<PAGE>

================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    Form 10-K

[X]   Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
      Act of 1934 for the Fiscal Year Ended December 31, 2001

                  or

[_]   Transition Report Pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934

for the transition period from ___________ to ___________
                         Commission File Number 0-25996

                             TRANSWITCH CORPORATION
             (Exact name of Registrant as Specified in its Charter)

       Delaware                                         06-1236189
(State of Incorporation)                 (I.R.S. Employer Identification Number)

                             Three Enterprise Drive
                           Shelton, Connecticut 06484
          (Address of principal executive offices, including zip code)
                            Telephone (203) 929-8810

           Securities registered pursuant to Section 12(b) of the Act:
                                      None
           Securities registered pursuant to Section 12(g) of the Act:
                    Common Stock, par value $.001 per share,
                    outstanding at March 15, 2002: 89,949,758
          Series A Junior Participating Preferred Stock Purchase Rights
  4 1/2% Convertible Notes due 2005 outstanding at March 15, 2002: $114,113,000

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

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

      The aggregate market value of the voting common stock held by
non-affiliates of the Registrant, based upon the closing sale price of common
stock on March 15, 2002, as reported on the Nasdaq National Market, was
approximately $301.3 million. Shares of common stock held by each executive
officer and director and by each person who to the Company's knowledge owns 5%
or more of the outstanding voting common stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.

                       DOCUMENTS INCORPORATED BY REFERENCE

      Parts of the following document are incorporated by reference in Part III
of this Form 10-K Report:

      (1) Proxy Statement for Registrant's 2001 Annual Meeting of
Shareholders--Items 10, 11, 12 and 13.

================================================================================


                                        1

<PAGE>


Item 1. Business.

      The following description of our business should be read in conjunction
with the information included elsewhere in this document. The description
contains certain forward-looking statements that involve risks and
uncertainties. When used in this document, the word "intend", "believe",
"estimate", "plan", and "expect" and similar expressions as they relate to us
are included to identify forward-looking statements. Our actual results could
differ materially from the results discussed in the forward-looking statements
as a result of certain risk factors set forth elsewhere in this document. See
also, "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Certain Factors That May Affect Future Results."

General

      We are a Delaware corporation incorporated on April 26, 1988, that
designs, develops, markets and supports highly integrated digital and
mixed-signal (analog and digital) semiconductor system-on-a-chip solutions for
use in building emerging networks for telecommunications and data communications
applications. Our very large-scale integrated (VLSI) semiconductor devices
provide core functionality for communications network equipment. Our
programmable VLSI solutions can be tailored by network equipment manufacturers
to provide high levels of functionality for broadband communication networks and
to implement value-added features, thus differentiating our products from
competitive offerings. Our programmable VLSI solutions also accommodate new
customer application requirements and protocol changes throughout the networking
equipment life cycle. Our VLSI devices are compliant with
Asynchronous/Plesiochronous Digital Hierarchy (Asynchronous/PDH), Synchronous
Optical Network/Synchronous Digital Hierarchy (SONET/SDH) and Asynchronous
Transfer Mode/Internet Protocol (ATM/IP) standards. We also offer products that
combine multi-protocol capabilities on a single chip that can be programmed for
multi-service applications. Our mixed-signal and digital design capability, in
conjunction with our communications systems expertise, enables us to determine
and implement optimal combinations of design elements for enhanced
functionality. We believe that this approach permits our customers to achieve
faster time-to-market and to introduce systems that offer greater functionality,
improved performance, lower power dissipation, reduced system size and cost and
greater reliability relative to discrete solutions.

      Our principal customers are Original Equipment Manufacturers (OEMs) that
serve three market segments:

      o     the worldwide public network infrastructure that supports voice and
            data communications;

      o     the Internet infrastructure that supports the World Wide Web and
            other data services; and

      o     corporate Wide Area Networks (WANs) that support voice and data
            information exchange within medium-sized and large enterprises.

      We have sold our VLSI devices to more than 400 customers worldwide. We
sell our products through a worldwide direct sales force and a worldwide network
of independent distributors and sales representatives.

Products and Applications

      We supply high-speed, broadband VLSI semiconductor devices to network
systems OEMs that serve three market segments: the worldwide public network
infrastructure that supports both voice and data communications, the Internet
infrastructure that supports the World Wide Web and other data services and
corporate WANs. As a system-on-a-chip innovation leader, our core competencies
include:

      o     an in-depth understanding of SONET/SDH, Asynchronous/PDH and ATM/IP
            standards;

      o     the ability to design complex mixed-signal high-speed VLSI devices;
            and

      o     the capability to verify the design against our customers'
            requirements and industry standards through analysis, simulation,
            emulation, verification and certification.


                                       2

<PAGE>

      Our three product lines consist of (a) SONET/SDH, (b) Asynchronous/PDH and
(c) ATM/IP VLSI semiconductor devices. We believe that our chip-set approach and
broad product coverage in all three product lines position us as a "one-stop
source" for broadband communications VLSI products. Network equipment OEMs can
mix and match our VLSI devices to optimally configure their specific systems.
Our product lines can be combined to provide a cost-effective communication
systems solution with increased functional integration and features while
providing seamless integration of SONET/SDH, Asynchronous/PDH and ATM/IP for
broadband network applications. In 2001, the prices for our products typically
ranged from approximately $10 to $200 per device, depending on technology,
volume, complexity and functionality.

      During the last few years, we extended our product family to provide
seamless integration of Asynchronous/PDH, SONET/SDH and ATM/IP protocols on a
single chip. The mix and match of protocols in these products enables our
telecommunications and data communications OEMs to develop multi-service systems
for access and transport applications.

SONET/SDH Products

      In the SONET/SDH area, we offer devices that provide a direct interface
for fiber optic transmission in North America, Europe and Asia. Our mappers,
which bridge the interconnections between SONET/SDH equipment and asynchronous
equipment, allow DS-series and E-series transmission lines to be connected with
SONET/SDH lines. These mappers transparently transport Asynchronous/PDH signals
across the SONET/SDH network.

      Our current SONET/SDH products are used to build access equipment,
add/drop multiplexers, digital cross connects and other telecommunication and
data communications equipment. This equipment is configured for use in both
domestic and international fiber-based public networks. Our SONET/SDH products
have applications in Customer Premise Equipment (CPE), such as routers and hubs
and in central offices, adding integrated fiber optic transmission capability to
telephone switches.

Asynchronous/PDH Products

      Our Asynchronous/PDH products provide high-bandwidth connections and are
used to configure transmission equipment for use in the public network. This
equipment is used to increase the capacity of the copper-based public network.
Our Asynchronous/PDH VLSI products also enable CPE, such as hubs and routers
used in WANs and Local Area Networks (LANs), to access the public network for
voice and data communications with similar products in other locations.

      Our Asynchronous/PDH products provide high levels of integration, as well
as cost, power and performance benefits relative to discrete and competing
integrated circuit solutions. Our Asynchronous/PDH VLSI products include devices
that provide solutions for DS-0 through DS-3 and E-1 through E-3 transmission
lines. This product line includes line interfaces, multiplexers, which combine
multiple low-speed lines to form a higher speed line, as well as demultiplexers,
which perform the reverse function. In addition, we offer framers, which are
devices that identify the starting points of defined bit streams and enable
systems to recognize the remaining bits.

ATM/IP Products

      Our ATM/IP family of products targets the core elements of ATM/IP-based
multi-service access multiplexer systems. Our CellBus(R) is a system
architecture for implementing ATM/IP access multiplexers and ATM/IP switching
systems. The first two products incorporating our CellBus Technology were the
CUBIT and CUBIT-Pro VLSI devices. Our CellBus Technology provides single-chip
ATM/IP switching capability in access equipment. These products have been
designed into many network system OEMs' solutions since late 1995, establishing
CellBus as a significant technology in the global broadband network access
market. Our ATM/IP products also include VLSI semiconductor devices for line
interfacing and service adaptation functions.

Technology

      We believe that one of our core competencies is our personnels' knowledge
of the telecommunications and data communications landscape. Specifically, our
systems engineering personnel group possess substantial


                                       3

<PAGE>

telecommunications and data communications design experience, as well as
extensive knowledge of these relevant standards. This includes not only a
thorough understanding of the actual written standards, but also an awareness of
and appreciation for the nuances associated with these standards necessary for
assuring that device designs are fully compliant. To date, we have been very
successful in delivering VLSI devices that are standards compliant as we have
insignificant warranty claims.

      Complementing our communications industry expertise is our VLSI design
competence. Our VLSI design personnel have extensive experience in designing
high-speed digital and mixed-signal devices for communications applications.
These designs require a sophisticated understanding of complex technology, as
well as the specifics of the deep submicron manufacturing processes and their
resulting impact on device performance. We have developed a large number of VLSI
blocks and intellectual property (IP) cores that operate under the demanding
requirements of the telecommunications and data communications industries. These
blocks and IP cores have been designed using standard VLSI-oriented programming
languages such as Visic Hardware Descriptive Language (VHDL) and Verilog and
verified with standard verification tools.

      We have developed proprietary tool sets, called "Test Benches", that
facilitate on-time development of VLSI products and help assure that our
products meet customer and standards requirements. These Test Benches consist of
behavioral models of all applicable functions in a high level design environment
and also include test signal generators and analyzers such as models of
SONET/SDH signals. Systems engineers use Test Benches to test new architectural
concepts, while VLSI designers use Test Benches to ensure that the device
conforms to product specifications.

      We have invested significant resources in developing a multi-million gate
system-on-a-chip architecture, with a high level of software functionality for
our programmable products. Besides our ASPEN family, we have our PHAST
(Programmable High Performance ATM/PPP (Point-to-Point Protocol)/TDM (Time
Division Multiplexing) SONET/SDH Terminator) series of products that target
simultaneous mapping and transport of ATM/PPP and TDM services over fiber optic
networks. In addition, we have introduced the first product in a family of
devices to provide complete channeled services for Access Networks. The T3BwP
VLSI device supports both data and management planes with an on-chip Reduced
Instruction Set Computing (RISC) processor supporting full standards based
management and performance monitoring.

      We have enhanced our internal chip layout through the acquisition of
experienced personnel through standard hiring practices and enhanced our design
for test capability through the acquisition of Horizon Semiconductors, Inc.,
both of which have resulted in significant improvements in silicon efficiency
and time-to-market. Our system-on-a-chip definition, architecture, verification
expertise and design methodology ensure that hardware and software architectural
trade-offs yield desired performance from our VLSI solutions. The
system-on-a-chip performance, simulation, emulation, verification and stress
testing, using Test Benches and test equipment, provides customers with wire
speed services.

Marketing and Sales

      Our marketing strategy focuses on key customer relationships to promote
early adoption of our VLSI devices in the products of market-leading
communications equipment OEMs. Through our customer sponsorship program, OEMs
collaborate on product specifications and applications while participating in
product testing in parallel with our own certification process. This approach
accelerates our customers' time-to-market delivery while enabling us to achieve
early design wins for our products and derive non-recurring engineering expense
support and volume forecasts for specific products from these sponsors.

      Our sales strategy focuses on worldwide suppliers of high-speed
communications and communications-oriented equipment. These customers include
telecommunications, data communications, Internet, customer premise, computing,
process control and defense equipment vendors. In addition, we target emerging
technology leaders in the communications equipment market that are developing
next generation solutions for the telecommunications and data communications
markets. We identify and address sales opportunities through our worldwide
direct sales force and our worldwide network of independent distributors and
sales representatives.

      Our worldwide direct sales force, technical support personnel and key
engineers work together in teams to support our customers. We have technical
support capabilities located in key geographical locations throughout the world
as well as a technical support team at our headquarters as a backup to the field
applications engineers.

      We have established foreign distributors and sales representative
relationships in Australia, Benelux, Brazil, Canada, China, France, Germany,
Great Britain, Israel, Italy, Japan, Korea, Spain, Sweden, Switzerland and
Taiwan. We also sell our products through domestic distributors and a network of
domestic sales representatives. We have


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<PAGE>

regional sales and technical support capabilities in Boston, Massachusetts;
Chicago, Illinois; San Jose, California; Morristown, New Jersey; Raleigh/Durham,
North Carolina; Dallas, Texas; Ottawa, Ontario; Stockholm, Sweden; Paris,
France; Rome, Italy; Berkshire, England; Hilversum, Netherlands; Brussels,
Belgium; Tel Aviv, Israel; New Delhi, India; Singapore, Singapore; and Taipei,
Taiwan, as well as at our headquarters facility in Shelton, Connecticut.

Customers

      We have sold our products and services to over 400 customers since
shipping our first product in 1990. Our customers include public network systems
OEMs that incorporate our products into telecommunications systems, WAN and LAN
equipment OEMs, Internet-oriented OEMs, communications test and performance
measurement equipment OEMs and government, university and private laboratories
that use our products in advanced public network and WAN and LAN developments.

      Foreign net revenues, consisting primarily of shipments to customers in
Europe and Asia, constituted 69%, 46% and 32% of net revenues in the years 2001,
2000 and 1999, respectively. Refer also to note 6 of our financial statements of
our consolidated financial statements for additional detail about geographic
sales.

      We sell our products through a worldwide direct sales force and through a
worldwide network of distributors and sales representatives. The following
tables set forth the percentage of net revenues attributable to all of our major
distributors as well as the significant customers that had total purchases
(either direct or through distributors) of greater than 10% of net revenues for
the three years ended December 31, 2001:

<TABLE>
<CAPTION>
                                                                                       Years ended December 31,
                                                                                   2001           2000         1999
                                                                              -------------------------------------------
<S>                                                                                 <C>            <C>          <C>
Distributors:
      Insight Electronics, Inc.(1)............................................      24%            32%          33%
      Weone Corporation(2)....................................................      10%             *            *
      Unique Memec(3).........................................................      10%            16%           *
      Arrow Electronics, Inc.(4)..............................................       *              *           18%

Significant Customers:
      Siemens AG(3)...........................................................      21%             *            *
      Redback Networks, Inc.(1)...............................................      12%             *            *
      Samsung Corporation(2)..................................................      11%             *            *
      Lucent Technologies, Inc.(1)(5).........................................      11%            11%          16%
      Tellabs, Inc.(1)(4).....................................................       *             16%          13%
      Nortel Networks Corporation(1)(4).......................................       *              *           13%
</TABLE>

(1)   The end customers of the shipments to Insight Electronics, Inc. include
      Redback Networks, Inc. in 2001, Lucent Technologies, Inc. in 2001, 2000
      and 1999, a portion of Tellabs, Inc. purchases in 2000 and a portion of
      Nortel Networks Corporation's purchases in 1999.

(2)   The primary end customer of the shipments to Weone Corporation was Samsung
      Corporation in 2001.

(3)   A portion of the shipments to Siemens AG were distributed through Unique
      Memec.

(4)   The end customers of the shipments to Arrow Electronics, Inc. include
      Tellabs, Inc. in 1999 and 2000 as well as Nortel Networks Corporation in
      1999.

(5)   Shipments to Lucent Technologies, Inc. also includes those made to Ascend
      Communications, which was acquired by Lucent Technologies, Inc. during
      1999.

*     Revenues were less than 10% of our net revenues in these years.

      A limited number of customers have accounted for a substantial portion of
our net revenues. Shipments in 2001, 2000 and 1999 to our top five customers,
including sales to distributors, accounted for approximately 64%, 66% and 72%
respectively, of our net revenues. We expect that a limited number of customers
may account for a substantial portion of the net revenues for the foreseeable
future.


                                       5

<PAGE>

Research and Development

      We believe that the continued introduction of new products in our target
markets is essential to our growth. As of December 31, 2001, we had 291
full-time employees engaged in research and development efforts. We have added
98 employees to our research and development staff since December 31, 2000. We
employ designers who have the necessary engineering and systems qualifications
and are experienced in software, mixed-signal, high-speed digital,
telecommunications and data communications technologies. See Item 2
"Properties," for a listing of our design centers that are engaged in product
development.

      Research and development expenditures for the years 2001, 2000 and 1999
were $49.3 million, $24.2 million, and $14.5 million, respectively. In 2001 and
2000, we also expensed $22.0 and $2.8 million of purchased in-process research
and development related to the acquisitions of Opal Acquisition Corporation
(formerly known as Onex Communications Corporation) (Onex) and TranSwitch
Silicon Valley, Inc. (formerly known as Alacrity Communications, Inc.)
(Alacrity), respectively.

      All development efforts are carried out using ISO 9001 certified design
processes and the design tools and environment are continuously updated to
improve design, fabrication and verification of products. From time to time, we
subcontract design services and acquire products from third parties to enhance
our product lines. Our internal research and development organization thoroughly
reviews the external development processes and the design of these products as
part of its quality assurance process.

Patents and Licenses

      We have ninety patents issued and eighty-eight patent applications pending
worldwide. Of the ninety issued patents, one is co-owned by ECI Telecom Ltd. and
one is co-owned by Siemens Telecommunications Systems Ltd. We have thirty-seven
patents issued and nineteen patent applications pending in the United States. We
have nine patents issued and nineteen patent applications pending in Canada. We
have seven patents issued in Taiwan, with one patent being co-owned by Siemens
Telecommunications Systems Ltd. We have four patents issued and twelve patents
pending in the People's Republic of China and one patent pending in Hong Kong.
We have five, two, five, four, three, two, one and one patents issued in the
United Kingdom, Belgium, France, Germany, Italy, Sweden, Spain and Ireland,
respectively. We also have two, seventeen and six patent applications pending in
the United Kingdom, in selected countries in the European Patent Office (EPO)
and under the Patent Cooperation Treaty (PCT). In addition, we have two patents
issued and nine patent applications pending in Japan and eight patents issued
and four patents pending in Israel. None of our domestic or foreign patents that
have been issued will expire in the near future unless we choose not to pay
renewal fees. Our oldest patent is not scheduled to expire for over six years.

      We cannot guarantee that our patents will not be challenged or
circumvented by our competitors, and we cannot be sure that pending patent
applications will ultimately be issued as patents. Under current law, patent
applications in the United States filed before November 29, 2000 are maintained
in secrecy until they are issued but applications filed after November 29, 2000
(and foreign applications) are generally published 18 months after their
priority date, which is generally the filing date. The right to a patent in the
United States is attributable to the first to invent, while in most
jurisdictions the right to a patent is obtained by the first to file the patent
application. We cannot be sure that our products or technologies do not infringe
patents that may be granted in the future based upon currently pending
non-published patent applications or that our products do not infringe any
patents or proprietary rights of third parties. From time to time, we receive
communications from third parties alleging patent infringement. If any relevant
claims of third-party patents are upheld as valid and enforceable, we could be
prevented from selling our products or could be required to obtain licenses from
the owners of such patents or be required to redesign our products to avoid
infringement. We cannot be assured that such licenses would be available or, if
available, would be on terms acceptable to us or that we would be successful in
any attempts to redesign our products or processes to avoid infringement. Our
failure to obtain these licenses or to redesign our products would have a
material adverse effect on our business.


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<PAGE>

      We also have been granted registration of 14 trade or service marks in the
United States, and we have twelve more U.S. applications for trademarks awaiting
approval. We have also obtained four trademark registrations under the European
Community Trademark (ECT) procedure with three awaiting approvals for the ECT as
well as Canada.

      Our ability to compete depends upon our ability to protect our proprietary
information through various means, including ownership of patents, copyrights,
mask work registrations and trademarks. While no intellectual property right of
ours has been invalidated or declared unenforceable, we cannot assure that such
rights will be upheld in the future. We believe that, in view of the rapid pace
of technological change in the communication semiconductor industry, the
technical experience and creative skills of our engineers and other personnel
are the most important factors in determining our future technological success.

      We have entered into various license agreements for product or technology
exchange. The purpose of these licenses has, in general, been to obtain second
sources for standard products or to convey or receive rights to certain
proprietary or patented cores, cells or other technology.

      We sell our products into the telecommunications and data communications
industries, in which products are subject to various standards that are agreed
upon by recognized industry standards committees. Where applicable, we design
our products to be in conformity with these standards. We have received and
expect to continue to receive, in the normal course of business, communications
from third parties stating that if certain of our products meet a particular
standard, these products may infringe one or more patents of that third party.
We will review the circumstances of each communication, and, in our discretion
and upon the advice of legal counsel, have taken or may take in the future one
of the following courses of action: we may negotiate payment for a license under
the patent or patents that may be infringed, we may use our technology and/or
patents to negotiate a cross-license with the third party or we may decline to
obtain a license on the basis that we do not infringe the claimant's patent or
patents, or that such patents are not valid, or other bases. We cannot assure
that licenses for any of these patents will be available to us on reasonable
terms or that we would prevail in any litigation seeking damages or expenses
from us or to enjoin us from selling our products on the basis of any of the
alleged infringements.

Manufacturing and Quality

      Our manufacturing objective is to produce reliable, high-quality devices
cost-competitively. To this end, we seek to differentiate ourselves by:

      o     maximizing the reliability and quality of our products;

      o     achieving on-time delivery of our products to our customers;

      o     minimizing capital and other resource requirements by subcontracting
            capital-intensive manufacturing; and

      o     achieving a gross margin commensurate with the value of our
            products.

      Established independent foundries manufacture all of our VLSI devices.
This approach permits us to focus on our design strengths, minimize fixed costs
and capital expenditures and access diverse manufacturing technologies.
Currently, we utilize seven foundries to process our wafers of which four are
governed by foundry agreements: Texas Instruments Incorporated (TI), LSI Logic
Corporation (LSI), IBM Microelectronics (a division of IBM) and Taiwan
Semiconductor Manufacturing Company Limited (TSMC). Foundries are required to
have qualified and reliable processes. The selection of a foundry for a specific
device is based on availability of the required process technology and the
foundry's capability to support the particular set of tools used by us for that
device. Currently, TI manufactures all of our Bipolar Complementary Metal Oxide
Semiconductor (BiCMOS) devices. We have no agreements with any other foundries.

      Various independent subcontractors and foundry suppliers perform assembly
and testing functions. Additionally, certain testing and inspection functions
are performed at our facility in Shelton, Connecticut.

      TUV Rheinland of North America, Inc. registers us as complying with the
requirements of ISO 9001.


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<PAGE>

Acquisitions

      While some of the next generation products we introduce are based on
technologies that we develop ourselves, we have filled some of our technology
gaps through acquisitions. The following is a table that summarizes technology
and skills we obtained through acquisitions of stand-alone companies during the
three years ended December 31, 2001.

<TABLE>
<CAPTION>
              Acquired Company                      Date Acquired                     Technology / Skill Acquired
---------------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>                 <C>
Easics NV                                             May 2000         Design methodology/design resources

TranSwitch Silicon Valley, Inc.                      August 2000       ATM  Switching, design resources, Astrix and Sertopia
   (formerly known as Alacrity                                         products
   Communications, Inc.)

ADV Engineering S.A.                                January 2001       Telecom VLSI design/software resources

Horizon Semiconductors, Inc.                        February 2001      Built-in self-test technology/CAD resources

Opal Acquisition Corporation                       September 2001      Multi-protocol, high-speed switching products/design
   (formerly known as Onex                                             resources
   Communication Corporation)
</TABLE>

Investments in Non-Publicly Traded Companies

      We will, from time-to-time, make investments of less than 20% in early
stage venture-backed, start-up companies that develop technologies that are
complementary to our product roadmap. The following is a table that summarizes
the investments we have made and their related technologies during the three
years ended December 31, 2001.

<TABLE>
<CAPTION>
                                            Initial
                                           Investment
       Investee Company                       Date                                 Technology
------------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>                 <C>
OptiX Networks, Inc.                      February 2000       10 Gb/s and 40 Gb/s SONET/SDH framing devices

Intellectual Capital for                  December 2000       Next generation wireless base station VLSI devices
   Integrated Circuits, Inc.

Systems On Silicon, Inc.                   January 2001       Integrated access products with voice over packet capability

TeraOp (USA), Inc.                           May 2001         Optical switching devices based on MEMS technology

Accordion Networks, Inc.                  December 2001       Carrier class broadband multi-service access systems
</TABLE>

      A summary of each of these businesses including their locations and our
ownership percentage follows. We are including our direct ownership, which is
comprised of TranSwitch, and indirect ownership which is comprised of employees
and directors of TranSwitch or held by GTV Capital, L.P., an limited partnership
in which we have an investment.

      Systems On Silicon, Inc. (SOSi) is a Delaware corporation with offices in
      Monmouth Junction, New Jersey. The company is developing highly integrated
      VLSI solutions leveraging its proprietary Voice over Packet technology
      into highly integrated, systems level solutions that address the
      requirements of converged networks with an initial focus on the
      intelligent integrated access device. TranSwitch Corporation owns directly
      and indirectly an aggregate of 10.2% of the outstanding shares of Systems
      On Silicon, Inc.

      OptiX Networks, Inc. is a Delaware corporation with offices in Weston,
      Massachusetts and a research and development center in Kfar Saba, Israel.
      OptiX Networks is developing VLSI devices in advanced technologies for the
      broadband optical backbone, interoffice and metro area communications.
      Initial products will focus on 10 Gb/s and 40 Gb/s SONET/SDH framing.
      TranSwitch Corporation directly and indirectly owns an aggregate of 19.0%
      of the outstanding shares of OptiX Networks, Inc.


                                       8

<PAGE>

      TeraOp (USA), Inc. is a Delaware corporation with a research and
      development center in Magshimim, Israel. TeraOp designs Micro Electro
      Mechanical Systems (MEMS) based optical crossbars for next generation
      core, metro, storage switches and routers. TranSwitch Corporation directly
      and indirectly owns an aggregate of 12.1% of the outstanding shares of
      TeraOp (USA), Inc.

      Accordion Networks, Inc. is a California corporation with offices in
      Milpitas, California. Accordion designs and supplies broadband services
      platforms designed to allow service providers to remotely activate,
      personalize and manage bandwidth-intensive applications. Accordion's
      target market is metro area telecommunications and data communications
      providers. TranSwitch Corporation directly and indirectly owns an
      aggregate of 9.5% of the outstanding shares of Accordion Networks, Inc.

      Intellectual Capital for Integrated Circuits, Inc. (IC4IC) is a Delaware
      corporation with offices in Yokneam Illit, Israel. IC4IC specializes in
      the designing, developing and marketing of VLSI solutions serving the
      wireless Internet market segment for multi-access platform. TranSwitch
      Corporation directly and indirectly owns an aggregate of 17.8% of the
      outstanding shares of IC4IC.

      We do not have any obligation to participate in future rounds of financing
of the above companies although we do have a right of first refusal to purchase
additional securities offered by the above companies. We do not have any
commitments to acquire or merge with any of the companies that we have
investments in. Additionally, we do not have a right of first refusal to acquire
these companies. Our rights are consistent with the rights of all shareholders
in the class of stock that we have purchased.

      In fiscal 2001, we also invested in GTV Capital, L.P., which is a
partnership in the business of making, supervising and disposing of capital
investments in equity or equity-related securities in companies engaged in
high-technology industries. The partnership focuses on seed and early-stage
investments in communication infrastructure technology companies including
wireless and optical systems technology, storage and related semiconductor
technology, and media convergence technology. We have a 48% ownership interest
in this partnership and we account for it under the equity method.

Competition

      The communication semiconductor industry is intensely competitive and is
characterized by the following:

      o     rapid technological change in design tools, wafer-manufacturing
            technologies, process tools and alternate networking technologies;

      o     availability of fabrication capacity;

      o     price erosion;

      o     unforeseen manufacturing yield problems; and

      o     heightened international competition in many markets.

      The telecommunications and data communications industries, which are our
primary target markets, are also intensely competitive due to deregulation and
heightened international competition.

      Our competition consists of specialized semiconductor companies from the
United States as well as other countries and semiconductor divisions of
vertically integrated companies, such as IBM Corporation, Lucent Technologies,
Inc., NEC Corporation and Siemens Corporation. New entrants are also likely to
attempt to obtain a share of the market for our current and future products.

      Our principal competitors in the Asynchronous/PDH and SONET/SDH areas are
Applied Micro Circuits Corporation, Conexant Systems, Inc., Cirrus Logic, Inc.,
Maxim Integrated Products Inc., Infineon Technologies, Exar Corporation, Agere
Systems, PMC-Sierra Inc., Texas Instruments, Inc., TriQuint Semiconductor, Inc.,
Vitesse Semiconductor Corporation and Broadcom Corporation. In addition, there
are a number of ASIC vendors, including AMI Semiconductor, LSI Logic Corp. and
STM Microelectronics Group, that compete with us by supplying customer-specific
products to OEMs. In the ATM market, the principal competitors include all the
vendors


                                       9

<PAGE>

mentioned above and, in addition, Advanced Micro Devices, Inc. and Intel
Corporation. Numerous other domestic and international vendors have announced
plans to enter into this market.

      We believe that the principal bases of competition include:

      o     product functionality;

      o     product definition;

      o     product design;

      o     test capabilities;

      o     reliability/quality;

      o     technical support;

      o     price;

      o     time-to-market;

      o     reputation for quality; and

      o     financial stability.

      We believe that we compete favorably with respect to these factors. We
also believe that our competitive strengths include the distribution channels we
have established, our workforce of highly experienced digital and mixed-signal
circuit designers with strong system architecture skills, and our proprietary
design and development tools, including our proprietary simulation and testing
software, our library of analog and digital blocks and cells and our high
quality worldwide technical support.

Backlog

      As of December 31, 2001, our backlog was $4.0 million, as compared to
$66.5 million as of December 31, 2000. Backlog represents firm orders
anticipated to be shipped within the next 12 months. Our business and, to a
large extent, that of the entire communication semiconductor industry, is
characterized by short-term order and shipment schedules. Since orders
constituting our current backlog are subject to changes in delivery schedules or
to cancellation at the option of the purchaser without significant penalty,
backlog is not necessarily an indication of future revenue. During 2001, many of
our customers experienced decreased demand, order cancellations or postponements
and had accumulated significant inventories of our products.


                                       10

<PAGE>

Item 2. Properties.

      Our headquarters are located in a suburban office park in Shelton,
Connecticut. We have additional sales offices and design centers located
throughout the world. The following is a summary of our offices and locations
for which we have lease commitments of greater than one year:

<TABLE>
<CAPTION>
              Location                                Business Use                 Square Footage  Lease Expiration Dates
--------------------------------------------------------------------------------------------------------------------------
<S>                             <C>                                                   <C>             <C>
Shelton, Connecticut(1)         Corporation Headquarters, Product                     181,711          October 2007 -
                                    Development, Operations, Sales,                                      April 2117
                                    Marketing and Administration
Raleigh, North Carolina         Product Development                                     6,604           October 2005
Stoneham, Massachusetts(2)      Product Development and Sales Support                   8,924          September 2005
Bedford, Massachusetts          Product Development                                    17,907          September 2003
Milpitas, California            Product Development, Sales and Sales Support            8,800            July 2003
Taipei, Taiwan                  Sales Support                                           2,500         Less then 1 Year
New Delhi, India                Product Development                                    14,000         Less then 1 Year
Eclubens, Switzerland           Product Development                                     2,640         Less then 1 Year
Leuven, Belgium                 Product Development, Sales and Sales Support            7,400         Less then 1 Year
Toulouse, France                Product Development                                     4,200         Less then 1 Year
</TABLE>

      Notes

      Refer to note 13 of our consolidated financial statements for additional
      disclosures regarding our commitments under lease obligations. Also, refer
      to note 11 of our consolidated financial statements regarding our
      restructuring charges during fiscal 2001 as we have recorded charges
      during the year for future rent payments relating to excess office space.

      (1) Of the space being leased in Shelton, Connecticut, approximately
      114,000 feet is considered excess for which we have taken a restructuring
      charge for in 2001. A portion of this space is currently being sublet.

      (2) We have exited the facility in Stoneham, Massachusetts effective
      December 31, 2001 and have transitioned the staff and business functions
      to our Bedford, Massachusetts facility.

Item 3. Legal Proceedings

      We are not party to any material litigation proceedings.

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

      We did not submit any matters to a vote of our security-holders during the
three months ended December 31, 2001.


                                       11

<PAGE>

                                     PART II

Item 5. Market for Registrants' Common Equity and Related Stockholder Matters

      Our common stock is traded on the Nasdaq National Market under the symbol
"TXCC". The following table sets forth, for the periods indicated, the range of
high and low closing prices for our common stock on the Nasdaq National Market.
The prices set forth below reflect a 3-for-2 stock split in the form of a
dividend effected on June 8, 1999, a 3-for-2 stock split in the form of a
dividend effected on January 11, 2000, and 2-for-1 stock split in the form of a
dividend effected on August 10, 2000.

                                                              High          Low
                                                              ----          ---
Year Ended December 31, 2000:
      First Quarter.....................................     $67.25       $19.21
      Second Quarter....................................     $48.75       $22.56
      Third Quarter.....................................     $67.86       $33.19
      Fourth Quarter....................................     $74.69       $24.50

Year Ended December 31, 2001:
      First Quarter.....................................     $55.75       $12.00
      Second Quarter....................................     $20.35        $6.69
      Third Quarter.....................................     $10.75        $2.80
      Fourth Quarter....................................      $6.38        $2.15

      As of March 15, 2002 there were approximately 557 holders of record and
approximately 41,000 beneficial shareholders of our common stock.

      We have never paid cash dividends on our common stock. We currently intend
to retain earnings for use in our business and do not anticipate paying any cash
dividend in the foreseeable future. Any future declaration and payment of
dividends will be subject to the discretion of our Board of Directors, will be
subject to applicable law and will depend upon our results of operations,
earnings, financial condition, contractual limitations, cash requirements,
future prospects and any other factors deemed relevant by our Board of
Directors.


                                       12

<PAGE>

Item 6. Selected Financial Data

      The following selected consolidated financial data should be read in
conjunction with the consolidated financial statements and related notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing in Item 7 of this Form 10-K. The selected statement of
operations data as well as the selected balance sheet data presented below are
derived from our consolidated financial statements, which have been audited by
KPMG LLP, our independent auditors, and together with their report thereon are
included in Item 8 of this Form 10-K. Historical periods have been restated to
reflect the share-for-share exchange accounted for as a pooling of interests
with Easics NV in May 2000.

<TABLE>
<CAPTION>
Amounts presented in thousands, except per share data                         Years ended December 31,
                                                                --------------------------------------------------
                                                                  2001        2000       1999      1998      1997
                                                                --------    --------   -------   -------   -------
<S>                                                             <C>         <C>        <C>       <C>       <C>
Selected Statement of Operations Data:
Net revenues ................................................   $ 58,682    $155,083   $73,533   $45,993   $28,802
Gross (loss) profit .........................................     (1,799)    108,936    48,323    28,719    17,000
Income (loss) before extraordinary gain .....................    (99,557)     38,355    25,334     6,157    (1,722)
Extraordinary gain from repurchase of 4 1/2% convertible
  notes due 2005, net of income taxes of $13,214 ............     22,093          --        --        --        --
                                                                --------------------------------------------------
Net income (loss)(1) ........................................   $(77,464)   $ 38,355   $25,334   $ 6,157   $(1,722)
                                                                ==================================================
Basic earnings (loss) per share before extraordinary gain
  (1)(2)(3)(4) ..............................................   $  (1.14)   $    .47   $   .33   $   .10   $  (.03)
Basic earnings (loss) per share(1)(2)(4) ....................   $   (.89)   $    .47   $   .33   $   .10   $  (.03)
Diluted earnings (loss) per share(1)(2)(3)(4) ...............   $   (.89)   $    .44   $   .31   $   .09   $  (.03)
Shares used in calculation of basic earnings (loss) per
  Share(2)(4) ...............................................     86,904      81,681    76,676    63,174    55,190
Shares used in calculation of diluted earnings (loss) per
  Share(2)(3)(4) ............................................     86,904      87,559    81,596    67,482    55,190
</TABLE>

<TABLE>
<CAPTION>
                                                                            December 31,
                                                        --------------------------------------------------
                                                          2001       2000       1999       1998      1997
                                                        --------   --------   --------   -------   -------
<S>                                                     <C>        <C>        <C>        <C>       <C>
Selected Balance Sheet Data:
Cash, cash equivalents and short-term investments ...   $409,592   $564,124   $ 75,802   $27,903   $22,169
Working capital .....................................   $402,007   $592,934   $ 92,439   $34,286   $26,313
Long-term investments ...............................   $ 26,582   $ 54,183   $ 36,003        --        --
Total assets ........................................   $618,711   $741,630   $162,067   $50,175   $38,125
4 1/2% Convertible Notes due 2005 ...................   $314,050   $460,000         --        --        --
Total stockholders' equity ..........................   $252,440   $257,739   $152,138   $41,255   $30,584
</TABLE>

(1)   Net loss for fiscal 2001 includes one-time charges for excess inventories
      of $39.2 million, restructuring of $32.5 million and asset impairments of
      $1.7 million. In fiscal 2001, we recorded a valuation allowance on certain
      deferred tax credit carryforwards from which we expect to no longer
      realize a future tax benefit. This resulted in a deferred tax expense for
      the year ended December 31, 2001 of $3.2 million. In fiscal 1999, we
      reversed a valuation allowance for deferred tax assets, which contributed
      to the recognition of a tax benefit of $2.8 million for the year ended
      December 31, 1999.

(2)   Revised to reflect a 3-for-2 stock split in the form of a dividend on June
      8, 1999, a 3-for-2 stock split in the form of a dividend on January 11,
      2000 and a 2-for-1 stock split in the form of a dividend on August 10,
      2000.

(3)   For purposes of calculating diluted earnings (loss) per share in 2000 and
      2001, the assumed conversion of 4 1/2% Convertible Notes due 2005 is not
      taken into consideration as it is anti-dilutive.

(4)   Diluted loss per share amounts for the years ended December 31, 2001 and
      1997 are the same as basic. Because we recorded a net loss in each of
      these years, the assumed exercise of dilutive securities would be
      anti-dilutive.


                                       13

<PAGE>

Computation of Ratio of Earnings to Fixed Charges:

<TABLE>
<CAPTION>
                                                                                   Years ended December 31,
                                                                     ---------------------------------------------------
Amounts presented in thousands                                          2001        2000      1999     1998       1997
                                                                     ---------    -------   -------   ------    -------
<S>                                                                  <C>          <C>       <C>       <C>       <C>
Earnings:
   Income (loss) before income taxes and extraordinary gain(1) ...   ($138,407)   $62,738   $22,522   $6,544    $(1,621)
Add:
   Fixed charges as described below ..............................      23,994      8,988       380      395        439
                                                                     ---------------------------------------------------
                                                                     ($114,413)   $71,726   $22,902   $6,939    $(1,182)
                                                                     ===================================================

Ratio of earnings to fixed charges ...............................        (4.8)       8.0      60.3     17.6       (2.7)
                                                                     ===================================================

Fixed charges:
   Interest expense ..............................................   $  20,613    $ 7,472   $    35   $  143    $   208
   Amortization of costs related to indebtedness .................   $   2,647    $ 1,088        --       --         --
   Estimated interest factor in rent expense(2) ..................         734        428       345      252        231
                                                                     ---------------------------------------------------
                                                                     $  23,994    $ 8,988   $   380   $  395    $   439
                                                                     ===================================================
</TABLE>

(1)   The deficiency in earnings to fixed charges is $162.4 million for the year
      ended December 31, 2001 and $2.1 million for the year ended December 31,
      1997.

(2)   The interest factor in rent expense is estimated as one-third of rental
      expense.


                                       14

<PAGE>

Item 7. Management's Discussion and Analysis of Financial Condition and Results
        of Operations.

      The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements that involve risks
and uncertainties. When used in this report, the words, "intend", "anticipate",
"believe", "estimate", "plan" and "expect" and similar expressions as they
relate to us are included to identify forward-looking statements. Our actual
results could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including those set forth under
"Certain Factors That May Affect Future Results" and elsewhere in this report.
You should read this discussion in conjunction with the consolidated financial
statements and the notes thereto included in this report.

Significant Accounting Policies and Use of Estimates

      Our financial statements and related disclosures, which are prepared to
conform with accounting principles generally accepted in the United States of
America, require us to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses during the period
reported. We are also required to disclose amounts of contingent assets and
liabilities at the date of the financial statements. Our actual results in
future periods could differ from those estimates. Estimates and assumptions are
reviewed periodically, and the effects of revisions are reflected in the
consolidated financial statements in the period they are determined to be
necessary.

      We consider the most significant estimates in our consolidated financial
statements to be those surrounding: (1) revenues, cost of revenues and gross
profit; (2) reserves for excess inventories; (3) valuation of deferred tax
assets; (4) valuation and impairment of goodwill, other intangibles and
long-lived assets; and (5) estimated restructuring reserves. The accounting
policies, basis for these estimates and potential impact to our consolidated
financial statements, should any of these estimates change, are further
described as follows:

Revenues, Cost of Revenues and Gross Profit. Net revenues are comprised of
product shipments, principally to domestic and international telecommunications
and data communications OEMs and to distributors. Net revenues from product
sales are recognized at the time of product shipment when the following criteria
are met: (1) title and risk of loss transfers to the customer; (2) the selling
price is fixed or determinable; and (3) collectibility is reasonably assured.
Agreements with certain distributors provide price protection and return and
allowance rights. With respect to revenues to our distributors the: (1) prices
are fixed at the date of shipment from our facilities; (2) payment is not
contractually or otherwise excused until the product is resold; (3) we do not
have any obligations for future performance relating to the resale of the
product; and (4) the amount of future returns, allowances, refunds and costs to
be incurred can be reasonably estimated and are accrued at the time of shipment.

      At the time of shipment, we record a liability against our gross revenues
for price protection, sales allowances and potential returns. This liability is
established based on historical experience, contractually agreed to provisions
and future shipment forecasts. As of December 31, 2001, we had established
liabilities totaling $2.3 million for future returns, price protection and
allowances related to sales which were recorded during fiscal 2001. Should our
actual experience differ from our estimated liabilities, there could be
adjustments (either favorable or unfavorable) to our net revenues, cost of sales
and gross margins.

      We warranty our products for up to one year from the date of shipment. A
liability is recorded for estimated claims to be incurred under product
warranties and is based primarily on historical experience. Estimated warranty
expense is recorded as cost of revenues when products are shipped. As of
December 31, 2001, we had a warranty liability established in the amount of $0.2
million, which is included in accrued expenses on the consolidated balance
sheet. Should future warranty claims differ from our estimated current
liability, there could be adjustments (either favorable or unfavorable) to our
cost of sales. Any adjustments to cost of sales could also impact future gross
margins.

Reserves for Excess Inventories. We periodically review our inventory levels to
determine if inventory is stated at the lower of cost or our net realizable
value. Due to the severe downturn in the telecommunications and data
communications industry, we evaluated our inventory position based on known
backlog of orders, projected sales and marketing forecasts, shipment activity
and inventory held at our significant distributors. As a result of current


                                       15

<PAGE>

and anticipated business conditions, as well as lower than anticipated demand,
we recorded a provision for excess inventories during the year ended December
31, 2001 of approximately $39.2 million. We currently do not anticipate the
excess inventories subject to this provision will be used at a later date based
upon our current demand forecast. Should our future demand exceed the estimates
that we used in reserving for excess inventories, then we will recognize a
favorable impact to cost of sales and gross margin. Should demand fall below our
current expectations, then we may establish additional inventory reserves which
will result in a negative impact to cost of sales and gross margins. Any future
changes to our inventory reserves for excess inventories will be disclosed in
the notes of our consolidated financial statements.

Valuation of Deferred Tax Assets. Income taxes are accounted for under the asset
and liability method. Deferred income tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carry forwards.
Deferred income tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
income tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. To the extent that it is
more likely than not that we will not be able to utilize deferred income tax
assets in the future, then a valuation allowance is established. At December 31,
2001, we had deferred income tax assets, net of valuation allowances of $68.6
million. We estimate that we will generate operating income in future periods
and will be able to use our deferred income tax assets before they expire to
offset future income tax liabilities. Should our actual results differ from our
current forecasts then we may need to establish an additional valuation
allowance, thereby reducing future income tax benefits and reducing future net
income or increase in future net loss.

Valuation and Impairment of Goodwill, Other Intangibles and Long-Lived Assets.
We review long-lived assets, goodwill and certain identifiable intangible assets
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. When factors indicate that
an intangible or long-lived asset should be evaluated for possible impairment,
an estimate of the related asset's undiscounted future cash flows over the
remaining life of the asset will be made to measure whether the carrying value
is recoverable. Any impairment is measured based upon the excess of the carrying
value of the asset over its estimated fair value which is generally based on an
estimate of future discounted cash flows. A significant amount of management
judgment is used in estimating future discounted cash flows. At December 31,
2001 we had goodwill, other intangibles and long-lived assets on our
consolidated balance sheet totaling $88.2 million. Should our business or market
conditions vary from our current expectations, then we may not be able to
realize the carrying value of these assets and will record an impairment charge
at that time.

Estimated Restructuring Reserves. As mentioned below and in note 11 of our
consolidated financial statements, we recorded restructuring charges totaling
$32.5 million during fiscal 2001. At December 31, 2001 the restructuring
liabilities that remain totaled $29.9 million on our consolidated balance
sheets. Of this amount, $3.0 million is related to employee termination benefits
that we expect to pay in early 2002. The remaining $26.9 is related to estimated
future payments, primarily for rent and related operating expenses, due over the
next fifteen years. Certain assumptions went into this estimate including future
maintenance costs, price escalation and sublease income derived from these
facilities. Should we negotiate additional subleases or reach a settlement with
our landlords to be released from our existing obligations, then we could
realize a favorable benefit to our results of future operations. Should future
lease, maintenance or other costs related to these facilities exceed our
estimates, then we could incur additional expense in future periods.

Overview

      We commenced operations in April 1988. Since incorporation, we have
designed, sourced and marketed high-speed VLSI semiconductor devices for public
and private network applications worldwide. We shipped our first product in
1990. We have focused our product development efforts on devices that meet the
needs of public and private network telecommunications and data communications
equipment providers that serve the worldwide public network, Internet and
corporate wide area network markets. Our devices are compliant with established
standards in these markets, including SONET/SDH, Asynchronous/PDH and ATM/IP. We
also offer products that combine multi-protocol capabilities on a single chip
that can be programmed for multi-service applications. Our mixed-signal and
digital design capability, in conjunction with our communications systems
expertise, enables us to determine


                                       16

<PAGE>

and implement optimal combinations of design elements for enhanced
functionality. We believe that this approach permits our customers to achieve
faster time-to-market and to introduce systems that offer greater functionality,
improved performance, lower power dissipation, reduced system size and cost and
greater reliability relative to discrete solutions.

      Our principal customers are OEMs that serve three market segments:

      .     the worldwide public network infrastructure that supports voice and
            data communications;

      .     the Internet infrastructure that supports the World Wide Web and
            other data services; and

      .     corporate WANs that support voice and data information exchange
            within medium-sized and large enterprises.

      We have sold our VLSI devices to more than 400 customers worldwide. We
sell our products through a worldwide direct sales force and a worldwide network
of independent distributors and sales representatives.

      We conduct our business in foreign markets with approximately 69% of our
net sales in fiscal 2001 coming from overseas. The countries that account for
the majority of this percentage include Germany, China, United Kingdom, Korea
and Israel.

      We work with network equipment OEMs during their system design phase with
the goal of having our products designed into the OEMs' products. Our sales
cycle often extends beyond one year because of the long lead times between an
OEM's design to the start of volume shipments. We incur product research and
development expenses well before the generation of substantial net revenues from
product shipments to OEMs. A significant portion of our net revenues have been,
and are anticipated to be, shipped into foreign markets. Substantially all of
our foreign net revenues are currently denominated in U.S. dollars. Our cost of
revenues consists primarily of the purchase cost of finished VLSI devices
produced by third-party semiconductor manufacturers. We intend to continue to
outsource all of our VLSI device fabrication requirements.

      Our operating results are subject to quarterly and annual fluctuations as
a result of several factors that could materially and adversely affect
profitability, as discussed below in "CERTAIN FACTORS THAT MAY AFFECT FUTURE
RESULTS".


                                       17

<PAGE>

Results of Operations

      The results of operations which follow should be read in conjunction with
our significant accounting policies and estimates summarized above as well as
our consolidated financial statements and notes thereof contained in Item 8 of
this report.

      The following table sets forth certain consolidated statements of
operations data as a percentage of net revenues for the periods indicated.

<TABLE>
<CAPTION>
                                                             Years ended December 31,
                                                             ------------------------
                                                               2001    2000   1999
                                                               ----    ----   ----
<S>                                                            <C>      <C>    <C>
Net revenues                                                    100%    100%   100%

Cost of revenues                                                 36%     30%    34%
Cost of revenues - provision for excess inventories              67%     --     --
                                                               ----     ---    ---

Gross (loss) profit                                              (3%)    70%    66%

Operating expenses:
    Research and development                                     84%     15%    20%
    Marketing and sales                                          38%     13%    16%
    General and administrative                                   15%      4%     5%
    Amortization of goodwill and purchased intangible assets      4%     --     --
    In-process research and development                          37%      2%    --
    EASICS NV merger costs                                       --       1%    --
    Restructuring charges                                        56%     --     --
    Asset impairments                                             3%     --     --
                                                               ----     ---    ---
Total operating expenses                                        237%     35%    41%
                                                               ----     ---    ---
Operating (loss) income                                        (240%)    35%    25%
                                                               ====     ===    ===
</TABLE>

COMPARISON OF FISCAL YEARS 2001 AND 2000

      Net Revenues. The following table summarizes our revenue mix by product
line for the three years ended December 31, 2001:

                                            Years ended December 31,
                                       --------------------------------
                                       2001          2000          1999
                                       ----          ----          ----
        SONET/SDH                       56%           59%           57%
        Asynchronous/PDH                13%           18%           29%
        ATM/IP                          31%           23%           14%
                                       ---           ---           ---
        Total                          100%          100%          100%

      Net revenues for the year ended December 31, 2001 decreased by $96.4
million, or 62%, over fiscal 2000. The decrease in absolute dollars was
distributed across all three of our product lines. The decrease in SONET/SDH was
not as significant as the decrease in Asynchronous/PDH and ATM/IP product lines.
These decreases were primarily related to a decline in volumes shipped over
prior comparable periods. We believe that the significant decline in revenues is
part of an industry wide condition where end-users of our products
(telecommunications and data communications OEMs) found themselves with too much
inventory during a time of declining demand and depressed market conditions. As
a result, the product mix percentage mentioned above is not consistent with
historical trends. Given the lack of visibility in the current market, we cannot
predict when, and to the extent that, historical product mix percentages will
return. Our customer base during the year ended December 31, 2001 has remained
relatively constant compared to the prior year, although our customers are
ordering substantially less product due to market conditions.


                                       18

<PAGE>

      International net revenues represented approximately 69% of net revenues
for fiscal 2001, compared with approximately 46% in fiscal 2000. The increase in
the percentage of international net revenues to total net revenues during fiscal
2001 is due to the fact that the telecommunication and data communications
markets have experienced a more significant decline in the United States than in
international markets.

      Gross Profit. Gross profit for the year ended December 31, 2001 decreased
by $110.7 million, or 102%, over the prior year. The decrease of gross profit
dollars and the percentage of net revenues is the result of lower net revenues
for the comparable period, shift in product mix and the provision for excess
inventories of $39.2 million which was recorded in 2001. Our gross profit,
excluding the excess inventory provision, was $37.4 million, or a 64% gross
margin, for fiscal 2001 compared to $108.9 million, or 70% gross margin, for
fiscal 2000. The decrease in gross margin percentage is due to a change in
product mix sold during 2001 over the previous year.

      Research and Development. Research and development expenses for the year
ended December 31, 2001 increased by $25.1 million, or 104%, over the prior year
from $24.2 million to $49.3 million. This increase in absolute dollars is the
result of acquisitions during 2001 and continued investment in personnel,
depreciation, software and related tools to develop next generation
telecommunication and data communication products. As a percentage of net
revenues, our research and development costs increased as we continued investing
in the design and development of future products notwithstanding the fact that
current product shipments have declined due to industry conditions. We have
monitored our sales volumes and expense run rates closely and, as a result, took
two restructuring actions in 2001 which we expect will reduce research and
development costs. We currently believe that the level of personnel and other
fixed costs in the research and development area is appropriate based on our
expectation of sales growth from new products in future periods. We will
continue to closely monitor both our costs and our growth expectations in future
periods and will take actions as market conditions dictate. There can be no
assurances that future acquisitions, market conditions or unforeseen events will
not cause our expenses to rise in future periods.

      Marketing and Sales. Marketing and sales expenses for the year ended
December 31, 2001 increased by $1.7 million, or 8%, over the prior year from
$20.5 million to $22.2 million. This increase includes increased provisions for
doubtful customer accounts by approximately $1.0 million during the fiscal year
2001 as we specifically identified customer collection risks that exist in light
of the current general economic weakness in the communication semiconductor
industry. We also added sales and marketing personnel and infrastructure during
fiscal 2001. We have monitored our sales volumes and expense run rates closely
and, as a result, took two restructuring actions in 2001 which we expect will
reduce sales and marketing costs in the future. We currently believe that the
level of personnel and other fixed costs in the sales and marketing area is
appropriate based on our expectation of sales growth from new products in future
periods. We will continue to closely monitor both our costs and our growth
expectations in future periods and will take actions as market conditions
dictate. There can be no assurances that future acquisitions, market conditions
or unforeseen events will not cause our expenses to rise in future periods.

      General and Administrative. General and administrative expenses for the
year ended December 31, 2001 increased by $3.4 million, or 60%, over the prior
year from $5.6 million to $9.0 million. The increase in absolute dollars was the
result of acquisitions, and increases in personnel, legal and professional fees
and our continued infrastructure investment in the general and administrative
area. As a percentage of net revenues, our general and administrative costs
increased since the fixed components of these costs do not fluctuate with net
revenues which decreased during fiscal 2001. We have monitored our sales volumes
and expense run rates closely and, as a result, took two restructuring actions
in 2001 which we expect will reduce general and administrative costs in the
future. We currently believe that the level of personnel and other fixed costs
in the general and administrative area is appropriate based on our expectation
of sales growth from new products in future periods. We will continue to closely
monitor both our costs and our growth expectations in future periods and will
take actions as market conditions dictate. There can be no assurances that
future acquisitions, market conditions or unforeseen events will not cause our
expenses to rise in future periods.

      Amortization of Goodwill and Purchased Intangible Assets. Amortization of
goodwill and purchased intangible assets for the year ended December 31, 2001
increased by, $2.1 million or 545%, over the prior year. This expense is related
to business combinations of Alacrity, ADV Engineering and Horizon Semiconductors


                                       19

<PAGE>

accounted for as purchases in August 2000, January 2001 and February 2001,
respectively. For the comparable period of the prior year the only amortization
was that of Alacrity acquired in August 2000. The increase as a percentage of
net revenues for the year ended December 31, 2001, compared to fiscal 2000, is
due to the increase of goodwill and purchased intangibles during fiscal 2001 and
the decline in net revenues compared to the prior year.

      We adopted the recently issued accounting pronouncements SFAS 141,
Accounting for Business Combinations, and adopted SFAS 142, Accounting for
Intangibles, effective January 1, 2002, at which time all future amortization of
goodwill will cease. We will be required to review goodwill and purchased
intangibles for impairment, at a minimum, annually.

      Purchased In-Process Research and Development. During the year ended
December 31, 2001, we recorded a charge for in-process research and development
(IPR&D) of $22.0 million related to our purchase of Onex in September 2001.
During the year ended December 31, 2000 we recorded a charge for in-process
research and development of $2.8 million related to our purchase of Alacrity
Communications in August 2000.

      We determined the fair value of the existing products as well as the
technology that was currently under development using the income approach. Under
the income approach, expected future after-tax cash flows from each of the
projects under development for the companies acquired (Onex and Alacrity) are
estimated and discounted to their net present value at an appropriate risk-
adjusted rate of return. Revenues were estimated based on relevant market size
and growth factors, expected industry trends, individual product sales cycles
and the estimated life of each product's underlying technology. Estimated
operating expenses, income taxes and charges for the use of contributory assets
were deducted from estimated revenues to determine estimated after-tax cash
flows for each project. These projected future cash flows were further adjusted
for the value contributed by any core technology and development efforts
expected to be completed post acquisition.

      These forecasted cash flows were then discounted based on rates derived
from our weighted average cost of capital, weighted average return on assets and
venture capital rates of return adjusted upward to reflect additional risks
inherent in the development life cycle. The risk adjusted discount rates used
involved consideration of the characteristics and applications of each product,
the inherent uncertainties in achieving technological feasibility, anticipated
levels of market acceptance and penetration, market growth rates and risks
related to the impact of potential changes in future target markets. After
considering these factors, we determined the risk adjusted discount rates for
the Onex and Alacrity product portfolios to be 30%.

      We believe that the pricing model used for the product portfolios related
to these acquisitions is representative within the telecommunications and data
communications industries and that the estimated IPR&D amounts determined
represent fair value and do not exceed the amounts that a third party would pay
for these projects. When we acquire companies we do not expect to achieve a
material amount of expense reductions or synergies as a result of integrating
the acquired in-process technology. Therefore, the valuation assumptions do not
include anticipated cost savings.

      The in-process technology acquired from Onex consisted of two projects:
Switch Processor (SP) and Switch Element (SE). The technology acquired from
Alacrity was 6400 cell-bus switching technology. A description of the IPR&D
projects acquired are set forth below:

            The SP technology consists of highly integrated and programmable
            silicon that can combine any and all combinations of SONET/SDH
            transmission and native support for TDM, ATM and packet processing
            on a single chip. Significant features under development of the SP
            technology include the fact that SP is a 17 million-gate device. The
            portion of in-process research and development allocated to this
            project was $14.1 million. It was estimated that the SP project was
            approximately 60% complete and the remaining costs to complete the
            project were $4.9 million. This project is expected to be completed
            in April 2002. The risks associated with the development of SP
            product are technical completion, timing, cost, and market risks.
            Technical completion must bear the risk that the technology's
            backend layout is appropriate. Timing risk of developing the SP is
            significant due to the unpredictable nature of technical issues with
            such technology. Although a market exists for this type of product,
            producing the SP product cost-effectively and gaining general market
            acceptance has yet to be proven and presents risk to the success of
            the SP product.


                                       20

<PAGE>

            The SE technology consists of a 30 gigabits per second (Gbps) (12
            port OC-48) switch technology capable of switching TDM, ATM or
            variable length packet traffic. Significant features under
            development of the SE technology include frequency and phase
            synchronization. The portion of in-process research and development
            allocated to this project was $7.9 million. It was estimated that
            the SE technology was approximately 75% complete and the remaining
            costs to complete the project were $2.7 million. The initial
            development of this project was completed in December 2001 and is
            being tested at year end. The risks associated with the development
            of SE product are technical completion, timing, cost, and market
            risks. Technical completion for the initial prototype lots centers
            on the reliability of certain IBM technology. Although a market for
            the SE product exists, producing the SE product cost-effectively and
            gaining general market acceptance has yet to be proven and presents
            risk to the success of the product.

            The 6400 cell-bus switch technology utilizes unidirectional,
            time-slotted, looped bus and multiple switch interfaces. The
            cell-bus switch simultaneously supports prioritized asynchronous and
            isochronous cell access. Significant features of this technology
            include efficiency, prioritized cell access, fairness, minimal
            latency for real time traffic, capacity, simplicity and scalability.
            At the date of acquisition we estimated that Alacrity technology was
            75% complete and the costs to complete the project to be $2.6
            million. This technology was completed in June 2001.

      The above estimates were determined by comparing the time and costs spent
to date and the complexity of the technologies achieved to date to the total
costs, time and complexities that were expected to be expended to bring the
technologies to completion.

      Restructuring Charges, Asset Impairments and Merger Costs. During fiscal
2001 we announced restructuring plans on July 16, 2001 (the "July Plan") and
November 15, 2001 (the "November Plan") due to current and anticipated business
conditions. These plans resulted in 77 positions being eliminated in North
America and the closing of four locations. The July Plan restructuring charges
consisted of employee termination benefits of approximately $1.3 million related
solely to a workforce reduction of 30 positions throughout the Company. These
employees were terminated during the third quarter of 2001 and were provided
severance and related benefits. The November Plan restructuring charges
consisted of employee termination benefits of approximately $1.9 million related
to a workforce reduction of 47 positions throughout all functional areas of the
Company. These employees were terminated during the fourth quarter of 2001 and
were provided severance and related benefits. The November Plan also consisted
of the closing of facilities in four locations. We are obligated for certain
lease commitments for the facilities which we have exited through fiscal 2017.
We have secured and are in the process of negotiating sub-lease commitments with
interested parties on a portion of the excess space over the next several years.
For the space for which we do not have sub-lease commitments in place as of
December 31, 2001, we have taken a charge of $28.6 million, which represents the
remaining rent and operating cost obligations related to these excess facilities
net of future expected sublease income. Excess furniture, leasehold improvements
and equipment of $0.6 million was written off in conjunction with these facility
closures.

      During fiscal 2001, we also reduced the asset carrying value of a
technology product license and certain tooling by approximately $1.7 million as
a result of an impairment analysis performed pursuant to Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be disposed of." Refer to note 11 of our
consolidated financial statements for additional detail on the restructuring
plans and asset impairment charges.

      During the fiscal year ended December 31, 2000, we expensed merger costs
of $1.2 million related to the EASICS NV transaction completed in May 2000.
There were no such comparable costs for the year ended December 31, 2001.

      Interest Income (Expense). Interest income, net of interest expense, for
year ended December 31, 2001 decreased 69% from the prior year. Our 4 1/2%
Convertible Notes due 2005 were issued in September of 2000, thus we recorded
less than four months of interest expense associated with these notes for the
year ended December 31, 2000. These notes were outstanding during the entire
year ended December 31, 2001 which resulted in an additional eight and a half
months interest expense partially offset by lower convertible note balances
compared to the same period in the prior year. During fiscal 2001, we have
experienced declining interest income due to lower cash


                                       21

<PAGE>

balances and lower interest rates. At December 31, 2001 and 2000, the effective
interest rate on our interest-bearing securities was approximately 3.52%, and
5.60%, respectively.

      During the year ended December 31, 2001, we repurchased $145.9 million,
face value, of our convertible notes. These purchases were made with our
existing cash, cash equivalents, and short-term investments. Subsequent to
year-end, in February 2002, we announced a tender offer to repurchase up to $200
million face value of our outstanding notes. This tender offer was completed in
March 2002. Refer also to note 17 of our consolidated financial statements.

      Income Tax Expense (Benefit). Our effective tax rate, before extraordinary
items, for the year ended December 31, 2001 is a benefit of 28.1%, compared to
an effective income tax rate expense of approximately 38.9% for the year ended
December 31, 2000. Excluding the write-off of purchased in-process research and
development, for which there is no income tax benefit, the effective income tax
benefit would have been 33.7% for the year ended December 31, 2001. The income
tax benefit for the year ended December 31, 2001 differed from statutory rates
primarily due to the non tax deductible write-off of purchased in-process
research and development of $22.0 million and a valuation allowance of $3.2
million taken against certain tax credits which we expect will expire
unutilized. The following table summarizes the differences between the U.S.
federal statutory rate and our effective tax rate on continuing operations for
financial statement purposes for the years ended December 31, 2001 and 2000:

                                                  Years ended December 31,
                                                  ------------------------
                                                     2001        2000
                                                     ----        ----
    U.S. federal statutory tax rate ............    (35.0)%      35.0%
    State taxes ................................     (1.8)        3.4
    In-process research and development ........      5.6         1.6
    Foreign sales corporation benefit ..........       --        (1.9)
    Change in beginning valuation allowance ....      2.4          --
    Permanent differences and other ............      0.7         0.8
                                                    ------------------
    Effective income tax rate ..................    (28.1)%      38.9%
                                                    ==================

      In addition to the tax benefit recorded during the year ended December 31,
2001, we recorded income tax expense of $13.2 million on the extraordinary gain
from the repurchase of a portion of the 4 1/2% Convertible Notes due 2005.

      We continue to periodically review the realizability of deferred income
tax assets considering all positive and negative evidence available to us which
includes, among other factors, our specific historical operating results,
changes in our future expectations of revenues and its impact on future
profitability. To the extent that we believe that it is more likely than not
that some or all of our deferred income tax assets will not be realized, we will
establish or adjust established valuation allowances. Such a valuation allowance
adjustment may impact our effective tax rate. We recorded a valuation allowance
in 2001 as noted above.

      Extraordinary Gain from Repurchase of 4 1/2% Convertible Notes due 2005.
In April 2001, we announced a repurchase program for our 4 1/2% Convertible
Notes due 2005. During the year ended December 31, 2001, we have repurchased
$145.9 million face value of our outstanding convertible notes for $106.1
million, including a write-off of deferred financing fees of $4.4 million,
realizing a pre-tax gain of $35.3 million. Net of income taxes, this
extraordinary gain was $22.1 million for the year ended December 31 2001. The
timing and amount of any additional repurchases will depend on many factors,
including, but not limited to, the prevailing market price of the convertible
notes and overall market conditions. We intend to fund additional repurchases of
the convertible notes, if any, from available cash, cash equivalents and
short-term investments. Subsequent to year-end, in February 2002, we announced a
tender offer to repurchase up to $200 million face value of our outstanding
convertible notes. This tender offer was completed in March 2002. Refer to the
subsequent events paragraph in this section as well as note 17 to our
consolidated financial statements.


                                       22

<PAGE>

COMPARISON OF FISCAL 2000 AND 1999

      Net Revenues. In fiscal 2000, we reported net revenues of $155.1 million,
an increase of 110.9% over fiscal 1999. The increase was driven by the strength
in our SONET/SDH and ATM/IP product lines. Foreign net revenues, consisting
primarily of shipments to customers in Europe, the Middle East and the Far East,
constituted 46% and 32% of net revenues in fiscal 2000 and 1999, respectively.

      Gross Profit. Gross margin for fiscal 2000 increased to 70.2% from 65.7%
for fiscal 1999. The increase in gross margin in fiscal 2000 was primarily a
result of the continued reduction in the costs of our products, achieved by
meeting higher volume milestones established by our foundries.

      During fiscal 2000, gross profit increased to $108.9 million from $48.3
million in 1999. This increase was a function of the continued increase in
overall volume and the improvement in the gross margin on certain product lines.

      Research and Development. In fiscal 2000, research and development
expenses were $24.2 million, or 15.6% of net revenues, an increase of 66.5% over
1999 expenditures. The increase was primarily attributable to increases in staff
and in engineering charges related to the introduction of new products during
fiscal 2000. We believe that the continued introduction of new products is
essential to our competitiveness, and we are committed to continuing our
investment in research and development.

      Marketing and Sales. In fiscal 2000, marketing and sales expenses
increased 69.6% over 1999, to $20.5 million, which represented 13.2% of net
revenues. The increase was the result of the increase in variable cost of
commissions on the increased net revenues and additional staff during fiscal
2000.

      General and Administrative. In fiscal 2000, general and administrative
expenses increased 45.8% over 1999 to $5.6 million, or 3.6% of net revenues. The
increase in overall expenses was the result of our continued investment in the
general and administrative area.

      Amortization of Goodwill and Purchased In-Process Research and
Development. We recorded $0.4 million of amortization of goodwill and purchased
intangible assets and a $2.8 million charge to operations for purchased
in-process research and development both related to the acquisition of Alacrity
Communications Inc., completed in August 2000. The expense for purchased IPR&D
was determined in that the underlying project did not reach technological
feasibility, had no alternative future use and successful development was
uncertain. This project was 75% completed at the date of acquisition. It is
anticipated that net cash inflows for this project will commence in 2002,
however, there can be no assurance. To date there have been no shipments of this
product and development efforts are continuing as planned. If the development of
this project is unsuccessful, our sales and profitability may be adversely
affected in future periods. Commercial results are also subject to certain
market events and risks, which are beyond our control.

      Merger Costs. During fiscal 2000, we incurred $1.2 million in transaction
costs related to the combination with Easics NV completed in May 2000.

      Income Taxes. For fiscal 2000, our effective tax rate was 38.9%. During
the third quarter of 1999, we concluded that it is more likely than not that
substantially all of our net deferred tax assets would be realized. Accordingly,
we reversed our valuation allowance for net deferred tax assets, which
contributed to the resulting net tax benefit of $2.8 million for fiscal 1999.
This resulted in a 1999 effective tax rate benefit of (12.5%).


                                       23

<PAGE>

Liquidity and Capital Resources

Cash Inflows and Outflows

      During fiscal 2001, the net decrease in cash and cash equivalents was
$137.3 million compared to a net increase of $451.9 million during fiscal 2000.
Details of our cash inflows and outflows are as follows:

Operating Activities: During fiscal 2001, we recorded a net loss of $77.5
million and had a net decrease of $14.4 million in working capital. These uses
of cash were offset by non-cash items of $15.2 million and restructuring
liabilities of $29.9 million, resulting in $46.8 million in cash used in
operating activities.

      The more significant changes in our cash flows from operations were:

            .     accounts receivable, net of allowances, decreased by $24.9
                  million, or 87.6%, in fiscal 2001 due to the decline in
                  customer shipments;

            .     inventories declined by $6.7 million, or 45%, in fiscal 2001
                  due to lower sales volumes because of industry conditions. In
                  fiscal 2001, we recorded charges of $39.2 million for excess
                  inventories; and

            .     the restructuring liabilities consist of approximately $1.3
                  million in employee termination benefits to be paid in early
                  2002 and $28.6 million in rent and operating cost payments due
                  for excess facilities over the next fifteen years.

Investing Activities: In fiscal 2001, we invested approximately $11.5 million in
capital equipment and product licenses. We also invested $9.0 million to acquire
minority (less than 20%) ownership in non-publicly traded companies and $12.7
million (net of cash acquired) to acquire Onex. These investments were offset by
net proceeds from held-to-maturity investments of $44.8 million.

Financing Activities: In fiscal 2001, we used $102.1 million in financing
activities, which consisted primarily of $106.2 million used to repurchase our 4
1/2% Convertible Notes due 2005 and $4.2 million used to repurchase our common
stock, offset by proceeds from the exercise of stock options of $8.3 million.

Effect of Exchange Rates and Inflation: Exchange rates and inflation have not
had a significant impact on our operations.

Cash, Cash Equivalents and Investments

       We have financed our operations and have met our capital requirements
since incorporation in 1988 primarily through private and public issuances of
equity securities, convertible notes, bank borrowings and cash generated from
operations. Our principal sources of liquidity as of December 31, 2001 consisted
of $370.3 million in cash and cash equivalents, $39.3 million in short-term
investments and $26.6 million in long-term investments for a total cash and
investment balance of $436.2 million. Cash and cash equivalents are cash or
instruments with maturities of less than 90 days, short-term investments have
maturities of greater then 90 days but less than one year and long-term
investments have maturities of greater than one year. Our cash investments
consist of U.S. Treasury Bills, corporate debt, taxable municipal securities,
money market instruments, overnight repurchase investments and commercial paper.

       We believe that our existing cash, cash equivalents and investments will
be sufficient to fund operating losses, capital expenditures and provide
adequate working capital at least through December 31, 2002. However, there can
be no assurance that events in the future will not require us to seek additional
capital and, if so required, that capital will be available on terms favorable
or acceptable us, if at all.


                                       24

<PAGE>

Commitments

       We had a line of credit agreement in place with Silicon Valley Bank,
which expired in July of 2001. Since we did not have an outstanding balance on
this obligation and had sufficient cash and investments to fund operations as
well as its investment and financing requirements through the end of fiscal
2002, we did not renew this line of credit and, thus were released from all
obligations, restrictions and financial covenants thereof.

      We have outstanding operating lease commitments of approximately $46.6
million payable over the next fifteen years. Some of these commitments are for
space which was not being utilized and, as a result, we recorded a restructuring
charge of $28.6 during fiscal 2001 for excess facilities. We are in the process
of trying to sublease some of this excess space, however, it is unlikely that
any sublease income generated will offset the entire future commitment. We
currently believe that we can fund these lease commitments in the future,
however, there can be no assurances that we will not be required to seek
additional capital or provide additional guarantees or collateral on these
obligations.

      We have existing commitments to make future interest payments on our
existing 4 1/2% Convertible Notes due 2005. As of December 31, 2001, we had $4.1
million in accrued interest payable on our consolidated balance sheet. In March
2002, we repurchased $199.9 million of our outstanding 4 1/2% Convertible Notes
due 2005. Over the remaining life of the outstanding notes, we expect to accrue
and pay approximately $20.9 million in interest to the holders. Refer to the
subsequent event disclosure below and note 17 of our consolidated financial
statements regarding our tender offer.

      A summary of our significant future commitments (which reflects the impact
of the tender of the 4 1/2% Convertible Notes due 2005 discussed in the
subsequent events paragraph below) and their payments by fiscal year is
summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                  Scheduled payments for the years ended December 31,
                                                  ---------------------------------------------------
                                                                                      2006 -     Total
                Commitment                     2002       2003     2004      2005      2017   Commitments
---------------------------------------------------------------------------------------------------------
<S>                                          <C>        <C>       <C>      <C>        <C>       <C>
Interest on Convertible Notes                $  7,009   $ 5,135   $5,135   $  3,638   $    --   $ 20,917
Redemption of Convertible Notes               199,937        --       --    114,113        --    314,050
Operating Lease Commitments                     4,378     4,911    4,534      3,797    28,972     46,592
                                             -----------------------------------------------------------
                                     Total   $211,324   $10,046   $9,669   $121,548   $28,972   $381,559
                                             ===========================================================
</TABLE>

Related Party Transactions

      On a limited basis, we conduct certain related party transactions with the
companies in which we have less than 20% ownership interest. During 2001, these
transactions consisted primarily of design work that was performed for us, for
which we paid approximately $0.8 million. In addition to TranSwitch, certain
directors and officers of TranSwitch currently have, or have had, investments in
these companies on the same terms that were available to TranSwitch. As a result
of their investment in Onex, certain directors and officers received cash and
shares of our common stock in exchange for their shares of Onex when this
acquisition was completed in fiscal 2001.

      We do not have any obligation to participate in future rounds of financing
in the companies which we have less then 20% ownership interest in, although we
do have a right of first refusal to purchase additional securities offered by
the above companies. We do not have any commitments to acquire or merge with any
of the companies that we have investments in. Additionally, we do not have a
right of first refusal to acquire these companies. Our rights are consistent
with the rights of all shareholders in the class of stock that we have
purchased.

      In fiscal 2001, we also invested in GTV Capital, L.P., which is a
partnership in the business of making, supervising and disposing of capital
investments in equity or equity-related securities in companies engaged in
high-technology industries. The partnership focuses on seed and early-stage
investments in communication infrastructure technology companies including
wireless and optical systems technology, storage and related semiconductor
technology, and media convergence technology. We have a 48% ownership interest
in this partnership and we account for it under the equity method.


                                       25

<PAGE>

Subsequent Events

      On January 24, 2002, ADV achieved certain milestones that had been set in
its purchase agreement. As a result, we paid $5.0 million in cash that was
recorded as additional goodwill on the consolidated balance sheets.

      In January 2002, we pledged $1.4 million in available cash and cash
equivalents as collateral for a stand-by letter of credit that guarantees
certain long-term property lease obligations.

      On February 11, 2002, our Board of Directors approved a tender offer to
purchase up to $200 million (the "Offer Amount") aggregate principal amount of
our outstanding 4 1/2% Convertible Notes due 2005 at a price not greater than
$700 nor less than $650 per $1,000 principal amount, plus accrued and unpaid
interest thereon to, but not including, the date of the purchase. This tender
offer expired at midnight on March 11, 2002 and we repurchased $199.9 million
face value of our convertible notes at the price of $700 per $1,000 principal
amount for a cash payment of $139.9 million. Net of taxes, deferred financing
costs and transaction fees, we expect this transaction to result in an
extraordinary gain of approximately $32.5 million which will be recorded in the
first quarter of 2002. Upon completion of the tender offer, the remaining
outstanding balance of our 4 1/2% Convertible Notes due 2005 is $114.1 million.

Recent Accounting Pronouncements

      In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, "Business Combinations" (SFAS 141). SFAS 141 requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001. SFAS 141 also specifies certain criteria that must be met in order for
intangible assets acquired in a purchase method business combination to be
recognized and reported apart from goodwill, noting that any purchase price
allocable to an assembled workforce may not be accounted for separately. We
adopted the provisions of SFAS 141 as of July 1, 2001.

      In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" (SFAS 142) which is effective
for TranSwitch's fiscal year beginning January 1, 2002. SFAS 142 requires, among
other things, the discontinuance of goodwill amortization. In addition, the
standard includes provisions, upon adoption, for the reclassification of certain
existing recognized intangibles as goodwill, reassessment of the useful lives of
existing recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the testing for impairment of existing goodwill
and other intangibles. Upon adoption of SFAS 142, we will cease to amortize
approximately $54.5 million of goodwill and assembled workforce intangible
assets. We had recorded approximately $2.5 million of amortization on these
amounts during 2001 and would have recorded approximately $2.6 million of
amortization during 2002. In lieu of amortization we will be required to perform
an impairment review of our goodwill balance upon the initial adoption of SFAS
142. We expect to complete the initial review during the second quarter of 2002.
We do not expect to record an impairment charge upon completion of the initial
review, however, there can be no assurance that at the time the review is
completed a material impairment loss will not be recorded. Any impairment loss
will be measured as of the date of adoption and recognized as the cumulative
effect of a change in accounting principle.

      In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"). SFAS 144 supercedes SFAS 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of".
SFAS 144 applies to all long-lived assets (including discontinued operations)
and consequently amends Accounting Principles Board Opinion No. 30 (APB 30),
Reporting Results of Operations-Reporting the Effects of Disposal of a Division
of a Business. SFAS 144 develops one accounting model for long-lived assets that
are to be disposed of by sale and requires that long-lived assets that are to be
disposed of by sale be measured at the lower of book value or fair value less
cost to sell. Additionally, SFAS 144 expands the scope of discontinued
operations to include all components of an entity with operations that (1) can
be distinguished from the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS 144 is
effective for TranSwitch's fiscal year beginning January 1, 2002. We do not
expect the adoption of this standard to have a material impact on our financial
position, results of operations, or liquidity.


                                       26

<PAGE>

      In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No.
133), and in June 2000 it issued SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities, an Amendment of FASB
Statement No. 133" (SFAS No. 138). SFAS No. 133, as amended by SFAS No. 138,
requires companies to recognize all derivatives as assets or liabilities
measured at their fair value. Gains or losses resulting from changes in the
value of those derivatives would be accounted for depending on the use of the
derivative and whether it qualifies for hedge accounting. The adoption of SFAS
No. 133 as of January 1, 2001, had no material impact on our financial position,
results of operations or liquidity.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

From time to time, information provided by us, statements made by our employees
or information included in our filings with the Securities and Exchange
Commission (including this Form 10-K) may contain statements that are not
historical facts, so-called "forward-looking statements," which involve risks
and uncertainties. Such forward-looking statements are made pursuant to the safe
harbor provisions of Section 21E of the Securities Exchange Act of 1934, as
amended. These statements can be identified by the use of forward-looking
terminology such as "may", "should", "could", "will", "expect", "anticipate",
"estimate", "continue", "believe" or the negative of these terms or other
similar words. These statements discuss future expectations, contain projections
of results of operations or of financial condition or state other
forward-looking information. When considering forward-looking statements, you
should keep in mind the risk factors and other cautionary statements in this
Form 10-K.

Our actual future results may differ significantly from those stated in any
forward-looking statements. Factors that may cause such differences include, but
are not limited to, the factors discussed below. Each of these factors, and
others, are discussed from time to time in our filings with the Securities and
Exchange Commission.

Our operating results may fluctuate because of a number of factors, many of
which are beyond our control. If our operating results are below the
expectations of public market analysts or investors, then the market price of
our common stock could decline. Some of the factors that affect our quarterly
and annual results, but which are difficult to control or predict are:

We recently experienced a significant decline in net revenues.

Our net revenues declined substantially during the twelve months ended December
31, 2001, to $58.7 million from $155.1 million during the twelve months ended
December 31, 2000. Due to declining current economic conditions and slowdowns in
purchases of VLSI semiconductor devices, it has become increasingly difficult
for us to predict the purchasing activities of our customers and we expect that
our net revenues will fluctuate substantially in the future.

We expect that our operating results will fluctuate in the future due to reduced
demand in our markets.

Our business is characterized by short-term orders and shipment schedules, and
customer orders typically can be cancelled or rescheduled without significant
penalty to our customers. Because we do not have substantial non-cancelable
backlog, we typically plan our production and inventory levels based on internal
forecasts of customer demand, which are highly unpredictable and can fluctuate
substantially. Future fluctuations to our operating results may also be caused
by a number of factors, many of which are beyond our control.

In response to anticipated long lead times to obtain inventory and materials
from our foundries, we may order in advance of anticipated customer demand,
which might result in excess inventory levels if the expected orders fail to
materialize. As a result, we cannot predict the timing and amount of shipments
to our customers, and any significant downturn in customer demand for our
products would reduce our quarterly and our annual operating results. During
2001, these conditions occurred and as a result, we recorded a provision for
excess inventories of an aggregate of $39.2 million during fiscal 2001.

Historically, average selling prices in the communication semiconductor industry
have decreased over the life of a product, and, as a result, the average selling
prices of our products may decrease in the future. Decreases in the price of our
products would adversely affect our operating results.


                                       27

<PAGE>

In the past, we have incurred significant new product and process development
costs because our policy is to expense these costs, including tooling and
pre-production expenses, at the time that they are incurred. We may continue to
incur these types of expenses in the future. These additional expenses will have
a material and adverse effect on our earnings in future periods. The occurrence
of any of the above mentioned risk factors could have a material adverse effect
on our business and financial results.

Sudden shortages of raw materials or production capacity constraints can lead
producers to allocate available supplies or capacity to larger customers than
us, which could interrupt our ability to meet our production obligations.

We are using our available cash each quarter to fund our operating activities.

During the fourth quarter of fiscal 2001, we used $25.9 million of our available
cash, cash equivalents and investments to fund our operating, investing and
financing activities. We anticipate that we will use a similar amount of our
available cash, cash equivalents and investments to fund our operating,
investing and financing activities in the first quarter of fiscal 2002. We
believe that we will continue to use our available cash, cash equivalents and
investments in the future although we believe that we have sufficient cash for
our needs to last through December 31, 2002. We will continue to experience
losses and to use our cash, cash equivalents and investments if we do not
receive sufficient product orders and our costs are not controlled.

We may have to further restructure our business.

On July 16, 2001, we announced a restructuring plan as a result of current and
anticipated business conditions. We incurred a restructuring charge of
approximately $1.3 million, which was solely related to a workforce reduction of
thirty positions throughout our company. We terminated these employees during
the third quarter of 2001 and provided severance and related benefits. On
November 15, 2001, we announced further restructuring and incurred an additional
restructuring charge of $31.2 million related to a workforce reduction of 47
positions throughout our company and the related consolidation of several of our
leased facilities. We terminated these employees during the fourth quarter of
2001 and provided severance and related benefits. We cannot be sure that these
measures will be sufficient to offset lower net revenues, and if they are not,
our earnings will be adversely affected.

We anticipate that shipments of our products to relatively few customers will
continue to account for a significant portion of our net revenues.

Historically, a relatively small number of customers have accounted for a
significant portion of our net revenues in any particular period. For the year
ended December 31, 2001, shipments to our top five customers, including sales to
distributors, accounted for approximately 64% of our net revenues. We expect
that a limited number of customers may account for a substantial portion of our
net revenues for the foreseeable future.

Some of the following may reduce our net revenues:

      .     reduction, delay or cancellation of orders from one or more of our
            significant customers;

      .     development by one or more of our significant customers of other
            sources of supply for current or future products;

      .     loss of one or more of our current customers or a disruption in our
            sales and distribution channels; and

      .     failure of one or more of our significant customers to make timely
            payment of our invoices.


                                       28

<PAGE>

      We cannot be certain that our current customers will continue to place
orders with us, that orders by existing customers will return to the levels of
previous periods or that we will be able to obtain orders from new customers. We
have no long-term volume purchase commitments from any of our significant
customers. The following table sets forth our significant distributors (who have
accounted for at least 10% of our net revenues during fiscal 2001) and customers
(who accounted for at least 10% of our net revenues during 2001 either directly
or through distributors during fiscal 2001):

      Significant Distributors:                Major Customers:
      --------------------------------------------------------------------------
      Insight Electronics, Inc.                Lucent Technologies, Inc.
      Unique Memec                             Nortel Networks Corporation
      Weone Corporation                        Samsung Corporation
                                               Siemens AG
                                               Redback Networks, Inc.

Our international business operations expose us to a variety of business risks.

Foreign markets are a significant part of our net revenues. In the year ended
December 31, 2001, foreign shipments accounted for 69% of our net revenues. We
expect foreign markets to continue to account for a significant percentage of
our net revenues. A significant portion of our net revenues will, therefore, be
subject to risks associated with foreign markets, including the following:

      .     unexpected changes in legal and regulatory requirements and policy
            changes affecting the telecommunications and data communications
            markets;

      .     changes in tariffs;

      .     exchange rates and other barriers;

      .     political and economic instability;

      .     difficulties in accounts receivable collection;

      .     difficulties in managing distributors and representatives;

      .     difficulties in staffing and managing foreign operations;

      .     difficulties in protecting our intellectual property overseas;

      .     seasonality of customer buying patterns; and

      .     potentially adverse tax consequences.

Although substantially all of our net revenues to date have been denominated in
U.S. dollars, the value of the U.S. dollar in relation to foreign currencies
also may reduce our net revenues to foreign customers. To the extent that we
expand our international operations or change our pricing practices to
denominate prices in foreign currencies, we will expose our margins to increased
risks of currency fluctuations. We have assessed the risks related to foreign
exchange fluctuations, and have determined at this time that any such risk is
not material.

We must successfully transition to new process technologies to remain
competitive.

Our future success depends upon our ability to do the following:

      .     to develop products that utilize new process technologies;

      .     to introduce new process technologies to the marketplace ahead of
            competitors; and

      .     to have new process technologies selected to be designed into
            products of leading systems manufacturers.

Semiconductor design and process methodologies are subject to rapid
technological change and require large expenditures for research and
development. We currently manufacture our products using 0.8, 0.5, 0.35 and 0.25
micron complementary metal oxide semiconductor (CMOS) processes and a 1.0 micron
bipolar CMOS (BiCMOS) process. We continuously evaluate the benefits, on a
product-by-product basis, of migrating to smaller geometry process technologies.
We are migrating to a 0.18 micron CMOS process, and we anticipate that we will
need to migrate to smaller CMOS processes in the future. Other companies in the
industry have experienced difficulty in transitioning to new manufacturing
processes and, consequently, have suffered reduced yields or delays in product


                                       29

<PAGE>

deliveries. We believe that transitioning our products to smaller geometry
process technologies will be important for us to remain competitive, and we
cannot be certain that we can make such a transition successfully, if at all,
without delay or inefficiencies.

Our success depends on the timely development of new products, and we face risks
of product development delays.

Our success depends upon our ability to develop new VLSI devices and software
for existing and new markets. The development of these new devices and software
is highly complex, and from time to time we have experienced delays in
completing the development of new products. Successful product development and
introduction depends on a number of factors, including the following:

      .     accurate new product definition;

      .     timely completion and introduction of new product designs;

      .     availability of foundry capacity;

      .     achievement of manufacturing yields; and

      .     market acceptance of our products and our customers' products.

Our success also depends upon our ability to do the following:

      .     build products to applicable standards;

      .     develop products that meet customer requirements;

      .     adjust to changing market conditions as quickly and cost-effectively
            as necessary to compete successfully;

      .     introduce new products that achieve market acceptance; and

      .     develop reliable software to meet our customers' application needs
            in a timely fashion.

In addition, we cannot ensure that the systems manufactured by our customers
will be introduced in a timely manner or that such systems will achieve market
acceptance.

Our net revenues depend on the success of our customers' products.

Our customers generally incorporate our new products into their products or
systems at the design stage. However, customer decisions to use our products
(design wins), which can often require significant expenditures by us without
any assurance of success, often precede the generation of volume sales, if any,
by a year or more. In addition, even after we achieve a design win, a customer
may require further design changes. Implementing these design changes can
require significant expenditures of time and expense by us in the development
and pre-production process. Moreover, the value of any design win largely will
depend upon the commercial success of the customer's product and on the extent
to which the design of the customer's systems accommodates components
manufactured by our competitors. We cannot ensure that we will continue to
achieve design wins in customer products that achieve market acceptance.

We sell a range of products that each have a different profit margin. Our net
revenues will be adversely affected if most of our shipments are of products
with low profit margins.

We currently sell more than 50 products. Some of our products have a high profit
margin while others do not. If our customers decide to buy more of our products
with low profit margins and fewer of our products with high profit margins, our
net revenues could be adversely affected. We plan our mix of products based on
our internal forecasts of customer demand, which are highly unpredictable and
can fluctuate substantially.

Our success depends on the rate of growth of the global communications
infrastructure.

We derive virtually all of our net revenues from products for telecommunications
and data communications applications. These markets are characterized by the
following:


                                       30

<PAGE>

      .     susceptibility to seasonality of customer buying patterns;

      .     general business cycles;

      .     intense competition;

      .     rapid technological change; and

      .     short product life cycles.

In addition, although the telecommunications and data communications equipment
markets have grown rapidly in the last few years, we are currently experiencing
a significant slowdown in these markets. We anticipate that these markets will
not grow at the same historical rates in the near future.

Our products must successfully include industry standards to remain competitive.

Products for telecommunications and data communications applications are based
on industry standards, which are continually evolving. Our future success will
depend, in part, upon our ability to successfully develop and introduce new
products based on emerging industry standards, which could render our existing
products unmarketable or obsolete. If the telecommunications or data
communications markets evolve to new standards, we cannot be certain that we
will be able to design and manufacture new products successfully that address
the needs of our customers or that such new products will meet with substantial
market acceptance.

We face intense competition in the communication semiconductor market.

The communication semiconductor industry is intensely competitive and is
characterized by the following:

      .     rapid technological change;

      .     general business cycles;

      .     shortage in fabrication capacity;

      .     price erosion;

      .     unforeseen manufacturing yield problems; and

      .     heightened international competition in many markets.

These factors are likely to result in pricing pressures on our products, thus
potentially affecting our operating results.

Our ability to compete successfully in the rapidly evolving area of
high-performance integrated circuit technology depends on factors both within
and outside our control, including:

      .     success in designing and subcontracting the manufacture of new
            products that implement new technologies;

      .     protection of our products by effective use of intellectual property
            laws;

      .     product quality;

      .     reliability;

      .     price;

      .     efficiency of production;

      .     the pace at which customers incorporate our products into their
            products;

      .     success of competitors' products; and

      .     general economic conditions.

The telecommunications and data communications industries, which are our primary
target markets, have become intensely competitive because of deregulation and
heightened international competition.


                                       31

<PAGE>

The cyclical nature of the communication semiconductor industry affects our
business and we are currently experiencing a significant downturn.

We provide semiconductor devices to the telecommunications and data
communications markets. The semiconductor industry is highly cyclical and
currently is experiencing a significant contraction of the market. These
downturns are characterized by:

      .     diminished product demand;

      .     accelerated erosion of average selling prices; and

      .     production over-capacity.

We may experience substantial fluctuations in future operating results due to
general semiconductor industry conditions, overall economic conditions,
seasonality of customers' buying patterns and other factors. We are currently
experiencing a significant slowdown in the communication semiconductor industry.

We rely on outside fabrication facilities, and our business could be hurt if our
relationships with our foundry suppliers are damaged.

We do not own or operate a VLSI circuit fabrication facility. Seven foundries
currently supply us with most of our semiconductor device requirements. While we
have had good relations with these foundries, we cannot be certain that we will
be able to renew or maintain contracts with them or negotiate new contracts to
replace those that expire. In addition, we cannot be certain that renewed or new
contracts will contain terms as favorable as our current terms. There are other
significant risks associated with our reliance on outside foundries, including
the following:

      .     the lack of assured semiconductor wafer supply and control over
            delivery schedules;

      .     the unavailability of, or delays in obtaining access to, key process
            technologies; and

      .     limited control over quality assurance, manufacturing yields and
            production costs.

Reliance on third-party fabrication facilities limits our control of the
manufacturing process.

Manufacturing integrated circuits is a highly complex and technology-intensive
process. Although we try to diversify our sources of semiconductor device supply
and work closely with our foundries to minimize the likelihood of reduced
manufacturing yields, our foundries occasionally experience lower than
anticipated manufacturing yields, particularly in connection with the
introduction of new products and the installation and start-up of new process
technologies. Such reduced manufacturing yields have at times reduced our
operating results. A manufacturing disruption at one or more of our outside
foundries, including as a result of natural occurrences, could impact production
for an extended period of time.

Our dependence on a small number of fabrication facilities exposes us to risks
of interruptions in deliveries of semiconductor devices.

We purchase semiconductor devices from outside foundries pursuant to purchase
orders, and we do not have a guaranteed level of production capacity at any of
our foundries. We provide the foundries with rolling forecasts of our production
requirements. However, the ability of each foundry to provide wafers to us is
limited by the foundry's available capacity. Therefore, our foundry suppliers
could choose to prioritize capacity for other customers or reduce or eliminate
deliveries to us on short notice. Accordingly, we cannot be certain that our
foundries will allocate sufficient capacity to satisfy our requirements.

      We have been, and expect in the future to be, particularly dependent upon
a limited number of foundries for our VLSI device requirements. In particular,
as of the date of this Form 10-K, a single foundry manufactures all of our
BiCMOS devices. As a result, we expect that we could experience substantial
delays or interruptions in the shipment of our products due to the following:


                                       32

<PAGE>

      .     sudden demand for an increased amount of semiconductor devices or
            sudden reduction or elimination of any existing source or sources of
            semiconductor devices;

      .     time required to qualify alternative manufacturing sources for
            existing or new products could be substantial; and

      .     failure to find alternative manufacturing sources to produce VLSI
            devices with acceptable manufacturing yields.

Our failure to protect our proprietary rights, or the costs of protecting these
rights, may harm our ability to compete.

Our success depends in part on our ability to obtain patents and licenses and to
preserve other intellectual property rights covering our products and
development and testing tools. To that end, we have obtained certain domestic
and foreign patents and intend to continue to seek patents on our inventions
when appropriate. The process of seeking patent protection can be time consuming
and expensive. We cannot ensure the following:

      .     that patents will be issued from currently pending or future
            applications;

      .     that our existing patents or any new patents will be sufficient in
            scope or strength to provide meaningful protection or any commercial
            advantage to us;

      .     that foreign intellectual property laws will protect our foreign
            intellectual property rights; and

      .     that others will not independently develop similar products,
            duplicate our products or design around any patents issued to us.

Intellectual property rights are uncertain and involve complex legal and factual
questions. We may be unknowingly infringing on the proprietary rights of others
and may be liable for that infringement, which could result in significant
liability for us. For example, we are not aware of any third-party intellectual
property rights that would prevent our use and sale of our products, although we
have received correspondence from others alleging infringement. If we do
infringe the proprietary rights of others, we could be forced to either seek a
license to intellectual property rights of others or alter our products so that
they no longer infringe the proprietary rights of others. A license could be
very expensive to obtain or may not be available at all. Similarly, changing our
products or processes to avoid infringing the rights of others may be costly or
impractical.

We are responsible for any patent litigation costs. If we were to become
involved in a dispute regarding intellectual property, whether ours or that of
another company, we may have to participate in legal proceedings in the United
States Patent and Trademark Office or in the United States or foreign courts to
determine one or more of patent validity, patent infringement, patent ownership
or inventorship. These types of proceedings may be costly and time consuming for
us, even if we eventually prevail. If we do not prevail, we might be forced to
pay significant damages, obtain a license, if available, or stop making a
certain product.

We also rely on trade secrets, proprietary know-how and confidentiality
provisions in agreements with employees and consultants to protect our
intellectual property. Other parties may not comply with the terms of their
agreements with us, and we may not be able to adequately enforce our rights
against these people.

We may engage in acquisitions that may harm our operating results, dilute our
stockholders and cause us to incur debt or assume contingent liabilities.

We may pursue acquisitions that could provide new technologies, skills, products
or service offerings. Future acquisitions by us may involve the following:

      .     use of significant amounts of cash;

      .     potentially dilutive issuances of equity securities; and

      .     incurrence of debt or amortization expenses related to intangible
            assets with definitive lives.


                                       33

<PAGE>

In addition, acquisitions involve numerous other risks, including:

      .     diversion of management's attention from other business concerns;

      .     risks of entering markets in which we have no or limited prior
            experience; and

      .     unanticipated expenses and operational disruptions while acquiring
            and integrating new acquisitions.

From time to time, we have engaged in discussions with third parties concerning
potential acquisitions of product lines, technologies and businesses. However,
we currently have no commitments or agreements with respect to any such
acquisition. If such an acquisition does occur, we cannot be certain that our
business, operating results and financial condition will not be materially
adversely affected or that we will realize the anticipated benefits of the
acquisition.

We have made, and may continue to make, investments in development stage
companies which may not produce any returns for us in the future.

We have made investments of less then 20% in early stage venture-backed,
start-up companies that develop technologies that are complementary to our
product roadmap. The following table summarizes the investments we have made and
their related technologies during the three years ended December 31, 2001.

<TABLE>
<CAPTION>
                                             Initial
                                            Investment
          Investee Company                     Date                                Technology
---------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>                 <C>
OptiX Networks, Inc.                      February 2000       10 Gb/s and 40 Gb/s SONET/SDH framing devices

Intellectual Capital for                  December 2000       Next generation wireless base station VLSI devices
   Integrated Circuits, Inc.

Systems On Silicon, Inc.                   January 2001       Integrated access products with voice over packet capability

TeraOp (USA), Inc.                           May 2001         Optical switching devices based on MEMS technology

Accordion Networks, Inc.                  December 2001       Carrier class broadband multi-service access systems
</TABLE>

The total investments in these companies is approximately $12.1 million and is
recorded on the cost basis on our consolidated balance sheet. These investments
involve all the risks normally associated with investments in development stage
companies. As such, there can be no assurance that we will receive a favorable
return on these or any future venture backed investments that we may make.
Additionally, our original investment may become impaired if these companies do
not succeed in their business plans. Any impairment of these investments could
negatively impact our future operating results.

The loss of key management could affect our ability to run our business.

Our success depends largely upon the continued service of our executive
officers, including Dr. Santanu Das, President, Chief Executive Officer and
Chairman of the Board of Directors, and other key management and technical
personnel and on our ability to continue to attract, retain and motivate other
qualified personnel. The competition for such employees is intense.

We continue to have substantial indebtedness after the completion of our tender
offer for some of our notes.

In the third quarter of 2000, we sold in a private placement $460 million of 4
1/2% Convertible Notes due 2005. As a result, we incurred $460 million of
additional indebtedness, substantially increasing our ratio of debt to total
capitalization. In April 2001, we adopted a repurchase program for our notes
through which we repurchased some of the convertible notes from time to time at
varying prices. During fiscal 2001, we repurchased $145.9 million of our 4 1/2%
Convertible Notes due 2005. We did not repurchase any 4 1/2% Convertible Notes
due 2005 during the three months ended December 31, 2001. Subsequent to year
end, in February 2002, we announced a tender offer to buy back up to $200
million face value of the outstanding 4 1/2% Convertible Notes due 2005 at an
aggregate purchase


                                       34

<PAGE>

price of approximately $140 million. This tender offer was completed in March
2002 with approximately $199.9 million of face value notes being tendered.
Subsequent to the tender offer, we will continue to have approximately $114.1
million in face value of indebtedness outstanding. Subject to compliance with
federal securities laws, we may continue to repurchase our 4 1/2% Convertible
Notes due 2005 after the consummation of the tender offer. We funded repurchases
of the notes in the tender offer and will fund any additional repurchases of the
convertible notes, if any, made after the tender offer, from available cash,
cash equivalents and short-term investments.

We may incur substantial additional indebtedness in the future. The level of our
indebtedness, among other things, could:

      .     make it difficult for us to make payments on the notes outstanding
            after consummation of the tender offer;

      .     make it difficult for us to obtain any necessary future financing
            for working capital, capital expenditures, debt service requirements
            or other purposes;

      .     limit our flexibility in planning for, or reacting to changes in,
            our business; and

      .     make us more vulnerable in the event of a downturn in our business.

There can be no assurance that we will be able to meet our debt service
obligations, including our obligations under the convertible notes.

We may not be able to satisfy a change in control offer.

The indenture governing the 4 1/2% Convertible Notes due 2005 contains
provisions that apply to a change in our control. If someone triggers a change
in control as defined in the indenture, we must offer to purchase the 4 1/2%
Convertible Notes due 2005 with cash. If we have to make that offer, we cannot
be sure that we will have enough funds to pay for all the 4 1/2% Convertible
Notes due 2005 that the holders could tender.

We may not be able to pay our debt and other obligations.

If our cash flow is inadequate to meet our obligations, we could face
substantial liquidity problems. If we are unable to generate sufficient cash
flow or otherwise obtain funds necessary to make required payments on the 4 1/2%
Convertible Notes due 2005 or our other obligations, we would be in default
under the terms thereof, which would permit the holders of the notes to
accelerate the maturity of the 4 1/2% Convertible Notes due 2005 and also could
cause defaults under future indebtedness we may incur. Any such default could
have a material adverse effect on our business, prospects, financial condition
and operating results. In addition, we cannot assure you that we would be able
to repay amounts due in respect of the 4 1/2% Convertible Notes due 2005 if
payment of the notes were to be accelerated following the occurrence of an event
of default as defined in the indenture. In April 2001, we adopted a repurchase
program for our 4 1/2% Convertible Notes due 2005 through which we repurchased
some of the convertible notes from time to time at varying prices. During fiscal
2001, we repurchased $145.9 million of our 4 1/2% Convertible Notes due 2005. We
did not repurchase any 4 1/2% Convertible Notes due 2005 during the three months
ended December 31, 2001. Subsequent to year-end, in February 2002, we announced
a tender offer to buy back up to $200 million face value of the outstanding
convertible notes at an aggregate purchase price of approximately $140 million.
This tender offer was completed in March 2002 with approximately $199.9 million
of face value notes being tendered. Subsequent to the tender offer, we will
continue to have approximately $114.1 million in face value of indebtedness
outstanding. Subject to compliance with federal securities laws, we may continue
to repurchase 4 1/2% Convertible Notes due 2005 after the consummation of the
tender offer. We funded repurchases of the notes in the tender offer and will
fund any additional repurchases of the notes, if any, made after the tender
offer, from available cash, cash equivalents and short-term investments.


                                       35

<PAGE>

Our stock price is volatile.

The market for securities for communication semiconductor companies, including
TranSwitch, has been highly volatile. The market sale price of our common stock
has fluctuated between a low of $0.80 and a high of $74.69 during the period
from June 19, 1995 to December 31, 2001. The closing price was $2.87 on February
28, 2002. It is likely that the price of our common stock will continue to
fluctuate widely in the future. In September 2001, we adopted a repurchase
program for up to 10% of our common stock. During the third quarter of 2001, we
repurchased approximately one million shares of our common stock. We may
continue to purchase some of our shares from time to time on the open market.
Factors affecting the trading price of our common stock include:

      .     responses to quarter-to-quarter variations in operating results;

      .     announcements of technological innovations or new products by us or
            our competitors;

      .     current market conditions in the telecommunications and data
            communications equipment markets (we are currently experiencing a
            significant downturn); and

      .     changes in earnings estimates by analysts.

We could be subject to class action litigation due to stock price volatility,
which if it occurs, will distract our management and could result in substantial
costs or large judgments against us.

In the past, securities and class action litigation has often been brought
against companies following periods of volatility in the market prices of their
securities. We may be the target of similar litigation in the future. Securities
litigation could result in substantial costs and divert our management's
attention and resources, which could cause serious harm to our business,
operating results and financial condition or dilution to our stockholders.

Provisions of our certificate of incorporation, by-laws, stockholder rights plan
and Delaware law may discourage take over offers and may limit the price
investors would be willing to pay for our common stock.

Delaware corporate law contains, and our certificate of incorporation and
by-laws and shareholder rights plan contain, certain provisions that could have
the effect of delaying, deferring or preventing a change in control of
TranSwitch even if a change of control would be beneficial to our stockholders.
These provisions could limit the price that certain investors might be willing
to pay in the future for shares of our common stock. Certain of these
provisions:

      .     authorize the issuance of "blank check" preferred stock (preferred
            stock which our Board of Directors can create and issue without
            prior stockholder approval) with rights senior to those of common
            stock;

      .     prohibit stockholder action by written consent;

      .     establish advance notice requirements for submitting nominations for
            election to the Board of Directors and for proposing matters that
            can be acted upon by stockholders at a meeting; and

      .     dilute stockholders who acquire more than 15% of our common stock.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Interest Rate Risk. We have investments in money market accounts, government
securities and commercial paper that earns interest income that is a function of
the market rates. As a result we do have exposure to changes in interest rates.
For example, if interest rates were to decrease by one percentage point from
their current levels, our potential interest income, assuming a constant cash
balance, for calendar year 2002 would decrease by approximately $4.3 million. We
do, however, expect our cash balance to decline during fiscal 2002.

Foreign Currency Exchange Risk. All of our sales and the majority of our
expenses to date have been denominated in U.S. dollars, and, as a result, we
have relatively little exposure to foreign currency exchange risk. We do not
currently enter into any significant forward exchange contracts to hedge
exposures denominated in foreign currencies or any other derivative financial
instruments for trading or speculative purposes. However, in the event our
exposure to foreign currency risk increases, we may choose to hedge those
exposures in the future.


                                       36

<PAGE>

Fair Value of Financial Instruments. As of December 31, 2001, our long-term debt
consisted of convertible notes with interest at a fixed rate of 4 1/2%.
Consequently, we do not have significant cash flow exposure on our long-term
debt. However, the fair value of the convertible notes is subject to significant
fluctuation due to changes in market interest rates and their convertibility
into shares of our common stock. The fair market value of the convertible notes
was approximately $178.5 million and $400 million at December 31, 2001 and 2000,
respectively. Changes in interest rates affect the fair value of our convertible
notes.


                                       37

<PAGE>

Item 8. Financial Statements and Supplementary Data.

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                        AND FINANCIAL STATEMENT SCHEDULE

<TABLE>
<CAPTION>
                                                                                                             Page
                                                                                                             ----
<S>                                                                                                           <C>
Financial Statements:
Independent Auditors' Report...............................................................................   39
Consolidated Balance Sheets as of December 31, 2001 and 2000...............................................   40
Consolidated Statements of Operations for each of the years in the three-year period ended
   December 31, 2001.......................................................................................   41
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) for each of the
   years in the three-year period ended December 31, 2001..................................................   42
Consolidated Statements of Cash Flows for each of the years in the three-year period ended
   December 31, 2001.......................................................................................   43
Notes to Consolidated Financial Statements.................................................................   44

Financial Statement Schedules:
Schedule II, Valuation and Qualifying Accounts.............................................................   67
</TABLE>


                                       38

<PAGE>

                          Independent Auditors' Report

The Board of Directors and Shareholders
TranSwitch Corporation:

      We have audited the consolidated financial statements of TranSwitch
Corporation and subsidiaries as listed in the accompanying index. In connection
with our audits of the consolidated financial statements, we have also audited
the financial statement schedule as listed in the accompanying index. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audits.

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

      In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of TranSwitch
Corporation and subsidiaries as of December 31, 2001 and 2000, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States of America. Also in our opinion, the
related financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.

      As discussed in Note 1 to the consolidated financial statements, effective
July 1, 2001, the Company adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 141, "Business Combinations," and certain
provisions of SFAS No. 142, "Goodwill and Other Intangible Assets," as required
for goodwill and intangible assets resulting from business combinations
consummated after June 30, 2001.


/s/ KPMG LLP

Stamford, Connecticut
January 17, 2002, except for note 17, which is as of March 11, 2002


                                       39

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                        (in thousands, except share data)

<TABLE>
<CAPTION>
                                                                                                      December 31,
                                                                                                   2001         2000
                                                                                                ----------------------
<S>                                                                                             <C>          <C>
                                     ASSETS
Current assets:
      Cash and cash equivalents .............................................................   $ 370,248    $ 507,552
      Short-term investments ................................................................      39,344       56,572
      Accounts receivable, net of allowances of $1,601 and $604, respectively ...............       3,525       28,443
      Inventories ...........................................................................       8,227       14,898
      Deferred income tax assets ............................................................       3,023        3,692
      Prepaid expenses and other current assets .............................................       2,936        5,668
                                                                                                ----------------------
            Total current assets ............................................................     427,303      616,825
Long-term investments .......................................................................      26,582       54,183
Property and equipment, net .................................................................      18,946       13,464
Deferred income tax assets ..................................................................      65,536       22,019
Goodwill and purchased intangible assets, net ...............................................      56,107        8,447
Investments in non-publicly traded companies, at cost .......................................      12,138        8,630
Deferred financing costs, net ...............................................................       8,092       15,219
Other assets ................................................................................       4,007        2,843
                                                                                                ----------------------
            Total assets ....................................................................   $ 618,711    $ 741,630
                                                                                                ======================

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
      Accounts payable ......................................................................   $   3,960    $   8,393
      Accrued expenses and other current liabilities ........................................       9,200        2,730
      Accrued compensation and benefits .....................................................       2,717        3,961
      Accrued sales returns, allowances and stock rotation ..................................       2,300        2,600
      Accrued interest ......................................................................       4,120        6,207
      Restructuring liabilities .............................................................       2,999           --
                                                                                                ----------------------
            Total current liabilities .......................................................      25,296       23,891
Restructuring liabilities - long term .......................................................      26,925           --
4 1/2% Convertible Notes due 2005 ...........................................................     314,050      460,000
                                                                                                ----------------------
Total liabilities ...........................................................................     366,271      483,891
                                                                                                ----------------------

Commitments and contingencies (note 12)

Stockholders' equity:
      Common stock $.001 par value; authorized 300,000,000 shares; issued and outstanding
      90,932,469 shares at December 31, 2001 and 83,500,125 shares at December 31, 2000 .....          91           84
      Additional paid-in capital ............................................................     293,902      217,455
      Accumulated other comprehensive loss ..................................................        (303)        (225)
      Accumulated (deficit) earnings ........................................................     (37,039)      40,425
      Less, 1,010,000 shares of common stock in treasury, at cost ...........................      (4,211)          --
                                                                                                ----------------------
            Total stockholders' equity ......................................................     252,440      257,739
                                                                                                ----------------------
            Total liabilities and stockholders' equity ......................................   $ 618,711    $ 741,630
                                                                                                ======================
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       40

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                                        Years ended December 31,
                                                                                      2001        2000        1999
                                                                                   --------------------------------
<S>                                                                                <C>          <C>         <C>
Net revenues ...................................................................   $  58,682    $155,083    $73,533
Cost of revenues ...............................................................      21,263      46,147     25,210
Cost of revenues - charge for excess inventories ...............................      39,218          --         --
                                                                                   --------------------------------
Gross (loss) profit ............................................................      (1,799)    108,936     48,323
                                                                                   --------------------------------
Operating expenses:
      Research and development .................................................      49,324      24,221     14,543
      Marketing and sales ......................................................      22,169      20,518     12,098
      General and administrative ...............................................       9,024       5,634      3,865
      Amortization of goodwill and purchased intangible assets .................       2,476         384         --
      Purchased in-process research and development ............................      22,000       2,800         --
      EASICS NV merger costs ...................................................          --       1,163         --
      Restructuring charges ....................................................      32,492          --         --
      Asset impairments ........................................................       1,731          --         --
                                                                                   --------------------------------
            Total operating expenses ...........................................     139,216      54,720     30,506
                                                                                   --------------------------------
Operating (loss) income ........................................................    (141,015)     54,216     17,817
Interest income (expense):
      Interest income ..........................................................      23,221      15,994      4,740
      Interest expense .........................................................     (20,613)     (7,472)       (35)
                                                                                   --------------------------------
            Interest income, net ...............................................       2,608       8,522      4,705
                                                                                   --------------------------------
(Loss) income before income taxes and extraordinary gain .......................    (138,407)     62,738     22,522
Income tax expense (benefit) ...................................................     (38,850)     24,383     (2,812)
                                                                                   --------------------------------
(Loss) income before extraordinary gain ........................................     (99,557)     38,355     25,334
Extraordinary gain from repurchase of 4 1/2% Convertible Notes due 2005, net
of income taxes of $13,214 .....................................................      22,093          --         --
                                                                                   --------------------------------

Net (loss) income ..............................................................   $ (77,464)   $ 38,355    $25,334
                                                                                   ================================

Basic (loss) earnings per common share:
(Loss) income before extraordinary gain ........................................   $   (1.14)   $   0.47    $  0.33
Extraordinary gain .............................................................        0.25          --         --
                                                                                   --------------------------------
Net (loss) income ..............................................................   $   (0.89)   $   0.47    $  0.33
                                                                                   ================================

Diluted (loss) earnings per common share:
(Loss) income before extraordinary gain ........................................   $   (1.14)   $   0.44    $  0.31
Extraordinary gain .............................................................        0.25          --         --
                                                                                   --------------------------------
Net (loss) income ..............................................................   $   (0.89)   $   0.44    $  0.31
                                                                                   ================================

Basic average shares outstanding ...............................................      86,904      81,681     76,676

Diluted average shares outstanding .............................................      86,904      87,559     81,596
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       41

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                         AND COMPREHENSIVE INCOME (LOSS)
                        (in thousands, except share data)

<TABLE>
<CAPTION>
                                                                      Common stock          Common stock,   Additional
                                                                                             in treasury,     paid-in
                                                                 Shares          Amount        at cost        capital
                                                               ---------------------------------------------------------
<S>                                                            <C>              <C>            <C>           <C>
Balance at December 31, 1998 ...........................       66,558,774       $     66       $    --       $ 64,479
                                                               =========================================================
Comprehensive income:
      Net income .......................................
      Currency translation adjustment ..................

            Total comprehensive income .................

Shares of common stock issued under stock option and
      stock purchase plans .............................        3,682,038              4            --          7,101

Shares of common stock issued in connection with
      follow on public offering, net of issuance
      costs ............................................        8,797,500              9            --         68,172

Tax benefit from exercise of employee stock options ....               --             --            --          8,266

Reversal of deferred tax asset valuation allowance
      relating to tax benefits on stock options ........               --             --            --          2,000

Compensation related to issuance of stock options ......               --             --            --            133
                                                               ---------------------------------------------------------
Balance at December 31, 1999 ...........................       79,038,312             79            --        150,151
                                                               =========================================================
Comprehensive income:
      Net income .......................................
      Currency translation adjustment ..................

            Total comprehensive income .................

Shares of common stock issued under stock option and
      stock purchase plans .............................        4,194,977              5            --         21,418
Shares of common stock issued to acquire Alacrity
      Communications, Inc. .............................          266,836             --            --         10,657

Tax benefit from exercise of employee stock options ....               --             --            --         35,229
                                                               ---------------------------------------------------------
Balance at December 31, 2000 ...........................       83,500,125             84            --        217,455
                                                               =========================================================
Comprehensive income (loss):
      Net loss .........................................
      Currency translation adjustment ..................

            Total comprehensive loss ...................

Shares of common stock issued under stock option and
      stock purchase plans .............................        1,777,362              2            --          8,293

Repurchase of 1,010,000 shares of common stock .........               --             --        (4,211)            --

Shares of common stock issued to acquire ADV
      Engineering S.A ..................................          129,971             --            --          5,569

Shares of common stock issued to acquire Horizon
      Semiconductors, Inc. .............................           43,507             --            --          1,693

Shares of common stock issued to acquire Onex
      Communications Corporation .......................        5,481,504              5            --         52,839

Tax benefit from exercise of employee stock options ....               --             --            --          8,053
                                                               ---------------------------------------------------------
Balance at December 31, 2001 ...........................       90,932,469       $     91       $(4,211)      $293,902
                                                               =========================================================

<CAPTION>
                                                                Accumulated
                                                                   other        Accumulated
                                                               comprehensive     earnings
                                                               income (loss)     (deficit)        Total
                                                               ------------------------------------------
<S>                                                                <C>           <C>            <C>
Balance at December 31, 1998 ...........................           $ (26)        $(23,264)      $  41,255
                                                               ==========================================
Comprehensive income:
      Net income .......................................                           25,334          25,334
      Currency translation adjustment ..................            (136)                            (136)
                                                                   -----                        ---------
            Total comprehensive income .................                                           25,198
                                                                                                ---------
Shares of common stock issued under stock option and
      stock purchase plans .............................              --               --           7,105

Shares of common stock issued in connection with
      follow on public offering, net of issuance
      costs ............................................              --               --          68,181

Tax benefit from exercise of employee stock options ....              --               --           8,266

Reversal of deferred tax asset valuation allowance
      relating to tax benefits on stock options ........              --               --           2,000

Compensation related to issuance of stock options ......              --               --             133
                                                               ------------------------------------------
Balance at December 31, 1999 ...........................            (162)           2,070         152,138
                                                               ==========================================
Comprehensive income:
      Net income .......................................                           38,355          38,355
      Currency translation adjustment ..................             (63)                             (63)
                                                                   -----                        ---------
            Total comprehensive income .................                                           38,292
                                                                                                ---------
Shares of common stock issued under stock option and
      stock purchase plans .............................              --               --          21,423
Shares of common stock issued to acquire Alacrity
      Communications, Inc. .............................              --               --          10,657

Tax benefit from exercise of employee stock options ....              --               --          35,229
                                                               ------------------------------------------
Balance at December 31, 2000 ...........................            (225)          40,425         257,739
                                                               ==========================================
Comprehensive income (loss):
      Net loss .........................................                          (77,464)        (77,464)
      Currency translation adjustment ..................             (78)                             (78)
                                                                   -----                        ---------
            Total comprehensive loss ...................                                          (77,542)
                                                                                                ---------
Shares of common stock issued under stock option and
      stock purchase plans .............................              --               --           8,295

Repurchase of 1,010,000 shares of common stock .........              --               --          (4,211)

Shares of common stock issued to acquire ADV
      Engineering S.A ..................................              --               --           5,569

Shares of common stock issued to acquire Horizon
      Semiconductors, Inc. .............................              --               --           1,693

Shares of common stock issued to acquire Onex
      Communications Corporation .......................              --               --          52,844

Tax benefit from exercise of employee stock options ....              --               --           8,053
                                                               ------------------------------------------
Balance at December 31, 2001 ...........................           $(303)        $(37,039)      $ 252,440
                                                               ==========================================
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       42

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                                                  Years ended December 31,
                                                                                            2001           2000            1999
                                                                                         ----------------------------------------
<S>                                                                                      <C>             <C>             <C>
Cash flows from operating activities:
      Net (loss) income ............................................................     $ (77,464)      $  38,355       $ 25,334
      Adjustments required to reconcile net (loss) income to cash flows provided
      by (used in) operating activities, net of effects of acquisitions:
            Depreciation and amortization ..........................................        11,547           6,496          3,494
            Deferred income taxes ..................................................       (46,926)        (33,955)       (13,309)
            Non-cash restructuring charges and asset impairments ...................         2,367              --             --
            Provision for doubtful accounts ........................................           997             500             47
            Tax benefits from exercise of employee stock options ...................         8,053          35,229          8,266
            Charge for excess inventories ..........................................        39,218              --             --
            Other non-cash items ...................................................            --             230            133
            Purchased in-process research and development ..........................        22,000           2,800             --
            Extraordinary gain on extinguishment of 4 1/2% Convertible Notes due
            2005, net of income taxes ..............................................       (22,093)             --             --
            Decrease (increase) in operating assets:
                  Accounts receivable ..............................................        24,538         (15,735)        (5,239)
                  Inventories ......................................................       (32,547)         (6,998)        (2,424)
                  Prepaid expenses and other assets ................................         3,728          (2,634)        (1,844)
            (Decrease) increase in operating liabilities:
                  Accounts payable .................................................        (4,433)          3,661          1,294
                  Accrued expenses and other liabilities ...........................        (5,679)         30,832          1,416
                  Restructuring liabilities ........................................        29,924              --             --
                                                                                         ----------------------------------------
                       Net cash (used in) provided by operating activities .........       (46,770)         58,781         17,168
                                                                                         ----------------------------------------

Cash flows from investing activities:
      Purchase of product licenses .................................................        (2,000)           (500)        (1,000)
      Capital expenditures .........................................................        (9,469)        (10,481)        (5,053)
      Purchases of investments in non-publicly traded companies ....................        (9,009)         (6,505)        (2,499)
      Acquisition of businesses, net of cash acquired ..............................       (12,729)             90             --
      Purchases of held-to-maturity investments ....................................      (271,673)       (256,858)       (98,855)
      Proceeds from held-to-maturity of investments ................................       316,503         202,286         45,824
                                                                                         ----------------------------------------
                       Net cash provided by (used in) investing activities .........        11,623         (71,968)       (61,583)
                                                                                         ----------------------------------------

Cash flows from financing activities:
      Proceeds from issuance of 4 1/2% Convertible Notes due 2005, net of
      issuance costs ...............................................................            --         443,694             --
      Repurchase of 4 1/2% Convertible Notes due 2005 ..............................      (106,163)             --             --
      Proceeds from the exercise of stock options ..................................         8,295          21,423          7,105
      Repurchase of common stock held in treasury, at cost .........................        (4,211)             --             --
      Proceeds from the issuance of common stock, net of issuance costs ............            --              --         68,181
                                                                                         ----------------------------------------
                       Net cash (used in) provided by financing activities .........      (102,079)        465,117         75,286
                                                                                         ----------------------------------------

                                                                                         ----------------------------------------
Effect of exchange rate change on cash and cash equivalents ........................           (78)            (63)          (136)
                                                                                         ----------------------------------------

(Decrease) increase in cash and cash equivalents ...................................      (137,304)        451,867         30,735
Cash and cash equivalents at beginning of year .....................................       507,552          55,685         24,950
                                                                                         ----------------------------------------
Cash and cash equivalents at end of year ...........................................     $ 370,248       $ 507,552       $ 55,685
                                                                                         ========================================
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       43

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       (Tabular dollars in thousands, except share and per share amounts)

Note 1. Summary of Significant Accounting Policies

Description of Business

      TranSwitch Corporation ("TranSwitch" or the "Company") was incorporated in
Delaware on April 26, 1988 and is headquartered in Shelton, Connecticut. The
Company and its subsidiaries (collectively, "TranSwitch" or the "Company")
design, develop, market and support highly integrated digital and mixed-signal
semiconductor devices for the telecommunications and data communications
markets.

Principles of Consolidation

      The consolidated financial statements include the accounts of TranSwitch
Corporation and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated.

Use of Estimates

      The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the consolidated financial statements and
revenues and expenses during the period reported. Actual results could differ
from those estimates. Estimates are used in accounting for, among other things,
allowances for uncollectable receivables, inventory obsolescence, product
warranty, depreciation and amortization, taxes, and contingencies. Estimates and
assumptions are reviewed periodically, and the effects of revisions are
reflected in the consolidated financial statements in the period they are
determined to be necessary.

Cash, Cash Equivalents and Investments in Marketable Securities

      All highly liquid investments with an original maturity of three months or
less are considered cash equivalents. Cash equivalents were approximately $370.2
and $470.7 million for the fiscal years ended December 31, 2001 and 2000,
respectively. Cash equivalents consist of overnight bank repurchase agreements,
certificates of deposit, U.S. Treasury Bills, commercial paper and U.S. Agency
Notes. The majority of the Company's cash and cash equivalents are maintained
with three major financial institutions. The cash, cash equivalents and
investment balances at institutions may, at times, be above the Federal Deposit
Insurance Corporation insured limit of $0.1 million per account.

      Short and long-term investments are comprised of marketable securities,
primarily U.S. Treasury Bills, commercial paper, and corporate debt securities.
Investments with remaining maturities greater then ninety days, but less than
one year, as of the date of the balance sheet are considered short-term.
Long-term investments consist of the same mix of securities with maturity dates
greater than one year from the balance sheet date. At December 31, 2001 and
2000, all of the Company's marketable securities are classified as
held-to-maturity. Held-to-maturity securities are those securities in which the
Company has the ability and intent to hold the securities to maturity. These
investments are recorded at amortized cost.

Fair Value of Financial Instruments

      The carrying amounts for cash and cash equivalents, short-term
investments, accounts receivable, and accounts payable approximate fair value
because of their short maturities. The fair values of long-term investments and
the 4 1/2% Convertible Notes due 2005 are determined using quoted market prices
for those securities or similar financial instruments. The fair value of the
outstanding 4 1/2% Convertible Notes due 2005 was approximately $178.5 and
$400.0 million at December 31, 2001 and 2000, respectively. The fair value of
the Company's long-term investments are disclosed in note 3 to the consolidated
financial statements.


                                       44

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

Inventories

      Inventories are carried at the lower of cost (on a weighted-average cost
basis) or estimated net realizable value.

Product Licenses

      Product licenses are amortized using the greater of: (1) the amount
computed using the ratio of a product's current gross revenues to the product's
total of current and estimated future gross revenues; or (2) or the
straight-line method over the estimated useful life of the asset, generally
three to five years, not to exceed the term of the license. The Company
capitalized $2.0 million, $0.5 million and $1.0 million for the years ended
December 31, 2001, 2000 and 1999, respectively, in connection with the
acquisition of selected technologies. Amortization of product licenses amounted
to $0.3, $0.4 and $0.5 million for the years ended December 31, 2001, 2000 and
1999, respectively. Product licenses, net, are included in other assets on the
consolidated balance sheets. During fiscal 2001, the Company recorded an
impairment charge related to a product license, refer to note 11.

Property and Equipment

      Property and equipment are carried at cost less accumulated depreciation
and amortization. Depreciation and amortization of property and equipment is
calculated using the half-year convention method over the asset's estimated
useful lives, ranging from three to seven years. Any gain or loss resulting from
sale or retirement is included in the consolidated statement of operations.
Repairs and maintenance are expensed as incurred while renewals and betterments
are capitalized. Costs incurred for assets being constructed or installed but
not yet placed in service at the balance sheet date are recorded as construction
in progress.

Goodwill and Purchased Intangible Assets

      Goodwill and purchased intangible assets are carried at cost less
accumulated amortization, and are being amortized over the estimated economic
lives of the respective assets, generally five to ten years. Accumulated
amortization for goodwill and purchased intangible assets amounted to $2.9
million and $0.4 million for the years ended December 31, 2001 and 2000. Refer
also to "Recent Accounting Pronouncements" below as well as note 2 "Business
Combinations" for additional disclosure.

Deferred Financing Costs

      Deferred financing costs on our 4 1/2% Convertible Notes due 2005 are
amortized using the interest method over the term of the related notes. The
Company had deferred financing costs, net of $8.1 and $15.2 million at December
31, 2001 and 2000, respectively. Amortization, included in the consolidated
statement of operations as a component of interest expense, was $2.7 million and
$1.1 million for the years ended December 31, 2001 and 2000, respectively.
During the year ended December 31, 2001, the Company recognized a gain related
to the early extinguishment of convertible notes which were reduced by the
write-off of $4.5 million in associated deferred financing costs. Refer to note
10 for additional details on our 4 1/2% convertible notes due 2005.

Impairment of Intangibles and Long-Lived Assets

      The Company reviews long-lived assets, goodwill and certain identifiable
intangible assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. When
factors indicate that an intangible or long-lived asset should be evaluated for
possible impairment, an estimate of the related asset's undiscounted future cash
flows over the remaining life of the asset will be made to determine whether the
carrying value is recoverable. Any impairment is measured based upon the excess
of the carrying value of the asset over its estimated fair value which is
generally based on an estimate of future discounted cash flows.


                                       45

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

Investments in Non-Publicly Traded Companies

      The Company has certain minority investments in the convertible preferred
stock of several non-publicly traded companies in which it has less than 20
percent of the voting rights and does not exercise significant influence. These
investments are carried at cost and are reviewed periodically for impairment.
The appropriate reductions in carrying values are recorded when and if
necessary. During the three years ended December 31, 2001, the Company did not
record any impairment charges on these investments.

Revenue Recognition

      Net revenues are comprised of product shipments, principally to domestic
and international telecommunications and data communications OEMs and to
distributors. Net revenues from product sales are recognized at the time of
product shipment when the following criteria are met: (1) title and risk of loss
transfers to the customer; (2) the selling price is fixed or determinable; and
(3) collectibility is reasonably assured.

      Agreements with certain distributors provide price protection and return
and allowance rights. With respect to the sales to distributors the: (1) prices
are fixed at the date of shipment from the Company's facilities; (2) payment is
not contractually or otherwise excused until the product is resold; (3) Company
does not have any obligations for future performance relating to the resale of
the product; and (4) amount of future returns, allowances, refunds and costs to
be incurred can and are reasonably estimated and accrued at the time of
shipment.

Concentrations of Credit Risk

      Financial instruments that potentially subject us to significant
concentrations of credit risk consist principally of cash and cash equivalents,
marketable securities, and accounts receivable.

      Cash, cash equivalents, and marketable securities are maintained in
investment grade financial instruments with high-quality financial institutions,
thereby reducing credit risk concentrations. In addition, the Company limits the
amount of credit exposure to any one financial institution and any one type of
investment.

      At December 31, 2001, over 90% of accounts receivable were due from four
major customers. The majority of the Company's sales are to customers in the
telecommunications and data communications industries. The Company performs
ongoing credit evaluations of its customers and generally does not require
collateral. The Company does establish an allowance for doubtful accounts based
upon factors surrounding the credit risk of specific customers, historical
trends and other information.

Product Warranties

      TranSwitch provides warranties on its products for up to one year from the
date of sale. A liability is recorded for estimated costs to be incurred under
product warranties, which is based primarily on historical experience. Estimated
warranty expense is recorded as cost of revenues as products are sold.

Research and Development Costs

      Research and development costs are expensed as incurred.

Income Taxes

      Income taxes are accounted for under the asset and liability method.
Deferred income tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carry forwards. Deferred income tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred income tax assets and
liabilities of a change in tax rates is recognized in income in the period that


                                       46

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

includes the enactment date. To the extent that it is more likely than not that
the Company will not be able to utilize deferred income tax assets in the
future, a valuation allowance is established.

Stock-Based Compensation

     As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation,"
the Company accounts for employee stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock
Issued to Employees", and FASB Interpretation No. 44 (FIN 44), "Accounting for
Certain Transactions Involving Stock-Based Compensation, an interpretation of
APB Opinion No. 25" and related interpretations in accounting for its
stock-based compensation plans. Stock-based compensation related to
non-employees is based on the fair value of the related stock or options in
accordance with SFAS No. 123 and its interpretations. Expense associated with
stock-based compensation is amortized over the vesting period of each individual
award.

Earnings Per Share

      Basic earnings per share are based upon the weighted average common shares
outstanding during the period. Diluted earnings per share assume exercise of all
outstanding "in-the-money" stock options and the conversion of the 4 1/2%
Convertible Notes due 2005 into common stock at the beginning of the period or
the date of issuance, if later, unless they are anti-dilutive.

Foreign Currency Translation

      All foreign subsidiaries use their local currency as their functional
currency. Therefore, assets and liabilities of foreign subsidiaries are
translated at exchange rates in effect at the balance sheet date and revenue and
expense accounts are translated at average exchange rates during the year. The
resulting translation adjustments are recorded in accumulated other
comprehensive income (loss). Gains and losses related to monetary assets and
liabilities denominated in a currency different than a subsidiary's functional
currency are included in the consolidated statements of operations.

Reclassifications

      Certain reclassifications have been made in the 2000 balance sheet to
conform to the 2001 presentation.

Recent Accounting Pronouncements

      In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, "Business Combinations" ("SFAS 141"). SFAS 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. SFAS 141 also specifies certain criteria that must be met
in order for intangible assets acquired in a purchase method business
combination to be recognized and reported apart from goodwill, noting that any
purchase price allocable to an assembled workforce may not be accounted for
separately. The Company adopted the provisions of SFAS 141 as of July 1, 2001.
Accordingly, for the acquisition of Onex, the Company recorded $40.6 million in
goodwill which is not being amortized. Refer also to note 2 of these
consolidated financial statements.

      In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") which is effective
for TranSwitch's fiscal year beginning January 1, 2002. SFAS 142 requires, among
other things, the discontinuance of goodwill amortization. In addition, the
standard includes provisions, upon adoption, for the reclassification of certain
existing recognized intangibles as goodwill, reassessment of the useful lives of
existing recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the testing for impairment of existing goodwill
and other intangibles. Upon adoption of SFAS 142, the Company will cease to
amortize approximately $54.5 million of goodwill and assembled workforce
intangible assets. The Company had recorded approximately $2.5 million of
amortization on these amounts during 2001 and would have recorded approximately
$2.6 million of amortization during 2002. In lieu of


                                       47

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

amortization, the Company will be required to perform an impairment review of
its goodwill balance upon the initial adoption of SFAS 142. The Company expects
to complete the initial review during the second quarter of 2002. The Company
does not expect to record an impairment charge upon completion of the initial
review, however there can be no assurance that at the time the review is
completed a material impairment loss will not be recorded. Any impairment loss
will be measured as of the date of adoption and recognized as the cumulative
effect of a change in accounting principle.

      In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"). SFAS 144 supercedes SFAS 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of".
SFAS 144 applies to all long-lived assets (including discontinued operations)
and consequently amends Accounting Principles Board Opinion No. 30 (APB 30),
Reporting Results of Operations -Reporting the Effects of Disposal of a Division
of a Business. SFAS 144 develops one accounting model for long-lived assets that
are to be disposed of by sale and requires that long-lived assets that are to be
disposed of by sale be measured at the lower of book value or fair value less
cost to sell. Additionally, SFAS 144 expands the scope of discontinued
operations to include all components of an entity with operations that (1) can
be distinguished from the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS 144 is
effective for TranSwitch's fiscal year beginning January 1, 2002. The Company
does not expect the adoption of this standard to have a material impact on its
financial statements.

Note 2. Business Combinations

      During the years ended December 31, 2001 and 2000, the Company completed
five acquisitions. All acquisitions during 2001 and 2000 were accounted for
under the purchase method of accounting for business combinations, with the
exception of EASICS NV which was accounted for as a pooling of interests during
2000. The consolidated financial statements include the operating results of
each business from the date of acquisition, except EASICS NV where historical
balances are reflected. All significant intercompany balances and transactions
have been eliminated.

FISCAL 2001

      A summary of purchase transactions completed during fiscal 2001 is
outlined as follows:

<TABLE>
<CAPTION>
                                                                 Onex             Horizon             ADV               Total
                                                            Communications     Semiconductors,     Engineering         Purchase
                                                              Corporation           Inc.              S.A.           Acquisitions
                                                            ---------------------------------------------------------------------
<S>                                                             <C>                <C>               <C>               <C>
Purchase Price Allocation:
Purchased in-process research and development .......           $22,000            $   --            $   --            $22,000
Goodwill & assembled workforce ......................            40,621             2,379             5,424             48,424
Deferred income tax assets ..........................             9,137                --                --              9,137
Cash and other tangible assets ......................            11,890               199             1,072             13,161
Patents .............................................             1,600                --                --              1,600
Accrued liabilities .................................            (3,888)             (254)             (280)            (4,422)
                                                            ---------------------------------------------------------------------
                             Total Purchase Price ...           $81,360            $2,324            $6,216            $89,900
                                                            =====================================================================
</TABLE>

      Onex Communications Corporation

            On September 21, 2001 the Company acquired Onex, which develops
      System Silicon Solutions for multi-service platforms. This acquisition was
      a strategic investment aimed at enhancing the Company's product offering
      with higher speed solutions. As a result of this acquisition, the Company
      issued 5,481,504 shares of its common stock and assumed 523,543 common
      stock options. The common stock issued was valued at the closing price of
      $8.80 per share as listed on the Nasdaq National Market on the date that
      the definitive merger agreement was signed (August 17, 2001) as the number
      of common shares to be issued were fixed on that date. This equates to a
      total fair value of $52.8 million in common stock. The Company also paid
      $20.0 million in


                                       48

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

      cash. The Company incurred transaction fees of approximately $3.5 million
      in conjunction with this purchase, which were substantially paid as
      December 31, 2001. This purchase, combined with a previous investment of
      $5.1 million accounted for under the cost method, brings the Company's
      total purchase price of Onex to $81.4 million.

            Purchased In-Process Research and Development

                  The $22.0 million allocated to IPR&D was determined through
            independent valuations using established valuation techniques in our
            industry. The value allocated to IPR&D was based upon the forecasted
            operating after-tax cash flows from the technology acquired, giving
            effect to the stage of completion at the acquisition date. Future
            cash flows were adjusted for the value contributed by any core
            technology and development efforts expected to be completed post
            acquisition. These forecasted cash flows were then discounted at
            rates commensurate with the risks involved in completing the
            acquired technologies taking into consideration the characteristics
            and applications of each product, the inherent uncertainties in
            achieving technological feasibility, anticipated levels of market
            acceptance and penetration, market growth rates and risks related to
            the impact of potential changes in future target markets. After
            considering these factors, the risk adjusted discount rates for the
            Onex products were determined to be 30%. Acquired technology that
            had not yet reached technological feasibility and for which no
            alternative future uses existed was expensed upon acquisition. The
            in-process technology acquired from Onex consisted of two projects:
            Switch Processor (SP) and Switch Element (SE). These projects are
            further described as follows:

                  The SP technology consists of highly integrated and
            programmable silicon that can combine any and all combinations of
            SONET/SDH transmission and native support for TDM, ATM and packet
            processing on a single chip. Significant features under development
            of the SP technology include the fact that SP is a 17 million gate
            device. The portion of in-process research and development allocated
            to this project was $14.1 million. It was estimated that the SP
            project was approximately 60% complete and the remaining costs to
            complete the project were $4.9 million. This project is expected to
            be completed in April 2002. The risks associated with the
            development of SP product are technical completion, timing, cost,
            and market risks. Technical completion must bear the risk that the
            technology's back-end layout is appropriate. Timing risk of
            developing the SP is significant due to the unpredictable nature of
            technical issues with such technology. Although a market exists for
            this type of product, producing the SP product cost-effectively and
            gaining general market acceptance has yet to be proven and presents
            risk to the success of the SP product.

                  The SE technology consists of a 30 Gbps (12 port OC-48) switch
            technology capable of switching TDM, ATM or variable length packet
            traffic. Significant features under development of the SE technology
            include frequency and phase synchronization. The portion of
            in-process research and development allocated to this project was
            $7.9 million. It was estimated that the SE technology was
            approximately 75% complete and the remaining costs to complete the
            project were $2.7 million. The initial development of this project
            was completed in December 2001 and was in the process of being
            tested at year end. The risks associated with the development of SE
            product are technical completion, timing, cost, and market risks.
            Technical completion for the initial prototype lots centers on the
            reliability of IBM's Unilink technology. Although a market for the
            SE product exists, producing the SE product cost-effectively and
            gaining general market acceptance has yet to be proven and presents
            risk to the success of the product.

            Goodwill

                  The excess purchase price, including the Company's original
            investment in Onex, over the fair value of the net identifiable
            assets and liabilities acquired of $40.6 million has been recorded
            as goodwill. In accordance with SFAS 141 and SFAS 142, the Company
            is not amortizing this asset as the transaction was completed after
            June 30, 2001, but will perform a periodic evaluation for
            impairment.


                                       49

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

            Patents

                  Patents of $1.6 million acquired were determined to have an
            estimated useful life of 10 years and are being amortized, on a
            straight-line basis, over this period.

            Proforma Financial Information

                  The following unaudited proforma financial information
            presents the combined results of operations of TranSwitch and Onex
            as if the acquisition had occurred on January 1, 2000. This
            presentation gives effect to certain adjustments including: the
            write-off of acquired in-process research and development,
            amortization of the acquired patents, additional depreciation
            expense and related income tax effects. The proforma financial
            information does not necessarily reflect the results of operations
            that would have occurred had TranSwitch and Onex constituted a
            single entity during such periods.

            <TABLE>
            <CAPTION>
                                                                 Twelve months ended
                                                                     December 31,
            Proforma results TranSwitch and Onex combined            (unaudited)
                                                               -----------------------
                                                                 2001           2000
                                                               -----------------------
            <S>                                                <C>            <C>
            Net revenues ................................      $ 58,682       $155,083
                                                               =======================

            (Loss) income before extraordinary gain .....       (94,391)        29,664
                                                               =======================

            Basic (loss) earnings per common share:
            (Loss) income before extraordinary gain .....      $  (1.09)      $   0.34
                                                               =======================

            Diluted (loss) earnings per common share:
            (Loss) income before extraordinary gain .....      $  (1.09)      $   0.32
                                                               =======================
            </TABLE>

      Horizon Semiconductors, Inc.

            On February 6, 2001, the Company acquired all of the outstanding
      stock of Horizon Semiconductors, Inc. (Horizon) for 43,507 shares of
      common stock valued at approximately $1.7 million, and $0.5 million of
      cash paid to Horizon stockholders. The common stock issued was valued at
      the average closing price of $38.47 per share as listed on the Nasdaq
      National Market for the twenty trading days immediately preceding the two
      trading days prior to the closing date in accordance with the purchase
      agreement. The total purchase price of approximately $2.3 million includes
      direct costs of the acquisition totaling approximately $0.2 million.
      Horizon is a specialized design company for test and diagnostics
      engineering and was acquired for the strategic value of its products and
      processes to TranSwitch.

            Goodwill of $2.1 million is being amortized on a straight-line basis
      over 5 years, and the assembled workforce of $0.2 million is being
      amortized on a straight-line basis over 3 years. As described in note 1,
      upon full adoption of SFAS 142 as of January 1, 2002 the Company will no
      longer amortize goodwill but perform periodic evaluations of impairment.
      In addition, assembled workforce is not an intangible asset under SFAS 142
      and will be combined with goodwill. Pro forma results of operations for
      Horizon have not been presented because the effects of this acquisition
      were not material to the financial statements either individually or
      combined with other acquisitions.

      ADV Engineering S.A.

            On January 18, 2001, the Company acquired all of the outstanding
      stock of ADV Engineering S.A. (ADV) for 129,971 shares of common stock
      valued, in the aggregate, at approximately $5.6 million. The common stock
      issued was valued at the average closing price of $42.85 per share as
      listed on the Nasdaq National Market for the thirty trading days
      immediately preceding the two trading days prior to the closing date in
      accordance with the purchase agreement. The total purchase price of
      approximately $6.2 million includes direct


                                       50

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

      costs of the acquisition totaling approximately $0.6 million. In addition,
      if ADV achieved certain milestones, the Company was obligated to pay out
      an additional $5 million in cash or stock in January 2002. Subsequent to
      year end, the milestones were achieved and the Company paid $5 million in
      cash on January 24, 2002; which we recorded as goodwill (refer to
      subsequent events, note 17 for additional detail). ADV is a fabless
      semiconductor company and was acquired for the strategic value of its
      products and processes to TranSwitch.

            Goodwill of $4.9 million is being amortized on a straight-line basis
      over 5 years, and the assembled workforce of $0.5 million was being
      amortized on a straight-line basis over 3 years. As described in note 1,
      the Company will adopt SFAS 142 as of January 1, 2002 at which time it
      will no longer amortize goodwill but perform periodic evaluations of
      impairment. In addition, assembled workforce is not an intangible asset
      under SFAS No. 141 and will be combined with goodwill. Pro forma results
      of operations for ADV have not been presented because the effects of this
      acquisition were not material to the financial statements either
      individually or combined with other acquisitions.

FISCAL YEAR 2000

      EASICS NV

            In May 2000, the Company completed a combination with EASICS NV, a
      Belgian communications semiconductor design service provider, in which
      Easics NV became a wholly-owned subsidiary of TranSwitch. The Company
      issued 505,382 shares of common stock in exchange for all of the
      outstanding stock of EASICS NV. The transaction was accounted for as a
      pooling-of-interests and, accordingly, the historical consolidated
      financial statements were restated to include the financial position,
      results of operations, and cash flows of EASICS NV for all periods
      presented. During the year ended December 31, 2000, merger-related
      transaction costs of $1.2 million were recorded and included under merger
      costs in the Consolidated Statements of Operations. There were no
      significant adjustments required to the accounting policies of EASICS NV.

      Alacrity Communications, Inc.

            On August 1, 2000, the Company acquired all of the outstanding stock
      of Alacrity for 266,836 shares of common stock, which includes the
      conversion of stock options to purchase 5,756 shares of common stock,
      valued, in the aggregate, at approximately $10.7 million. The total
      purchase price of approximately $11.3 million also includes professional
      fees and other direct costs of the acquisition totaling $0.6 million.
      Alacrity specializes in the development and marketing of high-capacity
      VLSI switching devices for telecommunications and data communications
      applications. The allocation of purchase price among tangible and
      intangible assets acquired and liabilities assumed are as follows:

            Tangible assets .......................      $    359
            Intangible assets:
            Goodwill ..............................         8,477
            Assembled workforce ...................           350
            In-process research and development ...         2,800
            Liabilities ...........................          (697)
                                                         --------
            Total purchase price ..................      $ 11,289
                                                         ========

            The amount allocated to in-process research and development of $2.8
      million was expensed upon acquisition, as it was determined that the
      underlying project had not reached technological feasibility, had no
      alternative future use and successful development was uncertain. The
      charge for IPR&D was based on a methodology that focused on the present
      value of after-tax cash flows attributable to the in-process project
      combined with the consideration of the stage of completion of the
      individual research and development project at the date of acquisition.


                                       51

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

            The significant assumptions used in determining the valuation of the
      IPR&D are as follows:

      o     Net cash inflows are anticipated to commence in 2002;

      o     Risk adjusted discount rate applied to cash flows of 30%; and

      o     No anticipated material changes from historical pricing margin and
            expense levels.

            To date, there have been no shipments related to this product or
      changes in development that would require an adjustment to the valuation.

Note 3. Investments in Marketable Securities and Investments in Non-Publicly
        Traded Companies

Investments in Marketable Securities

      The following table summarizes investments in securities classified as
cash and cash equivalents, short-term and long-term investments at December 31,
2001 and 2000:

<TABLE>
<CAPTION>
                                                                       Gross       Gross
                                                       Amortized    Unrealized   Unrealized
                                                         cost          Gains      (losses)    Fair value
                                                       -------------------------------------------------
<S>                                                    <C>           <C>           <C>         <C>
Fiscal Year Ended December 31, 2001
      Money market & certificates of deposit ....      $309,043      $     --      $  --       $309,043
      U.S. government & agency obligations ......        41,695           747         --         42,442
      Corporate bonds & commercial paper ........        66,020         1,797         --         67,817
                                                       -------------------------------------------------
                  Total at December 31, 2001 ....      $416,758      $  2,544      $  --       $419,302
                                                       =================================================

<CAPTION>
                                                                       Gross       Gross
                                                       Amortized     Unrealized  Unrealized
                                                         cost          Gains      (losses)    Fair value
                                                       -------------------------------------------------
<S>                                                    <C>           <C>           <C>         <C>
Fiscal Year Ended December 31, 2000
      Money market & certificates of deposit ....      $    748      $     --      $  --       $    748
      U.S. government & agency obligations ......       499,420            --       (502)       498,918
      Corporate bonds & commercial paper ........        81,304            --       (167)        81,137
                                                       -------------------------------------------------
                  Total at December 31, 2000 ....      $581,472      $     --      $(669)      $580,803
                                                       =================================================

<CAPTION>
                                                             December 31,
                                                         2001           2000
                                                       ----------------------
<S>                                                    <C>           <C>
Reported as:
            Cash and cash equivalents ...........      $350,910      $470,717
            Short-term investments ..............        39,344        56,572
            Long-term investments ...............        26,504        54,183
                                                       ----------------------
                  Total .........................      $416,758      $581,472
                                                       ======================
</TABLE>

      Marketable debt securities had scheduled maturities of less than three and
four years for the years ended December 31, 2001 and 2000 respectively.

      During the year ended December 31, 2001, the Company sold certain
held-to-maturity securities prior to their maturity date due to a decline in
credit quality of the underlying issuers. The total amortized cost of the
securities sold prior to maturity was approximately $5.4 million and the Company
recognized a loss of approximately $0.1 million on these sales. This loss is
netted against interest income on the Company's consolidated statements of
operations. There were no early sales of held -to- maturity securities during
the year ended December 31, 2000.

Investments in Non-Publicly Traded Companies

      The Company has purchased shares of convertible preferred stock of certain
privately held companies. The Company's direct and indirect (which include
certain board members and employees) voting interest is less than 20% of the
total ownership of each of these companies as of December 31, 2001, and the
Company does not exercise significant influence over the management of these
companies as defined by APB Opinion No. 18 "The


                                       52

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

Equity Method of Accounting for Investments in Common Stock," and other relevant
literature. During 2001, the Company has also purchased an interest of
approximately 48% in GTV Capital, L.P., a venture capital limited partnership.
This investment has been accounted for under the equity method. The Company has
recorded 48% of the limited partnership's losses from its date of investment
through December 31, 2001 which have been insignificant. Excluding GTV Capital,
L.P., all investments in non-publicly traded companies are carried at cost.

      The following table summarizes the Company's investments in non
publicly-traded companies at December 31, 2001 and 2000:

                                                                 December 31,
Investee company:                                              2001        2000
                                                             -------------------
TeraOp (USA) Inc. .........................................  $ 4,000      $   --
OptiX Networks, Inc. ......................................    3,658       2,554
Accordion Networks, Inc. ..................................    1,500          --
Intellectual Capital for Integrated Circuits, Inc. ........    1,385         831
Onex Communications Corporation(1) ........................       --       5,095
GTV Capital, L.P. .........................................    1,186         150
Systems On Silicon, Inc. ..................................      409          --
                                                             -------------------
                              Total minority investments ..  $12,138      $8,630
                                                             ===================

      (1)   The Company acquired Onex Communications Corporation during fiscal
            2001, refer to note 2.

      From time to time, the Company will conduct business transactions with the
companies listed above. During fiscal 2001, the Company contracted IC4IC, Inc.
to perform approximately $0.8 million in design services.

Note 4. Inventories

      The components of inventories at December 31, 2001 and 2000 are as
follows:

                                                         December 31,
                                                      2001         2000
                                                     -------------------
            Raw material ......................      $3,961      $ 1,414
            Work-in-process ...................       1,031        4,130
            Finished goods ....................       3,235        9,354
                                                     -------------------
                         Total inventories ....      $8,227      $14,898
                                                     ===================

      As a result of current and anticipated business conditions, as well as
lower than anticipated demand, the Company recorded a provision for excess
inventories of approximately $39.2 million during the year ended December 31,
2001. This provision was calculated in accordance with the Company's accounting
policy. The effect of this inventory provision was to write inventory down to a
new cost basis. There has been no subsequent disposal of inventory previously
written-down reflected in the consolidated statement of operations.


                                       53

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

Note 5. Property and Equipment, Net

      The components of property and equipment, net at December 31, 2001 and
2000 are as follows:

<TABLE>
<CAPTION>
                                                                   Estimated           December 31,
                                                                  Useful Lives      2001         2000
                                                                  -------------------------------------
<S>                                                                <C>            <C>          <C>
Purchased computer software...................................       3 years      $ 14,960     $ 10,071
Equipment.....................................................      3-7 years       14,209       13,221
Semiconductor tooling.........................................       3 years         1,232        1,232
Furniture.....................................................      3-7 years        3,037        2,741
Leasehold improvements........................................     Lease term*       1,548        1,394
Construction in-progress (software and equipment).............                       1,683          737
                                                                                  ---------------------
Gross property and equipment..................................                      36,669       29,396
Less accumulated depreciation and amortization................                     (17,723)     (15,932)
                                                                                  ---------------------
Property and equipment, net...................................                    $ 18,946     $ 13,464
                                                                                  =====================
</TABLE>

----------
* Shorter of estimated useful life or lease term.

      Depreciation expense was $6.1, $4.6 and $3.5 million for the years ended
December 31, 2001, 2000 and 1999, respectively.

Note 6. Segment Information and Major Customers

      Under SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," the Company uses the "management" approach to reporting
segments. The management approach designates the internal organization that is
used by management for making operating decisions and assessing performance as
the source of the Company's reportable segments. SFAS No. 131 also requires
disclosures about products and services, geographic areas, and major customers.
Under SFAS No. 131, there is one business segment: communication semiconductor
products.

Products and Services

      TranSwitch's products are VLSI semiconductor devices that provide core
functionality of communications network equipment. The integration of various
technologies and standards in these devices result in a homogeneous product line
for management and measurement purposes.


                                       54

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

Enterprise-wide Information

      Enterprise-wide information provided on geographic net revenues is based
on the customer's ordering location. Long-lived asset information is based on
the physical location of the assets. The following tables present net revenues
and long-lived assets information for geographic areas:

<TABLE>
<CAPTION>
                                                 Years ended December 31,
                                          2001            2000             1999
                                        ----------------------------------------
<S>                                     <C>             <C>              <C>
Net revenues:
      United States ...........         $17,922         $ 84,517         $50,334
      Canada ..................           1,193              988           2,458
      Germany .................          10,882            4,259             610
      United Kingdom ..........           6,142           24,423           2,283
      China ...................           8,418           15,150           2,358
      Korea ...................           5,613           14,285           2,864
      Israel ..................           4,838            7,520           2,937
      Other countries .........           3,674            3,941           9,689
                                        ----------------------------------------
            Total .............         $58,682         $155,083         $73,533
                                        ========================================

<CAPTION>
                                                      December 31,
                                          2001            2000             1999
                                        ----------------------------------------
<S>                                     <C>             <C>              <C>
Long-lived assets:
      United States ...........         $84,926         $ 28,524         $ 8,841
      Other countries .........           3,276            3,093           1,767
                                        ----------------------------------------
            Total .............         $88,202         $ 31,617         $10,608
                                        ========================================
</TABLE>

Information about Major Customers

      The Company ships its products to both distributors and directly to end
customers. The following tables set forth the percentage of net revenues
attributable to all of the Company's major distributors as well as the
significant customers that had total purchases (either direct or through
distributors) of greater than 10% of net revenues for the three years ended
December 31, 2001:

<TABLE>
<CAPTION>
                                                                    Years ended December 31,
                                                              2001           2000         1999
                                                              --------------------------------
<S>                                                            <C>            <C>          <C>
Distributors:
      Insight Electronics, Inc.(1).......................      24%            32%          33%
      Weone Corporation (2)..............................      10%             *            *
      Unique Memec (3)...................................      10%            16%           *
      Arrow Electronics, Inc.(4).........................       *              *           18%

Significant Customers:
      Siemens AG (3).....................................      21%             *            *
      Redback Networks, Inc. (1).........................      12%             *            *
      Samsung Corporation (2)............................      11%             *            *
      Lucent Technologies, Inc. (1)(5)...................      11%            11%          16%
      Tellabs, Inc. (1)(4)...............................       *             16%          13%
      Nortel Networks Corporation (1)(4).................       *              *           13%
</TABLE>

------------
      (1)   The end customers of the shipments to Insight Electronics, Inc.
            include Redback Networks, Inc. in 2001, Lucent in 2001, 2000 and
            1999, a portion of Tellabs, Inc. purchases in 2000 and a portion of
            Nortel Networks Corporation's purchases in 1999.
      (2)   The primary end customer of the shipments to Weone Corporation was
            Samsung Corporation in 2001.


                                       55

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

      (3)   A portion of the shipments to Siemens AG were distributed through
            Unique Memec.
      (4)   The end customers of the shipments to Arrow Electronics, Inc.
            include Tellabs, Inc. in 1999 and 2000 as well as Nortel Networks
            Corporation in 1999.
      (5)   Shipments to Lucent Technologies, Inc. also includes those made to
            Ascend Communications, which was acquired by Lucent Technologies,
            Inc. during 1999.

*     Revenues were less than 10% of our net revenues in these years.

Note 7. Income Taxes

      The components of income (loss) before income taxes and extraordinary gain
for the three years ended December 31, 2001 are as follows:

<TABLE>
<CAPTION>
                                                                              Years ended December 31,
                                                                          2001           2000         1999
                                                                       ------------------------------------
<S>                                                                    <C>             <C>          <C>
U.S. domestic income (loss) .....................................      $(139,732)      $62,085      $22,262
Foreign income ..................................................          1,325           653          260
                                                                       ------------------------------------
Income (loss) from before income taxes and extraordinary gain ...      $(138,407)      $62,738      $22,522
                                                                       ====================================
</TABLE>

      The provision (benefit) for income taxes is comprised of the following:

                                                  Years ended December 31,
                                             2001           2000          1999
                                          -------------------------------------
      Federal income taxes:
            Current ..................... $     --        $19,638       $ 1,581
            Deferred ....................  (36,906)         1,184        (4,682)
      State income taxes:
            Current .....................       --          3,210           434
            Deferred ....................   (2,395)            90          (263)
      Foreign income taxes:
            Current .....................      451            261           216
            Deferred ....................       --             --           (98)
                                          -------------------------------------
      Income tax expense (benefit) ...... $(38,850)       $24,383       $(2,812)
                                          =====================================

      In addition, there was income tax expense of $13.2 million related to the
extraordinary gain from the repurchase of the 4 1/2% Convertible Notes due 2005.

      The following table summarizes the differences between the U.S. federal
statutory rate and the Company's effective tax rate for financial statement
purposes for the three years ended December 31, 2001:

                                                    Years ended December 31,
                                                2001         2000         1999
                                               --------------------------------
      U.S. federal statutory tax rate ......   (35.0)%       35.0%        35.0%
      State taxes ..........................    (1.8)         3.4          0.8
      In-process research and development ..     5.6          1.6           --
      Foreign sales corporation benefit ....      --         (1.9)          --
      Change in valuation allowance ........     2.4           --        (48.2)
      Permanent differences and other ......     0.7          0.8         (0.1)
                                               --------------------------------
      Effective income tax rate ............   (28.1)%       38.9%       (12.5)%
                                               ================================


                                       56

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

      The tax effect of temporary differences that give rise to deferred income
tax assets and deferred income tax liabilities at December 31, 2001 and 2000 are
presented below:

<TABLE>
<CAPTION>
                                                                         2001           2000
                                                                       -----------------------
<S>                                                                    <C>            <C>
Deferred income tax assets:
      Property and equipment ....................................      $  1,117       $    302
      Other nondeductible reserves ..............................         1,645          3,776
      Restructuring reserve .....................................        10,864             --
      Capitalized research & development for tax purposes .......         5,636             --
      Capitalized start up costs for tax purposes ...............         1,998             --
      Net operating losses ......................................        48,268         19,306
      Research & development and other credits ..................        10,868          3,158
      Other .....................................................         1,165             64
                                                                       -----------------------
      Total gross deferred income tax assets ....................        81,561         26,606
      Less valuation allowance ..................................       (12,289)          (833)
                                                                       -----------------------
      Net deferred income tax assets ............................        69,207         25,773
                                                                       -----------------------
      Deferred income tax liabilities
            Other ...............................................          (713)           (62)
                                                                       -----------------------
      Total deferred income taxes, net of valuation allowance ...      $ 68,559       $ 25,711
                                                                       =======================
</TABLE>

      The valuation allowance of $12.3 million relates to state tax net
operating losses and federal and state research and development and other
credits which management believes it more likely than not will expire
unutilized. Subsequently recognized income tax benefits, if any, in the amount
of $3.8 million will be applied directly to additional paid-in capital and $0.6
million will be applied to reduce goodwill. Of the total deferred income tax
assets at December 31, 2001, $3.0 million is recorded as current and $65.5
million is recorded as non-current.

      At December 31, 2001, the Company had available, for federal income tax
purposes, net operating loss ("NOL") carryforwards of approximately $126.2
million and research and development tax credit carryforwards of approximately
$7.2 million expiring in varying amounts from 2003 through 2021. For state
income tax purposes, the Company had available NOL carryforwards of
approximately $45.6 million and state tax credit carryforwards of $5.3 million
expiring in varying amounts from 2002 to 2021.

      Certain transactions involving the Company's beneficial ownership have
occurred which resulted in a stock ownership change for purposes of Section 382
of the Internal Revenue Code of 1986, as amended. Consequently, approximately
$21.9 million of the NOL carryforwards and $1.4 million of research and
development tax credit carryforwards are subject to these limitations. However,
the Company believes it is more likely than not that the NOL carryforwards will
be utilized.

Note 8. Stockholders' Equity

Stockholders' Rights Plan

      On October 1, 2001, the Board of Directors enacted a stockholder rights
plan and declared a dividend of one preferred share purchase right for each
outstanding share of TranSwitch common stock outstanding at the close of
business on October 1, 2001 to the stockholders of record on that date. Each
stockholder of record as of October 1, 2001 received a summary of the rights and
any new stock certificates issued after the record date contain a legend
describing the rights. Each preferred share purchase right entitles the
registered holder to purchase from us one one-thousandth of a share of Series A
Junior Participating Preferred Stock, par value $0.001 per share, of the
Company, at a price of $50.00 per one one-thousandth of a Preferred Share,
subject to adjustment, upon the occurrence of certain triggering events,
including the purchase of 15% or more of the Company's outstanding common stock
by a third party. Until a triggering event occurs, the common stockholders have
no right to purchase shares under the stockholder rights plan. If the right to
purchase the preferred stock is triggered, the common stockholders will have the
ability to purchase sufficient stock to significantly dilute the 15% or greater
holder.


                                       57

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

Stock Buyback

      On September 17, 2001, the Company announced it had adopted a plan to buy
back up to 10% of the then outstanding shares of its common stock, based on the
price and general market conditions over the next twelve months. The purpose for
this stock buy back plan was to stabilize the price of the Company's common
stock following the events of September 11, 2001. During the year ended December
31, 2001, TranSwitch repurchased 1,010,000 shares at an average price of $4.13
per share for approximately $4.2 million. Accordingly, this transaction has been
reflected on the Company's consolidated balance sheets and consolidated
statements of cash flows. The stock repurchases were made with the Company's
available cash and cash equivalents.

Authorized Shares

      In connection with the May 2000 annual shareholders' meeting, the
shareholders approved an increase to the authorized number of shares of common
stock from 100,000,000 to 300,000,000 shares.

Stock Splits

      In June 1999 and January 2000, the Company effected three-for-two splits,
and in August 2000, the Company effected a two-for-one split of its common stock
paid in the form of a stock dividend. All share and per share data for all
periods presented have been adjusted to reflect these stock splits.

Follow-on Common Stock Offering

      On February 9, 1999 and March 16, 1999, the Company completed a follow-on
public offering of 8,797,500 shares of its common stock for net proceeds, after
issuance costs, of $68.2 million.

Note 9. Employee Benefit Plans

Employee Stock Purchase Plan

      To provide employees with an opportunity to purchase common stock through
payroll deductions, the Company established the 1995 Employee Stock Purchase
Plan (the "Purchase Plan"), under which 450,000 shares of common stock have been
reserved for issuance. Under the Purchase Plan, eligible employees may purchase
a limited number of shares of common stock at 85% of the fair market value at
either the date of enrollment or the date of purchase, whichever is less. Under
the Purchase Plan, 75,585, 10,340 and 25,305 shares were issued in 2001, 2000,
and 1999, respectively. At December 31, 2001, 62,542 shares remained available
for future issuance.

Stock Option Plans

      The Company has three stock options plans: the 1995 Stock Plan, as amended
(the "1995 Plan"); the 1995 Non-Employee Director Stock Option Plan (the
"Director Plan"); and the 2000 Stock Option Plan (the "2000 Plan").

      With respect to the 1995 Plan, in connection with the May 2000 annual
shareholders meeting, the shareholders approved an increase to the maximum
number of shares reserved and authorized for issuance to 31,400,000 shares of
TranSwitch common stock, pursuant to the grant to employees of incentive stock
options and the grant of non-qualified stock options, stock awards or
opportunities to make direct purchases of common stock to employees,
consultants, directors and executive officers. The terms of the options granted
are subject to the provisions of the 1995 Plan as determined by the Compensation
Committee of the Board of Directors. The 1995 Plan will terminate ten years
after its adoption unless earlier terminated by the Board of Directors. As of
December 31, 2001, 7,026,102 shares were available for grant under the 1995
Plan.

      The 2000 Plan, adopted by the Board of Directors on July 14, 2000 and
amended on December 21, 2001, provides for the grant of non-qualified options to
purchase shares of common stock, up to an aggregate of 10,000,000 shares, to
employees and consultants. No member of the Board of Directors or executive
officers as


                                       58

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

appointed by the Board of Directors shall be eligible for grants of options
under the 2000 Plan. The terms of the options granted are subject to the
provisions of the 2000 Plan as determined by the Compensation Committee of the
Board of Directors. Each non-qualified stock option shall either be fully
exercisable on the date of grant or shall become exercisable thereafter in such
installments as the Board of Directors may specify. The 2000 Plan will terminate
ten years after its adoption. No option granted under the 2000 Plan may be
exercised after the expiration of seven years from the date of grant. The
exercise price of options under the 2000 Plan must be equal to the fair market
value of the Common Stock on the date of grant. Options granted under the 2000
Plan are generally nontransferable. As of December 31, 2001, 2,878,419 shares
were available for grant under the 2000 Plan.

      The Director Plan provides for the automatic grant of options to purchase
shares of common stock, up to an aggregate of 1,575,000 shares, to non-employee
directors on the anniversary date of each individual board member joining the
Board of Directors. Upon joining the Board of Directors, each director is
granted an option to purchase 37,500 shares, one-third of which vest
immediately, one-third after the first year, and the remaining one-third after
the second year. Annually thereafter, each director is granted an option to
purchase 28,800 shares, which vest fully after one year.

      The Director Plan is administered by the Compensation Committee of the
Board of Directors. No option granted under the Director Plan may be exercised
after the expiration of five years from the date of grant. The exercise price of
options under the Director Plan must be equal to the fair market value of the
common stock on the date of grant. Options granted under the Director Plan are
generally nontransferable. As of December 31, 2001, 9,899 shares were available
for grant under the Director Plan.

      Information regarding stock options is set forth as follows:

                                                    Number    Weighted average
                                                  of options   exercise price
                                                 outstanding      per share
                                              --------------------------------
      Outstanding at December 31, 1998 ...       12,909,430       $    2.65
            Granted ......................        5,470,116           11.54
            Exercised ....................       (3,643,948)           1.83
            Canceled .....................         (915,526)           4.54
                                              --------------------------------
      Outstanding at December 31, 1999 ...       13,820,072       $    8.76
            Granted and assumed ..........        6,442,610           33.55
            Exercised ....................       (4,173,771)           5.04
            Canceled .....................         (255,034)          13.64
                                              --------------------------------
      Outstanding at December 31, 2000 ...       15,833,877       $   25.45
            Granted and assumed ..........        9,582,662           14.35
            Exercised ....................       (1,701,777)           4.68
            Canceled .....................       (2,169,907)          22.03
                                              --------------------------------
      Outstanding at December 31, 2001 ...       21,544,855       $   16.61
                                              ================================

      The Company has, in connection with the acquisitions of various companies,
assumed the stock option plans of each acquired company, and the related options
are included in the preceding table.


                                       59

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

      Options outstanding and exercisable at December 31, 2001 are as follows:

<TABLE>
<CAPTION>
                                                       Options Outstanding                             Options Exercisable
                                         -----------------------------------------------          ------------------------------
                                                             Weighted
                                                             Average            Weighted                                Weighted
                                                            Remaining           average                                  average
           Range of                         Number         Contractual          exercise             Number             exercise
       Exercise prices                   outstanding           Life              price            exercisable             price
--------------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>                  <C>               <C>               <C>                   <C>
$ 0.92 to  2.96................            2,173,215           6.49              $ 2.07            1,676,607             $ 2.07
  3.10 to  3.94................            2,152,006           6.75                3.41            1,503,111               3.31
  4.02 to  5.00................            2,201,481           6.80                4.15              113,439               4.20
  5.46 to  9.98................            4,279,421           6.01                8.91            1,653,738               8.65
 10.05 to 15.00................            2,161,817           6.11               11.56              295,815              12.91
 15.37 to 19.78................            2,125,155           4.96               18.70            1,140,685              18.86
 20.06 to 39.94................            4,783,885           5.69               31.83            1,381,667              31.46
 40.26 to 67.81................            1,667,875           5.49               49.05              550,468              47.63
                                  ----------------------------------------------------------------------------------------------
$ 0.92 to 67.81................           21,544,855           6.01              $16.61            8,315,530             $14.22
                                  ==============================================================================================
</TABLE>

      Stock options generally expire five, seven or ten years from the date of
grant and generally vest ratably over four years from the date of grant and
exercisable thereafter.

      As part of our November 2001 Restructuring Plan (see note 11), which
resulted in a wage freeze and salary reductions throughout the Company, the
Board of Directors approved a special option grant for most employees where
options have a two year vesting schedule beginning in January 2002. These
grants, which occurred in November 2001, were for approximately 2 million shares
and are included in the $4.02 to $5.00 range above.

Stock-Based Compensation Fair Value Disclosures

      As permitted by SFAS 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), the Company applies APB 25 and related interpretations in accounting for
stock-based awards. Under APB 25, no compensation expense is recognized in the
financial statements for employee stock options because the exercise price of
the option equals the market price of the underlying stock on the date of grant.

      The Company is required under SFAS 123 to disclose pro forma information
regarding option grants made to employees based on specified valuation
techniques that produce estimated compensation charges. Pro forma information
under SFAS 123 is as follows:

                                               Years ended December 31,
                                           2001           2000          1999
                                        -------------------------------------
Net income (loss):
      As reported ................      $ (77,464)      $38,355       $25,334
      Pro forma ..................      $(137,185)      $(4,113)      $13,254
Basic earnings (loss) per share:
      As reported ................      $   (0.89)      $  0.47       $  0.33
      Pro forma ..................      $   (1.58)      $ (0.05)      $  0.17
Diluted earnings (loss) per share:
      As reported ................      $   (0.89)      $  0.44       $  0.31
      Pro forma ..................      $   (1.58)      $ (0.05)      $  0.16


                                       60

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

      The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing with the following assumptions:

                                     2001         2000         1999
                                     -------------------------------
      Risk-free interest rate ....    4.7%         5.1%         6.7%
      Expected life in years .....    2.9          3.0          3.2
      Expected volatility ........   97.6%        85.8%        73.0%
      Expected dividend yield ....     --           --           --

      The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected volatility of the stock price.
Because the Company's stock-based awards have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock-based awards to employees.

      The weighted average fair value of stock options granted, calculated using
the Black-Scholes option-pricing model, is $11.86, $19.03 and $6.16 for the
three years ended December 31, 2001.

      As required by SFAS 123, the Company recognized compensation expense
related to stock options granted to non-employees of $.09 million, $.06 million,
and $.06 million for each of the three years ended December 31, 2001,
respectively.

Employee 401(k) Plan

      TranSwitch sponsors a 401(k) plan known as the TranSwitch Corporation
401(k) Retirement Plan (the "Plan"). The Plan provides tax-deferred salary
deductions for eligible employees. Employees may contribute from 1% to 20% of
their annual compensation to the Plan, limited to an annual maximum amount as
set periodically by the Internal Revenue Service. The Company provides matching
contributions equal to 50% of the employees' deferred compensation, up to a
maximum of 6% of the employee's annual compensation. All matching contributions
vest immediately. The contribution expense related to the Plan amounted to $0.6
million, $0.4 million and $0.3 million for each of the three years ended
December 31, 2001, respectively.

Note 10.  4 1/2% Convertible Notes due 2005 and Extraordinary Gain

      In September 2000, the Company issued $460 million of 4 1/2% Convertible
Notes due September 12, 2005, and received proceeds of $444 million, net of debt
issuance costs. The notes are convertible, at the option of the holder, at any
time on or prior to maturity, into shares of common stock at a conversion price
of $61.9225 per share.

      The notes are unsecured and unsubordinated obligations and rank on a
parity in right of payment with all existing and future unsecured and
unsubordinated indebtedness.

      The Company may redeem the notes, in whole or in part, at any time on or
prior to September 12, 2003 at a redemption price equal to 100 percent of the
principal amount of notes to be redeemed plus accrued and unpaid interest, if
any, to the date of redemption if the closing price of the Company's common
stock has exceeded 150 percent of the conversion price then in effect for at
least 20 trading days within a period of 30 consecutive trading days
("Provisional Redemption").

      Upon any Provisional Redemption, the Company will make an additional
payment with respect to the notes called for redemption in an amount equal to
$135 per $1,000 principal amount of notes, less the amount of any interest
actually paid on the notes before the provisional redemption date. These
additional payments are made, at each holder's option, either in cash or common
stock or a combination of both.


                                       61

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

      During the second and third quarters of 2001, the Company repurchased some
of its outstanding 4 1/2% Convertible Notes due September 12, 2005. The gain on
these repurchases, net of deferred financing fees and income taxes, has been
recorded as an extraordinary gain in the consolidated statement of operations.
Details of the repurchase and resulting gain on these notes for the year ended
December 31, 2001 are as follows:

                                                                   Year ended
                                                               December 31, 2001
                                                               -----------------
      4 1/2% Convertible Notes due 2005 repurchased at par ...     $ 145,950
      Write-off of related deferred financing fees ...........        (4,480)
      Purchase price of 4 1/2% Convertible Notes due 2005 ....      (106,163)
                                                                   ---------
      Gain on repurchase of notes
                                                                      35,307

      Income taxes on gain on repurchase of notes ............       (13,214)
                                                                   ---------
      Extraordinary gain .....................................     $  22,093
                                                                   =========

      The Company has funded the repurchases of the 4 1/2% Convertible Notes due
2005 from available cash, cash equivalents and short-term investments. Refer
also to note 17 - subsequent events regarding additional repurchases of these
notes.

Note 11.  Restructuring and Asset Impairment Charges

      The Company announced restructuring plans on July 16, 2001 (the "July
Plan") and November 15, 2001 (the "November Plan") due to current and
anticipated business conditions. These plans resulted in the elimination of
seventy-seven positions in North America and the closing of four office
buildings in Canada, Massachusetts and Connecticut. A summary and explanation of
the restructuring charges and outstanding liabilities are as follows:

                                                July       November
                                                Plan         Plan        Total
                                               --------------------------------
Restructuring Charges:
Employee termination benefits ...............  $1,292      $ 1,944      $ 3,236
Costs to exit facilities ....................      --       29,256       29,256
                                               --------------------------------
              Total Restructuring charges ...  $1,292      $31,200      $32,492
                                               ================================

Restructuring Liabilities:

Current .....................................  $   --      $ 2,999      $ 2,999
Long-term ...................................      --       26,925       26,925
                                               --------------------------------
          Total Restructuring Liabilities ...  $   --      $29,924      $29,924
                                               ================================

      The July Plan consisted of employee termination benefits of approximately
$1.3 million related solely to a workforce reduction of thirty positions in
North America and across all functional areas of the Company. These employees
were terminated during the third quarter of 2001 and provided severance and
related benefits. As of December 31, 2001, all obligations under the July Plan
have been paid.

      The November Plan consisted of employee termination benefits of
approximately $1.9 million related to a workforce reduction of forty-seven
positions in North America and across all functional areas of the Company. These
employees were terminated during the fourth quarter of 2001 and provided
severance and related benefits. As of December 31, 2001, the Company has made
cash payments totaling approximately $0.6 million which have been charged
against the restructuring liabilities. The remaining $1.3 million in employee
termination obligations under this plan is included in current restructuring
liabilities on the consolidated balance sheet and is expected to be paid out
during the first quarter of 2002.


                                       62

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

      The November Plan also included the closing of two facilities in Shelton,
Connecticut, one facility in Stoneham, Massachusetts and one facility in
Montreal, Canada. The Company is obligated through fiscal 2017 for certain lease
commitments for the facilities that were exited. The Company has secured and is
in the process of negotiating sub-lease commitments with interested parties on a
portion of the excess space over the next several years. The space for which
there are no sub-lease commitments in place as of December 31, 2001, the Company
has taken a charge of $28.6 million which represents the remaining future
minimum lease payments and operating cost obligations related to these excess
facilities net of future expected sublease income. Of this outstanding rent
obligation, approximately $1.7 million is included in current restructuring
liabilities on the consolidated balance sheets and $26.9 million is included in
restructuring liabilities - long term on the consolidated balance sheets.

      Excess furniture, leasehold improvements and equipment of $0.6 million was
written off in conjunction with these facility closures.

      During the year ended December 31, 2001, the Company also reduced the
asset carrying value of a technology product license and certain tooling by
approximately $1.7 million as a result of an impairment analysis performed
pursuant to SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of.

Note 12.  Earnings (Loss) Per Share

      Basic earnings (loss) per share for the three years ended December 31,
2001 are as follows:

                                                   Years ended December 31,
                                               2001          2000         1999
                                            -----------------------------------
Net (loss) income .......................   $(77,464)      $38,355      $25,334
                                            ===================================
Weighted average shares (in thousands) ..     86,904        81,681       76,676
Basic earnings per share ................   $  (0.89)      $  0.47      $  0.33
                                            ===================================

      Diluted earnings per share for the years ended December 31, 2001, 2000,
and 1999 are as follows:

<TABLE>
<CAPTION>
                                                                        Years ended December 31,
                                                                    2001           2000         1999
                                                                  -----------------------------------
<S>                                                               <C>            <C>          <C>
Net income (loss) ..........................................      $(77,464)      $38,355      $25,334
                                                                  ===================================
Weighted average common shares outstanding for the
   period (in thousands) ...................................        86,904        81,681       76,676
Stock options, net of assumed treasury share repurchases
  (in thousands)(1) ........................................            --         5,878        4,920
                                                                  -----------------------------------
Adjusted weighted average shares outstanding for the
  period (in thousands) ....................................        86,904        87,559       81,596
                                                                  ===================================
Diluted earnings (loss) per share(2) .......................      $  (0.89)      $  0.44      $  0.31
                                                                  ===================================
</TABLE>

      (1) As the Company recorded a loss in fiscal year 2001, the assumed
      exercise of dilutive securities (4.3 million shares of in-the-money stock
      options) was not considered as they would have been anti-dilutive.

      (2) For purposes of calculating the dilutive earnings (loss) per share for
      the year ended December 31, 2000, the assumed conversion of 4 1/2%
      Convertible Notes due 2005 is not taken into consideration as its effect
      is anti-dilutive. For the purposes of calculating diluted earnings per
      share had the 4 1/2% Convertible Notes due 2005 been converted,
      approximately $6.2 and $3.8 million of interest expense (after tax) would
      have been added to net income during the years ended December 31, 2001 and
      2000, respectively. Also, 5,072,000 and 2,476,000 additional shares of
      common stock would have been assumed outstanding for the years ended
      December 31, 2001 and 2000, respectively.


                                       63

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

Note 13. Commitments and Contingencies

Line of Credit

      The Company had a line of credit agreement in place with Silicon Valley
Bank that expired in July 2001. As the Company did not have an outstanding
balance on this obligation and had sufficient cash and investments to fund
operations as well as its investment and financing requirements for at least
through the end of fiscal 2002, it did not renew this line of credit and was
released from all its obligations, restrictions and financial covenants.

Development Agreements

      From time to time, TranSwitch and its subsidiaries have entered into
agreements with third parties for the development and/or licensing of products
for its manufacture and sale, or the licensing of technology that may be used in
the manufacture of products, for which royalties are paid based upon actual
sales of these products. The Company recognized royalty expense of $0.3, $0.2
and $0.6 million in the three years ended December 31, 2001, respectively. These
amounts are included in cost of revenues in the consolidated statements of
operations.

Lease Agreements

      The Company leases buildings and equipment at its headquarters in Shelton,
Connecticut as well as at its subsidiaries worldwide. Total rental costs
expensed under all operating lease agreements was $2.1, $1.3 and $1.2 million in
the years ended December 31, 2001, 2000, and 1999, respectively.

      Future minimum operating lease commitments, including contractually
obligated building operating commitments, that have remaining, non-cancelable
lease terms in excess of one year at December 31, 2001 are as follows:

            2002..................................           $ 4,378
            2003..................................             4,911
            2004..................................             4,534
            2005..................................             3,797
            2006..................................             3,523
            Thereafter............................            25,449
                                                             -------
                                                             $46,592
                                                             =======

      During the fiscal year ended December 31, 2001, the Company recorded a
restructuring charge for the rent and operating cost commitments on excess
facilities in the amount of $28.6 million (see note 11).

Note 14. Supplemental Cash Flow Information

      The following represents supplemental cash flow information:

<TABLE>
<CAPTION>
                                                                                       Years ended December 31,
                                                                                    2001          2000          1999
                                                                                   ---------------------------------
<S>                                                                                <C>          <C>             <C>
Cash paid for interest.......................................................      $22,700      $    24         $ 62
Cash paid for income taxes...................................................      $   164      $ 1,276         $669
</TABLE>

      The following represents a supplemental schedule of non-cash investing and
financing activities:

<TABLE>
<S>                                                                                <C>          <C>             <C>
Company common stock issued in acquisitions..................................      $60,106      $10,657           --
Capital lease obligations in connection with property and equipment..........      $   202      $   340           --
</TABLE>

      The Company includes capital lease obligations as part of accrued expenses
on the consolidated balance sheets.


                                       64

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

Note 15. Quarterly Information (Unaudited)

      The following tables contain selected unaudited consolidated statement of
operations data for each quarter of fiscal years 2001 and 2000. The Company
believes that the following information reflects all normal recurring
adjustments necessary for a fair presentation of the information for the periods
presented. The operating results for any quarter are not necessarily indicative
of results to be expected for any future period.

<TABLE>
<CAPTION>
                                                                       First     Second       Third      Fourth
                                                                      Quarter    Quarter     Quarter     Quarter      Year
                                                                      -------    -------     -------     -------      ----
<S>                                                                   <C>       <C>         <C>         <C>         <C>
Year ended December 31, 2001
Net revenues ......................................................   $38,650   $ 11,032    $  4,502    $  4,498    $ 58,682
Cost of revenues ..................................................    11,596      6,306       1,163       2,198      21,263
Cost of revenues - provision for excess inventories ...............        --     24,694          --      14,524      39,218
Gross profit ......................................................    27,054    (19,968)      3,339     (12,224)     (1,799)
Income (loss) before extraordinary gain ...........................     5,559    (25,980)    (33,167)    (45,969)    (99,557)
Net income (loss) .................................................   $ 5,559   $(13,838)   $(22,249)   $(46,936)   $(77,464)

Earnings (loss) per common share before extraordinary items(1):
      Basic .......................................................   $  0.07     ($0.30)     ($0.38)     ($0.51)     ($1.14)
      Diluted .....................................................   $  0.06     ($0.30)     ($0.38)     ($0.51)     ($1.14)

Earnings (loss) per common share(1):
      Basic .......................................................   $  0.07     ($0.16)     ($0.25)     ($0.52)     ($0.89)
      Diluted .....................................................   $  0.06     ($0.16)     ($0.25)     ($0.52)     ($0.89)

Year ended December 31, 2000
Net revenues ......................................................   $27,359   $ 34,072    $ 42,600    $ 51,052    $155,083
Cost of revenues ..................................................     8,777     10,412      12,506      14,452      46,147
Gross profit ......................................................    18,582     23,660      30,094      36,600     108,936
Net income ........................................................   $ 6,478   $  7,949    $  9,135    $ 14,793    $ 38,355

Earnings (loss) per common share(1):
      Basic .......................................................   $  0.08       0.10        0.11        0.18        0.47
      Diluted .....................................................   $  0.07       0.09        0.11        0.17        0.44
</TABLE>

--------
(1) The sum of quarterly per share amounts may not equal per share amounts
reported for year-to-date periods. This is due to changes in the number of
weighted average shares outstanding and the effects of rounding for each period.

Note 16. Fourth Quarter Results

      In the fourth quarter of fiscal 2001, the Company announced a
restructuring plan as well as a number of other charges which impacted its
operating results. These charges, which are further described throughout these
footnotes, included: (1) the write-down of approximately $14.5 million of excess
inventory based on the Company's assessment of demand for current products, (2)
the impact of approximately $31.2 million of restructuring costs of which
approximately $1.8 million was related to the November 2001 workforce reduction
and the remainder relating to the consolidation of four TranSwitch locations
including future lease commitments, (3) a one-time non-cash charge of
approximately $1.1 million to reflect the impairment of certain software, tools
and licenses and (4) a non-cash charge of approximately $4.2 million (after tax)
related to the valuation allowance for deferred income taxes and other income
tax adjustments. Refer also to note 15 which summarizes of the Company's
quarterly information.


                                       65

<PAGE>

                     TRANSWITCH CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
       (Tabular dollars in thousands, except share and per share amounts)

Note 17. Subsequent Events

A. On January 24, 2002, ADV achieved certain milestones that had been set in its
purchase agreement. As a result, TranSwitch paid $5.0 million in cash that was
recorded as additional goodwill on the consolidated balance sheets.

B. On January 24, 2002, the Company pledged $1.4 million in available cash and
cash equivalents as collateral for a stand-by letter of credit that guarantees
certain long-term property lease obligations.

C. On February 11, 2002, the Company's Board of Directors approved a tender
offer to purchase up to $200 million (the Offer Amount) aggregate principal
amount of the Company's outstanding 4 1/2% Convertible Notes due 2005 at a price
not greater than $700 nor less than $650 per $1,000 principal amount, plus
accrued and unpaid interest thereon to, but not including, the date of the
purchase. This tender offer expired at midnight on March 11, 2002 and the
Company repurchased $199.9 million face value of the outstanding notes at the
price of $700 per $1,000 principal amount for a cash payment of $139.9 million.
Net of taxes, deferred financing costs and transaction fees, the Company expects
that this transaction to result in an extraordinary gain of approximately $32.5
million which will be recorded in the first quarter of 2002. Upon completion of
the tender offer, the remaining outstanding balance of the 4 1/2% Convertible
Notes due 2005 is $114.1 million.


                                       66

<PAGE>

                                   Schedule II
                             TranSwitch Corporation
                        Valuation and Qualifying Accounts
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                   ----------------------
                                                                          Additions
                                                       ----------------------------------------------------------------
                                                       Balance at  Charges to     Charges                      Balance
                                                       Beginning    Costs and    to Other                      at End
                                                       of Period    Expenses     Accounts      Deductions     of Period
                                                       ----------------------------------------------------------------
<S>                                                     <C>          <C>          <C>           <C>            <C>
                    Description

Year ended December 31, 2001:
Allowance for losses on:
      Accounts receivable ........................      $   604      $ 1,769      $    --       $   (772)      $ 1,601
      Inventory(1) ...............................        1,791       39,154           --        (40,945)           --
      Sales returns and allowance ................        1,050        5,469           --         (4,619)        1,900
      Stock rotation .............................        1,550        5,427           --         (6,577)          400
      Warranty ...................................          504          187           --           (541)          150
Deferred income tax assets valuation allowance ...          833       11,456           --             --        12,289
                                                       ----------------------------------------------------------------
                                                        $ 6,332      $63,462      $    --       $(53,454)      $16,340
                                                       ================================================================

Year ended December 31, 2000:
Allowance for losses on:
      Accounts receivable ........................      $   294      $   500      $    --       $   (190)      $   604
      Inventory ..................................        1,519          825           --           (553)        1,791
      Sales returns and allowance ................        1,494        9,017       (1,275)        (8,186)        1,050
      Stock rotation .............................           --        2,839        1,275         (2,564)        1,550
      Warranty ...................................          425          200           --           (121)          504
Deferred income tax assets valuation allowance ...          833           --           --             --           833
                                                       ----------------------------------------------------------------
                                                        $ 4,565      $13,381      $    --       $(11,614)      $ 6,332
                                                       ================================================================

Year ended December 31, 1999:
Allowance for losses on:
      Accounts receivable ........................      $   261      $    47      $    --       $    (14)      $   294
      Inventory ..................................        1,543          539           --           (563)        1,519
      Sales returns and allowance ................        1,049        5,977           --         (5,532)        1,494
      Warranty ...................................          661           61           --           (297)          425
Deferred income tax assets valuation allowance ...       14,825           --           --        (13,992)          833
                                                       ----------------------------------------------------------------
                                                        $18,339      $ 6,624      $    --       $(20,398)      $ 4,565
                                                       ================================================================
</TABLE>

----------
      (1) During fiscal 2001, the Company recorded a permanent charge to its
inventory position for inventories which were determined to be excess. Refer to
note 4 of the consolidated financial statements.


                                       67

<PAGE>

Item 9. Changes in and Disagreements with Accountants on Accounting and
        Financial Disclosure.

      Not applicable.

                                    PART III

Item 10. Directors and Executive Officers of the Registrant.

      The information required by this Item is incorporated herein by reference
to the information in the sections entitled Proposal No. 1 "Election of
Directors" and "Compensation and Other Information Concerning Named Executive
Officers" contained in our definitive proxy statement to be filed with the
Securities and Exchange Commission not later than 120 days after the close of
the fiscal year ended December 31, 2001.

Item 11. Executive Compensation.

      The information required by this Item is incorporated herein by reference
to the information in the section entitled "Compensation and Other Information
Concerning Named Executive Officers" contained in our definitive proxy statement
to be filed with the Securities and Exchange Commission not later than 120 days
after the close of the fiscal year ended December 31, 2001.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

The information required by this Item is incorporated herein by reference to the
information in the section entitled "Security Ownership of Certain Beneficial
Owners and Management" contained in our definitive proxy statement to be filed
with the Securities and Exchange Commission not later than 120 days after the
close of the fiscal year ended December 31, 2001.

Item 13. Certain Relationships and Related Transactions.

      The information required by this Item is incorporated herein by reference
to the information in the sections entitled "Compensation Committee Interlocks
and Insider Participation" and "Certain Transactions" contained in our
definitive proxy statement to be filed with the Securities and Exchange
Commission not later than 120 days after the close of the fiscal year ended
December 31, 2001.

                                     PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a) (1) and (2) Consolidated Financial Statements and Financial Statement
                Schedule

      See "Index to Consolidated Financial Statements and Supplementary Data" at
Item 8 to this Annual Report on Form 10-K. All other schedules are not submitted
because they are either not applicable, not required or because the information
is included in the Consolidated Financial Statements and Financial Statement
Schedule.

(a) (3) Exhibits

2.1   Agreement and Plan of Reorganization, dated as of August 16, 2001, by and
      among TranSwitch, Opal Acquisition Corporation, Onex Communications
      Corporation and the other parties thereto (previously filed as Exhibit 2.1
      to TranSwitch's registration statement on Form S-3 (File No. 333-70508)
      and incorporated by reference herein).

2.2   Escrow Agreement, dated as of September 21, 2001, by and among TranSwitch,
      the Onex stockholders and State Street Bank and Trust Company, N.A., as
      escrow agent (previously filed as Exhibit 2.2 to TranSwitch's registration
      statement on Form S-3 (File No. 333-70508) and incorporated by reference
      herein).


                                       68

<PAGE>

2.3   Form of Investment Agreement, dated as of September 21, 2001, by and among
      TranSwitch Corporation and the Onex stockholders (previously filed as
      Exhibit 2.4 to TranSwitch's registration statement on Form S-3 (File No.
      333-70508) and incorporated by reference herein).

2.4   Form of Voting Agreement, dated as of September 21, 2001, by and among
      TranSwitch Corporation and the Onex stockholders (previously filed as
      Exhibit 2.5 to TranSwitch's registration statement on Form S-3 (File No.
      333-70508) and incorporated by reference herein).

2.5   Share Purchase Agreement, dated January 18, 2001, by and among TranSwitch,
      Inc., and the ADV Stockholders (filed as Exhibit 2.1 to the TranSwitch
      registration statement on Form S-3 (File No. 333-54368) and incorporated
      herein by reference).

2.6   Escrow Agreement, dated January 18, 2001, by and among TranSwitch, the ADV
      Stockholders and the other parties thereto (filed as Exhibit 2.2 to the
      TranSwitch registration statement on Form S-3 (File No. 333-54368) and
      incorporated herein by reference).

2.7   Warranty Agreement, dated January 18, 2001, by and among TranSwitch III
      Inc., Robert Bousquet, and Patricia Baert (filed as Exhibit 2.3 to the
      TranSwitch registration statement on Form S-3 (File No. 333-54368) and
      incorporated herein by reference).

2.8   Guaranty, dated January 18, 2001, by and among TranSwitch and the ADV
      stockholders (filed as Exhibit 2.4 to the TranSwitch registration
      statement on Form S-3 (File No. 333-54368) and incorporated herein by
      reference).

2.9   Agreement and Plan of Reorganization, dated as of February 6, 2001, by and
      among TranSwitch Corporation, Sea Level Acquisition Corporation, Horizon
      Semiconductors, Inc., and certain Horizon Stockholders (filed as Exhibit
      2.1 to the TranSwitch registration statement on Form S-3 (File No.
      333-56740) and incorporated herein by reference).

2.10  Escrow Agreement, dated as of February 6, 2001, by and among TranSwitch
      Corporation and the Horizon Stockholders (filed as Exhibit 2.2 to the
      TranSwitch registration statement on Form S-3 (File No. 333-56740) and
      incorporated herein by reference).

3.1   Amended and Restated Articles of Incorporation of TranSwitch, as amended
      to date (previously filed as Exhibit 3.1 to TranSwitch's quarterly report
      on Form 10-Q for the quarter ended September 30, 2001 and incorporated
      herein by reference).

3.2   By-Laws, as amended and restated, of the Company (filed herewith).

4.1   Amended and Restated Articles of Incorporation of TranSwitch, as amended
      to date (previously filed as Exhibit 3.1 to TranSwitch's quarterly report
      on Form 10-Q for the quarter ended September 30, 2001 and incorporated
      herein by reference).

4.2   Specimen certificate representing the common stock of TranSwitch
      (previously filed as Exhibit 4.1 to TranSwitch's quarterly report on Form
      10-Q for the quarter ended September 30, 2001 and incorporated herein by
      reference).

4.3   2000 Stock Option Plan of TranSwitch Corporation (previously filed as
      Exhibit 4.2 to TranSwitch's registration statement on Form S-8 and
      incorporated by reference herein).

4.3   Registration Rights Agreement, dated September 21, 2001, by and among
      TranSwitch and the Onex stockholders (previously filed as Exhibit 2.3 to
      TranSwitch's registration statement on Form S-3 (File No. 333-70508) and
      incorporated by reference herein).

4.4   Form of Non-Qualified Stock Option Agreement under the 2000 Stock Option
      Plan (previously filed as Exhibit 4.3 to TranSwitch's registration
      statement on Form S-8 and incorporated by reference herein).


                                       69

<PAGE>

4.5   Rights Agreement, dated as of October 1, 2001, between TranSwitch
      Corporation and Equiserve Trust Company, N.A., which includes the form of
      Rights Certificate and the Summary of Rights to Purchase Preferred Shares
      (previously filed as Exhibit 1 to TranSwitch's registration statement No.
      0-25996 on Form 8-A filed on October 2, 2001 and incorporated by reference
      herein).

4.6   1999 Stock Incentive Plan of Onex Communications Corporation (previously
      filed as Exhibit 4.2 to TranSwitch's registration statement on Form S-8
      (File No. 333-70344) and incorporated by reference herein).

4.7   Form of Incentive Stock Option Agreement under the 1999 Stock Incentive
      Plan of Onex Communications Corporation (previously filed as Exhibit 4.3
      to TranSwitch's registration statement on Form S-8 (File No. 333-70344)
      and incorporated by reference herein).

4.7   1995 Stock Plan of Alacrity Communications, Inc. (previously filed as
      Exhibit 4.2 of the TranSwitch's Registration Statement on Form S-8 (File
      No. 333-44032) and incorporated herein by reference).

4.8   Registration Rights Agreement, dated as of January 18, 2001, by and among
      TranSwitch and the ADV Stockholders (filed as Exhibit 4.1 to the
      TranSwitch registration statement on Form S-3 (File No. 333-54368) and
      incorporated herein by reference).

4.8   Form of Stock Option Agreement under the 1995 Stock Plan of Alacrity
      Communications, Inc. (previously filed as Exhibit 4.3 to the TranSwitch's
      Registration Statement on Form S-8 (File No. 333-44032) and incorporated
      herein by reference).

4.9   Registration Rights Agreement, dated as of February 6, 2001, by and among
      TranSwitch and the Horizon Stockholders (filed as Exhibit 4.1 to the
      TranSwitch registration statement on Form S-3 (File No. 333-56740) and
      incorporated herein by reference).

10.1  Third Amended and Restated 1995 Stock Option Plan as amended (previously
      filed as an exhibit to the TranSwitch's Definitive Proxy Statement on
      Schedule 14A dated April 26, 1999 and incorporated herein by reference).

10.2  1995 Employee Stock Purchase Plan (previously filed as an exhibit to the
      TranSwitch's Registration Statement on Form S-1 (File No. 33-91694) and
      incorporated herein by reference).

10.3  1995 Non-Employee Director Stock Option Plan, as amended (previously filed
      as an exhibit to the TranSwitch's Definitive Proxy Statement on Schedule
      14A dated April 26, 1999 and incorporated herein by reference).

10.4  Form of Incentive Stock Option Agreement under the 1995 Stock Plan of the
      Company (previously filed as an exhibit to the TranSwitch's Registration
      Statement on Form S-8 (File No. 33-94324) and incorporated herein by
      reference).

10.5  Form of Non-Qualified Stock Option Agreement under the 1995 Stock Plan of
      the Company (previously filed as an exhibit to the TranSwitch's
      Registration Statement on Form S-8 (File No. 33-94324) and incorporated
      herein by reference).

10.6  1995 Employee Stock Purchase Plan Enrollment/Authorization Form of the
      Company (filed herewith).

10.7  Form of Non-Qualified Stock Option Agreement under the 1995 Non-Employee
      Director Stock Option Plan of the Company (previously filed as an exhibit
      to the TranSwitch's Registration Statement on Form S-8 (File No. 33-94324)
      and incorporated herein by reference).

10.8  Lease Agreement, as amended, with Robert D. Scinto (previously filed as an
      exhibit to the TranSwitch's Annual Report on Form 10-K for the fiscal year
      ended December 31, 1997 and incorporated herein by reference).


                                       70

<PAGE>

21.1  Subsidiaries of the Company (filed herewith).

23.1  Consent of KPMG LLP (filed herewith).

----------
      # Confidential treatment obtained as to certain portions.

(b)   Reports on Form 8-K.

      We filed with the Securities and Exchange Commission on October 2, 2001, a
Current Report on Form 8-K for the September 17, 2001 event reporting the public
dissemination of a press release announcing that the Company's board of
directors approved a stock repurchase program for up to 10% of the Company's
outstanding shares.

      The Company filed with the Securities and Exchange Commission on October
2, 2001, a Current Report on Form 8-K for the September 24, 2001 event reporting
the public dissemination of a press release announcing that we completed our
previously announced acquisition of Onex Communications Corporation for $20
million in cash and approximately 6 million shares of TranSwitch common stock.
This transaction closed on September 21, 2001.

      We filed with the Securities and Exchange Commission on November 21, 2001,
a Current Report on Form 8-K for the November 16, 2001 event reporting the
public dissemination of a press release announcing that we had reduced our
workforce by approximately 10 percent of the 460 people that we employ worldwide
and that we had been named in a lawsuit filed by The Lemelson Medical, Education
& Research Foundation, Limited Partnership.

(c)   Exhibits

      We hereby file as exhibits to this Form 10-K, those exhibits listed in
Item 14 (a) (3) above.

(d)   Financial Statement Schedule

      TranSwitch files as a financial statement schedule to this Form 10-K, the
financial statement schedule listed in Item 8 and 14(a) (2) above.


                                       71

<PAGE>

                                   SIGNATURES

      Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

March 22, 2002

                             TRANSWITCH CORPORATION


                             By:            /s/ Dr. Santanu Das
                                -------------------------------------------
                                              Dr. Santanu Das
                                           Chairman of the Board,
                                   President and Chief Executive Officer


                        POWER OF ATTORNEY AND SIGNATURES

      We, the undersigned named executive officers and directors of TranSwitch
Corporation, hereby severally constitute and appoint Dr. Santanu Das and Mr.
Peter J. Tallian, and each of them singly, our true and lawful attorneys, with
full power to them and each of them singly, to sign for us in our names in the
capacities indicated below, all amendments to this report, and generally to do
all things in our names and on our behalf in such capacities to enable
TranSwitch Corporation to comply with the provisions of the Securities Exchange
Act of 1934, as amended and all requirements of the Securities and Exchange
Commission.

      Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
              Name and Signature                                      Title(s)                            Date
      ---------------------------------                      ------------------------                --------------
<S>                                                <C>                                               <C>
             /s/ Dr. Santanu Das                     Chairman of the Board, President and Chief
-----------------------------------------------                  Executive Officer
               Dr. Santanu Das                             (principal executive officer)             March 22, 2002

             /s/ Peter J. Tallian                  Senior Vice President, Chief Financial Officer
-----------------------------------------------                    and Treasurer
             Mr. Peter J. Tallian                   (principal financial and accounting officer)     March 22, 2002

           /s/ Alfred F. Boschulte
-----------------------------------------------
           Mr. Alfred F. Boschulte                                    Director                       March 22, 2002

             /s/ Gerald F. Montry
-----------------------------------------------
             Mr. Gerald F. Montry                                     Director                       March 22, 2002

              /s/ James M. Pagos
-----------------------------------------------
              Mr. James M. Pagos                                      Director                       March 22, 2002

            /s/ Albert E. Paladino
-----------------------------------------------
            Dr. Albert E. Paladino                                    Director                       March 22, 2002

           /s/ Erik H. van der Kaay
-----------------------------------------------
           Mr. Erik H. van der Kaay                                   Director                       March 22, 2002

              /s/ Hagen Hultzsch
-----------------------------------------------
              Dr. Hagen Hultzsch                                      Director                       March 22, 2002
</TABLE>


                                       72