high-quality products, our competitive position, reputation and business could be harmed.



We currently rely on four contract manufacturers for all of our manufacturing requirements except for the final assembly, testing and quality assurance on
our lower volume, higher margin products. We do not have long-term contracts with any of these manufacturers. As a result, our manufacturers could refuse to continue to manufacture all or some of our products or attempt to change the terms under
which they manufacture our products. Previously, we experienced delays in product shipments from some of our manufacturers, which forced us to delay product shipments. We may experience similar future delays or other problems, such as inferior
quality and insufficient quantity of products, any of which could significantly harm our business. Our manufacturers may not be able to meet our future requirements for timely delivery of products of sufficient quality and quantity. We intend to
introduce new products and product enhancements regularly, which will require that we rapidly achieve volume production by coordinating our efforts with those of our suppliers and contract manufacturers. The inability of our manufacturers to provide
us with adequate supplies of high quality products or the loss of any manufacturer would cause a delay in our ability to fulfill orders while we obtain a replacement.



If we fail to accurately forecast our supply needs, our costs may increase or we may not be able to ship products in a timely manner.



We purchase components used in the manufacture of our
products from several key sources. We depend on these sources to deliver components in a timely manner based on twelve-month rolling forecasts we provide. Lead times for materials and components we order vary significantly and depend on factors such
as specific supplier requirements, contract terms and current market demand. If we overestimate our component requirements, we may develop excess inventory, which would increase our costs. If we underestimate our component requirements, we may not
be able to timely fulfill orders.



We depend on sole source suppliers for
several key product components and we may lose sales if they fail to meet our needs.



We obtain some parts, components and packaging used in our products from sole sources of supply. If suppliers are unable to meet our demand for sole source components at reasonable costs and if we are unable to obtain
an alternative source or the price for an alternative source is prohibitive, our ability to maintain timely and cost-effective production of our products would be harmed. In addition, because we rely on purchase orders rather than long-term
contracts with our suppliers, including our sole source suppliers, we cannot predict with certainty our ability to obtain components in the long term. If we are unable to obtain components or receive a smaller allocation of components than is
necessary to meet demand, customers could choose to purchase competing products.



If our distributors and manufacturers representatives do not actively sell our products, our product sales may decline.



Historically, we have relied on both manufacturers representatives to sell our products domestically and distributors to sell our products
internationally. We sell a substantial portion of our products through our distributors and manufacturers representatives, including Toyo, a holder of our Common Stock and our primary distributor in Japan. Toyo accounted for approximately
14.4% of our revenue in the quarter ended June 30, 2003. Our distributors and manufacturers representatives generally offer products from multiple manufacturers. Accordingly, there is a



21



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risk that these distributors and manufacturers representatives may give higher priority to selling products from
other suppliers and reduce their efforts to sell our products. Our distributors and manufacturers representatives may not market our products effectively or continue to devote the resources necessary to provide us with effective sales,
marketing and technical support. Our distributors may on occasion build inventories in anticipation of substantial growth in sales and, if growth does not occur as rapidly as anticipated, may decrease the quantity of products ordered from us in
subsequent quarters. A slowdown in orders from our distributors or manufacturers representatives could reduce our revenue in any given quarter and give rise to fluctuations in our operating results.



In addition, sales to our distributors are initiated by purchase orders
rather than long-term commitments. The loss of any major distributor, the delay of significant orders from our distributors, or the failure of our distributors to timely pay for products purchased could result in decreased or deferred recognition of
revenue.



If we are unable to expand our direct sales operations and our
distributor and manufacturers representatives channels or successfully manage our expanded sales organization, our operations may be harmed.



We intend to continue development and expansion of our direct sales organization in North America and our indirect distribution channels internationally.
Managing our distribution channels has become more complex as we have expanded both our product lines and our geographic presence. As a result, it has also become increasingly critical that we optimize our distribution channels around complementary
products and users. We may not be able to expand our direct sales organization or distribution channels successfully, manage them optimally, and the cost of any expansion may exceed the revenue generated.



If we are unable to retain and motivate our personnel, our operations will be impaired.



To be successful and maintain a high level of quality, we
will need to retain and motivate highly skilled personnel. If we are unable to retain a sufficient number of qualified employees, our operations may be impaired. We may have even greater difficulty retaining employees if employees perceive the
equity component of our compensation package to be less valuable as a result of market fluctuations in the price of our Common Stock.



If we fail to manage our operations effectively, our business could suffer.



Our ability to offer products and implement our business plan successfully in a rapidly evolving market requires effective
planning and management. We implemented two separate corporate restructuring plans in 2002, in the second and fourth quarters. Some or all of the adopted measures in these restructures may not yield the intended results, if any, and may furthermore
give rise to unforeseen complications and inefficiencies as we adjust personnel assignments. Moreover, reductions in force and cost cutting measures effected in both of these restructurings can adversely impact the morale of our personnel leading to
further complications and operational inefficiencies. If this were to occur, our profitability or financial position could be negatively impacted and our operating results could suffer.



Our products may contain defects that cause us to incur significant corrective costs, divert our attention from product development
efforts and result in a loss of customers.



Highly complex
products such as our verification systems frequently contain defects when they are first introduced or as new versions are released. If any of our products contain defects or have reliability, quality or compatibility problems, our reputation
may be damaged and customers may be reluctant to buy our products. In addition, these defects could interrupt or delay sales. We may have to invest significant capital and other resources to alleviate these problems. If any problem remains
undiscovered until after we have commenced commercial production of a new product, we may be required to incur additional development costs and product recall, repair or replacement costs. These problems may also result in claims against us by our
customers or others. In addition, these problems may divert our technical and other resources from other development efforts.



Any acquisitions that we undertake could be difficult to integrate, disrupt our business, dilute stockholder value and harm our operating results.



We expect to continue to review opportunities to acquire other businesses or
technologies that complement our current products, expand our markets, enhance our technical capabilities or that might otherwise offer growth opportunities. If we make any acquisitions, we could issue stock that would dilute the percentage
ownership of our existing stockholders, incur substantial debt or assume contingent liabilities. For example, we issued 360,000 shares of our Common Stock in connection with our acquisition of Verisys in June 2002. In addition, in the quarter ended
September 30, 2002, we recorded a goodwill impairment of $1.4 million, and a partial impairment write-down of



22



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$194,000 of purchased intangibles, arising from our purchase of Verisys. Moreover, the Verisys acquisition and other
potential acquisitions involve numerous risks, including:



| |  |  | problems in assimilating the purchased operations, technologies or products;
| | - |  | ----------------------------------------------------------------------------



| |  |  | costs or accounting charges associated with the acquisition;
| | - |  | ------------------------------------------------------------



| |  |  | diversion of managements attention from our existing business;
| | - |  | ---------------------------------------------------------------



| |  |  | adverse effects on existing business relationships with suppliers and customers;
| | - |  | --------------------------------------------------------------------------------



| |  |  | risks associated with entering markets in which we have little or no prior experience; and
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | potential loss of key employees of purchased businesses.
| | - |  | --------------------------------------------------------



Economic, political and other risks associated with international sales and operations could adversely affect sales.



Because we sell our products worldwide, our business is subject to risks
associated with doing business internationally. We recognized 50.5% of our revenue from sales to international customers in the quarter ended June 30, 2003. We anticipate that revenue from international operations will continue to represent a
substantial portion of our revenue. In addition, several of our manufacturers facilities and suppliers are located outside the United States. Accordingly, our future results could be harmed by a variety of factors, including:



| |  |  | changes in foreign currency exchange rates;
| | - |  | -------------------------------------------



| |  |  | changes in a specific countrys or regions political or economic conditions, particularly in emerging markets;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | trade protection measures and import or export licensing requirements;
| | - |  | ----------------------------------------------------------------------



| |  |  | potentially negative consequences from changes in tax laws;
| | - |  | -----------------------------------------------------------



| |  |  | difficulty in staffing and managing widespread operations;
| | - |  | ----------------------------------------------------------



| |  |  | differing labor regulations;
| | - |  | ----------------------------



| |  |  | war or other international conflicts;
| | - |  | -------------------------------------



| |  |  | differing protection of intellectual property; and
| | - |  | --------------------------------------------------



| |  |  | unexpected changes in regulatory requirements.
| | - |  | ----------------------------------------------



Geopolitical instability and the threat of terrorist attacks have created many economic and political uncertainties, some of which may harm our business, our prospects
and our ability to conduct business generally.



Geopolitical instability and the continued threat of terrorism and the resulting military, economic and political responses (including, without limitation, war between sovereign nations) as well as heightened security measures may cause
significant disruption to commerce worldwide. To the extent any disruption results in a general decrease or delay in our customers spending, our business and results of operations could be materially adversely affected. We are unable to
predict whether the threat of such instability and terrorism or the responses thereto will result in any long-term commercial disruptions or have long-term adverse effects on our business, results of operations or financial condition.



Our headquarters and our contract manufacturers are located in Northern California, Asia
and other areas where natural disasters may occur.



Currently, our corporate headquarters and some of our contract manufacturers are located in Northern California and our other contract manufacturers are located in Asia. Northern California and Asia historically have been vulnerable to
natural disasters and other risks, such as earthquakes, fires, floods, power loss and telecommunications failure, which at times have disrupted the local economy and posed physical risks to our and our manufacturers properties. We do not have
redundant, multiple site capacity in the event of a natural disaster.



23



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Any failure to protect our intellectual property adequately may significantly harm our business.



We protect our proprietary processes, software, know-how and other
intellectual property and related rights through copyrights, trademarks and the maintenance of trade secrets, including entering into confidentiality agreements. Our success and ability to compete depend in part on our proprietary technology. We
currently do not have any registered patents. Although we have six patents pending, patents may not issue as a result of these or other patent applications. Any patents that ultimately issue may be successfully challenged or invalidated, or may not
provide us with a significant competitive advantage. Third parties may breach confidentiality agreements or other protective contracts with us and we may not be able to enforce our rights in the event of these breaches. We may be required to spend
significant resources to monitor and police our intellectual property rights, including pursuing remedies in court. We may become involved in legal proceedings against other parties, which may also cause other parties to assert claims against us. We
report material pending legal proceedings, if any, under the separate caption Part II, Item 1. Legal Proceedings elsewhere in this Quarterly Report. In the future we may not be able to detect infringements and may lose
competitive position in our markets before we do so. In addition, competitors may design around our technologies or develop competing technologies. The laws of other countries in which we market our products might offer little or no effective
protection of our proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without payment, which could significantly harm our
business.



Claims that we infringe third-party intellectual property rights
could result in significant expenses or restrictions on our ability to sell our products.



Our industry is characterized by uncertain and conflicting intellectual property claims and frequent litigation, especially regarding patent rights. We cannot be certain that our products do not and will not infringe
issued patents or the intellectual property rights of others. Historically, patent applications in the United States of America have not been publicly disclosed until the patent is issued, and we may not be aware of filed patent applications that
relate to our products or technology. If patents are later issued in connection with these applications, we may be liable for infringement. Periodically, other parties may assert patent, copyright and other rights to technologies in various
jurisdictions that are important to our business. Any claims asserting that our products infringe or may infringe the rights of third parties, including claims arising through our contractual indemnification of our customers, regardless of their
merit or resolution, would likely be costly and time-consuming, divert the efforts of our technical and management personnel, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements,
if required, may not be available on terms acceptable to us, or at all.



Changes in current laws or regulations or the imposition of new laws or regulations could impede the sale of our products.



We and many of our customers and their products are subject to regulations and standards set by the Federal Communications Commission, or FCC.
Internationally, many of our customers and their products may also be required to comply with regulations established by authorities in various countries. We are required to determine to what extent our products may be subject to FCC standards and
regulations and to what extent we are required to obtain authorizations from the FCC directly or from a third-party authorized by the FCC to issue such authorizations. We are also required to maintain in good standing any equipment authorization we
receive from the FCC or an FCC-approved party. In addition, the regulations in force both in the United States and in foreign jurisdictions may change. Failure to comply with regulations established by regulatory authorities or to obtain timely
domestic or foreign regulatory approvals or certificates could significantly harm our business.



Item 3.    Quantitative and Qualitative Disclosures About Market Risk



The primary objective of our investment activities is to preserve principal while concurrently maximizing the after-tax income we receive from our
investments without significantly increasing risk. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For
example, if we hold a security that was issued with an interest rate fixed at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. Since cash equivalents and short-term
investments consist principally of investments in commercial paper, investment quality corporate and municipal bonds, money market funds, collateralized mortgage obligations, and U.S. government agency securities, we believe there is no material
market risk exposure.



24



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Item 4.    Controls and Procedures



Subsequent to June 30, 2003, we carried out an evaluation, under the
supervision and with the participation of our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), of the effectiveness of the design and operation of our disclosure controls and
procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the date of the evaluation, our disclosure controls and procedures are effective in timely alerting them to material information
required to be included in our periodic SEC filings. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions, regardless of how remote.



There have been no significant changes in our internal control over financial reporting or in other factors that could significantly affect internal
controls subsequent to our most recent evaluation of our internal controls.



Part IIOTHER INFORMATION



Item
1.    Legal Proceedings



On December
29, 2000, we filed in the United States District Court for the Northern District of California a complaint against Catalyst Enterprises, Inc., alleging trademark and trade dress infringement, copyright infringement and unfair competition and seeking
damages and attorneys fees. The case is referred to as Computer Access Technology Corporation v. Catalyst Enterprises, Inc., Case No. C 00 4852 DLJ. Catalyst responded to the complaint on April 6, 2001 by denying each of the
substantive claims and asserting federal and state unfair competition counterclaims, and requesting an award of attorneys fees. We answered the counterclaims on September 27, 2001, and denied all the substantive claims of Catalysts
counterclaims.



On December 11, 2001, Catalyst filed a
motion for partial summary judgment on the issue of trade dress functionality. On January 25, 2002, we filed a motion for judgment on the pleadings or, in the alternative, a special motion to strike Catalysts counterclaims. The Court
denied Catalysts motion and granted our motion for judgment on the pleadings by order entered March 29, 2002, and dismissed each of Catalysts counterclaims with prejudice.



The case was tried before a jury, with trial commencing October 28,
2002. On November 15, 2002, a unanimous jury returned a verdict finding that we own valid trademark rights in our CATC Trace design and that Catalyst infringed our trademark, that Catalyst violated the federal and state unfair competition statutes,
and that Catalyst acted willfully when it violated the unfair competition statutes. The jury further found that Catalyst did not infringe our copyright and that we did not prove that our CATC Trace design is protectible trade dress. On
November 26, 2002, the Court heard our request for injunctive relief and restitution under federal and state law and, by an order issued the same day, the Court stayed execution of the judgment and deferred ruling on the equitable relief claims
pending resolution of Catalysts motion for judgment as a matter of law, or alternatively, for retrial.



On January 10, 2003, the Court held a hearing on Catalysts motion for judgment as a matter of law in favor of Catalyst or, alternatively, for
retrial of the trademark, federal and state unfair competition causes of action. On February 18, 2003, the Court granted Catalysts motion for a new trial on the claims of trademark infringement and violation of federal and state unfair
competition statutes by Catalyst. The Court furthermore granted our motion for retrial on our claims of copyright and trade dress infringement.



A status conference was held on March 14, 2003 and the Court set the matter for re-trial in September 2003. We cannot predict the outcome of this
litigation at this time.



25



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



Our 2003 annual meeting of stockholders was held on May 22, 2003. At the
meeting, our stockholders approved the following proposals presented to them pursuant to the vote totals indicated next to each item:



|                                                                                                                     |  | Vote (No. of Shares)
|-------------------------------------------------------------------------------------------------------------------- |  | --------------------
|Proposal                                                                                                             |  | For                 
|Election of Peretz Tzarnotzky and Dan Wilnai as Class III Directors                                                  |  | 17,714,251          
|Ratification of PricewaterhouseCoopers LLP as independent public accountants for fiscal year ended December 31, 2003 |  | 17,754,038          



Andrei Manoliu, Ph.D.,
Philip Pollok, and Roger W. Johnson are directors of the Company, each with terms of office continuing after the annual meeting of stockholders referenced above.



|Item 6.                                                                                                                                                                                                                                       |  | Exhibits and Reports on Form 8-K
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------
|                                                                                                                                                                                                                                              |  |                                 
|                                                                                                                                                                                                                                              |  | a.                              
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|                                                                                                                                                                                                                                             
|* Previously filed as an exhibit to the Companys Registration Statement on Form S-1 (Registration
No. 333- 43866) as filed with the SEC on August 16, 2000, as subsequently amended, and incorporated in this Quarterly Report by
reference.
|                                                                                                                                                                                                                                              |  |                                 
|                                                                                                                                                                                                                                              |  | b.                              
|                                                                                                                                                                                                                                              |  |                                 
|                                                                                                                                                                                                                                              |  |                                 





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SIGNATURES



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



Date    August 8, 2003

Computer Access Technology CorporationBy:

/s/    Carmine J. NapolitanoCarmine J. Napolitano Vice President,
Chief Financial Officer and Secretary (Principal Financial Officer and Principal Accounting Officer)




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