UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q/A

(Amendment No. 1)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended September 30, 2003

or

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

for the transition period from                      to                     

Commission File Number 0-25996

TRANSWITCH CORPORATION

(Exact name of Registrant as Specified in its Charter)

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

3 Enterprise Drive

Shelton, Connecticut 06484

(Address of Principal Executive Offices)

Telephone (203) 929-8810

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.001 per share, outstanding at November 6, 2003: 90,731,857

Series A Junior Participating Preferred Stock Purchase Rights

4.50% Convertible Notes due 2005 outstanding at November 6, 2003: $24,442,000

5.45% Convertible Plus Cash Notes due 2007 outstanding at November 6, 2003: $97,963,000

EXPLANATORY NOTE

This Form 10-Q/A is being filed solely to correct a clerical error reflected on the Company’s consolidated balance sheet as of September 30, 2003 and footnote 10 concerning the Company’s 5.45% convertible plus cash notes due 2007. The corrections contained in this Form 10-Q/A do not result in any change to the total assets, total liabilities or total stockholders’ equity on the consolidated balance sheet as of September 30, 2003, nor do they result in any change to the consolidated statement of operations for the three and nine months ended September 30, 2003 or consolidated statement of cash flows for the nine months ended September 30, 2003.

This Form 10-Q/A speaks as of the date of the original Form 10-Q and does not reflect events occurring after the filing of the original Form 10-Q, or modify or update the disclosures therein in any way, other than as required to reflect the corrections described above.

TranSwitch Corporation And Subsidiaries

FORM 10-Q/A

(Amendment No. 1)

For the Quarterly Period Ended September 30, 2003

Table of Contents

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Consolidated Balance Sheets as of September 30, 2003 (as restated) and December 31, 2002	3
	Consolidated Statements of Operations for the three and nine month periods ended September 30, 2003 and 2002	4
	Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2003 and 2002	5
	Notes to Unaudited Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	39
Item 4.	Controls and Procedures	39
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	40
Item 2.	Changes in Securities and Use of Proceeds	40
Item 6.	Exhibits and Reports on Form 8-K	40
	Signatures	42

2

TRANSWITCH CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

	September 30, 2003			December 31, 2002
	(as restated)
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	143,215		$	150,548
Short-term investments		30,501			33,099
Accounts receivable, net		2,486			2,228
Inventories		2,808			4,658
Prepaid expenses and other current assets		3,716			5,480
Total current assets		182,726			196,013
Long-term marketable securities		15,314			21,819
Property and equipment, net		10,555			17,219
Deferred financing fees, net		4,766			2,193
Other assets		3,737			6,109
Total assets	$	217,098		$	243,353
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,236		$	2,044
Accrued expenses and other current liabilities		6,717			8,992
Accrued compensation and benefits		1,432			1,961
Accrued sales returns, allowances and stock rotation		1,015			1,479
Accrued interest		61			1,546
Restructuring liabilities		1,449			1,708
Total current liabilities		11,910			17,730
Restructuring liabilities—long term		23,633			25,849
5.45% Convertible Plus Cash Notes due 2007, net of debt discount of $23,278		74,685			—
Derivative liability		23,278			—
4.50% Convertible Notes due 2005		24,442			114,113
Total liabilities		157,948			157,692
Stockholders’ equity:
Common stock $.001 par value; authorized 300,000,000 shares; issued and outstanding, 90,606,635 shares at September 30, 2003 and 90,131,672 shares at December 31, 2002		91			90
Additional paid-in capital		290,566			290,007
Accumulated other comprehensive income		484			174
Accumulated deficit		(231,991	)		(204,610	)
Total stockholders’ equity		59,150			85,661
Total liabilities and stockholders’ equity	$	217,098		$	243,353

See accompanying notes to unaudited consolidated financial statements

3

TRANSWITCH CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002(1)			2003			2002(1)
Net revenues:
Product revenues	$	5,264		$	3,635		$	15,711		$	12,430
Service revenues		421			23			679			579
Total net revenues		5,685			3,658			16,390			13,009
Cost of revenues:
Cost of product revenues		1,502			1,604			4,499			4,149
Provision for excess inventories		—			4,832			1,498			4,832
Cost of service revenues		110			—			226			846
Total cost of revenues		1,612			6,436			6,224			9,827
Gross profit (loss)		4,073			(2,778	)		10,167			3,182
Operating expenses:
Research and development		10,656			13,972			31,354			40,487
Marketing and sales		2,784			3,393			8,176			10,070
General and administrative		1,374			1,618			4,094			5,814
Impairment of goodwill		—			59,901			—			59,901
Restructuring (benefit) charge and asset impairments, net		(860	)		5,532			3,064			4,052
Purchased in-process research and development		476			—			476			2,000
Total operating expenses		14,430			84,416			47,164			122,324
Operating loss		(10,357	)		(87,194	)		(36,997	)		(119,142	)
Other income (expense):
Impairment of investments in non-publicly traded companies		—			(7,719	)		(50	)		(7,719	)
Equity in net losses of affiliates		(582	)		(733	)		(1,368	)		(1,848	)
Gain from exchange and repurchase of 4.50% Convertible Notes due 2005		14,463			—			14,463			51,976
Interest (expense) income:
Interest income		727			1,395			2,312			5,306
Interest expense		(1,557	)		(1,422	)		(4,595	)		(6,828	)
Interest expense, net		(830	)		(27	)		(2,284	)		(1,522	)
Total other income (expense)		13,050			(8,479	)		10,762			40,887
Income (loss) before income taxes, extraordinary loss and cumulative effect of change in accounting principle		2,693			(95,673	)		(26,236	)		(78,255	)
Income tax expense		73			61,478			257			69,243
Income (loss) before extraordinary loss and cumulative effect of change in accounting principle		2,620			(157,151	)		(26,493	)		(147,498	)
Extraordinary loss upon consolidation of TeraOp (USA), Inc.		—			—			(83	)		—
Cumulative effect on prior years of retroactive application of new depreciation method		—			—			(805	)		—
Net income (loss)	$	2,620		$	(157,151	)	$	(27,381	)	$	(147,498	)
Basic and diluted income (loss) per common share:
Income (loss) before extraordinary loss and cumulative effect of change in accounting principle	$	0.03		$	(1.74	)	$	(0.29	)	$	(1.64	)
Cumulative effect on prior years of retroactive application of new depreciation method		—			—			(0.01	)		—
Net income (loss)	$	0.03		$	(1.74	)	$	(0.30	)	$	(1.64	)
Basic average shares outstanding		90,451			90,085			90,261			90,023
Diluted average shares outstanding		92,698			90,085			90,261			90,023

⁽¹⁾ The 2002 figures have been adjusted for the effect of the change in the investment in OptiX Networks, Inc. from the cost to the equity method of accounting, which occurred in the quarter ended September 30, 2002. Also, the gain on debt extinguishment, previously classified as extraordinary, has been reclassified to continuing operations in accordance with SFAS No. 145.

See accompanying notes to unaudited consolidated financial statements.

4

TRANSWITCH CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended September 30,
	2003			2002(1)
Cash flows from operating activities:
Net loss	$	(27,381	)	$	(147,498	)
Adjustments required to reconcile net loss to cash flows used in operating activities, net of effects of acquisitions:
Depreciation and amortization		9,029			10,213
Provision for excess inventories		1,498			4,832
Deferred income taxes		—			68,973
Impairment of goodwill		—			59,901
Tax benefit from exercise of employee stock options		—			27
Provision (benefit) for doubtful accounts		7			(1,070	)
Cumulative effect on prior years of retroactive application of new depreciation method		805			—
Extraordinary loss upon consolidation of TeraOp (USA), Inc.		83			—
Non-cash restructuring (benefit) charge and asset impairment		(474	)		(1,116	)
Equity in net losses of affiliates		1,368			1,848
Impairment of investments in non-publicly traded companies		50			7,719
Purchased in-process research and development		476			2,000
Gain from exchange and repurchase of 4.50% Convertible Notes due 2005		(14,463	)		(51,976	)
Other non-cash items		—			(178	)
(Increase) decrease in operating assets:
Accounts receivable		(260	)		2,097
Inventories		352			(403	)
Prepaid expenses and other assets		1,109			(1,679	)
Decrease in operating liabilities:
Accounts payable		(965	)		(2,387	)
Accrued expenses and other current liabilities		(4,260	)		(6,249	)
Restructuring liabilities		(1,458	)		(66	)
Net cash used in operating activities		(34,484	)		(55,012	)
Cash flows from investing activities:
Purchase of product licenses		—			(2,000	)
Capital expenditures		(1,329	)		(6,841	)
Investments in non-publicly traded companies		(1,374	)		(3,668	)
Cash received from liquidation of limited partnership investment		886			—
Acquisition of businesses, net of cash acquired		(354	)		(5,789	)
Cash acquired upon consolidation of TeraOp (USA), Inc.		17			—
Purchases of short and long term held-to-maturity investments		(49,017	)		(40,137	)
Proceeds from maturities of short and long term investments		58,120			62,278
Net cash provided by investing activities		6,949			3,843
Cash flows from financing activities:
Repurchase of 4.50% Convertible Notes due 2005		—			(143,156	)
Proceeds from the issuance of common stock		319			607
Proceeds from the issuance of 5.45% Convertible Plus Cash Notes due 2007, net of deferred financing fees		19,573			—
Net cash provided by (used in) financing activities		19,892			(142,549	)
Effect of exchange rate changes on cash and cash equivalents		310			224
Decrease in cash and cash equivalents		(7,333	)		(193,494	)
Cash and cash equivalents at beginning of period		50,548			70,248
Cash and cash equivalents at end of period	$	143,215		$	176,754

⁽¹⁾ The 2002 figures have been adjusted for the effect of the change in the investment in OptiX Networks, Inc. from the cost to the equity method of accounting, which occurred in the quarter ended September 30, 2002.

See accompanying notes to unaudited consolidated financial statements.

5

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Tabular dollars in thousands, except per share amounts)

Note 1. Summary of Significant Accounting Policies

Description of Business

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

Basis of Presentation—Interim Financial Statements

The unaudited interim consolidated financial statements include the accounts of TranSwitch Corporation and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The accompanying unaudited interim consolidated financial statements of TranSwitch have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Accordingly, certain information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements are not included herein. The unaudited interim consolidated financial statements are prepared on a consistent basis with, and should be read in conjunction with, the audited consolidated financial statements and the related notes thereto as of and for the year ended December 31, 2002, contained in the Company’s Annual Report on Form 10-K, as amended, filed with the Securities and Exchange Commission on August 12, 2003.

In the opinion of management, the accompanying unaudited interim consolidated financial statements include all adjustments, consisting of normal recurring adjustments, which are necessary for a fair presentation for such periods. The results of operations for any interim period are not necessarily indicative of the results that may be achieved for the entire year ending December 31, 2003.

Stock-Based Compensation

As permitted by Statement of Financial Accounting Standard (SFAS), No. 123, “Accounting for Stock-Based Compensation,” (SFAS 123), the Company accounts for employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) and the Financial Accounting Standards Board (FASB) Interpretation No. 44, “Accounting for Certain Transactions Involving Stock-Based Compensation, an interpretation of APB Opinion No. 25” (FIN 44) and related interpretations. Stock-based compensation related to non-employees is based on the fair value of the related stock or options in accordance with SFAS 123 and its interpretations. Expense associated with stock-based compensation is amortized over the vesting period of each individual award. The following table illustrates the effect on net income (loss) and income (loss) per common share as if the Black-Scholes fair value method described in SFAS 123 had been applied to the Company’s stock purchase and stock option plans:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
Net income (loss):
As reported	$	2,620		$	(157,151	)	$	(27,381	)	$	(147,498	)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(9,454	)		(11,544	)		(29,217	)		(36,505	)
Pro forma loss	$	(6,834	)	$	(168,695	)	$	(56,598	)	$	(184,003	)
Basic income (loss) per common share:
As reported	$	0.03		$	(1.74	)	$	(0.30	)	$	(1.64	)
Pro forma	$	(0.08	)	$	(1.87	)	$	(0.63	)	$	(2.04	)
Diluted income (loss) per common share:
As reported	$	0.03		$	(1.74	)	$	(0.30	)	$	(1.64	)
Pro forma	$	(0.07	)	$	(1.87	)	$	(0.63	)	$	(2.04	)

6

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements–Continued

(Tabular dollars in thousands, except per share amounts)

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

	September 30,
	2003		2002
Risk-free interest rate	2.85	%	2.94	%
Expected life in years	1.99		1.69
Expected volatility	100.03	%	97.3	%
Expected dividend yield	—		—

Restatements

As disclosed in the Company’s Annual Report on Form 10-K, as amended, filed with the Securities and Exchange Commission on August 12, 2003, the Company restated prior period results to reflect the change from the cost to the equity method of accounting for its investment in OptiX Networks, Inc. (OptiX) as the Company, during fiscal 2002, obtained the ability to significantly influence the operating and financial policies of OptiX through its investments in convertible preferred stock and a bridge loan.

In addition, the Company adopted SFAS No. 145, “Recission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (SFAS 145) effective January 1, 2003 and, accordingly, reclassified the gain on the early extinguishment of its debt, which included the related transaction fees, deferred financing fees and income taxes, which was previously recorded in the consolidated statement of operations as an extraordinary item to other income (expense) and income tax expense, respectively.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period’s presentation.

Note 2. Recent Accounting Pronouncements

In April 2002, the FASB issued SFAS 145. As it applies to the Company, SFAS 145 requires that certain gains and losses on extinguishments of debt be classified as income or loss from continuing operations, rather than as extraordinary items, as previously required under SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt” (SFAS 4). The Company adopted SFAS 145 effective January 1, 2003 and, accordingly, reclassified the gain on the early extinguishment of its debt which included the related transaction fees, deferred financing fees and income taxes, which was previously recorded in the consolidated statement of operations as an extraordinary item to other income (expense) and income tax expense, respectively.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). The effect of SFAS 146 is to spread out the reporting of expenses related to restructurings initiated after 2002, because commitment to a plan to exit an activity or dispose of long-lived assets is no longer sufficient to record a liability for the anticipated costs. Instead, companies are to record exit and disposal costs when they are “incurred” and can be measured at fair value, and they will subsequently adjust the recorded liability for changes in estimated cash flows. The provisions of SFAS 146 are effective for exit and disposal activities that are initiated after December 31, 2002. In conjunction with the January 2003 restructuring plan, the Company has applied the provisions of SFAS 146. Refer also to Note 6—Restructuring Liabilities for further details on the January 2003 restructuring plan.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (SFAS 148). SFAS 148 amends SFAS No. 123 “Accounting for Stock-Based Compensation,” (SFAS 123) to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The additional disclosure requirements of SFAS 148 are effective for fiscal years ending after December 15, 2002. The Company has elected to continue to follow the intrinsic value method of accounting as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). The Company has complied with the disclosure requirements of SFAS 148 in the “Stock Based Compensation” paragraph above.

7

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements–Continued

(Tabular dollars in thousands, except per share amounts)

In January 2003, FIN No. 46, “Consolidation of Variable Interest Entities” (FIN 46) was issued. The interpretation provides guidance on consolidating variable interest entities and applies immediately to variable interests in variable interest entities created after January 31, 2003. The guidelines of the interpretation will become applicable for the Company as of December 31, 2003 for variable interest entities created before February 1, 2003 as the Financial Accounting Standards Board has issued a staff position delaying the effective date of the FIN 46 for public companies. The interpretation requires variable interest entities to be consolidated if the equity investment at risk is not sufficient to permit an entity to finance its activities without support from other parties or the equity investors lack certain specified characteristics. The Company applied the provisions of FIN 46 as of February 1, 2003, for its investment in TeraOp (USA), Inc. (TeraOp), which resulted in the Company consolidating the results of TeraOp (USA), Inc. Refer also to Note 7—Investments in Non-Publicly Traded Companies for further details.

On April 30, 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149). SFAS 149 amends and clarifies accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). SFAS 149 is effective for contracts entered into or modified after June 30, 2003. The Company adopted SFAS 149 beginning in the third quarter of 2003. The adoption of SFAS 149 did not have a material impact on the Company’s financial position, cash flows or results of operations.

On May 15, 2003 the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). SFAS 150 requires that an issuer classify financial instruments that are within its scope as a liability (or as an asset in some circumstances). Many of those instruments were classified as equity under previous guidance. Most of the guidance in SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted SFAS 150 beginning in the third quarter of 2003. The adoption of SFAS 150 did not have a material impact on the Company’s financial position, cash flows or results of operations.

Note 3. Inventories

The components of inventories at September 30, 2003 and December 31, 2002 are as follows:

	September 30, 2003		December 31, 2002
Raw material	$	232	$	906
Work-in-process		1,083		2,307
Finished goods		1,493		1,445
Total inventories	$	2,808	$	4,658

8

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements–Continued

(Tabular dollars in thousands, except per share amounts)

As a result of current and anticipated business conditions, as well as lower than anticipated demand, the Company recorded a charge for excess inventories totaling approximately $4.8 million during the three months ended September 30, 2002. No charges were taken in the corresponding period of 2003. For the nine months ended September 30, 2003 and 2002, the Company recorded a charge for excess inventories of $1.5 million and $4.8 million, respectively. The effect of these inventory provisions was to write this excess inventory down to a new cost basis of zero. During fiscal 2003 and 2002, the Company has sold certain products that had previously been written down to a cost basis of zero. The following tables present the impact to gross profit from the sale of this previously written down inventory for the three and nine months ended September 30, 2003 and 2002, respectively:

	Three months ended September 30, 2003					Three months ended September 30, 2002
	Gross Profit $			Gross Profit %		Gross Profit $			Gross Profit %
Gross profit—as reported	$	4,073		72	%	$	(2,778	)	(76	%)
Excess inventory benefit (1)		(602	)	(11	%)		(182	)	(5	%)
Excess inventory charge (2)		—		—			4,832		133	%
Gross profit—as adjusted	$	3,471		61	%	$	1,872		52	%
	Nine months ended September 30, 2003					Nine months ended September 30, 2002
	Gross Profit $			Gross Profit %		Gross Profit $			Gross Profit %
Gross profit—as reported	$	10,167		62	%	$	3,182		24	%
Excess inventory benefit (1)		(2,948	)	(18	%)		(1,735	)	(13	%)
Excess inventory charge (2)		1,498		9	%		4,832		37	%
Gross profit—as adjusted	$	8,717		53	%	$	6,279		48	%

⁽¹⁾ The Company realized an excess inventory benefit from the sale of products that had previously been written down to a cost basis of zero. For the purposes of comparing the change in gross profit on net revenues, the Company is excluding this benefit and calculating gross profit on these product revenues as if they had been sold at their approximate historical average costs.

⁽²⁾ The Company recorded a charge for excess inventories during the respective period. For the purposes of comparing the change in gross profit on net revenues, the Company is excluding this charge and calculating gross profit on these product revenues as if they had been sold at their approximate historical average costs.

Note 4. Comprehensive Income (Loss)

The components of comprehensive income (loss) are as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2003		2002			2003			2002
Net income (loss)	$	2,620	$	(157,151	)	$	(27,381	)	$	(147,498	)
Foreign currency translation adjustment		54		(13	)		310			224
Total comprehensive income (loss)	$	2,674	$	(157,164	)	$	(27,071	)	$	(147,274	)

9

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements–Continued

(Tabular dollars in thousands, except per share amounts)

Note 5. Income (Loss) Per Common Share

Basic and diluted income (loss) per common share for the three and nine month periods ended September 30, 2003 and 2002 are as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2003		2002			2003			2002
Net income (loss)	$	2,620	$	(157,151	)	$	(27,381	)	$	(147,498	)
Basic weighted average shares outstanding for the period (in thousands)		90,451		90,085			90,261			90,023
Stock options, net of assumed treasury shares repurchased (in thousands)		2,247		—			—			—
Diluted weighted average shares outstanding for the period (in thousands)		92,698		90,085			90,261			90,023
Basic income (loss) per common share	$	0.03	$	(1.74	)	$	(0.30	)	$	(1.64	)
Diluted income (loss) per common share (1)(2)	$	0.03	$	(1.74	)	$	(0.30	)	$	(1.64	)

⁽¹⁾ For the purposes of calculating the diluted income (loss) per common share for the three months ended September 30, 2003, the assumed exercise of “in-the-money” stock options of approximately 2,247,000 shares has been included because its effect is dilutive. For the purposes of calculating the diluted income (loss) per common share for the nine months ended September 30, 2003, the assumed exercise of “in-the-money” stock options of approximately 1,008,000 shares has been excluded because its effect is anti-dilutive. For the purposes of calculating the diluted income (loss) per common share for the three and nine months ended September 30, 2002, the assumed exercise of “in-the-money” stock options of approximately 5,000 and 367,000 shares (respectively) has been excluded because its effect is anti-dilutive.

⁽²⁾ For purposes of calculating the diluted income (loss) per common share for the three and nine month periods ended September 30, 2003 and 2002, the assumed conversion of both the 4.50% Convertible Notes due 2005 and the 5.45% Convertible Plus Cash Notes due 2007 is not taken into consideration as their effect is anti-dilutive.

Note 6. Restructuring Liabilities

In January 2003, the Company announced a restructuring plan in order to lower its operating expense run-rate due to then current and anticipated business conditions. This plan resulted in a work-force reduction of approximately 25% of existing personnel. Also, the Company announced the closing of its South Brunswick, NJ (formerly known as Systems On Silicon, Inc. and referred to as SOSi) design center and the reduction of staff in Boston, MA, and Shelton, CT. This workforce reduction also impacted the Company’s Switzerland and Belgium locations. In addition, the Company has postponed the completion of the Integrated Access Device (IAD) product line and archived the related intellectual property until that market returns, if ever. During the nine months ended September 30, 2003, the Company incurred approximately $3.4 million in restructuring expenses related to employee termination benefits and $0.5 million related to excess facility costs. In addition, the Company determined that fixed assets with a net book value totaling $0.3 million and a patent on its IAD product line with a net book value of $0.2 million were impaired. This resulted in a total restructuring and asset impairment charge for the nine months ended September 30, 2003 totaling $4.3 million. This restructuring charge was offset by a restructuring benefit of $1.2 million as the Company was able to sub-lease portions of its excess facilities and by adjustments to original estimates of severance costs related to previously announced restructuring programs.

The Company adopted SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146) as of January 1, 2003. The effect of SFAS 146 is to spread out the reporting of expenses related to restructurings initiated after 2002 because commitment to a plan to exit an activity or dispose of long-lived assets is no longer sufficient to record a liability for the anticipated costs. The Company is now required to record exit and disposal costs when they are “incurred” and can be measured at fair value. The recorded liability will be adjusted in future periods for changes in estimated cash flows. As such, the future excess facility costs incurred in fiscal 2003 have been recorded net of future anticipated lease income (although there are no firm commitments) and discounted to their current net present value resulting in a liability of $0.2 million. This liability will be adjusted quarterly based upon actual cash flows and changes to estimates. Quarterly adjustments to this liability will be recorded as restructuring expenses on the consolidated statement of operations. The liability related to employee termination benefits is short-term in nature and is recorded at its fair value.

During fiscal years 2002 and 2001, the Company announced three restructuring plans due to then current and anticipated business conditions. These plans resulted in the elimination of approximately 130 positions in North America and the closing of six leased facilities in Canada, Massachusetts, North Carolina, California and Connecticut. In addition, the Company discontinued its AsTrix and Sertopia product lines.

10

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements–Continued

(Tabular dollars in thousands, except per share amounts)

A summary of the restructuring liabilities and the activity from December 31, 2002 through September 30, 2003 is as follows:

	Fiscal 2003 Activity
	Restructuring Liabilities December 31, 2002(1)		Restructuring Charges Incurred with the January 15, 2003 Restructuring Plan		Cash Payments January 1, 2003 – September 30, 2003(2)			Non- cash Asset write- offs(3)			Adjustments and Changes to Estimates(4)			Restructuring Liabilities September 30, 2003
Employee termination benefits	$	—	$	3,428	$	(3,077	)	$	(77	)	$	(258	)	$	16
Facility lease costs		27,557		467		(1,778	)					(1,180	)		25,066
Asset impairments		—		466		—			(466	)		—			—
Totals	$	27,557	$	4,361	$	(4,855	)	$	(543	)	$	(1,438	)	$	25,082

⁽¹⁾ All cash payments for employee termination benefits related to the fiscal 2001 and 2002 restructuring plans have been paid.

⁽²⁾ Cash payments made for facility lease costs are presented net of sub-lease payments received from tenants who are renting the Company’s excess facilities.

⁽³⁾ Non-cash asset write-offs included certain employee receivables, fixed assets and a patent for the IAD product line.

⁽⁴⁾ During the nine months ended September 30, 2003, the Company sublet a portion of its unused excess facilities. As a result, the Company recognized income (restructuring benefit) of approximately $1.2 million with a corresponding reduction to the restructuring liability. Commissions were paid to rent these facilities that reduced the benefit and the related liability.

At September 30, 2003, the Company has classified approximately $23.6 million of this restructuring liability as long-term, representing net lease commitments that are not due in the succeeding twelve-month period.

Note 7. Investments in Non-Publicly Traded Companies

Equity Method Investments

The Company accounts for its venture capital limited partnership investment in GTV Capital, L.P. under the equity method of accounting. The Company also accounts for its investment in OptiX Networks, Inc. under the equity method of accounting. Under the equity method of accounting, the Company’s pro-rata share of the net income or loss from the investee companies is recorded in the consolidated statements of operations and, accordingly, the carrying value of the investment is adjusted on the consolidated balance sheets. In February 2003, the Company terminated its limited partnership agreement with GTV Capital, L.P. and was paid the remaining balance of its investment totaling approximately $0.9 million.

Variable Interest Entities

In January 2003, FIN No. 46, “Consolidation of Variable Interest Entities” (FIN 46) was issued. The interpretation provides guidance on consolidating variable interest entities and applies to all variable interests in variable interest entities created after January 31, 2003. The interpretation requires variable interest entities to be consolidated if the equity investment at risk is not sufficient to permit an entity to finance its activities without support from other parties or the equity investors lack certain specified characteristics. The Company applied the provisions of FIN 46 as of February 1, 2003 to its investment in TeraOp, which resulted in the Company consolidating the results of TeraOp.

During the first quarter 2003, the Company loaned TeraOp $0.5 million under a new convertible loan agreement, which provides the Company with additional contractual rights over existing debt or equity investors. In addition, the Company also is in a position, as a result of the loan, to negotiate a more favorable conversion price of its interest in TeraOp and has the ability to control the operations of TeraOp. None of the existing debt or equity investors, other than the Company, expects to, or is obligated to, absorb any additional losses from their investment given that the equity in TeraOp is negative as of January 31, 2003. As a result, the convertible loan has been determined to be a variable interest and TeraOp was considered a variable interest entity, as defined by FIN 46. The Company has calculated the effect of the initial measurement as of January 31, 2003. As a result of this measurement and consolidation of TeraOp, the Company recognized an extraordinary loss of approximately $0.1 million as the fair value of TeraOp’s liabilities exceeded those of its assets by this amount. All significant intercompany balances, including the Company’s investments in TeraOp, have been eliminated upon consolidation. In the third quarter of 2003, the Company provided additional financing to TeraOp and continues to consolidate its results.

11

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements–Continued

(Tabular dollars in thousands, except per share amounts)

Cost Method Investments

The Company has purchased a limited partnership interest in Neurone Ventures II, L.P. (Neurone), shares of convertible preferred stock in Accordion Networks, Inc. (Accordion) and Intellectual Capital for Integrated Circuits, Inc. (IC4IC). The Company has also loaned Accordion and Opulan Technologies (Opulan) approximately $0.3 million and $0.1 million under separate convertible bridge financing agreements, respectively. The Company’s direct and indirect voting interest (which include certain board members and employees) is less than 20% of the total ownership of each of these companies as of September 30, 2003, and the Company does not exercise significant influence over the management of these companies as defined by APB Opinion No. 18 “The Equity Method of Accounting for Investments in Common Stock,” and other relevant literature. The Company accounts for these investments at cost and monitors the carrying value of these investments for impairment. The maximum exposure to loss the Company has with respect to its investments in these entities is their carrying values at September 30, 2003.

In February 2003, the Company made a convertible bridge loan investment in IC4IC totaling $0.05 million. In March 2003, this investment was impaired, as IC4IC was not able to raise sufficient equity or debt to fund its operations. During early April 2003, IC4IC’s Board of Directors made the decision to discontinue its operations.

Summary of Investments in Non-Publicly Traded Companies

The following table summarizes the Company’s investments and changes to investment values as of December 31, 2002 and for the nine months ended September 30, 2003:

	Fiscal 2003 Activity
	Investment Balance December 31, 2002		Investments(1)		Elimination on Consolidation(2)			Equity Losses(3)			Liability for Losses in Excess of Advances(4)			Return of Capital(5)			Impairments			Investment Balance September 30, 2003
Investee company:
GTV	$	1,016	$	—	$	—		$	(130	)	$	—		$	(886	)	$	—		$	—
Neurone Ventures II, L.P.		102		45		—			(19	)		—			—			—			128
OptiX		—		1,506		—			(1,219	)		(287	)		—			—			—
TeraOp		—		900		(900	)		—			—			—			—			—
Accordion		870		310		—			—			—			—			—			1,180
Opulan Technologies		—		81		—			—			—			—			—			81
IC4IC		—		50		—			—			—			—			(50	)		—
Total investments	$	1,988	$	2,892	$	(900	)	$	(1,368	)	$	(287	)	$	(886	)	$	(50	)	$	1,389

⁽¹⁾ Represents cash payments made to the investee company for either convertible preferred stock or for bridge loans convertible to convertible preferred stock.

⁽²⁾ During the period ended March 31, 2003, the Company began consolidating the results and balances of TeraOp in its consolidated financial statements in accordance with FIN 46 as TeraOp has been determined to be a variable interest entity.

⁽³⁾ Reflects the Company’s pro-rata share of losses in the respective investee company. These are recorded as other income (expense) on the consolidated statement of operations.

⁽⁴⁾ Represents a reduction in the liability for equity losses established as of December 31, 2002 for losses incurred to date in excess of our advances under the bridge loan investment.

⁽⁵⁾ The Company liquidated its interest in GTV Capital, Inc. during the three months ended March 31, 2003 and received approximately $0.9 million in cash from this investment, representing a return of its capital.

12

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements–Continued

(Tabular dollars in thousands, except per share amounts)

Note 8. Property and Equipment, Net

The components of property and equipment, net at September 30, 2003 and December 31, 2002 are as follows:

	Estimated Useful Lives		September 30, 2003			December 31, 2002
Purchased computer software	3 years		$	17,714		$	19,000
Computers and equipment	3-7 years			12,118			13,639
Furniture	3-7 years			2,580			2,847
Leasehold improvements	Lease term	*		1,339			1,634
Construction in-progress (software and equipment)				307			756
Gross property and equipment				34,058			37,876
Less accumulated depreciation and amortization				(23,503	)		(20,657	)
Property and equipment, net			$	10,555		$	17,219

* Shorter of estimated useful life or lease term.

Depreciation expense was $2.1 million and $2.4 million for the three months ended September 30, 2003 and 2002, respectively. Depreciation expense was $6.5 million and $6.9 million for the nine months ended September 30, 2003 and 2002, respectively.

Effective January 1, 2003, the Company changed the method of depreciating property and equipment to the straight-line method. Depreciation of property and equipment in prior years was computed using the half-year convention method. The Company evaluated the use and related consumption of all classes of acquired property and equipment and determined that many assets are used and consumed on a consistent level over their estimated economic lives. Under the half-year convention method, property and equipment placed in service during the first year of acquisition was subject to six months of depreciation expense regardless of when the asset was acquired, placed in service and consumed. The Company believes that the straight-line method results in a better approximation of the underlying consumption of the asset over its estimated useful life and provides a better matching of revenues and expenses. The effect of the change in depreciation method as of January 1, 2003 was applied retroactively to property and equipment acquisitions of prior years. The cumulative effect of the change with respect to the retroactive application of the straight-line method is an approximately $0.8 million charge (or $0.01 loss per diluted common share) and has been recorded as such on the consolidated statement of operations. This charge has not been presented net of an income tax benefit as the Company continues to maintain a full valuation allowance against its net deferred tax assets. Pro forma amounts have not been presented because the effects of this change in accounting principle were not material to the consolidated financial statements.

Note 9. Stockholders’ Equity

Nasdaq Listing Requirements

Nasdaq notified the Company on June 10, 2003 that it had regained compliance with all listing requirements on the Nasdaq SmallCap Market. On July 9, 2003, the Company applied for, and was granted, transfer of its common stock listing to the Nasdaq National Market. TranSwitch’s common stock resumed trading on the Nasdaq National Market on July 10, 2003.

Note 10. Exchange Offer and New Money Offering

On September 30, 2003, the Company completed its exchange offer with and new money offering to holders of its 4.50% Convertible Notes due 2005 (the 4.50% Notes). The Company issued $98.0 million aggregated principal amount of 5.45% Convertible Plus Cash Notes_sm due September 30, 2007 (the Plus Cash Notes), which represented $74.0 million of Plus Cash Notes issued in exchange for 4.50% Notes tendered in the exchange offer and $24.0 million of additional Plus Cash Notes sold for cash to holders of existing notes. The net proceeds from the new money offering will be used for general corporate purposes, including working capital and research and development. The Company recorded a gain on the exchange of approximately $14.5 million. After the completion of the exchange offer approximately $24.4 million of our 4.50% Notes remain outstanding.

The following description provides a brief overview of the terms and conditions of the Plus Cash Notes. Each Plus Cash Note, may be converted by the holders thereof into 182.71 shares of the Company’s common stock (the base share) plus $500 in cash (the plus cash amount), which the Company may elect to pay with shares of its common stock subject to the terms and conditions of the Plus Cash Notes indenture. Interest on the Plus Cash Notes is payable at a rate of 5.45% per year payable on March 31 and September 30 of each year, commencing on March 31, 2004. The Company may elect to pay interest in cash or common stock, subject to the terms and conditions of the Plus Cash Notes. At any time prior to maturity, the Company may, at its option, elect to automatically-convert (an auto-conversion) the Plus Cash Notes if the closing price of its common stock exceeds $5.47 for 20 trading days during any

13

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements–Continued

(Tabular dollars in thousands, except per share amounts)

consecutive 25 trading day period, subject to the terms and conditions of the Plus Cash Notes. The Company may elect to satisfy the plus cash amount issuable in connection with any auto-conversion in cash or common stock, subject to the terms and conditions of the Plus Cash Notes. If the Company effects an auto-conversion prior to September 30, 2005, the Company will pay the additional interest in cash as described in the terms and conditions of the Plus Cash Notes indenture. We recorded a gain on the exchange of approximately $14.5 million, which is calculated as follows:

Carrying value of 4.50% Notes exchanged	$	89,671
Less: deferred financing fees		1,245
Net carrying value of 4.50% Notes		88,426
Less: fair value of Plus Cash Notes issued on exchange		73,963
Gain on exchange	$	14,463

In accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“Statement 133”), the auto-conversion make-whole provision and the holder’s conversion right (collectively, “the features”) contained in the Plus Cash Notes are not clearly and closely related to the characteristics of the Plus Cash Notes. Accordingly, these features qualify as embedded derivative instruments and because they do not qualify for any scope exception within Statement 133, they are required by Statement 133 to be accounted for separately from the debt instrument and recorded as derivative financial instruments. In addition, the Company will apply the guidance set forth in Emerging Issues Task Force (“EITF”) 98-5 and EITF 00-27 which specifies the appropriate basis to account for the contingent beneficial conversion premium, a 5% discount contained in the Plus Cash Notes. This could occur in the future if and when the following conditions are met upon conversion of the Plus Cash Notes by the holder or issuer: (1) our common stock price exceeds the threshold price of $2.61 or the auto-conversion price of $5.47 and (2) we elect to settle these features with our common stock instead of with cash. To the extent we believe it is likely that the settlement of the conversion rights mentioned above and/or the interest accruing to the holder’s of the Plus Cash Notes will be made with our common stock, we will record incremental interest expense at that time.

Of the aggregate principal amount of Plus Cash Notes issued in the exchange offer and new money offering, $23.3 million has been allocated to these instruments based on their estimated fair values, of which $3.0 million and $20.3 million relates to the auto conversion make-whole provision and holder’s conversion right, respectively. The fair value of the auto-conversion make-whole provision and the holder’s conversion right was determined using a Monte Carlo simulation model and the Black-Scholes option pricing model, respectively. These embedded derivative instruments have been recorded as a derivative liability. Assuming the plus cash settlement price determined according to the voluntary conversion provision is or remains below the threshold price of $2.61, the derivative related to the holder’s conversion right will be adjusted quarterly for changes in fair value during the period of time that any such Plus Cash Notes are outstanding and classified as a liability, with the corresponding charge or credit to other expense or income. In subsequent periods, if the plus cash settlement price determined according to the voluntary conversion provision exceeds the threshold price of $2.61, the derivative related to the holder’s conversion right will be classified within stockholders’ equity and then be adjusted quarterly for changes in fair value during the period of time that any such Plus Cash Notes are outstanding, with the corresponding charge or credit to additional paid-in-capital. The auto-conversion make-whole provision will be adjusted quarterly for changes in fair value during the first two years that any such Plus Cash Notes are outstanding, with the corresponding charge or credit to other expense or income. The auto-conversion make-whole provision can only be settled with cash and, accordingly, will always be classified as a liability. The fair value of the auto-conversion make-whole provision and the holder’s conversion right of approximately $23.3 million has been recorded as a discount on the Plus Cash Notes. The discount on the Plus Cash Notes will be accreted to par value through quarterly interest charges over the four-year term of the Plus Cash Notes.

The following table summarizes the effects of the correction of a clerical error reflected on the Company’s previously reported consolidated balance sheet as of September 30, 2003. The corrections do not result in any change to the total assets, total liabilities or stockholders’ equity on the consolidated balance sheet, nor do they result in any change to the consolidated statement of operations for the three and nine months ended September 30, 2003 or consolidated statement of cash flows for the nine months ended September 30, 2003.

	September 30, 2003 (As Restated)			September 30, 2003 (As Previously Reported)
5.45% Convertible Notes due 2007, net of debt discount	$	74,685		$	94,952
Debt discount	$	(23,278	)	$	(3,011	)
Derivative liability	$	23,278		$	3,011

Note 11. Acquisition

ASIC Design Services, Inc.

On August 18, 2003, the Company acquired ASIC Design Services, Inc. (ADS) located in Massachusetts, which is developing a product for existing and next generation SONET/SDH and data communications switching solutions. As a result of this acquisition, the Company acquired all intellectual property of ADS and is using this intellectual property to develop next generation SONET/SDH products. The Company paid $0.5 million, which consisted of approximately $0.3 million in cash (which was used to extinguish ADS’s liabilities) and $0.2 million in common stock for the outstanding shares of stock in ADS. The Company incurred transaction fees of approximately $0.1 million in conjunction with this purchase.

The results of operations of ADS have been included in the Company’s consolidated financial results beginning on August 18, 2003, the date of acquisition, and all significant intercompany balances have been eliminated. The acquisition was accounted for under the purchase method of accounting for business combinations. ADS is a wholly owned subsidiary of TranSwitch.

The Company is still in the process of reviewing its preliminary purchase price and its allocation and will make adjustments, as appropriate, in future periods.

14

TRANSWITCH CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements–Continued

(Tabular dollars in thousands, except per share amounts)

The interim purchase price of and investment in ADS has been allocated, on a preliminary basis, in the Company’s unaudited interim consolidated financial statements as shown in the following table:

Purchased in-process research and development	$	476
Cash		19
Other current assets and software licenses		173
Accrued liabilities		(26	)
Investment In ADS	$	642

Purchased in-process research and development

At the time of acquisition, ADS had one project that qualified for in-process research and development activities, which is referred to as the VTXP chip. The project was started concurrently with ADS’s inception in 2002 and is scheduled for its first release during 2004.

The $0.5 million allocated to in-process research and development (“IPR&D”) was determined through an independent valuation using established valuation techniques in the telecommunications and data communications industries. The value allocated to IPR&D was based upon the forecasted operating after-tax cash flows from the technology acquired, giving effect to the stage of completion at the acquisition date. Future cash flows were adjusted for the value contributed by any core technology and development efforts expected to be completed post acquisition. These forecasted cash flows were then discounted at rates commensurate with the risks involved in completing the acquired technologies taking into consideration the characteristics and applications of each product, the inherent uncertainties in achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets. A project’s risk is the highest at its inception. As the project progresses, the risk of a project generally decreases. As of the acquisition date, the VTXP chip was still in its initial stages of development. After considering these factors, the risk-adjusted discount rates for the VTXP chip product was determined to be 50%. The acquired technology that had not yet reached technological feasibility, and for which no alternative future uses existed, it was expensed upon acquisition in accordance with FASB issued Statement No. 2, “Accounting for Research and Development Costs.”

Proforma financial information

Pro forma results of operations for ADS have not been presented because the effects of this acquisition are not material to the unaudited interim consolidated financial statements.

15

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

Management’s Discussion and Analysis of Financial Conditions and Results of Operations (MD&A) is provided as a supplement to the accompanying unaudited interim consolidated financial statements and footnotes to help provide an understanding of our financial condition, changes in our financial condition and results of operations. The MD&A is organized as follows:

Caution concerning forward-looking statements. This section discusses how forward-looking statements made by us throughout the MD&A are based on management’s present expectations about future events and are inherently susceptible to uncertainty and changes in circumstances.

Overview. This section provides a general description of our business and where investors can find additional information.

Critical accounting policies and use of estimates. This section discusses those accounting policies that are both considered important to our financial condition and operating results and require significant judgment and estimates on the part of management in their application.

Results of operations. This section provides an analysis of our results of operations for the three and nine months ended September 30, 2003 and 2002, respectively. In addition, a brief description is provided of transactions and events that impact the comparability of the results being analyzed.

Liquidity and capital resources. This section provides an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements. In this section, we also summarize commitments and significant contractual obligations and recent accounting pronouncements.

Factors that may affect future results. In this section, we detail risk factors that affect our quarterly and annual results, but which are difficult to predict.

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

Management’s Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements that involve risks and uncertainties. When used in this report, the words, “intend”, “anticipate”, “believe”, “estimate”, “plan”, “expect” and similar expressions, as they relate to us, are included to identify forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of factors, including those set forth under “FACTORS THAT MAY AFFECT FUTURE RESULTS” and elsewhere in this report. You should read this discussion in conjunction with the unaudited interim consolidated financial statements and the notes thereto included in this report.

OVERVIEW

We are a Delaware corporation incorporated on April 26, 1988. We design, develop and market highly integrated semiconductor devices that provide core functionality in voice and data communications network equipment deployed in the global network infrastructure. In addition to their high degree of functionality, our products incorporate digital and mixed-signal (analog and digital) processing capabilities, providing comprehensive system-on-a-chip (SOC) solutions to our customers.

Our products are compliant with all of the relevant network standards including Asynchronous/Plesiochronous Digital Hierarchy (Asynchronous/PDH), Synchronous Optical Network/Synchronous Digital Hierarchy (SONET/SDH) and Asynchronous Transfer Mode/Internet Protocol (ATM/IP). We offer several products that combine multi-protocol capabilities on a single chip, enabling our customers to develop network equipment for multi-service (voice, data and video) applications. A key attribute of our products is their inherent flexibility. Many of our products incorporate embedded programmable processors, enabling us to rapidly accommodate new customer requirements or evolving network standards.

We bring value to our customers through our communications systems expertise, VLSI design skills and commitment to excellence in customer support. Our innovative skills and technical capabilities enable us to define and develop products that permit our customers to achieve faster time-to-market and to produce communications systems that offer a host of benefits such as greater functionality, improved performance, lower power dissipation, reduced system size and cost, and greater reliability.

Available Information

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports will be made available free of charge through the Investor Relations section of the Company’s Internet website (http://www.transwitch.com) as soon as practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. Material contained on our website is not incorporated by reference in this report. Our executive offices are located at Three Enterprise Drive, Shelton, CT 06484.

16

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

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

We consider the most critical accounting policies and uses of estimates in our consolidated financial statements to be those surrounding:

(1) Revenues, cost of revenues and gross profit;

(2) Estimated excess inventories;

(3) Valuation of deferred tax assets;

(4) Estimated restructuring reserves; and

(5) Valuation of investments in non-publicly traded companies.

These accounting policies, the basis for these estimates and their potential impact to our consolidated financial statements, should any of these estimates change, are further described as follows:

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

At the time of shipment, we record an expense (and related liability) against our gross product revenues for future price protection and sales allowances. This liability is established based on historical experience, contractually agreed to provisions and future shipment forecasts. We had established liabilities totaling $0.6 million and $1.0 million as of September 30, 2003 and December 31, 2002, respectively, for price protection and sales allowances related to shipments that were recorded as revenue during the preceding 12 months. Should our actual experience differ from our estimated liabilities, there could be adjustments (either favorable or unfavorable) to our net revenues, cost of revenues and gross profits.

We also record, at the time of shipment, an expense (and related liability) against our gross product revenues and an inventory asset against product cost of revenues, in order to establish a provision for the gross margin related to future returns under our distributor stock rotation program. Under our distributor stock rotation program, we have entered into sales agreements with certain distributors that provide for semi-annual inventory rotation. These agreements permit the distributors to rotate to us, on a semi-annual basis, a contractually agreed to percentage of their previous six-month inventory purchases (typically up to 10% or 25% depending on the agreement). In order for the rotation to occur: (i) the product returned must be free of defects or damage and in merchantable condition; (ii) a distributor must order a quantity of products, the value of which at least equals the value of the returned product shippable within the same quarter the returned product is accepted and received; (iii) prior to returning any product, the distributor receives a return authorization from TranSwitch; and (iv) all freight costs to return the product to TranSwitch are borne by the distributor. As of September 30, 2003, we had established a liability of $0.4 million and an inventory asset of $0.2 million for a stock rotation reserve, for future estimated returns totaling $0.2 million. This compares to a liability of $0.5 million and an inventory asset of $0.25 million for a stock rotation reserve, for future estimated returns totaling $0.25 million as of December 31, 2002. Should our actual experience differ from our estimated liabilities, there could be adjustments (either favorable or unfavorable) to our net revenues, cost of revenues and gross profits.

17

We warranty our products for up to one year from the date of shipment. A liability is recorded for estimated claims to be incurred under product warranties and is based primarily on historical experience. Estimated warranty expense is recorded as cost of product revenues when products are shipped. As of September 30, 2003 and December 31, 2002, we had a warranty liability established in the amounts of $0.2 million and $0.2 million, respectively, which is included in accrued expenses on the consolidated balance sheets. We had no material warranty claims during the period ended September 30, 2003. Should future warranty claims differ from our estimated current liability, there could be adjustments (either favorable or unfavorable) to our cost of revenues. Any adjustments to cost of revenues could also impact future gross profits.

Estimated Excess Inventories. We periodically review our inventory levels to determine if inventory is stated at the lower of cost or net realizable value. The telecommunications and data communications industries have experienced a significant downturn during the past few years and, as a result, we have had to evaluate our inventory position based on known backlog of orders, projected sales and marketing forecasts, shipment activity and inventory held at our significant distributors. During the second quarter of 2003, as a result of current and anticipated business conditions, as well as lower than anticipated demand, we recorded a charge for excess inventories of approximately $1.5 million. We also recorded excess inventory charges totaling $4.8 million in fiscal 2002 and $39.2 million in fiscal 2001. These charges are attributable to severe industry conditions whereby the Company and other telecommunication equipment providers experienced a significant decline in demand for products and customer cancellations of orders. Based on our assessment, we concluded that there was no foreseeable demand for this excess inventory and, as a result, wrote down this excess inventory to a new cost basis of zero. Most of these products have not been disposed of and remain in inventory.

We recorded net product revenues of approximately $5.3 million and $3.6 million on the sale of products that included shipments of excess inventory that had previously been written down to their estimated net realizable value of zero for the three months ended September 30, 2003 and 2002, respectively. This resulted in gross margins of approximately 72% and (76%) (including the effect of the charge for excess inventories of $4.8 million) on these product revenues. Had these products been sold at our historical average cost basis, a 61% and 52% gross margin would have been recorded on these product shipments for the three months ended September 30, 2003 and 2002, respectively. We currently do not anticipate that a significant amount of the excess inventories subject to the write-downs described above will be used in the future based upon our current demand forecast. Should actual future demand exceed the estimates that we used in writing down our excess inventories, we will recognize a favorable impact to cost of revenues and gross profits. Should demand fall below our current expectations, we may record additional inventory write-downs which will result in a negative impact to cost of revenues and gross profits.

Valuation of Deferred Tax Assets. Income taxes are accounted for under the asset and liability method. Deferred income tax assets or liabilities are recognized when differences exist between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating losses and tax credit carry forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date.

We continually evaluate our deferred income tax assets as to whether it is “more likely than not” that the deferred tax assets will be realized. In assessing the realizability of our deferred tax assets, we consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies. Based on this assessment, we believe that significant uncertainty exists surrounding the recoverability of the deferred tax assets and we accordingly maintain a valuation allowance for all of our net deferred tax assets.

Estimated Restructuring Reserves. During the nine months ended September 30, 2003, we have recorded restructuring charges and asset impairments totaling $3.1 million related to employee termination benefits and costs to exit certain facilities, net of sub-lease benefits. We also recorded restructuring charges and asset impairments totaling $3.9 million and $32.5 million in the years ended December 31, 2002 and 2001, respectively. At September 30, 2003, the restructuring liabilities that remain total $25.1 million on our consolidated balance sheets, compared to $27.5 million as of December 31, 2002. The decrease of $2.4 million during the nine months ended September 30, 2003 was related to cash payments for severance and lease costs on excess facilities and a non-cash reduction to the remaining restructuring liability as we entered into new sub-lease arrangements with third parties to rent a portion of our excess space, offset by the restructuring charges and adjustments taken in the first, second and third quarters of fiscal 2003. Management used certain assumptions to derive this estimate, including future maintenance costs, price escalation and sublease income derived from these facilities. Should we negotiate additional sublease rental income agreements or reach a settlement with our lessors to be released from our existing obligations, we could realize a favorable benefit to our results of future operations. Should future lease, maintenance or other costs related to these facilities exceed our estimates, we could incur additional expenses in future periods.

18

Valuation of Investments in Non-Publicly Traded Companies. Since 1999, we have been making strategic debt and equity investments in non-publicly traded companies that develop technologies that are complementary to our product road map. We consider the provisions of FIN No. 46 “Consolidation of Variable Interest Entities (FIN 46), as amended, as it relates to investments in entities formed subsequent to February 1, 2003 to determine if consolidation is appropriate. If we conclude that consolidation of the investment is not appropriate, then we evaluate each investment based on our level of ownership and whether or not we have the ability to exercise significant influence over the investee company. As a result of this evaluation, we then account for these investments through either the cost or equity method. These investments are reviewed periodically for impairment. The appropriate reductions in carrying values are recorded when, and if, necessary. The process of assessing whether a particular investment’s net realizable value is less than its carrying cost requires a significant amount of judgment. In making this judgment, we carefully consider the investee’s cash position, projected cash flows (both short and long-term), financing needs, most recent valuation data, the current investing environment, management / ownership changes and competition. This evaluation process is based on information that we request from these privately held companies. This information is not subject to the same disclosure and audit requirements as the reports required of U.S. public companies, and as such, the reliability and accuracy of the data may vary. Based on our evaluations, we recorded impairment charges related to our investments in non-publicly traded companies of $0.05 million during the nine months ended September 30, 2003 and $8.7 million during the year ended December 31, 2002. We used the modified equity method of accounting to determine the impairment loss for certain investments accounted for under the cost method. It was determined that no better current evidence of the value for our cost method investments existed and we believe that this gives us the best basis for our estimate given the negative cash flows of these companies. The modified equity method of accounting results in recording an impairment loss for a cost method investment equal to the investor’s proportionate share of the investee’s losses. The impairment loss approximates, from the inception of the investor’s investment, the proportionate reduction in the investor’s contributed capital as it is consumed to fund operating losses of the investee company.

The total investment in non-publicly traded companies was $1.4 million and $2.0 million as of September 30, 2003 and December 31, 2002, respectively on the consolidated balance sheets. During the three months ended March 31, 2003, the Company liquidated its limited partnership investment in GTV Capital, Inc. and received a cash payment of approximately $0.9 million, representing a return of capital. Refer also to Note 7—Investments in Non-Publicly Traded Companies in our unaudited interim consolidated financial statements for additional details.

19

RESULTS OF OPERATIONS

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2003		2002		2003		2002
Net revenues:
Product revenues	93	%	99	%	96	%	96	%
Service revenues	7	%	1	%	4	%	4	%
Total net revenues	100	%	100	%	100	%	100	%
Cost of revenues:
Product cost of revenues	26	%	44	%	27	%	32	%
Provision for excess inventories	—		132	%	9	%	37	%
Service cost of revenues	2	%	—		1	%	7	%
Total cost of revenues	28	%	176	%	38	%	76	%
Gross profit (loss)	72	%	(76	%)	62	%	24	%
Total operating expenses:
Research and development	187	%	382	%	191	%	311	%
Marketing and sales	49	%	93	%	50	%	77	%
General and administrative	24	%	44	%	25	%	45	%
Goodwill impairment	—		1,638	%	—		460	%
Restructuring (benefit)/charge and asset impairments	(15	%)	151	%	19	%	31	%
Purchased in-process research and development	8	%	—		3	%	15	%
Total operating expenses	254	%	2,308	%	288	%	940	%
Operating (loss)	(182	%)	(2,384	%)	(226	%)	(916	%)

Net Revenues

The following tables summarizes our net product revenue mix by product line for the three and nine months ended September 30, 2003 and 2002 (dollar amounts in thousands), respectively:

	Three Months Ended September 30, 2003				Three Months Ended September 30, 2002				Percentage Increase / (Decrease) in Product Revenues
	Product Revenues		Percent of Product Revenues		Product Revenues		Percent of Product Revenues
SONET/SDH	$	2,869	54	%	$	382	11	%	651	%
Asynchronous/PDH		874	17	%		919	25	%	(5	%)
ATM/IP		939	18	%		1,669	46	%	(44	%)
Multi Service/Switching		582	11	%		665	18	%	(13	%)
Total	$	5,264	100	%	$	3,635	100	%	45	%
	Nine Months Ended September 30, 2003				Nine Months Ended September 30, 2002				Percentage Increase / (Decrease) in Product Revenues
	Product Revenues		Percent of Product Revenues		Product Revenues		Percent of Product Revenues
SONET/SDH	$	5,727	36	%	$	3,951	32	%	45	%
Asynchronous/PDH		2,633	17	%		3,060	25	%	(13	%)
ATM/IP		6,167	39	%		4,673	37	%	32	%
Multi Service/Switching		1,183	8	%		746	6	%	59	%
Total	$	15,711	100	%	$	12,430	100	%	26	%

Net product revenues for the three and nine months ended September 30, 2003 increased by $1.6 million and $3.3 million from the comparable periods in 2002. This represents a 45% and 26% increase from the comparable three and nine months of the prior year. The increase in revenues for the three months ended September 30, 2003 is attributable primarily to our SONET/SDH product line and in particular, our products, L3M and OMNI-TP. This increase was offset by reduced shipments within the quarter primarily of our ASPEN devices. Revenues for the nine months ended September 30, 2003 increased primarily due to shipments of our ATM/IP products: ASPEN and CUBIT-Pro and our SONET/SDH products: SOT-3 and L3M. Given the lack of visibility in the current market, we cannot predict when, and to the extent that, historical revenue levels or product mix percentages will return, if at all.

20

Included in total net revenues were service revenues consisting principally of design services performed for third parties on a short-term contract basis. Service revenues for the three and nine months ended September 30, 2003 were $0.4 million and $0.7 million compared to $0.02 million and $0.6 million from the comparable periods in 2002. Service revenues are not our primary strategic focus and, as such, will fluctuate up or down from period to period, depending on business priorities.

International net revenues represented approximately 60% and 68% of net revenues for the three and nine months ended September 30, 2003, compared with approximately 66% and 54% of net revenues for the three and nine months ended September 30, 2002.

Gross Profit

The following tables present the impact to gross profit from the sale of previously written down inventory for the three and nine months ended September 30, 2003 and 2002, respectively:

	Three months ended September 30, 2003					Three months ended September 30, 2002
	Gross Profit $			Gross Profit %		Gross Profit $			Gross Profit %
Gross profit—as reported	$	4,073		72	%	$	(2,778	)	(76	%)
Excess inventory benefit (1)		(602	)	11	%		(182	)	(5	%)
Excess inventory charge (2)		—		—			4,832		133	%
Gross profit—as adjusted	$	3,471		61	%	$	1,872		52	%
	Nine months ended September 30, 2003					Nine months ended September 30, 2002
	Gross Profit $			Gross Profit %		Gross Profit $			Gross Profit %
Gross profit—as reported	$	10,167		62	%	$	3,182		24	%
Excess inventory benefit (1)		(2,948	)	(18	%)		(1,735	)	(13	%)
Excess inventory charge (2)		1,498		9	%		4,832		37	%
Gross profit—as adjusted	$	8,717		53	%	$	6,279		48	%

⁽¹⁾ We realized an excess inventory benefit from the sale of products that had previously been written down to a cost basis of zero. For the purpose of comparing the change in gross profit on net revenues, we are excluding this benefit and calculating gross profit on these product revenues as if they had been sold at their approximate historical average costs.

⁽²⁾ We recorded a charge for excess inventories during the respective period. For the purposes of comparing the change in gross profit on net revenues, we are excluding this charge and calculating gross profit on these product revenues as if they had been sold at their approximate historical average costs.

Total gross profit for the three months ended September 30, 2003 increased by $1.3 million, or 69%, from the comparable three months of the prior year. Total gross profit for the nine months ended September 30, 2003 increased by $2.4 million, or 38%, from the comparable nine months of the prior year. The increase in gross profit for the three and nine months ended September 30, 2003 is the result of changes in the product mix and lower inventory charges over the prior year. We do not believe that these quarterly fluctuations of our gross margins indicate a shift in our long-term expected margin trend, either positive or negative.

We anticipate that gross profit will continue to fluctuate due to the impact of product mix at current revenue levels and the continued impact of fixed cost absorption of our production operations.

Research and Development

Research and development expenses for the three and nine months ended September 30, 2003 decreased by $3.3 million and $9.1 million respectively, or 24% and 23% from the comparable three and nine months of the prior year. This decrease is due, in part, to the restructuring plans implemented in 2002 and 2003, which resulted in reduced headcount and space that lowered our compensation, benefit and facility costs. This decrease was offset by an increase in fabrication charges compared to the same period a year ago. We currently do not expect any significant changes in our salary and benefit costs in fiscal 2003. However, fabrication and other development costs will continue to fluctuate up and down as we complete the development cycle of several new products. As a percentage of total net revenues, our research and development costs decreased as we continue to lower these expenses and our revenues have increased from the prior periods.

We have monitored our known and forecasted sales demand and operating expense run rates closely and, as a result, have taken four restructuring actions since June of 2001. We will continue to closely monitor both our costs and our revenue expectations in

21

future periods and will take actions as market conditions dictate. There can be no assurances that future acquisitions, market conditions or unforeseen events will not cause our expenses to rise or fall in future periods.

Marketing and Sales

Marketing and sales expenses for the three and nine months ended September 30, 2003 decreased by $0.6 million and $1.9 million respectively, or 18% and 19%, from the comparable three and nine months of the prior year. This decrease in absolute dollars is due primarily to the restructuring plans implemented in 2002 and 2003, which resulted in reduced headcount and facility space that lowered our compensation, benefit and facility costs. As a percentage of total net revenues, our marketing and sales costs have decreased as we continue to lower these expenses and our revenues have increased from prior periods.

We have monitored our known and forecasted sales demand and operating expense run rates closely and, as a result, have taken four restructuring actions since June of 2001. We will continue to closely monitor both our costs and our revenue expectations in future periods and will take actions as market conditions dictate. There can be no assurances that future acquisitions, market conditions or unforeseen events will not cause our expenses to rise or fall in future periods.

General and Administrative

General and administrative expenses for the three and nine months ended September 30, 2003 decreased by $0.2 million and $1.7 million respectively, or 15% and 30%, from the comparable three and nine months of the prior year. This decrease is due, in part, to the restructuring plans implemented in 2002 and 2003, which resulted in reduced headcount and facility space that lowered our compensation, benefit and facility costs. We also reduced our legal and professional fees, which were offset by higher insurance costs over the prior year. As a percentage of total net revenues, our general and administrative costs have decreased as we continue to lower these expenses and our revenues have increased from prior periods.

We have monitored our known and forecasted sales demand and operating expense run rates closely and, as a result, have taken four restructuring actions since June of 2001. We will continue to closely monitor both our costs and our revenue expectations in future periods and will take actions as market conditions dictate. There can be no assurances that future acquisitions, market conditions or unforeseen events will not cause our expenses to rise or fall in future periods.

Restructuring (Benefit) Charge and Asset Impairments

In January 2003, we announced a restructuring plan in order to lower our operating expense run-rate due to then current and anticipated business conditions. This plan resulted in a work-force reduction of approximately 25% of existing personnel. Also, we announced the closing of our South Brunswick, NJ (SOSi) design center, and the reduction of staff in Boston, MA and Shelton, CT. This workforce reduction also impacted our Switzerland and Belgium locations. In addition, we have postponed the completion of the IAD product line and archived the related intellectual property until that market returns, if ever. During the three months ended September 30, 2003, we incurred approximately $0.9 million in restructuring benefit as we leased a portion of our excess facilities. During the nine months ended September 30, 2003, we incurred approximately $3.4 million in restructuring expenses related to employee termination benefits and $0.5 million related to excess facility costs. In addition, we recorded a charge for fixed assets that were impaired with a net book value totaling $0.3 and a patent on our IAD product line with a net book value of $0.2 million. This resulted in a total restructuring and asset impairment charge for the nine months ended September 30, 2003 totaling $4.3 million. This restructuring charge was partially off set by a benefit of $1.2 million realized, as we were able to sub-lease portions of our excess facilities, for a net restructuring expense for the nine months ended September 30, 2003 of $3.1 million. We do not anticipate any significant additional charges related to employee termination benefits. We estimate that there will be future adjustments to our liability for future lease payments as market conditions change. We estimate future operating expense savings related to this plan to be approximately $8.3 million of personnel costs and $0.3 million of facility costs for total annual savings of approximately $8.6 million. However, there can be no assurances that future events will not cause the actual savings to rise or fall in future periods.

Purchased In-Process Research and Development

During the three months ended September 30, 2003, we recorded a charge for purchased in-process research and development (“IPR&D”) of $0.5 million related to the purchase of ASIC Design, Inc. There were no charges for IPR&D in the same period of the prior year. During the nine months ended September 30, 2003 and 2002, we recorded a charge for purchased IPR&D of $0.5 and $2.0 million related to our purchase of ADS and SOSi (in March of 2002), respectively.

At the time of acquisition, ADS had one project that qualified for IPR&D activities, which is referred to as the VTXP chip. The project was started concurrently with ADS’s inception in 2002 and is scheduled for its first release during 2004.

22

The $0.5 million allocated to IPR&D was determined through an independent valuation using established valuation techniques in the telecommunications and data communications industries. The value allocated to IPR&D was based upon the forecasted operating after-tax cash flows from the technology acquired, giving effect to the stage of completion at the acquisition date. Future cash flows were adjusted for the value contributed by any core technology and development efforts expected to be completed post acquisition. These forecasted cash flows were then discounted at rates commensurate with the risks involved in completing the acquired technologies, taking into consideration the characteristics and applications of each product, the inherent uncertainties in achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets. A project’s risk is the highest at its inception. As the project progresses, the risk of a project generally decreases. As of the acquisition date, the VTXP chip was still in its initial stages of development. After considering these factors, the risk-adjusted discount rates for the VTXP chip product was determined to be 50%. As this acquired technology had not yet reached technological feasibility and for which no alternative future uses existed, it was expensed upon acquisition in accordance with FASB issued Statement No. 2, “Accounting for Research and Development Costs.”

Impairment of Investments in Non-Publicly Traded Companies

In February 2003, we made a convertible bridge loan investment in IC4IC totaling $0.05 million. In March 2003, this investment was impaired, as IC4IC was not able to raise sufficient equity or debt to fund its operations. During early April 2003, IC4IC’s Board of Directors made the decision to discontinue operations.

Equity in Net Losses of Affiliates

We account for our investments in OptiX Networks, Inc. (OptiX), and GTV Capital, L.P. (GTV) under the equity method of accounting whereby our pro-rata share of the net income or losses from these investee companies are recorded on the consolidated statements of operations and, accordingly, the carrying value of the investments is reduced on the consolidated balance sheets. During the first quarter of 2003, we received the remaining balance of our investment in GTV of approximately $0.9 million, which represented a return of capital. As of March 31, 2003, we no longer had an investment in GTV.

Prior to June 30, 2002, we had been accounting for our investment in OptiX under the cost method. However, during the third quarter of fiscal 2002, in connection with a bridge loan of $4.0 million which is convertible to convertible preferred stock upon OptiX closing its anticipated round of financing, we obtained the ability to exercise significant influence over the financial and operating policies of OptiX. Therefore, we now account for our investment in OptiX under the equity method of accounting. All prior period financial information has been retroactively restated to reflect this change in reporting entity.

Our pro-rata share of equity losses were $0.6 million and $1.4 million for the three and nine months ended September 30, 2003 compared to $0.7 million and $1.8 million for the three and nine months ended September 30, 2002, respectively. Equity losses in GTV ceased after the first quarter of 2003 with the return of our remaining capital from this venture capital limited partnership. The decrease in equity losses is due to lower overall operating expenses at OptiX in fiscal 2003 compared to the same period in 2002. Equity in net losses of affiliates will continue to be a component of our other income (expense) in future periods and amounts will fluctuate depending primarily on the business results of OptiX.

Gain on the Exchange and Repurchase of our 4.50% Convertible Notes due 2005

We did not repurchase any of our notes during the three and nine months ended September 30, 2003. However, on September 30, 2003, we completed our exchange offer with and new money offering to the holders of our 4.50% Convertible Notes due 2005 (4.50% Notes). We issued $98.0 million aggregate principal amount of 5.45% Convertible Plus Cash Notes_SM due September 30, 2007 (Plus Cash Notes), which represented $74.0 million of Plus Cash Notes issued in exchange for $89.7 million in principal amount of its 4.50% Notes tendered in the exchange offer and $24.0 million of Plus Cash Notes sold for cash. We recorded a gain on the exchange of approximately $14.5 million, which is calculated as follows:

Carrying value of 4.50% Notes exchanged	$	89,671
Less: deferred financing fees		1,245
Net carrying value of 4.50% Notes		88,426
Less: fair value of Plus Cash Notes issued on exchange		73,963
Gain on exchange	$	14,463

In the three months ended March 31, 2002, we repurchased, through a tender offer, approximately $199.9 million face value of our outstanding 4.50% Notes for a cash payment of $139.9 million. This resulted in a gain of $52.0 million, net of transaction costs, $4.8 million in deferred financing fees related to these notes and approximately $19.5 million recorded as income tax expense during the three months ended March 31, 2002. Prior to fiscal year 2003, this gain had been classified as extraordinary on the consolidated statement of operations. However, we adopted SFAS No. 145 “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” effective January 1, 2003, which requires gains from the extinguishment of debt

23

to be included in results from continuing operations. Accordingly, we have reclassified the gains on the early extinguishment of debt and the related deferred financing fees and income taxes that were previously recorded in the consolidated statements of operations as an extraordinary item to other (expense) income and income tax expense, respectively.

Interest Income (Expense)

Interest expense, net for the three months ended September 30, 2003 increased by $0.8 million compared to the three months ended September 30, 2002. This increase for the three months ended September 30, 2003 is due to lower interest income, as a result of a lower average cash balance and declining interest rates, in which to offset interest expense during the third quarter of fiscal 2003 compared to the third quarter of fiscal 2002.

Interest expense, net for the nine months ended September 30, 2003 was $2.3 million compared to $1.5 million for the nine months ended September 30, 2002. This increase for the nine months ended September 30, 2003 is due to lower interest income, as a result of a lower average cash balance and declining interest rates, in which to offset interest expense during the nine months of fiscal 2003 compared to the nine months of fiscal 2002.

At September 30, 2003 and 2002, the effective interest rate on our interest-bearing securities was approximately 1.3% and 2.5%, respectively.

Income Tax Expense

For the three months ended September 30, 2003 and 2002, the income tax expense was $0.1 million and $61.5 million, respectively. During the three months ended September 30, 2002 we evaluated and determined that it was not “more likely than not” that all of the deferred tax assets will be realized. Accordingly, a valuation reserve was recorded against all of our net deferred tax assets, which accounted for the decrease between the 2002 and 2003 quarterly periods. We have not or will not recognize a deferred tax benefit until the business achieves sustained profitability. We have and expect to continue to maintain a deferred tax valuation allowance. We expect to continue to incur foreign income tax expenses on our consolidated statements of operations in future periods

For the nine months ended September 30, 2003 and 2002, the income tax expense was $0.3 and $69.2 million respectively. The decrease for the nine month period from the prior year is due primarily to the Company recording a valuation allowance against all of our net deferred tax assets in 2002.

Extraordinary Loss Upon Consolidation of TeraOp (USA), Inc.

In January 2003, FIN No. 46 “Consolidation of Variable Interest Entities “ (FIN 46) was issued. The interpretation provides guidance on consolidating variable interest entities and applies to all variable interests in variable interest entities created after January 31, 2003. The interpretation requires variable interest entities to be consolidated if the equity investment at risk is not sufficient to permit an entity to finance its activities without support from other parties or if the equity investors lack certain specified characteristics. We applied the provisions of FIN 46 to our investment in TeraOp (USA), Inc. (TeraOp) as of February 1, 2003, which required us to consolidate the results of TeraOp.

During the first quarter 2003, we loaned TeraOp $0.5 million under a new convertible loan agreement, which provides us with additional contractual rights over existing debt or equity investors. In addition, we are also in a position, as a result of the loan, to negotiate a more favorable conversion price of the equity securities of TeraOp and have the ability to control the operations of TeraOp. None of the existing debt or equity investors, other than us, is expected to, or is obligated to, absorb any additional losses from their investment given that the equity in TeraOp was negative as of January 31, 2003. As a result, the convertible loan has been determined to be a variable interest and TeraOp is now considered a variable interest entity, as defined by FIN 46. We have calculated the effect of the initial measurement as of January 31, 2003. As a result of this measurement and consolidation of TeraOp, we recognized an extraordinary loss of approximately $0.1 million, as the fair value of TeraOp’s liabilities exceeded its assets by this amount. All significant intercompany balances, including our investments in TeraOp, have been eliminated upon consolidation.

Cumulative Effect on Prior Years of Retroactive Application of New Depreciation Method

Effective January 1, 2003, we changed the method of depreciating property and equipment to the straight-line method. Depreciation of property and equipment in prior years was computed using the half-year convention method. We evaluated the use and related consumption of all classes of acquired property and equipment and have determined that many of our assets are used and consumed on a consistent level over their estimated economic lives. Under the half-year convention method, property and equipment placed in service during the first year of acquisition was subject to six months of depreciation expense regardless of when the asset was acquired, placed in service and consumed. We believe that the straight-line method results in a better approximation of the

24

underlying consumption of the asset over its estimated useful life and provides a better matching of revenues and expenses. The effect of the change in depreciation method as of January 1, 2003 was applied retroactively to property and equipment acquisitions of prior years. The cumulative effect of the change with respect to the retroactive application of the straight-line method is approximately an $0.8 million charge and has been recorded as such on the consolidated statement of operations for the period ended March 31, 2003. This charge has not been presented net of an income tax benefit as we continue to maintain a full valuation allowance against our net deferred income tax assets. There were no such charges during the quarter ended September 30, 2003 or in the comparable three and nine month periods of the prior year.

25

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2003, we had total cash, cash equivalents and marketable securities of approximately $189.0 million. We continue to invest in new product development and, as such, we are not currently generating positive cash flow from our operations. Our cash, cash equivalents and marketable securities are our primary source of liquidity.

Cash, Cash Equivalents and Investments

We have financed our operations and have met our capital requirements since incorporation in 1988 primarily through private and public issuances of equity securities, convertible notes, bank borrowings and cash generated from operations. Our principal sources of liquidity as of September 30, 2003 consisted of $143.2 million in cash and cash equivalents, $30.5 million in short-term investments and $15.3 million in long-term investments in marketable securities for a total cash and investment balance of $189.0 million. Cash equivalents are instruments with maturities of less than 90 days, short-term investments have maturities of greater then 90 days but less than one year and long-term investments have maturities of greater than one year. Our cash equivalents and short-term and long-term investments consist of U.S. Treasury Bills, corporate bonds, asset-backed obligations, taxable municipal securities, money market instruments and overnight repurchase investments.

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

Cash Inflows and Outflows

During the nine months ended September 30, 2003, the net decrease in cash and cash equivalents and short and long-term investments was $16.4 million compared with a net decrease of $215.6 million during the nine months ended September 30, 2002. We used a total of $7.3 million of cash and cash equivalents during the nine months ended September 30, 2003 as well as $9.1 million of matured short and long-term investments.

As reported on our consolidated statements of cash flows, our decrease in cash and cash equivalents during the nine months ended September 30, 2003 and 2002 is summarized as follows (in thousands):

	Nine Months ended September 30,
	2003			2002
Net cash used in operating activities	$	(34,484	)	$	(55,012	)
Net cash provided by investing activities		6,949			3,843
Net cash provided by (used in) financing activities		19,892			(142,549	)
Effect of foreign exchange rate changes		310			224
Total decrease in cash and cash equivalents	$	(7,333	)	$	(193,494	)

Details of our cash inflows and outflows are as follows for the nine months ended September 30, 2003 and 2002:

Operating Activities: During the nine months ended September 30, 2003, we used $34.5 million in cash, which consists principally of our net loss for the period of approximately $27.4 million, offset by non-cash adjustments of $1.6 million, plus net restructuring payments of $1.5 million and working capital usage of approximately $4.0 million. This compares to an operating cash usage of $55.0 million during the nine months ended September 30, 2002. We have reduced our operating cash usage by lowering overall operating expenses through workforce reductions and facility closings.

Investing Activities: During the nine months ended September 30, 2003, we generated approximately $6.9 million from investing activities. This compares to cash generated from investing activities of $3.8 million during the nine months ended September 30, 2002. The net cash generated was primarily due to the net proceeds (investments matured were greater than investments purchased) of held-to-maturity short and long-term investments totaling $9.1 million partially offset by capital expenditures and net investments in non-publicly traded companies. Capital expenditures for the nine months ended September 30, 2003 were approximately $1.3 million compared to $8.8 million in the comparable nine months of the prior year as we have significantly scaled back our capital spending along with reducing facilities and the size of our work force. Finally, during the nine months ended September 30, 2003, we made investments in non-publicly traded companies of approximately $1.4 million versus $3.7 million during the nine months ended September 30, 2002. These investments were partially offset by a cash inflow of $0.9 million as we liquidated our limited partnership investment in GTV Capital, Inc. during the period.

Financing Activities: During the nine months ended September 30, 2003, we generated $19.9 million in financing activities, which consisted primarily of the proceeds from the issuance of our 5.45% Convertible Plus Cash Notes due 2007 of $24.0

26

million offset by $4.4 million of deferred financing fees. This compares with a use of approximately $142.6 million in the prior year, which was related to the repurchase of our 4.50% Convertible Notes due 2005.

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

Commitments and Significant Contractual Obligations

We have existing commitments to make future interest payments on our existing 4.50% Convertible Notes due 2005 (the 4.50% Notes) and to redeem these notes in September 2005. We also have commitments to make future interest payments on our 5.45% Convertible Plus Cash Notes due 2007 (the Plus Cash Notes) and to redeem these notes in September 2007. Over the remaining life of the outstanding notes, we expect to accrue and pay approximately $23.6 million in interest to the holders of both the 4.50% Notes and the Plus Cash Notes.

We have outstanding operating lease commitments of approximately $47.9 million payable through 2017. Some of these commitments are for space that is not being utilized and, as a result, we have recorded restructuring charges for excess facilities. As of September 30, 2003, we have in place sublease agreements totaling $11.9 million to rent portions of our excess facilities generally over the next seven years. We are in the process of trying to sublease additional excess space but it is unlikely that any sublease income generated will offset the entire future commitment. We currently believe that we can fund these lease commitments in the future. However, there can be no assurances that we will not be required to seek additional capital or provide additional guarantees or collateral on these obligations. A summary of our significant future contractual obligations as September 30, 2003 and their payments by fiscal year is summarized as follows (in thousands):

	Total		Payments Due by Period
Contractual Obligations			Less than 1 Year		1–3 Years		3–5 Years		More than 5 Years
Interest on convertible notes	$	23,556	$	6,439	$	11,778	$	5,339	$	—
Redemption of convertible notes		122,405		—		24,442		97,963		—
Operating lease commitments		47,887		5,169		9,021		7,397		26,300
Capital lease and other commitments (principal and interest)		847		259		220		368		—
	$	194,695	$	11,867	$	45,461	$	111,067	$	26,300

We also have pledged approximately $1.2 million in available cash and cash equivalents as collateral for stand-by letters of credit that guarantee certain long-term property lease obligations.

Recent Accounting Pronouncements

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (SFAS 145). As it applies to the Company, SFAS 145 requires that certain gains and losses on extinguishments of debt be classified as income or loss from continuing operations, rather than as extraordinary items, as previously required under SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt” (SFAS 4). The Company adopted SFAS 145 effective January 1, 2003 and, accordingly, reclassified the gain on the early extinguishment of its debt, which included the related transaction fees, deferred financing fees and income taxes which was previously recorded in the consolidated statement of operations as an extraordinary item to other income (expense) and income tax expense, respectively.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). The effect of SFAS 146 is to spread out the reporting of expenses related to restructurings initiated after 2002, because commitment to a plan to exit an activity or dispose of long-lived assets is no longer sufficient to record a liability for the anticipated costs. Instead, companies are to record exit and disposal costs when they are “incurred” and can be measured at fair value, and they will subsequently adjust the recorded liability for changes in estimated cash flows. The provisions of SFAS 146 are effective for exit and disposal activities that are initiated after December 31, 2002. In conjunction with the January 2003 restructuring plan, the Company has applied the provisions of SFAS 146. Refer also to Note 6—Restructuring Liabilities for further details on the January 2003 restructuring plan.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (SFAS 148). SFAS 148 amends SFAS No. 123 “Accounting for Stock-Based Compensation” (SFAS 123) to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The additional disclosure requirements of SFAS 148 are effective for fiscal years ending after December 15, 2002. The Company has elected to continue to follow the intrinsic value method of accounting as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). The Company has complied with the disclosure requirements of SFAS 148 in the “Stock Based Compensation” paragraph above.

27

In January 2003, FIN No. 46, “Consolidation of Variable Interest Entities” (FIN 46) was issued. The interpretation provides guidance on consolidating variable interest entities and applies immediately to variable interests in variable interest entities created after January 31, 2003. The guidelines of the interpretation will become applicable for the Company as of December 31, 2003 for variable interest entities created before February 1, 2003, as the Financial Accounting Standards Board has issued a staff position delaying the effective date of the FIN 46 for public companies. The interpretation requires variable interest entities to be consolidated if the equity investment at risk is not sufficient to permit an entity to finance its activities without support from other parties or the equity investors lack certain specified characteristics. The Company applied the provisions of FIN 46 as of February 1, 2003, for its investment in TeraOp (USA), Inc. (TeraOp), which resulted in the Company consolidating the results of TeraOp (USA), Inc. Refer also to Note 7—Investments in Non-Publicly Traded Companies for further details.

On April 30, 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149). SFAS 149 amends and clarifies accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). SFAS 149 is effective for contracts entered into or modified after June 30, 2003. The Company adopted SFAS 149 beginning in the third quarter of 2003. The adoption of SFAS 149 did not have a material impact on the Company’s financial position, cash flows or results of operations.

On May 15, 2003 the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (SFAS 150). SFAS 150 requires that an issuer classify financial instruments that are within its scope as a liability (or as an asset in some circumstances). Many of those instruments were classified as equity under previous guidance. Most of the guidance in SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted SFAS 150 beginning in the third quarter of 2003. The adoption of SFAS 150 did not have a material impact on the Company’s financial position, cash flows or results of operations.

FACTORS THAT MAY AFFECT FUTURE RESULTS

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

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

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

There has been a significant decline in our net revenues.

Our net revenues have declined substantially during the past two years. Net revenues for the years ended December 31, 2002 and 2001 were $16.6 million and $58.7 million, respectively. Our net revenues recorded during the three and nine months ended September 30, 2003 were $5.7 million and $16.4 million, respectively. Due to current economic conditions and slowdowns in purchases of VLSI semiconductor devices, it has become increasingly difficult for us to predict the purchasing activities of our customers and we expect that our net revenues could fluctuate substantially in the future.

There has been a significant increase in our net losses.

Our net losses have increased substantially during the past two years. Net loss for the years ended December 31, 2002 and 2001 were $165.2 million and $79.4 million, respectively. Our net income (loss) recorded during the three and nine months ended September 30, 2003 were $2.6 million and $(27.4) million, respectively. Due to current economic conditions and a significant decline in our net revenues, we expect that our operating results will continue to fluctuate substantially in the future.

28

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

During the nine months ended September 30, 2003, we used $7.3 million of our available cash and cash equivalents to fund our operating, investing and financing activities and redeemed $9.1 million of short and long-term investments for a total cash and investment usage of $16.4 million.

During the year ended December 31, 2002, we used $219.7 million of our available cash and cash equivalents to fund our operating, investing and financing activities and redeemed $11.0 million of short and long-term investments for a total cash and investment usage of $230.7 million. This significant use of cash included approximately $143.2 million to repurchase some of our outstanding 4.50% Convertible Notes due 2005 (including transaction fees) through a tender offer in March 2002.

We anticipate that we will use approximately $12 million to $14 million in cash, cash equivalents and investments during the fourth quarter of 2003 to fund our operating, investing and financing activities. We will continue to use our available cash, cash equivalents and investments in the future and we believe that we have sufficient cash for our needs for at least the next twelve months. We will continue to experience losses and use our cash, cash equivalents and investments if we do not receive sufficient product orders and our costs are not reduced to offset the decline in revenue.

We have substantial indebtedness and recently took steps to restructure this indebtedness by offering new convertible notes.

We currently have $24.4 million in principal amount of indebtedness outstanding in the form of our 4.50% Convertible Notes due September 2005 (the 4.50% Notes). On September 30, 2003, we exchanged $89.7 million of our 4.50% Notes for $74.0 million of our 5.45% Convertible Plus Cash Notes_SM due 2007 (the Plus Cash Notes) (the exchange offer). We also issued an additional $24.0 million of our Plus Cash Notes for cash (the new money offering).

In addition to this indebtedness, we may incur substantial additional indebtedness in the future. The level of our indebtedness, among other things, could:

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

• make it difficult for us to make payments on our 4.50% Notes or our Plus Cash Notes;

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

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

There can be no assurance that we will be able to meet our debt service obligations, including our obligations under the 4.50% Notes or the Plus Cash Notes. The terms of our Plus Cash Notes permit the holders thereof to voluntarily convert their notes at any time into a certain number of shares of our common stock and receive a certain amount in cash, which we refer to as the plus cash amount, and we have the option of settling this cash amount in additional shares of our common stock. These Plus Cash Notes also permit us to automatically convert some or all of the Plus Cash Notes subject to certain conditions. As a result of these shares of our common stock being issued upon voluntary or automatic conversion of the Plus Cash Notes our stockholders may experience substantial dilution of their ownership interest. In addition, we may not elect to settle the plus cash amount payable upon voluntary or automatic conversion in additional shares of our common stock, or we may be restricted from doing so pursuant to the terms of the Plus Cash Notes. If a significant percentage of our Plus Cash Notes are voluntarily or automatically converted, we may be required to use all or a significant portion of our available cash, which could have a material adverse effect on our business, prospects, financial condition and operating results.

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

If our cash, cash equivalents, short and long term investments and operating cash flows are inadequate to meet our obligations, we could face substantial liquidity problems. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments on the 4.50% Notes, the Plus Cash Notes or our other obligations, we would be in default under the terms thereof, which would permit the holders of the 4.50% Notes, the Plus Cash Notes and our other obligations to accelerate their maturities and which could also cause defaults under any future indebtedness we may incur. Any such default or cross default would have a material adverse effect on our business, prospects, financial condition and operating results. In addition, we cannot be sure that we would be able to repay amounts due in respect of the 4.50% Notes and the Plus Cash Notes if payment of those notes were to be accelerated following the occurrence of an event of default as defined in the respective indentures of the 4.50% Notes and Plus Cash Notes.

29

We may incur additional indebtedness, including secured indebtedness, which may have rights to payment superior to our 4.50% Notes and Plus Cash Notes.

Our 4.50% Notes and Plus Cash Notes are unsecured obligations. The terms of the 4.50% Notes and the Plus Cash Notes do not limit the amount of additional indebtedness, including secured indebtedness, that we can create, incur, assume or guarantee. Upon any distribution of our assets upon any insolvency, dissolution or reorganization, the payment of the principal of and interest on our secured indebtedness will be distributed out of our assets, which represent the security for such indebtedness. There may not be sufficient assets remaining to pay amounts due on any or all of the 4.50% Notes or the Plus Cash Notes then outstanding once payment of the principal and interest on our secured indebtedness has been made.

If we seek to secure additional financing we may not be able to do so. If we are able to secure additional financing our stockholders may experience dilution of their ownership interest or we may be subject to limitations on our operations.

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

If we are unable to generate sufficient cash flows from operations to meet our anticipated needs for working capital and capital expenditures, we may need to raise additional funds. If we raise additional funds through the issuance of equity securities, our stockholders may experience dilution of their ownership interest, and the newly issued securities may have rights superior to those of common stock. If we raise additional funds by issuing debt, we may be subject to limitations on our operations.

The terms of the Plus Cash Notes include voluntary and automatic conversion provisions upon which shares of our common stock would be issued, and would also permit us to satisfy certain interest and other payments with additional shares of our common stock. As a result of these shares of our common stock being issued our stockholders may experience substantial dilution of their ownership interest.

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

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

In response to anticipated long lead times to obtain inventory and materials from our foundries, we may order inventory and materials in advance of anticipated customer demand, which might result in excess inventory levels if the expected orders fail to materialize. As a result, we cannot predict the timing and amount of shipments to our customers, and any significant downturn in customer demand for our products would reduce our quarterly and our annual operating results. As a result of these conditions, during the nine months ended September 30, 2003 and for the years ended December 31, 2002 and 2001, we recorded write-downs for excess inventories totaling $1.5 million, $4.8 million and $39.2 million, respectively.

We may have to further restructure our business.

In January 2003, we announced a restructuring plan in order to lower our operating expense run-rate due to current and anticipated business conditions. This plan resulted in a work-force reduction of approximately 25% of existing personnel. Also, we announced the closing of our South Brunswick, NJ (SOSi) design center, and reduced staff in Boston, MA and Shelton, CT. This workforce reduction also impacted our Switzerland and Belgium locations. In addition, we have postponed the completion of the IAD product line and archived the related intellectual property until that market returns, if ever. During the nine months ended September 30, 2003, we incurred approximately $3.1 million in restructuring expenses related to employee termination benefits, excess facility costs and asset impairments.

During fiscal 2002, we announced a restructuring plan due to continued weakness in our business and the industry. As a result of this plan, we eliminated 56 positions and announced the closing of design centers in Milpitas, CA and Raleigh, NC. In conjunction with this restructuring, we discontinued certain product lines and strategically refocused our research and development efforts. As a result of this plan, we incurred restructuring charges and asset impairments of approximately $5.5 million.

During fiscal 2001, we announced restructuring plans as a result of then current and anticipated business conditions. As a result of those plans, we incurred restructuring charges and asset impairments of approximately $32.5 million related to workforce reductions of 77 positions throughout our Company and the related consolidation of several of our leased facilities.

30

We cannot be sure that these measures will be sufficient to offset lower total net revenues, and if they are not, further measures will be required and our operating results will be adversely affected.

Our board of directors may elect to exercise its discretion to effect a reverse stock split. There are risks and uncertainties inherent in a reverse stock split.

By resolution approved by our stockholders at the annual meeting of stockholders held on May 22, 2003, our board of directors has the authority, in its sole discretion, to effect a reverse stock split of our common stock at any time prior to the date of our annual meeting of stockholders to be held in 2004 at a ratio between one for two and one for twenty as selected by the board of directors. In addition, notwithstanding approval of the reverse stock split by the stockholders, the board of directors may choose, in its sole discretion, not to effect the reverse stock split without further approval or action by or prior notice to the stockholders.

There can be no assurance that any increase in the market price for our common stock resulting from a reverse stock split, if implemented, will be sustainable since there are numerous factors and contingencies that would effect such price, including the market conditions for our common stock at the time, our reported results of operations in future periods and general economic, geopolitical, stock market and industry conditions. Accordingly, the total market capitalization of our common stock after a reverse stock split may be lower than the total market capitalization before such reverse stock split and, in the future, the market price of the common stock may not exceed or remain higher than the market price prior to such reverse stock split.

While a higher share price may help generate investor interest in our common stock, there can be no assurance that a reverse stock split will result in a per share market price that will attract institutional investors or investment funds or that such price will satisfy the investing guidelines of institutional investors or investment funds. As a result, the trading liquidity of our common stock may not necessarily improve as a result of the reverse stock split. Furthermore, the liquidity of our common stock could be adversely affected by the reduced number of shares of our common stock that would be outstanding after the reverse stock split.

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

Historically, a relatively small number of customers have accounted for a significant portion of our total net revenues in any particular period. For the quarter ended September 30, 2003, shipments to our top five customers, including sales to distributors, accounted for approximately 53% of our total net revenues. For the years ended December 31, 2002 and 2001, shipments to our top five customers, including sales to distributors, accounted for approximately 70% and 64% of our total net revenues, respectively. We expect that a limited number of customers may account for a substantial portion of our total net revenues for the foreseeable future. Some of the following may reduce our total net revenues or adversely affect our business:

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

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

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

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

We cannot be certain that our current customers will continue to place orders with us, that orders by existing customers will return to the levels of previous periods or that we will be able to obtain orders from new customers. We have no long-term volume purchase commitments from any of our significant customers.

The cyclical nature of the communication semiconductor industry affects our business and we are currently, and for the past two years have been, experiencing a significant downturn.

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

• diminished product demand;

• accelerated erosion of average selling prices; and

• production over-capacity.

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

31

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

Foreign markets are a significant part of our net revenues. Foreign shipments accounted for approximately 60% and 68% of our total net revenues for the three and nine months ended September 30, 2003, respectively and 59% for the year ended December 31, 2002. We expect foreign markets to continue to account for a significant percentage of our total net revenues. A significant portion of our total net revenues will, therefore, be subject to risks associated with foreign markets, including the following:

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

• changes in tariffs;

• exchange rates and other barriers;

• political and economic instability;

• difficulties in accounts receivable collection;

• difficulties in managing distributors and representatives;

• difficulties in staffing and managing foreign operations;

• difficulties in protecting our intellectual property overseas;

• seasonality of customer buying patterns; and

• potentially adverse tax consequences.

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

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

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

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

Our future success depends upon our ability to develop products that utilize new process technologies. Semiconductor design and process methodologies are subject to rapid technological change and require large expenditures for research and development. We currently manufacture our products using 0.8, 0.5, 0.35, 0.25 and 0.18 micron complementary metal oxide semiconductor (CMOS) processes and a 1.0 micron bipolar CMOS (BiCMOS) process. We continuously evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies. We are migrating to a 0.13 micron CMOS process, and we anticipate that we will need to migrate to smaller CMOS processes in the future. Other companies in the industry have experienced difficulty in transitioning to new manufacturing processes and, consequently, have suffered increased costs, reduced yields or delays in product deliveries. We believe that transitioning our products to smaller geometry process technologies will be important for us to remain competitive. We cannot be certain that we can make such a transition successfully, if at all, without delay or inefficiencies.

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

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

• accurate new product definition;

• timely completion and introduction of new product designs;

32

• availability of foundry capacity;

• achievement of manufacturing yields; and

• market acceptance of our products and our customers’ products.

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

• build products to applicable standards;

• develop products that meet customer requirements;

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

• introduce new products that achieve market acceptance; and

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

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

We sell a range of products that each have a different gross profit. Our total gross profits will be adversely affected if most of our shipments are of products with low gross profits.

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

The prices of our products tend to decrease over the lives of our products.

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

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

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

• susceptibility to seasonality of customer buying patterns;

• subject to general business cycles;

• intense competition;

• rapid technological change; and

• short product life cycles.

In addition, although the telecommunications and data communications equipment markets grew rapidly in the late 1990s and early 2000s, we have been experiencing a significant slowdown in these markets since the beginning of 2001. We anticipate that these markets will continue to experience significant volatility in the near future.

Our products must successfully meet industry standards to remain competitive.

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

33

We continue to expense our new product process development costs when incurred.

In the past, we have incurred significant new product and process development costs. Our policy is to expense these costs, including tooling, fabrication and pre-production expenses, at the time that they are incurred. We may continue to incur these types of expenses in the future. These additional expenses will have a material and adverse effect on our operating results in future periods.

We face intense competition in the communication semiconductor market.

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

• rapid technological change;

• subject to general business cycles;

• access to fabrication capacity;

• price erosion;

• unforeseen manufacturing yield problems; and

• heightened international competition in many markets.

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

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

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

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

• product quality;

• product reliability;

• price;

• efficiency of production;

• the ability to find alternative manufacturing sources, if necessary, to produce VLSI devices with acceptable manufacturing yields;

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

• success of competitors’ products; and

• general economic conditions.

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

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

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

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

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

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

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

Manufacturing integrated circuits is a highly complex and technology-intensive process. Although we try to diversify our sources of semiconductor device supply and work closely with our foundries to minimize the likelihood of reduced manufacturing yields, our foundries occasionally experience lower than anticipated manufacturing yields, particularly in connection with the introduction of new products and the installation and start-up of new process technologies. Such reduced manufacturing yields have at times reduced our

34

operating results. Manufacturing disruptions at one or more of our outside foundries, including those that may result from natural occurrences, could impact production for an extended period of time.

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

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

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

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

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

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

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

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

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

• that our existing patents or any new patents will be upheld or valid and enforceable;

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

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

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

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

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

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

35

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

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

• use of significant amounts of cash;

• potentially dilutive issuances of equity securities; and

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

In addition, acquisitions involve numerous other risks, including:

• diversion of management’s attention from other business concerns;

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

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

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

Our business could be harmed if we fail to integrate future acquisitions adequately.

During the past three years, we have acquired seven privately held companies based in the United States and Europe. The integration of the operations of our seven acquisitions, Easics N.V., acquired in May 2000, Alacrity Communications, Inc., acquired in August 2000, ADV Engineering S.A., acquired in January 2001, Horizon Semiconductors, Inc., acquired in February 2001, Onex Communications Corporation, acquired in September 2001, Systems On Silicon, Inc., (SOSi) acquired in March 2002, and ASIC Design Services, Inc., acquired in August 2003, has been completed.

Our management must devote time and resources to the integration of the operations of any future acquisitions. The process of integrating research and development initiatives, computer and accounting systems and other aspects of the operations of any future acquisitions presents a significant challenge to our management. This is compounded by the challenge of simultaneously managing a larger and more geographically dispersed entity.

Future acquisitions could present a number of additional difficulties of integration, including:

• difficulties in integrating personnel with disparate business backgrounds and cultures;

• difficulties in defining and executing a comprehensive product strategy; and

• difficulties in minimizing the loss of key employees of the acquired company.

If we delay integration of or fail to integrate operations or experience other unforeseen difficulties, the integration process may require a disproportionate amount of our management’s attention and financial and other resources. Our failure to address these difficulties adequately could harm our business or financial results, and we could fail to realize the anticipated benefits of the transaction.

We have in the past, as a result of industry conditions, later discontinued, abandoned or postponed certain product lines acquired through prior acquisitions, specifically SOSi and Alacrity Communications.

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

We have made investments in early stage, venture-backed, start-up companies that develop technologies that are complementary to our product roadmap. The following table summarizes these investments as of September 30, 2003:

Investee Company	Initial Investment Date	Technology
OptiX Networks, Inc.	February 2000	10 Gb/s and 40 Gb/s SONET/SDH framing devices
Accordion Networks, Inc.	December 2001	Carrier class broadband multi-service access systems
Opulan Technologies	April 2003	High performance and cost-effective IP convergence ASSPs (application-specific standard products)

These investments involve all the risks normally associated with investments in development stage companies and, as a result, we have had to record impairment charges against most of these investments. As such, there can be no assurance that we will receive a favorable return on these or any future venture-backed investments that we may make. Additionally, our original and any future

36

investments may continue to become impaired if these companies do not succeed in the execution of their business plans. Any further impairment or equity losses in these investments could negatively impact our future operating results.

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

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

Our stock price is volatile.

The market for securities of communication semiconductor companies, including those of TranSwitch, has been highly volatile. The market sale price of our common stock has fluctuated between a low of $0.21 and a high of $74.69 during the period from June 19, 1995 to September 30, 2003. The closing price was $3.13 on November 6, 2003. It is likely that the price of our common stock will continue to fluctuate widely in the future. Factors affecting the trading price of our common stock include:

• response to quarter-to-quarter variations in operating results;

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

• current market conditions in the telecommunications and data communications equipment markets (we are currently and have been for the past two years experiencing a significant downturn); and

• changes in earnings estimates by analysts.

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

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

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

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

• authorize the issuance of “blank check” preferred stock (preferred stock which our board of directors can create and issue without prior stockholder approval) with rights senior to those of common stock;

• prohibit stockholder action by written consent;

• establish advance notice requirements for submitting nominations for election to the board of directors and for proposed matters that can be acted upon by stockholders at a meeting; and

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

Acts of terrorism affecting our locations or those of our suppliers in the United States or internationally may negatively impact our business.

We operate our businesses in the United States and internationally, including the operation of design centers in India and Europe. We also work with companies in Israel that provide research and design services for us and with companies in Taiwan that fabricate our products. Some of these countries have, in the past, been subject to terrorist acts and could continue to be subject to acts of terrorism. If our facilities, or those of our suppliers, are affected by a terrorist act, our employees could be injured and our facilities damaged, which could lead to loss of skill sets and affect the development or fabrication of our products, which could lead to lower short- and long-term revenues. In addition, terrorist acts in the areas in which we operate or in which our suppliers operate could lead to changes in security and operations at those locations, which could increase our operating costs. Although we have no reason to believe that our facilities, or those of our suppliers, may be the subject of a terrorist attack, we cannot be sure that this will not happen.

37

We may have difficulty obtaining director and officer liability insurance in acceptable amounts for acceptable rates.

Like most other public companies, we carry insurance protecting our directors and officers against claims relating to the conduct of our business. This insurance covers, among other things, the costs incurred by companies and their board of directors and officers to defend against and resolve claims relating to such matters as securities class action claims. These claims typically are extremely expensive to defend against and resolve. We pay significant premiums to acquire and maintain this insurance, which is provided by third-party insurers, and we agree to underwrite a portion of such exposures under the terms of the insurance coverage. Over the last several years, the premiums we have paid for this insurance have increased substantially. This increase in premiums is due, in large part, to the current economic downturn, decline in stock prices by many public corporations and the substantial increase in the number of securities class actions and similar claims brought against public corporations, their boards of directors and officers. Each year we negotiate with insurers to renew our directors’ and officers’ insurance. In the current economic environment, we cannot assure you that in the future we will be able to obtain sufficient directors’ and officers’ liability insurance coverage at acceptable rates or with acceptable terms, conditions and retentions.

Failure to obtain such insurance could have a materially adverse impact on future financial results in the event that we are required to defend against and resolve any securities claims made against our Company, its board of directors and officers. Further, the inability to obtain such insurance in adequate amounts may impair our future ability to attract or retain qualified directors and/or officers.

38

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Interest Rate Risk. We have investments in overnight repurchase agreements, money market accounts, government securities, corporate bonds and asset backed obligations that earn interest income and such interest income is a function of the market rates. As a result, we have exposure to changes in interest rates. For example, if interest rates were to decrease by one half percentage point from their current levels, our potential interest income for the remainder of 2003, assuming a constant cash balance, would decrease by approximately $0.9 million. We expect our cash balance to decline during fiscal 2003 and therefore expect that our interest income will also decrease.

Foreign Currency Exchange Risk. As substantially all of our net revenues are currently made or denominated in U.S. dollars, a strengthening of the dollar could make our products less competitive in foreign markets. Although we recognize our revenues in U.S. dollars, we incur expenses in currencies other than U.S. dollars. In fiscal 2002, operating expenses incurred in foreign currency comprised approximately 10% of our total operating expenses. Although we have not experienced significant foreign currency losses to date, we may in the future, especially to the extent that we do not engage in hedging. We do not enter into derivative financial instruments for trading or speculative purposes. The economic impact of currency exchange rate movements on our operating results is complex because such currency exchange rate movement is often linked to additional economic factors, including variability in real growth, inflation, interest rates, governmental actions and other factors. Currency exchange rate movement and its consequent impact on additional economic factors, if material, may cause us to adjust our financing and operating strategies. Isolating the effect of changes in currency does not incorporate these other important economic factors, and because of the impact of such movement on additional economic factors, such isolation does not present a complete picture of the impact of currency exchange rate movement.

Fair Value of Financial Instruments. As of September 30, 2003, our long-term debt consisted of convertible notes with interest at fixed rates of 4.50% and 5.45%, respectively. Consequently, we do not have significant cash flow exposure on our convertible notes. However, the fair market value of the convertible notes is subject to significant fluctuation due to changes in market interest rates and their convertibility into shares of our common stock. The fair market value of the then outstanding 4.50% and 5.45% convertible notes was approximately $21.5 million and $99.4 million and $68.7 million and zero at September 30, 2003 and December 31, 2002, respectively. Among other factors, changes in interest rates and our stock price affect the fair market value of our convertible notes.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, our management, including our President and Chief Executive Officer, and Senior Vice President, Chief Financial Officer and Treasurer, carried out an evaluation of the effectiveness of “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)). Based upon and as of that date of evaluation, these officers have concluded that our disclosure controls and procedures are adequate and designed to ensure that material information relating to us and our consolidated subsidiaries would be made known to them in a timely fashion by others within those entities.

There have been no significant changes in the Company’s internal controls or in other factors which could significantly affect internal controls subsequent to the date our management carried out its evaluation. There were no significant deficiencies or material weaknesses identified in the evaluation and, therefore, no corrective actions were taken.

39

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are not party to any material litigation proceedings. However, we are currently prosecuting civil action number 03-10228NG in U.S. District Court in Massachusetts, entitled TranSwitch Corp. v. Galazar Networks, Inc., and are responsible for litigation costs therefrom. We have asserted that Galazar Networks, Inc. (Galazar) infringes three of our United States Patents. In that action Galazar has alleged that those three patents are not infringed, are invalid and are unenforceable, and that we have committed unfair competition. There can be no assurances that we will be successful in our suit against Galazar or that Galazar will be unsuccessful in its allegations. In addition, on October 27, 2003 Galazar filed a motion for leave to amend its answer and counterclaims to the aforementioned action, which counterclaims include further allegations of unfair competition and allegations of anti-trust violations.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On August 18, 2003, we paid $0.2 million in cash and we issued under Regulation D of the Securities Act of 1933, as amended, 189,482 shares of common stock to the former stockholders of ASIC Design Services, Inc. (ASIC), a Delaware corporation, and in exchange for all of ASIC’s outstanding shares. We informed the former ASIC stockholder prior to the consummation of the transaction that the TranSwitch shares they would receive in exchange for their ASIC shares were not registered under the Securities Act and could not be resold without registration or an exemption therefrom. The former ASIC stockholders received shares of TranSwitch common stock bearing a restrictive legend. The former ASIC stockholders represented to us that they were acquiring the TranSwitch shares for their own account. The shares issued to the former ASIC stockholders were registered in a registration statement on Form S-3 (File No. 33-109571) that was declared effective on October 17, 2003.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

Exhibit 3.1	Amended and Restated Articles of Incorporation, as amended to date (previously filed as Exhibit 3.1 to TranSwitch Corporation’s quarterly report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference).
Exhibit 3.2	By-Laws, as amended and restated, (previously filed as Exhibit 3.2 to TranSwitch Corporation’s annual report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference).
Exhibit 4.1	Indenture, by and between TranSwitch and U.S. Bank National Association, as trustee, relating to TranSwitch Corporation’s 5.45% Convertible Plus Cash NotesSM due September 30, 2007, dated September 30, 2003 (previously filed as Exhibit 4.1 to TranSwitch Corporation’s quarterly report on Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference).
Exhibit 10.1	Dealer Manager Agreement, by and between TranSwitch and U.S. Bancorp Piper Jaffray, dated August 27, 2003 (previously filed as Exhibit 10.1 to TranSwitch Corporation’s quarterly report on Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference).
Exhibit 10.2	Placement Agreement, by and between TranSwitch and U.S. Bancorp Piper Jaffray, dated August 27, 2003 (previously filed as Exhibit 10.1 to TranSwitch Corporation’s quarterly report on Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference).
Exhibit 31.1	CEO Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
Exhibit 31.2	CFO Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
Exhibit 32.1	CEO Certification pursuant to Rule 13a-14(b) and Rule 15d-14(b), as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
Exhibit 32.2	CFO Certification pursuant to Rule 13a-14(b) and Rule 15d-14(b), as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

40

(b) Reports on Form 8-K:

The Company filed with the Securities and Exchange Commission on July 17, 2003, a Current Report on Form 8-K for the July 16, 2003 event reporting the public dissemination of a press release announcing the second quarter of fiscal 2003 financial results. The Company furnished forward-looking statements relating to the third quarter of 2003.

The Company furnished with the Securities and Exchange Commission on July 18, 2003, a Current Report on Form 8-K for the July 16, 2003 event of a public conference call with investors discussing the Company’s second quarter results and certain forward looking statements. The Company furnished a transcript of its conference call with investors.

41

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.

	TRANSWITCH CORPORATION (Registrant)
December 18, 2003 Date	/s/ Santanu Das
	Dr. Santanu Das Chairman of the Board, Chief Executive Officer and President (Principal Executive Officer)
December 18, 2003 Date	/s/ Peter J. Tallian
	Peter J. Tallian Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer and Principal Accounting Officer)

42

INDEX OF EXHIBITS

Exhibit 3.1	Amended and Restated Articles of Incorporation, as amended to date (previously filed as Exhibit 3.1 to TranSwitch Corporation’s quarterly report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference).
Exhibit 3.2	By-Laws, as amended and restated, (previously filed as Exhibit 3.2 to TranSwitch Corporation’s annual report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference).
Exhibit 4.1	Indenture, by and between TranSwitch Corporation and U.S. Bank National Association as trustee, relating to TranSwitch Corporation’s 5.45% Convertible Plus Cash Notessm due September 30, 2007, dated September 30, 2003 (previously filed as Exhibit 4.1 to TranSwitch Corporation’s quarterly report on Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference).
Exhibit 10.1	Dealer Manager Agreement, by and between TranSwitch Corporation and U.S. Bancorp Piper Jaffray, dated August 27, 2003 (previously filed as Exhibit 10.1 to TranSwitch Corporation’s quarterly report on Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference)
Exhibit 10.2	Placement Agreement, by and between TranSwitch Corporation and U.S. Bancorp Piper Jaffray, dated August 27, 2003 (previously filed as Exhibit 10.2 to TranSwitch Corporation’s quarterly report on Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference).
Exhibit 31.1	CEO Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
Exhibit 31.2	CFO Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
Exhibit 32.1	CEO Certification pursuant to Rule 13a-14(b) and Rule 15d-14(b), as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
Exhibit 32.2	CFO Certification pursuant to Rule 13a-14(b) and Rule 15d-14(b), as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

43