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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



(Mark
One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended March 31, 2004



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 000-30649



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CENTILLIUM COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 94-3263530                          
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification Number)



215 Fourier Avenue

Fremont, California 94539

(Address of principal executive offices including zip code)



(510) 771-3700

(Registrants telephone number, including area code)



---



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



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

Yes
x No ̈



On April 29, 2004, approximately 37,936,362 shares of the Registrants Common Stock, $0.001 par value, were outstanding.



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##### Table of Contents

Centillium Communications, Inc.

TABLE OF CONTENTS



|                              |  |                                                                                                    |  |         
|----------------------------- |  | -------------------------------------------------------------------------------------------------- |  | --------
|                              |  |                                                                                                    |  | Page No.
|PART I. Financial Information |  |                                                                                                   
|                              |  |                                                                                                   
|Item 1.                       |  | Financial Statements (Unaudited)                                                                   |  | 3       
|                              |  |                                                                                                   
|                              |  | Condensed Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003                   |  | 3       
|                              |  |                                                                                                   
|                              |  | Condensed Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003 |  | 4       
|                              |  |                                                                                                   
|                              |  | Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003 |  | 5       
|                              |  |                                                                                                   
|                              |  | Notes to Condensed Consolidated Financial Statements                                               |  | 6       
|                              |  |                                                                                                   
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations              |  | 10      
|                              |  |                                                                                                   
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                         |  | 22      
|                              |  |                                                                                                   
|Item 4.                       |  | Controls and Procedures                                                                            |  | 23      
|                              | 
|PART II. Other Information    |  |                                                                                                   
|                              |  |                                                                                                   
|Item 1.                       |  | Legal Proceedings                                                                                  |  | 23      
|                              |  |                                                                                                   
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                          |  | 23      
|                              |  |                                                                                                   
|Item 3.                       |  | Defaults Upon Senior Securities                                                                    |  | 23      
|                              |  |                                                                                                   
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                |  | 23      
|                              |  |                                                                                                   
|Item 5.                       |  | Other Information                                                                                  |  | 23      
|                              |  |                                                                                                   
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                   |  | 24      
|                              | 
|Signatures                    |  | 25                                                                                                



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##### Table of Contents

PART IFINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------



CENTILLIUM COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)



|                                                                                                             |  |                |          |   |                   |   |          |  
|------------------------------------------------------------------------------------------------------------ |  | -------------- | -------- | - | ----------------- | - | -------- | -
|                                                                                                             |  | March 31, 2004 |          |   | December 31, 2003 |  
|ASSETS                                                                                                       |  |                |          |   |                   |   |          |  
|Current assets:                                                                                              |  |                |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                    |  | $              | 25,303   |   |                   | $ | 24,734   |  
|Short-term investments                                                                                       |  |                | 61,711   |   |                   |   | 64,892   |  
|Accounts receivable - net of allowance for doubtful accounts of $109 at March 31, 2004 and December 31, 2003 |  |                | 5,544    |   |                   |   | 12,476   |  
|Inventories                                                                                                  |  |                | 6,949    |   |                   |   | 11,908   |  
|Prepaid and other current assets                                                                             |  |                | 3,064    |   |                   |   | 3,718    |  
|                                                                                                             |  |                |          |   |                   |   |          |  
|Total current assets                                                                                         |  |                | 102,571  |   |                   |   | 117,728  |  
|Property and equipment, net                                                                                  |  |                | 7,134    |   |                   |   | 7,385    |  
|Other assets                                                                                                 |  |                | 518      |   |                   |   | 511      |  
|                                                                                                             |  |                |          |   |                   |   |          |  
|Total assets                                                                                                 |  | $              | 110,223  |   |                   | $ | 125,624  |  
|                                                                                                             |  |                |          |   |                   |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                         |  |                |          |   |                   |   |          |  
|Current liabilities:                                                                                         |  |                |          |   |                   |   |          |  
|Accounts payable                                                                                             |  | $              | 6,432    |   |                   | $ | 7,434    |  
|Accrued payroll & related expenses                                                                           |  |                | 4,575    |   |                   |   | 5,315    |  
|Accrued liabilities                                                                                          |  |                | 15,351   |   |                   |   | 16,168   |  
|Capital leases - current portion                                                                             |  |                |         |   |                   |   | 527      |  
|                                                                                                             |  |                |          |   |                   |   |          |  
|Total current liabilities                                                                                    |  |                | 26,358   |   |                   |   | 29,444   |  
|Other liabilities                                                                                            |  |                | 174      |   |                   |   | 143      |  
|Commitments and contingencies                                                                                |  |                |          |   |                   |   |          |  
|Stockholders equity:                                                                                        |  |                |          |   |                   |   |          |  
|Common stock                                                                                                 |  |                | 38       |   |                   |   | 38       |  
|Additional paid-in capital                                                                                   |  |                | 242,528  |   |                   |   | 242,348  |  
|Deferred compensation                                                                                        |  |                | (139     | ) |                   |   | (292     | )
|Accumulated other comprehensive income                                                                       |  |                | 46       |   |                   |   | 36       |  
|Accumulated deficit                                                                                          |  |                | (158,782 | ) |                   |   | (146,093 | )
|                                                                                                             |  |                |          |   |                   |   |          |  
|Total stockholders equity                                                                                   |  |                | 83,691   |   |                   |   | 96,037   |  
|                                                                                                             |  |                |          |   |                   |   |          |  
|Total liabilities and stockholders equity                                                                   |  | $              | 110,223  |   |                   | $ | 125,624  |  
|                                                                                                             |  |                |          |   |                   |   |          |  



See accompanying notes



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CENTILLIUM COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands except per share data)



|                                                                             |  |                              |         |   |      |   |        |  
|---------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | ------ | -
|                                                                             |  | Three Months Ended March 31, |        
|                                                                             |  | 2004                         |         |   | 2003 |  
|Net revenues                                                                 |  | $                            | 15,839  |   |      | $ | 27,829 |  
|Cost of revenues                                                             |  |                              | 8,784   |   |      |   | 14,276 |  
|                                                                             |  |                              |         |   |      |   |        |  
|Gross profit                                                                 |  |                              | 7,055   |   |      |   | 13,553 |  
|                                                                             |  |                              |         |   |      |   |        |  
|Operating expenses:                                                          |  |                              |         |   |      |   |        |  
|Research and development                                                     |  |                              | 14,261  |   |      |   | 11,585 |  
|Sales and marketing                                                          |  |                              | 3,371   |   |      |   | 2,789  |  
|General and administrative                                                   |  |                              | 2,363   |   |      |   | 2,380  |  
|Amortization of other acquisition - related intangibles                      |  |                              |        |   |      |   | 42     |  
|                                                                             |  |                              |         |   |      |   |        |  
|Total operating expenses                                                     |  |                              | 19,995  |   |      |   | 16,796 |  
|                                                                             |  |                              |         |   |      |   |        |  
|Operating loss                                                               |  |                              | (12,940 | ) |      |   | (3,243 | )
|Interest income, net                                                         |  |                              | 277     |   |      |   | 324    |  
|                                                                             |  |                              |         |   |      |   |        |  
|Loss before provision for income taxes                                       |  |                              | (12,663 | ) |      |   | (2,919 | )
|Provision for income taxes                                                   |  |                              | (26     | ) |      |   | (41    | )
|                                                                             |  |                              |         |   |      |   |        |  
|Net loss                                                                     |  | $                            | (12,689 | ) |      | $ | (2,960 | )
|                                                                             |  |                              |         |   |      |   |        |  
|Basic and diluted net loss per share                                         |  | $                            | (0.33   | ) |      | $ | (0.08  | )
|                                                                             |  |                              |         |   |      |   |        |  
|Weighted average shares used to compute basic and diluted net loss per share |  |                              | 37,891  |   |      |   | 35,235 |  
|                                                                             |  |                              |         |   |      |   |        |  



See accompanying notes



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CENTILLIUM COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)



|                                                                            |  |                              |         |   |      |   |        |  
|--------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | ------ | -
|                                                                            |  | Three Months Ended March 31, |        
|                                                                            |  | 2004                         |         |   | 2003 |  
|Operating activities                                                        |  |                              |         |   |      |   |        |  
|Net loss                                                                    |  | $                            | (12,689 | ) |      | $ | (2,960 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                              |         |   |      |   |        |  
|Depreciation and amortization expense                                       |  |                              | 1,405   |   |      |   | 1,659  |  
|Stock based compensation expense                                            |  |                              | 150     |   |      |   | 301    |  
|Loss on retirements of property and equipment                               |  |                              |        |   |      |   | 14     |  
|Amortization of other acquisition-related intangibles                       |  |                              |        |   |      |   | 41     |  
|Changes in operating assets and liabilities:                                |  |                              |         |   |      |   |        |  
|Accounts receivable                                                         |  |                              | 6,932   |   |      |   | (3,978 | )
|Inventories                                                                 |  |                              | 4,959   |   |      |   | 1,935  |  
|Prepaid and other current assets                                            |  |                              | 654     |   |      |   | (248   | )
|Other assets                                                                |  |                              | (7      | ) |      |   | (1     | )
|Accounts payable                                                            |  |                              | (1,002  | ) |      |   | (1,101 | )
|Accrued payroll and related expenses                                        |  |                              | (740    | ) |      |   | 150    |  
|Accrued liabilities                                                         |  |                              | (817    | ) |      |   | 2,408  |  
|Other liabilities                                                           |  |                              | 31      |   |      |   | (28    | )
|                                                                            |  |                              |         |   |      |   |        |  
|Net cash used in operating activities                                       |  |                              | (1,124  | ) |      |   | (1,808 | )
|Investing activities                                                        |  |                              |         |   |      |   |        |  
|Purchases of short-term investments                                         |  |                              | (9,459  | ) |      |   | (9,357 | )
|Sales and maturities of short-term investments                              |  |                              | 12,650  |   |      |   | 3,538  |  
|Purchases of property and equipment                                         |  |                              | (1,154  | ) |      |   | (525   | )
|                                                                            |  |                              |         |   |      |   |        |  
|Net cash provided by (used in) investing activities                         |  |                              | 2,037   |   |      |   | (6,344 | )
|Financing activities                                                        |  |                              |         |   |      |   |        |  
|Principal payments on capital lease obligations                             |  |                              | (527    | ) |      |   | (210   | )
|Proceeds from issuance of common stock, net of repurchases                  |  |                              | 183     |   |      |   | 68     |  
|                                                                            |  |                              |         |   |      |   |        |  
|Net cash used in financing activities                                       |  |                              | (344    | ) |      |   | (142   | )
|                                                                            |  |                              |         |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                        |  |                              | 569     |   |      |   | (8,294 | )
|Cash and cash equivalents at beginning of period                            |  |                              | 24,734  |   |      |   | 93,513 |  
|                                                                            |  |                              |         |   |      |   |        |  
|Cash and cash equivalents at end of period                                  |  | $                            | 25,303  |   |      | $ | 85,219 |  
|                                                                            |  |                              |         |   |      |   |        |  



See accompanying notes



5



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CENTILLIUM COMMUNICATIONS, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(UNAUDITED)



March 31,
2004



1. Description of Business



Centillium Communications, Inc. (Centillium or the
Company) was incorporated in California on February 21, 1997. The Company develops products designed for the Digital Subscriber Line (DSL) and Voice-over-Internet Protocol (VoIP) markets and is also developing Fiber-To-The-Premises
(FTTP) products, which it expects to introduce in 2004.



Our
revenues currently are derived primarily from the sale of our DSL and VoIP products, which include the CopperFlite, Palladia, Maximus and Entropia families of products.



2. Summary of Significant Accounting Policies



Basis of Presentation



The accompanying condensed consolidated financial statements are unaudited; however, they have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the unaudited condensed consolidated financial statements contain all adjustments (consisting of normal
recurring adjustments) that are necessary for a fair presentation of the Companys consolidated financial position at March 31, 2004, and the consolidated results of its operations and cash flows for the three months ended March 31, 2004 and
2003. Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.



The unaudited condensed consolidated financial statements include all the accounts of the Company and those of its wholly-owned
subsidiaries. All intercompany accounts and transactions have been eliminated.



The accompanying unaudited condensed consolidated financial statements do not include certain financial footnotes and financial information normally required under accounting principles generally accepted in the United States. Therefore,
these financial statements should be read in conjunction with the Companys audited consolidated financial statements and footnotes thereto for the year ended December 31, 2003 included in the Companys Annual Report on Form 10-K, filed
with the Securities and Exchange Commission on March 5, 2004.



Use of
Estimates



The preparation of the consolidated financial statements in
conformity with accounting principles generally accepted in the United States of America requires Centillium 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 the reported amounts of sales and expenses during the reporting periods. Such management estimates include allowances for doubtful accounts receivable, provisions for inventories
to reflect net realizable value, sales returns and allowances, product warranty and other liabilities. Actual results could differ from those estimates.



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3. Stock-based Compensation



The Company has elected to account for its employee stock plans in accordance with the intrinsic value method under Accounting Principles
Board Opinion No. 25, Accounting For Stock Issued to Employees (APB Opinion No. 25). The following table illustrates the effect on net loss and loss per share had compensation expense for the Companys stock-based award plans been
determined based on the awards fair value on the grant date consistent with the preferred method of Statement of Financial Accounting Standards No. 123, Accounting For Stock Issued to Employees (FAS 123). For purposes of FAS 123
pro forma disclosures, the estimated fair value of the options is amortized to expense over the options vesting period (in thousands):



|                                                                                                                               |  |                             |         |   |      |   |        |  
|------------------------------------------------------------------------------------------------------------------------------ |  | --------------------------- | ------- | - | ---- | - | ------ | -
|                                                                                                                               |  | Three Months EndedMarch 31, |        
|                                                                                                                               |  | 2004                        |         |   | 2003 |  
|Net loss as reported                                                                                                           |  | $                           | (12,689 | ) |      | $ | (2,960 | )
|Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects                       |  |                             | 150     |   |      |   | 301    |  
|Less: Total stock-based employee compensation expense under fair value based method for all awards, net of related tax effects |  |                             | (3,746  | ) |      |   | (7,169 | )
|                                                                                                                               |  |                             |         |   |      |   |        |  
|Pro forma net loss                                                                                                             |  | $                           | (16,285 | ) |      | $ | (9,828 | )
|                                                                                                                               |  |                             |         |   |      |   |        |  
|Basic and diluted net loss per share - as reported                                                                             |  | $                           | (0.33   | ) |      | $ | (0.08  | )
|                                                                                                                               |  |                             |         |   |      |   |        |  
|Basic and diluted net loss per share - pro forma                                                                               |  | $                           | (0.43   | ) |      | $ | (0.28  | )
|                                                                                                                               |  |                             |         |   |      |   |        |  



4. Commitments and Contingencies



The Company enters into standard indemnification agreements in the
ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our business partners or customers,
in connection with certain patent, copyright or other intellectual property infringement claims by any third parties with respect to its products. The term of these indemnification agreements is generally perpetual. The Company has not incurred
significant costs to defend lawsuits or settle claims related to these indemnification agreements, and therefore has not recorded any liabilities for these agreements as of March 31, 2004.



The semiconductor and telecommunications industries are characterized by substantial
litigation regarding patent and other intellectual property rights. From time to time, the Company receives various inquiries or claims in connection with these rights and may become a party to associated claims. In certain cases, management has
accrued estimates of the amounts it expects to pay upon resolution of such matters and such amounts are included in accrued liabilities. Should the Company not be able to secure the terms it expects, these estimates may change and will be recognized
in the period in which they are identified, resulting in decreased profits. Although the ultimate outcome of such inquiries is not presently determinable, management believes that the resolution of these matters will not have a material adverse
effect on the Companys financial position or results of operations.



The
Company does not own or operate a fabrication facility and foundries located in Asia currently supply substantially all of its wafer requirements. The Companys purchase obligations to these foundries are based on wafer supply agreements or
non-cancelable purchase orders. As of March 31, 2004, the Companys non-cancelable purchase obligations for wafers expected to be delivered within the next three months are $6.4 million.



5. Balance Sheet Information



Inventories:



The components of inventories are as follows (in thousands):



|                |  |               |       |                  |   |       
|--------------- |  | ------------- | ----- | ---------------- | - | ------
|                |  | March 31,2004 |       | December 31,2003
|Work-in-process |  | $             | 4,412 |                  | $ | 5,475 
|Finished goods  |  |               | 2,537 |                  |   | 6,433 
|                |  |               |       |                  |   |       
|                |  | $             | 6,949 |                  | $ | 11,908
|                |  |               |       |                  |   |       



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Accrued Liabilities:



The components of accrued liabilities are as follows (in thousands):



|                          |  |               |        |                  |   |       
|------------------------- |  | ------------- | ------ | ---------------- | - | ------
|                          |  | March 31,2004 |        | December 31,2003
|Accrued royalties         |  | $             | 12,823 |                  | $ | 13,211
|Accrued other liabilities |  |               | 2,528  |                  |   | 2,957 
|                          |  |               |        |                  |   |       
|                          |  | $             | 15,351 |                  | $ | 16,168
|                          |  |               |        |                  |   |       



Warranty:



Warranty activity for the three months ended March 31,
2004 and March 31, 2003 was as follows (in thousands):



|                                |  |                              |      |   |      |   |      |  
|------------------------------- |  | ---------------------------- | ---- | - | ---- | - | ---- | -
|                                |  | Three Months Ended March 31, |     
|                                |  | 2004                         |      |   | 2003 |  
|Balances at beginning of period |  | $                            | 460  |   |      | $ | 608  |  
|Product warranty accruals       |  |                              | (101 | ) |      |   | 143  |  
|Warranty costs incurred         |  |                              | (23  | ) |      |   | (242 | )
|                                |  |                              |      |   |      |   |      |  
|Balances at end of period       |  | $                            | 336  |   |      | $ | 509  |  
|                                |  |                              |      |   |      |   |      |  



6. Provision for Income Taxes



The provision for income taxes for the three months ended March 31, 2004
and 2003 relates to current taxes payable for the Companys subsidiaries located in foreign jurisdictions. Income tax expense differs from the expected benefit that was derived by applying the applicable U.S. federal statutory rate to the loss
from operations primarily due to losses that are not currently benefited. Due to the Companys loss position, a full valuation allowance has been established against the Companys deferred tax assets, consisting primarily of net operating
loss carryforwards.



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7. Net Loss Per Share



Basic and diluted net loss per share have been computed using the weighted average number of shares of common stock outstanding during the period, less shares subject to
repurchase. The following table presents the computation of basic and diluted net loss per share (in thousands, except per share amounts):



|                                                                         |  |                             |         |   |      |   |        |  
|------------------------------------------------------------------------ |  | --------------------------- | ------- | - | ---- | - | ------ | -
|                                                                         |  | Three Months EndedMarch 31, |        
|                                                                         |  | 2004                        |         |   | 2003 |  
|Net loss                                                                 |  | $                           | (12,689 | ) |      | $ | (2,960 | )
|                                                                         |  |                             |         |   |      |   |        |  
|Basic and diluted:                                                       |  |                             |         |   |      |   |        |  
|Weighted average shares of common stock outstanding                      |  |                             | 37,891  |   |      |   | 35,279 |  
|Less weighted average shares subject to repurchase                       |  |                             |        |   |      |   | (44    | )
|                                                                         |  |                             |         |   |      |   |        |  
|Weighted average shares used to compute basic and diluted loss per share |  |                             | 37,891  |   |      |   | 35,235 |  
|                                                                         |  |                             |         |   |      |   |        |  
|Basic and diluted loss per share                                         |  | $                           | (0.33   | ) |      | $ | (0.08  | )
|                                                                         |  |                             |         |   |      |   |        |  



The Company has excluded all
outstanding warrants, stock options, and shares subject to repurchase by the Company from the calculation of diluted net loss per share because these securities are antidilutive for all periods presented. These excluded common share equivalents
could be dilutive in the future. Options, warrants and shares subject to repurchase of approximately 12,828,000 and 13,156,000 shares of common stock have been excluded for the three months ended March 31, 2004 and 2003, respectively.



8. Comprehensive Net Loss



The following table presents the computation of comprehensive net loss (in thousands):



|                                                            |  |                             |         |   |      |   |        |  
|----------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------ | -
|                                                            |  | Three Months EndedMarch 31, |        
|                                                            |  | 2004                        |         |   | 2003 |  
|Net loss                                                    |  | $                           | (12,689 | ) |      | $ | (2,960 | )
|Change in unrealized gain on available-for-sale investments |  |                             | 10      |   |      |   | (1     | )
|                                                            |  |                             |         |   |      |   |        |  
|Total comprehensive loss.                                   |  | $                           | (12,679 | ) |      | $ | (2,961 | )
|                                                            |  |                             |         |   |      |   |        |  



9. Business Segment Information and
Customer Concentration



The Companys operations
involve the design, development, marketing and technical support of semiconductor products that enable broadband communications. Through March 31, 2004, the Companys revenues have been primarily derived from one business segment, the sale of
broadband communication products for the DSL and VoIP markets. The Company sells primarily to original equipment manufacturers and companies in the communications industries.



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The following customers, the first two of whom are located in Japan, accounted for more than 10% of net revenues:



|                             |  |                             |   |  |      |  
|---------------------------- |  | --------------------------- | - |  | ---- | -
|                             |  | Three Months EndedMarch 31, |  
|                             |  | 2004                        |   |  | 2003 |  
|NEC                          |  | 36                          | % |  | 42   | %
|Sumitomo Electric Industries |  | 35                          | % |  | 41   | %
|Lucent                       |  | 19                          | % |  | (1   | )
|(1) Less than 10%            |  |                             |   |  |      |  



The following is a
summary of net revenues by major geographic area (in thousands):



|                       |  |                             |        |      |   |       
|---------------------- |  | --------------------------- | ------ | ---- | - | ------
|                       |  | Three Months EndedMarch 31,
|                       |  | 2004                        |        | 2003
|Japan                  |  | $                           | 11,590 |      | $ | 23,241
|United States          |  |                             | 3,201  |      |   | 3,219 
|Asia  Excluding Japan |  |                             | 1,043  |      |   | 756   
|All other              |  |                             | 5      |      |   | 613   
|                       |  |                             |        |      |   |       
|Total                  |  | $                           | 15,839 |      | $ | 27,829
|                       |  |                             |        |      |   |       



10. Related Party Transactions



In the first quarter of 2004, one of the Companys
directors was elected to the Board of Directors of Cadence Design Systems, Inc. (Cadence). During this period, the Company paid $304,000 as license fees for software tools and had recorded a liability of $430,000 as of March 31, 2004 for accounts
payable due to Cadence.



One of the Companys directors is
also a director of Semiconductor Manufacturing International Corporation (SMIC). The Company purchased $954,000 and $486,000 of foundry services and products from SMIC during the three months ended March 31, 2004 and 2003, respectively. As of March
31, 2004 and 2003, the Company had $511,000 and $486,000, respectively, of accounts payable due to SMIC.



|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes
thereto included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 5, 2004. The information in this report is not a complete description of our business or the risks associated with an investment in our
common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC.



Our discussion contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Forward-looking statements are generally preceded by words that imply a future state such as expected or anticipated or imply that a particular future event or events will occur such as will. Investors are
cautioned that all forward-looking statements involve risks and uncertainties and those actual results could be materially different from those discussed in this report. We undertake no obligation to revise or update publicly any forward-looking
statements for any reason.



The section entitled Risk Factors and
similar discussions in our other SEC reports filed with the SEC discuss some of the important risk factors that may affect our business, results of operations and financial condition. Copies of our reports filed with the SEC are available from us
without charge and on the SECs website at www.sec.gov. You should carefully consider those risks, in addition to the other information in this report and in our other filings with the SEC, before deciding to invest in our Company or to
maintain or increase your investment.



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Overview



Founded in 1997, Centillium Communications, Inc (Centillium or the Company) provides semiconductor products that enable broadband communications
to the home and business enterprise. We serve the DSL and the Voice over Internet Protocol markets. Our current customers are broadband access equipment vendors who manufacture DSL equipment for use in the phone companies communications
infrastructure or in the customer premise for high-speed Internet or other network access in a home or small business. Our customers also include equipment vendors who supply products that allow convergence of data and voice networks. Our revenues
are derived primarily from the sale of our DSL and Voice over Internet Protocol semiconductor products, which include the Maximus, Palladia, CopperFlite and Entropia families of products.



Critical Accounting Policies



There have been no significant changes in our critical accounting policies during the three
months ended March 31, 2004 as compared to the accounting policies previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission on March 5, 2004.



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Results of Operations for the Three Months Ended March 31, 2004 and 2003



The following table sets forth, for the periods presented, certain data from our unaudited
consolidated statements of operations expressed as a percentage of net revenues.



|                                                       |  |                    |    |  |              |   
|------------------------------------------------------ |  | ------------------ | -- |  | ------------ | --
|                                                       |  | Three Months Ended |   
|                                                       |  | March 312004       |    |  | March 312003 |   
|Net revenues                                           |  | 100                | %  |  | 100          | % 
|Cost of revenues                                       |  | 55                 |    |  | 51           |   
|                                                       |  |                    |    |  |              |   
|Gross profit                                           |  | 45                 |    |  | 49           |   
|                                                       |  |                    |    |  |              |   
|Operating expenses:                                    |  |                    |    |  |              |   
|Research and development                               |  | 90                 |    |  | 42           |   
|Sales and marketing                                    |  | 22                 |    |  | 10           |   
|General and administrative                             |  | 15                 |    |  | 9            |   
|Amortization of other acquisition -related intangibles |  |                   |    |  |             |   
|                                                       |  |                    |    |  |              |   
|Total operating expenses                               |  | 127                |    |  | 61           |   
|                                                       |  |                    |    |  |              |   
|Operating loss                                         |  | (82                | )  |  | (12          | ) 
|Interest income, net                                   |  | 2                  |    |  | 1            |   
|Provision for income taxes                             |  |                   |    |  |             |   
|                                                       |  |                    |    |  |              |   
|Net loss                                               |  | (80                | )% |  | (11          | )%
|                                                       |  |                    |    |  |              |   



Net Revenues.
Net revenues for the three months ended March 31, 2004 were $15.8 million compared to $27.8 million for the three months ended March 31, 2003, a decrease of $12.0 million or 43%. This decrease in net revenues for the three months ended March 31,
2004 as compared with the three months ended March 31, 2003 primarily resulted from a 33% decrease in the total unit volume shipments of our DSL products and a 19% decline in the weighted average selling price of our DSL products. We expect the unit
volume of shipments to increase slightly in the second quarter of 2004 as compared to the first quarter. Average unit selling prices are expected to decrease slightly in the second quarter as we sell inventory on hand and transition to our next
generation products.



Competition and technological change in
the rapidly evolving DSL market has influenced and may continue to influence our quarterly and annual net revenues and results of operations. Average selling prices of our DSL and VoIP products tend to be higher at the time we introduce new products
and decline over time due to competitive pressures. We expect this pattern to continue with existing and future products. Our average selling prices are also impacted by our customer concentration and product mix.



Revenue from our DSL products accounted for $15.3 million or 96% of net
revenues for the three months ended March 31, 2004, as compared to $27.2 million or 98% of net revenues for the three months ended March 31, 2003. Revenues from VoIP products accounted for $33,000 of revenues in the three months ended March 31, 2004
as compared to $464,000 for the three months ended March 31, 2003, or approximately 0.2% and 2% of net revenues, respectively. Revenues from technology development services accounted for $505,000 of revenues in the three months ended March 31, 2004
as compared to $123,000 for the three months ended March 31, 2003 or approxiamately 3% and 0.4%, respectively.We anticipate that revenues from our DSL products will continue to account for greater than 90% of our net revenues for the balance of
2004. Revenues from technology development services are not expected to be material in future periods.



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The following customers accounted for more than 10% of net revenues:



|                             |  |                             |   |  |      |  
|---------------------------- |  | --------------------------- | - |  | ---- | -
|                             |  | Three Months EndedMarch 31, |  
|                             |  | 2004                        |   |  | 2003 |  
|NEC                          |  | 36                          | % |  | 42   | %
|Sumitomo Electric Industries |  | 35                          | % |  | 41   | %
|Lucent                       |  | 19                          | % |  | (1   | )

| | (1) | Less than 10%
| | --- | -------------



Net revenues to international customers, who were primarily located in Japan, comprised 80% and 88% of our net revenues for the three months ended March 31, 2004 and
2003, respectively. Japans DSL market is an important part of our business and net new DSL subscribers are a significant driver of consumption for Centilliums DSL products.



Cost of Revenues, Gross Profit and Gross Profit Margin.Cost of revenues includes the cost of purchasing the finished
silicon wafers manufactured by independent foundries, costs associated with assembly, packaging, test and quality assurance for semiconductor products, royalties related to purchased technology, and manufacturing overhead, including costs of
personnel and equipment associated with manufacturing support. Cost of revenues was $8.8 million and $14.3 million for the three months ended March 31, 2004 and 2003, resulting in a gross profit of $7.1 million and $13.6 million and a gross profit
margin of 45% and 49%, respectively. The decrease in gross profit was primarily due to lower revenue while the decrease in gross profit margin resulted from lower average selling prices offset, in part, by reduced manufacturing costs. Our future
gross profit margins may be affected by competitive pricing strategies, fluctuation in the volume of our product sales, fluctuations in silicon wafer costs, possible changes in product mix and the introduction of certain lower margin products, among
other factors.



Research and Development Expenses.Research and development expenses consist primarily of salaries and related personnel costs, fees paid to consultants and outside service providers, prototype costs related to the fabrication of our silicon chips, depreciation associated with
software development tools, and amortization of deferred stock-based compensation. We expense our research and development costs as they are incurred. Several components of our research and development effort require significant expenditures, the
timing of which can cause significant quarterly variability in our expenses. Research and development expenditures increased by approximately $2.7 million, or 23%, to $14.3 million for the three months ended March 31, 2004 as compared to $11.6
million for the three months ended March 31, 2003. These increases were primarily due to increases in software tools & equipment expense, salaries, consultant and prototype expenses.



Sales and Marketing Expenses.Sales and marketing expenses consist primarily of salaries, commissions, and related
expenses for personnel engaged in marketing, sales, customer service and applications engineering support functions, costs associated with promotional and other marketing expenses, as well as amortization of deferred stock-based compensation. Sales
and marketing expenditures increased by approximately $582,000 or 21%, to $3.4 million for the three months ended March 31, 2004 as compared to $2.8 million for the three months ended March 31, 2003. The increase was due primarily to an increases in
salaries and related costs, evaluation board costs, consultant expenses, recruiting expenses and travel related expenses, partially offset by lower commission expense for the external sales representatives and internal sales force.



General and Administrative Expenses.General and administrative
expenses consist primarily of salaries and personnel related expenses for executives, finance, accounting, facilities, information services, and human resources; corporate insurance, amortization of deferred stock-based compensation, recruiting
expenses, legal, audit and other professional fees, and other corporate expenses. General and administrative expenditures were $2.4 million in the three month periods ended March 31, 2004 and 2003.



Stock-Based Compensation Expense. Stock-based compensation expense,
which is allocated among the above expense categories, was $150,000 in the three months ended March 31, 2004 as compared to $301,000 in the three months ended March 31, 2003. This expense decrease of $151,000 is primarily related to the use of the
graded vesting method, which results in accelerated amortization of deferred compensation expense in the earlier years of the awards expected life.



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Amortization of Other Acquisition Intangibles. Amortization of goodwill and other
acquisition-related intangibles was zero and $42,000 in the three months ended March 31, 2004 and 2003, respectively. These intangible assets were fully amortized at June 30, 2003.



Interest Income, Net.Interest income, net, was $277,000 for the three months ended March 31, 2004 as compared to
$324,000 for the three months ended March 31, 2003, a decrease of $47,000 or 15%. This decrease was primarily due to lower invested balances in our cash, cash equivalents and short-term investment portfolio.



Provision for Income Taxes. Income tax expense was $26,000 and $41,000
for the three months ended March 31, 2004 and 2003, respectively. The provisions for income taxes relate to current taxes payable for the Companys subsidiaries located in foreign jurisdictions. Income tax expense differs from the expected
benefit that was derived by applying the applicable U.S. federal statutory rate to the loss from operations primarily due to losses that are not currently benefited. Due to the Companys loss position, a full valuation allowance has been
established against the Companys deferred tax assets, consisting primarily of net operating loss carryforwards.



Liquidity and Capital Resources



Since our inception, we have financed our operations through a combination of sales of equity securities and cash generated by operations. At March 31, 2004, we had $87.0
million in cash, cash equivalents and short-term investments as compared to $89.6 million at December 31, 2003.



Operating activities for the three months ended March 31, 2004 used $1.1 million in cash. The net cash used in operating activities was primarily the result of our net
loss of $12.7 million, a decrease in accounts payable of $1.0 million and a decrease in accrued liabilities of $1.6 million partially offset by a decrease in our accounts receivable of $6.9 million, a decrease in inventory of $5.0 million, a
decrease in prepaid and other current assets of $654,000 and non-cash expenses of $1.4 million for depreciation and amortization and $150,000 for stock based compensation. The decrease in accounts receivable is the result of lower sales in the first
quarter of 2004 as compared to sales in the fourth quarter of 2003. Inventories decreased in the first quarter of 2004 as we managed down the inventories from the high levels at December 31, 2003. The decrease in accounts payable was the result of
the lower purchase commitments in the first quarter of 2004 as we reduced our inventory balances. We anticipate our operating expenses to remain relatively constant for the remainder of 2004 as we continue to invest in new product development.



For the three months ended March 31, 2004, net cash provided by investing
activities was $2.0 million. Net cash provided by investing activities related to sales and maturities of short-term investments of $12.7 million, partially offset by purchases of short-term investments of $9.5 million and purchases of property and
equipment of $1.2 million. Property and equipment purchases relate principally to the purchase of software development tools, lab equipment and computer hardware to support our research and development activities.



Net cash used by financing activities was $344,000 for the three months ended March 31, 2004.
Net cash used by financing activities consisted of principal payments on capital lease obligations of $527,000 offset by net proceeds of $183,000 from the issuance of common stock under employee stock plans.



Our principal source of liquidity as of March 31, 2004 consisted of $87.0 million of cash and
cash equivalents and short-term investments. We believe our cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next twelve months. The
rate at which we will consume cash will be dependent on the cash needs of future operations that will, in turn, be directly affected by various risks and uncertainties, including but not limited to, the levels of demand for our products and other
risks listed in the Risk Factors section.



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Our principal commitments as of March 31, 2004 consist of obligations under operating leases and non-cancelable purchase
obligations. Significant contractual obligations and commercial commitments as of March 31, 2004 are shown in the table below (in thousands):



|                              |  |       |        |                 |   |            |  |              |       |  |   |      
|----------------------------- |  | ----- | ------ | --------------- | - | ---------- |  | ------------ | ----- |  | - | -----
|                              |  | Total |        | Less than1 Year |   | 1 - 3Years |  | After 3Years
|Operating leases - facilities |  | $     | 7,255  |                 | $ | 1,285      |  | $            | 3,015 |  | $ | 2,955
|Operating leases - software   |  |       | 3,363  |                 |   | 2,356      |  |              | 1,007 |  |   |     
|Inventory purchases           |  |       | 6,427  |                 |   | 6,427      |  |              |      |  |   |     
|                              |  |       |        |                 |   |            |  |              |       |  |   |      
|Total cash obligations        |  | $     | 17,045 |                 | $ | 10,068     |  | $            | 4,022 |  | $ | 2,955
|                              |  |       |        |                 |   |            |  |              |       |  |   |      



Our future capital
requirements depend on many factors that affect our research, development, collaboration and sales and marketing activities. We believe that existing cash and investment securities and anticipated cash flow from operations will be sufficient to
support our current operating plan for 2004. These cash flow and profitability expectations are subject to numerous assumptions, many of which may not actually occur. If some or all of such assumptions do not occur, our results may be substantially
lower or different than expected. Such assumptions include, without limitation, assumptions that new product introductions will occur on a timely basis and achieve market acceptance, that our existing and potential customer base will continue to
grow and that our industrys competitive landscape will not change adversely. For more information about the risks relating to our business, please read carefully the Risk Factors set forth below.



We expect to devote capital resources to continue our research and development efforts, to
support our sales, marketing, and product development programs and to fund other general corporate activities. From time to time, we receive various inquiries or claims in connection with intellectual property and other rights and may become party
to associated claims. In certain cases, management has accrued estimates of the amounts it expects to pay upon resolution of such matters. Depending on the amount and timing of the resolutions of these claims, our future cash flows could be
materially adversely affected in a particular period.



If our existing
resources and cash generated from operations are insufficient to satisfy our liquidity requirements, we may seek to raise additional funds through public or private debt or equity financings. The sale of equity or convertible debt securities could
result in additional dilution to our stockholders, and we cannot be certain that additional financing will be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain this additional financing, we may be required to
reduce the scope of our planned product development and sales and marketing efforts, which could harm our business, financial condition and operating results.



On July 29, 2003, Centillium announced the filing of a universal shelf registration statement on Form S-3 with the Securities and Exchange Commission (SEC)
for the registration and potential issuance of up to $90 million of Centillium securities. The securities covered by the universal shelf, which may include common stock, preferred stock, warrants or debt securities, are being registered on a delayed
basis because Centillium did not intend to sell securities immediately upon the effectiveness of the registration statement. The actual amount and type of securities, or combination of securities, to be issued and the terms of those securities, will
be determined at the time of sale, if such sale occurs.



At the time any of the
securities covered by the registration statement are offered for sale, a prospectus supplement will be provided containing specific information about the terms of any such offering. Centillium currently anticipates that the net proceeds from any
sale of the shares will be used for general corporate purposes, including the investment in and development of new products, capital expenditures and acquisitions. However, Centillium currently has no commitments or agreements for any specific
acquisitions or investments that require additional capital.



Risk Factors



You should carefully consider the risks described below and all of the
information contained in this Form 10-Q and on our Form 10-K, filed with the Securities and Exchange Commission on March 5, 2004. If any of the following risks actually occurs, our business, financial condition and results of operations could be
harmed and the trading price of our common stock could decline and you may lose all or part of your investment in our common stock.



WE HAVE A HISTORY OF LOSSES AND WE MAY NOT MAINTAIN PROFITABILITY.



We have not reported an operating profit for any year since our incorporation and have experienced a net loss of approximately $12.7 million in the first quarter of
2004 and net losses of $13.4 million and $33.3 million for the years ended December 31, 2003 and 2002, respectively.



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WE ANTICIPATE LOWER MARGINS, WHICH COULD ADVERSELY AFFECT OUR PROFITABILITY.



We expect the average selling prices of our products to decline as they mature.
Historically, competition in the semiconductor industry has driven down the average selling prices of products. If we price our products too high, our customers may use a competitors product or an in-house solution. To maintain profit margins,
we must reduce our costs sufficiently to offset declines in average selling prices, or successfully sell proportionately more new products with higher average selling prices. Yield or other production problems, or shortages of supply may preclude us
from lowering or maintaining current product costs.



We have also experienced
more aggressive price competition from competitors in market segments in which we are attempting to expand our business. These circumstances may make some of our products less competitive and we may be forced to decrease our prices significantly to
win a design. We may lose design opportunities or may experience overall declines in gross margins as a result of increased price competition.



OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE.



The market price of our common stock has been volatile and will likely continue to fluctuate significantly in response to the following factors, some of which are beyond
our control:



| |  | variations in our quarterly operating results;
| | - | ----------------------------------------------



| |  | changes in financial estimates of our revenues and operating results by securities analysts;
| | - | --------------------------------------------------------------------------------------------



| |  | changes in market valuations of integrated circuit companies;
| | - | -------------------------------------------------------------



| |  | announcements by us, our competitors or others in related market segments of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | loss or decrease in sales to a major customer or failure to complete significant transactions;
| | - | ----------------------------------------------------------------------------------------------



| |  | loss or reduction in manufacturing capacity from one or more of our key suppliers;
| | - | ----------------------------------------------------------------------------------



| |  | additions or departures of key personnel;
| | - | -----------------------------------------



| |  | future sales of our common stock;
| | - | ---------------------------------



| |  | inconsistent or low levels of trading volume of our common stock;
| | - | -----------------------------------------------------------------



| |  | commencement of or involvement in litigation;
| | - | ---------------------------------------------



| |  | announcements by us or our competitors of key design wins and product introductions;
| | - | ------------------------------------------------------------------------------------



| |  | a decrease in the average selling price of our products;
| | - | --------------------------------------------------------



| |  | ability to achieve cost reductions; and
| | - | ---------------------------------------



| |  | fluctuations in the timing and amount of customer requests for product shipments.
| | - | ---------------------------------------------------------------------------------



A GENERAL ECONOMIC SLOWDOWN, AND A SLOWDOWN IN SPENDING IN THE TELECOMMUNICATIONS INDUSTRY, HAS AFFECTED AND MAY CONTINUE TO
NEGATIVELY AFFECT OUR BUSINESS AND OPERATING RESULTS.



There have been
announcements throughout the worldwide telecommunications industry of current and planned reductions in component inventory levels and equipment production volumes, and of delays in the build-out of new infrastructure. Any of these trends, if
continued, could result in lower than expected demand for our products, which could have a material adverse effect on our revenues and results of operations generally, and could cause the market price of our common stock to decline. Specifically, we
have experienced:



| |  | reduced demand for our products;
| | - | --------------------------------



| |  | increased price competition for our products;
| | - | ---------------------------------------------



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| |  | increased risk of excess and obsolete inventories;
| | - | --------------------------------------------------



| |  | excess facilities and manufacturing capacity; and
| | - | -------------------------------------------------



| |  | higher general and administrative costs, as a percentage of revenue.
| | - | --------------------------------------------------------------------



Recent geopolitical and social turmoil in many parts of the world, including actual incidents and potential future acts of terrorism and war, may continue to put pressure
on global economic conditions. These geopolitical and social conditions, together with the resulting economic uncertainties, make it extremely difficult for our company, our customers and our vendors to accurately forecast and plan future business
activities. This reduced predictability challenges our ability to operate profitably or to increase revenues. In particular, it is difficult to develop and implement strategies to create sustainable business models and efficient operations, and to
effectively manage outsourced relationships for services such as contract manufacturing and information technology. If the current uncertain economic conditions continue or deteriorate, there could be additional material adverse impact on our
financial position, revenues, results of operations, or cash flow.



SIGNIFICANT FLUCTUATIONS OR A SLOWDOWN IN DEPLOYMENT OF DSL IN JAPAN WOULD ADVERSELY AFFECT OUR BUSINESS AND OPERATING RESULTS.



Sales to customers located in Japan accounted for 73% of net revenues for the three months ended March 31, 2004, compared to 84% of net revenues for the three months
ended March 31, 2003. To date, our sales have been dependent on the continuous growth of new DSL subscribers in Japan. During the first nine months of 2003, new DSL subscribers in Japan increased significantly compared to prior and subsequent
periods. Fluctuations in new subscribers in Japan impact our revenues on a quarterly basis and a sustained slow down in such a growth may cause our revenue to decline. Our sales have been historically denominated in U.S. dollars and major
fluctuations in currency exchange rates could materially affect our Japanese customers demand, thereby forcing them to reduce their orders, which could adversely affect our operating results.



WE DERIVE A SUBSTANTIAL AMOUNT OF OUR REVENUES FROM JAPAN, AND OUR FAILURE TO DIVERSIFY
THE GEOGRAPHIC SOURCES OF OUR REVENUE COULD HARM OUR BUSINESS AND OPERATING RESULTS.



Because a substantial portion of our revenues have been derived from sales into Japan, our revenues have been heavily dependent on developments in the Japan market. While part of our strategy is to diversify the
geographic sources of our revenues, failure to further penetrate markets outside of Japan could harm our business and results of operations.



WE DERIVE A SUBSTANTIAL AMOUNT OF OUR REVENUES FROM INTERNATIONAL SOURCES, AND DIFFICULTIES ASSOCIATED WITH INTERNATIONAL OPERATIONS COULD HARM OUR BUSINESS.



A substantial portion of our revenues has been derived from customers
located outside of the United States. For the three months ended March 31, 2004 and the year ended December 31, 2003, 80% and 87% respectively, of our net revenues were to customers located in Asia. We may be unable to successfully overcome the
difficulties associated with international operations. These difficulties include:



| |  | staffing and managing foreign operations;
| | - | -----------------------------------------



| |  | changes in regulatory requirements;
| | - | -----------------------------------



| |  | licenses, tariffs and other trade barriers;
| | - | -------------------------------------------



| |  | political and economic instability;
| | - | -----------------------------------



| |  | difficulties in protecting intellectual property rights in some foreign countries;
| | - | ----------------------------------------------------------------------------------



| |  | a limited ability to enforce agreements and other rights in some foreign countries;
| | - | -----------------------------------------------------------------------------------



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| |  | obtaining governmental approvals for products; and
| | - | --------------------------------------------------



| |  | complying with a wide variety of complex foreign laws and treaties.
| | - | -------------------------------------------------------------------



Because sales of our products are denominated exclusively in United States dollars, increases in the value of the United States dollar could increase the price of our
products so that they become relatively more expensive to customers in the local currency of a particular country, leading to a reduction in sales and profitability in that country.



WE DEPEND ON A FEW CUSTOMERS, AND IF WE LOSE ANY OF THEM, OUR SALES AND OPERATIONS WILL SUFFER.



We sell our DSL products primarily to network equipment manufacturers. Our top two customers
for the three month period ended March 31, 2004 were NEC and Sumitomo, accounting for 36% and 35% of our net revenues, respectively. For the year ended December 31, 2003, NEC and Sumitomo accounted for 49% and 31% of our net revenues, respectively.
We do not have contractual volume commitments with these customers but rather sell our products to them on an order-by-order basis. We expect to be dependent upon a relatively small number of large customers in future periods, although the specific
customers may vary from period to period. If we are not successful in maintaining relationships with key customers and winning new customers, our business and results of operations will suffer.



WE ARE SUBJECT TO ORDER AND SHIPMENT UNCERTAINTIES, AND ANY SIGNIFICANT ORDER
CANCELLATIONS OR DEFERRALS COULD ADVERSELY AFFECT OUR BUSINESS.



We
typically sell products pursuant to purchase orders that customers can generally cancel or defer on short notice without incurring a significant penalty. Any significant cancellations or deferrals in the future could materially and adversely affect
our business, financial condition and results of operations. In addition, cancellations or deferrals of product orders, the return of previously sold products or the overproduction of products due to the failure of anticipated orders to materialize
could cause us to hold excess or obsolete inventory, which could reduce our profit margins, increase product obsolescence and restrict our ability to fund our operations. Furthermore, we generally recognize revenue upon shipment of products to a
customer. If a customer refuses to accept shipped products, we could incur significant charges against our revenue.



OUR CUSTOMERS MAY DEMAND PREFERENTIAL TERMS OR DELAY OUR SALES CYCLE, WHICH WOULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.



Our customers are in most cases larger than us and are able to exert a high degree of
influence over us. These customers may have sufficient bargaining power to demand low prices and other terms and conditions that may materially adversely affect our business, financial condition and results of operations. In addition, prior to
selling our products to such customers, we must typically undergo lengthy product approval processes, often taking up to one year. Accordingly, we are continually submitting successive versions of our products as well as new products to our
customers for approval. The length of the approval process can vary and is affected by a number of factors, including customer priorities, customer budgets and regulatory issues affecting telecommunication service providers. Delays in the product
approval process could materially adversely affect our business, financial condition and results of operations. While we have been successful in the past in obtaining product approvals from our customers, such approvals and the ensuing sales of such
products may not continue to occur. Delays can also be caused by late deliveries by other vendors, changes in implementation priorities and slower than anticipated growth in demand for the services that our products support. A delay in, or
cancellation of, the sale of our products could adversely affect our results from operations or cause them to significantly vary from quarter to quarter.



SALES OF OUR PRODUCTS DEPEND ON THE WIDESPREAD ADOPTION OF BROADBAND ACCESS SERVICES, ESPECIALLY DSL. IF THE DEMAND FOR BROADBAND ACCESS SERVICE DOES NOT INCREASE,
WE MAY NOT BE ABLE TO GENERATE SUBSTANTIAL SALES.



Sales of our
products depend on the increased use and widespread adoption of broadband access services, and DSL services in particular, and the ability of telecommunications service providers to market and sell broadband access services. Our business would be
harmed, and our results of operations and financial condition would be adversely affected, if the use of broadband access services does not increase as anticipated. Certain critical factors will likely continue to affect the development of the
broadband access service market. These factors include:



| |  | inconsistent quality and reliability of service;
| | - | ------------------------------------------------



| |  | lack of availability of cost-effective, high-speed service;
| | - | -----------------------------------------------------------



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| |  | lack of interoperability among multiple vendors network equipment;
| | - | -------------------------------------------------------------------



| |  | congestion in service providers networks;
| | - | ------------------------------------------



| |  | inadequate security; and
| | - | ------------------------



| |  | slow deployment of new broadband services over DSL lines.
| | - | ---------------------------------------------------------



BECAUSE OTHER BROADBAND TECHNOLOGIES MAY COMPETE EFFECTIVELY WITH DSL SERVICES OR OTHER SERVICES ADDRESSED BY OUR PRODUCTS, A SLOWDOWN IN DEPLOYMENT OF DSL
SERVICES, THE LACK OF SIGNIFICANT GROWTH IN NON-DSL MARKETS THAT WE ARE TARGETING AND OUR LACK OF SUCCESS IN PENETRATING SUCH MARKETS WOULD ADVERSELY AFFECT OUR BUSINESS AND OPERATING RESULTS.



Our revenues are heavily dependent on the increase in demand for DSL services. DSL services
are competing with a variety of different broadband data transmission technologies, including cable modems, satellite and other wireless technologies. While part of our strategy is to diversify our product markets beyond DSL into such areas as
Fiber-to-the-Premises and VoIP, if any technology that is competing with the technologies that we offer is more reliable, faster and/or less expensive or has any other advantages over the technologies for which we have products, then the demand for
our products may decrease. The lack of significant growth in those markets we are targeting in general and the lack of success of our products in particular would also adversely affect our business and results of operations.



BECAUSE THE SALES CYCLE FOR OUR PRODUCTS TYPICALLY LASTS UP TO ONE YEAR, AND MAY BE
SUBJECT TO DELAYS, IT IS DIFFICULT TO FORECAST SALES FOR ANY GIVEN PERIOD.



If we fail to realize forecasted sales for a particular period, our stock price could decline significantly. The sales cycle of our products is lengthy and typically involves a detailed initial technical evaluation of our products by our
prospective customers, followed by the design, construction and testing of prototypes incorporating our products. Only after these steps are complete will we receive a purchase order from a customer for volume shipments. This process generally takes
from 9 to 12 months, and may last longer. Given this lengthy sales cycle, it is difficult to accurately predict when sales to a particular customer will occur. In addition, we may experience unexpected delays in orders from customers, which may
prevent us from realizing forecasted sales for a particular period. Our products are typically sold to equipment manufacturers, who incorporate our products in the products that they in turn sell to consumers or to network service providers. As a
result, any delay by our customers, or by our customers customers, in the manufacture or distribution of their products will result in a delay in obtaining orders for our products, which could cause our business and results to suffer.



RAPID CHANGES IN THE MARKET FOR DSL CHIP SETS MAY RENDER OUR CHIP SETS
OBSOLETE OR UNMARKETABLE.



The market for chip sets for DSL products
is characterized by:



| |  | intense competition;
| | - | --------------------



| |  | rapid technological change;
| | - | ---------------------------



| |  | frequent new product introductions by our competitors;
| | - | ------------------------------------------------------



| |  | changes in customer demands; and
| | - | --------------------------------



| |  | evolving industry standards.
| | - | ----------------------------



Any of these factors could make our products obsolete or unmarketable. In addition, the life cycles of some of our products may depend upon the life cycles of the end products into which our products will be designed.
Products with short life cycles require us to closely manage production and inventory levels. Unanticipated changes in the estimated total demand for our products and/or the estimated life cycles of the end products into which our products are
designed may result in obsolete or excess inventories, which in turn may adversely affect our operating results. To compete, we must innovate and introduce new products. If we fail to successfully introduce new products on a timely and
cost-effective basis that meet customer requirements and are compatible with evolving industry standards, then our business, financial condition and results of operations will be seriously harmed.



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OUR MARKETS ARE HIGHLY COMPETITIVE AND MANY OF OUR COMPETITORS ARE ESTABLISHED AND HAVE GREATER RESOURCES THAN WE
HAVE.



The market for communications semiconductor and software
solutions is intensely competitive. Given our stage of development, there is a substantial risk that we will not have the financial resources, technical expertise or marketing and support capabilities to compete successfully. In addition, a number
of other semiconductor companies have announced their intent to enter the market segments adjacent to or addressed by our products. These competitors have longer operating histories, greater name recognition, larger installed customer bases and
significantly greater financial, technical and marketing resources than we have. We may also face competition from customers or prospective customers own internal development efforts. Any of these competitors may be able to introduce new
technologies, respond more quickly to changing customer requirements or devote greater resources to the development, promotion and sale of their products than we can.



BECAUSE OUR PRODUCTS ARE COMPONENTS OF OTHER EQUIPMENT, IF BROADBAND EQUIPMENT MANUFACTURERS DO NOT INCORPORATE OUR PRODUCTS IN THEIR
EQUIPMENT, WE MAY NOT BE ABLE TO GENERATE SALES OF OUR PRODUCTS IN VOLUME QUANTITIES.



Our products are not sold directly to the end-user; they are components of other products. As a result, we rely upon equipment manufacturers to design our products into their equipment. We further rely on the
manufacturing and deployment of the equipment to be successful. If equipment that incorporates our products is not accepted in the marketplace, we may not achieve sales of our products in volume quantities, which would have a negative impact on our
results of operations.



BECAUSE MANUFACTURERS OF COMMUNICATIONS EQUIPMENT
MAY BE RELUCTANT TO CHANGE THEIR SOURCES OF COMPONENTS, IF WE DO NOT ACHIEVE DESIGN WINS WITH SUCH MANUFACTURERS, WE MAY BE UNABLE TO SECURE SALES FROM THESE CUSTOMERS IN THE FUTURE.



Once a manufacturer of communications equipment has designed a suppliers semiconductor
into its products, the manufacturer may be reluctant to change its source of semiconductors due to the significant costs associated with qualifying a new supplier. Accordingly, our failure to achieve design wins with equipment manufacturers, who
have chosen a competitors semiconductor could create barriers to future sales opportunities with these manufacturers.



THIRD-PARTY CLAIMS REGARDING INTELLECTUAL PROPERTY MATTERS COULD CAUSE US TO STOP SELLING OUR PRODUCTS, PAY MONETARY DAMAGES OR OBTAIN LICENSES ON ADVERSE TERMS.



There is a significant risk that third parties, including current and
potential competitors, will claim that our products, or our customers products, infringe on their intellectual property rights. The owners of these intellectual property rights may bring infringement claims against us or our customers. Any
such litigation, whether or not determined in our favor or settled by us, would be costly and divert the attention of our management and technical personnel. Inquiries with respect to the coverage of our intellectual property could develop into
litigation. In the event of an adverse ruling for an intellectual property infringement claim, we could be required to obtain a license or pay substantial damages or have the sale of our products stopped by an injunction. Such a license may not be
available on reasonable terms, or at all. In addition, if a customer of our products cannot acquire a required license on commercially reasonable terms, that customer may choose not to use our products. We have obligations to indemnify our customers
under some circumstances for infringement of third-party intellectual property rights. If any intellectual property claims from third parties against one of our customers whom we have indemnified is held to be valid, the costs to us could be
substantial and our business could be harmed.



We have received correspondence
from certain parties, including Texas Instruments, Alcatel and Ricoh, requesting us to discuss the potential need for non-exclusive licenses permitting us to utilize technology covered by various patents held by these parties. We could be subject to
claims similar to the Texas Instruments, Alcatel and Ricoh claims in the future. Depending on the amount and timing of any unfavorable resolutions of these claims, our future results of operations or cash flows could be materially adversely
affected.



WE DEPEND ON SOLE SOURCE SUPPLIERS FOR SEVERAL KEY COMPONENTS
OF OUR PRODUCTS.



We obtain certain parts, components and packaging
used in the delivery of our products from sole sources of supply. For example, we obtain digital semiconductor wafers from Taiwan Semiconductor Manufacturing Co., Ltd and we obtain analog silicon wafers from United Microelectronics Corporation. If
we fail to obtain components in sufficient quantities when required or if we cannot adequately control manufacturing process quality, product yields or production costs, our business could be harmed. Developing and maintaining these strategic
relationships with our vendors is critical for us to be successful.



Any of our
sole source suppliers may:



| |  | enter into exclusive arrangements with our competitors;
| | - | -------------------------------------------------------



| |  | stop selling their products or components to us at commercially reasonable prices;
| | - | ----------------------------------------------------------------------------------



| |  | refuse to sell their products or components to us at any price; or
| | - | ------------------------------------------------------------------



| |  | be subject to production disruptions such as earthquakes.
| | - | ---------------------------------------------------------



IF WE DELIVER PRODUCTS WITH DEFECTS, OUR CREDIBILITY WILL BE HARMED, AND THE SALES AND MARKET ACCEPTANCE OF OUR PRODUCTS WILL DECREASE.



Our products are complex and have contained errors, defects and bugs when introduced and
revised. If we deliver products with errors, defects or bugs or products that have reliability, quality or compatibility problems, our credibility and the market acceptance and sales of our products could be harmed, which could adversely affect our
ability to retain existing customers or attract new customers. Further, if our products contain errors, defects and bugs, then we may be required to expend significant capital and resources to alleviate such problems and may have our sales to
customers interrupted or delayed. If any of these problems are not found until we have commenced commercial production, we may be required to incur additional development costs and product repair or replacement costs. Defects could also lead to
potential liability as a result of product liability lawsuits against us or against our



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customers. We have agreed to indemnify our customers in some circumstances against liability from defects in our products. A successful product liability
claim could seriously harm our business, financial condition and results of operations, and may divert our technical and other resources from other development efforts.



WE MAY EXPERIENCE DIFFICULTIES IN TRANSITIONING TO SMALLER GEOMETRY PROCESS TECHNOLOGIES OR IN ACHIEVING HIGHER LEVELS OF DESIGN
INTEGRATION AND THAT MAY RESULT IN REDUCED MANUFACTURING YIELDS, DELAYS IN PRODUCT DELIVERIES AND INCREASED EXPENSES.



In order to remain competitive, we expect to continue to transition our products to increasingly smaller line width geometries. This transition will require us to modify
the manufacturing processes for our products and redesign some products. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our costs, and we have designed some of
our products to be manufactured in .35 micron, .25 micron, .18 micron and .13 micron geometry processes. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which
resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes. We are dependent on our
relationships with our foundries to transition to smaller geometry processes successfully. We cannot assure you that our foundries will be able to effectively manage the transition or that we will be able to maintain our foundry relationships. If
our foundries or we experience significant delays in this transition or fail to efficiently implement this transition, our business, financial condition and results of operations could be materially and adversely affected. As smaller geometry
processes become more prevalent, we expect to continue to integrate greater levels of functionality, as well as customer and third party intellectual property, into our products. However, we may not be able to achieve higher levels of design
integration or deliver new integrated products on a timely basis, or at all.



FUTURE CONSOLIDATION IN THE TELECOMMUNICATIONS EQUIPMENT INDUSTRY MAY INCREASE COMPETITION THAT COULD HARM OUR BUSINESS.



The markets in which we compete are characterized by increasing consolidation both within the telecommunications equipment sector and by companies combining or acquiring
data communications assets and assets for delivering voice-related services. We cannot predict with certainty how industry consolidation will affect our competitors. We may not be able to compete successfully in an increasingly consolidated
industry. Increased competition and consolidation in our industry may require that we reduce the prices of our products or result in a loss of market share, which could materially adversely affect our business, financial condition and results of
operations. Additionally, because we are now, and may in the future be, dependent on certain strategic relationships with third parties in our industry, any additional consolidation involving these parties could reduce the demand for our products
and otherwise harm our business prospects.



WE MAY MAKE FUTURE
ACQUISITIONS AND ACQUISITIONS INVOLVE NUMEROUS RISKS.



Our business is
highly competitive and, as such, our growth is dependent upon market growth, our ability to enhance our existing products and our ability to introduce new products on a timely basis. One of the ways we have addressed and may continue to address the
need to develop new products is through acquisitions of other companies. Acquisitions involve numerous risks, including the following:



| |  | difficulties in integration of the operations, technologies and products of the acquired companies;
| | - | ---------------------------------------------------------------------------------------------------



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| |  | the risk of diverting managements attention from normal daily operations of the business;
| | - | ------------------------------------------------------------------------------------------



| |  | potential difficulties in completing projects associated with purchased in-process research and development;
| | - | ------------------------------------------------------------------------------------------------------------



| |  | risks of entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the potential loss of key employees of the acquired company.
| | - | ------------------------------------------------------------



Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful and
will not materially adversely affect our business, operating results or financial condition.



We must also maintain our ability to manage such growth effectively. Failure to manage growth effectively and successfully integrate acquisitions could harm our business and operating results.



OUR EXECUTIVE OFFICERS AND KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS, AND THESE
OFFICERS AND PERSONNEL MAY NOT REMAIN WITH US IN THE FUTURE.



We
depend upon the continuing contributions of our key management, sales, customer support and product development personnel. The loss of such personnel could seriously harm us. In addition, we have not obtained key-man life insurance on any of our
executive officers or key employees.



OUR FUTURE SUCCESS WILL DEPEND IN
PART ON OUR ABILITY TO PROTECT OUR PROPRIETARY RIGHTS AND THE TECHNOLOGIES USED IN OUR PRINCIPAL PRODUCTS, AND IF WE DO NOT ENFORCE AND PROTECT OUR INTELLECTUAL PROPERTY, OUR BUSINESS WILL BE HARMED.



We rely on a combination of patent, copyright and trademark laws, trade secrets,
confidentiality agreements and other contractual provisions to protect our proprietary rights. However, these measures afford only limited protection. Our failure to adequately protect our proprietary rights may adversely affect us. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use trade secrets or other information that we regard as proprietary.



The laws of some foreign countries do not protect our proprietary rights to the same extent
as do the laws of the United States, and many U.S. companies have encountered substantial infringement problems in these countries. There is a risk that our efforts to protect proprietary rights may not be adequate. For example, our competitors may
independently develop similar technology, duplicate our products or design around our patents or our other intellectual property rights. If we fail to adequately protect our intellectual property or if the laws of a foreign jurisdiction do not
effectively permit such protection, it would be easier for our competitors to sell competing products.



WE MAY NEED TO RAISE ADDITIONAL CAPITAL WHICH MIGHT NOT BE AVAILABLE OR WHICH, IF AVAILABLE, COULD BE ON TERMS ADVERSE TO OUR COMMON STOCKHOLDERS.



We expect that our current cash and cash equivalents and short-term investment balances will
be adequate to meet our working capital and capital expenditure needs for at least twelve months. After that, we may need to raise additional funds, and we cannot be certain that we will be able to obtain additional financing on favorable terms, if
at all. We may also require additional capital for the acquisition of businesses, products and technologies that are complementary to ours. Further, if we issue equity securities, the ownership percentage of our stockholders would be reduced, and
the new equity securities may have rights, preferences or privileges senior to those existing holders of our common stock. If we cannot raise needed funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of
future opportunities or respond to competitive pressures or unanticipated requirements, which could seriously harm our business, operating results and financial condition.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------



The primary objective of our cash and short-term investment activities is to preserve principal while concurrently maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we may invest in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if
we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the current value of the principal amount of our investment will decline. To minimize this risk in the future, we
intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper,



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money market funds, government and non-government debt securities and certificates of deposit. In general, money market funds are not subject to market risk
because the interest paid on such funds fluctuates with the prevailing interest rate. As of March 31, 2004, all of our investments were in money market funds, high quality commercial paper, government and non-government debt securities and auction
rate preferred securities. A hypothetical 100 basis point increase in interest rates would result in an approximate $234,000 decrease in the fair value of our available-for-sale securities as of March 31, 2004.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------



Evaluation of disclosure controls and procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer,
the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our
disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms.



Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or
is reasonably likely to materially affect, our internal control over financial reporting.



PART II. OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------



None



|ITEM 2. | CHANGES IN SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------



None



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------



None



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



None



|ITEM 5. | OTHER INFORMATION
|------- | -----------------



None



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|ITEM 6. | EXHIBITS AND REPORTS ON FORM 8-K
|------- | --------------------------------



|(a) | Exhibits
|--- | --------



|     |  |                                                                                                                                                                                                                               
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification of Faraj Aalaei, Chief Executive Officer Pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.                   
|     | 
|31.2 |  | Certification of Darrel Slack, Vice President and Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
|     | 
|32.1 |  | Certification of Faraj Aalaei, Chief Executive Officer of Centillium Communications, Inc., Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.                          
|     | 
|32.2 |  | Certification of Darrel Slack, Vice President and Chief Financial Officer of Centillium Communications, Inc., Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.       



|(b) | Reports on Form 8-K
|--- | -------------------



We filed or furnished the following current reports on Form 8-K during the quarter ended March 31, 2004:



| | (i) | Form 8-K furnished on January 29, 2004 reporting fourth quarter and annual earnings for 2003.
| | --- | ---------------------------------------------------------------------------------------------



| | (ii) | Form 8-K furnished on March 22, 2004 announcing the resignation of Shahin Hedayat from Centilliums board of directors and the appointment of Syrus Madavi to Centilliums
board of directors.
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES



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



|                   |  |  |  |                                              |  |                     |  |                                                                                                     
|------------------ |  |  |  | -------------------------------------------- |  | ------------------- |  | ----------------------------------------------------------------------------------------------------
|                   |  |  |  | CENTILLIUM COMMUNICATIONS, INC. (Registrant)
|                   |  |  | 
|Dated: May 6, 2004 |  |  |  | By:                                          |  | /s/    DARREL SLACK
|                   |  |  |  |                                              |  |                     | 
|                   |  |  |  |                                              |  |                     |  | Darrel Slack Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)



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