---




SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





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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 September 30, 2002





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




Commission file number: 000-31863





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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)





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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  ̈





As of November 1, 2002, there were 19,424,325 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)





December 31, 2001


September 30, 2002ASSETSCurrent assets:Cash and cash equivalents

$
42,941


$
28,159Short-term investments


4,620



16,652Trade accounts receivable, net


1,370



1,328Related party receivable


747



670Inventories


805



1,210Deferred tax assets


512



1,497Other current assets


1,435



1,781Total current assets


52,430



51,297Property and equipment, net


1,357



1,148Purchased intangibles, including goodwill






340Other assets


101



87$
53,888


$
52,872LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
602


$
835Accrued expenses


1,046



1,514Accrued restructuring






143Deferred revenue


220



766Total current liabilities


1,868



3,258Deferred rent


4



Total liabilities


1,872



3,258Stockholders equity:Common stock


19



19Additional paid-in capital


53,093



53,284Deferred stock-based compensation


(2,492
)


(492
)Retained earnings (accumulated deficit)


1,396



(3,197
)Total stockholders equity


52,016



49,614$
53,888


$
52,872





See accompanying notes.




2




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COMPUTER ACCESS TECHNOLOGY CORPORATION





CONDENSED CONSOLIDATED STATEMENTS OF INCOME


(unaudited, in thousands, except per share amounts)





Three Month Period Ended September 30,


Nine Month Period Ended September 30,2001


2002


2001


2002Revenue

$
3,554


$
4,016


$
13,376


$
10,931Cost of revenue (inclusive of amortization of deferred stock-based compensation (recovery) of $(19) and $32 in the three
month period ended September 30, 2001 and 2002, respectively, and of $327 and $112 in the nine month period ended September 30, 2001 and 2002, respectively)


740



979



3,218



2,315Amortization of acquired developed technology






160







177Gross profit


2,814



2,877



10,158



8,439Operating expenses:Research and development (exclusive of amortization of deferred stock-based compensation (recovery) of $478 and $(38) in
the three month period ended September 30, 2001 and 2002, respectively, and of $1,954 and $32 in the nine month period ended September 30, 2001 and 2002, respectively)


1,831



2,043



5,540



5,938Sales and marketing (exclusive of amortization of deferred stock-based compensation (recovery) of $(196) and $24 in the
three month period ended September 30, 2001 and 2002, respectively, and of $164 and $(131) in the nine month period ended September 30, 2001 and 2002, respectively)


798



1,098



2,175



3,578General and administrative (exclusive of amortization of deferred stock-based compensation of $184 and $293 in the three
month period ended September 30, 2001 and 2002, respectively, and of $966 and $484 in the nine month period ended September 30, 2001 and 2002, respectively)


733



1,426



2,297



3,599Goodwill impairment






1,427







1,427Acquired in-process research and development














410Amortization of purchased intangibles






228







240Restructuring expenses














443Amortization of deferred stock-based compensation


466



279



3,084



385Total operating expenses


3,828



6,501



13,096



16,020Loss from operations


(1,014
)


(3,624
)


(2,938
)


(7,581
)Other income, net


419



157



1,593



527Loss before provision for (benefit from) income taxes


(595
)


(3,467
)


(1,345
)


(7,054
)Provision for (benefit from) income taxes


(681
)


(690
)


26



(2,461
)Net income (loss)

$
86


$
(2,777
)

$
(1,371
)

$
(4,593
)Net income (loss) per share:Basic

$
0.00


$
(0.14
)

$
(0.07
)

$
(0.24
)Diluted

$
0.00


$
(0.14
)

$
(0.07
)

$
(0.24
)Weighted average shares outstanding:Basic


18,783



19,401



18,702



19,131Diluted


19,176



19,401



18,702



19,131





See accompanying notes.




3




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COMPUTER ACCESS TECHNOLOGY CORPORATION





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(unaudited, in thousands)





Nine Month Period Ended September 30,2001


2002Cash flows from operating activities:Net loss

$
(1,371
)

$
(4,593
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization


322



489Provision for doubtful accounts


1



(10
)Write-down of property and equipment in connection with restructuring






134Fair value of stock options in exchange for services


25



Amortization of acquired developed technology






177Goodwill impairment






1,427Acquired in-process research and development






410Amortization of purchased intangibles






240Amortization of deferred stock-based compensation


3,411



497Changes in assets and liabilities:Trade accounts receivable


1,293



284Inventories


(124
)


(74
)Deferred tax assets


12



(867
)Other assets


(1,095
)


(314
)Accounts payable


(119
)


94Accrued expenses


(1,914
)


(426
)Accrued restructuring






143Deferred revenue






546Deferred rent


(9
)


(4
)Net cash provided by (used in) operating activities


432



(1,847
)Cash flows from investing activities:Acquisition of property and equipment


(771
)


(346
)Purchase of short-term investments






(17,108
)Sale of short-term investments


285



5,076Acquisition of subsidiary, net of cash assumed






(980
)Net cash used in investing activities


(486
)


(13,358
)Cash flows from financing activities:Proceeds from exercise of stock options


166



213Proceeds from employee stock purchase plan


137



210Net cash provided by financing activities


303



423Net increase (decrease) in cash and cash equivalents


249



(14,782
)Cash and cash equivalents at beginning of period


47,411



42,941Cash and cash equivalents at end of period

$
47,660


$
28,159





See accompanying notes.




4




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COMPUTER ACCESS TECHNOLOGY CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE 1BUSINESS





Business





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





We have expertise in the USB, IEEE 1394,
Bluetooth, InfiniBand, Serial ATA, SCSI and Ethernet standards and are actively engaged with our customers throughout their development and production processes. Utilizing our easy to use, color-coded software, the CATC Trace  , our development products generate, capture, filter and analyze communications traffic, allowing our customers
to quickly discover and correct persistent and intermittent errors and flaws in their product design. Our production products are used in manufacturing 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. Our connectivity products are devices that translate communications traffic between USB and Ethernet and enable reliable, uninterrupted service for broadband Internet access. These
connectivity products also allow for simple installation and incorporate an application specific integrated circuit, or ASIC, and our proprietary embedded software and software drivers.





Interim Financial Information and Basis of Presentation





The accompanying unaudited condensed consolidated financial statements as of September 30, 2002, and for the three and nine month periods ended September 30, 2002 and 2001, 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 Securities and Exchange Commission (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 consolidated financial position
at September 30, 2002, the consolidated operating results for the three and nine month periods ended September 30, 2002 and 2001, and consolidated cash flows for the nine month periods ended September 30, 2002 and 2001. These unaudited condensed
consolidated financial statements should be read in conjunction with the Companys audited consolidated financial statements and notes for the year ended December 31, 2001.





The unaudited condensed consolidated balance sheet at December 31, 2001 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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COMPUTER ACCESS TECHNOLOGY CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







Concentrations of credit risk





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





Nine Month Period Ended September 30,2001


2002Revenue:Company A

28
%

19
%Company C

2
%

11
%December 31, 2001


September 30, 2002Accounts receivable:Company A

32
%

23
%Company B

13
%


%





NOTE 2COMPREHENSIVE INCOME (LOSS)





Comprehensive income (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 income (loss) and comprehensive income (loss) for the Company in any of the periods presented.





NOTE 3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 $311,000 and $497,000 in the quarter ended September 30, 2002 and the nine month period
ended September 30, 2002, respectively, of which $32,000 and $112,000 was included in cost of revenue in the quarter ended September 30, 2002 and the nine month period ended September 30, 2002, respectively. Amortization of deferred stock-based
compensation was $447,000 and $3.4 million in the quarter ended September 30, 2001 and the nine month period ended September 30, 2001, respectively, of which $(19,000) resulting from cancellations and $327,000 was included in cost of revenue in the
quarter ended September 30, 2001 and the nine month period ended September 30, 2001, respectively. Amortization of deferred stock-based compensation on grants prior to December 31, 2000 is estimated to be approximately $140,000 for the remainder of
the year ending December 31, 2002 and $312,000 and $40,000 in the years ending December 31, 2003 and 2004, respectively, and may change due to the granting of additional options or the cancellation of existing grants in future periods.





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 (loss) income per




6




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COMPUTER ACCESS TECHNOLOGY CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




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.





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





Three Month PeriodEnded September 30,


Nine Month PeriodEnded September 30,2001

2002


2001


2002Numerator:Net income (loss)

$
86

$
(2,777
)

$
(1,371
)

$
(4,593
)Denominator:Weighted average shares outstanding


18,783


19,401



18,702



19,131Denominator for basic calculation


18,783


19,401



18,702



19,131Dilutive effect of stock options


393










Denominator for diluted calculation


19,176


19,401



18,702



19,131Net income (loss) per share:Basic

$
0.00

$
(0.14
)

$
(0.07
)

$
(0.24
)Diluted

$
0.00

$
(0.14
)

$
(0.07
)

$
(0.24
)Total common stock equivalents, related to options outstanding, excluded from the computation of earnings per share as
their effect is antidilutive


575


4,470



1,055



4,035





NOTE 5INVENTORIES





Inventories consist of the following (in thousands):





December 31, 2001

September 30, 2002Raw materials

$
451

$
540Work in progress


141


140Finished goods


213


530$
805

$
1,210





NOTE 6GOODWILL AND OTHER INTANGIBLE ASSETS





Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business acquisitions accounted for
under the purchase accounting method. Other purchased intangibles include identifiable intangible assets purchased by the Company in connection with business acquisitions. Other purchased intangibles are presented net of related accumulated
amortization and charges and are being amortized over lives ranging from three to five years.





The Company records
impairment losses on goodwill and other intangible assets when events and circumstances indicate that such assets might be impaired and the estimated fair value of the asset is less than its




7




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COMPUTER ACCESS TECHNOLOGY CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




recorded amount. Conditions that would necessitate an impairment assessment include material adverse changes in operations, significant adverse differences in actual results in comparison with
initial valuation forecasts prepared at the time of acquisition, a decision to abandon acquired products, services or technologies, or other significant adverse changes that would indicate the carrying amount of the recorded asset might not be
recoverable.





NOTE 7RESTRUCTURING





During the quarter ended June 30, 2002, the Company implemented a restructuring plan designed to consolidate operations and reduce costs. The restructuring plan included the closure of our facilities
in San Diego, California and Netanya, Israel and a reduction in staff by a total of 18 positions, primarily from the research and development group. The Company expects that the majority of the remaining restructuring actions such as office closures
and office subleasing will be completed by the end of 2002. Obligations related to subleasing may continue until 2004 as estimated and accrued for as of September 30, 2002. The Company had restructuring expenses of $443,000 for the quarter ended
June 30, 2002.





The following table summarizes the components of the accrued restructuring, by geographic region
(in thousands):





Employee Severance

Office Closure

Asset Disposal Loses

Other  Costs

TotalNorth America

$
95

$
86

$
44

$
19

$
244Europe





67


90


42


199Restructuring expenses, three months ended June 30, 2002


95


153


134


61


443Asset disposals made during the three months ended June 30, 2002








134





134Cash payments made during the three months ended June 30, 2002


19








28


47Accrued restructuring balance, June 30, 2002


76


153





33


262Cash payments made during the three months ended September 30, 2002


76


23





20


119Accrued restructuring balance, September 30, 2002

$


$
130

$


$
13

$
143





NOTE 8INCOME TAXES





The reconciliation between the effective tax rates and statutory federal income tax rate is shown in the following table:





Three Month PeriodEndedSeptember 30,


Nine Month PeriodEndedSeptember 30,2001


2002


2001


2002Statutory federal income tax rate

34.0
%

34.0
%

34.0
%

34.0
%State taxes, net of federal income tax benefit

18.6


4.1


2.2


5.6Amortization of deferred stock-based compensation

75.6


(4.1
)

(41.5
)

(2.9
)Research and development credit

(0.5
)

1.7


6.1


4.1Other

(13.2
)

(15.8
)

(2.7
)

(5.9
)Effective tax rate

114.5
%

19.9
%

(1.9
)%

34.9
%




8




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COMPUTER ACCESS TECHNOLOGY CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE 9REPORTABLE SEGMENTS AND GEOGRAPHIC INFORMATION





The Company has three reportable segments categorized by product type: development products; production products; and connectivity
products. The development products are advanced verification systems that assist hardware and software manufacturers in the efficient design of reliable and interoperable systems and devices. Production products are production verification systems
and connectivity solutions designed to assist hardware and software manufacturers in volume production of reliable devices and systems. Connectivity products are designed to assist broadband Internet service providers in delivering convenient and
dependable service and device manufacturers in producing reliable products. 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.





Segment information (in thousands):





Development Products

Production Products

Connectivity Products


Unallocated Stock-based Compensation Expense


TotalThree Month Period Ended September 30, 2001Segment revenue from external customers

$
2,781

$
453

$
320


$



$
3,554Segment gross profit

$
2,382

$
334

$
79


$
19


$
2,814Three Month Period Ended September 30, 2002Segment revenue from external customers

$
3,467

$
505

$
44


$



$
4,016Segment gross profit

$
2,622

$
294

$
(7
)

$
(32
)

$
2,877Nine Month Period Ended September 30, 2001Segment revenue from external customers

$
10,120

$
1,437

$
1,819


$



$
13,376Segment gross profit

$
8,794

$
1,116

$
575


$
(327
)

$
10,158Nine Month Period Ended September 30, 2002Segment revenue from external customers

$
9,304

$
1,402

$
225


$



$
10,931Segment gross profit

$
7,576

$
889

$
86


$
(112
)

$
8,439




9




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COMPUTER ACCESS TECHNOLOGY CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







Geographic information (in thousands):





Revenue

Long-Lived AssetsThree Month Period Ended September 30, 2001North America

$
1,379Europe


475Asia


1,694Rest of world


6Total

$
3,554Three Month Period Ended September 30, 2002North America

$
1,382

$
1,148Europe


1,166


Asia


1,468


Rest of world





Total

$
4,016

$
1,148Nine Month Period Ended September 30, 2001North America

$
5,831Europe


1,983Asia


5,493Rest of world


69Total

$
13,376Nine Month Period Ended September 30, 2002North America

$
4,263

$
1,148Europe


2,272


Asia


4,366


Rest of world


30


Total

$
10,931

$
1,148





Revenues are attributed to countries based on delivery locations. Sales to foreign
customers accounted for 61.2% and 65.6% of revenue during the quarters ended September 30, 2001 and 2002, respectively, and 56.4% and 61.0% for the nine month period ended September 30, 2001 and 2002, respectively.





NOTE 10ACQUISITIONS





On May 9, 2002, the Company entered into an Agreement and Plan of Merger with Verisys and its shareholders (Merger Agreement) pursuant to which the Company acquired Verisys. The transaction closed on June 4, 2002, and was
accounted for under the purchase method of accounting. The accompanying condensed consolidated financial statements include the results of operations of Verisys subsequent to June 4, 2002, the date the Company designated as the acquisition date for
accounting purposes. Verisys has operations in Aptos, California. Verisys was founded in 1992 and develops, manufactures and sells bus analysis tools for the SCSI market.





Pursuant to the Merger Agreement, the Company paid $825,000 and issued 360,000 shares of its common stock, of which 61,200 shares have been retained to secure certain
Verisys obligations under the Merger Agreement for a period of eighteen months, in exchange for all of the outstanding shares of Verisys common stock. The




10




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COMPUTER ACCESS TECHNOLOGY CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




Companys initial cost to acquire Verisys was calculated to be $2.3 million using the Company common stock price of $3.53, which was the closing market price of the Companys common
stock on May 9, 2002. Verisys currently operates as a wholly owned subsidiary of the Company.





The total initial
purchase cost of Verisys is as follows (in thousands):





Cash Paid

$
825Value of securities issued


1,271Estimated transaction costs and expenses


191$
2,287





The cost to acquire Verisys has been allocated to the assets
acquired and liabilities assumed according to their respective fair values, with the excess purchase price being allocated to goodwill. The purchase price allocation is as follows (in thousands):





Net tangible liabilities

$
(440
)Intangible assets acquired:Goodwill


1,427In-process research and development


410Acquired developed technology


380Non-compete agreements


280Core technology


230Total purchase price allocation

$
2,287





The purchase price was allocated to Verisys tangible assets
and specific intangible assets such as in-process research and development, developed technology, non-compete agreements and core technology, based upon an independent valuation performed by an outside valuation specialist.





Goodwill represents the excess of the purchase price for Verisys over the fair value of the underlying net identifiable assets.





In-process research and development represents that portion of the purchase price of an acquisition related to
the research and development activities which (i) have not demonstrated their technological feasibility, and (ii) have no alternative future uses. Accordingly, the Company recognized an in-process research and development expense of $410,000 during
the three months ended June 30, 2002 in conjunction with the acquisition.





The acquired developed technology,
which is comprised of products that are already technologically feasible, mainly includes the SV-8320, SV-8160, and SV-4080 SCSI analyzers. As of September 30, 2002, the Company is amortizing the remaining acquired developed technology on a
straight-line basis over an estimated useful life of two years.





Non-compete agreements represent the value of
non-compete agreements the Company has with certain former Verisys executives. As of September 30, 2002, the Company is amortizing the remaining non-compete agreements on a straight-line basis over an estimated useful life of three years.





Core technology represents the value of the underlying proprietary technology of Verisys products. As of
September 30, 2002, the Company is amortizing the remaining core technology on a straight-line basis over an estimated useful life of two years.




11




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COMPUTER ACCESS TECHNOLOGY CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







As a result of the decline in the Companys market valuation and
reduced SCSI sales, the Company performed the required impairment tests of goodwill and indefinite-lived intangible assets as of September 30, 2002, in accordance with SFAS 142, Goodwill and Other Intangible Asset. These tests
were based upon an independent valuation performed by an outside valuation specialist that utilized a combination of income and market value approaches. It was determined that, as of September 30, 2002, there was full impairment of goodwill within
the development products segment of $1.4 million, and partial impairment of acquired developed technology, non-compete agreements and core technology of $147,000, $59,000 and $135,000, respectively. As of September 30, 2002, the valuations of
acquired developed technology, non-compete agreements and core technology was $70,000, $190,000 and $80,000, respectively.





NOTE
11RECENT ACCOUNTING PRONOUNCEMENTS





In April 2002, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards No. 145 (SFAS 145), Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections,which is
effective for fiscal years beginning after May 15, 2002. Under SFAS 145, gains and losses from the extinguishment of debt should be classified as extraordinary items only if they meet the criteria of Accounting Principles Board Opinion No. 30. SFAS
145 also addresses financial accounting and reporting for capital leases that are modified in such a way as to give rise to a new agreement classified as an operating lease. The Company believes that the adoption of SFAS 145 will not have a material
impact on the consolidated financial position or results of the operations of the Company.





In June 2002, the FASB
issued Statement of Financial Accounting Standards No. 146 (SFAS 146), Accounting for Costs Associated with Exit or Disposal Activities,which is effective for exit or disposal activities initiated after December 31,
2002. SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under
SFAS 146, a liability is required to be recognized for a cost associated with an exit or disposal activity when the liability is incurred. SFAS 146 applies to costs associated with an exit activity that does not involve an entity newly acquired in a
business combination or with a retirement or disposal activity covered by FASB Statements No. 143, Accounting for Asset Retirement Obligations, and No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. The Company believes that the adoption of SFAS 146 will not have a material impact on the consolidated financial position or results of the operations of the Company.





NOTE 12SUBSEQUENT EVENTS





On October 3, 2002, we
announced that Jean-Louis Gassée, President, Chief Executive Officer and a member of our Board of Directors, had resigned from all positions with our company and that Dan Wilnai, Chairman of the Board of Directors, had been appointed to act
as our interim President and Chief Executive Officer, while maintaining his title as Chairman of the Board. In connection with his resignation, on October 1, 2002, we entered into an agreement with Mr. Gassée to pay him nine months severance
at his base salary then in effect.





On October 24, 2002, we announced that we were implementing a second
restructuring plan in the fourth quarter of 2002 to further consolidate operations and reduce costs in addition to the restructuring plan we implemented in the second quarter of 2002. As part of this second restructuring plan, we intend to reduce
total headcount by approximately 13%, which will result in a charge of approximately $350,000 to $400,000 in the quarter ending December 31, 2002.




12




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





The following information 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 28, 2002.





This report contains forward-looking statements within the
meaning of the federal securities laws. These statements may contain words such as expects, anticipates, intends, plans, believes, estimates, or other wording indicating future
results. Forward-looking statements are subject to risks and uncertainties. Actual results may differ materially from the results discussed in forward-looking statements. Factors that could cause actual results to differ materially include, but are
not limited to, those discussed under Risk Factors following Liquidity and Capital Resources below, and elsewhere in this report. We undertake no obligation to revise or update any forward-looking statements to reflect any
event or circumstance that may arise after the date of this report.





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 are believed 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.





We
report our revenue and gross profit in three business segments: development; production; and connectivity products. Due to the significant software content of our products, we have adopted Statement of Position, or 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 customers price protection, return or exchange rights. Generally, our distributors do not maintain inventory; however, they
do have the right to return inventory upon termination of their distribution agreement. We review inventory levels held by distributors, if any, quarterly 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 three professional money management firms under the investment guidelines we have established. These guidelines
address the critical objectives of preservation of principal, avoiding inappropriate concentrations, meeting liquidity requirements and delivering maximum 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 91 days but less than one year to be short-term investments. Cash equivalents and short-term investments consist principally of investments in commercial
paper, investment quality corporate and municipal bonds, collateralized mortgage obligations, U.S. government agency securities and money market funds.





We account for income taxes under the liability method, which requires, among other things, that deferred income taxes be provided 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




13




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net operating losses and research and development credit carryforwards. The preparation of our tax provision and deferred tax assets requires us to make estimates and assumptions including areas
such as the calculation of research and development credits, and future taxable income. If these estimates change in the future, we may be required to record additional valuation allowances against deferred tax assets, and our future tax provisions
may result in different effective tax rates. A valuation allowance is provided against deferred tax assets unless it is more likely than not that they will be realized.





Our purchased intangible assets total $340,000 as of September 30, 2002. We are required to make judgments about the recoverability of these assets whenever events or
changes in circumstances indicate that the carrying value 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 the judgments and assumptions we have made 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 USB, IEEE 1394, Bluetooth wireless technology, InfiniBand, Serial ATA, SCSI and Ethernet.
Our products are used by semiconductor, device, system and software 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. Our connectivity products enable reliable, uninterrupted service for broadband Internet access. We currently outsource most of the manufacturing of our verification systems and connectivity products 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 three business segments: development; production; and connectivity products. In the quarter ended September 30, 2002, revenue from our development products was $3.5 million, from production products was $505,000 and from connectivity
products was $44,000. Historically, we have generated a majority of our revenue across all segments from products for the USB standard. Revenue from USB products accounted for approximately 59.6% of our revenue in the quarter ended September 30,
2002, of which 47.9% was from USB 2.0 products.





We sell our products to technology, infrastructure and
application companies through our direct sales force and indirectly primarily through our distributors and manufacturers representatives. Historically, a substantial portion of our revenue has been derived from customers outside of the United
States. In the quarter ended September 30, 2002, 65.6% of our revenue was derived from international customers, of which 17.2% was derived from customers in Japan, 19.3% was derived from customers in other parts of Asia, and 29.0% was derived from
customers in Europe. International revenue increased as a percentage of total revenue in the quarter ended September 30, 2002 as compared to the quarter ended September 30, 2001, primarily due to increased sales in Europe of approximately 145%,
coupled with the general economic slowdown in the United States. All of our revenue and accounts receivable are denominated in U.S. dollars. Although seasonality affects many of our target markets, to date our revenues and financial condition as a
whole have not been materially impacted by seasonality.





The development of emerging communications standards and
technological change have influenced and are 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 estimates on a timely basis, our expenses may increase as a percentage of revenue.




14




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The overall economic environment continues to create uncertainties for us and our
customers. We have experienced continuing weakness in each of our business segments over the last eighteen months as a result of slowing growth in the global economy and delays in orders as a result of reduced spending by many of our customers. Our
near term financial results have been and may continue to be affected by our decision in 2001 to invest in our sales, marketing and research and development infrastructure. However, during the second quarter of 2002, we implemented a restructuring
plan designed to consolidate operations and reduce costs. The restructuring plan included the closure of our facilities in San Diego, California and Netanya, Israel and a reduction in staff by a total of 18 positions. We expect that the majority of
the remaining restructuring actions related to this second quarter restructuring plan, such as office closures and office subleasing, will be completed by the end of 2002. Obligations related to subleasing may continue until 2004. We incurred
restructuring expenses of $443,000 for the quarter ended June 30, 2002.





On May 9, 2002 we entered into an
Agreement and Plan of Merger with Verisys and its shareholders pursuant to which we acquired Verisys. The transaction closed on June 4, 2002 and we accounted for the acquisition under the purchase method of accounting. The accompanying consolidated
condensed financial statements include the results of operations of Verisys subsequent to June 4, 2002, the date that we designated as the acquisition date for accounting purposes. Verisys has operations in Aptos, California. Verisys was founded in
1992 and develops, manufactures and sells bus analysis tools for the SCSI market. Verisys currently operates as a wholly owned subsidiary of our company.





Results of Operations





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





Three Month Period Ended September 30,


Nine Month Period Ended September 30,2001


2002


2001


2002Consolidated Statement of Income Data:Revenue

100.0
%

100.0
%

100.0
%

100.0
%Cost of Revenue

20.8


24.4


24.1


21.2Amortization of acquired developed technology




4.0





1.6Gross profit

79.2


71.6


75.9


77.2Operating expenses:Research and development

51.5


50.9


41.4


54.3Sales and marketing

22.5


27.3


16.3


32.7General and administrative

20.6


35.5


17.2


32.9Goodwill impairment




35.5





13.1Acquired in-process research and development










3.8Amortization of purchased intangibles




5.7





2.2Restructuring expenses










4.1Amortization of deferred stock-based compensation

13.1


6.9


23.0


3.5Total operating expenses

107.7


161.8


97.9


146.6Loss from operations

(28.5
)

(90.2
)

(22.0
)

(69.4
)Other income, net

11.8


3.9


11.9


4.8Loss before provision for (benefit from) income taxes

(16.7
)

(86.3
)

(10.1
)

(64.6
)Provision for (benefit from) income taxes

(19.1
)

(17.2
)

.2


(22.5
)Net income (loss)

2.4
%

(69.1
)%

(10.3
)%

(42.1
)%




15




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Comparisons of Quarters Ended September 30, 2001 and 2002





Revenue.    Our revenue was $4.0 million in the quarter ended September 30, 2002 compared to $3.6 million in
the quarter ended September 30, 2001, representing an increase of 13.0%. The increase in revenue was due primarily to increases in sales of new development and production products, which represented $1.1 million and $472,000, respectively, offset by
decreases in sales of certain existing development, production and connectivity products of $398,000, $420,000 and $275,000, respectively. The decrease in sales of existing development and production products was primarily the result of the slowdown
in the Bluetooth and USB 1.1 markets and the general economic slowdown. The decrease in sales of connectivity products was primarily the result of additional competitive pressure due to improved availability of next generation cable and DSL modems
with integrated USB support. In January 2002, we converted our resellers to manufacturers representatives. This conversion resulted in an estimated amount of additional revenue for the quarter ended September 30, 2002 of $149,000 as we sold
directly to our end customers without discount. However, this estimated additional revenue was partially offset by an increase in sales and marketing expense relating to manufacturers representatives commissions. Revenue from
international customers represented 65.6% of our revenue in the quarter ended September 30, 2002 and 61.2 % of our revenue in the quarter ended September 30, 2001.





Cost of Revenue and Gross Profit.    Our gross profit was $2.9 million in the quarter ended September 30, 2002 compared to $2.8 million in the
quarter ended September 30, 2001, representing an increase of 2.3%. The dollar increase in gross profit was primarily the result of an increase in unit sales of development products offset by approximately $200,000 of inventory write-offs for
obsolete inventory, an increase in the amortization of acquired developed technology of $160,000, and an increase in the amortization of deferred stock-based compensation of $51,000. Our gross margin percentage was 71.6% in the quarter ended
September 30, 2002 and 79.2% in the quarter ended September 30, 2001. The decrease in gross margin percentage was primarily due to the increase in costs noted above and reduced margins for our production products, resulting from higher costs
associated with components and lower volume 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 8.1%, our lower margin business segment, production products, decreased as a percentage of revenue by 0.2%, and our lowest margin business segment, connectivity products, decreased as a percentage of revenue by 7.9%. In January 2002, we converted
our resellers to manufacturers representatives. This conversion improved gross margins by 0.9% for the quarter ended September 30, 2002, as we sell directly to our end customers without discount. Excluding amortization of deferred stock-based
compensation, our gross margin would have been 72.4% for the quarter ended September 30, 2002 and 78.6% for the quarter ended September 30, 2001.





Research and Development.    Our research and development expenses were $2.0 million in the quarter ended September 30, 2002 compared to $1.8 million in the quarter ended
September 30, 2001, representing an increase of 11.6%. Research and development expenses represented 50.9% of revenue in the quarter ended September 30, 2002 and 51.5% of revenue in the quarter ended September 30, 2001. The dollar increase was
primarily due to increases in other research and development costs of approximately $217,000 and increases in consulting fees of $124,000, offset by decreases in personnel and related costs of approximately $148,000. The percentage of revenue
decrease for the quarter ended September 30, 2002 was primarily due to the impact of increased revenue from the quarter ended September 30, 2001, partially offset by the increase in costs noted in this paragraph from the quarter ended September 30,
2001.





Sales and Marketing.    Our sales and marketing expenses were $1.1 million in
the quarter ended September 30, 2002 compared to $798,000 in the quarter ended September 30, 2001, representing an increase of 37.6%. Sales and marketing expenses represented 27.3% of revenue in the quarter ended September 30, 2002 and 22.5% of
revenue in the quarter ended September 30, 2001. The dollar increase was primarily due to commissions earned by our manufacturers representatives of $122,000, increases in marketing programs of $69,000, and increases in personnel and related
costs of approximately $59,000. The percentage of revenue increase for the quarter ended September 30, 2002 was primarily due to the increase in costs noted in this paragraph from the quarter ended September 30, 2001.





General and Administrative.    Our general and administrative expenses were $1.4 million in the quarter ended
September 30, 2002 compared to $733,000 in the quarter ended September 30, 2001, representing an increase of 94.5%. General and administrative expenses represented 35.5% of revenue in the quarter ended September 30, 2002 and 20.6% of revenue in the
quarter ended September 30, 2001. The dollar increase was primarily due to an




16




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increase in professional services of $410,000, primarily legal fees associated with ongoing litigation, and increases in personnel and related costs of $245,000. The percentage of revenue
increase for the quarter ended September 30, 2002 was primarily due to the increase in costs noted above from the quarter ended September 30, 2001.





Goodwill Impairment.    In the quarter ended September 30, 2002, we recorded a goodwill impairment of $1.4 million. See Note 10 to our condensed consolidated financial
statements elsewhere in this report for goodwill and other intangible asset impairment losses recorded in the quarter ended September 30, 2002. There were no comparable charges in the quarter ended September 30, 2001. Goodwill impairment represented
35.5% of revenue in the quarter ended September 30, 2002.





Amortization of Purchased
Intangibles.    Our amortization of purchased intangibles resulting from our purchase of Verisys was $228,000, including a partial impairment write-down of $194,000, in the quarter ended September 30, 2002. There were no
comparable charges in the quarter ended September 30, 2001. Amortization of purchased intangibles represented 5.7% of revenue in the quarter ended September 30, 2002.





Amortization of Deferred Stock-based Compensation.    Amortization of deferred stock-based compensation represents the difference between the
exercise price and the deemed fair value at the date of grant, in connection with certain stock option grants in 2000, 1999 and 1998, which is being recognized over the vesting period of the related options. Amortization of deferred stock-based
compensation was $311,000 in the quarter ended September 30, 2002, of which $32,000 was included in cost of revenue. This amount reflects increased amortization due to option cancellations of approximately $114,000 due to employee terminations and
related acceleration of vesting. Amortization of deferred stock-based compensation was $447,000 in the quarter ended September 30, 2001, of which a credit of $(19,000) resulting from cancellations was included in cost of revenue. Amortization of
deferred stock-based compensation on grants prior to December 31, 2000 is estimated to be approximately $140,000 for the remainder of the year ending December 31, 2002 and $312,000 and $40,000 in the years ending December 31, 2003 and 2004,
respectively, and may change due to the granting of additional options or the cancellation of existing grants in future periods.





Other Income.    Other income was $157,000 in the quarter ended September 30, 2002 compared to $419,000 in the quarter ended September 30, 2001, representing a decrease of 62.5%. This decrease resulted from
declining interest income earned on the investment of the additional excess cash balances and the proceeds from our initial public offering in November 2000.





Benefit from Income Taxes.    Benefit from income taxes was $690,000 in the quarter ended September 30, 2002 compared to $681,000 in the quarter ended September 30, 2001,
representing an increase of 1.3%. Our effective tax rate decreased from 114.5% in the quarter ended September 30, 2001 to 19.9% in the quarter ended September 30, 2002. This decrease was due primarily to and increased loss from operations, a
decrease in the amortization of deferred stock-based compensation, and the effect of annual accounting adjustments associated with an estimate of the effective tax rate for the full year. Our effective tax rate after excluding the effect of
amortization of deferred stock-based compensation was 21.9% in the quarter ended September 30, 2002 and 460.1% in the quarter ended September 30, 2001.





Net Income (loss).    Our net loss was $2.8 million in the quarter ended September 30, 2002 compared to our net income of $86,000 in the quarter ended September 30, 2001,
representing a decrease of 3,329.1%. Our net loss represented (69.1)% of revenue in the quarter ended September 30, 2002 and our net income represented 2.4% of revenue in the quarter ended September 30, 2001. The dollar and percentage of revenue
decreases in net income (loss) were primarily the result of increased operating costs and reduced interest income. Net loss before the effect of the amortization of deferred stock-based compensation was $2.5 million in the quarter ended September
30, 2002, and our net income before the effect of the amortization of deferred stock-based compensation was $533,000 in the quarter ended September 30, 2001.




17




---




The following table sets forth net income (loss) and net income (loss) per share,
excluding the amortization of deferred stock-based compensation (in thousands, except per share amounts).





Three Month Period Ended September 30,2001

2002Net income (loss), excluding amortization of deferred compensation

$
533

$
(2,466
)Net income (loss) per share, excluding amortization of deferred compensation:Basic

$
0.03

$
(0.13
)Diluted

$
0.03

$
(0.13
)Weighted average shares outstanding:Basic


18,783


19,401Diluted


19,176


19,401





Comparison of Nine Months Ended September 30, 2001 and 2002





Revenue.    Our revenue was $10.9 million in the nine months ended September 30, 2002 compared to
$13.4 million in the nine months ended September 30, 2001, representing a decrease of 18.3%. The decrease in revenue was due primarily to decreases in sales of certain existing development, production and connectivity products of $3.9 million, $1.0
million and $1.6 million, respectively, offset by increases in sales of new development and production products, which represented $3.1 million and $1.0 million, respectively. The decrease in sales of existing development and production products was
primarily the result of the slowdown in the Bluetooth and USB 1.1 markets and the general economic slowdown. The decrease in sales of connectivity products was primarily the result of additional competitive pressure due to improved availability of
next generation cable and DSL modems with integrated USB support. In January 2002, we converted our resellers to manufacturers representatives. This conversion resulted in an estimated amount of additional revenue for the nine months ended
September 30, 2002 of $399,000 as we sold directly to our end customers without discount. However, this estimated additional revenue was partially offset by an increase in sales and marketing expense relating to manufacturers
representatives commissions. Revenue from international customers represented 61.0% of our revenue in the nine months ended September 30, 2002 and 56.4% for the nine months ended September 30, 2001.





Cost of Revenue and Gross Profit.    Our gross profit was $8.4 million in the nine months ended September 30,
2002 compared to $10.2 million in the nine months ended September 30, 2001, representing a decrease of 16.9%. The dollar decrease in gross profit was primarily the result of a decrease in unit sales of development and connectivity products,
approximately $200,000 of inventory write-offs for obsolete inventory, and amortization of acquired developed technology of $177,000, offset by a decrease in amortization of deferred stock-based compensation of $215,000. Our gross margin percentage
was 77.2% in the nine months ended September 30, 2002 and 75.9% in the nine months ended September 30, 2001. The increase in gross margin percentage was primarily due to increases in development product sales as a percentage of revenue, decreases in
connectivity product sales as a percentage of revenue, offset by reduced margins for our production products resulting from higher costs associated with components and lower volume manufacturing of new products and the increase in costs noted above.
Our higher margin business segment, development products, increased as a percentage of revenue by 9.5%, our lower margin business segment, production products, increased as a percentage of revenue by 2.1% and our lowest margin business segment,
connectivity products, decreased as a percentage of revenue by 11.5%. In January 2002, we converted our resellers to manufacturers representatives. This change improved gross margins by 0.8% for the nine months ended September 30, 2002, as we
sell directly to our end customers without discount. Excluding amortization of deferred stock-based compensation, our gross margin would have been 78.2% for the nine months ended September 30, 2002 and 78.4% for the nine months ended September 30,
2001.





Research and Development.    Our research and development expenses were $5.9
million in the nine months ended September 30, 2002 compared to $5.5 million in the nine months ended September 30, 2001, representing an increase of 7.2%. Research and development expenses represented 54.3% of revenue in the nine months ended
September 30, 2002 and 41.4% of revenue in the nine months ended September 30, 2001. The dollar increase was primarily due to increases in other research and development costs of approximately $308,000 and increases in consulting fees of $146,000,
offset by decreases in personnel and related costs of approximately $86,000 for the nine months ended September 30, 2002. The percentage of revenue increase for the nine months ended September 30,




18




---

2002 was primarily due to the impact of the decrease in revenue from the nine months ended September 30, 2001 and the increase in costs noted in this paragraph.





Sales and Marketing.    Our sales and marketing expenses were $3.6 million in the nine months ended September
30, 2002 compared to $2.2 million in the nine months ended September 30, 2001, representing an increase of 64.5%. Sales and marketing expenses represented 32.7% of revenue in the nine months ended September 30, 2002 and 16.3% of revenue in the nine
months ended September 30, 2001. The dollar increase was primarily due to increases in personnel and related costs of approximately $531,000, commissions earned by our manufacturers representatives of $459,000 and increases in marketing
programs of $174,000. The percentage of revenue increase for the nine months ended September 30, 2002 was primarily due to the impact of the decrease in revenue from the nine months ended September 30, 2001 and the increase in costs noted in this
paragraph.





General and Administrative.    Our general and administrative expenses were
$3.6 million in the nine months ended September 30, 2002 compared to $2.3 million in the nine months ended September 30, 2001, representing an increase of 56.7%. General and administrative expenses represented 32.9% of revenue in the nine months
ended September 30, 2002 and 17.2% of revenue in the nine months ended September 30, 2001. The dollar increase was primarily due to an increase in professional services of $787,000, primarily legal fees associated with ongoing litigation, and the
addition of personnel and related costs of $405,000. The percentage of revenue increase for the nine months ended September 30, 2002 was primarily due to the impact of the decrease in revenue from the nine months ended September 30, 2001 and the
increase in costs noted in this paragraph.





Goodwill Impairment.    In the quarter
ended September 30, 2002, we recorded a goodwill impairment of $1.4 million. See Note 10 to our condensed consolidated financial statements elsewhere in this report for goodwill and other intangible asset impairment losses recorded in the quarter
ended September 30, 2002. There were no comparable charges in the nine months ended September 30, 2001. Goodwill impairment represented 13.1% of revenue in the nine months ended September 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 nine months ended September 30, 2002.There were no comparable charges in the nine months ended September 30, 2001. Acquired in-process research and development expenses represented 3.8% of
revenue in the nine months ended September 30, 2002.





Amortization of Purchased
Intangibles.    Our amortization of purchased intangibles resulting from our purchase of Verisys was $228,000, including a partial impairment write-down of $194,000, in the nine months ended September 30, 2002. There were no
comparable charges in the nine months ended September 30, 2001. Amortization of purchased intangibles represented 2.2% of revenue in the nine months ended September 30, 2002.





Restructuring Expenses.    Restructuring expenses were $443,000 in the nine months ended September 30, 2002. There were no comparable charges in
the nine months ended September 30, 2001. Restructuring expenses represented 4.1% of revenue in the nine months ended September 30, 2002. 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 represents the difference between the
exercise price and the deemed fair value at the date of grant, in connection with certain stock option grants in 2000, 1999 and 1998, which is being recognized over the vesting period of the related options. Amortization of deferred stock-based
compensation was $497,000 in the nine months ended September 30, 2002, of which $112,000 was included in cost of revenue. This amount reflects decreased amortization due to cancellations of approximately $647,000 due to employee terminations.
Amortization of deferred stock-based compensation was $3.4 million in the nine months ended September 30, 2001, of which $327,000 was included in cost of revenue. Amortization of deferred stock-based compensation on grants prior to December 31, 2000
is estimated to be approximately $140,000 for the remainder of the year ending December 31, 2002 and $312,000 and $40,000 in the years ending December 31, 2003 and 2004, respectively, and may change due to the granting of additional options or the
cancellation of existing grants in future periods.




19




---




Other Income.    Other income was $527,000 in the nine
months ended September 30, 2002 compared to $1.6 million in the nine months ended September 30, 2001, representing a decrease of 66.9%. This decrease resulted from declining interest income earned on the investment of the additional excess cash
balances and the proceeds from our initial public offering in November 2000.





Provision for (Benefit from)
Income Taxes.    Benefit for income taxes was $2.5 million in the nine months ended September 30, 2002 compared to provision for income taxes of $26,000 in the nine months ended September 30, 2001, representing a decrease of
9,565.4%. Our effective tax rate decreased from (1.9)% in the nine months ended September 30, 2001 to 34.9% in the nine months ended September 30, 2002. This decrease was due primarily to and increased loss from operations, a decrease in the
amortization of deferred stock-based compensation, and the effect of annual accounting adjustments associated with an estimate of the effective tax rate for the full year. Our effective tax rate after excluding the effect of amortization of deferred
stock-based compensation was 37.5% in the nine months ended September 30, 2002, and 1.3% in the nine months ended September 30, 2001.





Net loss.    Our net loss was $4.6 million in the nine months ended September 30, 2002 compared to $1.4 million in the nine months ended September 30, 2001, representing an increase of 234.9%. Our
net loss represented (42.1)% of revenue in the nine months ended September 30, 2002 and (10.3)% of revenue in the nine months ended September 30, 2001. The dollar and percentage of revenue increases in net loss were primarily the result of reduced
revenue, increased operating costs and reduced interest income, offset by the benefit for income taxes. Net loss before the effect of the amortization of deferred stock-based compensation was $4.1 million in the nine months ended September 30, 2002,
and our net income before the effect of the amortization of deferred stock-based compensation was $2.0 million in the nine months ended September 30, 2001.





The following table sets forth net income (loss) and net income (loss) per share, both after excluding the amortization of deferred stock-based compensation (in thousands, except per share amounts).





Nine Month Period Ended September 30,2001

2002Net income (loss), excluding amortization of deferred compensation

$
2,040

$
(4,096
)Net income (loss) per share, excluding amortization of deferred compensationBasic

$
0.11

$
(0.21
)Diluted

$
0.11

$
(0.21
)Weighted average shares outstandingBasic


18,702


19,131Diluted


19,294


19,131





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 nine months ended September 30, 2002, cash used in operating activities of $1.8 million was primarily a result of net loss of $4.6
million and a decrease in related assets and liabilities for working capital purposes of $618,000, offset by non-cash expenses associated with goodwill impairment of $1.4 million, amortization of deferred stock-based compensation of $497,000,
acquired in-process research and development of $410,000, depreciation expenses of $489,000, amortization of other purchased intangibles of $240,000, amortization of other acquired developed technology of $177,000, and write-down of property and
equipment in connection with restructuring of $134,000. Cash used in investing activities was $13.4 million, related to the purchase of short-term investments of $17.1 million, acquisition of a subsidiary of $980,000, capital expenditures of
$237,000, offset by proceeds from the sale of short-term investments of $5.1 million. Cash provided by financing activities was




20




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$423,000, consisting of the proceeds from the exercise of stock options of $213,000 and the sale of stock pursuant to our employee stock purchase plan of $210,000.





In the nine months ended September 30, 2001, cash provided by operating activities of $432,000 was primarily a result of net loss of $1.4
million, a decrease in related assets and liabilities for working capital purposes of $2.0 million, offset by non-cash expenses associated with amortization of deferred stock-based compensation of $3.4 million, and depreciation expenses of $322,000.
Cash used in investing activities was $486,000, related to the capital expenditures of $771,000, offset by proceeds from the sale of short-term investments of $285,000. Cash provided by financing activities was $303,000, consisting of proceeds from
the exercise of stock options of $166,000 and the sale of stock pursuant to our employee stock purchase plan of $137,000.





As of September 30, 2002, we had cash, cash equivalents and short-term investments of $44.8 million, working capital of $48.0 million and no debt.





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 more distant 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 or 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 quarterly report. The occurrence of any of the developments or risks identified below may make the occurrence of one or more of the other risk facts 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 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 for our products, and longer lead times needed to close sales. If global economic conditions do not improve, or if there is a worsening in the global economic
slowdown, we may continue to experience adverse impacts on our business, operating results and financial condition.





Our future
operating results are unpredictable and are likely to fluctuate from quarter to quarter and, 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 of our control. Several of these risks are described in the risk factors listed 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:





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




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




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




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




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



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




| |  |  | changes in the average selling prices of our 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.





We currently derive a substantial majority of our revenue
from sales of our USB products. Sales of our USB products accounted for approximately 59.6% of our revenue in the quarter ended September 30, 2002. We expect that revenue from these products will continue to account for a substantial portion of our
revenue for the foreseeable future. If the market does not continue to accept our USB products, our revenue will decline significantly. Factors that may affect sales of our current USB products include the continued growth of the 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 as they are developed, such as USB 2.0.
Many of these factors are beyond our control. In addition, in order to maintain widespread market acceptance, we must continue to differentiate ourselves from the competition through our technical expertise, product offerings and brand name
recognition.





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 introduce new products or product enhancements that address these changes, meet new customer
requirements and support new standards. 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 others.
| | - |  | ---------------------------------------------------------------------------------




If we are unable to identify, develop, manufacture, market or support new or enhanced products successfully or on a timely basis, our competitors could gain market share or
our new products or product enhancements might not gain market acceptance. Further, we might not be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards.





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. Although we have not experienced any material product development delays in the past, these types of delays could occur in the
future. To the extent that we do not timely introduce a product for an emerging standard or customers defer or cancel orders with the expectation of the release of a new product or product enhancement, our operating results could suffer. Product
development delays may result from numerous factors, including:




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




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




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




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




| |  |  | changing market or competitive product requirements; and
| | - |  | --------------------------------------------------------




| |  |  | unanticipated engineering complexities.
| | - |  | ---------------------------------------




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 manufacture and sell in volume advanced computer, communications and consumer electronic products for emerging communications
standards such as Bluetooth wireless technology, InfiniBand and Serial ATA and the acceptance of these products by consumers. The markets for emerging standards products have only recently begun to develop and are rapidly evolving. As a result,
there is significant uncertainty as to whether these markets 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 in
developing products for emerging communications standards that may not 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 companies that are leaders in developing emerging
communications standards in our target markets. We believe that we need to work closely with these core or promoter companies to gain valuable insights into the market demands for new products, to obtain early access to emerging communications
standards as they develop and to help us design new products. We will need to maintain our relationships with leading technology and infrastructure companies, as well as expand our relationships with leaders in markets that are new for us.
Generally, we do not enter into formal contracts that obligate these companies to work or share their technology with us. Industry leaders could choose to work with other companies as they develop new communications standards in the future. If we
fail to maintain and expand our industry relationships, we could lose the opportunity for 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.





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





We may experience a delay in 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 from those orders until a later date. Because we budget our operating expenses on anticipated revenue trends and a high percentage of our expenses is 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 among our products, with our gross margins generally being
higher on our advanced verification systems than on our connectivity 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.




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Decreases in average selling prices of our products may reduce gross margins and revenue.





The average selling prices of our products may decrease in the future in response to product introductions or
enhancements by us or our competitors, or as a result of other factors, including discounts given on volume purchase orders or pricing pressures. We anticipate that we will need to 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.





Continued competition in our markets may lead to a reduction in our prices, revenue and market share.





The markets for advanced verification and connectivity products for emerging communications standards are highly competitive. We compete with multiple companies in various markets, including Yokagawa in the markets for
products for the 1394 standard, Tektronix and Frontline in the markets for products for the Bluetooth wireless technology, Finisar in the markets for products for the InfiniBand standard, Catalyst Enterprises in the markets for products for the USB
standard, and Data Transit Corporation in the markets for products in the Serial ATA standard. Any of our competitors may develop technologies that address our targeted markets more effectively and at a lower cost. In addition, these competitors may
enter into strategic alliances or business combinations that increase their ability to innovate and address our markets.





We may also face competition from other equipment manufacturers, such as Agilent, National Instruments and Rhode & Schwartz. Many of these companies have substantially greater financial, technical, marketing and distribution
resources and brand name recognition. We expect that more companies, including some of our customers, will enter our markets. If these companies develop products that compete with our products or form alliances with or acquire companies offering
competing products, even if those products do not have capabilities comparable to our products, they would be significant competitors and their activities could cause us to reduce our prices. 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.





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 change the terms under which they manufacture our products. We have experienced delays in product shipments from some of our contract manufacturers in the past, which in turn forced us to delay product shipments to our customers. We may
in the future experience similar delays or other problems, such as inferior quality and insufficient quantity of products, any of which could significantly harm our business. Our contract 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 contract manufacturers to provide us with adequate supplies of high quality products or the loss of any of our contract manufacturers would cause a delay in our ability to fulfill orders
while we obtain a replacement manufacturer.





If we are unable to forecast our supply needs accurately, 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 necessary components in a timely manner based on twelve-month rolling forecasts that we provide. Lead times for materials and components that we order vary significantly and
depend on factors such as specific supplier requirements, contract terms and current market demand for particular components. 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 fulfill customer orders.




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We depend on sole source suppliers for several key components of our products, 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. For example, we obtain field programmable gate array integrated circuits from Altera and Xilinx, ASICs from LSI Logic through Arrow Electronics, Inc., certain Bluetooth components from Ericsson, semiconductor devices from Agilent,
and micro-controllers from Intel, SMSC and Cypress Semiconductor. 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 longer 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 on distributors to sell our products internationally. We sell a substantial portion of our products through our distributors and manufacturers representatives, including Toyo, our primary distributor in Japan, which accounted
for approximately 17.2% of our revenue in the quarter ended September 30, 2002. Our distributors and manufacturers representatives generally offer products from multiple manufacturers. Accordingly, there is a 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, our sales to Toyo and our other distributors are made on the
basis of purchase orders rather than a long-term commitment. The loss of any one of our major distributors, or the delay of significant orders from these distributors, could result in decreased 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 ability to increase our revenue will be harmed.





We intend to develop and
expand our direct sales organization in North America and our indirect distribution channels internationally. We may not be able to expand our direct sales organization successfully, and the cost of any expansion may exceed the revenue generated
from expansion.





If we are unable to retain and motivate our sales, marketing, engineering, operations and finance personnel, our
growth will be impaired.





To grow our business successfully and maintain a high level of quality, we will need
to retain and motivate highly skilled sales, marketing, engineering, operations and finance personnel. If we are not able and retain a sufficient number of qualified employees, our growth will 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.





The loss of key management personnel, on whose knowledge, leadership and technical expertise we rely, would 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. All of our executive officers and key




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personnel are employees at will. We maintain no key person insurance on any of our personnel. If we were to 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. In addition, employees who leave our company may subsequently compete against us.





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





Our
ability to offer products and implement our business plan successfully in a rapidly evolving market requires an effective planning and management process. For example, we recently migrated our operations to a new enterprise resource planning system
that affects almost every facet of our business operations. Typically, these conversions negatively affect a companys near-term ability to conduct business due to problems such as historical data conversion errors, personnel training time
associated with the new system, delays in implementation or unforeseen technical problems during conversion. If problems arise in connection with this transition, we could experience delays in or lack of shipping, an inability to support our
existing customer base, delays in paying vendors, delays in collecting from customers, an inability to place or receive product orders or other operational problems. In addition, although we have implemented two separate corporate restructuring
plans in the second quarter of 2002 and more recently in October 2002, respectively, 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. 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 costs, divert our attention from product development efforts and result in a loss of customers.





Highly complex products such as our verification systems and connectivity products frequently contain defects when they are first
introduced or as new versions are released. Although none of our products has contained any material defects in the past, our products may contain defects of this nature in the future. If any of our products contains defects or have
reliability, quality or compatibility problems, our reputation may be damaged and customers may be reluctant to buy our products. As a result, our ability to retain existing customers or attract new customers could be harmed. In addition, these
defects could interrupt or delay sales to our customers. We may have to invest significant capital and other resources to alleviate these problems. If any of these problems 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 buy other businesses or technologies that would complement our current products, expand the breadth of our markets or enhance our technical capabilities or that might otherwise offer growth opportunities. If we make any
future 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 company common stock in
connection with our acquisition of Verisys in June 2002. In addition, 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
| | - |  | ------------------------------------------------------------------------------------------



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




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





Because we sell our products worldwide, our business is subject to risks associated with doing business internationally. We recognized 65.6% of our revenue from sales to
international customers in the quarter ended September 30, 2002. 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;
| | - |  | ----------------------------




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




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




The threat of terrorist attacks have created many economic and political uncertainties, some of which may harm our business and prospects and our ability in general to conduct business in the ordinary course.





The continued threat of terrorism and the resulting military, economic and political response and heightened
security measures may cause significant disruption to commerce throughout the world. To the extent that this disruption results in a general decrease in our customers spending, our business and results of operations could be materially and
adversely affected. We are unable to predict whether the threat of terrorism or the responses thereto will result in any long-term commercial disruptions or if such activities or responses will have a long-term adverse effect 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.





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





To date, we protect our proprietary processes, software, know-how and other intellectual property and related rights through
copyrights, trademarks and 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 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 by others or invalidated, or may not provide us with a significant competitive advantage.
Third parties may breach confidentiality agreements or other protective contracts into which we have entered, and we may not be able to enforce our rights in




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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. However, in the future, we may not be able to detect infringement 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 paying us for it, 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 intellectual property litigation, especially regarding patent rights. We cannot be certain that our
products do not and will not infringe issued patents or other intellectual property rights of others. Historically, patent applications in the United States 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. From time to time, other parties may assert patent, copyright and other
intellectual property rights to technologies and in various jurisdictions that are important to our business. Any claims asserting that our products infringe or may infringe proprietary 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, result in costly litigation, 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.





An energy crisis in California may cause our operating results to
suffer.





California has encountered, and may again encounter, an energy crisis that could disrupt our
operations and increase our expenses. Suppliers of electric power have on some occasions implemented, and may in the future implement, rolling blackouts throughout California. We currently do not have backup generators or alternate sources of power
in the event of a blackout, and our current insurance does not provide coverage for any damages our customers or we may suffer as a result of any interruption in the power supply. If blackouts interrupt our power supply, we would be temporarily
unable to continue operations at our facilities in California. Any such interruption in our ability to continue operations at our facilities could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and
result in lost revenue.





Item 3.    Quantitative and Qualitative Disclosures About Market Risk





The primary objective of our investment activities is to preserve principal while at the same time maximizing the 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




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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. As of September 30, 2002, cash equivalents and short-term investments consist principally of investments in commercial paper, investment quality corporate and
municipal bonds, collateralized mortgage obligations, U.S. government agency securities and money market funds.





Item
4.    Controls and Procedures





(a) Evaluation of disclosure controls and procedures. Based
on their evaluation as of a date within 90 days of the date of the filing date of this quarterly report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as defined in
Rule 13a-14(c) under the Securities Exchange Act of 1934 (the Exchange Act), are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and Exchange Commissions rules and forms.





(b) Changes in internal controls. There were no significant changes in our internal controls or in other factors that could significantly affect these internal controls subsequent to the date of their evaluation.





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 March 28, 2001, we filed a motion for preliminary injunction against Catalyst. The Court denied this motion by order entered
June 13, 2001. We filed a notice of appeal to the 9th Circuit Court of Appeals on July 12, 2001, and we filed a motion to voluntarily withdraw the appeal on November 28, 2001. The appeal was dismissed by order dated December 4, 2001.





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.





On July 24, 2002,
Catalyst filed a motion for leave to file a motion for reconsideration of its motion for partial summary judgment, and CATC opposed this motion on July 26, 2002. The court denied Catalysts motion.





Trial commenced on October 28, 2002, and is expected to last for several weeks.





We cannot predict the outcome of this matter at this time.





Item 5.    Other Information





On September 3, 2002, we announced the
appointment of Carmine J. Napolitano as our Vice President, Chief Financial Officer, and Secretary and the appointment of Peretz Tzarnotzky as our Executive Vice President of Engineering. In connection with the hiring of Mr. Napolitano, we entered
into an employment agreement with him on July 22, 2002. The agreement provides for a starting annual salary of $230,000. The agreement also provides for an annual bonus for the achievement of certain objectives as defined by our Board of Directors.
Furthermore, Mr. Napolitano was granted options to purchase up to 350,000 shares of common stock pursuant to our 2000 Stock Incentive Plan at a per share price of $2.54. In the event of Mr. Napolitanos employment is involuntarily terminated
without cause after the first twelve months of his start date or his employment is terminated in




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connection with a change of control, he will be entitled to a lump sum severance payment equal to twelve months of his base salary plus acceleration of 50% of all unvested options previously
granted.





On August 2, 2002, we entered into an agreement with our former Executive Vice President, CFO and
Secretary, Dennis W. Evans, in connection with the termination of his employment. Under the terms of the agreement, we agreed that Mr. Evans employment with us would terminate on September 30, 2002 and that he would be paid six months
severance at his base salary then in effect with an option for up to an additional 6 months if he remains unemployed through September 30, 2003. Additionally, the vesting of all stock options previously granted to him was immediately accelerated
such that he is now fully vested in all of his options and his period to exercise those options was extended to September 30, 2004.





On August 28, 2002, we entered into an agreement (which was later amended on November 1, 2002) with Sri Chandran, in connection with the termination of his employment as Vice President of Engineering. Under the terms of the
amended agreement, we agreed that vesting of all stock options previously granted to him would be immediately accelerated such that he would be fully vested in all of his options.





Also on October 3, 2002, we announced that Jean-Louis Gassée, President, Chief Executive Officer and a member of our Board of Directors, had resigned from all
positions with our company and that Dan Wilnai, Chairman of the Board of Directors, had been appointed to act as our interim President and Chief Executive Officer, while maintaining his title as Chairman of the Board. In connection with his
resignation, on October 1, 2002, we entered into an agreement with Mr. Gassée to pay him nine months severance at his base salary then in effect. The nine months severance will be included in the Companys restructuring plan in the
fourth quarter of 2002.





Item 6.    Exhibits and Reports on Form 8-K





| | a. |  | Exhibits.
| | -- |  | ---------




Exhibit No.

Document Name3.1*

Amended and Restated Certificate of Incorporation of the Company.3.2*

Bylaws of the Company.4.1*

Specimen Certificate of the Companys common stock.


---

|* |  | 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. |  | Reports on Form 8-K
| | -- |  | -------------------




On September 3, 2002, we filed a Form 8-K to announce the appointment of Carmine J. Napolitano as our Vice President, Chief Financial Officer, and Secretary and the appointment of Peretz Tzarnotzky as our Executive Vice President of
Engineering. On October 3, 2002, we filed a Form 8-K to announce that Jean-Louis Gassée, President, Chief Executive Officer and a member of our Board of Directors, had resigned from all positions with our company and that Dan Wilnai, Chairman
of the Board of Directors, had been appointed to act as our interim Chief Executive Officer.




30




---

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    November 13, 2002



COMPUTER ACCESS TECHNOLOGY
CORPORATIONBy:

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




31




---

CERTIFICATION





I, Dan Wilnai, President, Chief Executive Officer, and Chairman of the Board of Directors of Computer Access Technology Corporation (the Company), certify that:





| | 1. |  | I have reviewed this quarterly report on Form 10-Q of the Company;
| | -- |  | ------------------------------------------------------------------




| | 2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | 3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | 4. |  | The Companys other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as such term is defined
in Exchange Act Rules 13a-14 and 15d-14 for the Company and we have:
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) |  | evaluated the effectiveness of the Companys disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly
report (Evaluation Date); and
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date.
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | 5. |  | The Companys other certifying officer and I have disclosed, based on our most recent evaluation, to the Companys auditors and the audit committee of
the Companys Board of Directors:
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the Companys ability to record, process,
summarize and report financial data and have identified for the Companys auditors any material weaknesses in internal controls; and
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the Companys internal controls; and
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------




| | 6. |  | The Companys other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Dated: November 13, 2002





/s/    DAN WILNAIDan Wilnai President, Chief
Executive Officer, and Chairman of the Board of Directors




32




---

CERTIFICATION





I, Carmine J. Napolitano, Vice President, Chief Financial Officer and Secretary of Computer Access Technology Corporation (the Company), certify that:





| | 1. |  | I have reviewed this quarterly report on Form 10-Q of the Company;
| | -- |  | ------------------------------------------------------------------




| | 2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | 3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | 4. |  | The Companys other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as such term is defined
in Exchange Act Rules 13a-14 and 15d-14 for the Company and we have:
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) |  | evaluated the effectiveness of the Companys disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly
report (Evaluation Date); and
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date.
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | 5. |  | The Companys other certifying officer and I have disclosed, based on our most recent evaluation, to the Companys auditors and the audit committee of
the Companys Board of Directors:
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the Companys ability to record, process,
summarize and report financial data and have identified for the Companys auditors any material weaknesses in internal controls; and
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the Companys internal controls; and
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------




| | 6. |  | The Companys other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Dated: November 13, 2002





/s/    CARMINE J.
NAPOLITANOCarmine J. Napolitano Vice
President, Chief Financial Officer and Secretary




33




---

CERTIFICATION





Each of the undersigned hereby certifies, for the purposes of section 1350 of chapter 63 of title 18 of the United States Code, in his capacity as an officer of the Company, that, to his knowledge, the
quarterly report of the Company on Form 10-Q for the period ended September 30, 2002, fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained in such report fairly presents, in
all material respects, the financial condition and results of operation of the Company.





Dated:    November 13, 2002





/s/    DAN WILNAIDan Wilnai President, Chief
Executive Officer, and Chairman of the Board of Directors





Dated:    November 13, 2002





/s/    CARMINE J. NAPOLITANOCarmine J. Napolitano Vice
President, Chief Financial Officer and Secretary




34