Stockholders of record at the close of business on June 16, 2003 (the "Record Date") are entitled to notice of and to vote at the 2003 Annual Meeting. At the Record Date, 28,475,370 shares of the Company's common stock were issued and outstanding having an equivalent number of votes.

Any proxy given in connection with this solicitation may be revoked by the person giving it at any time before its use by delivering to the Secretary of the Company at or before the taking of the vote at the 2003 Annual Meeting a written notice of revocation or a duly executed proxy bearing a later date or by attending the 2003 Annual Meeting and voting in person.

Each stockholder holding common stock is entitled to one vote for each share of the Company's common stock they hold on all matters presented at the 2003 Annual Meeting. Stockholders do not have the right to cumulate their votes in the election of directors.

Shares of the Company's common stock represented by properly executed proxies will, unless such proxies have been previously revoked, be voted in accordance with the instructions indicated thereon. In the absence of specific instructions to the contrary, properly executed proxies will be voted: (i) FOR the election of each of the Company's nominees for director; and (ii) FOR ratification of the appointment of PricewaterhouseCoopers LLP as independent accountants for the Company for the period ending March 31, 2004. No business other than that set forth in the accompanying Notice of Annual Meeting of Stockholders is expected to come before the 2003 Annual Meeting. Should any other matter requiring a vote of stockholders properly arise, the persons named in the enclosed form of proxy will vote such proxy in accordance with the recommendation of the Board of Directors.

The Company will bear the cost of soliciting proxies. In addition, the Company may reimburse brokerage firms and other persons representing beneficial owners of shares for their expenses in forwarding solicitation materials to such beneficial owners. Solicitation of proxies by mail may be supplemented by telephone, telegram, facsimile or personal solicitation by directors, officers or regular employees of the Company. No additional compensation will be paid to such persons for such services.

The required quorum for the transaction of business at the 2003 Annual Meeting is a majority of the votes eligible to be cast by holders of shares of the Company's common stock issued and outstanding on the Record Date. Shares that are voted "FOR," "AGAINST," "WITHHELD" or "ABSTAIN" are treated as being present at the meeting for purposes of establishing a quorum and are also treated as shares entitled to vote at the 2003 Annual Meeting with respect to such matter.

Abstentions shall be counted for purposes of determining both (i) the presence or absence of a quorum for the transaction of business and (ii) the total number of shares entitled to vote with respect to a proposal (other than the election of directors). Accordingly, abstentions will have the same effect as a vote against the proposal.

In instances where brokers are prohibited from exercising discretionary authority for beneficial holders who have not returned a proxy (so-called "broker non-votes"), those shares will be counted for purposes of determining the presence or absence of a quorum for the transaction of business, but will not be counted for purposes of determining the number of shares entitled to vote. Thus, a broker non-vote will not affect the outcome of the voting on a proposal.

The Company's Board of Directors currently consists of six directors. Five of our current directors, as listed below, have been nominated for re-election at the 2003 Annual Meeting. One of our current directors is not standing for re-election.

Proxies cannot be voted for a greater number of persons than the number of nominees named. Each of the directors elected at the 2003 Annual Meeting will hold office until the 2004 Annual Meeting of Stockholders, or until his successor has been duly elected and qualified. Unless otherwise instructed, the proxy holders will vote the proxies received by them for the Company's five nominees named below, all of whom are currently directors of the Company. In the event that any nominee of the Company becomes unable or declines to serve as a director at the time of the 2003 Annual Meeting, the proxy holders will vote the proxies for any substitute nominee who is designated by the current Board of Directors to fill the vacancy. It is not expected that any nominee listed below will be unable or will decline to serve as a director.

In January 2000, the Company entered into a strategic relationship with STMicroelectronics NV, or STM, which included STM acquiring shares of the Company' common stock and obtaining the right to nominate a qualified representative to serve on the Board of Directors so long as STM holds at least 10% of the Company's outstanding common stock. STM currently holds 13% of the Company's common stock. Therefore, the Company has selected STM's nominee, Christos Lagomichos, for re-election to the Board of Directors. For further discussion of the Company's relationship with STM, please see the section of this proxy statement entitled "Certain Relationships and Related Party Transactions."

The names of the nominees and certain information about each of them are set forth below.

Except as indicated below, each nominee or incumbent director has been engaged in the principal occupation set forth above during the past five years. There are no family relationships between any directors or executive officers of the Company.

Joe Parkinson has been Chairman of the Board of the Company since November 2000, and served as its Chief Executive Officer from January 2001 to February 2002. He was Chairman and Chief Executive Officer of Netergy from November 2000 to January 2001. From October 1999 through August 2000, he served on the board of directors of Photobit Corporation, and from June 2000 through August 2000 served as its President and Chief Executive Officer. From October 1998 through September 1999, Mr. Parkinson served as Chairman of the Board of Diamonex, Incorporated. He also served as Chairman of the Board and Chief Executive Officer of the Company from June 1995 to January 1998. He previously served as Chairman of the Board and Chief Executive Officer of Micron Technology, Inc. He currently serves on the board of directors of Tulane University and of several private companies. Mr. Parkinson received a B.A. from Columbia College, a J.D. from Tulane University, and a L.L.M. in Taxation from New York University.

Bryan R. Martin has served as President and Chief Executive Officer and as a director of the Company since February 2002. From February 2001 to February 2002, he served as President and Chief Operating Officer and a director of the Company. He has served as a director of Netergy since January 2001 and of Centile, Inc. ("Centile"), a subsidiary of the Company, since March 2001. He served as Senior Vice President, Engineering Operations from July 2000 to February 2001 and as the Company's Chief Technical Officer from August 1995 to August 2000. He also served as a director of the Company from January 1998 through July 1999. In addition, Mr. Martin served in various technical roles for the Company from April 1990 to August 1995. He received a B.S. and an M.S. in Electrical Engineering from Stanford University.

Dr. Bernd Girod has served as a director of the Company since November 1996 and has served as a director of Netergy Microelectronics, Inc. ("Netergy"), a subsidiary of the Company, since January 2001. Dr. Girod is Professor of Electrical Engineering and (by courtesy) Computer Science in the Information Systems Laboratory of Stanford University, a position he has held since 1999. He was Chaired Professor of Telecommunications in the Electrical Engineering Department of the University of Erlangen-Nuremberg from 1993 to 1999. His research interests are in the areas of networked multimedia systems, video signal compression, and 3-D image analysis and synthesis. Prior visiting or regular faculty positions included MIT and Georgia Tech. He has been involved with several startup ventures as founder, director, investor, or advisor, among them Polycom, Vivo Software and RealNetworks. Dr. Girod received a M.S. in Electrical Engineering from the Georgia Institute of Technology and a Doctoral degree from the University of Hanover, Germany. Dr. Girod is a Fellow of the Institute of Electrical and Electronics Engineers.

Major General Guy L. Hecker, Jr. has served as a director of the Company since August 1997 and has served as a director of Netergy since December 2000. He has served as the President of Stafford, Burke and Hecker, Inc., a consulting firm based in Alexandria, Virginia, since 1982. Prior to his retirement from the Air Force in 1982, Major General Hecker's most recent positions included Director of the Air Force Office of Legislative Liaison and an appointment in the Office of the Deputy Chief of Staff, Research, Development and Acquisition for the Air Force. Earlier, he served as a pilot and commander in both fighter and bomber aircraft units, including command of a bomber wing and an air division. During his Air Force career, Major General Hecker was awarded a number of military decorations, including the Air Force Distinguished Service Medal, the Silver Star, the Legion of Merit (awarded twice) and the Distinguished Flying Cross. Major General Hecker received a B.A. from The Citadel, an M.A. in International Relations from George Washington University, an honorary Ph.D. in military science from The Citadel and completed the management development program at Harvard Business School.

Christos Lagomichos has served as a director of the Company since June 2000. Mr. Lagomichos has been Vice President and General Manager of the Set-Top Box Division of STMicroelectronics, Inc., a subsidiary of STM, since July 1997. In December 1996, Mr. Lagomichos was promoted to Director of STM's PPG/Semicustom Products Division for the Americas, and was subsequently promoted to Worldwide General Manager of the Division in May 1997. From October 1989 through December 1996, Mr. Lagomichos served as Product Marketing Manager of STM's Semicustom Business Unit. From 1985 through 1988, he served in various technical roles in STM's Munich design center. Mr. Lagomichos holds an engineering degree from the Technical University of Munich.

The five nominees receiving the highest number of affirmative votes of the shares entitled to vote on this matter shall be elected as directors. Votes withheld from any director will be counted for purposes of determining the presence or absence of a quorum, but are not counted as affirmative votes. A broker non-vote will be counted for purposes of determining the presence or absence of a quorum, but, under Delaware law, it will have no other legal effect upon the election of directors.

The Board of Directors held a total of twelve meetings during the fiscal year ended March 31, 2003. No incumbent director attended fewer than 75% of the total number of meetings of the Board of Directors and committees of the Board of Directors upon which such director served during fiscal 2003. The Board of Directors has an Audit Committee and a Compensation Committee. The Board of Directors does not have a nominating committee or any committee performing similar functions.

The Audit Committee currently consists of Dr. Girod, Mr. Hecker and Mr. William P. Tai. The Audit Committee reviews the Company's financial controls, evaluates the scope of the annual audit, reviews audit results, and consults with management and the Company's independent auditors prior to the presentation of financial statements to stockholders and, as appropriate, initiates inquiries into aspects of the Company's financial affairs. The Audit Committee held four meetings during fiscal 2003.

The Compensation Committee currently consists of Dr. Girod and Mr. Tai. The Compensation Committee makes recommendations to the Board of Directors concerning the compensation for the Company's officers and directors and the administration of the Company's stock option and employee stock purchase plans. The Compensation Committee held one meeting during fiscal 2003.

Cash remuneration for non-employee directors consists of a $1,000 fee for attendance of meetings of the Board of Directors. In addition, directors are reimbursed for reasonable expenses incurred in attending board and committee meetings upon approval of such reimbursement by the Board of Directors. Non-employee directors are also eligible for discretionary and non- discretionary grants of stock options under the 1996 Director Plan (the "Director Plan") and the 1996 Stock Option Plan (the "1996 Plan"). Under an amendment to the Director Plan approved by the Company's stockholders in August 2000, non-employee directors receive a non-discretionary option grant of 40,000 shares upon their initial election to the Board of Directors and receive annual grants of 15,000 shares upon their re-election to the board. The initial non- discretionary grant vests annually over a period of four years and subsequent non-discretionary grants vest monthly over a period of forty-eight months. Grants are not made upon re-election in cases where the initial term is shorter than six months. In April 2002, the Board of Directors reassessed its compensation policy and determined that another increase in non-discretionary grants to non-employee directors was warranted. As a result of this reevaluation, the Board of Directors increased the amount of the annual non- discretionary option grant for non-employee directors to 25,000 shares.

In addition, upon termination of service as a director of the Company or upon a Change in Control (as defined below) of the Company, each of the non-employee directors and their immediate families will be eligible for medical insurance coverage for life, subject to the director reimbursing the cost of such coverage to the Company. However, if an individual commences coverage under another plan, coverage under the Company's medical insurance will be discontinued. In addition, upon a Change in Control of the Company any unvested non-employee director options shall become fully vested. For these purposes, a Change in Control is defined as a transaction or series of transactions, including by merger or consolidation of the Company into or with any other entity or corporation or the merger or consolidation of any other corporation into or with the Company, in which any person, entity or group of persons and/or entities acting in concert acquire(s) shares of the Company's stock representing 50% or more of the outstanding voting power of the Company, including voting shares issued or issuable upon conversion of any convertible security outstanding on the date of such transaction including, without limitation, stock options.

Under a policy of STM, Mr. Lagomichos does not receive option grants in connection with his service on the board, nor does he receive the $1,000 per meeting payment for attending meetings of the Board of Directors.

Directors who are also employees do not receive any additional compensation for their services as members of the Board of Directors.

The Compensation Committee of the Board of Directors currently consists of Dr. Girod and Mr. William P. Tai. Neither individual was, at any time since the formation of the Company, an officer or employee of the Company. No executive officer of the Company serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of the Company's Board of Directors or Compensation Committee. The employee directors of the Company, Messrs. Martin and Parkinson, participated in deliberations of the Company's Board of Directors concerning executive officer compensation during fiscal 2003.

The following table sets forth certain information regarding the executive officers of the Company not shown in the table of the nominees for director above:

Dr. Barry Andrews was appointed Vice President, Engineering and Chief Technical Officer of the Company in February 2001. From December 2000 to February 2001, he served as Director of Customer Premise Equipment & Gateway Development of the Company. From January 1996 to December 2000, Dr. Andrews served as Video R&D Manager and Senior Software Engineer of the Company. He received a B.A.Sc. in Engineering Science from Simon Fraser University, a M.S. in Electrical Engineering, a M.S. in Statistics, and a Ph.D. in Electrical Engineering from Stanford University.

Dr. Paul Ning was appointed Vice President, Engineering of Netergy and Vice President, Microelectronics Engineering of the Company in November 2002. Dr. Ning has been with Netergy and 8x8 since December 1996, and in previous roles served as Director of Software Engineering, Director of Platform Engineering, and Manager of Video Systems. His prior experience includes compression and digital media development at Silicon Graphics, ROLM Corporation, and Ford Aerospace. Dr. Ning received a B.S. and M.S. from the Massachusetts Institute of Technology, and a Ph.D. from Stanford University, all in Electrical Engineering.

Christopher Peters has served as the Chairman and Chief Executive Officer of Netergy since November 2002 and as a member of the Board of Directors of Centile since October 2001. From October 2001 to November 2002 he served as the Company's Corporate Development Officer. From September 2000 to October 2001, Mr. Peters was Vice President of Business Development for Kinetic Tide, Inc. Prior to Kinetic Tide, Mr. Peters was Vice President of Sales for 8x8 from July 1997, and Vice President of Business Development from July 1999 to June 2000. Between January 1995 and July 1997, he held various sales positions at the Company. His prior experience includes sales positions at Media Vision Technology, and various technical and marketing roles at NCR Microelectronics. He received a B.S.E.E. from Colorado State University.

Huw Rees has served as the Chairman and Chief Executive Officer of Centile since July 2001 and has been a member of Centile's board of directors since March 2001. From February 2001 to July 2001, he served as Vice President, Sales of the Company. Additionally, he served as Vice President, Sales and Business Development of Centile from March 2001 to July 2001. He served as Vice President, Sales of the Solutions Group of the Company from August 2000 until February 2001 and as Director, North American Sales of the Company from April 1999 to August 2000. He previously worked at Mitel Corporation as Sales Manager of the Western Region. He received a B.Sc. (Hons) from the University of Manchester, Institute of Science and Technology in Electrical and Electronic Engineering and a M.B.A. from the University of LaVerne.

James Sullivan has been Chief Financial Officer of the Company since July 2002. Mr. Sullivan served as the Chief Financial Officer of Netergy from January 2001 to July 2002. Prior to joining the Company, Mr. Sullivan held various positions at PricewaterhouseCoopers LLP. He received a B.S. from New York University and is a certified public accountant.

The following table sets forth all compensation received for services rendered to the Company in all capacities during the fiscal years ended March 31, 2003, 2002 and 2001 by the Company's Chief Executive Officer and the Company's other four most highly compensated executive officers who served as executive officers of the Company on March 31, 2003 (collectively, the "Named Executive Officers").

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1. Consists of Company contributions to the 8x8, Inc. 401(k) plan and premiums paid with respect to term life insurance on behalf of the Named Executive Officer.
2. Dr. Andrews became an officer of the Company in February 2001.
3. Dr. Ning became an officer of the Company in November 2002.
4. Mr. Peters became an officer of the Company in October 2001. In fiscal 2003, Mr. Peters was also granted an option to purchase 200,000 shares of Netergy common stock at an exercise price of $0.50 per share.
5. Mr. Rees became an officer of the Company in February 2001. Mr. Rees' fiscal 2001 salary consisted of a base salary of $157,864 and sales commissions of $80,000. Mr. Rees' fiscal 2002 and 2003 compensation packages represented base salary only. In fiscal 2001, Mr. Rees was also granted an option to purchase 300,000 shares of Centile common stock at an exercise price of $0.43 per share.

The following table provides information with respect to stock option grants to each of the Named Executive Officers during the fiscal year ended March 31, 2003:

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* less than 1%.

1. The options were granted under the Company's 1996 Stock Plan and vest at a rate of 1/48^th of the shares at the end of each month, subject to continued service as an employee, consultant or director. The term of each option is ten years. The exercise price of each option granted equaled the fair market value of the common stock of the Company on the date of grant. See information provided under the heading "Employment Contracts and Termination of Employment and Change-In-Control Arrangements" for circumstances that would give rise to an acceleration of vesting for outstanding options held by the Named Executive Officers.
2. The Company granted options representing 782,800 shares to employees during fiscal 2003.
3. The exercise price for each option may be paid in cash, in shares of common stock valued at fair market value on the exercise date or through a cashless exercise procedure involving a same day sale of the purchased shares.
4. Potential gains are net of the exercise price, but before taxes associated with the exercise. The 5% and 10% assumed annual rates of compounded stock appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of the future price of the Company's common stock. Actual gains, if any, on stock option exercises are dependent on the future financial performance of the Company, overall market conditions and the option holders' continued employment through the vesting period. There can be no assurance that the potential realizable values shown in this table will be achieved.

None of the Named Executive Officers exercised any stock options during fiscal 2003. The following table provides information with respect to the value of unexercised stock options held as of March 31, 2003 by each of the Named Executive Officers.

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1. The value of unexercised options is based upon the difference between the exercise price and the closing price on The Nasdaq SmallCap Market on March 31, 2003 of $0.22, multiplied by the number of shares underlying the option.
2. At March 31, 2003, Dr. Ning had an unexercised option to purchase 200,000 shares of Netergy's common stock at $0.50 per share, of which 112,499 were exercisable and 87,501 were not exercisable.
3. At March 31, 2003, Mr. Peters had an unexercised option to purchase 200,000 shares of Netergy's common stock at $0.50 per share, of which no shares were exercisable. In addition, Mr. Peters had an unexercised option to purchase 300,000 shares of Centile's common stock at $0.43 per share, of which 106,249 shares were exercisable and 193,751 were not exercisable.
4. At March 31, 2003, Mr. Rees had an unexercised option to purchase 300,000 shares of Centile's common stock at $0.43 per share, of which 149,998 were exercisable and 150,002 were not exercisable.

In March 2002, the Board of Directors authorized the Company to open securities trading accounts and make investments in classes of securities that may generate higher returns than the yields on governmental and corporate debt securities and money market funds. The amount allocated for such investments was $1.0 million to be invested on behalf of 8x8 as directed by the Company's Chairman, Chief Executive Officer, or Chief Financial Officer. Mr. Parkinson agreed to personally reimburse 8x8 on a quarterly basis for any losses resulting from his trading activities in order to maintain a minimum investment account balance of $1.0 million. The Board of Directors has been assured of Mr. Parkinson's ability to cover any such losses. As part of the arrangement, the Company's Board of Directors has expressed its intent, but not obligation, to pay Mr. Parkinson a quarterly bonus in an amount equal to 25% of the profits attributable to investments made on the Company's behalf by Mr. Parkinson to the extent such a bonus exceeds his salary for the corresponding period. The Company or Mr. Parkinson can terminate this arrangement at any time, subject to the terms of an agreement between Mr. Parkinson and the Company.

During fiscal 2003, the investment accounts opened by the Company incurred net trading losses (realized and unrealized) of approximately $119,000. During fiscal 2003, Mr. Parkinson made replenishment payments to the Company of approximately $137,000 to offset trading losses incurred. For tax purposes, these replenishment payments were treated as a reduction of Mr. Parkinson's compensation by the Company. As of March 31, 2003, the investment account balance approximated $1,018,000, and the Company had a payable to Mr. Parkinson of $18,000.

In February 2001, the Board of Directors authorized a severance arrangement for Mr. Parkinson that provided for one year of severance benefits and option vesting. In November 2002, this severance arrangement was terminated at Mr. Parkinson's request.

In January 2001, the Board of Directors authorized a severance arrangement with Mr. Martin that provided for one year of severance benefits and option vesting. In November 2002, this severance arrangement was terminated at Mr. Martin's request.

In January and February 2001, the Board of Directors authorized severance arrangements with Dr. Theodore Beck, Dr. Philip Bednarz, Mr. David Stoll and two other executives of Netergy Microelectronics, Inc., which provided for one year of severance benefits and option vesting. The severance was payable month by month, commencing upon the voluntary or involuntary termination of the executive, conditioned on the individual not competing with the Company and being available for consulting to the extent it did not interfere with his job responsibilities at a new company, in the discretion of the Chairman of the Board of Directors. If the Company is sold before the expiration of the twelve-month severance period, all remaining severance would be paid, and all remaining unvested options would vest, as of the closing of the sale of the Company. The executives were also entitled to continue coverage under the Company's medical plans for the severance period. During fiscal 2003, each of these five employees voluntarily terminated their employment with the Company and became eligible for their severance. Lump sum payments of approximately $195,000 were made to Messrs. Beck and Bednarz and another executive of Netergy for one year of severance and the estimated costs of one year of medical benefits. Stock options granted to these executives terminated thirty to ninety days subsequent to the termination of employment, based on their respective option agreement terms. Mr. Stoll and an executive of Netergy are receiving their $190,000 annual severance monthly and continue to participate in the Company's medical plans. Mr. Stoll's severance payments and participation in the Company's medical plans terminates in July 2003, and the arrangement with the Netergy officer terminates in November 2003.

Pursuant to the terms of the Netergy Microelectronics, Inc. 2000 Stock Option Plan, the initial option grants to Dr. Ning, Mr. Peters, Dr. Girod and Mr. Hecker for the purchase of Netergy common stock will vest immediately upon a Change in Control of Netergy.

Notwithstanding the arrangements discussed above, in the event an individual or corporate entity and any related parties cumulatively acquire at least 35% of the Company's fully diluted stock, all stock options held by officers under any 8x8, Inc. stock option plan shall vest immediately without regard to the term of the option. In addition, in such an event, each officer shall be entitled to one year of severance pay and continuing medical benefits for life after leaving the Company, provided that such medical benefits shall cease should such officer accept employment with a competing company.

In the quarter ended March 31, 2000, the Company entered into a strategic relationship with STM. Under various agreements, STM purchased shares of the Company's common stock and was granted certain related rights, licensed certain of the Company's intellectual property and engaged the Company to jointly develop products that enable voice and other multimedia services over internet protocol networks. In addition, STM and the Company entered into a cross license agreement in March 2002 that is more fully described below.

Stock Purchase and Related Rights. As part of the arrangement, STM purchased 3.7 million shares of 8x8's common stock for $27.75 million. STM's share ownership currently represents 13.1% of our outstanding common stock making them the Company's largest stockholder. STM has been granted certain registration rights that expire upon the earlier of the date that STM can sell the remaining shares it holds in any three-month period under Rule 144, or February 2007. The registration rights allow STM to:

• require us to file a registration statement with the U.S. Securities and Exchange Commission covering the resale of some or all of the 3.7 million shares still held by STM, subject to certain conditions; and
• participate in future registration statements, including a registered public offering involving an underwriting, subject to certain conditions and limitations.

In addition, STM has preemptive rights that allow STM to purchase additional shares of common stock from the Company or receive rights to acquire shares of 8x8 common stock, in proportion to their ownership percentage, to the extent that shares of 8x8 common stock or rights to acquire 8x8 common stock are issued in connection with financing activities. STM's preemptive rights terminate on the later of the date that it owns less than 10% of 8x8's outstanding common stock or February 2003. Further, so long as STM holds at least 10% of 8x8's outstanding common stock, the Company is obligated to nominate one qualified nominee selected by STM for election to 8x8's board of directors. Christos Lagomichos, vice president and general manager of the Set- Top Box Division of STM's subsidiary, STMicroelectronics, Inc., was selected as a nominee by STM and currently serves on 8x8's board of directors.

License and Development Agreements. Under a non- exclusive, royalty-bearing license agreement entered into in the quarter ended March 31, 2000 in conjunction with the stock purchase and rights agreements discussed above, the Company provided a subsidiary of STM, STMicroelectronics, Inc., or STM Inc., with rights to use certain of its voice-over-internet- protocol semiconductor and embedded software technology. STM Inc. is required to pay royalties based on a percentage of the net sales price of products sold by STM Inc. that incorporate the licensed technology.

Under a separate development agreement that was also executed in the quarter ended March 31, 2000, the Company and STM Inc. established a framework for the joint development of semiconductor products and defined two initial projects. One project provides for the joint development of a voice- enabled chipset for cable modems and cable television set-top boxes. STM Inc. is not required to pay the Company any engineering fees associated with the development efforts necessary to support this project, which is still ongoing. STM Inc. is required to pay certain per-unit royalties based upon shipments of products that may eventually result from this development effort. The other project involves the integration of certain of the Company's voice-over-internet protocol technology into products intended to be used in various internet telephony applications including digital subscriber line, or DSL, modems and internet protocol telephones. In May 2000, STM Inc. paid us $1.0 million associated with this project; $500,000 for engineering fees associated with the development effort and $500,000 of prepaid royalties. We have substantially completed our obligations under this project and STM Inc. is currently marketing and selling a product resulting from this joint development effort. STM Inc. is required to pay the Company additional per-unit royalties based upon shipments of this product only if cumulative royalties owed eventually exceed the balance of prepaid royalties. Should STM Inc. elect to have us provide extended product maintenance and support, they are required to pay us additional fees of which a portion will be considered prepaid royalties. To date, royalties paid to the Company under this arrangement have not been significant.

In March 2002, the Company licensed certain Very Long Instruction Word, or VLIW, microprocessor cores, related tools and MPEG4 video compression firmware from STM for use in the Company's Internet protocol, or IP, video communication processor development initiatives. Additionally, the Company agreed to license STM certain of its existing and future H.263 and H.26L video compression/decompression firmware implementations for use with STM's semiconductor products. The licenses are non-exclusive, non-transferable and non-assignable and provide for the sharing of updates and enhancements to the licensed technology, subject to certain limitations. The agreement includes provisions that allow the Company to manufacture semiconductor devices that contain the VLIW microprocessor cores at STM or at other third-party fabrication facilities. The Company is required to pay STM per-unit royalties based upon shipments of products that incorporate the VLIW technology. In addition, STM is required to pay the Company certain per-unit royalties based upon shipments of STM semiconductor products that contain the Company's video technology.

REPORT OF THE AUDIT COMMITTEE OF THE BOARD OF DIRECTORS

The Audit Committee of the Board of Directors is comprised of three directors, and operates under a written charter adopted by the Board of Directors. Each member of the Audit Committee is "independent," as such term is defined under the Nasdaq SmallCap Market listing standards.

The Audit Committee oversees the Company's financial reporting process on behalf of the Board of Directors. Management is responsible for the Company's internal controls, financial reporting process and compliance with laws, regulations and ethical business standards. The Company's independent accountants, PricewaterhouseCoopers LLP (the "Auditors"), are responsible for performing an independent audit of the Company's consolidated financial statements in accordance with generally accepted auditing standards and to issue a report thereon. The Audit Committee's responsibility is to monitor and oversee these processes. In this capacity, the Audit Committee provides advice, counsel, and direction to management and the Auditors on the basis of the information it receives, discussions with management and the Auditors, and the experience of the Audit Committee's members in business, financial and accounting matters.

The Audit Committee has reviewed and discussed the Company's audited consolidated financial statements with the Company's management. The Audit Committee also discussed and reviewed with the Auditors all matters required to be discussed by Statement on Auditing Standards No. 61 (Communication with Audit Committees). The Audit Committee has met with the Auditors, with and without management present, to discuss the overall scope of their audit, the results of their examinations, their evaluation of the Company's internal controls and the overall quality of the Company's financial reporting. Furthermore, the Audit Committee has discussed the Company's critical accounting policies with management and the Auditors.

The Audit Committee has received from the Auditors a formal written statement describing all relationships between the Auditors and the Company that might bear on the independence of the Auditors consistent with Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees), discussed with them any relationships that may impact their objectivity and independence, considered the compatibility of non-audit services with the independence of the Auditors, and in so doing has satisfied itself as to the independence of the Auditors. Fees for audit and non-audit services provided by the Auditors in fiscal 2003 are summarized as follows:

Audit Fees. During the fiscal year ended March 31, 2003, the aggregate fees billed by the Auditors for the audit of the Company's consolidated financial statements for such fiscal year, including the reviews of the Company's interim financial statements included in the Company's Quarterly Reports on Form 10-Q, and statutory audits of international subsidiaries were $114,000.

Financial Information Systems Design and Implementation Fees. During the fiscal year ended March 31, 2003, the Auditors billed no fees for information technology consulting services.

All Other Fees. During the fiscal year ended March 31, 2003, the aggregate fees billed by the Auditors for professional services other than audit fees were $57,000, $44,000 of which were billed in connection with tax related services and $13,000 of which were billed for services such as consulting on accounting standards and the review of registration statements.

Based on these reviews and discussions, the Audit Committee recommended to the Board of Directors, and the Board of Directors approved the inclusion of the Company's audited consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2003. The Audit Committee and the Board of Directors also have recommended, subject to stockholder approval, the ratification of the Company's Auditors.

Submitted by the following members of the Audit Committee:

This report of the Compensation Committee of the Board of Directors describes the Company's compensation policies and rationales applicable to the Company's executive officers with respect to compensation paid to such executive officers for fiscal 2003. The Compensation Committee makes recommendations to the board concerning the compensation for the Company's executive officers. The Board of Directors is responsible for reviewing and approving the Company's compensation policies and the compensation paid to executive officers, based in part on recommendations of the Compensation Committee. The Compensation Committee held one meeting during fiscal 2003 and compensation decisions during the fiscal year were made by the full Board of Directors.

The general philosophy of the Company's compensation program is to offer executive officers competitive compensation based both on the Company's performance and on the individual's contribution and performance. The Company's compensation policies are intended to motivate, reward and retain highly qualified executives for long-term strategic management and the enhancement of stockholder value, to support a performance-oriented environment that rewards achievement of specific internal Company goals and to attract and retain executives whose abilities are critical to the long-term success and competitiveness of the Company. There are three main components in the Company's executive compensation program: i) base salary, ii) incentive bonus and iii) stock incentives.

The salaries of the executive officers, including the Chief Executive Officer, are generally reviewed annually by the Compensation Committee and the Board of Directors with reference to surveys of salaries paid to executives with similar responsibilities at comparable companies, generally in the high technology industry and often within the Company's geographic area. The peer group for each executive officer is composed of executives whose responsibilities are similar in scope and content. The Company seeks to set executive compensation levels that are competitive with the average levels of peer group compensation. Salaries for executive officers are generally determined on an individual basis by evaluating each executive's scope of responsibility, performance, prior experience and salary history as well as the salaries for similar positions at comparable companies. In light of the Company's efforts to contain expenditures, there were no increases in the salaries of the Named Executive Officers during fiscal 2003. In June 2002, Mr. Parkinson requested that his base salary be reduced from $200,000 to $100,000 effective July 1, 2002, and in February 2003, Mr. Parkinson requested that his base salary be reduced to $10, effective February 15, 2003. The Board of Directors agreed to honor these requests, and his base salary was adjusted accordingly. In February 2003, Mr. Martin requested that his base salary be reduced to $202,500, effective February 15, 2003. The Board of Directors agreed to honor this request, and his base salary was adjusted accordingly.

Annual incentive bonuses for executive officers are intended to reflect the Compensation Committee's belief that a significant portion of the annual compensation of each executive officer should be contingent upon the performance of the Company, as well as the individual contribution of each officer. The Company and its subsidiaries, Netergy and Centile, have implemented profit sharing plans that provide the potential for additional compensation to employees of the respective entities equal to up to 15% of the applicable entity's quarterly net income, if approved by the Board of Directors. Of these amounts, one third is shared by all employees of the respective entity, one third is shared by key employees identified by the Board of Directors, and one third is shared by officers. Additionally, officers are eligible for certain discretionary bonuses based on criteria established by the Board of Directors and management. No profit sharing or discretionary bonuses were paid to officers during fiscal 2003.

The Company utilizes stock options as long-term incentives to reward and retain executive officers. The Compensation Committee believes that this practice links management interests with stockholder interests and motivates executive officers to make long-term decisions that are in the best interests of the Company. The Compensation Committee also believes that executive officers and other key employees should own a significant percentage of the Company's stock. Generally, stock options vest over four years after the grant date and optionees must be employed by the Company at the time of vesting in order to exercise the options.

The Compensation Committee believes that stock option grants provide an incentive that focuses the executives' attention on the Company from the perspective of an owner with an equity stake in the business. Because options are typically granted with an exercise price equal to the fair market value of the Company's common stock on the date of grant, the Company's stock options are tied to the future performance of the Company's common stock and will provide value to the recipient only when the price of the Company's stock increases above the exercise price, that is, only to the extent that stockholders as a whole have benefited. In fiscal 2003, the Compensation Committee and the Board of Directors considered all of these factors and authorized the granting of options to executive officers in July 2002 as part of a company-wide option grant program focusing on employee retention.

Mr. Martin's annual base salary had been increased from $190,000 to $225,000 in February 2001 when he was promoted to President and Chief Operating Officer of the Company. Mr. Martin was promoted to Chief Executive Officer of the Company in February 2002; however, no corresponding adjustment was made to his base salary at that time. In February 2003, Mr. Martin requested that his base salary be reduced from $225,000 to $202,500, effective February 15, 2003. The Board of Directors agreed to honor this request, and his base salary was adjusted accordingly.

In July 2002, Mr. Martin was granted an option to purchase 2,000 shares of the Company's common stock at a price of $0.56 per share, which represented the fair market value of the Company's stock on the date of such grant. This grant will vest monthly for up to forty-eight months subject to his continued service as an officer or director of the Company.

Submitted by the following members of the Compensation Committee:

The graph compares the cumulative total stockholder return for the Company's common stock with the Nasdaq Stock Market (US) Composite Index and the Nasdaq Computer Index for the period commencing July 2, 1997 and ending March 31, 2003. The graph assumes that $100 was invested on the date of the Company's initial public offering, July 2, 1997, and that all dividends for the respective Nasdaq indexes have been reinvested. The Company has never paid dividends on its common stock and has no present plans to do so. Historic stock price performance should not be considered indicative of future stock price performance.