SILICON LABORATORIES INC, 10-Q, 2000-10-16

SILICON LABORATORIES INC
10-Q, 2000-10-16
SEMICONDUCTORS & RELATED DEVICES

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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 September 30, 2000
-------------------------------------------------

/ / 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:
-------------------------------------------------------

SILICON LABORATORIES INC.
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(Exact name of registrant as specified in its charter)

Delaware 74-2793174
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)

4635 Boston Lane, Austin, Texas 78735
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(Address of principal executive offices) (Zip Code)

(512) 416-8500
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(Registrant's telephone number, including area code)

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(Former name, former address and former fiscal year,
if changed since last report)

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Sections 12, 13 or 15(d) of the
Securities Exchange Act of 1934 subsequent to the distribution of securities
under a plan confirmed by a court. / / Yes / / No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
As of September 30, 2000, 47,745,621 shares of common
stock of Silicon Laboratories Inc. were outstanding.

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<PAGE>

<TABLE>
<CAPTION>
PAGE
PART I. FINANCIAL INFORMATION NUMBER
<S> <C>
Item 1 Financial Statements:

Condensed Consolidated Balance Sheets at September 30, 2000 and
January 1, 2000 .................................................. 3

Condensed Consolidated Statements of Income for the
three and nine months ended September 30, 2000 and
October 2, 1999 -------------------------------------------------- 4

Condensed Consolidated Statements of Cash Flows for
the nine months ended September 30, 2000 and
October 2, 1999................................................... 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.......... 17

PART II. OTHER INFORMATION

Item 1 Legal Proceedings................................................... 29

Item 2 Changes in Securities and Use of Proceeds........................... 31

Item 3 Defaults Upon Senior Securities..................................... 31

Item 4 Submission of Matter to a Vote of Securities Holders................ 31

Item 5 Other Information................................................... 31

Item 6 Exhibits and Reports on Form 8-K.................................... 31
</TABLE>

2
<PAGE>

PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

SILICON LABORATORIES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

SEPTEMBER 30, JANUARY 1,
2000 2000
------------- ----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................................... $ 46,555 $ 8,197
Short-term investments ...................................................... 43,411 6,509
Accounts receivable, net of allowance for doubtful
accounts of $758 at September 30, 2000 and $569 at
January 1, 2000 ........................................................... 16,458 10,322
Inventories ................................................................. 6,929 2,837
Deferred income taxes ....................................................... 1,585 963
Prepaid expenses and other .................................................. 816 435
------------- ----------
Total current assets ........................................................... 115,754 29,263
Property, equipment and software, net .......................................... 21,737 12,350
Goodwill and other intangible assets ........................................... 40,193 --
Other assets ................................................................... 418 345
------------- ----------
Total assets ................................................................... $ 178,102 $ 41,958
============= ==========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................ $ 7,422 $ 7,374
Accrued expenses ............................................................ 5,082 1,083
Deferred revenue ............................................................ 2,510 1,006
Current portion of long-term obligations .................................... 2,030 2,697
Income taxes payable ........................................................ 873 2,822
------------- ----------
Total current liabilities ...................................................... 17,917 14,982
Long-term debt and leases, net of current maturities ........................... 3,919 6,081
Other long-term obligations .................................................... 1,288 142
------------- ----------
Total liabilities .............................................................. 23,124 21,205
Redeemable convertible preferred stock ......................................... -- 12,750
Stockholders' equity:
Common stock--$.0001 par value; 250,000 and 52,000 shares
authorized and 47,746 and 30,016 shares issued and outstanding at
September 30, 2000 and January 1, 2000,
respectively .............................................................. 5 3
Additional paid-in capital .................................................. 154,883 19,014
Stockholder notes receivable ................................................ (1,472) (1,472)
Deferred stock compensation ................................................. (15,377) (15,330)
Retained earnings ........................................................... 16,939 5,788
------------- ----------
Total stockholders' equity ..................................................... 154,978 8,003
------------- ----------
Total liabilities and stockholders' equity ..................................... $ 178,102 $ 41,958
============= ==========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

3
<PAGE>

SILICON LABORATORIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, OCTOBER 2, SEPTEMBER 30, OCTOBER 2,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Sales .......................................................... $ 29,427 $ 14,574 $ 73,400 $ 28,437
Cost of goods sold ............................................. 10,130 4,582 25,277 9,862
-------- -------- -------- --------
Gross profit ................................................... 19,297 9,992 48,123 18,575
Operating expenses:
Research and development .................................... 5,263 2,109 13,290 5,000
Selling, general and administrative ......................... 5,128 2,105 12,702 4,737
Write off of in-process research & development .............. 394 -- 394 --
Goodwill amortization ....................................... 1,240 -- 1,240 --
Amortization of deferred stock compensation ................. 884 254 2,451 403
-------- -------- -------- --------
Operating expenses ............................................. 12,909 4,468 30,077 10,140
-------- -------- -------- --------
Operating income ............................................... 6,388 5,524 18,046 8,435
Other (income) and expenses:
Interest income ............................................. (1,248) (98) (2,753) (236)
Interest expense ............................................ 339 217 957 477
-------- -------- -------- --------
Income before tax expense ...................................... 7,297 5,405 19,842 8,194
Income tax expense ............................................. 3,332 1,251 8,691 1,896
-------- -------- -------- ---------
Net income ..................................................... $ 3,965 $ 4,154 $ 11,151 $ 6,298
======== ======== ======== ========
Net income per share:
Basic ....................................................... $ 0.09 $ 0.26 $ 0.31 $ 0.44
Diluted ..................................................... $ 0.08 $ 0.09 $ 0.23 $ 0.14
Weighted average common shares outstanding:
Basic ....................................................... 43,917 15,902 36,119 14,378
Diluted ..................................................... 49,987 44,377 48,584 43,867

</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.

4
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SILICON LABORATORIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------
SEPTEMBER 30, OCTOBER 2,
2000 1999
--------------- -------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income..................................................................... $ 11,151 $ 6,298
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization expense ...................................... 5,963 1,293
Amortization of deferred stock compensation ................................ 2,451 403
Amortization of note/lease end-of-term interest
payments ................................................................. 242 62
Compensation expense related to stock options, direct
stock issuance, and warrants to non-employees ............................ 153 16
Investment interest receivable ............................................. (275) 19
Changes in operating assets and liabilities:
Prepaid expenses and other ............................................... (252) (96)
Accounts receivable ...................................................... (5,947) (5,290)
Inventories .............................................................. (3,556) (577)
Other assets ............................................................. (61) (18)
Accounts payable ......................................................... (1,709) 2,612
Accrued expenses ......................................................... 3,806 904
Deferred revenue ......................................................... 1,504 271
Deferred income taxes .................................................... (535) --
Income taxes payable ..................................................... (47) 1,773
-------- -------
Net cash provided by operating activities ..................................... 12,888 7,670

INVESTING ACTIVITIES
Purchases of short-term investments ........................................... (60,278) (6,390)
Maturities of short-term investments .......................................... 23,651 2,891
Purchases of property and equipment ........................................... (13,395) (4,993)
Payment for software license .................................................. (750) --
Acquisition of Krypton, net of cash acquired .................................. (13,285) --
-------- -------
Net cash used in investing activities ......................................... (64,057) (8,492)

FINANCING ACTIVITIES
Proceeds from long-term debt .................................................. 3,532 2,383
Payments on long-term debt .................................................... (5,997) (458)
Proceeds from credit facility ................................................. -- 1,100
Payments on credit facility ................................................... -- (1,100)
Proceeds from equipment lease financing ....................................... -- 1,242
Payments on capital leases .................................................... (364) (331)
Proceeds from exercise of warrants ............................................ 100 --
Net proceeds from initial public offering of common stock ..................... 90,646 --
Net proceeds from exercises of stock options .................................. 1,610 57
-------- -------
Net cash provided by financing activities ..................................... 89,527 2,893
-------- -------
Increase in cash and cash equivalents ......................................... 38,358 2,071
Cash and cash equivalents at beginning of period .............................. 8,197 2,867
-------- -------
Cash and cash equivalents at end of period .................................... $ 46,555 $ 4,938
======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid.................................................................. $ 706 $ 386
======== =======
Income taxes paid ............................................................. $ 9,170 $ 123
======== =======
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

5
<PAGE>

SILICON LABORATORIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 2000

1. Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements included herein are
unaudited; however, they contain all normal recurring accruals and
adjustments which, in the opinion of management, are necessary to present
fairly the consolidated financial position of Silicon Laboratories Inc. and
its subsidiary (collectively, the "Company") at September 30, 2000 and the
consolidated results of its operations and cash flows for the three and nine
months ended September 30, 2000 and October 2, 1999. All intercompany
accounts and transactions have been eliminated. The results of operations for
the three and nine months ended September 30, 2000 are not necessarily
indicative of the results to be expected for the full year.

The accompanying unaudited condensed consolidated financial
statements do not include footnotes and certain financial presentations
normally required under accounting principles generally accepted in the
United States. Therefore, these financial statements should be read in
conjunction with the audited consolidated financial statements and notes
thereto for the year ended January 1, 2000, included in the Company's
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission.

Short-Term Investments

The Company's short-term investments have been classified as
available-for-sale securities in accordance with Statement of Financial
Accounting Standard (SFAS) No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN
DEBT AND EQUITY SECURITIES. The carrying value of available-for-sale
securities approximates fair value.

Inventories

Inventories are stated at the lower of cost, determined using the
first-in, first-out method, or market. Inventories consist of the following
(in thousands):

<TABLE>
<CAPTION>
SEPTEMBER 30, JANUARY 1,
2000 2000
-------------- -----------
<S> <C> <C>
Work in progress................ $4,775 $ 1,902
Finished goods.................. 2,154 935
-------------- ------------
$6,929 $ 2,837
=============== ============
</TABLE>

Stock Based Compensation

6
<PAGE>

SILICON LABORATORIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

related to the definition of an employee apply to new awards granted after
December 15, 1998; (ii) modifications that directly or indirectly reduce the
exercise price of an award apply to modifications made after December 15,
1998; and (iii) modifications to add a reload feature to an award apply to
modifications made after January 12, 2000. The adoption of this pronouncement
had no impact on the earnings or the financial condition of the Company.

Other Comprehensive Income

In June 1997, the FASB issued SFAS No. 130, REPORTING COMPREHENSIVE
INCOME, which establishes standards for reporting and display of
comprehensive income and its components in the financial statements. There
were no material differences between net income and comprehensive income
during any of the periods presented.

Earnings Per Share

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

Basic:
Weighted-average shares of common stock outstanding 47,496 29,120 42,162 28,971
Weighted-average shares of common stock subject to repurchase (3,579) (13,218) (6,043) (14,593)
---------- --------- ---------- --------
Shares used in computing basic net income per share 43,917 15,902 36,119 14,378

Effect of dilutive securities:
Weighted-average shares of common stock subject to repurchase 3,506 13,111 5,932 14,425
Convertible preferred stock and warrants 115 13,967 4,281 13,957
Stock options 2,449 1,397 2,252 1,107
---------- --------- ---------- --------
Shares used in computing diluted net income per share 49,987 44,377 48,584 43,867
========== ========= ========== ========

Basic net income per share $0.09 $0.26 $0.31 $0.44

Diluted net income per share $0.08 $0.09 $0.23 $0.14
</TABLE>

7
<PAGE>

SILICON LABORATORIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

2. Acquisition of Krypton Isolation, Inc.

On August 9, 2000, the Company consummated a merger with Krypton
Isolation, Inc. (Krypton), a company specializing in patented total solid
state all-silicon Data Access Arrangement, or DAA, devices. The purchase price
of $42.0 million consisted of $15.0 million in cash, 384,100 shares of the
Company's common stock valued at $21.9 million, 90,449 options to purchase
the Company's common stock valued at $4.8 million, and direct acquisition
costs of $0.3 million. The direct acquisition costs consist primarily of
legal, accounting, and appraisal fees incurred by the Company that are
directly related to the merger. There can be no assurance that the Company
and Krypton will not incur additional charges related to the merger or that
management will be successful in its efforts to integrate the operations of
the two companies. To determine the value associated with the stock and stock
option portion of the consideration paid to Krypton shareholders, management
used the average of the closing prices of the Company's common stock for the
three days before and after the measurement date, August 4, 2000, in
accordance with Emerging Issues Task Force (EITF) 99-12 ACCOUNTING FOR
FORMULA ARRANGEMENTS UNDER EITF 95-19, DETERMINATION OF THE MEASUREMENT DATE
FOR THE MARKET PRICE OF ACQUIRER SECURITIES ISSUED IN A PURCHASE BUSINESS
COMBINATION. The average of these closing prices was $56.96. The number of
shares tendered was based on the average of the closing prices of the
Company's common stock in the ten trading days ending on August 4, 2000 in
accordance with the terms of the agreement.

The acquisition of Krypton is being accounted for under the purchase
method of accounting. The purchase price was allocated to the estimated fair
value of assets acquired and liabilities assumed based on independent
appraisals and management estimates as follows (in thousands):

<TABLE>
<CAPTION>
Amortization
Period
------------------
<S> <C> <C>
Intangibles:
Workforce $ 214 3 years
Customer base 1,006 5 years
Acquired technology 952 4-7 years
Patents 120 3 years
Goodwill 37,229 5 years
-------------
39,521

Net fair value of tangible assets acquired and liabilities
assumed 2,415
Net deferred tax liabilities assumed (373)
Deferred stock compensation 35
In-process research and development 394
-------------
Total purchase price $ 41,992
=============
</TABLE>

Since this acquisition was accounted for using the purchase method,
the results of operations of Krypton have been included with those of the
Company subsequent to the acquisition date, August 9, 2000. The following
presents the unaudited pro forma combined results of operations of the
Company with Krypton for the nine month periods ended September 30, 2000 and
October 2, 1999, after giving effect to certain pro forma adjustments, as if
Krypton has been acquired as of the beginning of the respective fiscal years.
The unaudited pro forma

8
<PAGE>

financial information for the nine months ended September 30, 2000 combines
the unaudited historical results of operations of the Company for the nine
months ended September 30, 2000 and the unaudited historical results of
operations of Krypton for the nine months ended July 31, 2000. The unaudited
pro forma financial information for the nine months ended October 2, 1999
combines the unaudited results of operations for the nine months ended
October 2, 1999 for the Company, and the unaudited results of operations for
the nine months ended July 31, 1999 for Krypton. (in thousands, except per
share data)

<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 2000 OCTOBER 2, 1999
-------------------- ---------------------
<S> <C> <C>
Sales $ 74,280 $ 29,852
Net income (loss) (1,834) 258
Diluted net income (loss) per share $ (0.04) $ 0.01
</TABLE>

The pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the operating results or financial
position that would have occurred if the merger had been consummated at the
beginning of the respective fiscal years, nor is it necessarily indicative of
future operating results or financial position of the Company.

Approximately $394,000 of the purchase price was allocated to
in-process research and development based upon an independent third party
appraisal and expensed upon the consummation of the transaction. The proforma
adjustments do not include a charge for this expense as it does not have a
continuing impact on the operations of the Company. Further, the unaudited
pro forma financial information does not include the realization of cost
savings from operating efficiencies, synergies or other restructurings that
may result from the merger.

3. Stockholders' Equity

During the quarter ended September 30, 2000, the Company recorded
deferred stock compensation of $1,669,000 in connection with nonqualified
stock options granted during the quarter at an exercise price lower than the
fair market value of the common stock on the date of grant. The deferred
stock compensation is being amortized over the vesting periods of the
applicable options. Amortization of deferred stock compensation resulted in
expense of $884,000 and $2,451,000 for the three and nine months ended
September 30, 2000 related to options granted and direct issuances either in
such quarter or in prior periods.

In March 2000, the Company completed its initial public offering
(the "Offering") of 3,680,000 shares of its Common Stock. Of these shares,
the Company sold 3,200,000 shares (including 480,000 shares issued in
connection with the exercise of the underwriters' over-allotment option), and
selling shareholders sold 480,000 shares, at a price of $31.00 per share. The
Company received aggregate proceeds from the Offering of $90,646,000 in cash
(net of underwriting discounts and commissions and estimated offering costs).
Upon consummation of the Offering, all outstanding shares of the Company's
Convertible Preferred Stock were automatically converted into an aggregate of
13,884,190 shares of Common Stock.

9
<PAGE>

4. Commitments and Contingencies

The Company is involved in various legal proceedings that have
arisen in the normal course of business. While the ultimate results of these
matters cannot be predicted with certainty, management does not expect them
to have a material adverse effect on the consolidated financial position and
results of operations.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES THERETO INCLUDED ELSEWHERE
IN THIS QUARTERLY REPORT ON FORM 10-Q, THE PRIOR QUARTERLY REPORTS ON FORM
10-Q FILED JULY 17, 2000 AND APRIL 26, 2000,FORM 8-K FILED AUGUST 11, 2000 AND
FORM 8-K/A FILED SEPTEMBER 8, 2000, AND THE SILICON LABORATORIES' PROSPECTUS
DATED MARCH 23, 2000. EXCEPT FOR THE HISTORICAL FINANCIAL INFORMATION
CONTAINED HEREIN, THE MATTERS DISCUSSED IN THIS QUARTERLY REPORT ON FORM 10-Q
MAY BE CONSIDERED "FORWARD-LOOKING" STATEMENTS WITHIN THE MEANING OF SECTION
27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. SUCH STATEMENTS INCLUDE
DECLARATIONS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF SILICON
LABORATORIES AND ITS MANAGEMENT AND MAY BE SIGNIFIED BY THE WORDS "EXPECTS,"
"ANTICIPATES," "INTENDS," "BELIEVES" OR SIMILAR LANGUAGE. PROSPECTIVE
INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE A NUMBER OF RISKS AND
UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE INDICATED BY
SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO
SUCH DIFFERENCES INCLUDE THOSE DISCUSSED BELOW, AS WELL AS THOSE DISCUSSED IN
SILICON LABORATORIES' PROSPECTUS DATED MARCH 23, 2000, PRIOR QUARTERLY REPORTS
ON FORM 10-Q FILED JULY 17, 2000 AND APRIL 26, 2000, AND PRIOR CURRENT REPORTS
ON FORM 8-K AND 8-K/A FILED AUGUST 11, 2000 AND SEPTEMBER 8, 2000. OUR FISCAL
YEAR-END FINANCIAL REPORTING PERIODS ARE A 52- OR 53- WEEK YEAR ENDING ON THE
SATURDAY CLOSEST TO DECEMBER 31ST. OUR THIRD QUARTER OF FISCAL YEAR 2000 ENDED
SEPTEMBER 30, 2000. OUR THIRD QUARTER OF FISCAL YEAR 1999 ENDED OCTOBER 2,
1999. ALL OF THE QUARTERLY PERIODS REPORTED IN THIS QUARTERLY REPORT ON FORM
10-Q HAD THIRTEEN WEEKS.

OVERVIEW

Silicon Laboratories designs and develops proprietary, analog-intensive,
mixed-signal integrated circuits, or ICs, for the rapidly growing
communications industry. Our innovative ICs can dramatically reduce the cost,
size and system power requirements of the products that our customers sell to
their end-user customers. We currently offer ICs that can be incorporated
into communications devices, such as modems and cellular phones, as well as
cable and satellite set-top boxes, credit card verification machines,
automated teller machines, network access equipment, remote gaming devices
and high speed optical networking equipment.

Our company was founded in 1996. Our business has grown rapidly since
our inception, as reflected by our employee headcount, which increased to 240
employees at September 30, 2000 from 148 at the end of fiscal 1999, 42 at the
end of fiscal 1998, and 17 at the end of fiscal 1997. As a "fabless"
semiconductor company, we rely on third-party semiconductor fabricators to
manufacture the silicon wafers that reflect our IC designs. Each wafer
contains numerous die, which are cut from the wafer to create a chip for an
IC. We also rely on third-party assemblers to assemble and package these die
prior to final product testing and shipping.

Our first IC product, the direct access arrangement, or DAA, had its
first commercial shipment in April 1998. Based on the success of our DAA
products, we became profitable in the fourth quarter of fiscal 1998 and have
been profitable in each succeeding quarter through the

10
<PAGE>

quarter ended September 30, 2000. Substantially all of our sales to date have
been derived from sales of our various DAA products and we expect to remain
dependent on continued sales of DAA products for a majority of our sales
until we are able to diversify sales with new products.

To date, a majority of our sales have been generated through our direct
sales force. In fiscal 1998, we began to establish a network of independent
sales representatives and distributors worldwide to support our sales and
marketing activities. We anticipate that sales to these representatives and
distributors will increase as a percentage of our sales in future periods.
However, we expect to continue to experience significant customer
concentration in direct sales to key customer accounts until we are able to
diversify sales with new customers.

The sales cycle for the test and evaluation of our ICs can range from 1
to 12 months or more. An additional 3 to 6 months or more may be required
before a customer ships a significant volume of devices that incorporate our
ICs. Due to this lengthy sales cycle, we may experience a significant delay
between incurring expenses for research and development and selling, general
and administrative efforts, and the generation of corresponding sales, if
any. We intend to continue to increase our investment in research and
development, selling, general and administrative functions and inventory as
we expand our operations in the future. Consequently, if sales in any quarter
do not occur when expected, expenses and inventory levels could be
disproportionately high, and our operating results for that quarter and,
potentially, future quarters would be adversely affected.

Our limited operating history and rapid growth make it difficult for us
to assess the impact of seasonal factors on our business. Because many of our
ICs are designed for use in consumer products such as PCs and cellular
telephones, we expect that the demand for our products will be subject to
seasonal demand resulting in increased sales in the third and fourth quarters
of each year when customers place orders to meet holiday demand. We expect to
experience seasonal fluctuations in the demand for our products as customer
demand increases in greater volume across our product offerings.

The following describes the line items set forth in our consolidated
statements of income:

SALES. Sales consists of revenue generated principally by sales of our ICs.
Generally, we recognize sales at the time of shipment to our customers. Sales
are deferred on shipments to distributors until they are resold by such
distributors. Our products typically carry a one-year warranty. Since our
inception, product returns and warranty costs have not been significant. Our
sales are subject to variation from period to period due to the volume of
shipments made within a period and the prices we charge for our products. The
vast majority of our sales were conducted at prices that reflect a discount
from the list prices for our products. These discounts are made for a variety
of reasons, including to establish a relationship with a new customer, as an
incentive for customers to purchase products in larger volumes or in response
to competition. In addition, as a product matures, we expect that the average
selling price for that product will decline. Therefore, our ability to
increase sales in the future is dependent on increased demand for our
established products and our ability to ship larger volumes of products in
response to such demand, as well as customer acceptance of newly introduced
products.

COST OF GOODS SOLD. Cost of goods sold includes the cost of purchasing
finished silicon wafers processed by independent foundries; costs associated
with assembly, test and shipping of those products; costs of personnel and
equipment associated with manufacturing support, logistics and quality
assurance; an allocated portion of our occupancy costs; and allocable
depreciation of testing equipment. Generally, we depreciate equipment over
four years on a straight line basis. We also depreciate our leasehold
improvements over the applicable lease term. Recently introduced products
tend to have higher cost of goods sold per unit due to initially low
production volumes required by our customers and higher costs associated with
new package variations. Generally, as production volumes for a product
increase, unit production costs tend to decrease as

11
<PAGE>

our semiconductor fabricators and assemblers achieve greater economies of
scale for that product. Additionally, the cost of wafer procurement, which is
a significant component of cost of goods sold, varies cyclically with overall
demand for semiconductors. The semiconductor industry has recently
experienced a period of high demand, resulting in higher wafer procurement
costs.

RESEARCH AND DEVELOPMENT. Research and development expense consists primarily
of compensation and related costs of employees engaged in research and
development activities, as well as an allocated portion of our occupancy
costs for such operations. We depreciate our research and development
equipment over four years and amortize our purchased software from
computer-aided design tool vendors over four years. Development activities
include the creation of test methodologies to assure compliance with required
specifications. We have granted stock options or directly issued stock to
patent attorneys and outside technical consultants for services previously
rendered. We recognize stock-based compensation expense for these
non-employees based on the deemed fair value of the options or stock at the
date of grant. We have issued a warrant to a university's Electrical
Engineering Department to support mixed signal analog intensive integrated
circuit design activities. We recognized expense for this warrant based on
the deemed fair value of the warrant at the date of grant.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expense consists primarily of personnel-related expenses, related allocable
portion of our occupancy costs, sales commissions to independent sales
representatives, professional fees, other promotional and marketing expenses
and reserves for bad debt. Write-offs of bad debt have been insignificant to
date. We awarded stock to non-employee sales persons in connection with a
sales incentive program that ended on January 1, 2000. We recognized
stock-based compensation expense for these non-employees based on the deemed
fair value of the stock at the date of grant.

AMORTIZATION OF DEFERRED STOCK COMPENSATION. In connection with the grant of
stock options and direct issuances of stock to our employees prior to our
initial public offering, we recorded deferred stock compensation of
approximately $16.3 million, representing, for accounting purposes, the
difference between the exercise price of option grants, or the issuance price
of direct issuances of stock, and the deemed fair value of our common stock
at the time of such grants or issuances. Since the initial public offering,
we have recorded additional deferred stock compensation of $2.5 million on
the same basis. The deferred stock compensation is amortized over the vesting
period of the applicable options or shares, generally five to eight years.
The amortization of deferred stock compensation is recorded as an operating
expense.

INTEREST INCOME. Interest income reflects interest earned on average cash
and cash equivalents and investment balances.

INTEREST EXPENSE. Interest expense consists of interest on our long-term
debt and capital lease obligations.

INCOME TAX EXPENSE. We accrue a provision for federal and state income tax
at the Company's estimated effective tax rate.

12
<PAGE>

RESULTS OF OPERATIONS

The following table sets forth our statement of operations data as a
percentage of sales for the periods indicated:

Operating expenses:
Research and development ......................... 17.9 14.5 18.1 17.6
Selling, general and administrative .............. 17.4 14.4 17.3 16.7
Write off of in-process research & .............. 1.3 -- 0.5 --
development
Goodwill amortization ........................... 4.2 -- 1.7 --
Amortization of deferred stock compensation ...... 3.0 1.7 3.3 1.4
------------------ --------------------
Operating expenses ................................. 43.9 30.7 41.0 35.7

Operating income ................................... 21.7 37.9 24.6 29.7

Interest income .................................... (4.2) (0.7) (3.8) (0.8)
Interest expense ................................... 1.2 1.5 1.3 1.7
Income before tax expense .......................... 24.8 37.1 27.0 28.8
Income tax expense ................................. 11.3 8.6 11.8 6.7
------------------ -------------------
Net income ......................................... 13.5% 28.5% 15.2% 22.1%
================== ===================
</TABLE>

COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 TO
THE THREE AND NINE MONTHS ENDED OCTOBER 2, 1999

SALES. Sales for the three months ended September 30, 2000 were $29.4
million, an increase of $14.9 million or 102% from sales of $14.6 million in
the three months ended October 2, 1999. Sales for the nine months ended
September 30, 2000 were $73.4 million, an increase of $44.9 million or 158%
from sales of $28.4 million in the nine months ended October 2, 1999. The
increases were principally attributable to the continued strong acceptance of
our DAA family of products, including our international DAA products. Sales
from other non-DAA products such as the ISOmodem, the ProSLIC and the RF
Synthesizer contributed to more than 15% of sales revenue for the quarter
ended September 30, 2000. The increases reflected both an increase in the
number of customers that purchased our IC products and an increase in the
volume that those customers bought.

GROSS PROFIT. Gross profit for the three months ended September 30, 2000 was
$19.3 million or 65.6% of sales, an increase of $9.3 million as compared with
gross profit of $10.0 million or 68.6% of sales in the three months ended
October 2, 1999. Gross profit for the nine months ended September 30, 2000
was $48.1 million or 65.6% of sales, an increase of $29.6 million as compared
with gross profit of $18.6 million or 65.3% of sales in the nine months ended
October 2, 1999. The increases in gross profit in both cases were primarily
due to the substantial increase in sales volume and the increased utilization
of less expensive internal testing of product. These factors were partially
offset by higher depreciation expense related to significantly higher
internal test floor capacity. Our gross margins may decline due to the
expected introduction of competitive products to the market and increased
demand for silicon wafer capacity within the semiconductor industry
generally. However, the impact of these factors on our gross margins may be
offset by increased sales of newly introduced products. We expect many of our
new products

13
<PAGE>

will have larger gross margins than products which have been in the market
for longer periods of time and that face greater competition as a result.

RESEARCH AND DEVELOPMENT. Research and development expense for the three
months ended September 30, 2000 was $5.3 million or 17.9% of sales, an
increase of $3.1 million or 150% as compared with research and development
expense of $2.1 million or 14.5% of sales for the three months ended October 2,
1999. Research and development expense for the nine months ended September 30,
2000 was $13.3 million or 18.1% of sales, an increase of $8.3 million or 166%
as compared with research and development expense of $5.0 million or 17.6% of
sales for the nine months ended October 2, 1999. The increase in the dollar
amount of research and development expense was principally due to continued
product development activities, significant increases in new product
development initiatives, and increased spending to develop test methodologies
for new products. The decrease in research and development expense as a
percentage of sales reflected our modest sales in the three and nine months
ended October 2, 1999 as compared to substantial sales growth in the three and
nine months ended September 30, 2000. We expect that research and development
expense will increase in absolute dollars in future periods as we develop new
ICs, and may fluctuate as a percentage of sales due to significant changes in
our sales volume and new product development initiatives.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expense increased $3.0 million or 144%, to $5.1 million in the quarter ended
September 30, 2000 from $2.1 million in the quarter ended October 2, 1999, and
represented 17.4% of sales in the quarter ended September 30, 2000 and 14.4%
of sales in the quarter ended October 2, 1999. Selling, general and
administrative expense for the nine months ended September 30, 2000 was $12.7
million or 17.3% of sales, an increase of $7.9 million or 168% as compared
with selling, general and administrative expense of $4.7 million or 16.7% of
sales for the nine months ended October 2, 1999. The increase in the dollar
amount of selling, general and administrative expense was principally
attributable to increased staffing. Additionally, we incurred $1.0 million and
$2.3 million in patent litigation expenses in the three months and nine months
ended September 30, 2000 related to a lawsuit we filed against Analog Devices
and 3Com on January 12, 2000 (See "Part II, Other Information, Item 1. Legal
Proceedings"). We expect that selling, general and administrative expense will
increase in absolute dollars in future periods as we expand our sales
channels, marketing efforts and administrative infrastructure. We also expect
our legal expenses to continue as a result of our pending lawsuit against
Analog Devices and 3Com. This lawsuit may also cause our sales to 3Com to
decline. 3Com accounted for 8% of our sales in the nine months ended September
30, 2000. In addition, we expect selling, general and administrative expense
to fluctuate as a percentage of sales because of (1) the likelihood that
indirect distribution channels, which entail the payment of commissions, will
account for a larger portion of our sales in future periods and, therefore,
increase our selling, general and administrative expense relative to a direct
sales force performing at satisfactory levels of productivity; (2) fluctuating
usage of advertising to promote our products and, in particular, our newly
introduced products; and (3) potential significant variability in our future
sales volume.

AMORTIZATION OF DEFERRED STOCK COMPENSATION. We have recorded deferred stock
compensation for the difference between the exercise price of option grants
or the issuance price of direct issuances of stock, and the deemed fair value
of our common stock at the time of such grants or issuances. We are
amortizing this amount over the vesting periods of the applicable options or
restricted stock, which resulted in amortization expense of $0.9 million and
$2.5 million for the three and nine months ended September 30, 2000 as
compared to $0.3 million and $0.4 million for the three and nine months ended
October 2, 1999.

INTEREST INCOME. Interest income for the three and nine months ended
September 30, 2000 was $1.2 million and $2.8 million as compared to $0.1
million and $0.2 million for the three and nine months ended October 2, 1999.
The net proceeds from our initial public offering of our common stock, which
were received on March 29, 2000, contributed to the increase in interest
income.

14
<PAGE>

INTEREST EXPENSE. Interest expense for the three and nine months ended
September 30, 2000 was $0.3 million and $1.0 million as compared to $0.2
million and $0.5 million for the three and nine months ended October 2, 1999.
The increase in interest expense was primarily due to higher levels of debt
during the year and lease financing used to finance capital expenditures,
particularly relating to the acquisition of IC testing equipment and
leasehold improvements.

INCOME TAX EXPENSE. Our effective tax rate was 45.7% and 43.8% for the three
and nine months ended September 30, 2000 as compared to 23.1% in both the
three months and nine months ended October 2, 1999. Our pro forma tax rate
after excluding the amortization of deferred stock compensation, write off of
in-process research and development and goodwill amortization all of which
are not tax deductible, would be 34.0% and 36.3% for the three and nine
months ended September 30, 2000. The lower effective tax rate in 1999 also
reflected net operating loss tax carryforwards that were available from our
development stage operations which were used to offset a portion of our tax
liability during the three and nine months ended October 2, 1999. These net
operating loss tax carryforwards were fully utilized during fiscal 1999.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of liquidity as of September 30, 2000 consisted of
$90 million in cash, cash equivalents and short-term investments and our bank
credit facilities.

Our bank credit facilities include a revolving line of credit available
for borrowings and letters of credit of up to the lesser of $5.0 million or
80.0% of eligible accounts receivable and a separate letter of credit
facility for $0.4 million related to a building lease. At September 30, 2000,
(1) a letter of credit for $0.5 million related to a building lease was
outstanding under the revolving line of credit and (2) the separate letter of
credit for $0.4 million was outstanding. At September 30, 2000, $4.5 million
was available under the revolving line of credit.

Borrowings under the revolving line of credit bear interest at the
bank's prime rate, which was 9.5% at September 30, 2000, and are payable at
annual renewal of the line. All bank facilities are secured by our accounts
receivable, inventories, capital equipment and all other unsecured assets
(excluding intellectual property). The line of credit and the separate letter
of credit facility contain provisions that prohibit the payment of cash
dividends and require the maintenance of tangible net worth and compliance
with financial ratios, which measure our immediate liquidity and our ongoing
ability to pay back our outstanding obligations. Any default on one of the
bank facilities will cause all of the bank facilities to be in default under
these agreements.

We also have entered into agreements with three institutional lenders
for equipment financing to purchase or lease equipment, leasehold
improvements and software. At September 30, 2000, the amount outstanding
under these agreements was $5.9 million. This indebtedness bears effective
interest rates (including end-of-term interest payments of $1.1 million)
ranging from 12.5% to 14.6% per annum and is secured by a security interest
in specific items, principally comprised of test equipment, and is repayable
over approximately the next four years.

Prior to receiving the net proceeds from our initial public offering, we
funded our operations primarily through sales of preferred stock which
resulted in gross aggregate proceeds to us of approximately $12.8 million,
and debt financing under the credit and lease obligations described above and
cash from operations. We raised $90.6 million through our initial public
offering in March 2000. During the nine months ended September 30, 2000, cash
provided by operating activities was $12.9 million as compared to cash
provided by operating activities of $7.7 million during the nine months ended
October 2, 1999.

Due to the nature of our business, we experience working capital needs
in the areas of accounts receivable and inventory. Typically, we bill our
customers on an open account basis on net 30 day payment terms or other
specific terms that may vary from account to account as

15
<PAGE>

individually negotiated with customers. As of September 30, 2000, we had an
accounts receivable balance of $16.5 million dollars. If sales levels were to
increase, it is likely that the level of receivables would also increase. In
the event that customers delayed their payments to us, the levels of accounts
receivable would also increase. In the area of inventory, we find that in
order to maintain an adequate supply of product to customers, we must carry a
certain level of inventory. This inventory level may vary based principally
upon either orders received from customers or our forecast of demand for
these products. Other considerations in determining inventory levels may
include the product life cycle stage of our products and competitive
situations in the marketplace. Such considerations are balanced against risk
of obsolescence or potentially excess inventory levels. As of September 30,
2000, we had inventory of $6.9 million which we deemed adequate to address
these inventory considerations.

Capital expenditures were $13.4 million for the nine months ended
September 30, 2000 and $5.0 million in the nine months ended October 2, 1999.
The expenditures in the recent quarter were incurred to purchase
semiconductor test equipment, design software and engineering tools, other
computer equipment, leasehold improvements and software to support our
business expansion. We anticipate capital expenditures in the remainder of
fiscal 2000 of approximately $3.5 million primarily to fund test floor
operations and capital expenditures associated with expanded engineering
product development activities.

Our future capital requirements will depend on many factors, including
the rate of sales growth, market acceptance of our products, the timing and
extent of research and development projects and the expansion of our sales
and marketing activities. We believe the net proceeds received from our
initial public offering, together with our existing cash balances, credit
facilities and cash generated by our operations, are sufficient to meet our
capital requirements through at least the next 12 months, although we could
be required, or could elect, to seek additional funding prior to that time.
We may enter into acquisitions or strategic arrangements in the future which
also could require us to seek additional equity or debt financing. There can
be no assurances that additional equity or debt financing, if required, will
be available to us on acceptable terms or at all.

RECENT ACCOUNTING PRONOUNCEMENTS

Stock Based Compensation

On March 31, 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK
COMPENSATION, an interpretation of APB Opinion No. 25. The interpretation
clarifies guidance for certain issues that arose in the application of APB
Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. The interpretation
has been applied prospectively to new awards, modifications to outstanding
awards, and changes in employee status on or after July 1, 2000, except as
follows: (i) requirements related to the definition of an employee apply to
new awards granted after December 15, 1998; (ii) modifications that directly
or indirectly reduce the exercise price of an award apply to modifications
made after December 15, 1998; and (iii) modifications to add a reload feature
to an award apply to modifications made after January 12, 2000. The adoption
of this pronouncement had no impact on the earnings or the financial
condition of the Company.

16
<PAGE>

QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

Our interest income is sensitive to changes in the general level of U.S.
interest rates, particularly since the majority of our investments are in
short-term instruments. Due to the nature of our short-term investments, we
have concluded that there is no material market risk exposure.

RISKS RELATED TO OUR BUSINESS

WE DEPEND ON A LIMITED NUMBER OF CUSTOMERS FOR THE VAST MAJORITY OF OUR SALES,
AND THE LOSS OF, OR A SIGNIFICANT REDUCTION IN ORDERS FROM, ANY KEY CUSTOMER
COULD SIGNIFICANTLY REDUCE OUR SALES

In fiscal 1999, our four largest customers, in the aggregate, accounted
for approximately 92% of our sales. Of these customers, PC-Tel accounted for
62%, SmartLink for 12%, 3Com for 10% and Motorola for 8% of our fiscal 1999
sales. Our operating results in the foreseeable future will continue to depend
on sales to a relatively small number of customers, as well as the ability of
these customers to sell products that use our integrated circuit, or IC,
products. In the future, these customers may decide not to purchase our ICs at
all, purchase fewer ICs than they did in the past or alter their purchasing
patterns, particularly because:

- we do not have any material long-term purchase arrangements with these
or any of our other customers;

- substantially all of our sales to date have been made on a purchase
order basis, which permits our customers to cancel, change or delay
product purchase commitments with little or no notice to us and
without penalty; and

- some of our customers have sought or are seeking relationships with
current or potential competitors which may affect our customers'
purchasing decisions.

While we have been the sole supplier of the direct access arrangement, or
DAA, IC used in PC-Tel's products, we believe PC-Tel may seek to qualify
alternative sources in the future in order to diversify its supplier base
which would increase its negotiating leverage with us and protect its ability
to secure DAA components. We have a volume purchase agreement with PC-Tel, but
the agreement does not require PC-Tel to purchase any minimum number of units
from us during fiscal 2000. We believe that any second source of DAA ICs for
PC-Tel could have an adverse effect on the prices we are able to charge PC-Tel
and the volume of DAA ICs that we sell to PC-Tel, which would negatively
affect our sales and operating results.

On January 12, 2000, we filed a lawsuit against Analog Devices and 3Com
claiming that Analog Devices has infringed, and is continuing to infringe,
one of our issued U.S. patents with respect to our DAA technology and that
Analog Devices and 3Com have misappropriated our confidential information,
know-how and trade secrets. On February 24, 2000, 3Com filed an answer
denying it has misappropriated our confidential information, know how and
trade secrets and, without specifying, asserted we have acted with unclean
hands. On August 11, 2000, we amended the original patent infringement claim
against Analog Devices to include 3Com. On August 22, 2000, we amended the
claim to include patent infringement on a recently issued related patent
against both Analog Devices and 3Com. On September 6, 2000, Analog Devices
and 3Com answered our amended complaints, denying that our patent is valid
and infringed and asserting additional defenses and counterclaims. On
September 26, 2000, we replied to Analog Devices' and 3Com's counterclaims
denying the assertions of invalidity, unenforceability and noninfringement.
Although 3Com, which is one of our key customers, may decide to cease
purchasing direct access arrangement ICs from Analog Devices as a result of
this suit, it is possible that 3Com may respond by ceasing its purchase of
our DAA products. The loss of sales to 3Com could have a material adverse
effect on our sales and operating results. 3Com accounted for 8% of our sales
during the nine months ended September 30, 2000.

<PAGE>

On March 21, 2000, 3Com announced a strategic alliance with Accton
Technology and Nat Steel Electronics. The three companies will form a new
company that will be responsible for the design, marketing and sales of
Internet access products, including the 3Com products which currently
incorporate our DAA IC's. If we are unable to establish and maintain a
supplier relationship with this new company, our operating results could be
adversely affected.

The loss of any of our key customers, or a significant reduction in sales
to any one of them, would significantly reduce our sales and adversely affect
our business.

WE HAVE DEPENDED ON OUR DIRECT ACCESS ARRANGEMENT, OR DAA, FAMILY OF PRODUCTS
FOR SUBSTANTIALLY ALL OF OUR SALES TO DATE, AND SIGNIFICANT REDUCTIONS IN
ORDERS FOR DAA PRODUCTS WOULD SIGNIFICANTLY REDUCE OUR SALES

A significant majority of our sales to date have been derived from sales
of our DAA family of ICs. Until we are able to diversify our sales through the
introduction of new products, we will continue to rely on sales of our DAA
products. Reduced market acceptance of our DAA products or the introduction of
products with superior price/performance characteristics by our competitors
could significantly reduce our sales. In addition, substantially all of our
DAA products that we have sold include technology related to one or more of
our issued U.S. patents. If these patents are found to be invalid or
unenforceable, our competitors could introduce competitive products that could
reduce both the volume and price per unit of our products.

WE DEPEND ON OUR CUSTOMERS TO SUPPORT OUR PRODUCTS

Our DAA products are currently used by our customers to produce modems
for the personal computer market. We rely on our customers to provide software
and other technical support for the modems that use our DAA products. If our
customers' software does not provide the required functionality or if our
customers do not provide satisfactory support for their modem products, the
demand for modems that incorporate our DAA products may diminish. Any
reduction in the demand for modems would significantly reduce our sales.

IF WE ARE UNABLE TO DEVELOP NEW AND ENHANCED PRODUCTS THAT ACHIEVE MARKET
ACCEPTANCE IN A TIMELY MANNER, OUR OPERATING RESULTS AND COMPETITIVE POSITION
COULD BE HARMED

We currently sell only our DAA products in commercial quantities. Our
future success will depend on our ability to reduce our dependence on our DAA
products by developing new ICs and product enhancements that achieve market
acceptance in a timely and cost-effective manner. The development of
mixed-signal ICs is highly complex, and we occasionally have experienced
delays in completing the development and introduction of new products and
product enhancements. Successful product development and market acceptance of
our products depend on a number of factors, including:

- changing requirements of customers within the wireline, wireless
communications and optical networking markets;

- accurate prediction of market requirements;

- timely completion and introduction of new designs;

- timely qualification and certification of our ICs for use in our
customers' products;

- commercial acceptance and volume production of the products into which
our ICs will be incorporated;

- availability of foundry and assembly capacity;

<PAGE>

- achievement of high manufacturing yields;

- quality, price, performance, power use and size of our products;

- availability, quality, price and performance of competing products and
technologies;

- our customer service and support capabilities and responsiveness;

- successful development of our relationships with existing and
potential customers; and

- changes in technology, industry standards or end-user preferences.

We cannot provide any assurance that new products which we recently have
developed or may develop in the future will achieve market acceptance. We have
recently introduced to market four new ICs:

- an RF synthesizer, which is used to generate high frequency signals
that are used in wireless communications systems to select a
particular radio channel;

- an ISOmodem, which is a miniaturized modem that can be embedded in
electronic devices with low transmission requirements, such as credit
card verification devices, to provide quick network access;

- a ProSLIC product, which provides dial tone, busy tone, caller ID and
ring signal functions at the source end of the telephone; and

- a high speed optical network product, which is a fully integrated
low-power clock and data recovery circuit designed for SONET/ATM
routers, multiplexers, digital cross connects and optical transceiver
modules.

We also are actively developing other ICs. If our recently introduced or
other ICs fail to achieve market acceptance, our operating results and
competitive position could be adversely affected.

DUE TO OUR LIMITED OPERATING HISTORY, WE MAY HAVE DIFFICULTY BOTH IN
ACCURATELY PREDICTING OUR FUTURE SALES AND APPROPRIATELY BUDGETING FOR OUR
EXPENSES

We were incorporated in 1996 and did not begin generating sales until the
second quarter of 1998. As a result, we have only a short history from which
to predict future sales. This limited operating experience combined with the
rapidly evolving nature of the markets in which we sell our products, as well
as other factors which are beyond our control, reduce our ability to
accurately forecast quarterly or annual sales. Additionally, because most of
our expenses are fixed in the short term or incurred in advance of anticipated
sales, we may not be able to decrease our expenses in a timely manner to
offset any shortfall of sales. We are currently expanding our staffing and
increasing our expense levels in anticipation of future sales growth. If our
sales do not increase as anticipated, significant losses could result due to
our higher expense levels.

<PAGE>

WE RELY ON THIRD PARTIES TO MANUFACTURE AND ASSEMBLE OUR PRODUCTS AND THE
FAILURE TO SUCCESSFULLY MANAGE OUR RELATIONSHIPS WITH OUR MANUFACTURERS AND
ASSEMBLERS WOULD NEGATIVELY IMPACT OUR ABILITY TO SELL OUR PRODUCTS

We do not have our own manufacturing facilities. Therefore, we must rely
on third-party vendors to manufacture the ICs we design. We also currently
rely on two third-party assembly contractors, Advanced Semiconductor
Engineering and Amkor, to assemble and package the silicon chips provided by
the wafers for use in final products. Additionally, we rely on third-party
vendors for a portion of the testing requirements of our products prior to
shipping.

There are significant risks associated with relying on these third-party
contractors, including:

- failure by us, our customers or their end customers to qualify a
selected supplier;

- capacity shortages during periods of high demand;

- reduced control over delivery schedules and quality;

- limited warranties on wafers or products supplied to us; and

- potential increases in prices.

We currently do not have long-term supply contracts with any of our
third-party vendors, and therefore, they are not obligated to perform services
or supply products to us for any specific period, or in any specific
quantities, except as may be provided in a particular purchase order. Although
we believe that other semiconductor foundries or assembly contractors can
adequately address our needs, we expect that it would take approximately two
to nine months to transition performance of these services from our current
providers to new providers. Such a transition may also require a qualification
process by our customers or their end customers. We generally place orders for
products with some of our suppliers approximately four months prior to the
anticipated delivery date, with order volumes based on our forecasts of demand
from our customers. Accordingly, if we inaccurately forecast demand for our
products, we may be unable to obtain adequate foundry or assembly capacity
from our third-party contractors to meet our customers' delivery requirements,
or we may accumulate excess inventories. On occasion, we have been unable to
adequately respond to unexpected increases in customer purchase orders, and
therefore, were unable to benefit from this incremental demand. None of our
third-party foundry or assembly contractors have provided assurances to us
that adequate capacity will be available to us within the time required to
meet additional demand for our products.

From our inception through fiscal 1999, all of the silicon wafers for the
products that we shipped were manufactured by Taiwan Semiconductor
Manufacturing Co. To address capacity considerations, we have qualified
Vanguard International Semiconductor, an affiliate of Taiwan Semiconductor
Manufacturing Co., as an additional semiconductor fabricator. Our customers
typically complete their own qualification process. Our customers may not
elect to spend the time and expense necessary to put Vanguard through their
qualification processes. Vanguard is currently producing on our behalf a
majority of our current work in progress. If we fail to balance customer
demand across semiconductor fabrications properly, we might not be able to
fulfill demand for our products, which would adversely affect our operating
results. Additionally, a resulting write-off of unusable inventories would
contribute to a decline in earnings.

The semiconductor manufacturing process is highly complex and, from time
to time, manufacturing yields may fall below our expectations which could
result in our inability to timely satisfy demand for our products.

<PAGE>

The manufacture of silicon wafers for our products is a highly complex
and technologically demanding process. Although we work closely with our
foundries to minimize the likelihood of reduced manufacturing yields, our
foundries from time to time have experienced lower than anticipated
manufacturing yields. Changes in manufacturing processes or the inadvertent
use of defective or contaminated materials by our foundries could result in
lower than anticipated manufacturing yields or unacceptable performance
deficiencies. If our foundries fail to timely deliver fabricated silicon
wafers of satisfactory quality, we will be unable to timely meet our
customers' demand for our products, which would adversely affect our operating
results and damage our customer relationships.

ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR FINANCIAL
CONDITION

As part of our growth strategy, we will continue to evaluate
opportunities to acquire other businesses or technologies that would
complement our current offerings, expand the breadth of our markets or enhance
our technical capabilities. On August 9, 2000, we completed the acquisition of
Krypton Isolation, Inc. for $42 million in cash and common stock. These
acquisitions and any other potential future acquisitions entail a number of
risks that could materially and adversely affect our business and operating
results, including:

- problems integrating the acquired operations, technologies or products
with our existing business and products;

- diversion of management's time and attention from our core business;

- difficulties in retaining business relationships with suppliers and
customers of the acquired company;

- risks associated with entering markets in which we lack prior
experience; and

- potential loss of key employees of the acquired company.

OUR CURRENT MANUFACTURERS AND ASSEMBLERS ARE CONCENTRATED IN THE SAME
GEOGRAPHIC REGION WHICH INCREASES THE RISK THAT A NATURAL DISASTER, LABOR
STRIKE, WAR OR POLITICAL UNREST COULD DISRUPT OUR OPERATIONS

Our current semiconductor manufacturers are located in the same region
within Taiwan and our assembly contractors are located in the Pacific Rim
region. The risk of earthquakes in Taiwan and the Pacific Rim region is
significant due to the proximity of major earthquake fault lines in the area.
We are not currently covered by insurance against business disruption caused
by earthquakes as such insurance is not currently available on terms that we
believe are commercially reasonable. Earthquakes, fire, flooding or other
natural disasters in Taiwan or the Pacific Rim region, or political unrest,
war, labor strikes or work stoppages in countries where our semiconductor
manufacturers' and assemblers' facilities are located, likely would result in
the disruption of our foundry or assembly capacity. Any disruption resulting
from these events could cause significant delays in shipments of our products
until we are able to shift our manufacturing or assembling from the affected
contractor to another third-party vendor. There can be no assurance that such
alternate capacity could be obtained on favorable terms, if at all.

WE ARE SUBJECT TO INCREASED INVENTORY RISKS AND COSTS BECAUSE WE BUILD OUR
PRODUCTS BASED ON FORECASTS PROVIDED BY CUSTOMERS BEFORE RECEIVING PURCHASE
ORDERS FOR THE PRODUCTS

In order to assure availability of our products for some of our largest
customers, we start the manufacturing of our products in advance of receiving
purchase orders based on forecasts provided by these customers. However, these
forecasts do not represent binding purchase

<PAGE>

commitments and we do not recognize sales for these products until they are
shipped to the customer. As a result, we incur inventory and manufacturing
costs in advance of anticipated sales. Because demand for our products may not
materialize, manufacturing based on forecasts subjects us to increased risks
of high inventory carrying costs and increased obsolescence and may increase
our operating costs.

WE MAY NOT BE ABLE TO MAINTAIN OUR EXISTING GROWTH RATE

Although we have experienced sales and earnings growth in our recent
quarterly and annual periods, we may not be able to sustain these growth
rates. In particular, we may gain significant market share in a relatively
short period of time following the introduction of a new product, resulting in
sales growth. However, incremental gains in market share for these newly
introduced products may not occur. Accordingly, you should not rely on the
results of any prior quarterly or annual periods as an indication of our
future operating performance.

WE MAY EXPERIENCE SIGNIFICANT PERIOD-TO-PERIOD QUARTERLY AND ANNUAL
FLUCTUATIONS IN OUR SALES AND OPERATING RESULTS, WHICH MAY RESULT IN
VOLATILITY IN OUR STOCK PRICE

We may experience significant period-to-period fluctuations in our sales
and operating results in the future due to a number of factors, and any such
variations may cause our stock price to fluctuate. It is likely that in some
future period our operating results will be below the expectations of public
market analysts or investors. If this occurs, our stock price may drop,
perhaps significantly.

A number of factors, in addition to those cited in other risk factors
applicable to our business, may contribute to fluctuations in our sales and
operating results, including:

- the timing and volume of orders from our customers;

- the rate of acceptance of our products by our customers, including the
acceptance of new products we may develop for integration in the
products manufactured by such customers, which we refer to as "design
wins";

- the demand for and life cycles of the products incorporating our ICs;

- the rate of adoption of mixed-signal ICs in the markets we target;

- deferrals of customer orders in anticipation of new products or
product enhancements from us or our competitors or other providers of
ICs;

- changes in product mix; and

- the rate at which new markets emerge for products we are currently
developing or for which our design expertise can be utilized to
develop products for these new markets.

For example, the personal computer modem market is characterized by rapid
fluctuations in demand which results in corresponding fluctuations in the
demand for our DAA products that are incorporated in personal computer modems.
Additionally, the rate of technology acceptance by our customers results in
fluctuating demand for our products as customers are reluctant to incorporate
a new IC into their products until the new IC has achieved market acceptance.
However, once a new IC achieves market acceptance, demand for the new IC
quickly accelerates and demand quickly declines for the product that the new
IC replaces.

22
<PAGE>

WE ARE A RELATIVELY SMALL COMPANY WITH LIMITED RESOURCES COMPARED TO SOME OF
OUR CURRENT AND POTENTIAL COMPETITORS AND WE MAY NOT BE ABLE TO COMPETE
EFFECTIVELY AND INCREASE MARKET SHARE

Some of our current and potential competitors have longer operating
histories, significantly greater resources and name recognition and a larger
base of customers than we have. As a result, these competitors may have
greater credibility with our existing and potential customers. They also may
be able to adopt more aggressive pricing policies and devote greater resources
to the development, promotion and sale of their products than we can to ours.
In addition, some of our current and potential competitors have already
established supplier or joint development relationships with the decision
makers at our current or potential customers. These competitors may be able to
leverage their existing relationships to discourage their customers from
purchasing products from us or persuade them to replace our products with
their products. Our competitors may also offer bundled chipset kit
arrangements offering a more complete product despite the technical merits or
advantages of our products. These competitors may elect not to support our
products which could complicate our sales efforts.

In addition, our largest competitors may restructure their operations to
create separate companies that are more focused on providing the types of
products we produce. For example, Rockwell's restructuring led to the creation
of Conexant which is a significant competitor. Additionally, Siemens spun off
its semiconductor business to create a more focused company named Infineon
Technologies. In July 2000, Lucent Technologies announced its plans to spin
off its microelectronics business with includes the optoelectronics components
and integrated circuits division, into a separate company in order to
accelerate the growth of the business and alleviate strategic conflicts with
Lucent's competitors. Increased competition could decrease our prices, reduce
our sales, lower our margins or decrease our market share. These and other
competitive pressures may prevent us from competing successfully against
current or future competitors, and may materially harm our business.

WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A
RAPIDLY CHANGING MARKET, AND IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL
AND HIRE ADDITIONAL PERSONNEL, OUR ABILITY TO DEVELOP AND SUCCESSFULLY MARKET
OUR PRODUCTS COULD BE HARMED

We believe our future success will depend in large part upon our ability
to attract and retain highly skilled managerial, engineering and sales and
marketing personnel. Specifically, due to the relatively early stage of our
company's business, we believe that our future success is highly dependent on
Navdeep Sooch, our co-founder, Chief Executive Officer and Chairman of the
Board, Jeffrey Scott, our co-founder and Vice President of Engineering, and
David Welland, our co-founder and Vice President of Technology. There is
currently a shortage of qualified personnel with significant experience in the
design, development, manufacturing, marketing and sales of analog and
mixed-signal communications ICs. In particular, there is a shortage of
engineers who are familiar with the intricacies of the design and
manufacturability of analog elements, and competition for such personnel is
intense. Our key technical personnel represent a significant asset and serve
as the source of our technological and product innovations. We may not be
successful in attracting and retaining sufficient numbers of technical
personnel to support our anticipated growth. The loss of any of our key
employees or the inability to attract or retain qualified personnel, including
engineers and sales and marketing personnel, could delay the development and
introduction of, and negatively impact our ability to sell, our products.

<PAGE>

OUR RESEARCH AND DEVELOPMENT EFFORTS ARE FOCUSED ON A LIMITED NUMBER OF NEW
TECHNOLOGIES AND PRODUCTS, AND ANY DELAY IN THE DEVELOPMENT, OR ABANDONMENT,
OF THESE TECHNOLOGIES OR PRODUCTS BY INDUSTRY PARTICIPANTS, OR THEIR FAILURE
TO ACHIEVE MARKET ACCEPTANCE, COULD COMPROMISE OUR COMPETITIVE POSITION

Our ICs are used as components in communications devices in the wireline,
wireless and optical networking markets. As a result, we have devoted and
expect to continue to devote a large amount of resources to develop products
based on new and emerging technologies and standards that will be commercially
introduced in the future. In the first nine months of fiscal 2000, our
research and development expense was $13.2 million, which represented 18.1% of
our sales compared to $5.0 million, or 17.6% of our sales for the first nine
months of fiscal year 1999. A number of large companies in the wireline,
wireless and optical networking industries are actively involved in the
development of these new technologies and standards. Should any of these
companies delay or abandon their efforts to develop commercially available
products based on new technologies and standards, our research and development
efforts with respect to these technologies and standards likely would have no
appreciable value. In addition, if we do not correctly anticipate new
technologies and standards, or if the products that we develop based on these
new technologies and standards fail to achieve market acceptance, our
competitors may be better able to address market demand than would we.
Furthermore, if markets for these new technologies and standards develop later
than we anticipate, or do not develop at all, demand for our products that are
currently in development would suffer, resulting in lower sales of these
products than we currently anticipate. We have introduced to market a RF
synthesizer product for use in cellular phones operating on the Global System
for Mobile Communications, or GSM, standard. The RF synthesizer is also
compatible with General Packet Radio Service, which is the emerging data
communications protocol for GSM based cellular phones. We cannot be certain
whether manufacturers of cellular phones using these standards will
incorporate our RF synthesizer or that these standards will not change,
thereby making our products unsuitable or impractical. In the area of Optical
Networking, our recently introduced clock and data recovery integrated circuit
operates within stringent specifications for high speed communications systems
known as SONET. Changes to this standard could make our products uncompetitive
or unsuitable to changing system requirements and result in the inability to
sell these products.

OUR PRODUCTS ARE COMPLEX AND MAY REQUIRE MODIFICATIONS TO RESOLVE UNDETECTED
ERRORS WHICH COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR SALES

Our products are complex and may contain errors when first introduced or
as new versions are released. We rely primarily on our in-house testing
personnel to design test operations and procedures to detect any errors prior
to delivery of our products to our customers. Because our products are
manufactured by third parties, should problems occur in the operation or
performance of our ICs, we may experience delays in meeting key introduction
dates or scheduled delivery dates to our customers. These errors also could
cause us to incur significant re-engineering costs, divert the attention of
our engineering personnel from our product development efforts and cause
significant customer relations and business reputation problems.

THE PERFORMANCE OF OUR DIRECT ACCESS ARRANGEMENT PRODUCTS MAY BE ADVERSELY
AFFECTED BY SEVERE ENVIRONMENTAL CONDITIONS THAT MAY REQUIRE MODIFICATIONS,
WHICH COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR SALES

Although our direct access arrangement products are compliant with
published specifications, these established specifications might not
adequately address all conditions that must be satisfied in order to operate
in harsh environments. This includes environments where there are wide
variations in electrical quality, telephone line quality, static electricity
and operating temperatures or that may be affected by lightning or improper
handling by customers and end users. Our products have had a limited period of
time in the field under operation, and these environmental

<PAGE>

factors may result in unanticipated returns of our products. Any necessary
modifications could cause us to incur significant re-engineering costs, divert
the attention of our engineering personnel from our product development
efforts and cause significant customer relations and business reputation
problems.

A SUBSTANTIAL PORTION OF THE FINAL TESTING OF OUR PRODUCTS IS PERFORMED
INTERNALLY BY US, WHICH INCREASES OUR FIXED COSTS

In 1999, approximately 74% of our final product test operations were
performed in-house. The balance of the final testing of our products is
provided by our contract manufacturers or other third parties. During the
three and nine months ended September 30, 2000, substantially all of our final
product test operations were performed in-house. While we believe performing
this testing in-house provides us with advantages in terms of lower per unit
cost, quality control and shorter time required to bring a product to market,
we may encounter difficulties and delays in maintaining or expanding our
internal test capabilities. In addition, final testing of complex
semiconductors requires substantial resources to acquire state-of-the-art
testing equipment and hiring additional qualified personnel, which has
increased our fixed costs. If demand for our products does not support the
effective utilization of these employees and additional equipment, we may not
realize any benefit from replacing our outside vendors with internal final
testing. Any decrease in the demand for our products could result in the
underutilization of our testing equipment and personnel. If our internal test
operations are underused or mismanaged, we may incur significant costs that
could adversely affect our operating results.

WE PLAN TO INCREASE OUR INTERNATIONAL SALES ACTIVITIES SIGNIFICANTLY, WHICH
WILL SUBJECT US TO ADDITIONAL BUSINESS RISKS INCLUDING INCREASED LOGISTICAL
COMPLEXITY, POLITICAL INSTABILITY AND CURRENCY FLUCTUATIONS

We intend to open sales offices in international markets to expand our
international sales activities in Europe and the Pacific Rim region. Our
planned international sales growth will be limited if we are unable to hire
additional personnel and develop relationships with international
distributors. We may not be able to maintain or increase international market
demand for our products. Our international operations are subject to a number
of risks, including:

- increased complexity and costs of managing international operations;

- protectionist laws and business practices that favor local competition
in some countries;

- multiple, conflicting and changing laws, regulations and tax schemes;

- longer sales cycles;

- greater difficulty in accounts receivable collection and longer
collection periods; and

- political and economic instability.

To date, all of our sales to international customers and purchases of
components from international suppliers have been denominated in U.S. dollars.
As a result, an increase in the value of the U.S. dollar relative to foreign
currencies could make our products more expensive for our international
customers to purchase, thus rendering them less competitive.

<PAGE>

OUR INABILITY TO MANAGE GROWTH COULD MATERIALLY AND ADVERSELY AFFECT OUR
BUSINESS

During the past 21 months, we have significantly increased the scope of
our operations and expanded our workforce from 42 employees at January 2, 1999
to 240 employees at September 30, 2000. This growth has placed, and any future
growth of our operations will continue to place, a significant strain on our
management personnel, systems and resources. We anticipate that we will need
to implement a variety of new and upgraded operational and financial systems,
procedures and controls, including the improvement of our accounting and other
internal management systems. We also expect that we will need to continue to
expand, train, manage and motivate our workforce. All of these endeavors will
require substantial management effort. If we are unable to effectively manage
our expanding operations, our business could be materially and adversely
affected.

WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH WOULD NEGATIVELY
AFFECT OUR ABILITY TO COMPETE

Our products rely on our proprietary technology, and we expect that
future technological advances made by us will be critical to sustain market
acceptance of our products. Therefore, we believe that the protection of our
intellectual property rights is and will continue to be important to the
success of our business. We rely on a combination of patent, copyright,
trademark and trade secret laws and restrictions on disclosure to protect our
intellectual property rights. We also enter into confidentiality or license
agreements with our employees, consultants and business partners, and control
access to and distribution of our documentation and other proprietary
information. Despite these efforts, unauthorized parties may attempt to copy
or otherwise obtain and use our proprietary technology. Monitoring
unauthorized use of our technology is difficult, and we cannot be certain that
the steps we have taken will prevent unauthorized use of our technology,
particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. We cannot be certain that
patents will be issued as a result of our pending applications nor can we be
certain that any issued patents would protect or benefit us or give us
adequate protection from competing products. For example, issued patents may
be circumvented or challenged and declared invalid or unenforceable. We also
cannot be certain that others will not develop our unpatented proprietary
technology or effective competing technologies on their own.

SIGNIFICANT LITIGATION OVER INTELLECTUAL PROPERTY IN OUR INDUSTRY MAY CAUSE US
TO BECOME INVOLVED IN COSTLY AND LENGTHY LITIGATION WHICH COULD SERIOUSLY HARM
OUR BUSINESS

In recent years, there has been significant litigation in the United
States involving patents and other intellectual property rights. From time to
time, we receive letters from various industry participants alleging
infringement of patents or trade secrets. The exploratory nature of these
inquiries has become relatively common in the semiconductor industry. We
typically respond when appropriate and as advised by legal counsel. We may
become involved in litigation to protect our intellectual property rights or
to defend allegations of infringement asserted by others. Legal proceedings
could subject us to significant liability for damages or invalidate our
proprietary rights. Legal proceedings initiated by us to protect our
intellectual property rights could also result in counterclaims or
countersuits against us. Any litigation, regardless of its outcome, would
likely be time consuming and expensive to resolve and would divert our
management's time and attention. Any intellectual property litigation also
could force us to take specific actions, including:

- cease selling products that use the challenged intellectual property;

26
<PAGE>

- obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not
be available on reasonable terms, or at all; or

- redesign those products that use infringing intellectual property.

On January 12, 2000, we filed a lawsuit against Analog Devices and 3Com
claiming that Analog Devices has infringed, and is continuing to infringe,
one of our issued U.S. patents with respect to our DAA technology and that
Analog Devices and 3Com have misappropriated our confidential information,
know-how and trade secrets. On January 26, 2000, Analog Devices served an
answer denying that it has misappropriated our confidential information,
know-how and trade secrets and brought a counterclaim against us seeking a
declaratory judgment that our issued U.S. patent is invalid and unenforceable
and that Analog Devices has not infringed our issued U.S. patent. We filed a
reply to Analog Devices' counterclaim asserting that our issued U.S. patent
is valid and enforceable and that Analog Devices has infringed our issued
U.S. patent. On February 24, 2000, 3Com served an answer denying it has
misappropriated our confidential information, know-how and trade secrets and,
without specifying, asserted we have acted with unclean hands. On August 11,
2000, we amended the original patent infringement claim against Analog
Devices to include 3Com. On August 22, 2000, we amended the claim to include
patent infringement on a recently issued related patent against both Analog
Devices and 3Com. On September 6, 2000, Analog Devices and 3Com answered our
amended complaints, denying that our patent is valid and infringed and
asserting additional defenses and counterclaims. On September 26, 2000, we
replied to Analog Devices' and 3Com's counterclaims denying the assertions of
invalidity, unenforceability and noninfringement. Our lawsuit will involve
significant expense and divert our management's time and attention from other
aspects of our business. The lawsuit may also damage our business
relationship with 3Com which accounted for 8% of our sales in the nine months
ended September 30, 2000, 10% of our sales in fiscal 1999 and 20% of our
sales in fiscal 1998. Due to the inherent uncertainties of litigation, we
cannot be certain of the outcome of this lawsuit.

FAILURE TO EXPAND OUR DISTRIBUTION CHANNELS AND MANAGE OUR DISTRIBUTION
RELATIONSHIPS COULD IMPEDE OUR FUTURE GROWTH

The future growth of our business will depend in part on our ability to
expand our existing relationships with distributors and sales representatives,
develop additional channels for the distribution and sale of our products and
manage these relationships. As part of our channel sales strategy, we intend
to expand our relationships with distributors and sales representatives. As we
develop our indirect sales capabilities, we will need to manage the potential
conflicts that may arise with our direct sales efforts. The inability to
successfully execute or manage a multi-channel sales strategy could impede our
future growth.

RISKS RELATED TO OUR INDUSTRY

COMPETITION WITHIN THE NUMEROUS MARKETS WE TARGET MAY REDUCE SALES OF OUR
PRODUCTS AND REDUCE MARKET SHARE

The markets for semiconductors in general, and for mixed-signal ICs in
particular, are intensely competitive. We expect that the market for our
products will continually evolve and will be subject to rapid technological
change. In addition, as we target and supply products to numerous markets and
applications, including wireline, wireless and other communications markets,
we face competition from a relatively large number of competitors. Across all
of our product areas, we compete with Advanced Micro Devices, Analog Devices,
Conexant, Delta Integration, Fujitsu, Infineon Technologies, National
Semiconductor, Philips and Texas Instruments, among others. We expect to face
competition in the future from our current competitors, other manufacturers
and designers of semiconductors, and innovative start-up semiconductor design
companies. Some of our customers, such as Intel, Lucent and Motorola, are also
large, established semiconductor suppliers. Our sales to and support of these
customers may

<PAGE>

enable them to become a source of competition to us, despite our efforts to
protect our intellectual property rights. As the markets for communications
products grow, we also may face competition from traditional communications
device companies. These companies may enter the mixed-signal semiconductor
market by introducing their own ICs or by entering into strategic
relationships with or acquiring other existing providers of semiconductor
products.

THE AVERAGE SELLING PRICES OF OUR PRODUCTS COULD DECREASE RAPIDLY WHICH MAY
NEGATIVELY IMPACT OUR GROSS MARGINS AND SALES

We may experience substantial period-to-period fluctuations in future
operating results due to the erosion of our average selling prices. We have
reduced the average unit price of our products in anticipation of future
competitive pricing pressures, new product introductions by us or our
competitors and other factors. We expect that we will have to do so again in
the future. If we are unable to offset any such reductions in our average
selling prices by increasing our sales volumes, our gross profits and sales
will suffer. To maintain gross margins, we will need to develop and introduce
new products and product enhancements on a timely basis and continually reduce
our costs. Our failure to do so would cause our sales and gross margins to
decline.

OUR CUSTOMERS REQUIRE OUR PRODUCTS TO UNDERGO A LENGTHY AND EXPENSIVE
QUALIFICATION PROCESS WHICH DOES NOT ASSURE PRODUCT SALES

Prior to purchasing our products, our customers require that our products
undergo an extensive qualification process, which involves testing of the
products in the customer's system as well as rigorous reliability testing.
This qualification process may continue for six months or longer. However,
qualification of a product by a customer does not assure any sales of the
product to that customer. Even after successful qualification and sales of a
product to a customer, a subsequent revision to the IC, changes in its
manufacturing process or the selection of a new supplier by us may require a
new qualification process, which may result in delays and in us holding excess
or obsolete inventory. After our products are qualified, it can take an
additional six months or more before the customer commences volume production
of components or devices that incorporate our products. Despite these
uncertainties, we devote substantial resources, including design, engineering,
sales, marketing and management efforts, toward qualifying our products with
customers in anticipation of sales. If we are unsuccessful or delayed in
qualifying any of our products with a customer, such failure or delay would
preclude or delay sales of such product to the customer, which may impede our
growth and cause our business to suffer.

WE ARE SUBJECT TO THE CYCLICAL NATURE OF THE SEMICONDUCTOR INDUSTRY

The semiconductor industry is highly cyclical and is characterized by
constant and rapid technological change, rapid product obsolescence and price
erosion, evolving standards, short product life cycles and wide fluctuations
in product supply and demand. The industry has experienced significant
downturns, often connected with, or in anticipation of, maturing product
cycles of both semiconductor companies' and their customers' products and
declines in general economic conditions. These downturns have been
characterized by diminished product demand, production overcapacity, high
inventory levels and accelerated erosion of average selling prices. Any future
downturns could have a material adverse effect on our business and operating
results. Furthermore, any upturn in the semiconductor industry could result in
increased competition for access to third-party foundry and assembly capacity.
We are dependent on the availability of such capacity to manufacture and
assemble our ICs. None of our third-party foundry or assembly contractors have
provided assurances that adequate capacity will be available to us.

OUR PRODUCTS MUST CONFORM TO INDUSTRY STANDARDS IN ORDER TO BE ACCEPTED BY END
USERS IN OUR MARKETS

<PAGE>

Generally, our products comprise only a part of a communications device.
All components of such devices must uniformly comply with industry standards
in order to operate efficiently together. We depend on companies that provide
other components of the devices to support prevailing industry standards. Many
of these companies are significantly larger and more influential in effecting
industry standards than we are. Some industry standards may not be widely
adopted or implemented uniformly, and competing standards may emerge that may
be preferred by our customers or end users. If larger companies do not support
the same industry standards that we do, or if competing standards emerge,
market acceptance of our products could be adversely affected which would harm
our business.

Products for communications applications are based on industry standards
that are continually evolving. Our ability to compete in the future will
depend on our ability to identify and ensure compliance with these evolving
industry standards. The emergence of new industry standards could render our
products incompatible with products developed by other suppliers. As a result,
we could be required to invest significant time and effort and to incur
significant expense to redesign our products to ensure compliance with
relevant standards. If our products are not in compliance with prevailing
industry standards for a significant period of time, we could miss
opportunities to achieve crucial design wins. We may not be successful in
developing or using new technologies or in developing new products or product
enhancements that achieve market acceptance. Our pursuit of necessary
technological advances may require substantial time and expense.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Information related to quantitative and qualitative disclosures
regarding market risk is set forth in Management's Discussion and Analysis of
Financial Condition and Results of Operations and the risk factors under Item
2 above. Such information is incorporated by reference herein.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On January 12, 2000, we filed a lawsuit against Analog Devices and
3Com in the United States District Court for the Western District of Texas
(Austin Division). The complaint asserts that Analog Devices has infringed,
and is continuing to infringe, on our U.S. Patent 5,870,046, entitled "Analog
Isolation System With Digital Communication Across A Capacitive Barrier," by
making, using, selling, offering to sell and/or importing silicon DAAs that
embody or use inventions claimed by our patent. The complaint also asserts,
among other things, that Analog Devices and 3Com have misappropriated our
confidential information, know-how and trade secrets relating to our DAA
technology, tortuously interfered with our business relations with our
existing and prospective customers, and been unjustly enriched by this
misappropriation. The suit seeks unspecified damages from Analog Devices,
including damages for willful infringement of our patent, and an injunction
prohibiting Analog Devices from infringing our patent. In addition, the suit
seeks unspecified damages, including punitive damages and attorneys' fees
arising, among other things, out of the misappropriation, tortious
interference and unjust enrichment, and an injunction prohibiting Analog
Devices and 3Com from designing, manufacturing, reproducing, using or selling
any ICs, modems or other products the conception, design or development of
which was based on our confidential information, know-how and trade secrets.

On January 26, 2000, Analog Devices served an answer denying that it
has misappropriated our confidential information, know-how and trade secrets
and brought a counterclaim against us seeking a declaratory judgment that our
issued U.S. patent is invalid and unenforceable and that

<PAGE>

Analog Devices has not infringed our issued U.S. patent. The counterclaim
further alleges that we improperly failed to disclose a relevant pre-existing
patent to the U.S. Patent and Trademark Office during the course of our patent
application process, and that we therefore are unable to enforce our patent.
We filed a reply to Analog Devices' counterclaim asserting that our issued
U.S. patent is valid and enforceable and that Analog Devices has infringed our
issued U.S. patent. We also denied that we improperly excluded any relevant
information in the course of our patent application process.

On February 24, 2000, 3Com served an answer denying it has
misappropriated our confidential information, know-how and trade secrets and,
without specifying, asserted we have acted with unclean hands. This litigation
is in the discovery phase and no trial date has been set by the trial court.

On May 22, 2000, Analog Devices filed a complaint in the United
States District Court for the District of Massachusetts asserting that we have
infringed on one of their patents. On June 26, 2000, Analog Devices withdrew
their complaint without prejudice before we were required to file a response.

On August 11, 2000, the Company filed an Amended Complaint in this
action to add a count for infringement of the Company's `046 patent against
3Com Corporation. The Amended Complaint avers that 3Com also has infringed the
`046 patent by making, using, selling, offering for sale and/or importing
modems that contain certain silicon DAA integrated circuits and chipsets. The
complaint seeks a preliminary and permanent injunction and unspecified damages.

On August 22, 2000, the Company filed a Second Amended Complaint to
add a count for infringement of the Company's Scott et al. United States
patent 6,107,948 (the `948 patent) against both Analog Devices and 3Com
Corporation. The amended complaint avers, inter alia, that Analog Devices has
infringed the `948 patent by making, using, selling, offering for sale and/or
importing certain silicon DAA integrated circuits and chipsets, and that 3Com
has infringed the `948 patent by making, using, selling, offering for sale
and/or importing modems that contain those same silicon DAA integrated
circuits and chipsets. The complaint seeks a preliminary and permanent
injunction and unspecified damages.

On September 6, 2000, Analog Devices and 3Com answered the Company's
amended complaints. Analog Devices denied that the `948 patent is valid and
infringed and asserted additional defenses and counterclaims. Analog Devices
also counterclaimed for a declaratory judgment that the `948 patent is invalid
and unenforceable, and not infringed. 3Com denied that the `046 and `948
patents are valid and infringed and asserted additional defenses and
counterclaims. 3Com also counterclaimed for a declaratory judgement that the
`046 and `948 patents are invalid and unenforceable, not infringed.

On September 26, 2000, the Company filed replies to Analog Devices'
and 3Com's counterclaims, denying Analog Devices' and 3Com's assertions of
invalidity, unenforceability and noninfringement.

The parties are conducting discovery, and the Court has set this
case for trial in March 2001. At present, we are unable to predict the
outcome of this matter.

For a description of risks associated with this pending lawsuit,
please see "We depend on a limited number of customers for the vast majority
of our sales, and the loss of, or a significant reduction in orders from, any
key customer could significantly reduce our sales" and "Significant litigation
over intellectual property in our industry may cause us to become involved in
costly and lengthy litigation which could seriously harm our business" in the
risk factors included in Item 2 of Part I of this Form 10-Q.

<PAGE>

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On August 9, 2000, we issued 384,100 shares of Silicon Laboratories
common stock in exchange for the outstanding capital stock of Krypton
Isolation, Inc. The issuance of Silicon Laboratories common stock in
connection with the acquisition of Krypton was deemed exempt from registration
under Section 5 of the Securities Act of 1933 in reliance upon Section
3(a)(10) thereof, pursuant to a fairness hearing conducted by the California
Department of Corporations.

Our registration statement (Registration No. 333-94853) under the
Securities Act of 1933, as amended, relating to our initial public offering of
our common stock became effective on March 23, 2000. A total of 3,680,000
shares of common stock were registered. We sold a total of 3,200,000 shares of
our common stock and selling stockholders sold a total of 480,000 to an
underwriting syndicate. The managing underwriters were Morgan Stanley & Co.
Incorporated, Lehman Brothers Inc., and Salomon Smith Barney Inc. The offering
commenced and was completed on March 24, 2000, at a price to the public of
$31.00 per share. The initial public offering resulted in net proceeds to us
of $90.6 million, after deducting underwriting commissions of $6.9 million and
offering expenses of $1.7 million. We used $15 million of the proceeds as part
of the consideration paid in the acquisition of Krypton Isolation Inc. on
August 9, 2000. Another $4.3 million was used to pay off the equipment loans
at Imperial Bank. As of September 30, 2000, the remaining proceeds were
invested in government securities and other short-term, investment-grade,
interest bearing instruments.

ITEM 3 DEFAULTS UPON SENIOR SECURITIES

Not applicable

ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable

ITEM 5 OTHER INFORMATION

Not applicable

ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K

(a) The following exhibit is filed as part of this report:

2.1 Merger Agreement and Plan of Reorganization dated
as of June 22, 2000, by and among Silicon Labs,
Karst Corporation, a California corporation and
wholly-owned subsidiary of Silicon Labs, and
Krypton Isolation, Inc., a California corporation,
and with respect to Section 7.2 of the Merger
Agreement only, Charles Welch, a Shareholder
Agent, is incorporated herein by reference to
Exhibit 2.1 to our Current report on Form 8-K filed
with the SEC on August 11, 2000

27.01 Financial Data Schedule (EDGAR version only)

(b) During the quarter ended September 30, 2000, we filed
the following Current Reports on Form 8-K:

1. We filed a Form 8-K on August 11, 2000 (Item 2)
announcing the completion of the Krypton acquisition

2. We filed a Form 8-K/A on September 8, 2000 (Item 7)
including the required financial statements with
respect to the Krypton acquisition

<PAGE>

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.

SILICON LABORATORIES INC.

By: /s/ John W. McGovern
---------------------------------
John W. McGovern
VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER

10/16/2000 /s/ Navdeep S. Sooch
------------------------------- -----------------------------------
Date Navdeep S. Sooch
CHAIRMAN AND
CHIEF EXECUTIVE OFFICER

10/16/2000 /s/ John W. McGovern
------------------------------- -----------------------------------
Date John W. McGovern
VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING OFFICER)