UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 
  FORM
10-K
  ANNUAL
REPORT
 PURSUANT
TO SECTION 13 OR 15(d)
 OF
THE SECURITIES EXCHANGE ACT OF 1934
  x
              ANNUAL REPORT PURSUANT TO
      SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934
  For
the fiscal year ended December 31, 2008
  OR
  o
              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 or Other Jurisdiction of Incorporation or Organization)
              
              (I.R.S. Employer Identification Number)
  Three
Enterprise Drive
 Shelton,
Connecticut 06484
 (Address
of principal executive offices, including zip code)
  Telephone
(203) 929-8810
  
 Securities
registered pursuant to Section 12(b) of the Act:
 None
  Securities
registered pursuant to Section 12(g) of the Act:
 
 Title of Each Class
                  
                  Name of Each Exchange on Which RegisteredCommon Stock, par value $.001 per share
                  
                  Nasdaq Capital Market
  
 Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
 Yes  ̈   No
x
  Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
 Yes  ̈   No
x
  Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes  x  No   ̈
  Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405) is not contained herein, and will not be contained, to
the best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.  ̈
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.  (check one):
  Large
      Accelerated Filer  ̈
                Accelerated
      Filer xNon-Accelerated
      Filer  ̈
                Smaller
      reporting company  ̈
  Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Yes  ̈   No
x
  The
aggregate market value of the outstanding common stock, other than shares held
by persons who may be deemed affiliates of the Registrant, on June 30, 2008 was
approximately $103.8 million. At February 28, 2009, as reported on the Nasdaq
Capital Market, there were 159,089,117 shares of common stock, par value $.001
per share, of the Registrant outstanding.
  DOCUMENTS
INCORPORATED BY REFERENCE
  Parts of
the following document are incorporated by reference in Part III of this Form
10-K Report:
  (1) Proxy
Statement for the Registrant’s 2008 Annual Meeting of Shareholders—Items 10, 11,
12, 13 and 14.
  
 
  Item
1.    Business
  The following description of our
business should be read in conjunction with the information included elsewhere
in this document. The description contains certain forward-looking statements
that involve risks and uncertainties. When used in this document, the 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 the results
discussed in the forward-looking statements as a result of risk factors set
forth elsewhere in this document. See also, “Item 1A. Risk Factors” and “Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations.”
  COMPANY
OVERVIEW
  TranSwitch
designs, develops and supplies innovative highly-integrated semiconductor
solutions that provide core functionality for voice, data and video
communications network equipment.  TranSwitch customers for these
semiconductor products are the original equipment manufacturers (“OEMs”) who
supply wire-line and wireless network operators who provide voice, data and
video services to end users such as consumers, corporations, municipalities etc.
Our system-on-a-chip products incorporate digital and mixed-signal semiconductor
technology and related embedded software. In addition to our system-on-a-chip
products, we have been in the business of licensing intellectual property cores
to both OEMs as well as other semiconductor companies.  One new area
where we have made significant progress in the past couple years is in the area
of licensing of our proprietary video interconnect technology that enables the
transmission and reception of both HDMI and DisplayPort.  We have over
200 active customers, including the leading global equipment providers, and our
products are deployed in the networks of the major service providers around the
world.
  TranSwitch
is a Delaware corporation incorporated on April 26, 1988. Our principal
executive offices are located at 3 Enterprise Drive, Shelton CT 06484, and our
telephone number at that location is (203) 929-8810. Our Internet address is
www.transwitch.com. We
make available free of charge on or through our Internet website our annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K and all amendments to those reports as soon as reasonably practicable after
such material is electronically filed with or furnished to the SEC. Our common
stock trades on the Nasdaq Capital Market under the symbol “TXCC.”
 
 INDUSTRY
ENVIRONMENT
 
 Over the
past two decades, communications technology has evolved from simple analog voice
signals transmitted over networks of copper telephone lines to complex analog
and digital voice and data signals transmitted over a variety of media, such as
copper wires, fiber optic strands and wireless transmission over radio
frequencies. This evolution has been driven by substantial increases in the
number of users and new bandwidth-intensive computing and communications
applications, such as web-based commerce, streaming audio and video, Internet
Protocol television, or IPTV, and online gaming. In addition, information is
increasingly available via wired and wireless networks through a variety of
access devices, including personal computers and handheld computing devices such
as personal digital assistants, portable digital audio players, digital cameras
and cellular phones. These applications and devices are continuing to require
higher and more cost-efficient data transfer rates throughout the network
communications infrastructures that serve them.
 
 This
evolution has inspired equipment manufacturers and service providers to develop
and expand existing broadband communications markets and has created the need
for new generations of integrated circuits. Broadband transmission of digital
information over existing infrastructure requires highly-integrated mixed-signal
semiconductor products to perform critical systems functions such as complex
signal processing and converting digital data to and from analog signals.
Broadband communications equipment requires substantially higher levels of
system performance, in terms of both speed and precision, which typically cannot
be adequately addressed by traditional semiconductor products developed for
low-speed transmission applications. Moreover, products that are based on
multiple discrete analog and digital chipsets generally cannot achieve the
cost-effectiveness, performance and reliability requirements demanded by today’s
broadband marketplace. These requirements are best addressed by new generations
of highly-integrated mixed-signal and digital devices that combine complex
system functions within high performance circuitry and can be manufactured in
high volumes using cost-effective process technologies.
  2
 
 TARGET
MARKETS AND PRODUCTS
  In
addition to an extensive portfolio of standard integrated circuit products
addressing voice, data, wireless and video markets, TranSwitch supplies a number
of intellectual property core products for Ethernet and high definition video
(HDMI protocol) applications as well as custom design services. Our combination
of standard products, intellectual property cores and custom design services
enables us to serve our customers needs more fully. Today, we provide our
products and services through a worldwide direct sales force and a worldwide
network of independent distributors and sales representatives.
  Our
products and services are compliant with relevant communications network
standards.  We offer several products that combine multi-protocol
capabilities on a single chip, enabling our customers to develop network
equipment for triple play (voice, data and video) applications. A key attribute
of our products is their inherent flexibility. Many of our products incorporate
embedded programmable micro-processors, enabling us to rapidly accommodate new
customer requirements or evolving network standards by modifying the
functionality of the device via software instructions.
  We bring
value to our customers through our communications systems expertise, very large
scale integration (“VLSI”) design skills and commitment to excellence in
customer support. Our emphasis on technical innovation results in defining and
developing products that permit our customers to achieve faster time-to-market
and to develop 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 for their customers.
  The
following provides a brief description of each of our target markets and the
semiconductor solutions we provide in each of these markets:
  Optical
Transport:  This market segment includes equipment that
transports information over optical networks based on the established SONET and
SDH standards as well as the emerging networks that utilize the more recently
introduced standards for Ethernet over SONET (“EoS”) and SDH. Our products are
incorporated in Optical Transport equipment, and enable the fiber optic network
to transport information with improved efficiency, thus increasing the overall
network capacity.  Our customers in this market segment include
Fujitsu, Alcatel-Lucent, ZTE, Tejas Networks, Cisco Systems and
Ericsson.
  Broadband
Access:  This market segment includes equipment that provides
“last mile” connectivity between the end customer and the network for broadband
services. It includes systems for connectivity over copper wires based on DSL,
technology, fiber connectivity using Passive Optical Network (PON) technology or
wireless connectivity using cellular, WiMAX or other technologies. Our products
are incorporated into Broadband Access equipment, enabling telecommunications
service providers to deliver next generation services such as voice, data and
video over the broadband connection. FTTP technologies provide higher speeds
than DSL for network access for both residential and business end users. FTTP
offers speeds of service up to 1 Gigabit per seconds, or Gbps, without the
limitations of distance or the symmetry/asymmetry profiles typical in DSL. In
addition, FTTP also has the potential to virtually eliminate the cost of an
entire class of equipment in the provider's network: the outside plant
electronics. This optical broadband infrastructure enables FTTP service
providers to offer a wider range of next generation bundled services to
potentially enhance their revenue streams. Our FTTP product offerings address
PON technology and we offer specific products that comply with the two
dominant variants of this technology namely Ethernet-based PON (EPON) which has
been adopted extensively in Japan and to a lesser extent in other Asian
countries, and Gigabit PON (GPON) which is currently being deployed primarily in
North America and is expected to be deployed in several other regions worldwide.
Each of our FTTP products consists of one or two semiconductor devices either
working independently or jointly - a mixed-signal device known as a protocol
chipset and an analog device known as a transceiver. The mixed-signal chip
translates signals between analog and digital formats, and our analog chip
incorporates innovative technologies to bring photonic signals into the protocol
device.  Our customers in this market segment include Alcatel-Lucent,
Oki Electronics, Sumitomo, Nokia Siemens Networksand other ASIC Design
Center customers.
  3
  Carrier Ethernet and
Voice-over-IP:  Data and video services are the main drivers
for future network infrastructure investments, and Carrier Ethernet is the
industry’s accepted standard technology for next-generation
networks.  This market segment includes a variety of equipment
including carrier grade Ethernet routers and switches.  Our products,
used in such equipment, enable carriers to provide robust and differentiated
services using Ethernet technology in their wide-area networks. Within this new
infrastructure, voice data is also carried over Ethernet, and TranSwitch VoIP
products are market leading for use in carrier-class and enterprise-class media
gateways and access gateways and for use in residential gateway
markets. Currently, most telephony service providers maintain two separate
networks - one for legacy voice traffic and a second for data traffic. VoIP
technology compresses voice signals into discrete packets of data, thereby
enabling the voice signals to be transmitted over lower-cost networks originally
designed for data-only transmission. VoIP technology is used in numerous new
types of communications equipment, such as next generation carrier- and
enterprise-class gateways, soft switches, digital loop carriers, IP DSL access
multiplexers, media terminal adapters, and home gateways for use by consumers
and small businesses. These VoIP technology-based devices enable more efficient
and cost-effective voice transmissions than their legacy circuit-switched
equipment counterparts. In addition to significant cost savings, VoIP also
enables advanced services that traditional telephony could not support. VoIP
technology enables and enhances features such as unified messaging and managed
services that provide additional value to consumers and businesses and allow
service providers to enhance revenue opportunities. Our customers in this market
segment include ZTE, Alcatel-Lucent and Tellabs.
  Non-Telecommunications:  In
2008, we began to license functional blocks for the transmission and reception
video data through our high-speed video interconnects (both HDMI and
DisplayPort).  We expect this business to grow in 2009 and beyond as
we expand our product offering in this area.  Additionally, for the
past several years we have been licensing our Ethernet interconnect technology
both to enable Fast Ethernet and Gigabit Ethernet. In addition to technology
licensing, our design services unit leverages our integrated circuits (IC)
design expertise, internal processes, tools and foundry relationships to develop
and supply IC products to customers in a variety of industries besides
telecommunications. Our customers in this market segment currently include
various integrated circuit manufacturers and certain defense
contractors.
  Telecommunications Industry
Overview
  Investment
in telecommunications infrastructure is being driven primarily by the need for
higher bandwidths, more ubiquitous connectivity and more flexibility of
services.  In the US, Canada and Western Europe there has been an
extensive telecommunications infrastructure in place for several decades;
however, this infrastructure was designed primarily for voice services, and is
in dire need of replacement in order to provide the high data bandwidth and
flexibility required by current and future services.  In other parts
of the world, such as China and India, the need for infrastructure expansion is
being driven by the rapidly expanding global economy. These infrastructure
requirements are driven by substantial increases in the number of users and new
bandwidth-intensive computing and communications applications, such as web-based
commerce, streaming audio and video, Internet Protocol television, or IPTV,
and online gaming. In addition, information is increasingly available via wired
and wireless networks through a variety of access devices, including personal
computers and handheld computing devices such as personal digital assistants,
portable digital audio players, digital cameras and cellular phones. These
applications and devices are continuing to require higher and more
cost-efficient data transfer rates throughout the network communications
infrastructures that serve them.
  This
evolution has inspired equipment manufacturers and service providers to develop
and expand existing broadband communications markets and has created the need
for new generations of integrated circuits. Broadband transmission of digital
information over existing infrastructure requires highly-integrated mixed-signal
semiconductor products to perform critical systems functions such as complex
signal processing and converting digital data to and from analog signals.
Broadband communications equipment requires substantially higher levels of
system performance, in terms of both speed and precision, which typically cannot
be adequately addressed by traditional semiconductor products developed for
low-speed transmission applications. Moreover, products that are based on
multiple discrete analog and digital chipsets generally cannot achieve the
cost-effectiveness, performance and reliability requirements demanded by today's
broadband marketplace. These requirements are best addressed by new generations
of highly-integrated mixed-signal and digital devices that combine complex
system functions within high performance circuitry and can be manufactured in
high volumes using cost-effective process technologies.
  Since
2001, when the worldwide telecommunications industry experienced a major
correction, the market has been undergoing a gradual recovery.  The
path to recovery has been shaped by a number of factors such as industry
consolidation, globalization, deregulation and competition.
  In recent
years, there were a number of mergers and acquisitions among North American
telecommunication carriers (“telcos”) and Western Hemisphere communications
OEMs.  As companies merge or consolidate, the rate of ordering,
purchasing and deploying new equipment typically slows.  As these
consolidations complete, we are seeing a shift in demand toward newer
technologies that we introduced into the market in the last several
years.  In 2006, 2007 and 2008, we saw demand for legacy network
products decline, which is an indicator that the industry is ready to replace
existing networks with new networks.
  4
  Communications
service providers, internet service providers, regional Bell operating companies
and inter-exchange carriers generally closely monitor their capital
expenditures. Spending on voice-only equipment has been slowing over the last
few years, while spending on equipment providing the efficient transport of data
services on existing infrastructure continues to grow. More importantly to us,
major infrastructure initiatives are underway where telcos are building new,
end-to-end internet protocol (IP)-based, next-generation
networks.  The clearest example of this is British Telecom’s 21st Century
Network.  Demand for new, high bandwidth services such as video
conferencing, broadband audio, high speed internet and other data services is
placing an increased burden on existing public network infrastructure.
Regulatory changes and advances in technology have fostered an intensively
competitive environment for service providers. They have to provide a variety of
services over the same infrastructure in order to maximize the revenue from
their network investment and minimize the risk of losing customers to their
competitors by bundling these services.  Competition between telcos
and cable TV providers offering “triple play” services (voice, data and video)
is driving equipment spending for broadband access, carrier-class
routers/switches, and metro optical gear. Equipment vendors and communications
IC suppliers with the right products and technologies will be major
beneficiaries of this spending by telcos and cable TV service
providers.
  Wireless
networks are also being driven by new, data oriented services requiring high
bandwidth.  Third generation wireless infrastructures, such as UMTS
and CDMA2000, and fourth generation wireless infrastructures based on LTE and
/or WiMAX will be heavily based on IP and Ethernet technologies.  The
convergence of the wire-line and wireless network infrastructures is underway,
driven by the desire of service providers to provide “quadruple play” services
(voice, data, video and mobility) to further enhance their competitive position
and profitability.
  The Importance of
Communications Standards in our Telecommunications Semiconductor
Business
  In
an effort to provide interoperability among communication networks and
equipment, the communications industry has established numerous standards and
protocols that address connectivity issues between networks and network
equipment. Communication standards and protocols for transmission of information
such as voice, high speed data or video over electrical, optical or wireless
media have been implemented to ensure that equipment from different
manufacturers and the various public and private networks can communicate with
each other reliably and efficiently. The VLSI devices supplied by us conform to
these standards, enabling such interoperability across the
networks.
  In the
Optical Transport arena, SONET and SDH standards were defined for efficient and
reliable transport of information over optical fiber. SONET is primarily a North
American standard, while SDH is its international counterpart. Introduced in the
late 1980s, SONET and SDH were initially employed primarily for the transport of
voice traffic in telephone networks. Prior to the introduction of the SONET/SDH
standards, Asynchronous/PDH standards were in use for transmission over metallic
cables, radio and optical fiber. Asynchronous Transfer Mode (ATM) is a
higher-level standard that enables public networks, internet, WAN and LAN
systems designers to provide a mix of services to network users. ATM allows
communication service providers to reduce the impact of network congestion,
assure quality of service and to provide mixed high-speed and high-volume data
communications, voice, video and imaging services. This ability allows the
communication service providers to generate more revenue by offering more
services to their customers.
  Recently,
industry standards have emerged for carrying Ethernet over SONET/SDH. Ethernet
is a protocol that is used throughout LANs. Increased requirements for
connectivity between corporate LANs and WANs are driving the need for bridging
Ethernet protocol over the public network. Communication service providers are
beginning to deploy EoS technology to provide data services because it is an
efficient means of transporting data over their embedded infrastructure and
enables them to generate additional revenue.
  Broadband
Access technologies utilize IP as a standard protocol to enable packetized data
to be forwarded, transmitted, and routed between networks. IP packets are often
carried over ATM which serves as a transport layer for the IP packets
particularly in DSL networks.   In newer DSL deployments, ATM is
replaced by Carrier Ethernet as a transport layer. Carrier Ethernet is a new and
evolving technology which brings with it a plethora of new standards that must
be implemented by the equipment and hence by the underlying semiconductor
components.  Fiber to the home (FTTH) and fiber to the curb (FTTC)
deployments are also based on new technologies such as GPON or EPON each of
which has a number of associated standards.
  5
  In order
to deploy new infrastructures and transmission protocols, communication service
providers are demanding improved time to market of cost-effective,
differentiated products from OEMs. The complexity of the equipment, increasing
cost pressures and the need for high reliability and standards compliance
mandate the use of VLSI devices incorporating a high degree of functionality.
OEMs recognize that, similar to the trend experienced in the computer industry,
the functionality incorporated into VLSI devices is contributing an increasing
share of the intellectual property and the value of network equipment. The
design of VLSI devices contained in Optical Transport, Broadband Access or
Carrier Ethernet equipment requires specialized expertise in mixed-signal
semiconductor design and implementation, in-depth knowledge of
telecommunications and data communications standards and systems engineering
expertise. Expertise in mixed-signal device design is relatively uncommon, and,
as a result, OEMs needing these capabilities often seek independent
semiconductor vendors. However, many semiconductor vendors lack the
communications industry knowledge and experience, as well as familiarity with
the standards, to be able to contribute significant value to the OEMs’ systems
designs. Consequently, OEMs require a semiconductor vendor that understands
their markets and the applicable standards and is able to provide a broad range
of cost-effective semiconductor devices. Our core competencies include the
ability to understand these standards and protocols and our experience in
designing these specialized VLSI products.
  Applications of our Products
in the Network
  Our
products are targeted primarily at the Access (including equipment at the
customers’ premises) and Metro segments of network infrastructure (as further
described below). The following briefly describes our view of these market
segments and some typical equipment types that may include our VLSI
products.
  The
Access Network
  This
Access portion of the network infrastructure interconnects end user locations
(residences or businesses) to the nearest service provider location (usually the
telephone company central office). The primary functions performed by equipment
in the Access network are aggregation and distribution of traffic, and
interconnection to the switching or transmission equipment that connects to the
WAN. The Access network may consist of electrical, optical or wireless
transmission equipment. Our Broadband Access products are used in a variety of
equipment in the Access network. For example, our Diplomat, ASPEN and Cubit
product families are used in equipment that provides DSL services or fiber based
FTTH and FTTC access services.  Our Mustang, Apollo, and Atlanta
products are used in FTTH or FTTC equipment located at or near customer premises
to either provide fiber-based access services to residences and business and, in
the case of Atlanta, route these services throughout a home or
building.  Our products are also used in Base Station equipment for
cellular phone service. Our Optical Transport products are used in Multi-Service
Provisioning Platform (MSPP) and Multi-Service Access Network (MSAN) equipment
that serve as primary vehicles for aggregation and distribution of traffic in
the Access network.
  The
Metro Network
  The Metro
network infrastructure is principally an optical fiber-based
network.  It provides high-speed communications and data transfer
covering an area larger than a campus area network and smaller than a WAN,
interconnects two or more LANs, and usually covers an entire metropolitan area,
such as a large city and its suburbs. In addition to interconnecting locations
within the metropolitan area, the Metro network connects to the Access portion
of the network and the long-haul or core network which interconnects different
metropolitan networks across a region, a country or internationally. Equipment
in the Metro network perform functions such as switching or routing of traffic,
processing of data in various protocols, and further aggregation and
distribution of traffic.  Our Optical Transport products are used in a
range of Metro network equipment such as Dense Wave Division Multiplexers
(DWDM), Coarse Wave Division Multiplexers (CWDM), Multi-Service Provisioning
Platforms (MSPP), Digital Cross-connect Systems (DCS) and Add-Drop Multiplexers
(ADM).
  Our Products and the
Functions they Serve
  We
believe that we are very well positioned to participate in the anticipated
telecommunications growth cycle during the next several years.  This
is because we anticipated many of the market trends, at least directionally if
not quantitatively, and aligned our product development direction
accordingly.
 
 Our
products address four high growth market segments within
telecommunications:
  6
 
 1.
              Optical
      Transport
 2.
              Broadband
      Access including FTTH/FTTC optical
access
 3.
              Carrier
      Ethernet
 4.
              Voice
      over IP
 
 Within
each of these segments, we have developed a number of product families as
described below:
 
 Optical
Transport Products
 
 The need
for data transport across existing SONET, SDH and PDH networks is effectively
addressed through our EtherMap and EtherPHAST product
families.  Low-level grooming of TDM circuits will continue to be a
requirement through the transition to IP.  The grooming will be done
predominantly in smaller Access platforms rather than larger Metro platforms.
The VTXP products, optimized for the access network, will continue to be
applicable as will our broad line of mappers and framers. Optical Transport
products include SONET/SDH/PDH mappers and framers and tributary switching and
grooming products.
  ·
              Sonet/SDH/PDH
      Mappers and Framers
  Our
products address the predominant formats and data speeds employed in the access
portion of the network.  We provide solutions that cover both North
American (SONET/ Async) as well as International (SDH/PDH)
standards.  Data rates covered by our products range from 1.5 mb/s to
2.5 Gb/s.  This product family includes devices that enable the
transport of Ethernet and other types of data traffic over SONET/SDH and
Asynch/PDH networks.
 
 ·
              Tributary
      Switching and Grooming Devices
  This
category includes switch fabric devices and adjunct switching devices that
enable traffic to be switched or re-arranged (groomed) to use network capacity
more efficiently.
 
 Broadband
Access Products
 
 We have
successfully participated in the DSL market with our CUBIT and ASPEN products
based on our patented CellBus architecture.  CellBus is based on ATM
technology, which was the predominant standard for DSL.  Industry
emphasis is shifting away from ATM based equipment towards IP/Ethernet-centric
DSL equipment.  We anticipated this evolution, and developed the new
Diplomat product line which addresses the latest industry standards in this
area.  The Diplomat family of products will address equipment for
broadband services over copper (ADSL2+, VDSL) as well as fiber-to-the-home and
fiber-to-the-curb services (GPON).  The acquisition of Centillium
Communications, Inc, has enabled us to significantly enhance our Broadband
Access product portfolio with the addition of the Mustang, COLT and Apollo
products that address EPON applications.
  ·
              ATM
      Controllers
 
 ATM
Controllers include TranSwitch’s CellBus line of products used extensively in
DSLAM and APON/BPON OLT equipment by a large number of vendors. These devices,
with built in switch engine, provide the single most cost-efficient means of
transporting and processing ATM cells in such gear. These devices range in port
density from 16-ports to 124-ports and in speed from STS-3/STM-1 to
STS-12/STM-4.
 
 ·
              FTTP
      Physical Layer Products
 
 Our
physical layer solution consists of the Apollo chipset that supports multiple
applications from a single, efficient footprint. This chipset integrates a broad
range of functionality into a small, standards-compliant package, without the
need for a separate microcontroller. The Apollo transceiver chip enables control
of point-to-point data traffic over fiber, and targets various areas of the
continuous data mode environment for data rates, from 100 Mbps through the
higher data rate architectures known as OC3, OC12, Gigabit Ethernet, and OC48.
Apollo addresses systems vendors’ and service providers’ requirement and offers
applications on a wide spectrum of data-delivery modes for deployment on a
global basis.
 
 ·
              FTTP
      Protocol Layer Products
 
 7
  Protocol
processors interface with the data streams to and from a transceiver, managing
the bi-directional flow of information for delivery to an end user. End users
may then use these streams of data to access the Internet over high speed
circuits, connect voice devices (VoIP or traditional analog telephones), receive
video broadcasts, and access video-on-demand (VoD) services.
 
 Our
protocol layer solutions include a mixed-signal EPON protocol engine and bridge
for CO-based optical line termination, the ColtTM family, as well as an EPON
protocol engine and bridge for CPE-based optical network units, the MustangTM
family. Centillium optical solutions are compliant with the latest industry
standards, including IEEE 802.3ah.
 
 Our Colt
100 SoC supports the complex set of capabilities required by service providers
deploying CO equipment in Ethernet Passive Optical Networks. This product is a
highly integrated, cost effective, mixed-signal EPON protocol processing
solution that is fully compliant with IEEE 802.3ah.
 
 Our
Mustang product family consists of our ME250 and proprietary ME300 products.
These highly-integrated, low power and turnkey FTTH solutions are ideal for
service providers deploying EPON in customer premise equipment (CPE) to deliver
premium triple play services such as bandwidth-intensive IPTV. We have been
heavily engaged in the development of a gigabit Ethernet Passive optical
networking, or GEPON, solution for the FTTP market. We introduced our newest
generation of GEPON chips, called ME300 in 2007.
 
 Carrier
Ethernet Products
 
 As
carriers move to packet-based networks for more and more of their
infrastructure, the need for both pure carrier class Ethernet devices as well as
transition products continues to grow.  Our Envoy line of Ethernet
controllers and switches allows for differentiation and creates the opportunity
for market leadership with trend setting metro Ethernet features. As an
important complement to our Optical Transport products, our PacketTrunk family
of circuit emulation and clock recovery devices provide vital interworking
capability between the new data (IP) based services and infrastructures and the
legacy voice (TDM) based services and infrastructures.  The
development of 10G PHY devices creates opportunities in the emerging high speed
Ethernet space and also brings future competitive advantages by giving us the
capability to provide more vertically integrated devices.
  ·
              Circuit
      Emulation Devices
  Circuit
Emulation, which is complementary to VoIP, offers a graceful, robust, and
affordable migration path for transporting T1, E1, T3 and E3 circuits over IP,
MPLS, and tag-switched Ethernet networks.
  ·
              Ethernet
      Switches
  Ethernet
Switches examine header information on an incoming packet such as
source/destination address, VLAN tags, and MPLS labels to decide which output
port to send the packet to.
  ·
              Ethernet
      Controllers
  Ethernet
Controllers manage Ethernet traffic to and from multiple physical interfaces,
providing important functions such as traffic aggregation and
flow-control.  Since Ethernet traffic is inherently “bursty” in
nature, these functions are necessary to ensure efficient utilization and robust
operation of the network.
  8
  ·
              Ethernet
      PHY
  Our
TransPHY 10-Gigabit PHY devices address copper (CX4) and fiber (LX4) 10-Gigabit
ethernet connectivity applications.  Our products feature industry
leading performance in terms of transmission distance, power consumption and
device footprint.
 
 Voice-over-IP
Products
 
 We
leverage our expertise in mixed-signal system-on-chip technology and embedded
software applications to deliver VoIP products for carrier-class media gateway,
access gateway and residential gateway markets. Comprising VoIP processors for
next-generation voice, media and wireless gateways along with carrier-grade VoIP
products for the rapidly growing customer premise equipment (CPE) market, our
EntropiaTM and
AtlantaTM product
families provide system designers with broad flexibility while delivering a
strong combination of performance and features.
 
 ·
              Media
      Gateway
 
 Entropia,
our flagship VoIP product line, is a series of advanced VoIP system-on-chip
processor. The Entropia III and IV can process up to 1,008 voice channels for
voice and media gateways, wireless infrastructure gateways, Class 4 and 5 switch
replacements, digital loop carriers, voice-enabled IP routers and IP private
branch exchange (PBX) systems. Entropia II LP is our VoIP product that processes
up to 336 or 96 voice channels per chip. Entropia II LP is marketed for use in
central office and enterprise voice equipment that require mid-level channel
densities and central office equipment that process both DSL and VoIP
signals.
 
 EntropiaTM
III-C is the newest member of our suite of system-on-chip (SoC) VoIP solutions
aimed at fast-growing multi-service access network (MSAN) applications such as
“plain old telephone service” (POTS) replacement. Entropia III-C scales the
market-proven features and performance advantages of our flagship system into a
smaller-sized, highly integrated chipset with cost structures and channel
densities that squarely target the requirements of business communications and
subscriber loop infrastructures. With a single-chip design and low per-channel
cost, the Entropia III-C provides a powerful and cost-efficient platform for
deployment within MSAN and Digital Loop Carrier (DLC) environments.
Carrier-proven algorithms improve voice quality, while the highly integrated
design reduces power consumption compared to other approaches. The chipset’s
high degree of integration minimizes external component counts and printed
circuit board, or PCB, layers to reduce overall system bill-of-materials (BOM)
costs.
 
 ·
              Customer
      Premises
 
 Our
Atlanta product family is a voice processing SoC for customer premises equipment
that supports toll-quality telephone voice, fax and routing functionality over
any broadband access network. System designs based on the Atlanta product family
can connect directly to a broadband modem or be added as part of a small
office-home office, or SOHO, network. The Atlanta A70TM product is the family’s
entry level SoC while the A80TM SoC adds the capability to interface with any
WiFi or high-speed adapter. The A90TM SoC is optimized for the SOHO market with
four voice channels and a high-performing routing engine available at 100
Mbit/second. At the top of the Atlanta family, the A100TM SoC adds powerful,
enterprise-level security and encryption of all data and voice.
  Serial Interconnect
Technology Licensing
  In
addition to our telecommunications portfolio of standard products, we are a
recognized worldwide leader in the licensing of interconnect
technologies.  Our intellectual property serves as a key building
block for many varied semiconductor applications ranging from consumer
electronics to home network equipment to industrial and automotive
applications.  Starting in 2006, we began licensing interface
technology, first for Ethernet with our MystiPHY line of IP cores acquired from
Mysticom Ltd in January of that year.  These technologies have been
adopted and incorporated by many of the world’s leading semiconductor and
equipment manufacturers.  In addition to the licensing of Ethernet
interface technology,  in 2008, we introduced our HD-PXL family of
products addressing multimedia interconnect standards specifically addressing
the HDMI and DisplayPort standards for consumer electronics and PC
appliances.
  9
 
 ·
              MystiPHY
 
 Our
MystiPHY 110 and MystiPHY 1011 DSP-based Ethernet transceiver cores address 10 /
100 megabit per second and 10/100/1000 megabit per second Ethernet data-rate
specifications.  Both cores are fully compliant with IEEE standards,
and the DSP-based design approach provides superior performance that exceeds
standard requirements for cable length and noise immunity, while providing
exceptionally low power consumption and small die size.
 
 ·
              HD-PXL
 
 Our
HD-PXL transmitter and receiver Intellectual Property (IP) cores can be used for
a variety of digital video and audio applications operating over standard DVI,
HDMI, or DisplayPort cables. The HD-PXL cores are compliant with DVI 1.0 and
HDMI 1.3 high definition standards and support a wide range of video interface
modes. Our cores support transmission rates of both 2.25 gigabit/second and 3.5
gigabit per second.
  Technology
  One of
our core competencies is knowledge of the telecommunications and data
communications landscape. Specifically, our systems engineering personnel
possess substantial telecommunications and data communications design
experience, as well as extensive knowledge of the relevant standards. This
includes not only a thorough understanding of the actual written standards, but
also an awareness of and appreciation for the nuances associated with the
standards necessary for assuring that device designs are fully
compliant.
  Complementing
our communications industry expertise is our VLSI design competence. Our VLSI
design personnel have extensive experience in designing high-speed digital and
mixed-signal devices for communications applications. These designs require a
sophisticated understanding of complex technology, as well as the specifics of
deep sub-micron manufacturing processes and their resulting impact on device
performance. We have developed a large number of VLSI blocks and intellectual
property cores that operate under the demanding requirements of the
telecommunications and data communications industries. These blocks and
intellectual property cores have been designed using standard VLSI-oriented
programming languages such as VHSIC Hardware Descriptive Language (VHDL) and
Verilog, and have been authenticated with standard verification
tools.
  We have
developed proprietary tool sets, called “Test Benches,” that facilitate rapid
development of VLSI products and help assure that our products are standards
compliant and meet customer requirements. These Test Benches consist of
behavioral models of all applicable functions in a high-level design environment
and also include test signal generators and analyzers such as models of
SONET/SDH signals. Systems engineers use Test Benches to test new architectural
concepts, while VLSI designers use Test Benches to ensure that the device
conforms to product specifications.
  In
addition to the extensive hardware functionality, many of our products utilize
embedded processors that are software programmable. This approach enables us to
develop products with higher levels of functionality and flexibility than are
possible with purely hardware based solutions. A digital signal processor, as it
relates to communications applications, encodes digital data for transmission
over bandwidth-limited media, such as copper telephone lines, and recovers the
encoded data at the receiving end. Our software programmable digital signal
processor is optimized for communications applications and provides high
processing bandwidth with low power requirements. This digital signal processor
can be programmed for several different applications, such as DSL and VoIP
networking. This software programmable digital signal processor technology gives
us the advantage of field programmability of devices. Field programmability
means that service providers can remotely upgrade their equipment to address new
standards or enable improved features, thereby extending the life cycles of
their equipment while incurring lower costs.
  Our Envoy
and EtherMap products are multi-million gate devices, which are implemented in
0.18 and 0.13 micron complementary metal oxide semiconductor (CMOS) silicon
technologies. They incorporate high speed mixed signal
circuitry.  Some of these devices are equipped with embedded
processors that provide added functionality through software.
  Other
products that incorporate programmability are the ASPEN family of ATM
processors, and the PHAST series of products that target simultaneous mapping
and transport of ATM/point-to-point protocol (PPP) and TDM services over fiber
optic networks.  The T3BwP and TEPro VLSI devices support both data
and management planes with an on-chip Reduced Instruction Set Computing (RISC)
processor supporting full standards-based management and performance
monitoring.
  10
  We have
developed substantial expertise in communications algorithms. Communications
algorithms are the processes and techniques used to transform a digital data
stream into a specially conditioned analog signal suitable for transmission
across copper telephone wires. We possess a thorough understanding of, and
practical experience in, the process of transmitting and receiving a digital
data stream in analog form. We also have significant experience developing
algorithms to enable voice compression, echo cancellation and telephony signal
processing. This expertise allows us to design highly efficient algorithms that
in turn enable us to create products with high performance, re-programmability
and low power consumption.
  We are
experts in the area of highly complex, high-speed digital chip development. We
design both the logic and the physical layout for our products. This design
expertise has enabled us to develop tightly integrated digital chips that have
small form factors with low power consumption. We have continued to improve upon
our internal chip layout capabilities and our design for test capability, both
of which have resulted in significant improvements in silicon efficiency,
silicon testability and time-to-market. Our system-on-a-chip definition,
architecture, verification expertise and design methodology ensure that hardware
and software architectural trade-offs yield desired performance testing from our
VLSI solutions. The system-on-a-chip performance simulation, emulation,
verification and stress testing, using Test Benches and test equipment, ensure
that our products meet carrier class quality, performance and reliability
requirements.
  We
have expertise in developing software embedded in our semiconductor products
that addresses the needs of network equipment manufacturers and service
providers. In addition, our understanding of various operating systems and
personal computer environments allows us to create software embedded on the chip
that provides for simple installation and operation.
  The
expertise of our personnel, our rigorous design methodology and our investment
in state-of-the-art electronic design automation tools enable us to develop the
complex and innovative products our customers demand.
  Strategy
  Our goal
is to be the leading supplier of innovative, complete VLSI solutions to
telecommunications and data communications OEMs worldwide. The key elements of
our business strategy include the following:
  Provide
Complete Solutions Within Target Markets
  We offer
network equipment OEMs chip sets that represent complete solutions for
SONET/SDH, Asynchronous/PDH and ATM/IP, VoIP and FTTP applications. In addition
to providing families of VLSI devices, we offer OEM customers the
following:
  •
              embedded
      software  in the computer chip for control of our configurable
      devices;
 
 •
              product
      reference design models for both hardware and software
      applications;
 
 •
              evaluation
      boards and reference design;
 
 •
              OEM
      product design support;
 
 •
              multi-tier
      applications support; and
 
 •
              product
      technical and design documentation.
  Our
“chip-set” approach allows OEMs to optimally configure their products while
maintaining product compatibility over multiple generations. This approach
allows equipment vendors to selectively upgrade their products with
next-generation higher functionality VLSI devices. We have extended this
approach to provide seamless integration of SONET/SDH, Asynchronous/PDH, ATM/IP
VoIP and FTTP applications.
  11
  Continue to Promote the Deployment of
Programmable Devices
  We will
continue to develop highly integrated products that combine the use of embedded
software-programmable blocks and optimized hardware blocks in order to provide
an optimal level of performance and flexibility to our
customers.  This flexibility enables customers to adapt the product
for their unique needs or to accommodate changes resulting from emerging
telecommunications standards.
  Seek
Early Market Penetration through Customer Sponsorship
  We
seek to develop close sponsoring relationships with strategic OEMs during
product development in order to secure early adoption of our solutions. We
believe that OEMs recognize the value of their early involvement through
sponsorship of our products, as they can design their system products in
parallel with our product development, thereby accelerating their time to
market. In addition, we believe that our sponsoring relationships with leading
OEMs help us to obtain early design wins and help reduce risks of market
acceptance for our new products.
  Focus
on Mixed-Signal Applications
  We seek
to identify applications requiring our mixed-signal VLSI device design
capabilities. By leveraging both our industry knowledge and the special design
skills required for mixed-signal devices, we are able to identify and implement
optimal combinations of design elements for desired analog and digital
functionality targeted toward the specific needs of network equipment OEMs. Our
experience and expertise provides our customers accelerated time to market,
better performance and lower costs than combinations of separate digital and
analog solutions.
  Partner With Selected
Foundries
  We work
with select third-party foundries to produce our semiconductor devices. This
approach allows us to avoid substantial capital spending, obtain competitive
pricing and technologies, and retain the ability to migrate our products to new
process technologies to reduce costs and optimize performance. Our design
methodology enables the production of our devices at multiple foundries using
well-established and proven processes. We engage foundries that are ISO
9001:2000 certified for quality and which use only semiconductor processes and
packages that are qualified under industry-standard requirements.
  Marketing and
Sales
  Our
marketing strategy focuses on key customer relationships to promote early
adoption of our VLSI devices in the products of market-leading communications
equipment OEMs. Through our customer sponsorship program, OEMs collaborate on
product specifications and applications while participating in product testing
in parallel with our own certification process. This approach accelerates our
customers’ time-to-market delivery while enabling us to achieve early design
wins for our products and volume forecasts for specific products from these
sponsors.
  Our
sales strategy primarily focuses on worldwide suppliers of high-speed
communications and communications-oriented equipment. These customers include
telecommunications, data communications, wireless and wire-line equipment,
internet access, customer premise, computing, process control and defense
equipment vendors. In addition, we target emerging technology leaders in the
communications equipment market that are developing next generation solutions
for the telecommunications and data communications markets. We identify and
address sales opportunities through our worldwide direct sales force and our
worldwide network of independent distributors and sales
representatives.
  Our
worldwide direct sales force, technical support personnel and design engineers
work together in teams to support our customers. We have technical support
capabilities located in key geographical locations throughout the world as well
as a technical support team at our headquarters as a backup to the field
applications engineers.
  We have
established foreign distributors and sales representative relationships in
Australia, Belgium, Brazil, Canada, China, Germany, India, Ireland, Israel,
Italy, Japan, Korea, Luxembourg, Mexico, the Scandinavian countries, Spain,
Switzerland, Taiwan, Turkey and the United Kingdom. We also sell our products
through domestic distributors and a network of domestic sales representatives.
We have regional sales and technical support capabilities in Boston,
Massachusetts; Fremont and San Jose, California; Raleigh/Durham, North Carolina;
Paris, France; Rome, Italy; Berkshire, England; Hilversum, Netherlands;
Brussels, Belgium; New Delhi and Bangalore,  India; Anyang-City,
Korea; Tokyo, Japan; Shanghai, China and Taipei, Taiwan, as well as at our
headquarters facility in Shelton, Connecticut.
  12
  Customers
  We have
sold our products and services to over 400 customers since shipping our first
product in 1990. Our customers include public network systems OEMs that
incorporate our products into telecommunications systems, WAN and LAN equipment
OEMs, internet-oriented OEMs, communications test and performance measurement
equipment OEMs and government, university and private laboratories that use our
products in advanced public network, and WAN and LAN developments. A small
number of our customers have historically accounted for a substantial portion of
our net revenues.
  Note
9 of the Notes to Consolidated Financial Statements provide data on major
customers for the last three years.
  Research and
Development
  We
believe that the continued introduction of new products in our target markets is
essential to our growth. As of December 31, 2008, we had 174 full-time employees
engaged in research and product development efforts. We employ engineers who
have the necessary VLSI, high speed mixed signal, firmware, software, hardware,
physical design, verification, and validation expertise and development
experience.  These engineers are responsible for delivering VLSI and
Evaluation/Demo products for telecommunications and data communications
applications.   Research and development expenditures for the
years ended December 31, 2008, 2007 and 2006 were $24.6 million, $21.7 million,
and $21.2 million, respectively.
  All
products are developed and delivered using documented design processes (product
life cycle) operating under a quality management system certified to meet the
ISO 9001:2000 international standard.  Our design tools and
development environment are continuously reviewed and updated to improve design,
verification, fabrication and validation methodology, design flow and processes
of our product life cycle.
  From time
to time, we subcontract design services and acquire products from third parties
to enhance our product lines.  Our internal research and development
organization thoroughly reviews the external development processes and the
design of these products as part of our quality assurance process.
  Patents and
Licenses
  Through
the end of 2008, we have been issued or became an assignee of 66 presently
maintained United States patents with an additional 25 patents pending in the
United States. Of that number two patents are co-assigned. Of the 66 United
States patents, we were granted 8 in 2008. Nine of the 25 pending patents were
applied for in 2008 and they cover HDMI and Systems on a Chip innovations. Many
of the United States issued and pending patents were also filed internationally.
For one or more of our United States patents, we have coverage in Canada, China,
Taiwan, Israel, Japan, France, Germany, United Kingdom, Belgium, Italy, Sweden,
Spain, and Hong Kong. Internationally, there are patents pending either in
specific countries, in the European Patent Office (EPO) or under the Patent
Cooperative Treaty (PCT). In addition we have lifetime licenses to use over 23
additional US patents and their foreign derivatives.
  We cannot
guarantee that our patents will not be challenged or circumvented by our
competitors, and we cannot be sure that pending patent applications will
ultimately be issued as patents. Under current law, patent applications in the
United States filed before November 29, 2000 are maintained in secrecy until
they are issued, but applications filed after November 29, 2000 (and foreign
applications) are generally published 18 months after their priority date, which
is generally the filing date. The right to a patent in the United States is
attributable to the first to invent, while in most other jurisdictions the right
to a patent is obtained by the first to file the patent application. We cannot
be sure that our products or technologies do not infringe patents that may be
granted in the future based upon currently pending non-published patent
applications or that our products do not infringe any patents or proprietary
rights of third parties. From time to time, we receive communications from third
parties alleging patent infringement. If any relevant claims of third-party
patents are upheld as valid and enforceable, we could be prevented from selling
our products or could be required to obtain licenses from the owners of such
patents or be required to redesign our products to avoid infringement. We cannot
be assured that such licenses would be available or, if available, would be on
terms acceptable to us or that we would be successful in any attempts to
redesign our products or processes to avoid infringement. Our failure to obtain
these licenses or to redesign our products could have a material adverse effect
on our business.
  13
  We also
have been granted registration of 16 presently maintained trade or service marks
in the United States and we have one more trademark registration awaiting
approval. We have also obtained 4 presently maintained trademark registrations
under the European Community Trademark (ECT) procedure and have two pending
trademarks awaiting approval in Canada and the ECT.
  Our
ability to compete depends to some extent upon our ability to protect our
proprietary information through various means, including ownership of patents,
copyrights, mask work registrations and trademarks. While no intellectual
property right of ours has been invalidated or declared unenforceable, we cannot
assure that such rights will be upheld in the future. We believe that, in view
of the rapid pace of technological changes in the communication semiconductor
industry, the technical experience and creative skills of our engineers and
other personnel are the most important factors in determining our future
technological success.
  We have
entered into various license agreements for products or technology exchange. The
purpose of these licenses has, in general, been to obtain second sources for
standard products or to convey or receive rights to certain proprietary or
patented cores, cells or other technology.
  We sell
our products for applications in the telecommunications and data communications
industries, which require our products to conform to various standards that are
agreed upon by recognized industry standards committees. Where applicable, we
design our products to be in conformity with these standards. We have received
and expect to continue to receive, in the normal course of business,
communications from third parties stating that if certain of our products meet a
particular standard, these products may infringe one or more patents of that
third party. We review the circumstances of each communication, and, in our
discretion and upon the advice of legal counsel, have taken or may take in the
future one of the following courses of action: we may negotiate payment for a
license under the patent or patents that may be infringed, we may use our
technology and/or patents to negotiate a cross-license with the third party or
we may decline to obtain a license on the basis that we do not infringe the
claimant’s patent or patents, or that such patents are not valid, or other
bases. We cannot be sure that licenses for any such patents will be available to
us on reasonable terms or that we would prevail in any litigation seeking
damages or expenses from us or to enjoin us from selling our products on the
bases of any of the alleged infringements.
  Manufacturing and Design
Services
  We
produce a variety of VLSI devices utilizing the Fabless Semiconductor Model.
This means that we do not own or operate any of the foundries used in the
production of our devices. Rather, we contract with established independent
foundries to manufacture all of our devices including silicon wafer production,
package assembly and testing. In most cases we maintain a fully functional test
environment for the purpose of production test development, low volume
production testing, and product certification. Once the device reaches
production volume, the test is transferred to a high volume, lower cost test
facility. In some cases, the test development is done at the subcontractor
site.
  This
approach permits us to focus on our design strengths, minimize fixed costs and
capital expenditures and access the most advanced manufacturing technologies. It
also allows us to maintain an effective and flexible supply chain which is
managed using fully integrated ERP system.  Quality assurance and
customer service activities are all performed at our Shelton, Connecticut and
Fremont, California facilities. Finished goods inventory, packing and shipping
are performed either in our Shelton, Connecticut facility or managed at our
subcontractors.
  Our
Shelton, Connecticut facility is registered toISO 9001:2000by TUV
Rheinland of North America, Inc.  We use only ISO certified suppliers
in the manufacture of our products.
  Our
manufacturing objectives and emphasis are focused in the following
areas:
  •
              maximizing
      the reliability and quality of our products utilizing world class foundry
      partners;
 
 •
              leveraging
      the most advanced semiconductor manufacturing technologies
      available;
 
 •
              maintaining
      a flexible supply chain to meet our customer’s demand and delivering on
      time;
 
 •
              minimizing
      capital and other resource requirements by subcontracting
      capital-intensive manufacturing;
and
  14
  •
              achieving
      a gross margin commensurate with the value of our
  products.
 
 Our
products and services can be categorized as follows:
  ·
              VLSI
      devices - This category covers the majority of our products. We purchase
      and own the unique mask sets (tools) required for the production of our
      silicon wafers. We then purchase the wafers from the foundry as needed
      which are shipped directly to one of our wafer sort or assembly partners.
      They are then stored until we issue an assembly or test release based on
      demand. We use a variety of assembly and test suppliers to complete the
      production process. We have supplier agreements in place with most of
      these suppliers including TSMC and IBM for wafers and Amkor and STATS
      ChipPAC for assembly and test.  For some of our devices, we
      purchase the product in its final form. In these cases, the supplier
      fabricates the wafers and manages the work in process including assembly
      and test. Kawasho Semiconductor Corp. is an example of a turnkey supplier
      where we are delivered fully tested and functional
  product.
  ·
              Intellectual
      Property Cores – We have several arrangements with foundries like Taiwan
      Semiconductor (TSMC) and Semiconductor Manufacturing International
      Corporation (SMIC) for example, where we make our intellectual property
      cores available to our customers for design in their products. The use of
      these cores is strictly controlled at the foundry and we receive license
      fees or royalties when they are
used.
  ·
              Services
      – We offer design and manufacturing services to our customers. In these
      cases we can utilize any of our established supply chain partners or use
      suppliers specified by our
customer.
  In 2003,
the European Union (EU) published its directive to restrict the use of certain
environmentally hazardous substances and defined the requirements for reducing
their impact on the environment.  This legislation, which became
effective July 1, 2006, restricts the use of Lead, Mercury, Cadmium, Hexavalent
Chromium, Polybrominated Biphenyls (PBBs) and Polybrominated Diphenyl Ethers
(PBDEs), as well as secondary elements defined in the
directive.  Since early 2003, we have been monitoring the activity of
the regulatory initiatives for Lead-free and "Green" products in compliance with
the Restriction of Hazardous Substances (RoHS) legislation defined by the EU’s
directive.  We have incorporated these requirements into our product
designs and packaging technology with cooperation from our
suppliers.  Our first RoHS device became available during
2004.
  In order
to facilitate a smooth transition without any supply disruptions, we offer RoHS
compliant devices while continuing to offer these same devices in packages
containing Lead. The RoHS compliant devices are clearly marked with a unique
part number and alloy code to help customers maintain quality and follow
appropriate manufacturing practices required by such devices.  We mark
all RoHS devices according to JEDEC specifications.  Additionally, all
RoHS compliant devices shipped are accompanied by a Certificate of Compliance
guaranteeing conformance to the RoHS directive
  Acquisitions
  While
some of the next generation products we introduce are based on technologies that
we develop ourselves, we have filled some of our technology and skills needs
through acquisitions. The following is a table that summarizes technology and
skills we obtained through acquisitions of stand-alone companies during the
years 2006 through 2008.
  Acquired Company
              
              Date Acquired
              
              Technology / Skill AcquiredCentillium Communications, Inc.
              
              October  2008
              
              VOIP and Optical transportASIC Design Center Division of Data – JCE
              
              January 2007
              
              Custom ASIC development and logisticsMysticom, Ltd.
              
              January 2006
              
              Analog/mixed signal design resources
  Investments in Non-Publicly
Traded Companies and Venture Capital Funds
  We will,
from time-to-time, make investments in early stage venture-backed, start-up
companies that develop technologies that are complementary to our product
roadmap. In all cases, when investing in other semiconductor companies, we have
also entered into commercial agreements giving us the rights to resell products
developed by these companies. When determining the accounting method for these
investments, we consider both direct ownership and indirect ownership. We also
consider other factors, such as our influence over the financial, technology and
operating policies of these companies.
  15
  We invest
in venture capital funds as it provides us access to new technologies and
relationships integral for maintaining technological advantages in the
development of advanced semiconductor products for the communications
industry.  Neurone Ventures II (Neurone), is a venture capital fund
organized as a partnership in the business of making, supervising and disposing
of privately negotiated equity and equity-related investments, principally in
early-stage Israeli and Israeli-related high-technology companies.  We
have a 3% ownership interest in this partnership.
  Competition
  The
communication semiconductor industry is intensely competitive and is
characterized by:
  •
              rapid
      technological changes in electronic design automation tools,
      wafer-manufacturing technologies, process tools and alternate networking
      technologies;
 
 •
              declining
      availability of fabrication
capacity;
 
 •
              manufacturing
      yield problems;
 
 •
              heightened
      international competition in many markets;
and
 
 •
              price
      erosion.
  The
telecommunications and data communications industries, which are our primary
target markets, are also intensely competitive due to deregulation and
heightened international competition.
  Through
on-going planning and analysis with our customers, our product strategy is
updated and focused on their current needs.  We participate in
industry standards setting groups that give us further insight into market
trends and requirements.  Recently, we introduced new product lines
that meet our customers’ evolving data communications requirements. Our Ethernet
over SONET/SDH product line enables telecommunication carriers and internet
service providers the ability to offer new revenue-generating services, such as
the high-speed transport of information over IP networks, based on their current
network infrastructure. By utilizing the current network infrastructure,
telecommunication carriers can realize revenue growth with only a modest
increase in their costs.
  In the
period following 2001 when the telecommunications industry suffered a major
correction, a number of our traditional competitors diverted their focus towards
alternate markets such as storage and enterprise.   However, we
made a deliberate decision to remain focused on telecommunications and to
improve our competitive standing in this arena as the market
recovered.  We concluded that future investment in communications
technology would be driven by video, high speed data and mobility services, and
adjusted our product focus accordingly to develop products for Ethernet over
SONET and Carrier Ethernet applications.
  Presently,
many of our traditional competitors are attempting to re-enter the
communications market.  However, our sustained focus on this market
during the past several years has enabled us to build a robust product
portfolio, secure several key design wins and strengthen our relationships with
Tier-1 customers.  As a result, we believe we are very well positioned
on a competitive basis.
  Our
competition consists of specialized semiconductor companies from the United
States as well as other countries and semiconductor divisions of vertically
integrated companies, such as IBM Corporation, NEC Corporation and Fujitsu
Corporation. New entrants are also likely to attempt to obtain a share of the
market for our current and future products.
  Our
principal competitors are Applied Micro Circuits Corporation, Conexant Systems,
Inc., Cirrus Logic, Inc., Infineon Technologies, Exar Corporation, Agere
Systems, PMC-Sierra Inc., TriQuint Semiconductor, Inc., Mindspeed Technologies
Inc., Vitesse Semiconductor Corporation and Broadcom Corporation. In addition,
there are a number of Applications Specific Integrated Circuit (ASIC) vendors,
including AMI Semiconductor, LSI Logic Corporation and STM Microelectronics
Group, which compete with us by supplying customer-specific products to
OEMs.  Other domestic and international vendors have announced plans
to enter into this market.
  16
  Employees
 
 At
December 31, 2008, we had 257 full time employees, including 174 in research and
development, 42 in marketing and sales, 17 in operations and quality assurance,
and 24 in administration. We have no collective bargaining
agreements.  We have never experienced any work stoppage and we
believe our employee relations are good.
 
 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 are made available free of charge
through the Investor Relations section of our 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. Our executive offices are located at Three Enterprise Drive,
Shelton, CT 06484.
 
 You may
read and copy any document we file at the SEC’s Public Reference Room located
at: Headquarters Office, 100F Street N.E., Room 1580, Washington, DC 20549. You
can request copies of these documents by writing to the Public Reference Section
of the SEC, 100F Street N.E., Washington, DC 20549 or by calling the SEC at
1-800-SEC-0330. Our SEC filings are also available at the SEC’s website at
http://www.sec.gov. This website address is included in this document as an
inactive textual reference only.
  Item
1A.  Risk
Factors
 
 From time
to time, information provided by us, statements made by our employees or
information included in our filings with the Securities and Exchange Commission
(including this Form 10-K) may contain statements that are not historical facts,
so-called “forward-looking statements,” which involve risks and uncertainties.
Such forward-looking statements are made pursuant to the safe harbor provisions
of Section 21E of the Securities Exchange Act of 1934, as amended.  In
some cases you can identify forward-looking statements by terminology such as
“may,” “should,” “could,” “will,” “expect,” “intend,” “plans,” “predict,”
“anticipate,” “estimate,” “continue,” “believe” or the negative of these terms
or other similar words. These statements discuss future expectations, contain
projections of results of operations or of financial condition or state other
forward-looking information. When considering forward-looking statements, you
should keep in mind the risk factors and other cautionary statements in this
Form 10-K.
 
 Our
actual future results may differ significantly from those stated in any
forward-looking statements. Factors that may cause such differences include, but
are not limited to, the factors discussed below. Each of these factors, and
others, are discussed from time to time in our filings with the Securities and
Exchange Commission.
 
 Our
operating results may fluctuate because of a number of factors, many of which
are beyond our control. If our operating results are below the expectations of
public market analysts or investors, then the market price of our common stock
could decline. Some of the factors that affect our quarterly and annual results,
but which are difficult to control or predict, are:
 
 We
have incurred significant net losses.
 
 Our net
losses have been considerable for the past several years.  Due to
current economic conditions, we expect that our revenues will continue to
fluctuate in the future and there is no assurance that we will attain positive
net earnings in the future.
 
 Our
net revenues may decrease.
 
 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 may
decrease.
 
 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.
  17
 
 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 annual operating
results.
 
 We
continue to have substantial indebtedness.
 
 As of
December 31, 2008, we have approximately $10.0 million in principal amount of
indebtedness outstanding in the form of our 5.45% Convertible Notes due
September 30, 2010 (2010 Notes).
 
 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 make payments on our 2010
  Notes;
 
 •
                  make
      it difficult for us to obtain any necessary future financing for working
      capital, capital expenditures, debt service requirements or other
      purposes;
 
 •
                limit
      our flexibility in planning for, or reacting to changes in, our business;
      and
 
 •
                  make
      us more vulnerable in the event of a downturn in our
    business.
 
 There can
be no assurance that we will be able to meet our debt service obligations,
including our obligations under the 2010 Notes.  The terms of our 2010
Notes permit the holders thereof to voluntarily convert their notes at any time
into a certain number of shares of our common stock.
 
 We
are using our available cash and cash equivalents each quarter to fund our
operations, investments and financing activities.
 
 Although
we have restructured our operating expenses to allow us to break-even at the
rate of sales attained in the fourth quarter of fiscal 2008, such rate of sales
may not be sustained. Also we may incur unforeseen expenses, which will cause us
to consume our available cash and cash equivalents.
 
 However,
we believe that we have adequate cash and cash equivalents to fund our
operations, investments and to meet our debt obligations through at least
December 31, 2009.
 
 We may not be able to pay our debt
and other obligations.
 
 If our
cash, cash equivalents 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 2010 Notes or our other obligations, we would be in
default under their respective terms.  This would permit the holders
of the 2010 Notes and our other obligations to accelerate their respective
maturities and 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 2010 Notes if payment of those notes were to
be accelerated following the occurrence of an event of default as defined in the
2010 Notes indenture.
  We
may seek to reduce our indebtedness by issuing equity securities, thereby
causing dilution of our stockholders’ ownership interests.
  18
 
 We may
from time to time seek to exchange our 2010 Notes for shares of our common stock
or other securities.  These exchanges may take different forms,
including exchange offers or privately negotiated transactions.  As a
result of shares of our common stock or other securities being issued upon such
conversion or pursuant to such exchanges, our stockholders may experience
substantial dilution of their ownership interest.
 
 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.
 
 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 capital and, if so required, that capital may not be available on
terms favorable or acceptable to us, if at all.  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 our common stock.  If we raise
additional funds by issuing debt, we may be limited in our success, as the terms
of the 2010 Notes restrict our ability to issue debt that is senior to or pari
passu with the 2010 Notes, without the consent of the holders of the 2010
Notes.
  The terms
of the 2010 Notes include voluntary conversion provisions upon which shares of
our common stock would be issued.  As a result of these shares of our
common stock being issued, our stockholders may experience dilution of their
ownership interest.
  We
may fail to realize the anticipated benefits of the acquisition of
Centillium.
 
 The
success of the acquisition of Centillium depends on, among other things, our
ability to realize anticipated cost savings and to combine the businesses of
TranSwitch and Centillium in a manner that does not materially disrupt
Centillium’s existing customer relationships or otherwise result in decreased
revenues, and that allows us to capitalize on Centillium’s growth opportunities.
If we are not able to successfully achieve these objectives, the anticipated
benefits of the acquisition may not be realized fully or at all or may take
longer to realize than expected.
 
 It is
possible that the ongoing integration process could result in the loss of key
employees, the disruption of our or Centillium’s ongoing businesses or
inconsistencies in standards, controls, procedures and policies that could
adversely affect our ability to maintain relationships with customers and
employees or to achieve the anticipated benefits of the
acquisition.
 
 Our
failure to continue to operate and manage the combined company effectively could
have a material adverse effect on our business, financial condition and
operating results.
 
 We will
need to meet significant challenges to realize the expected benefits and
synergies of the acquisition of Centillium. These challenges
include:
  •
                integrating
      the management teams, strategies, cultures and operations of the two
      companies;
  •
                retaining
      and assimilating the key personnel of each
  company;
  •
                integrating
      sales and business development
operations;
  •
                retaining
      existing customers of each company;
  •
                developing
      new products and services that utilize the technologies and resources of
      both companies; and
  •
                creating
      uniform standards, controls, procedures, policies and information
      systems.
  The
accomplishment of these objectives will involve considerable risk,
including:
  •
                the
      potential disruption of each company’s ongoing business and distraction of
      their respective management teams;
 •
                  the
      difficulty of incorporating acquired technology and rights into our
      products and services;
 19
 
 •
                unanticipated
      expenses related to technology
  integration; and
 
 •
                potential
      unknown liabilities associated with the
  acquisition.
 
 If we do
not succeed in addressing these challenges or any other problems encountered in
connection with the acquistion, our operating results and financial condition
could be adversely affected.
 
 Our
stock may be delisted on Nasdaq.
  On
January 28, 2008, we received notification from the Nasdaq Listing Qualification
Department providing notification that, for the last 30 consecutive business
days, the bid price of our common stock had closed below the minimum $1.00 per
share required for continued inclusion under Nasdaq Marketplace Rule
4450(a)(5).  On July 30, 2008, we received notice from the Listing
Qualifications Department of The NASDAQ Stock Market that our application to
list our common stock on The Nasdaq Capital Market was approved and our common
stock began trading on the Nasdaq Capital Market on that date. On October 22,
2008, we received notification from the Nasdaq Listing Qualification Department
providing notification that, due to the recent turmoil in U.S. and world
financial markets, Nasdaq has temporarily suspended its enforcement of the bid
price and market value of publicly held shares as required pursuant to Nasdaq
Marketplace Rule 4450(a)(5). As a result, and in accordance with Nasdaq
Marketplace Rule 4450(e)(2), we have been provided until July 26, 2009, to
regain compliance.  To regain compliance, the bid price of our common
stock must close at $1.00 per share or more for a minimum of ten consecutive
business days at any time before July 26, 2009.
  If we do
not regain compliance with Nasdaq Marketplace Rule 4450(a)(5) by July 26, 2009,
we will be notified that our securities will be delisted.  At that
time, we may appeal Nasdaq’s determination to delist our securities to a Listing
Qualification Panel.  On February 28, 2009 the price of our shares was
$0.28.
  We cannot
be sure that our price will comply with the requirements for continued listing
of our common stock on The Nasdaq Capital Market, or that any appeal of a
decision to delist our common stock will be successful. If our common stock
loses its status on The Nasdaq Capital Market, shares of our common stock would
likely trade on the over-the-counter market bulletin board, commonly referred to
as the “pink sheets.”
  If our
stock were to trade on the over-the-counter market, selling our common stock
could be more difficult because smaller quantities of shares would likely be
bought and sold, transactions could be delayed, and security analysts’ coverage
of us may be reduced.  In addition, in the event our common stock is
delisted, broker-dealers have certain regulatory burdens imposed upon them,
which may discourage broker-dealers from effecting transactions in our common
stock, further limiting the liquidity thereof. These factors could result in
lower prices and larger spreads in the bid and ask prices for shares of our
common stock.
  Such
delisting from The Nasdaq Capital Market or future declines in our stock price
could also greatly impair our ability to raise additional necessary capital
through equity or debt financing, and could significantly increase the ownership
dilution to stockholders caused by our issuing equity in financing or other
transactions.
  Our
Board of Directors may elect to exercise its discretion to affect 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, 2008, 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 2009 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 affect a 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 approved and implemented, would 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 our common stock may not exceed or remain
higher than the market price prior to such reverse stock split. Further, there
can be no assurance that after a reverse stock split, we would continue to meet
the minimum listing requirements of The Nasdaq Capital Market.
  20
  While a
higher share price may help generate investor interest in our common stock,
there can be no assurance that a reverse stock split would result in a per share
market price that attracts institutional investors or investment funds, or that
such price would satisfy the investing guidelines of institutional investors or
investment funds. As a result, the trading liquidity of our common stock may not
improve as a result of a 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.
 
 Our
stock price is volatile.
 
 The
market for securities for communication semiconductor companies, including our
Company, has been highly volatile. The daily closing price of our common stock
has fluctuated between a low of $0.26 and a high of $2.84 during the period from
January 1, 2005 to December 31, 2008. 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:
 
 •
                  responses
      to quarter-to-quarter variations in operating
  results;
 
 •
                  announcements
      of technological innovations or new products by us or our
      competitors;
 
 •
                  current
      market conditions in the telecommunications and data communications
      equipment markets; and
 
 •
                  changes
      in earnings estimates by
analysts.
 
 We may have to further restructure
our business.
 
 We may
have to make further restructuring changes if we do not sustain the current
level of quarterly revenues.
 
 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 years ended December
31, 2008 and 2007, shipments to our top five customers, including sales to
distributors, accounted for approximately 51% and 44% 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.
 
 Because
of our lack of diversity in geographic sources of revenues, economic factors
specific to certain countries may adversely affect our business and operating
results.
  21
 
 During
2008, a substantial amount of our revenue was from Israel, China, Japan and
other foreign countries. We expect revenues in 2009 will be substantial
concentrated in foreign markets.  All of our sales have been
historically denominated in U.S. dollars and major fluctuations in currency
exchange rates could materially affect our customers’ demand, thereby causing
them to reduce their orders, which could adversely affect our operating results.
While part of our strategy is to diversify the geographic sources of our
revenues, failure to further penetrate other markets could harm our business and
results of operations and subject us to increased currency risk.
 
 If
foreign exchange rates fluctuate significantly, our profitability may
decline.
  We
are exposed to foreign currency rate fluctuations because we incur a significant
portion of our operating expenses in currencies other than U.S. dollars (mainly
Indian rupees, Israeli shekels and Euros). The U.S. dollar has devalued
significantly and this trend may continue. To protect against reductions in
value and the volatility of future cash flows caused by changes in foreign
exchange rates, we enter into foreign currency forward contracts. The contracts
reduce, but do not eliminate, the impact of foreign currency exchange rate
movements. Also, this foreign currency risk management policy may not be
effective in addressing long-term fluctuations.
 
 The
cyclical nature of the communication semiconductor industry affects our
business.
  Communication service providers,
internet service providers, regional Bell operating companies and inter-exchange
carriers continue to closely monitor their capital expenditures. Spending on
voice-only equipment remains slow while spending on equipment providing the
efficient transport of data services on existing infrastructure appears to be
slowly recovering. Demand for new, high bandwidth applications such as video
conferencing, broadband audio and telephone is placing an increased burden on
existing public network infrastructure. We cannot be certain that the market for
our products will not decline in the future.
 
 Our
international business operations expose us to a variety of business
risks.
 
 Foreign
markets are a significant part of our net product revenues. For the years ended
December 31, 2008 and December 31, 2007 foreign shipments accounted for
approximately 85% and 79%, respectively of our total net product and services
revenues. We expect foreign markets to continue to account for a significant
percentage of our total net product revenues. A significant portion of our total
net product 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, currency controls and other
barriers;
 
 •
                  political
      and economic instability;
 
 •
                  risk
      of terrorism;
 
 •
                  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;
 
 •
                  natural
      disasters;
 
 •
                  seasonality
      of customer buying patterns;
and
  22
  •
                  potentially
      adverse tax consequences.
 
 Although
substantially all of our total net product revenues to date have been
denominated in U.S. dollars, the value of the U.S. dollar in relation to foreign
currencies also may reduce our total net revenues from foreign customers. With
the acquisition of our Israeli operations and the expansion of our India Design
Center a substantial amount of our costs are denominated in Israeli shekels and
the Indian rupee.  To the extent that we further 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.
 
 Our
net product revenues depend on the success of our customers’ products, and our
design wins do not necessarily generate revenues in a timely
fashion.
 
 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.  Some customer projects are canceled, and
thus will not generate revenues for our products.  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.  Further,
most revenue-generating design wins take several years to translate into
meaningful revenues.
 
 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, 0.18 and 0.13 micron and 65
nanometer complementary metal oxide semiconductor (CMOS) processes. We
continuously evaluate the benefits, on a product-by-product basis, of migrating
to smaller geometry process technologies.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;
 
 •
                  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:
  23
 
 •
                  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 has 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 70 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 are highly unpredictable and can fluctuate substantially.
 
 The
price of our products tends 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 price of our
products would adversely affect our operating results. Our customers are
increasingly more focused on price, as semiconductor products become more
prevalent in their equipment.  We may have to decrease our prices to
remain competitive in some situations, which may negatively impact our gross
margins.
 
 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.
 
 We
anticipate that these markets will continue to experience significant volatility
in the near future.
 
 Our
products must successfully include industry standards to remain
competitive.
 
 Products
for telecommunications and data communications applications are based on
industry standards, which are continually evolving. Our future success will
depend, in part, upon our ability to successfully develop and introduce new
products based on emerging industry standards, which could render our existing
products unmarketable or obsolete. If the telecommunications or data
communications markets evolve to new standards, we cannot be certain that we
will be able to design and manufacture new products successfully that address
the needs of our customers and include the new standards or that such new
products will meet with substantial market acceptance.
  24
 
 Our
intellectual property indemnification practices may adversely impact our
business.
 
 We have
historically agreed to indemnify our customers for certain costs and damages of
intellectual property rights in circumstances where one of our products is the
factor creating the customer’s infringement exposure. This practice may subject
us to significant indemnification claims by our customers. In some instances,
our products are designed for use in devices manufactured by our customers that
comply with international standards. These international standards are often
covered by patent rights held by third parties, which may include our
competitors. The costs of obtaining licenses from holders of patent rights
essential to such international standards could be high. The cost of not
obtaining such licenses could also be high if a holder of such patent rights
brings a claim for patent infringement. We are not aware of any claimed
violations on our part. However, we cannot assure you that claims for
indemnification will not be made or that if made, such claims would not have a
material adverse effect on our business, results of operations or financial
condition.
 
 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
because 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;
 
 •
                  price
      erosion;
 
 •
                  limited
      access to fabrication capacity;
 •
                  unforeseen
      manufacturing yield problems;
and
 
 •
                  heightened
      international competition in many
markets.
 
 These
factors are likely to result in pricing pressures on our products, thus
potentially affecting our operating results.
 
 Our
ability to compete successfully in the rapidly evolving area of high-performance
integrated circuit technology depends on factors both within and outside our
control, including:
 
 •
                  success
      in designing and subcontracting the manufacture of new products that
      implement new technologies;
 
 •
                  protection
      of our products by effective use of intellectual property
      laws;
 
 •
                  product
      quality;
 
 •
                  reliability;
 
 •
                  price;
 
 •
                  efficiency
      of production;
 
 •
                  failure
      to find alternative manufacturing sources to produce VLSI devices with
      acceptable manufacturing
yields;
 
 •
                  the
      pace at which customers incorporate our products into their
      products;
  25
  •
                  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 significant decreases in demand since
2000.  A number of our customers have internal semiconductor design or
manufacturing capability with which we also compete in addition to our other
competitors.  Any failure by us to compete successfully in these
target markets, particularly in the communications markets, would have a
material adverse effect on our business, financial condition and results of
operations.
 
 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. Fourfoundries currently
supply us with all of our semiconductor device requirements. While we have had
good relations with these foundries, we cannot be certain that we will be able
to renew or maintain contracts with them or negotiate new contracts to replace
those that expire. In addition, we cannot be certain that renewed or new
contracts will contain terms as favorable as our current terms. There are other
significant risks associated with our reliance on outside foundries, including
the following:
 
 •
                  the
      lack of assured semiconductor wafer supply and control over delivery
      schedules;
 
 •
                  the
      unavailability of, or delays in obtaining access to, key process
      technologies; and
 
 •
                  limited
      control over quality assurance, manufacturing yields and production
      costs.
 
 Reliance
on third-party fabrication facilities limits our 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 operating results. A
manufacturing disruption at one or more of our outside foundries, including,
without limitation, those that may result from natural disasters, accidents,
acts of terrorism or political instability or other 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. In particular, as of the
date of this Form 10-K, a single foundry manufactures all of our BiCMOS
devices.   As a result, we expect that we could experience
substantial delays or interruptions in the shipment of our products due to 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
  26
  •
                  failure
      to find alternative manufacturing sources to produce VLSI devices with
      acceptable manufacturing
yields.
 
 We
are subject to risks arising from our use of subcontractors to assemble our
products.
 
 Contract
assembly houses in Asia assemble all of our semiconductor
products.  Raw material shortages, natural disasters, political and
social instability, service disruptions, currency fluctuations, or other
circumstances in the region could force us to seek additional or alternative
sources of supply or assembly.  This could lead to supply constraints
or product delivery delays.
 
 Our
failure to protect our proprietary rights, or the costs of protecting these
rights, may harm our ability to compete.
 
 Our
success depends in part on our ability to obtain patents and licenses and to
preserve other intellectual property rights covering our products and
development and testing tools. To that end, we have obtained certain domestic
and foreign patents and intend to continue to seek patents on our inventions
when appropriate. The process of seeking patent protection can be time consuming
and expensive. We cannot ensure the following:
 
 •
                  that
      patents will be issued from currently pending or future
      applications;
 
 •
                  that
      our existing patents or any new patents will be sufficient in scope or
      strength to provide meaningful protection or any commercial advantage to
      us;
 
 •
                  that
      foreign intellectual property laws will protect our foreign intellectual
      property rights; and
 
 •
                  that
      others will not independently develop similar products, duplicate our
      products or design around any patents issued to
  us.
 
 Intellectual
property rights are uncertain and adjudication of such rights involves 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 are
found to 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 or in the United States or foreign courts to
determine any or all of the following issues: patent validity, patent
infringement, patent ownership or inventorship. These types of proceedings may
be costly and time consuming for us, even if we eventually prevail. If we do not
prevail, we might be forced to pay significant damages, obtain a license, if
available, or stop making a certain product. 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.
Such 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.
 
 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 and
technical personnel and on our ability to continue to attract, retain and
motivate other qualified personnel.
 
 We
may engage in acquisitions that may harm our operating results, dilute our
stockholders and cause us to incur debt or assume contingent
liabilities.
  27
 
 We may
pursue acquisitions from time to time that could provide new technologies,
skills, products or service offerings. Future acquisitions by us may involve the
following:
 
 •
                  use
      of significant amounts of cash and cash
  equivalents;
 
 •
                  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. We currently have no
commitments or agreements with respect to any such acquisition. If such an
acquisition does occur, we cannot be certain that our business, operating
results and financial condition will not be materially adversely affected or
that we will realize the anticipated benefits of the acquisition.
 
 We have made, and may continue to
make, investments in development stage companies, which may not produce any
returns for us in the future.
 
 From time
to time we have made investments in early stage venture-backed, start-up
companies that develop technologies that are complementary to our product
roadmap.  In April 2003, we made an initial investment in Opulan
Technologies Corp. (Opulan).  Opulan develops high performance and
cost-effective IP convergence ASSPs from its development facility in Shanghai,
China.  We plan to continue to use our cash to make selected
investments in these types of companies. Certain companies in which we invested
in the past have failed, and we have lost our entire investment in them. These
investments involve all the risks normally associated with investments in
development stage companies. As such, there can be no assurance that we will
receive a favorable return on these or any future venture-backed investments
that we may make. Additionally, our original and any future 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.
 
 We
could be subject to class action litigation due to stock price volatility, which
if it occurs, will distract our management and could result in substantial costs
or large judgments against us.
 
 In the
past, securities and class action litigation has often been brought against
companies following periods of volatility in the market prices of their
securities. We may be the target of similar litigation in the future. Securities
litigation could result in substantial costs and divert our management’s
attention and resources, which could cause serious harm to our business,
operating results and financial condition or dilution to our
stockholders.
 
 Provisions
of our certificate of incorporation, by-laws, stockholder rights plan and
Delaware law may discourage take over offers and may limit the price investors
would be willing to pay for our common stock.
 
 Delaware
corporate law contains, and our certificate of incorporation and by-laws and
shareholder rights plan contain, certain provisions that could have the effect
of delaying, deferring or preventing a change in control of our Company 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;
  28
  •
                  prohibit
      stockholder action by written
consent;
 
 •
                  establish
      advance notice requirements for submitting nominations for election to the
      Board of Directors and for proposing matters that can be acted upon by
      stockholders at a meeting;
and
 
 •
                  dilute
      stockholders who acquire more than 15% of our common
  stock.
 Natural
disasters or 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 a design center in India, and sales, design and engineering
operations in Israel.  Some of the countries in which we operate or in
which our customers are located have in the past been subject to terrorist acts
and could continue to be subject to acts of terrorism.  In addition,
some of these areas may be subject to natural disasters, such as earthquakes or
floods.  If our facilities, or those of our suppliers or customers,
are affected by a natural disaster or terrorist act, our employees could be
injured and those 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, natural disasters or terrorist acts
in the areas in which we operate or in which our customers or suppliers operate
could lead to delays or loss of business opportunities, as well as changes in
security and operations at those locations, which could increase our operating
costs.
  Our
ability to sublease excess office space may adversely affect our future cash
outflows.
  We
have outstanding operating lease commitments of approximately $34.2 million,
payable over the next nine years. Some of these commitments are for space that
is not being utilized and, for which, we recorded restructuring charges in prior
periods. 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. As of December 31, 2008, we have sublease agreements totaling
approximately $4.7 million to rent portions of our excess facilities over the
next four years. 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.
  Of the
office space being leased in our Shelton, Connecticut location, as of
December 31, 2008 approximately 142,375 square feet is considered excess for
which we have taken restructuring charges in prior years. Substantially all of
this space is currently being sublet, but not for the full term that we are
committed to under our lease agreements. If we are unable to re-lease this
space, at similar rates, our future cash outflows would be adversely
affected.
 
 Our
business could be harmed if we fail to integrate future acquisitions
adequately.
 
 During
the past three years, we have acquired three companies, one based in the United
States and two in Israel.
 
 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.
  29
  If we
delay integrating 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 or abandoned
certain product lines acquired through prior acquisitions.
  Item
1B.  Unresolved
Staff Comments
 
 Not
applicable.
  30
  Item
2. Properties
 
 Our
headquarters is located in a suburban office park in Shelton, Connecticut. We
have additional sales offices and design centers located throughout the
world.The following is
a summary of our material offices and locations for which we have lease
commitments:
 
 Location
                                                      
                                                      Business Use
                                                      
                                                      Square
                                                        Footage
                                                      
                                                      Lease
                                                        Expiration DatesShelton,
      Connecticut
                                                      
                                                      Corporation
      Headquarters, Product Development, Operations, Sales, Marketing and
      Administration
                                                      
                                                      
                                                      18,561
                                                      
                                                      November
      2012Herzeliya,
      Israel
                                                      
                                                      Product
      Development, Sales & Service
                                                      
                                                      
                                                      9,688
                                                      
                                                      Less
      than 1 YearSan
      Jose, California
                                                      
                                                      Sales
      & Service
                                                      
                                                      
                                                      2,535
                                                      
                                                      September
      2009New
      Delhi, India
                                                      
                                                      Product
      Development
                                                      
                                                      
                                                      48,554
                                                      
                                                      January
      2015Fremont,
      California
                                                      
                                                      Product
      Development, Sales, Marketing and Administration
                                                      
                                                      
                                                      12,500
                                                      
                                                      February
      2011Bangalore,
      India
                                                      
                                                      Product
      Development
                                                      
                                                      
                                                      48,734
                                                      
                                                      February
      2014Excess property:Fremont,
      California
                                                      
                                                      Available
      for Lease
                                                      
                                                      
                                                      91,500
                                                      
                                                      February
      2011Bedford,
      Massachusetts
                                                      
                                                      Available
      for Lease
                                                      
                                                      
                                                      4,100
                                                      
                                                      September
      2010Shelton,
      Connecticut
                                                      
                                                      Available
      for Lease
                                                      
                                                      
                                                      142,375
                                                      
                                                      November
      2012—
                                                        April
      2017
 
 Internationally,
we lease space in India and France for engineering design centers, and in Japan,
China, Taiwan, France and South Korea for sales offices. Our current facilities
are adequate for our needs.
 
 Refer to
Note 15—Commitments and Contingencies of our Consolidated Financial Statements
for additional disclosures regarding our commitments under lease
obligations.Also,
refer to Note 14—Restructuring and Asset Impairment Charges in our Consolidated
Financial Statements regarding our restructuring charges during fiscal years
2006 through 2008 as we have recorded charges for future rent payments relating
to excess office space.
 
 Item
3.Legal
Proceedings
 
 We are
not party to any material litigation proceedings.
 
 From time
to time, we may be subject to other legal proceedings and claims in the ordinary
course of business. We are not currently aware of any such proceedings or claims
that we believe will have, individually or in the aggregate, a material adverse
effect on the business, financial condition or results of our
operations.
 
 Item
4.    Submission of Matters to a Vote of
Security-Holders
 
 We did
not submit any matters to a vote of our security-holders during the three months
ended December 31, 2008.
  31
 
 PART
II
 
 Item
5.     Market for Registrant’s Common
Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
 
 Delisting
Notice
 
 On
October 22, 2008, TranSwitch received notification from the Nasdaq Listing
Qualification Department providing notification that, due to the recent turmoil
in U.S. and world financial markets, Nasdaq has temporarily suspended its
enforcement of the bid price and market value of publicly held shares as
required pursuant to Nasdaq Marketplace Rule 4450(a)(5). As a result, we now
have until July 26, 2009 to regain compliance with the minimum bid requirement.
To regain compliance, the bid price of our common stock must close at $1.00 per
share or more for a minimum of ten consecutive business days at any time before
July 26, 2009.
  If we do
not regain compliance with Nasdaq Marketplace Rule 4450(a)(5) by July 26, 2009,
we will be notified that our securities will be delisted.  At that
time, we may appeal Nasdaq’s determination to delist our securities to a Listing
Qualification Panel.
 
 Our
common stock is traded under the symbol “TXCC” on The Nasdaq Capital
Market.The
following table sets forth, for the periods indicated, the range of high and low
closing prices for our common stock.
 
 High
                            
                            
                            LowYear
      ended December 31, 2008First
      Quarter
                            
                            $
                            0.88
                            
                            
                            $
                            0.60Second
      Quarter
                            
                            $
                            0.92
                            
                            
                            $
                            0.61Third
      Quarter
                            
                            $
                            1.12
                            
                            
                            $
                            0.50Fourth
      Quarter
                            
                            $
                            0.50
                            
                            
                            $
                            0.26Year
      ended December 31, 2007First
      Quarter
                            
                            $
                            1.71
                            
                            
                            $
                            1.17Second
      Quarter
                            
                            $
                            1.92
                            
                            
                            $
                            1.45Third
      Quarter
                            
                            $
                            1.82
                            
                            
                            $
                            1.37Fourth
      Quarter
                            
                            $
                            1.38
                            
                            
                            $
                            0.80
 
 As of
February 24, 2009, there were approximately 469 holders of record and
approximately 17,978 beneficial shareholders of our common stock.
 
 We have
never paid cash dividends on our common stock.We currently do not
anticipate paying any cash dividend in the foreseeable future.Any future declaration and
payment of dividends will be subject to the discretion of our Board of
Directors, will be subject to applicable law and will depend upon our results of
operations, earnings, financial condition, contractual limitations, cash
requirements, future prospects and any other factors deemed relevant by our
Board of Directors.
 
 We also
have securities authorized for issuance under equity compensation plans. The
following table provides information as of December 31, 2008 with respect to
shares of our common stock that may be issued under our existing equity
compensation plans, including our 1995 Fourth Amended and Restated Stock Plan
(the “1995 Plan”), our 2000 Stock Option Plan (the “2000 Plan”), the 2008 Equity
Incentive Plan (the “2008 Plan”), the 1995 Non-Employee Director Stock Option
Plan (the “Non-Employee Director Plan”), the 2005 Employee Stock Purchase Plan
(the “Purchase Plan”) and the 1999 Stock Incentive Plan of Onex Communications
Corporation (the “Onex Plan”). As of May 22, 2008, no shares are available for
grant under our 1995 Plan or 2000 Plan.
  32
 
 Plan Category
                    
                    Number of
                      Securities to be
                      Issued upon
                      Exercise of
                      Outstanding
                      Options, Warrants
                      and Rights
                    
                    
                    Weighted
                      Average
                      Exercise Price
                      of Outstanding
                      Options,
                      Warrants and
                      Rights
                    
                    
                    Number of Securities
                      Remaining Available
                      for
                      Future Issuance
                      Under
                      Equity
                      Compensation
                      Plans (excluding
                      Securities reflected
                      in Column (a))(a)
                    
                    
                    (b)
                    
                    
                    (c)Equity
      Compensation Plans Approved by Stockholders (1)
                    
                    
                    19,514,528
                    (3)(4)
                    
                    $
                    2.04
                    (3)
                    
                    
                    5,044,419Equity
      Compensation Plans Not Approved by Stockholders (2)
                    
                    
                    4,538,813
                    
                    
                    $
                    1.43
                    
                    
                    
                    -Total
                    
                    
                    24,053,341
                    
                    
                    $
                    1.92
                    
                    
                    
                    5,044,419
 
 (1)
                Consists
      of the 1995 Plan, the 2008 Plan, the Non-Employee Director Plan and the
      Purchase Plan.
 (2)
                Consists
      of the 2000 Plan and shares subject to outstanding options granted under
      equity compensation plans assumed by us in connection
      with   mergers and acquisitions of the companies which
      originally granted those options. No additional options may be granted
      under the assumed plans.
 (3)
                Excludes
      purchase rights accruing under the Purchase Plan which has a
      stockholder-approved reserve of 1,000,000 shares. Under the Purchase Plan,
      each eligible employee is able to purchase up to 1,000 shares of our
      common stock at semi-annual intervals each year at a purchase price per
      share equal to 85% of the lower of the fair market value of our common
      stock on the first or last trading day of a purchase
    period.
 (4)
                Includes
      restricted stock units of 1,104,298. These awards have no strike price and
      are issued from our 2008 Plan.
  Equity
Compensation Plans Not Approved by Stockholders
 
 2000 Stock Option
Plan. The purpose of the 2000 Plan adopted by our Board of Directors on
July 14, 2000 and amended on December 21, 2001, was to promote our long-term
success, by providing financial incentives to employees and consultants of the
Company who are in positions to make significant contributions toward such
success except that no member of our Board of Directors or officer of the
Company appointed by the Board of Directors shall be eligible for grants of
options under the 2000 Plan. The 2000 Plan is designed to attract individuals of
outstanding ability to become or to continue as employees or consultants, to
enable such individuals to acquire or increase proprietary through the ownership
of shares of our Common Stock, and to render superior performance during their
associations with us, by providing opportunities to participate in the ownership
of our future growth through the granting of NQSOs. The 2000 Plan is
administered by our Board of Directors or, at its option, a committee appointed
by our Board of Directors. A total of 10,000,000 shares of common stock were
reserved for issuance under the 2000 Plan. In April 2008, our Board of Directors
determined that no further awards would be made under this plan and that all
remaining 2,427,033 shares available for issuance under the 2000 Plan that are
not subject to outstanding stock option awards will be eligible for issuance
under the 2008 Equity Incentive Plan.
 
 1999 Stock
Incentive Plan of Onex Communications Corporation. The purpose of the
Onex Plan was to advance the interests of the shareholders by enhancing the Onex
Communications Corporation’s ability to attract, retain and motivate persons who
make (or are expected to make) important contributions to Onex Communications
Corporation by providing those persons with opportunities for equity ownership
and performance-based incentives and thereby to better align the interests of
those persons with those of the shareholders. All of Onex Communications
Corporation’s employees, officers, directors, consultants and advisors were
eligible to be granted options, restricted, stock, or other stock-based awards
under the Onex Plan. We assumed the Onex Plan in connection with our acquisition
of Onex Communications Corporation in 2001. No additional awards may be granted
under the Onex Plan.
  33
 
 Issuer
Purchases of Equity Securities
  On
February 13, 2008, we announced that our Board of Directors authorized a stock
repurchase program under which we may repurchase up to $10 million of our
outstanding common stock.  The share repurchase program authorizes the
repurchase of shares through February 2010, from time to time, through
transactions in the open market or in privately negotiated
transactions.  The number of shares to be purchased and the timing of
the purchases will be based on market conditions and other
factors.  The stock repurchase program does not require us to
repurchase any specific dollar value or number of shares, and we may terminate
the repurchase program at any time.
  During
the year ended December 31, 2008, we repurchased 166,350 shares at an average
price of $0.68 per share for approximately $0.1 million, excluding approximately
$5,000 of commissions.  For the year ended December 31, 2008, our
total cost for repurchasing shares was approximately $0.1 million.
 
 (table in
thousands, except per share amounts)
 
 (a)
                      
                      
                      (b)
                      
                      
                      (c)
                      
                      
                      (d)Period
                      
                      Total
                        Number of
                        Shares
                        Purchased
                      
                      
                      Average Price
                        Paid per share
                      
                      
                      Total Number of
                        Shares Purchased
                        as Part of Publicly
                        Announced Plans
                        or Programs
                      
                      
                      Dollar Value of
                        Shares that May
                        Yet be Purchased
                        Under the Plans
                        or ProgramsFebruary
      1-29, 2008
                      
                      
                      120
                      
                      
                      $
                      0.67
                      
                      
                      
                      120
                      
                      
                      $
                      9,919March
      1-31, 2008
                      
                      
                      46
                      
                      
                      $
                      0.69
                      
                      
                      
                      46
                      
                      
                      $
                      9,887Total
                      
                      
                      166
                      
                      
                      $
                      0.68
                      
                      
                      
                      166
 
 34
  Item
6.    Selected Financial Data
 
 The
following selected consolidated financial data should be read in conjunction
with the consolidated financial statements and related notes thereto and
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” appearing in Item 7 of this Form 10-K.The selected consolidated
statements of operations data as well as the selected consolidated balance
sheets data presented below are derived from our consolidated financial
statements.
 
 Years ended December 31,2008
                                                  
                                                  
                                                  2007
                                                  
                                                  
                                                  2006
                                                  
                                                  
                                                  2005
                                                  
                                                  
                                                  2004(Amounts presented in thousands, except per share amounts)Selected
      Consolidated Statements of Operations Data:Net
      revenues
                                                  
                                                  $
                                                  41,934
                                                  
                                                  
                                                  $
                                                  32,565
                                                  
                                                  
                                                  $
                                                  38,920
                                                  
                                                  
                                                  $
                                                  32,900
                                                  
                                                  
                                                  $
                                                  33,687Gross
      profit
                                                  
                                                  
                                                  23,894
                                                  
                                                  
                                                  
                                                  20,171
                                                  
                                                  
                                                  
                                                  28,174
                                                  
                                                  
                                                  
                                                  23,984
                                                  
                                                  
                                                  
                                                  23,347Operating
      loss
                                                  
                                                  
                                                  (19,774
                                                  )
                                                  
                                                  
                                                  (18,800
                                                  )
                                                  
                                                  
                                                  (11,136
                                                  )
                                                  
                                                  
                                                  (14,662
                                                  )
                                                  
                                                  
                                                  (43,049
                                                  )Loss
      before cumulative effect of adoption of and change in accounting
      principle
                                                  
                                                  
                                                  (17,046
                                                  )
                                                  
                                                  
                                                  (19,712
                                                  )
                                                  
                                                  
                                                  (10,856
                                                  )
                                                  
                                                  
                                                  (23,754
                                                  )
                                                  
                                                  
                                                  (44,347
                                                  )Cumulative
      effect on prior years adoption of FIN 46R
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (277
                                                  )Net
      loss (1)
                                                  
                                                  $
                                                  (17,046
                                                  )
                                                  
                                                  $
                                                  (19,712
                                                  )
                                                  
                                                  $
                                                  (10,856
                                                  )
                                                  
                                                  $
                                                  (23,754
                                                  )
                                                  
                                                  $
                                                  (44,624
                                                  )Basic
      and diluted loss per common share before cumulative effect of a change in
      accounting principle
                                                  
                                                  $
                                                  (0.12
                                                  )
                                                  
                                                  $
                                                  (0.15
                                                  )
                                                  
                                                  $
                                                  (0.09
                                                  )
                                                  
                                                  $
                                                  (0.23
                                                  )
                                                  
                                                  $
                                                  (0.47
                                                  )Basic
      and diluted net loss per common share
                                                  
                                                  $
                                                  (0.12
                                                  )
                                                  
                                                  $
                                                  (0.15
                                                  )
                                                  
                                                  $
                                                  (0.09
                                                  )
                                                  
                                                  $
                                                  (0.23
                                                  )
                                                  
                                                  $
                                                  (0.47
                                                  )Shares
      used in calculation of basic and diluted net loss per common
      share
                                                  
                                                  
                                                  138,080
                                                  
                                                  
                                                  
                                                  132,529
                                                  
                                                  
                                                  
                                                  124,801
                                                  
                                                  
                                                  
                                                  104,779
                                                  
                                                  
                                                  
                                                  94,638
 
 December 31,2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004Selected
      Consolidated Balance Sheets Data:Cash,
      cash equivalents, restricted cash and short-term
    investments
                    
                    $
                    15,284
                    
                    
                    $
                    34,098
                    
                    
                    $
                    57,723
                    
                    
                    $
                    72,702
                    
                    
                    $
                    102,504Total
      current assets
                    
                    
                    35,179
                    
                    
                    
                    45,527
                    
                    
                    
                    68,236
                    
                    
                    
                    80,822
                    
                    
                    
                    112,475Working
      capital
                    
                    
                    8,708
                    
                    
                    
                    36,867
                    
                    
                    
                    30,323
                    
                    
                    
                    73,385
                    
                    
                    
                    76,361Long-term
      investments (marketable securities)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    32,178Total
      non-current assets
                    
                    
                    43,248
                    
                    
                    
                    22,060
                    
                    
                    
                    14,420
                    
                    
                    
                    6,004
                    
                    
                    
                    42,233Total
      assets
                    
                    
                    78,427
                    
                    
                    
                    67,587
                    
                    
                    
                    82,656
                    
                    
                    
                    86,826
                    
                    
                    
                    154,708Convertible
      Notes due within one year, net of discount
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    28,811
                    
                    
                    
                    —
                    
                    
                    
                    24,442Derivative
      liability, current
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    980
                    
                    
                    
                    —
                    
                    
                    
                    —Total
      current liabilities
                    
                    
                    26,471
                    
                    
                    
                    8,660
                    
                    
                    
                    37,913
                    
                    
                    
                    7,437
                    
                    
                    
                    36,1145.45%
      Convertible Plus Cash Notes due 2007, net of debt discount,
      long-term
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    49,102
                    
                    
                    
                    67,3705.45%
      Convertible Notes due 2010, long-term
                    
                    
                    10,013
                    
                    
                    
                    25,013
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Derivative
      liability, long-term
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    6,040
                    
                    
                    
                    8,461Total
      non-current liabilities
                    
                    
                    29,677
                    
                    
                    
                    45,259
                    
                    
                    
                    20,689
                    
                    
                    
                    76,180
                    
                    
                    
                    97,363Total
      stockholders’ equity
                    
                    
                    22,279
                    
                    
                    
                    13,668
                    
                    
                    
                    24,054
                    
                    
                    
                    3,209
                    
                    
                    
                    21,231Book
      value per share
                    
                    $
                    0.14
                    
                    
                    $
                    0.10
                    
                    
                    $
                    0.19
                    
                    
                    $
                    0.03
                    
                    
                    $
                    0.21
 
 (1)
                Effective
      January 1, 2006, we adopted SFAS No. 123R.  As such, the
      reported net loss for 2008, 2007 and 2006 reflects stock-based
      compensation expense of $1.5 million, $2.0 million and $2.4 million,
      respectively.
  35
  Item
7.    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 to supplement the accompanying consolidated financial
statements and notes in Item 8 to help provide an understanding of our financial
condition, changes in our financial condition and results of operations.
MD&A is organized as follows:
 
 Caution
concerning forward-looking statements.    This
section discusses how certain 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.
 
 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 years ended December 31, 2008, 2007 and 2006.
In addition, a brief description is provided of transactions and events that
impact the comparability of the results.
 
 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 related party
transactions and recent accounting pronouncements not yet adopted by
us.
 
 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 “Item 1A Risk Factors” and elsewhere in this
report. You should read this discussion in conjunction with the consolidated
financial statements and the notes thereto included in this report.
 
 OVERVIEW
 
 TranSwitch
is a Delaware corporation incorporated on April 26, 1988. TranSwitch designs,
develops and supplies innovative highly-integrated semiconductor solutions that
provide core functionality for voice, data and video communications network
equipment.  TranSwitch end customers are the original equipment
manufacturers (“OEMs”) who supply wire-line and wireless network operators who
provide voice, data and video services to end users such as consumers,
corporations, municipalities etc. Our system-on-a-chip products incorporate
digital and mixed-signal semiconductors and related embedded software. We serve
the Voice over Internet Protocol (VoIP) and Fiber-To-The-Premises (FTTP), which
is also known as optical networking, markets. We have over 200 active customers,
including the leading global equipment providers, and our products are deployed
in the networks of the major service providers around the world.
 
 In
addition to an extensive portfolio of standard integrated circuit products
addressing voice, data, wireless and video markets, TranSwitch supplies a number
of intellectual property core products for Ethernet and high definition video
(HDMI protocol) applications and custom design services. Our combination of
standard products, intellectual property cores and custom design services
enables us to serve our customers needs more fully.
 
 Our
products and services are compliant with relevant communications network
standards.  We offer several products that combine multi-protocol
capabilities on a single chip, enabling our customers to develop network
equipment for triple play (voice, data and video) applications. A key attribute
of our products is their inherent flexibility. Many of our products incorporate
embedded programmable micro-processors, enabling us to rapidly accommodate new
customer requirements or evolving network standards by modifying the
functionality of the device via software instructions.
  36
  We bring
value to our customers through our communications systems expertise, very large
scale integration (“VLSI”) design skills and commitment to excellence in
customer support. Our emphasis on technical innovation results in defining and
developing products that permit our customers to achieve faster time-to-market
and to develop 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 for their customers.
 
 Our revenues were $41.9 million
in 2008, $32.6 million in 2007 and $38.9 million in 2006.  2008 was a
successful year for TranSwitch. Our acquisition of Centillium further
diversified our product portfolio to include rapidly growing Fiber-to-the-Home
(FTTH) and Voice-over-Internet-Protocol (VoIP) solutions. The combination
strengthens our leadership position in the next-generation communications
semiconductor market. The combined companies will have greater scale, a
significantly improved expense structure and a truly global reach.
 
 We
attained revenue growth in three of our four major product revenue categories as
we continued to focus on the developing markets of Optical Transport, Broadband
Access and Carrier Ethernet and VoIP. Part of this growth came from our
acquisition of Centillium Communications, Inc., whose products are well
positioned in the Broadband Access and VoIP markets. Our previous acquisitions
of the ASIC Design Center Division of Data – JCE and Mysticom, Ltd. continue to
provide successful diversification in the areas of ASIC customer specific
telecom / non-telecom products and High Definition video processing,
respectively. In addition to growing our revenue streams, we are focusing on
improving our gross margin both by reducing costs on lower margin products and
working to increase sales of higher margin products.
 
 We
continued our move toward profitability by reducing our operating loss from 2007
both in a dollar amount and as a percentage of revenue. This was achieved
through strict cost control measures and the implementation of a force reduction
plan in both TranSwitch and Centillium. We were also able to enter into an
agreement with certain holders of our 2010 Notes to purchase $15.0 million of
the aggregate principal amount for $9.9 million in cash, plus accrued and unpaid
interest. This enabled us to reduce our long term debt by 60% and also realize a
$4.5 million gain.
 
 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 and assumptions.
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 relating to:
  (1)
recognizing net revenues, cost of revenues and gross profit;
 
 (2)
estimating allowances for doubtful accounts;
 
 (3)
estimating the derivative liability associated with our 5.45% Convertible Plus
Cash Notes due 2007;
 
 (4)
estimating stock-based compensation;
 
 (5)
estimating values for goodwill and long-lived assets;
 
 (6)
estimating excess inventories;
 
 (7)
estimating restructuring liabilities; and
  37
 
 (8)
estimating values of investments in non-publicly traded companies.
 
 These
accounting policies, the bases for these estimates and their potential impact to
our consolidated financial statements, should any of these estimates change, are
further described as follows:
 
 Net 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) collectability 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) collectability is reasonably
assured.
 
 At the
time of shipment, we record a reduction to revenue (with a related liability) to
accrue for future price protection. This liability is established based on
historical experience, contractually agreed-to provisions and future shipment
forecasts. Such accruals have been insignificant for the last three
years.
 
 We also
accrue, at the time of shipment, a reduction to revenue (with a related
liability) 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. Such accruals are insignificant to our
financial position and results of operations for all periods
presented.  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
warranty our products for up to one year from the date of shipment. Warranty
expense is insignificant to all periods presented.
 
 We
license HDMI and other intellectual property.  Revenues from licensing
arrangements generally consist of multiple elements such as license,
implementation and maintenance services. The items (deliverables) included in
the arrangement are evaluated pursuant to EITF Issue No. 00-21 “Revenue
Arrangements with Multiple Deliverables” to determine whether they represent
separate units of accounting. We perform this evaluation at the inception of an
arrangement and as we deliver each item in the arrangement.
 
 Generally,
we account for a deliverable (or a group of deliverables) separately if (1) the
delivered item(s) has standalone value to the customer, (2) there is objective
and reliable evidence of the fair value of the undelivered items included in the
arrangement, and (3) if we have given the customer a general right of return
relative to the delivered items, delivery or performance of the undelivered
items or services are probable and substantially in our control.
 
 We
also recognize revenue from royalties upon notification of sale by our
licensees. The terms of the royalty agreements generally require licensees to
give us notification and to pay royalties within 45 days of the end of the
quarter during which the sales by the licensees take place.
 
 Estimated
Allowances for Doubtful Accounts.  We record allowances for
doubtful accounts for estimated losses based upon specifically identified
amounts that we believe to be uncollectible along with our assessment of the
general financial condition of our customer base. If our actual collections
experience changes, revisions to our allowances may be required. We have a
limited number of customers with individually large amounts due at any given
balance sheet date. Any unanticipated change in one of those customers’
creditworthiness or other matters affecting the collectibility of amounts due
from such customers could have a material effect on our results of operations in
the period in which such changes or events occur.
 
 Derivative
Liability Associated with
our 5.45% Convertible Plus Cash Notes due 2007.In accordance
with Statement of Financial Accounting Standards No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” as amended (SFAS 133), the
holder’s conversion right contained in the terms governing our 5.45% Convertible
Plus Cash Notes due 2007 (the “Plus Cash Notes”) was not clearly and closely
related to the characteristics of the Plus Cash Notes upon issuance.
Accordingly, this feature qualified as an embedded derivative instrument and,
because it does not qualify for any scope exception within SFAS 133, it is
required by SFAS 133 to be accounted for separately from the debt instrument and
recorded as a derivative financial instrument.
  38
 
 During
the year ended December 31, 2008, there were no Plus Cash Notes outstanding.
During the years ended December 31, 2007 and 2006, we recorded other income of
$1.0 million and $5.1 million, respectively, all of which related to the
holder’s conversion right, to reflect the change in fair value of our derivative
liability.
 
 We adjust
the derivative financial instruments to their estimated fair value and analyze
the instruments to determine their classification as a liability or equity. As
of December 31, 2008 and 2007, the estimated fair value of our derivative
liability was zero as these Plus Cash Notes due 2007 were no longer outstanding.
On July 6, 2007, the Company exchanged approximately $21.2 million aggregate
principal amount of its outstanding Plus Cash Notes for an equivalent principal
amount of a new series of 5.45% Convertible Notes due September 30, 2010 (the
“2010 Notes”).  The remaining $8.9 million balance of the Plus Cash
Notes was redeemed at par value at the end of September, 2007.  The
estimated fair value of the holder’s conversion right was determined using a
lattice (trinomial) option-pricing model, while it was estimated.
 
 Stock-based
Compensation.Determining the amount of stock-based compensation for
awards granted includes selecting an appropriate model to calculate fair value
at the grant date. We have used the Black-Scholes option valuation model to
value employee stock option awards. Certain inputs to this valuation model
require considerable judgment. These inputs include estimating the volatility of
our stock, the expected life of the option awarded and the forfeiture rate. We
have estimated volatility, the expected life and the forfeiture rate based on
historical data. Volatility is estimated over a term that approximates the
expected life of the option awarded.
 
 Goodwill and
Long-Lived Assets.Our goodwill is tested for impairment
annually or more frequently if events or changes in circumstances indicate that
the asset might be impaired.  We perform impairment reviews using a
fair-value method based on management’s judgments and
assumptions.  The fair value represents the amount at which an entity
could be bought or sold in a current transaction between willing parties on an
arms-length basis.  In estimating fair value, we use our common’s
stock market price to determine fair value.  Quoted market prices are
the best evidence of fair value, and the market capitalization based on the
Company’s common stock price is apportioned based on revenue to the entity being
tested for impairment.  The estimated fair value is then compared with
the carrying amount of the entity, including goodwill.  In the case
where an entities’ estimated fair value would be lower than its carrying value,
we would perform discounted cash flow analysis on the entity to determine fair
value.  If after a discounted cash flow analysis the entities
estimated fair value is lower than its carrying value, we would retain
independent appraisers to perform additional fair value
calculations.  We are subject to financial statement risk to the
extent that the carrying amount exceeds the estimated fair value.  The
impairment testing performed by us at October 1, 2008 indicated that the
estimated fair value of entities tested exceeded their corresponding carrying
amount. As such, there was no impairment.  Indefinite lived intangible
assets are subject to annual impairment testing, as well.  On an
annual basis, the fair value of the indefinite lived assets is evaluated by us
to determine if an impairment charge is required. We have only nominal amounts
of indefinite lived assets.
 
 We review
long-lived assets for impairment when events or changes in business
circumstances indicate the carrying amount of the assets may not be fully
recoverable.  If such indicators are present, we perform undiscounted
operating cash flow analyses to determine if impairment exists.  If
impairment is determined to exist, any related impairment loss is calculated
based on fair value.
 
 A
considerable amount of management judgment and assumptions are required in
performing the impairment test.  While we believe that our judgments
and assumptions were reasonable, different assumptions could change the
estimated fair values and, therefore, impairment charges could be
required.
 
 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.  We recorded charges for excess and
obsolete inventories totaling approximately $0.3 million in 2008, $0.4 million
in 2007 and zero in 2006.  Most of these products have not been
disposed of and remain in our inventory.
  39





During
2008, 2007 and 2006, we recorded net product revenues of approximately $4.8
million, $3.5 million and $9.1 million, respectively, on shipments of excess and
obsolete inventory that had previously been written down to their estimated net
realizable value of zero. This resulted in almost 100% gross margin on these
product revenues. Had these products been sold at our historical average cost
basis, gross margin would have been 64%, 64% and 68% in 2008, 2007 and 2006
respectively. We currently do not anticipate that a significant amount of the
excess and obsolete inventories subject to the write-downs described above will
be used in the future based upon our current demand forecast. Should our actual
future demand exceed the estimates that we used in writing down our excess and
obsolete 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.





Estimated
Restructuring Liabilities.    During 2008, 2007 and
2006, we recorded restructuring charges and asset impairments totaling $3.8
million, $1.5 million and $0.4 million, respectively, related to employee
termination benefits and costs to exit certain facilities, net of sub-lease
benefits. At December 31, 2008 and 2007, the restructuring liabilities were
$25.4 million and $21.1 million, respectively, on our consolidated balance
sheets. Restructuring liabilities at December 31, 2008 include approximately
$22.5 million of liabilities for facility lease costs (Refer to Note 14 –
Restructuring and Asset Impairment Charges of the Notes to Consolidated
Financial Statements). These facility operating leases expire through 2017. The
future cash outlays for all of our operating lease commitments are discussed in
Note 15 of the Notes to Consolidated Financial Statements.  Certain
assumptions are used by us 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.




Valuation of
Investments in Non-Publicly Traded Companies.    Since
1999, we have been making strategic equity investments in non-publicly traded
companies that develop technologies that are complementary to our product road
map. Depending on our level of ownership and whether or not we have the ability
to exercise significant influence, we account for these investments on either
the cost or equity method, and review such investments 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 zero, $0.1 million and zero
during 2008, 2007 and 2006, respectively. The total investment in non-public
companies was $3.0 million and $2.9 million as of December 31, 2008 and 2007,
respectively. (For further discussion, please refer to Note 4. Investments in
Non-Publicly Traded Companies and Venture Capital Funds in our Consolidated
Financial Statements). We used the modified equity method of accounting to
determine the impairment loss for certain investments, as it was determined that
no better current evidence of the value of our cost method investments existed
and we believe that this gives us the best basis for our estimate given the
historic negative cash flows of these companies. The modified equity method of
accounting results in recording an impairment loss on a cost method investment
equal to the investor’s proportionate share of the investee’s losses as its
contributed capital is consumed to fund operating losses of the investee from
the inception of the investor’s investment.





RESULTS OF
OPERATIONS




The
results of operations that follow should be read in conjunction with our
critical accounting policies and estimates summarized above as well as our
consolidated financial statements and notes thereto contained in Item 8 of this
report. The following table sets forth certain consolidated statements of
operations data as a percentage of net revenues for the periods
indicated.




40


Years ended December 31,2008
                          
                          
                          2007
                          
                          
                          2006Net
      revenues:Product
      revenues
                          
                          
                          95
                          %
                          
                          
                          90
                          %
                          
                          
                          93
                          %Service
      revenues
                          
                          
                          5
                          %
                          
                          
                          10
                          %
                          
                          
                          7
                          %Total
      net revenues
                          
                          
                          100
                          %
                          
                          
                          100
                          %
                          
                          
                          100
                          %Cost
      of revenues:Product
      cost of revenues
                          
                          
                          40
                          %
                          
                          
                          32
                          %
                          
                          
                          24
                          %Provision
      for excess and obsolete inventories
                          
                          
                          1
                          %
                          
                          
                          1
                          %
                          
                          
                          -
                          %Service
      cost of revenues
                          
                          
                          2
                          %
                          
                          
                          5
                          %
                          
                          
                          3
                          %Total
      cost of revenues
                          
                          
                          43
                          %
                          
                          
                          38
                          %
                          
                          
                          27
                          %Gross
      profit
                          
                          
                          57
                          %
                          
                          
                          62
                          %
                          
                          
                          73
                          %Operating
      expenses:Research
      and development
                          
                          
                          58
                          %
                          
                          
                          67
                          %
                          
                          
                          55
                          %Marketing
      and sales
                          
                          
                          21
                          %
                          
                          
                          32
                          %
                          
                          
                          30
                          %General
      and administrative
                          
                          
                          16
                          %
                          
                          
                          17
                          %
                          
                          
                          16
                          %Restructuring
      charge and asset impairment, net
                          
                          
                          9
                          %
                          
                          
                          4
                          %
                          
                          
                          1
                          %Total
      operating expenses
                          
                          
                          104
                          %
                          
                          
                          120
                          %
                          
                          
                          102
                          %Operating
      loss
                          
                          
                          (47
                          )
      %
                          
                          
                          (58
                          )
      %
                          
                          
                          (29
                          )
      %


41


Comparison
of Fiscal Years 2008 and 2007





Net
Revenues. We have four product line categories: 1) Optical
Transport; 2) Broadband Access; 3) Carrier Ethernet and VOIP and 4)
Non-Telecommunications.  The Optical Transport product line is
incorporated into OEM systems that improve the efficiency of fiber optic
networks and in the process increase the overall network
capacity.  The Broadband Access product line is incorporated into OEM
systems that allow telecommunications service providers to transition their
legacy voice networks to support next generation services such as voice, data
and video.  The Carrier Ethernet product line allows carriers to
provide robust and differentiated services using Ethernet technology in their
wide-area networks. VoIP products are used in carrier-class and enterprise-class
media gateways and access gateways and for use in residential gateway
markets.  The Non-Telecommunications product line consists of
non-telecommunications ASIC products.  The following tables summarize
our net product revenue mix by product line:





(Tabular dollars in thousands)
                  
                  Year Ended
                    December 31, 2008
                  
                  
                  Year Ended
                    December 31, 2007
                  
                  
                  PercentageRevenues
                  
                  
                  Percent of
                    Total
                    Revenues
                  
                  
                  Revenues
                  
                  
                  Percent of
                    Total
                    Revenues
                  
                  
                  Increase
                    (Decrease) in
                    RevenuesOptical
      Transport
                  
                  $
                  20,258
                  
                  
                  
                  48
                  %
                  
                  $
                  18,055
                  
                  
                  
                  56
                  %
                  
                  
                  12
                  %Broadband
      Access
                  
                  
                  15,512
                  
                  
                  
                  37
                  %
                  
                  
                  7,731
                  
                  
                  
                  24
                  %
                  
                  
                  101
                  %Carrier
      Ethernet and VOIP
                  
                  
                  3,348
                  
                  
                  
                  8
                  %
                  
                  
                  2,431
                  
                  
                  
                  7
                  %
                  
                  
                  38
                  %Non-Telecommunications
                  
                  
                  885
                  
                  
                  
                  2
                  %
                  
                  
                  1,093
                  
                  
                  
                  3
                  %
                  
                  
                  (19
                  )%Sub-total
      product revenues
                  
                  
                  40,003
                  
                  
                  
                  95
                  %
                  
                  
                  29,310
                  
                  
                  
                  90
                  %
                  
                  
                  36
                  %Service
      revenues
                  
                  
                  1,931
                  
                  
                  
                  5
                  %
                  
                  
                  3,255
                  
                  
                  
                  10
                  %
                  
                  
                  (41
                  )%Total
                  
                  $
                  41,934
                  
                  
                  
                  100
                  %
                  
                  $
                  32,565
                  
                  
                  
                  100
                  %
                  
                  
                  29
                  %





Total
product sales in 2008 were $40.0 million as compared to $29.3 million in 2007,
an increase of $10.7 million or 36%.  The increase in net product
revenue for 2008 compared to 2007 includes approximately $6.0 million of
increased sales as a result of the acquisition of Centillium in the fourth
quarter of 2008.  Approximately $5.0 million of the Centillium revenue
is included in our Broadband Access products and $1.0 million is included in
Carrier Ethernet and VOIP.  The increase in Broadband Access product
sales in 2008 also included increased sales of our ASIC products partially
offset by lower sales of our ASPEN, ASPEN Express and CUBIT-PRO products. Our
Optical Transport product revenue increased approximately $2.2 million in 2008
as compared to 2007.  This included increased sales of our L3M, E1Mx21
and ET family of products which were partially offset by decreased sales of our
TEMx28, QE1F-Plus and DART products. Our Non-telecommunications products
decreased by approximately $0.2 million in 2008 as compared to
2007.





Service
revenues (approximately $1.9 million in 2008 and $3.3 million in 2007) consist
of design services performed for third parties on a contract basis and HDMI and
technology licenses.




For 2008
and 2007 international net revenues were approximately 85% and 79%,
respectively, of net revenues.




As of
December 31, 2008 our backlog was $8.3 million, as compared to $4.6 million as
of December 31, 2007. Backlog represents firm orders anticipated to be shipped,
and service revenue expected to be billed under existing contracts, during the
next 12 months. Our business and, to a large extent, that of the entire
communication semiconductor industry, is characterized by short-term order and
shipment schedules. Since orders constituting our current backlog are subject to
changes in delivery schedules or to cancellation at the option of the purchaser
without significant penalty, backlog is not necessarily indicative of future
revenues.


42





Gross
Profit. Gross profit was $23.9 million and $20.2 million for the years
ended December 31, 2008 and 2007, respectively. Gross profit increased by
approximately $3.7 million for 2008 as compared to 2007 while the gross profit
as a percentage of revenue decreased by approximately 5%.  This is a
result of increased revenue from our lower margin ASIC and newly acquired
Centillium products.





During
the years ended December 31, 2008 and 2007, gross profit was affected favorably
in the amount of $1.6 million and $1.2 million, respectively, from the sales of
products that had previously been written down to a cost basis of zero. Also
during the years ended December 31, 2008 and 2007, we recorded provisions for
excess and obsolete inventories in the amount of $0.3 million and $0.4 million,
respectively. These charges had a negative impact on our gross
profit.





We
anticipate that gross profit will continue to be impacted by fluctuations in the
volume and mix of our product shipments as well as material costs, yield and the
fixed cost absorption of our production operations.





Research and
Development.    Research and development expenses
consist primarily of salaries and related costs of employees engaged in
research, design and development activities, costs related to electronic design
automation tools, subcontracting and fabrication costs, depreciation and
amortization and facilities expenses. Research and development expenses for 2008
were $24.6 million which increased $2.9 million, or 13% as compared to the prior
year.  This increase was a result of increased expenses due to the
acquisition of Centillium and increased expenses due to our HDMI development
program partially offset by decreased depreciation and amortization and
decreases in salaries and subcontracting costs as a result of workforce
reductions and other cost cutting measures that were implemented in 2007 and
2008.




Marketing and
Sales.    Marketing and sales expenses consist
primarily of personnel-related, trade show, travel and facilities expenses.
Marketing and sales expenses for 2008 were $8.8 million which decreased $1.4
million, or 14% as compared to the prior year. These expense decreases were
primarily from lower salaries and employee related expenses partially offset by
increased marketing and sales expenses due to the acquisition of
Centillium.





General and
Administrative.   General and administrative
(G&A) expenses consist primarily of personnel-related expenses, professional
and legal fees, and facilities expenses.G&A expenses were $6.7
million in 2008, an increase of approximately $1.1 million or 19% compared to
the prior year.  The increase was due to increased expenses due to the
acquisition of Centillium.





Restructuring
Charges.   We
recorded restructuring charges of $3.8 million and $1.4 million for 2008 and
2007, respectively.  Information on restructuring charges and asset
impairments for each of the last two years is located in Note 14 of the Notes to
Consolidated Financial Statements.





Change in Fair
Value of the Derivative Liability.For 2008 and 2007, we
recorded other expense of approximately $0.3 million and other income of
approximately $1.0 million, respectively, to reflect the change in the fair
value of the derivative liabilities.





During
the first quarter of 2008 we entered into a number of foreign exchange contracts
to purchase Indian rupees to fund our India operations. For the year ended
December 31, 2008, we recorded other expense of approximately $0.3 million to
reflect the change in the fair value of these derivative financial instruments.
There were no foreign exchange contracts outstanding at December 31,
2008.





For the
year ended December 31, 2007, we recorded other income of approximately $1.0
million to reflect the change in the fair value of the derivative liability
resulting from the 5.45% Convertible Plus Cash Notes due 2007 (“Plus Cash
Notes”).   (Refer to Note 13 – Convertible Notes of the Notes to
Consolidated Financial Statements). There were no Plus Cash Notes outstanding at
December 31, 2008 and 2007.


43





Gain/Loss on
Extinguishment of Debt.On December 24, 2008, we entered into
an agreement with certain holders of our 5.45% Convertible Notes due 2010 (the
“2010 Notes”) to purchase $15.0 million aggregate principal amount of the Notes
for $9.9 million in cash, plus accrued and unpaid interest.  As a
result of this transaction, we recorded a $4.5 million gain on the
extinguishment of debt in 2008.





On July
6, 2007, we exchanged approximately $21.2 million aggregate principal amount of
our outstanding Plus Cash Notes for an equivalent principal amount of the 2010
Notes.  As a result, we recognized a $0.4 million extinguishment loss
in 2007.





Interest Expense
net.Interest expense, net decreased approximately $0.1
million to $1.0 million in 2008.





Interest
expense decreased from $3.6 million in 2007 to $1.9 million in 2008 due to lower
debt balances resulting from the exchanges of our Plus Cash Notes in 2007, the
payment at maturity of the remaining outstanding Plus Cash Notes in 2007 and the
elimination of the debt discount associated with the Plus Cash Notes during
2007.





Interest
income decreased from $2.5 million in 2007 to $0.9 million in 2008 as a result
of lower market yields due to decreased interest rates and lower cash and
investment balances. At December 31, 2008 and 2007, the effective interest rates
on our interest-bearing securities were approximately 1.63% and 4.70%,
respectively.




Income Tax
Expense.  Our income tax expense of $0.5 million in 2008 and
$0.3 million in 2007 is applicable to the operating results of certain of our
foreign subsidiaries.  We have incurred significant taxable losses for
U.S. federal and state purposes. We have not recognized any income tax benefits
on those losses because their realization is uncertain.





Comparison
of Fiscal Years 2007 and 2006





Net
Revenues.During 2007, we changed our presentation of net
revenues by product line.  We have four product line categories: 1)
Broadband Access; 2) Optical Transport; 3) Carrier Ethernet and 4)
Non-Telecommunications.  The Broadband Access product line is
incorporated into OEM systems that allow telecommunications service providers to
transition their legacy voice networks to support next generation services such
as voice, data and video.  The Optical Transport product line is
incorporated into OEM systems that improve the efficiency of fiber optic
networks and in the process increase the overall network
capacity.  The Carrier Ethernet product line allows carriers to
provide robust and differentiated services using Ethernet technology in their
wide-area networks.  The Non-Telecommunications product line consists
of non-telecommunications ASIC products.  The following tables
summarize our net product revenue mix by product line:





(Tabular dollars in thousands)
                      
                      Year Ended
                        December 31, 2007
                      
                      
                      Year Ended
                        December 31, 2006
                      
                      
                      PercentageRevenues
                      
                      
                      Percent of
                        Total
                        Revenues
                      
                      
                      Revenues
                      
                      
                      Percent of
                        Total
                        Revenues
                      
                      
                      Increase
                        (Decrease) in
                        RevenuesOptical
      Transport
                      
                      $
                      18,055
                      
                      
                      
                      56
                      %
                      
                      $
                      28,150
                      
                      
                      
                      72
                      %
                      
                      
                      36
                      %Broadband
      Access
                      
                      
                      7,731
                      
                      
                      
                      24
                      %
                      
                      
                      5,765
                      
                      
                      
                      15
                      %
                      
                      
                      34
                      %Carrier
      Ethernet
                      
                      
                      2,431
                      
                      
                      
                      7
                      %
                      
                      
                      1,969
                      
                      
                      
                      5
                      %
                      
                      
                      23
                      %Non-Telecommunications
                      
                      
                      1,093
                      
                      
                      
                      3
                      %
                      
                      
                      275
                      
                      
                      
                      1
                      %
                      
                      
                      297
                      %Sub-total
      product revenues
                      
                      
                      29,310
                      
                      
                      
                      90
                      %
                      
                      
                      36,159
                      
                      
                      
                      93
                      %
                      
                      
                      (19
                      )%Service
      revenues
                      
                      
                      3,255
                      
                      
                      
                      10
                      %
                      
                      
                      2,761
                      
                      
                      
                      7
                      %
                      
                      
                      18
                      %Total
                      
                      $
                      32,565
                      
                      
                      
                      100
                      %
                      
                      $
                      38,920
                      
                      
                      
                      100
                      %
                      
                      
                      (16
                      )%


44





Total
product sales in 2007 were $29.3 million as compared to $36.1 million in 2006, a
decrease of $6.8 million or 19%.  The decrease in net product revenue
for 2007 compared to 2006 reflects decreased volume of our Optical Transport
products of $10.1 million, including decreasing sales of $9.0 million in legacy
products (led by DART, L3M and SOT-3) and $1.1 million decreased sales in new
products (mainly EtherPHAST 48 Plus). Broadband Access, Carrier Ethernet and
Non-Telecommunications product sales increased by $3.2 million in total
primarily due to ASIC product sales in our Mysticom and ASIC Design Center
businesses.





Service
revenues (approximately $3.3 million in 2007 and $2.8 million in 2006) consist
of design services performed for third parties on a short-term contract basis
and technology licenses.




For 2007
and 2006 international net revenues were approximately 79% and 75%,
respectively, of net revenues.




As of
December 31, 2007 our backlog was $4.6 million, as compared to $7.0 million as
of December 31, 2006. Backlog represents firm orders anticipated to be shipped,
and service revenue expected to be billed under existing contracts, during the
next 12 months. Our business and, to a large extent, that of the entire
communication semiconductor industry, is characterized by short-term order and
shipment schedules. Since orders constituting our current backlog are subject to
changes in delivery schedules or to cancellation at the option of the purchaser
without significant penalty, backlog is not necessarily indicative of future
revenues.





Gross
Profit.  Gross profit was $20.2 million and $28.2 million for the
years ended December 31, 2007 and 2006, respectively. The decrease in gross
profit for 2007 as compared to 2006 reflects lower overall revenues, a decrease
in sales of our newer non-ASIC products, which generally yield a higher margin
than our legacy products, and an increase in sales of our lower margin ASIC
products.





During
the years ended December 31, 2007 and 2006, gross profit was affected favorably
in the amount of $1.2 million and $2.8 million, respectively, from the sales of
products that had previously been written down to a cost basis of zero. Also
during the year ended December 31, 2007, we recorded a provision for excess and
obsolete inventories in the amount of $0.4 million. This charge had a negative
impact on our gross profit.





We
anticipate that gross profit will continue to be impacted by fluctuations in the
volume and mix of our product shipments as well as material costs, yield and the
fixed cost absorption of our production operations.





Research and
Development.    Research and development expenses
consist primarily of salaries and related costs of employees engaged in
research, design and development activities, costs related to electronic design
automation tools, subcontracting and fabrication costs, depreciation and
amortization and facilities expenses. Research and development expenses for 2007
were $21.7 million which increased $0.5 million, or 2% as compared to the prior
year.  This increase is primarily due to increased fabrication costs
associated with new product development.





We
believe that continued investment in the design and development of future
products is vital to maintain a competitive edge. We have closely monitored our
known and forecasted revenue demand and operating expense run
rates.  We continue to seek opportunities to focus our research and
development activities and will continue to closely monitor both our costs and
our revenue expectations in future periods.  We will continue to
concentrate our spending in this area to meet our customer requirements and
respond to market conditions.




Marketing and
Sales.    Marketing and sales expenses consist
primarily of personnel-related, trade show, travel and facilities expenses.
Marketing and sales expenses for 2007 were $10.2 million which decreased $1.3
million, or 11% as compared to the prior year. The decrease is primarily due to
lower salary and commission expenses associated with a lower headcount and lower
levels of revenue.





General and
Administrative.   General and administrative
(G&A) expenses consist primarily of personnel-related expenses, professional
and legal fees, and facilities expenses.G&A expenses were $5.6
million in 2007 a decrease of approximately $0.5 million, or 9% compared to the
prior year.  The decrease was primarily due to a lower headcount
associated with cost cutting measures.


45





Restructuring
Charges.   We recorded restructuring charges of $1.4
million and $0.4 million for 2007 and 2006, respectively.  Information
on restructuring charges and asset impairments for each of the last two years is
located in Note 14 of the Notes to Consolidated Financial
Statements.





Change in Fair
Value of the Derivative Liability.For 2007 and 2006, we
recorded other income of approximately $1.0 million and $5.1 million,
respectively, to reflect the change in the fair value of the derivative
liability associated with the 5.45% Convertible Plus Cash Notes due September
30, 2007 (the “Plus Cash Notes”).  (Refer to Note 13 – Convertible
Notes of the Notes to Consolidated Financial Statements). There were no Plus
Cash Notes outstanding at December 31, 2007.





Loss on
Extinguishment of Debt.On July 6, 2007, the Company exchanged
approximately $21.2 million aggregate principal amount of its outstanding Plus
Cash Notes for an equivalent principal amount of a new series of 5.45%
Convertible Notes due September 30, 2010 (the “2010 Notes”).  As a
result we recognized a $0.4 million extinguishment loss.





Interest Expense
net.Interest expense, net decreased approximately $0.5
million to $1.1 million in 2007.





Interest
expense decreased from $4.4 million in 2006 to $3.6 million in 2007 due to lower
debt balances resulting from the exchanges of the Plus Cash Notes described
above.





Interest
income decreased slightly from $2.7 million in 2006 to $2.5 million in 2007, due
to lower interest earning cash equivalent balances. At December 31, 2007 and
2006, the effective interest rates on our interest-bearing securities were
approximately 4.70% and 5.20%, respectively.




Income Tax
Expense.  Our income tax expense of $0.3 million in 2007 and
$0.1 million in 2006 is applicable to the operating results of certain of our
foreign subsidiaries.  We have incurred significant taxable losses for
U.S. federal and state purposes. We have not recognized any income tax benefits
on those losses because their realization is uncertain.





Information
on income taxes for each of the last three years is located in Note 10 of the
Notes to Consolidated Financial Statements.





LIQUIDITY
AND CAPITAL RESOURCES





As of
December 31, 2008, we had cash, cash equivalents, restricted cash and short-term
investments of approximately $15.3 million compared to $34.1 million as of
December 31, 2007. Further, our working capital was $8.7 million compared to
$36.9 million last year. Our primary source of liquidity is cash, cash
equivalents and short term investments. We have used cash in our operating
activities in each of the last three years, including $18.5 million in 2008,
$12.8 million in 2007 and $6.9 million in 2006. During 2008 we reduced long-term
debt from $25.0 million as of December 31, 2007 to $10.0 million as of December
31, 2008.





In the
fourth quarter 2008, we implemented restructuring plans that included the
elimination of approximately 76 positions, primarily in our Shelton,
Connecticut, Bedford, Massachusetts, Fremont, California, Eclubens, Switzerland,
New Delhi, India and Bangalore, India locations.  As a result, we
incurred restructuring costs of approximately $7.2 million. We believe that we
have reduced our anticipated operating expenses to the point where we can
break-even, excluding stock compensation costs, at the rate of sales that we
achieved in the fourth quarter of 2008. Also, we intend to continue to assess
our cost structure in relationship to our revenue levels and to make appropriate
adjustments to expense levels as required. None-the-less we believe that our
existing cash and cash equivalents and short-term investments will be sufficient
to fund operating activities and capital expenditures, and provide adequate
working capital through at least December 31, 2009.





If our
existing resources and cash generated from operations are insufficient to
satisfy liquidity requirements, we may seek to raise additional funds through
public or private debt or equity financings.  The sale of equity or
debt securities could result in additional dilution to our stockholders, could
require us to pledge our intellectual property or other assets to secure the
financing, or could impose restrictive covenants on us.  We cannot be
certain that additional financing will be available in amounts or on terms
acceptable to us, or at all.  If we are unable to obtain this
additional financing, we may be required to reduce the scope of our planned
product development and sales and marketing efforts, which could harm our
business, financial condition and operating results, and/or cause us to sell
assets or otherwise restructure our business to remain viable.


46





Commitments
and Significant Contractual Obligations




We have
existing commitments to make future interest payments on the 2010 Notes and to
redeem these notes in September 2010.  Over the remaining life of the
outstanding 2010 Notes, we expect to pay approximately $1.1 million of interest
on them.




We have
outstanding operating lease commitments of $34.2 million, payable over the next
nine years. Some of these commitments are for space that is not being utilized
and, for which, we recorded restructuring charges in prior years for excess
facilities. 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. As of December 31, 2008, we have approximately $4.7 million
in anticipated sub-lease income over the next four years relating to portions of
our excess facilities. 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 and their payments follows (in
thousands):





Payments Due by PeriodContractual Obligations
                            
                            Total
                            
                            
                            2009
                            
                            
                            2010 &
                              2011
                            
                            
                            2012 &
                              2013
                            
                            
                            ThereafterInterest
      on convertible notes
                            
                            $
                            1,091
                            
                            
                            $
                            546
                            
                            
                            $
                            545
                            
                            
                            $
                            —
                            
                            
                            $
                            —Convertible
      notes
                            
                            
                            10,013
                            
                            
                            
                            —
                            
                            
                            
                            10,013
                            
                            
                            
                            —
                            
                            
                            
                            —Operating
      lease obligations
                            
                            
                            34,215
                            
                            
                            
                            6,178
                            
                            
                            
                            10,267
                            
                            
                            
                            8,155
                            
                            
                            
                            9,615Purchase
      obligations
                            
                            
                            6,432
                            
                            
                            
                            6,432
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —$
                            51,751
                            
                            
                            $
                            13,156
                            
                            
                            $
                            20,825
                            
                            
                            $
                            8,155
                            
                            
                            $
                            9,615





We also
have pledged approximately $3.1 million as collateral for stand-by letters of
credit that guarantee certain long-term property lease obligations and to
support customer credit requirements. This $3.1 million is in our bank accounts
and is included in our restricted cash as of December 31, 2008.




Recent
Accounting Pronouncements




Newly
issued accounting pronouncements that potentially impact our financial
statements are disclosed in the Notes to Consolidated Financial Statements of
this report.





Item
7A.Quantitative
and Qualitative Disclosures about Market Risk




Interest Rate
Risk.  We have investments in money market accounts that earn
interest income that 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 2009, assuming a constant cash balance, would decrease by
less than $0.1 million.




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 2008, operating expenses incurred in foreign currencies were
approximately 41% of our total operating expenses. Although we have not
experienced significant foreign exchange rate 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 changes are often linked to variability in real growth,
inflation, interest rates, governmental actions and other factors. These
changes, if material, may cause us to adjust our financing and operating
strategies. Consequently, isolating the effect of changes in currency does not
incorporate these other important economic factors.


47





Fair Market Value of Financial
Instruments.  As of December 31, 2008, our debt consisted
exclusively of convertible notes due September 30, 2010 with interest at a fixed
rate of 5.45%. Consequently, we do not have significant cash flow exposure on
the interest payments on these notes. However, the Company does have
considerable exposure in the requirement to redeem these convertible notes on
September 30, 2010.  There is no guarantee that the Company will have
either enough cash to pay down this debt, or the ability to refinance this debt
on terms acceptable to the Company.  The fair market value of our
outstanding 5.45% Convertible Notes due September 30, 2010 was estimated based
on current market conditions at approximately $6.6 million at December 31, 2008.
Among other factors, changes in interest rates and the price of our common stock
affect the fair value of our convertible notes. Refer to critical accounting
policies and use of estimates in Item 7 - “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” for additional information
associated with our 2010 Notes.


48


Item
8.Financial
Statements and Supplementary Data




TRANSWITCH
CORPORATION AND SUBSIDIARIES




INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS


AND
FINANCIAL STATEMENT SCHEDULE




PageFinancial
      Statements:Report
      of Independent Registered Public Accounting Firm
                      
                      50Consolidated
      Balance Sheets as of December 31, 2008 and 2007
                      
                      52Consolidated
      Statements of Operations for the years ended December 31, 2008, 2007 and
      2006
                      
                      53Consolidated
      Statements of Stockholders’ Equity and Comprehensive Loss for the years
      ended December 31, 2008, 2007 and 2006
                      
                      54Consolidated
      Statements of Cash Flows for the years ended December 31, 2008, 2007 and
      2006
                      
                      55Notes
      to Consolidated Financial Statements
                      
                      56Financial
      Statement Schedule:Schedule
      II, Valuation and Qualifying Accounts
                      
                      78


49





REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Stockholders and Board of Directors


TranSwitch
Corporation





We have
audited the accompanying consolidated balance sheets of TranSwitch Corporation
and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related
consolidated statements of operations, stockholders' equity and comprehensive
loss, and cash flows for each of the years in the three-year period ended
December 31, 2008.  Our audit also included the financial statement
schedule listed in the Index at Item 8. We have also audited the Company’s
internal control over financial reporting as of December 31, 2008, based on the
criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).  These financial statements and schedule
are the responsibility of the Company's management.  Further, the
Company’s management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in Management’s Annual Report on
Internal Control over Financial Reporting under Item 9A. Our responsibility is
to express an opinion on these financial statements and schedule, and an opinion
on the Company’s internal control over financial reporting based on our
audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation.  Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audits also included performing such other procedures as
we considered necessary in the circumstances.  We believe that our
audits provide a reasonable basis for our opinions.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the  financial position of the Company as of
December 31, 2008 and 2007, and the results of its operations and its cash flows
for each of the years in the three-year period ended December 31, 2008 in
conformity with accounting principles generally accepted in the United States of
America.  Also in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly, in all material respects, the information set forth
therein. Further, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2008,  based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).


50


As
discussed in Note 10, the Company adopted FIN 48, Accounting for Uncertainty in Income
Taxes – an Interpretation of FASB Statement No. 109,effective January 1,
2007.





/s/ UHY
LLP




New
Haven, Connecticut


March 12,
2009


51




TRANSWITCH
CORPORATION AND SUBSIDIARIES





CONSOLIDATED
BALANCE SHEETS


(in
thousands)





December 31,
                                        
                                        
                                        December 31,2008
                                        
                                        
                                        2007ASSETSCurrent
      assets:Cash
      and cash equivalents
                                        
                                        $
                                        7,462
                                        
                                        
                                        $
                                        34,098Restricted
      cash
                                        
                                        
                                        4,852
                                        
                                        
                                        
                                        —Short-term
      investments
                                        
                                        
                                        2,970
                                        
                                        
                                        
                                        —Accounts
      receivable, net of allowances of $536 and $623
                                        
                                        
                                        12,865
                                        
                                        
                                        
                                        6,850Inventories
                                        
                                        
                                        4,504
                                        
                                        
                                        
                                        3,069Prepaid
      expenses and other current assets
                                        
                                        
                                        2,526
                                        
                                        
                                        
                                        1,510Total
      current assets
                                        
                                        
                                        35,179
                                        
                                        
                                        
                                        45,527Property
      and equipment, net
                                        
                                        
                                        2,029
                                        
                                        
                                        
                                        5,116Goodwill
                                        
                                        
                                        25,079
                                        
                                        
                                        
                                        10,075Other
      intangible assets, net
                                        
                                        
                                        11,454
                                        
                                        
                                        
                                        1,483Investments
      in non-publicly traded companies
                                        
                                        
                                        2,963
                                        
                                        
                                        
                                        2,898Deferred
      financing costs, net
                                        
                                        
                                        403
                                        
                                        
                                        
                                        1,581Other
      assets
                                        
                                        
                                        1,320
                                        
                                        
                                        
                                        907Total
      assets
                                        
                                        $
                                        78,427
                                        
                                        
                                        $
                                        67,587LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                                        
                                        $
                                        4,240
                                        
                                        
                                        $
                                        1,665Accrued
      expenses and other current liabilities
                                        
                                        
                                        22,231
                                        
                                        
                                        
                                        6,995Total
      current liabilities
                                        
                                        
                                        26,471
                                        
                                        
                                        
                                        8,660Restructuring
      liabilities
                                        
                                        
                                        19,664
                                        
                                        
                                        
                                        20,2465.45%
      Convertible Notes due 2010
                                        
                                        
                                        10,013
                                        
                                        
                                        
                                        25,013Total
      liabilities
                                        
                                        
                                        56,148
                                        
                                        
                                        
                                        53,919Commitments
      and contingenciesStockholders’
      equity:Common
      stock, $.001 par value: authorized - 300,000,000 shares; issued -
      158,674,340 shares at December 31, 2008 and 133,098,432 shares at December
      31, 2007
                                        
                                        
                                        159
                                        
                                        
                                        
                                        133Additional
      paid-in capital
                                        
                                        
                                        381,384
                                        
                                        
                                        
                                        354,813Accumulated
      other comprehensive income – currency translation
                                        
                                        
                                        36
                                        
                                        
                                        
                                        858Common
      stock held in treasury (166,350 shares), at cost
                                        
                                        
                                        (118
                                        )
                                        
                                        
                                        —Accumulated
      deficit
                                        
                                        
                                        (359,182
                                        )
                                        
                                        
                                        (342,136
                                        )Total
      stockholders’ equity
                                        
                                        
                                        22,279
                                        
                                        
                                        
                                        13,668Total
      liabilities and stockholders’ equity
                                        
                                        $
                                        78,427
                                        
                                        
                                        $
                                        67,587




See
accompanying notes to consolidated financial statements.


52


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  CONSOLIDATED
STATEMENTS OF OPERATIONS
 (in
thousands, except per share data)


Years ended December 31,2008
                                              
                                              
                                              2007
                                              
                                              
                                              2006Net
      revenues:Product
      revenues
                                              
                                              $
                                              40,003
                                              
                                              
                                              $
                                              29,310
                                              
                                              
                                              $
                                              36,159Service
      revenues
                                              
                                              
                                              1,931
                                              
                                              
                                              
                                              3,255
                                              
                                              
                                              
                                              2,761Total
      net revenues
                                              
                                              
                                              41,934
                                              
                                              
                                              
                                              32,565
                                              
                                              
                                              
                                              38,920Cost
      of revenues:Cost
      of product revenues
                                              
                                              
                                              16,730
                                              
                                              
                                              
                                              10,514
                                              
                                              
                                              
                                              9,507Provision
      for excess and obsolete inventories
                                              
                                              
                                              316
                                              
                                              
                                              
                                              443
                                              
                                              
                                              
                                              —Cost
      of service revenues
                                              
                                              
                                              994
                                              
                                              
                                              
                                              1,437
                                              
                                              
                                              
                                              1,239Total
      cost of revenues
                                              
                                              
                                              18,040
                                              
                                              
                                              
                                              12,394
                                              
                                              
                                              
                                              10,746Gross
      profit
                                              
                                              
                                              23,894
                                              
                                              
                                              
                                              20,171
                                              
                                              
                                              
                                              28,174Operating
      expenses:Research
      and development
                                              
                                              
                                              24,568
                                              
                                              
                                              
                                              21,703
                                              
                                              
                                              
                                              21,245Marketing
      and sales
                                              
                                              
                                              8,816
                                              
                                              
                                              
                                              10,223
                                              
                                              
                                              
                                              11,523General
      and administrative
                                              
                                              
                                              6,678
                                              
                                              
                                              
                                              5,617
                                              
                                              
                                              
                                              6,139Restructuring
      charges, net
                                              
                                              
                                              3,804
                                              
                                              
                                              
                                              1,428
                                              
                                              
                                              
                                              403Reversal
      of accrued royalties
                                              
                                              
                                              (198
                                              )
                                              
                                              
                                              —
                                              
                                              
                                              
                                              —Total
      operating expenses
                                              
                                              
                                              43,668
                                              
                                              
                                              
                                              38,971
                                              
                                              
                                              
                                              39,310Operating
      loss
                                              
                                              
                                              (19,774
                                              )
                                              
                                              
                                              (18,800
                                              )
                                              
                                              
                                              (11,136
                                              )Other
      income (expense):Other
      income
                                              
                                              
                                              81
                                              
                                              
                                              
                                              —
                                              
                                              
                                              
                                              85Impairment
      of investments in non-publicly traded companies
                                              
                                              
                                              —
                                              
                                              
                                              
                                              (109
                                              )
                                              
                                              
                                              —Change
      in fair value of derivative liability
                                              
                                              
                                              (347
                                              )
                                              
                                              
                                              980
                                              
                                              
                                              
                                              5,060Gain
      (loss) on extinguishment of debt
                                              
                                              
                                              4,491
                                              
                                              
                                              
                                              (351
                                              )
                                              
                                              
                                              (3,124
                                              )Interest:Interest
      income
                                              
                                              
                                              934
                                              
                                              
                                              
                                              2,457
                                              
                                              
                                              
                                              2,728Interest
      expense
                                              
                                              
                                              (1,941
                                              )
                                              
                                              
                                              (3,606
                                              )
                                              
                                              
                                              (4,355
                                              )Interest
      expense, net
                                              
                                              
                                              (1,007
                                              )
                                              
                                              
                                              (1,149
                                              )
                                              
                                              
                                              (1,627
                                              )Total
      other income (expense), net
                                              
                                              
                                              3,218
                                              
                                              
                                              
                                              (629
                                              )
                                              
                                              
                                              394Loss
      before income taxes
                                              
                                              
                                              (16,556
                                              )
                                              
                                              
                                              (19,429
                                              )
                                              
                                              
                                              (10,742
                                              )Income
      taxes
                                              
                                              
                                              490
                                              
                                              
                                              
                                              283
                                              
                                              
                                              
                                              114Net
      loss
                                              
                                              $
                                              (17,046
                                              )
                                              
                                              $
                                              (19,712
                                              )
                                              
                                              $
                                              (10,856
                                              )Basic
      and diluted loss per common share:Net
      loss
                                              
                                              $
                                              (0.12
                                              )
                                              
                                              $
                                              (0.15
                                              )
                                              
                                              $
                                              (0.09
                                              )Basic
      and diluted average common shares outstanding
                                              
                                              
                                              138,080
                                              
                                              
                                              
                                              132,529
                                              
                                              
                                              
                                              124,801





See
accompanying notes to consolidated financial statements.


53


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
 AND
COMPREHENSIVE LOSS
 (dollars
in thousands)


AccumulatedCommon
                                                
                                                
                                                Additional
                                                
                                                
                                                other
                                                
                                                
                                                AccumulatedCommon
      stock
                                                
                                                
                                                stock
      held in
                                                
                                                
                                                paid-in
                                                
                                                
                                                comprehensive
                                                
                                                
                                                earningsShares
                                                
                                                
                                                Amount
                                                
                                                
                                                treasury
                                                
                                                
                                                capital
                                                
                                                
                                                (loss)
      income
                                                
                                                
                                                (deficit)
                                                
                                                
                                                TotalBalance
      at December 31, 2005
                                                
                                                
                                                108,345,342
                                                
                                                
                                                $
                                                108
                                                
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                314,697
                                                
                                                
                                                $
                                                (28
                                                )
                                                
                                                $
                                                (311,568
                                                )
                                                
                                                $
                                                3,209Comprehensive
      loss:Net
      loss
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                (10,856
                                                )
                                                
                                                
                                                (10,856
                                                )Currency
      translation adjustment
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                432
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                432Total
      comprehensive loss
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                (10,424
                                                )Stock
      compensation
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                2,385
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                2,385Shares
      of common stock issued in connection with common stock
      offering
                                                
                                                
                                                13,766,667
                                                
                                                
                                                
                                                14
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                18,856
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                18,870Shares
      of common stock issued in connection with business
    acquisition
                                                
                                                
                                                2,621,845
                                                
                                                
                                                
                                                3
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                4,832
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                4,835Shares
      of common stock issued under stock option and stock purchase
      plans
                                                
                                                
                                                1,879,364
                                                
                                                
                                                
                                                2
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                2,462
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                2,464Shares
      of common stock issued upon exchange of 5.45% Convertible Plus Cash
      Notesdue
      2007
                                                
                                                
                                                1,500,000
                                                
                                                
                                                
                                                1
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                2,714
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                2,715Balance
      at December 31, 2006
                                                
                                                
                                                128,113,218
                                                
                                                
                                                $
                                                128
                                                
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                345,946
                                                
                                                
                                                $
                                                404
                                                
                                                
                                                $
                                                (322,424
                                                )
                                                
                                                $
                                                24,054Comprehensive
      loss:Net
      loss
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                (19,712
                                                )
                                                
                                                
                                                (19,712
                                                )Currency
      translation adjustment
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                454
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                454Total
      comprehensive loss
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                (19,258
                                                )Stock
      compensation
                                                
                                                
                                                85,432
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                1,980
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                1,980Shares
      of common stock issued in connection with business
    acquisition
                                                
                                                
                                                3,746,713
                                                
                                                
                                                
                                                4
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                5,541
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                5,545Shares
      of common stock issued under stock option and stock purchase
      plans
                                                
                                                
                                                1,153,069
                                                
                                                
                                                
                                                1
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                1,346
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                1,347Balance
      at December 31, 2007
                                                
                                                
                                                133,098,432
                                                
                                                
                                                $
                                                133
                                                
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                354,813
                                                
                                                
                                                $
                                                858
                                                
                                                
                                                $
                                                (342,136
                                                )
                                                
                                                $
                                                13,668Comprehensive
      loss:Net
      loss
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                (17,046
                                                )
                                                
                                                
                                                (17,046
                                                )Currency
      translation adjustment
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                (822
                                                )
                                                
                                                
                                                —
                                                
                                                
                                                
                                                (822
                                                )Total
      comprehensive loss
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                (17,868
                                                )Stock
      compensation
                                                
                                                
                                                393,091
                                                
                                                
                                                
                                                1
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                1,515
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                1,516Shares
      of common stock issued in connection with business
    acquisition
                                                
                                                
                                                25,000,000
                                                
                                                
                                                
                                                25
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                24,925
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                24,950Shares
      of common stock issued under stock option and stock purchase
      plans
                                                
                                                
                                                182,817
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                131
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                131Repurchase
      of 116,350 shares of common stock
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                (118
                                                )
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                (118
                                                )Balance
      at December 31, 2008
                                                
                                                
                                                158,674,340
                                                
                                                
                                                $
                                                159
                                                
                                                
                                                $
                                                (118
                                                )
                                                
                                                $
                                                381,384
                                                
                                                
                                                $
                                                36
                                                
                                                
                                                $
                                                (359,182
                                                )
                                                
                                                $
                                                22,279





See
accompanying notes to consolidated financial statements.


54




TRANSWITCH
CORPORATION AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
thousands)


Years ended December 31,2008
                                                
                                                
                                                2007
                                                
                                                
                                                2006Operating
      activities:Net
      loss
                                                
                                                $
                                                (17,046
                                                )
                                                
                                                $
                                                (19,712
                                                )
                                                
                                                $
                                                (10,856
                                                )Adjustments
      required to reconcile net loss to net cash flows used by operating
      activities, net of effects of acquisitions:Depreciation
      and amortization
                                                
                                                
                                                4,020
                                                
                                                
                                                
                                                4,527
                                                
                                                
                                                
                                                4,214Amortization
      of debt discount and deferred financing fees
                                                
                                                
                                                569
                                                
                                                
                                                
                                                1,536
                                                
                                                
                                                
                                                2,308(Gain)
      loss on extinguishment of debt
                                                
                                                
                                                (4,491
                                                )
                                                
                                                
                                                351
                                                
                                                
                                                
                                                3,124(Benefit)
      provision  for doubtful accounts
                                                
                                                
                                                (87
                                                )
                                                
                                                
                                                150
                                                
                                                
                                                
                                                27Provision
      for excess and obsolete inventories
                                                
                                                
                                                316
                                                
                                                
                                                
                                                443
                                                
                                                
                                                
                                                —Non-cash
      restructuring charges
                                                
                                                
                                                835
                                                
                                                
                                                
                                                58
                                                
                                                
                                                
                                                184Stock-based
      compensation expense
                                                
                                                
                                                1,516
                                                
                                                
                                                
                                                1,970
                                                
                                                
                                                
                                                2,395Impairment
      of investments in non-publicly traded companies
                                                
                                                
                                                —
                                                
                                                
                                                
                                                109
                                                
                                                
                                                
                                                —Change
      in fair value of derivative liability
                                                
                                                
                                                179
                                                
                                                
                                                
                                                (980
                                                )
                                                
                                                
                                                (5,060
                                                )Loss
      on retirement of property and equipment
                                                
                                                
                                                74
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —Reversal
      of accrued royalties
                                                
                                                
                                                (198
                                                )
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —Other
      non-cash items
                                                
                                                
                                                15
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —Changes
      in operating assets and liabilities:Accounts
      receivable
                                                
                                                
                                                (3,452
                                                )
                                                
                                                
                                                (1,166
                                                )
                                                
                                                
                                                (1,838
                                                )Inventories
                                                
                                                
                                                437
                                                
                                                
                                                
                                                146
                                                
                                                
                                                
                                                (682
                                                )Prepaid
      expenses and other assets
                                                
                                                
                                                505
                                                
                                                
                                                
                                                (118
                                                )
                                                
                                                
                                                585Accounts
      payable
                                                
                                                
                                                747
                                                
                                                
                                                
                                                435
                                                
                                                
                                                
                                                717Accrued
      expenses and other current liabilities
                                                
                                                
                                                (2,131
                                                )
                                                
                                                
                                                (124
                                                )
                                                
                                                
                                                (1,181
                                                )Obligation
      under deferred revenue
                                                
                                                
                                                146
                                                
                                                
                                                
                                                37
                                                
                                                
                                                
                                                (562
                                                )Restructuring
      liabilities
                                                
                                                
                                                (500
                                                )
                                                
                                                
                                                (423
                                                )
                                                
                                                
                                                (247
                                                )Net
      cash used by operating activities
                                                
                                                
                                                (18,546
                                                )
                                                
                                                
                                                (12,761
                                                )
                                                
                                                
                                                (6,872
                                                )Investing
      activities:Capital
      expenditures
                                                
                                                
                                                (592
                                                )
                                                
                                                
                                                (3,884
                                                )
                                                
                                                
                                                (4,636
                                                )Investments
      in non-publicly traded companies
                                                
                                                
                                                (65
                                                )
                                                
                                                
                                                (42
                                                )
                                                
                                                
                                                (1,996
                                                )Acquisition
      of business, net of cash acquired
                                                
                                                
                                                7,369
                                                
                                                
                                                
                                                (1,650
                                                )
                                                
                                                
                                                (769
                                                )Increase
      in restricted cash
                                                
                                                
                                                (2,286
                                                )
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —Purchases
      of short and long-term investments
                                                
                                                
                                                (10,630
                                                )
                                                
                                                
                                                —
                                                
                                                
                                                
                                                (4,921
                                                )Proceeds
      from sales and maturities of short and long-term
    investments
                                                
                                                
                                                8,658
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                38,782Net
      cash provided (used) by investing activities
                                                
                                                
                                                2,454
                                                
                                                
                                                
                                                (5,576
                                                )
                                                
                                                
                                                26,460Financing
      activities:Net
      proceeds from issuance of common stock
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —
                                                
                                                
                                                
                                                18,870Issuance
      of common stock under employee stock plans
                                                
                                                
                                                131
                                                
                                                
                                                
                                                1,346
                                                
                                                
                                                
                                                2,464Payments
      to extinguish debt
                                                
                                                
                                                (9,900
                                                )
                                                
                                                
                                                (8,908
                                                )
                                                
                                                
                                                (22,176
                                                )Proceeds
      from issuance of debt (net of fees)
                                                
                                                
                                                —
                                                
                                                
                                                
                                                1,901
                                                
                                                
                                                
                                                —Purchase
      of 166,350 shares of common stock for treasury
                                                
                                                
                                                (118
                                                )
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —Net
      cash used by financing activities
                                                
                                                
                                                (9,887
                                                )
                                                
                                                
                                                (5,661
                                                )
                                                
                                                
                                                (842
                                                )Effect
      of exchange rate changes on cash and cash equivalents
                                                
                                                
                                                (657
                                                )
                                                
                                                
                                                373
                                                
                                                
                                                
                                                136Change
      in cash and cash equivalents
                                                
                                                
                                                (26,636
                                                )
                                                
                                                
                                                (23,625
                                                )
                                                
                                                
                                                18,882Cash
      and cash equivalents at beginning of year
                                                
                                                
                                                34,098
                                                
                                                
                                                
                                                57,723
                                                
                                                
                                                
                                                38,841Cash
      and cash equivalents at end of year
                                                
                                                $
                                                7,462
                                                
                                                
                                                $
                                                34,098
                                                
                                                
                                                $
                                                57,723





See
accompanying notes to consolidated financial statements.


55




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


Note
1.    Business and Summary of Significant Accounting
Policies




Description
of Business




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





Principles
of Consolidation




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





Use
of Estimates




The
preparation of financial statements and related disclosures in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and revenues
and expenses during the period reported. Actual results could differ from those
estimates. Estimates relate to uncollectable accounts receivable, excess or
slow-moving or obsolete inventories, impairment of assets, product warranty
allowances, depreciation and amortization, income taxes, sales returns and
allowances, stock rotation allowances and contingencies. Estimates and
assumptions are reviewed periodically, and the effects of revisions are
reflected in the consolidated financial statements in the period they are
determined to be necessary.




Liquidity





The Company has incurred
significant operating losses and used cash in its operating activities for the
past several years. Operating losses have resulted from inadequate sales levels
for the cost structure. The Company has made business acquisitions in each of
the past three years to increase revenue. In addition, in the fourth quarter of
2008, the Company executed a significant restructuring to eliminate cost
redundancies and enhance operating effectiveness. The Company’s management
believes it now has an appropriate cost structure for its anticipated sales. As
such, management believes that the Company will provide sufficient cash flows to
fund its operations in the ordinary course of business through at least December
31, 2009. Of course there can be no assurance that the anticipated sales level
will be achieved.




Cash,
Cash Equivalents and Investments




All
highly liquid investments with an original maturity of three months or less when
purchased are considered cash equivalents. Cash equivalents consist of money
market funds as of December 31, 2008 and 2007. The majority of the Company’s
cash and cash equivalents balances are maintained with a limited number of major
financial institutions. Cash and cash equivalents balances at institutions may,
at times, be above the Federal Deposit Insurance Corporation insured limit of
$0.25 million per account.





Short-term
investments as of December 31, 2008 consist of government bonds which are all
due within one year. Such investments are classified as held-to-maturity.
Held-to-maturity securities are those securities which the Company has both the
ability and intent to hold to maturity. Held-to-maturity securities are stated
at amortized cost. Amortized cost and accrued interest as of December 31, 2008
approximate market value.





Fair
Value of Financial Instruments




The
carrying amounts for cash and cash equivalents, short-term investments, accounts
receivable, and accounts payable approximate fair value. The fair value of the
outstanding 5.45% Convertible Notes due 2010 was estimated at approximately $6.6
million and $20.6 million as of December 31, 2008 and December 31, 2007,
respectively, based on current market conditions.


56




TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)


The fair
value of investments in non-publicly traded companies is not readily
determinable.





Inventories




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





Product
Licenses




All
product licenses were fully amortized as of December 31, 2008 and
2007.  Prior thereto product licenses were amortized using the greater
of: (1) the amount computed using the ratio of a product’s current gross
revenues to the product’s total of current and estimated future gross revenues;
or (2) the straight-line method over the estimated useful life of the asset,
generally three to five years, not to exceed the term of the license.
Amortization of product licenses amounted to $0.2 million
for  2006.





Property
and Equipment




Property
and equipment are carried at cost less accumulated depreciation and
amortization. Any gain or loss resulting from sale or retirement is included in
the consolidated statement of operations. Repairs and maintenance are expensed
as incurred while renewals and betterments are capitalized. Costs incurred for
assets being constructed or installed but not yet available for service at the
balance sheet date are shown as construction in progress.





Goodwill





Goodwill
represents the excess of the purchase price over the fair value of identifiable
net assets of the business acquired.  The Company reviews goodwill for
potential impairment at least annually.




Other
Intangible Assets





Other
intangible assets consist of purchased customer relationships and developed
technology and are stated at cost, less accumulated amortization. Customer
relationships and developed technology are being amortized by the straight line
method over their estimated economic useful lives ranging from five to twelve
years.





Deferred
Financing Costs




Deferred
financing costs are being amortized using the interest method over the term of
the related debt. Unamortized deferred financing fees were $0.4 million and $1.6
million as of December 31, 2008 and 2007, respectively. Amortization, included
in the consolidated statement of operations as a component of interest expense,
was $0.6 million, $0.5 million, and $0.4 million for 2008, 2007 and 2006,
respectively.




Impairment
of Intangibles and Long-Lived Assets




The
Company reviews long-lived and intangible assets (including goodwill) for
impairment at least annually, or whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be recoverable. When
factors indicate that a long-lived asset should be evaluated for possible
impairment, an estimate of the related asset’s undiscounted future cash flows
over the remaining life of the asset is made to measure whether the carrying
value is recoverable. Any impairment is measured based upon the excess of the
carrying value of the asset over its estimated fair value which is generally
based on an estimate of future discounted cash flows. A significant amount of
management judgment is used in estimating future discounted cash
flows.





Investments
in Non-Publicly Traded Companies




The
Company has minority investments in certain non-publicly traded companies.
Depending on the Company’s level of ownership and whether or not the Company has
the ability to exercise significant influence, these investments are accounted
for by either the cost or equity method. All such investments as of December 31,
2008 and 2007 are accounted for by the cost method.  These investments
are reviewed periodically for impairment.


57


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)


Revenue
Recognition




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) ownership and risk of loss transfers to the customer; (3) the
selling price is fixed or determinable; and (4) collectability is reasonably
assured.




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




At the
time of shipment, the Company records a reduction to revenue (with a related
liability) to accrue for future price protection. This liability is established
based on historical experience, contractually agreed-to provisions and future
shipment forecasts. Such accruals have been insignificant for the last three
years.




The
Company also accrues, at the time of shipment, a reduction to revenue (with a
related liability) and an inventory asset against product cost of revenues in
order to establish a provision for the gross margin related to future returns
under the Company’s distributor stock rotation program. Such accruals are
insignificant to the Company’s financial position and results of operations for
all periods presented.  Should actual experience differ from estimated
liabilities, there could be adjustments (either favorable or unfavorable) to the
Company’s net revenues, cost of revenues and gross profits.





Service
revenues are recognized when the following criteria are met: (1) persuasive
evidence of an arrangement exists; (2) services have been performed in
accordance with the contractual obligations; (3) the fee is fixed or
determinable; and (4) collectability is reasonably assured.





The
Company licenses HDMI and other intellectual property.  Revenues from
licensing arrangements generally consist of multiple elements such as license,
implementation and maintenance services. The items (deliverables) included in
the arrangement are evaluated pursuant to EITF Issue No. 00-21 “Revenue
Arrangements with Multiple Deliverables” to determine whether they represent
separate units of accounting. The Company performs this evaluation at the
inception of an arrangement and as the Company delivers each item in the
arrangement.





Generally,
the Company accounts for a deliverable (or a group of deliverables) separately
if (1) the delivered item(s) has standalone value to the customer, (2) there is
objective and reliable evidence of the fair value of the undelivered items
included in the arrangement, and (3) if the Company has given the customer a
general right of return relative to the delivered items, delivery or performance
of the undelivered items or services are probable and substantially in the
Company’s control.





The
Company recognizes revenue from royalties upon notification of sale by its
licensees. The terms of the royalty agreements generally require licensees to
give notification to the Company and to pay royalties within 45 days of the end
of the quarter during which the sales by its licensees take place.





Allowance
for Doubtful Accounts




The
Company records allowances for doubtful accounts for estimated losses based upon
specifically identified amounts that it believes to be uncollectible along with
the Company’s assessment of the general financial condition of its customer
base. If the Company’s actual collections experience changes, revisions to its
allowances may be required. The Company has a limited number of customers with
individually large amounts due at any given balance sheet date. Any
unanticipated change in one of those customers’ creditworthiness or other
matters affecting the collectibility of amounts due from such customers could
have a material effect on the Company’s results of operations in the period in
which such changes or events occur.





Concentrations
of Credit Risk




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




Cash and
cash equivalents are held by high-quality financial institutions, thereby
reducing credit risk concentrations. In addition, the Company limits the amount
of credit exposure to any one financial institution.


58


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)


At
December 31, 2008 and 2007, approximately 53% and 44% of accounts receivable
were due from five customers. The majority of the Company’s sales are to
customers in the telecommunications and data communications industries. The
Company performs ongoing credit evaluations of its customers and generally does
not require collateral. The Company establishes an allowance for potentially
uncollectable accounts based upon factors surrounding the credit risk of
specific customers, historical payment trends and other
information.





Product
Warranties




The
Company provides warranties on its products for up to one year from the date of
shipment. A liability is recorded for estimated costs to be incurred under
product warranties, which is based on various inputs including historical
experience. Estimated warranty expense is recorded as cost of revenues as
products are shipped.   Product warranty costs are nominal for
all periods presented.





Research
and Development Costs




Research
and development costs are expensed as incurred.




Income
Taxes




Deferred
income tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and for operating
loss and tax credit carry forwards. Deferred income tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred income tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date. A valuation allowance is provided to the extent that it is more likely
than not that the Company will not be able to utilize deferred income tax assets
in the future.





Stock-Based
Compensation





The
Company recognizes share-based compensation expense for the fair value of the
awards on the date granted on a straight-line basis over their vesting
term.




Compensation
expense is recognized only for share-based payments expected to vest. The
Company estimates forfeitures at the date of grant based on the Company’s
historical experience and future expectations.




As of
December 31, 2008, the unrecognized stock-based compensation cost related to
non-vested option awards was $0.7 million and such amount will be recognized in
operations over a weighted average period of 1.59 years.  As of
December 31, 2008, the unrecognized stock-based compensation cost related to
non-vested stock awards was $0.4 million and such amount will be recognized in
operations over a weighted average period of 3.35 years.




Stock
compensation charged to operations was $1.5 million in 2008, $2.0 million in
2007 and $2.4 million in 2006.





Loss
Per Common Share




The basic
and diluted loss per common share amount is based upon the weighted average
common shares outstanding during the periods. All “in-the-money” stock options
and shares issuable upon the conversion of the 5.45% Convertible Notes due 2010
were anti-dilutive.





Foreign
Currency Translation




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


59


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)


Derivatives
and Hedging Activities





Fluctuating
foreign exchange rates may significantly impact the Company’s operating results
and cash flows.  The Company periodically hedges forecasted foreign
currency transactions related to certain operating expenses.  All
derivatives are recorded in the balance sheet at fair value.  For a
derivative designated as a fair value hedge, the effective portion of changes in
the fair value of the derivative and of the hedged item attributable to the
hedged risk are recognized in operations.  For a derivative designated
as a cash flow hedge, the effective portions of changes in the fair value of
cash flow hedges are recorded in other comprehensive income.  If the
derivative used in an economic hedging activity is not designated in an
accounting hedging relationship or if it becomes ineffective, changes in the
fair value of the derivative are recognized in operations.





Recent
Accounting Pronouncements





The
Company continually assesses any new accounting pronouncements to determine
their applicability to the Company.  In the case where it is
determined that a new accounting pronouncement effects the Company’s financial
reporting, the Company undertakes a study to determine the consequence of the
change to its financial reporting, and assures that there are proper controls in
place to ascertain that the Company’s financials properly reflect the
change.   New pronouncements assessed by the Company are
discussed below:





In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair
value, establishes a framework for measuring the fair value of assets and
liabilities, and expands disclosure requirements regarding the fair value
measurement. SFAS 157 does not expand the use of fair value measurements. SFAS
157 also specifies a hierarchy of valuation techniques which requires an entity
to maximize the use of observable inputs that may be used to measure fair
value:




Level
1 – Quoted prices in active markets are available for identical assets and
liabilities.




Level 2 –
Observable inputs other than Level 1 prices such as quoted prices for similar
assets or liabilities or other inputs that are observable or can be corroborated
by observable market data.




Level 3 –
Unobservable inputs that reflect a reporting entity’s own assumptions about the
assumptions that market participants would use in pricing an asset or
liability.




This
statement, as issued, is effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim periods within those
fiscal years. FASB Staff Position (FSP) FAS No. 157-2 was issued in February
2008 and deferred the effective date of SFAS 157 for nonfinancial assets and
liabilities to fiscal years beginning after November 2008. As such, the Company
adopted SFAS 157 as of January 1, 2008 for financial assets and liabilities
only. There was no significant effect on the Company’s financial statements. As
of December 31, 2008, the Company’s financial assets included held to maturity
investments in marketable securities and investments in non-publicly traded
companies.





The
Company considers fair value for its investments in held to maturity marketable
securities and its investments in non-publicly traded companies for purposes of
determining asset impairment losses. There were no impairment losses for the
year ended December 31, 2008. As such, neither category of asset has been
measured at fair value on a nonrecurring basis.




The
Company does not believe that the adoption of SFAS 157 to non-financial assets
and liabilities will significantly affect its financial
statements.


60


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)


In
February 2007, the FASB issued SFAS 159, “The Fair Value Option for
Financial Assets and Liabilities—including an amendment of FASB Statement
No. 115” (“SFAS 159”). SFAS 159 expands the use of fair value
accounting but does not affect existing standards which requires assets or
liabilities to be carried at fair value. The objective of SFAS 159 is to
improve financial reporting by providing companies with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. Under SFAS 159, a company may elect to use fair value to
measure eligible items at specified election dates and report unrealized gains
and losses on items for which the fair value option has been elected in earnings
at each subsequent reporting date. Eligible items include, but are limited to,
accounts receivable, accounts payable, and issued debt. If elected,
SFAS 159 is effective for fiscal years beginning after November 15,
2007. The Company has not elected to measure any additional assets or
liabilities at fair value that are not already measured at fair value under
existing standards.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations”
(“SFAS 141(R)”). SFAS 141(R) establishes principles and requirements
for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, any non-controlling
interest in the acquiree and the goodwill acquired. SFAS 141(R) also
establishes disclosure requirements to enable the evaluation of the nature and
financial effects of the business combination. SFAS 141(R) is effective for
fiscal years beginning after December 15, 2008. The Company will apply the
provisions of SFAS 141 (R) to any acquisition after January 1,
2009.




In
December 2007, the FASB issued SFAS No. 160, “Accounting for Noncontrolling
Interests.” SFAS 160 clarifies the classification of noncontrolling interests in
consolidated balance sheets and reporting transactions between the reporting
entity and holders of noncontrolling interests. Under this statement,
noncontrolling interests are considered equity and reported as an element of
consolidated equity. Further, net income encompasses all consolidated
subsidiaries with disclosure of the attribution of net income between
controlling and noncontrolling interests. SFAS No. 160 is effective
prospectively for fiscal years beginning after December 15, 2008. Currently,
there are no noncontrolling interests in any of the Company’s
subsidiaries.




In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133”
or SFAS 161, which requires additional disclosures about the objectives of using
derivative instruments, the method by which the derivative instruments and
related hedged items are accounted for under FASB Statement No. 133 and its
related interpretations, and the effect of derivative instruments and related
hedged items on financial position, financial performance, and cash flows. SFAS
161 also requires disclosure of the fair values of derivative instruments and
their gains and losses in a tabular format. SFAS 161 is effective for financial
statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early adoption encouraged. The Company is currently
assessing the impact that the adoption of SFAS 161 will have on its
financial statement disclosures.





In
April 2008, the FASB issued FASB Staff Position No. 142-3,
“Determination of the Useful Life of Intangible Assets” or FSP No. 142-3,
to improve the consistency between the useful life of a recognized intangible
asset (under SFAS No. 142) and the period of expected cash flows used to
measure the fair value of the intangible asset (under SFAS No. 141(R)). FSP
No. 142-3 amends the factors to be considered when developing renewal or
extension assumptions that are used to estimate an intangible asset’s useful
life under SFAS No. 142. The guidance in the new staff position is to be
applied prospectively to intangible assets acquired after December 31,
2008. In addition, FSP No. 142-3 increases the disclosure requirements
related to renewal or extension assumptions. The Company does not believe
implementation of FSP No. 142-3 will have a material impact on its financial
statements.





In
June 2008, the FASB issued FASB Staff Position Emerging Issues Task
Force (EITF) No. 03-6-1, “Determining whether Instruments granted in
Share-Based Payment Transactions are Participating Securities” or FSP EITF No.
03-6-1.  Under FSP EITF No. 03-6-1, unvested share-based payment awards
that contain rights to receive nonforfeitable dividends (whether paid or unpaid)
are participating securities, and should be included in the two-class method of
computing EPS. FSP EITF No. 03-6-1 is effective for fiscal years beginning after
December 15, 2008, and interim periods within those years. It is not
expected to have a significant impact on the Company’s financial
statements.





In June
2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument
(or an Embedded Feature) Is Indexed to an Entity’s Own Stock” (EITF 07-5). EITF
07-5 provides that an entity should use a two step approach to evaluate whether
an equity-linked financial instrument (or embedded feature) is indexed to its
own stock, including evaluating the instrument’s contingent exercise and
settlement provisions. It also clarifies on the impact of foreign currency
denominated strike prices and market-based employee stock option valuation
instruments on the evaluation. EITF 07-5 is effective for fiscal years beginning
after December 15, 2008. The implementation of this standard will not have a
material impact on the Company’s financial statements.


61


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)


In June
2008, the FASB ratified EITF Issue No. 08-3, “Accounting for Lessees for
Maintenance Deposits Under Lease Arrangements” (EITF 08-3). EITF 08-3 provides
guidance for accounting for nonrefundable maintenance deposits. It also provides
revenue recognition accounting guidance for the lessor. EITF 08-3 is effective
for fiscal years beginning after December 15, 2008. The implementation of this
standard will not have a material impact on the Company’s consolidated financial
position and results of operations.





In
September 2008, the FASB issued FSP 133-1 and FIN 45-4, “Disclosures about
Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No.
133 and FASB Interpretation No. 45; and Clarification of the Effective Date of
FASB Statement No. 161” (FSP 133-1 and FIN 45-4). FSP 133-1 and FIN 45-4 amends
and enhances disclosure requirements for sellers of credit derivatives and
financial guarantees. It also clarifies that the disclosure requirements of SFAS
No. 161 are effective for quarterly periods beginning after November 15, 2008,
and fiscal years that include those periods. FSP 133-1 and FIN 45-4 is effective
for reporting periods (annual or interim) ending after November 15, 2008. The
implementation of this standard will not have a material impact on the Company’s
consolidated financial position and results of operations.





In
September 2008, the FASB ratified EITF Issue No. 08-5, “Issuer’s Accounting for
Liabilities Measured at Fair Value With a Third-Party Credit Enhancement” (EITF
08-5). EITF 08-5 provides guidance for measuring liabilities issued with an
attached third-party credit enhancement (such as a guarantee). It clarifies that
the issuer of a liability with a third-party credit enhancement (such as a
guarantee) should not include the effect of the credit enhancement in the fair
value measurement of the liability. EITF 08-5 is effective for the first
reporting period beginning after December 15, 2008. The Company is currently
assessing the impact of EITF 08-5 on its consolidated financial position and
results of operations.





In
October 2008, the FASB issued FSP 157-3 “Determining Fair Value of a Financial
Asset in a Market That Is Not Active” (FSP 157-3). FSP 157-3 clarified the
application of SFAS No. 157 in an inactive market. It demonstrated how the fair
value of a financial asset is determined when the market for that financial
asset is inactive. FSP 157-3 was effective upon issuance, including prior
periods for which financial statements had not been issued. The implementation
of this standard did not have a material impact on the Company’s consolidated
financial position and results of operations.





Note
2.    Acquisitions





On
October 24, 2008, the Company acquired Centillium Communications, Inc.
(“Centillium), a Delaware corporation. Centillium was a global company with
headquarters in Fremont, CA and delivered highly innovative communications
processing technology. The acquisition was financed with the issuance of
25,000,000 shares of the Company’s common stock with an approximate fair value
of $25.0 million and $15.0 million of cash.  The Company incurred
transaction costs of approximately $2.6 million which resulted in a total
purchase price of approximately $42.6 million. In connection with the
acquisition of Centillium, the Company implemented a worldwide reduction in
Centillium’s workforce to be implemented and concluded during the fourth quarter
of 2008 and the first quarter of 2009.  As such, the Company expects
to incur cash expenditures of approximately $3.4 million primarily for employee
related costs, $2.4 million of which was paid during 2008 and $1.0 million which
is estimated to be paid in 2009.  Such costs were added to the
Company’s purchase price of Centillium and allocated to the net assets acquired.
The results of operations of Centillium have been included in the Company's
consolidated financial results from October 24, 2008.  All significant
inter-company balances and transactions have been eliminated. The acquisition
was accounted for by the purchase method of accounting. The Company has
allocated the cost to acquire Centillium to its identifiable tangible and
intangible assets and liabilities, with the remaining amount classified as
goodwill.  None of the amount allocated to goodwill is expected to be
deductible for income tax reporting purposes.





On
January 11, 2007, the Company acquired the ASIC Design Center Division of Data –
JCE, an Israel-based publicly held electronics components distribution
company.  The ASIC Design Center develops and sells customer-specific
semiconductor products. The acquisition was financed with the issuance of
3,746,713 shares of the Company’s common stock with an approximate fair value of
$5.5 million and $1.4 million of cash.  The Company incurred
transaction costs of approximately $0.3 million which resulted in a total
purchase price of approximately $7.2 million. Under the earn-out provisions of
the ASIC Design Center acquisition agreement, the Company may have been required
to pay up to an additional $14.5 million in the form of TranSwitch common stock
or cash, at its option, if the ASIC Design Center achieved stipulated revenue
and operating profit for 2007.  Such targets were not achieved. The
results of operations of the ASIC Design Center have been included in the
Company's consolidated financial results from January 11, 2007.  All
significant inter-company balances and transactions have been eliminated. The
acquisition was accounted for by the purchase method of accounting. The Company
has allocated the cost to acquire the ASIC Design Center to its identifiable
tangible and intangible assets and liabilities, with the remaining amount
classified as goodwill.  None of the amount allocated to goodwill is
expected to be deductible for income tax reporting purposes.


62


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)


On
January 30, 2006, the Company completed its acquisition of Mysticom Ltd.
(“Mysticom”), an Israel-based, privately-held developer of high-performance,
low-power, multi-Gigabit Ethernet transceivers for the communications
industry.  The acquisition of Mysticom allows TranSwitch to integrate
high-speed SerDes and PHY capabilities in the Company’s next generation of
products as the market for 10-Gbps ports on telecommunications and data
communications equipment grows. TranSwitch acquired all the capital stock of
Mysticom through the issuance of 2,378,185 shares of TranSwitch common
stock.  The common stock issued was valued at approximately $4.4
million ($1.85 per share).  The Company incurred transaction costs of
approximately $1.0 million in conjunction with this acquisition, resulting in a
total purchase price of approximately $5.4 million. Under the earn-out
provisions of the Mysticom acquisition agreement, the Company could have paid up
to an additional $10 million in the form of TranSwitch common stock or cash,
upon Mysticom’s achievement of stipulated revenue objectives and a positive
operating cash flow over the 12 month period ending January 30,
2007.  Based on the operating performance of Mysticom there was no
earn-out provision payment. The results of operations of Mysticom have been
included in the Company's consolidated financial results beginning on January
31, 2006, and all significant inter-company balances have been eliminated. The
acquisition was accounted for under the purchase method of
accounting.  The Company has allocated the cost to acquire Mysticom to
its identifiable tangible and intangible assets and liabilities, with the
remaining amount classified as goodwill.  None of the amount allocated
to goodwill is expected to be deductible for tax reporting
purposes.





The total
purchase price of the Company’s acquisitions has been allocated in the Company's
consolidated financial statements as follows:





ASIC DesignCentillium
                    
                    
                    Center
                    
                    
                    Mysticom2008
                    
                    
                    2007
                    
                    
                    2006Current
      assets
                    
                    $
                    34,246
                    
                    
                    $
                    400
                    
                    
                    $
                    1,317Property,
      plant and equipment
                    
                    
                    709
                    
                    
                    
                    36
                    
                    
                    
                    369Long-term
      investments
                    
                    
                    992
                    
                    
                    
                    —
                    
                    
                    
                    —Other
      intangible assets  (1)
                    
                    
                    10,600
                    
                    
                    
                    1,756
                    
                    
                    
                    894Goodwill
                    
                    
                    15,004
                    
                    
                    
                    5,183
                    
                    
                    
                    4,892Obligation
      under deferred revenue
                    
                    
                    (23
                    )
                    
                    
                    (180
                    )
                    
                    
                    (625
                    )Accounts
      payable & accrued expenses
                    
                    
                    (14,158
                    )
                    
                    
                    —
                    
                    
                    
                    (1,408
                    )Restructuring
      reserve
                    
                    
                    (4,798
                    )
                    
                    
                    —
                    
                    
                    
                    —Purchase
      price
                    
                    
                    42,572
                    
                    
                    
                    7,195
                    
                    
                    
                    5,439Less:Common
      stock issued
                    
                    
                    (24,950
                    )
                    
                    
                    (5,545
                    )
                    
                    
                    (4,399
                    )Cash
      and cash equivalents acquired
                    
                    
                    (24,991
                    )
                    
                    
                    —
                    
                    
                    
                    (271
                    )Net
      cash (provided by) used for acquisitions
                    
                    $
                    (7,369
                    )
                    
                    $
                    1,650
                    
                    
                    $
                    769





(1)


The
valuation of Centillium’s customer relationships of $7.8 million was determined
based on their estimated fair value at the acquisition date. The excess earnings
methodology of the income approach was the technique used to value such
relationships. The value assigned to Centillium’s customer relationships is
being amortized ratably over twelve years, which represents the estimated
average remaining useful life.


63


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)


The
valuation of developed technology of Centillium of $2.8 million was determined
based on its estimated fair value at the acquisition date.  A form of
the income approach known as the relief-from-royalty method was the technique
used to value developed technology.  The developed technology is being
amortized ratably over five to seven years, which represents the estimated
average remaining useful life.




The
valuation of existing customer relationships of the ASIC Design Center of $1.8
million was determined based on their estimated fair value at the acquisition
date.  The income approach, which includes an analysis of the cash
flows and risks associated with achieving such cash flows, was the primary
technique used to value such contracts.  The value assigned to the
ASIC contracts is generally being amortized ratably over five years, which
represents the estimated contract average remaining useful life.




The
valuation of purchased intellectual property of Mysticom of $0.9 million was
determined based on its estimated fair value at the acquisition date. The income
approach, which includes an analysis of the cash flows and risks associated with
achieving such cash flows, was the primary technique utilized in valuing the
purchased intellectual property. The purchased intellectual property is
primarily being amortized ratably, based upon the recognition of the associated
license revenue.





Unaudited
pro forma results for 2008, 2007 and 2006 assuming that Centillium was acquired
as of January 1, 2007 and ASIC Design Center was acquired as of January 1, 2006
follows:  Net revenues of $58.3 million, $48.4 million and $43.7
million, respectively; net loss of $(31.3) million, $(46.5) million and $(10.4)
million, respectively; and basic and diluted loss per common share of $(0.20),
$(0.30) and $(0.08), respectively.





Note
3.  Restricted Cash





At
December 31, 2008, the Company’s liquidity is affected by restricted cash
balances of approximately $4.9 million, which are included in current assets and
are not available for general corporate use. The Company has pledged the $3.1
million of cash as collateral for stand-by letters of credit that guarantee
certain long-term property lease obligations and to support customer credit
requirements.  The other $1.8 million of restricted cash is being held
in escrow for one year as security for certain indemnification obligations of
Centillium as a result of an asset sale agreement which Centillium had entered
into in February of 2008.





Note
4.    Investments in Non-Publicly Traded Companies and
Venture Capital Funds





The
Company owns convertible preferred stock of Opulan Technologies Corp.
(“Opulan”), a 3% limited partnership interest in Neurone II, a venture capital
fund organized as a limited partnership and a 0.42% limited partnership interest
in Munich Venture Partners Fund (“MVP”).  The Company accounts for
these investments at cost.  The financial condition of these companies
is subject to significant changes resulting from their operating performance and
their ability to obtain financing.  The Company continually evaluates
its investments in these companies for impairment. In making this judgment, the
Company considers 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 the Company requests 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. SFAS 157 was adopted as
of January 1, 2008 to measure impairment, resulting in no additional
charges.





As of
December 31, 2005, the Company’s cost method investments were approximately $1.0
million, consisting of convertible preferred stock of Opulan of $0.7 million and
a 3% limited partnership interest in Neurone II of $0.3 million.





During
2006, the Company made additional investments of approximately $2.0 million
substantially all of which was invested in Opulan.





As of
December 31, 2006, the Company’s cost method investments were approximately $3.0
million, $2.7 million of which was in Opulan and $0.3 million of which was in
Neurone II.


64


TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 During
2007, the Company made additional investments of less than $0.1 million and
recognized an impairment of $0.1 million on its investment in Neurone
II.
 
 During
2008, the Company made additional investments of approximately $0.1 million in
MVP and incurred no impairment charges related to investments in non-publicly
traded companies. As of December 31, 2008, the Company’s cost method investments
were approximately $3.0 million.
 
 Note
5.    Inventories
  The
components of inventories follow:
  December 31,2008
                                  
                                  
                                  2007Raw
      material
                                  
                                  $
                                  315
                                  
                                  
                                  $
                                  401Work-in-process
                                  
                                  
                                  1,503
                                  
                                  
                                  
                                  992Finished
      goods
                                  
                                  
                                  2,686
                                  
                                  
                                  
                                  1676Total
      inventories
                                  
                                  $
                                  4,504
                                  
                                  
                                  $
                                  3,069
  Note
6.    Property and Equipment, Net
  The
components of property and equipment follow:
 
 Estimated
                                    
                                    December
      31,Useful Lives
                                    
                                    2008
                                    
                                    
                                    2007Purchased
      computer software
                                    1-3
      years
                                    
                                    $
                                    28,200
                                    
                                    
                                    $
                                    29,220Computers
      and equipment
                                    3-7 years
                                    
                                    
                                    13,730
                                    
                                    
                                    
                                    13,102Furniture
                                    3-7
      years
                                    
                                    
                                    2,488
                                    
                                    
                                    
                                    2,761Leasehold
      improvements
                                    Lease term*
                                    
                                    
                                    938
                                    
                                    
                                    
                                    1,039Construction-in-progress
      (software and equipment)
                                    
                                    
                                    
                                    25
                                    
                                    
                                    
                                    2,300Gross
      property and equipment
                                    
                                    
                                    $
                                    45,381
                                    
                                    
                                    $
                                    48,422Accumulated
      depreciation and amortization
                                    
                                    
                                    
                                    (43,352
                                    )
                                    
                                    
                                    (43,306
                                    )Property
      and equipment, net
                                    
                                    
                                    $
                                    2,029
                                    
                                    
                                    $
                                    5,116
 
 *
                Estimated useful life of
      improvement if
shorter.
 
 Depreciation
expense was $3.3 million, $3.9 million, and $3.5 million, for 2008, 2007 and
2006, respectively.
 
 65
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 Note
7    Goodwill and Other Intangible Assets
 
 Changes in the carrying amounts of
goodwill and information about intangible assets follow:
 
 GoodwillBalance
      at December 31, 2006
                        
                        $
                        4,892Business
      acquisition – ASIC Design Center
                        
                        
                        5,183Balance
      at December 31, 2007
                        
                        
                        10,075Business
      acquisition - Centillium
                        
                        
                        15,004Balance
      at December 31, 2008
                        
                        $
                        25,079
 
 Other Intangible AssetsDeveloped
                            Technology
                          
                          
                          Customer
                            Relationships
                          
                          
                          TotalBalances
      at December 31, 2008Cost
                          
                          $
                          3,014
                          
                          
                          $
                          9,557
                          
                          
                          $
                          12,571Accumulated
      amortization
                          
                          
                          (293
                          )
                          
                          
                          (824
                          )
                          
                          
                          (1,117
                          )$
                          2,721
                          
                          
                          $
                          8,733
                          
                          
                          $
                          11,454Balances
      at December 31, 2007Cost
                          
                          $
                          214
                          
                          
                          $
                          1,756
                          
                          
                          $
                          1,970Accumulated
      amortization
                          
                          
                          (137
                          )
                          
                          
                          (350
                          )
                          
                          
                          (487
                          )$
                          77
                          
                          
                          $
                          1,406
                          
                          
                          $
                          1,483Asset
      additions:2008Cost
                          
                          $
                          2,800
                          
                          
                          $
                          7,800
                          
                          
                          $
                          10,600Weighted
      average amortization period
                          
                          6.3
      years
                          
                          
                          12
      years
                          
                          
                          10.5
      years2007Cost
                          
                          $
                          —
                          
                          
                          $
                          1,756
                          
                          
                          $
                          1,756Weighted
      average amortization period
                          
                          
                          —
                          
                          
                          5
      years
                          
                          
                          5
      years
 
 Amortization
expense related to “Other intangible assets” was $0.6 million in 2008 and $0.4
million in 2007.  Future estimated aggregate amortization expense for
such assets for each of the five years succeeding December 31, 2008 follows:
2009 - $1.5 million; 2010 - $1.5 million; 2011 - $1.5 million; 2012 - $1.1
million and 2013 - $1.1 million.
 
 Note
8    Accrued Expenses and Other Current
Liabilities
  The
components of accrued and other current liabilities follow:
  December 31,2008
                              
                              
                              2007Accrued
      and other current liabilities
                              
                              $
                              5,578
                              
                              
                              $
                              3,517Accrued
      royalties
                              
                              
                              6,664
                              
                              
                              
                              147Accrued
      compensation and benefits
                              
                              
                              3,815
                              
                              
                              
                              2,207Restructuring
      liabilities
                              
                              
                              5,725
                              
                              
                              
                              844Obligation
      under deferred revenue
                              
                              
                              449
                              
                              
                              
                              280Total
      accrued and other current liabilities
                              
                              $
                              22,231
                              
                              
                              $
                              6,995
 
 66
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 The
Company periodically evaluates any contingent liabilities in connection with any
payments to be made for any potential intellectual property infringement
asserted or unasserted claims in accordance with FAS 5, “Accounting for
Contingencies”. The Company’s accrued royalties as of December 31, 2008 and 2007
represents the contingent payments for asserted or unasserted claims that are
probable as of the respective balance sheet dates based on the applicable patent
law.
 
 Note
9.    Segment and Major Customer Information
  The
Company has one business segment: communication semiconductor
products.  Its VLSI semiconductor devices provide core functionality
of communications network equipment. The integration of various technologies and
standards in these devices result in a homogeneous product line for management
and measurement purposes.
 
 Enterprise-wide
Information
  Enterprise-wide
information provided on geographic net revenues is based on billing locations.
Long-lived asset information is based on the physical location of the assets.
The following tables present net revenues and long-lived assets information for
geographic areas:
 
 Years Ended December 31,2008
                                
                                
                                2007
                                
                                
                                2006Net
      revenues:Israel
                                
                                $
                                10,937
                                
                                
                                $
                                5,193
                                
                                
                                $
                                2,670China
                                
                                
                                6,943
                                
                                
                                
                                7,468
                                
                                
                                
                                8,630United
      States
                                
                                
                                6,122
                                
                                
                                
                                6,943
                                
                                
                                
                                9,674Japan
                                
                                
                                4,813
                                
                                
                                
                                501
                                
                                
                                
                                858Korea
                                
                                
                                2,467
                                
                                
                                
                                1,773
                                
                                
                                
                                1,960Hong
      Kong
                                
                                
                                1,495
                                
                                
                                
                                71
                                
                                
                                
                                747Italy
                                
                                
                                1,324
                                
                                
                                
                                224
                                
                                
                                
                                —Belgium
                                
                                
                                1,166
                                
                                
                                
                                168
                                
                                
                                
                                728Germany
                                
                                
                                1,163
                                
                                
                                
                                4,055
                                
                                
                                
                                3,610Singapore
                                
                                
                                1,155
                                
                                
                                
                                838
                                
                                
                                
                                1,207Other
      countries
                                
                                
                                4,349
                                
                                
                                
                                5,331
                                
                                
                                
                                8,836Total
                                
                                $
                                41,934
                                
                                
                                $
                                32,565
                                
                                
                                $
                                38,920
  As of December 31,2008
                            
                            
                            2007
                            
                            
                            2006Long-lived
      tangible assets:United
      States
                            
                            $
                            1,261
                            
                            
                            $
                            3,952
                            
                            
                            $
                            4,086Other
      countries
                            
                            
                            2,089
                            
                            
                            
                            2,071
                            
                            
                            
                            2,069Total
                            
                            $
                            3,350
                            
                            
                            $
                            6,023
                            
                            
                            $
                            6,155
  67
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 Information
about Major Customers
  The
Company ships its products to distributors and directly to end customers. The
following table sets forth the percentage of net revenues attributable to the
Company’s significant customers:
  Years ended December 31,2008
                            
                            
                            2007
                            
                            
                            2006Significant
      Customers:PMC
      Sierra Israel
                            
                            
                            21
                            %
                            
                            
                            *
                            
                            
                            
                            *Alcatel-Lucent
                            
                            
                            18
                            %
                            
                            
                            17
                            %
                            
                            
                            11
                            %Nokia
      Siemens
                            
                            
                            *
                            
                            
                            
                            16
                            %
                            
                            
                            11
                            %
  *
              
              Revenues
      were less than 10% of the Company’s net revenues in these
      years.
 
 Note
10.    Income Taxes
 
 The
Company adopted FIN 48, “Accounting for Uncertainty in Income Taxes”,effective January 1,
2007.FIN 48
clarifies and sets forth consistent rules for accounting for uncertain income
tax positions in accordance with FAS 109 “Accounting for Income Taxes”. There was no
cumulative effect of applying the provisions of this interpretation upon
adoption due to the net operating loss and valuation allowance positions of the
Company.  Changes in unrecognized tax benefits follow:
 
 Balance
      at January 1, 2007
                    
                    $
                    5,356Increases
      related to current year tax positions
                    
                    
                    747Balance
      at December 31, 2007
                    
                    $
                    6,103Increases
      related to prior year tax positions
                    
                    
                    141Decreases
      related to prior year tax positions
                    
                    
                    (351
                    )Balance
      at December 31, 2008
                    
                    $
                    5,893
 
 Due
to the Company’s net operating loss position in the U.S., any subsequent
recognition of these tax benefits would not likely change the Company’s
effective tax rate. The Company does not reasonably expect any significant
changes in the amount of unrecognized tax benefits to occur within the next
year.
 
 Historically
the Company has not accrued or paid significant interest and penalties for
underpayments of income taxes due to its net operating loss
position.  Interest and penalties related to underpayment of income
taxes would be classified as a component of income tax expense in the
consolidated statement of operations.  Approximately $119,000 of
interest has been recognized in the balance sheet of the Company through
December 31, 2008. This amount has been recorded as a part of goodwill,
therefore, no interest expense related to this uncertainty has been included in
the consolidated statement of operations.
 
 The
Company files income tax returns in the U.S. and several foreign countries
and has not extended the statute of limitations to assess additional taxes for
any of these jurisdictions.  The Company has effectively settled U.S.
Federal tax positions taken through 2002 in accordance with FSP FIN
48-1.  However, the Company is subject to adjustment in each of these
periods, to the extent of its net operating loss carry forwards.  The
open tax years for foreign jurisdictions are 2002 through 2008 and 1997 through
2008 for U.S. state and local jurisdictions.
  The
components of the loss before income taxes follow:
 
 Years Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006U.S.
      loss
                      
                      $
                      (17,405
                      )
                      
                      $
                      (19,874
                      )
                      
                      $
                      (10,389
                      )Foreign
      income (loss)
                      
                      
                      849
                      
                      
                      
                      445
                      
                      
                      
                      (353
                      )Loss
      before income taxes
                      
                      $
                      (16,556
                      )
                      
                      $
                      (19,429
                      )
                      
                      $
                      (10,742
                      )
  68
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 The
provision for income taxes consists exclusively of current foreign income
taxes.
 
 A
reconciliation of the U.S. federal statutory rate to the effective income tax
rate follows:
  Years Ended December 31,2008
                              
                              
                              2007
                              
                              
                              2006U.S.
      federal statutory tax rate
                              
                              
                              (35.0
                              )%
                              
                              
                              (35.0
                              )%
                              
                              
                              (35.0
                              )%State
      taxes
                              
                              
                              (9.5
                              )
                              
                              
                              0.6
                              
                              
                              
                              12.6Disallowed
      interest deduction
                              
                              
                              -
                              
                              
                              
                              3.6
                              
                              
                              
                              6.9Change
      in valuation allowance
                              
                              
                              42.0
                              
                              
                              
                              27.4
                              
                              
                              
                              13.7Permanent
      differences, tax credits and other adjustments
                              
                              
                              4.4
                              
                              
                              
                              4.7
                              
                              
                              
                              2.9Effective
      income tax rate
                              
                              
                              1.9
                              %
                              
                              
                              1.3
                              %
                              
                              
                              1.1
                              %
  The tax
effects of temporary differences that give rise to deferred income taxes
follow:
  2008
                                    
                                    
                                    2007Deferred
      income tax assets:Property
      and equipment
                                    
                                    $
                                    1,882
                                    
                                    
                                    $
                                    526Other
      nondeductible accruals
                                    
                                    
                                    388
                                    
                                    
                                    
                                    249Restructuring
      accrual
                                    
                                    
                                    10,031
                                    
                                    
                                    
                                    7,894Capitalized
      research and development for tax purposes
                                    
                                    
                                    21,296
                                    
                                    
                                    
                                    15,082Investment
      impairment
                                    
                                    
                                    —
                                    
                                    
                                    
                                    50Net
      operating loss carry-forwards
                                    
                                    
                                    142,678
                                    
                                    
                                    
                                    81,320Capital
      losses
                                    
                                    
                                    15,263
                                    
                                    
                                    
                                    15,307Research
      and development and other credits
                                    
                                    
                                    21,762
                                    
                                    
                                    
                                    11,556Debt
      discount
                                    
                                    
                                    68
                                    
                                    
                                    
                                    —Inventories
                                    
                                    
                                    14,735
                                    
                                    
                                    
                                    14,311Stock
      compensation
                                    
                                    
                                    2,242
                                    
                                    
                                    
                                    1,618Other
                                    
                                    
                                    360
                                    
                                    
                                    
                                    1,424Total
      gross deferred income tax assets
                                    
                                    
                                    230,705
                                    
                                    
                                    
                                    149,337Valuation
      allowance
                                    
                                    
                                    (229,586
                                    )
                                    
                                    
                                    (148,250
                                    )Net
      deferred income tax assets
                                    
                                    
                                    1,119
                                    
                                    
                                    
                                    1,087Deferred
      income tax liabilities:Other
                                    
                                    
                                    (1,119
                                    )
                                    
                                    
                                    (1,087
                                    )Net
      deferred income tax liabilities
                                    
                                    
                                    (1,119
                                    )
                                    
                                    
                                    (1,087
                                    )Net
      deferred income taxes
                                    
                                    $
                                    —
                                    
                                    
                                    $
                                    —
  69
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 The
Company continually evaluates its deferred income tax assets to determine
whether it is more likely than not that such assets will be realized. In
assessing the realizability, management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies. Based on this assessment, management believes that significant
uncertainty exists concerning the recoverability of the deferred income tax
assets. As such, a valuation allowance has been provided for deferred income tax
assets as of December 31, 2008 and 2007. Of the $229.6 million valuation
allowance at December 31, 2008, subsequently recognized income tax benefits, if
any, in the amount of $4.7 million will be applied directly to additional
paid-in capital and $72.0 million to goodwill.
  At
December 31, 2008, the Company had available, for federal income tax purposes,
net operating loss (“NOL”) carry-forwards of approximately $401 million, capital
loss carry-forwards of approximately $40.7 million and research and development
tax credit carry-forwards of approximately $21.7 million expiring in varying
amounts from 2008 through 2027. For state income tax purposes, the Company had
available NOL carry-forwards of approximately $159.9 million, capital loss
carry-forwards of $40.7 million and state tax credit carry-forwards of $5.4
million expiring in varying amounts from 2008 to 2026.
  Certain
transactions involving the Company’s beneficial ownership have occurred in prior
years, which resulted in a stock ownership change for purposes of Section 382 of
the Internal Revenue Code of 1986, as amended. Consequently, approximately
$162.9 million of the NOL carry-forwards and $11.4 million of research and
development tax credit carry-forwards are subject to these limitations. The
Company has not yet determined if any of the NOL and credits generated through
2008 will be subject to limitation under Section 382.
 
 Note
11.    Stockholders’ Rights Plan
  On
October 1, 2001, the Board of Directors enacted a stockholder rights plan and
declared a dividend of one preferred share purchase right for each outstanding
share of TranSwitch common stock outstanding at the close of business on October
1, 2001 to the stockholders of record on that date. Each stockholder of record
as of October 1, 2001 received a summary of the rights and any new stock
certificates issued after the record date contain a legend describing the
rights. Each preferred share purchase right entitles the registered holder to
purchase from the Company one one-thousandth of a share of Series A Junior
Participating Preferred Stock, par value $0.01 per share, of the Company, at a
price of $50.00 per one one-thousandth of a Preferred Share, subject to
adjustment, upon the occurrence of certain triggering events, including the
purchase of 15% or more of the Company’s outstanding common stock by a third
party. Until a triggering event occurs, the common stockholders have no right to
purchase shares under the stockholder rights plan. If the right to purchase the
preferred stock is triggered, the common stockholders will have the ability to
purchase sufficient stock to significantly dilute the 15% or greater
holder.
  Note
12.    Employee Benefit Plans
  Employee
Stock Purchase Plans
  Under the
Company’s employee stock purchase plans, eligible employees may purchase a
limited number of shares of common stock at 85% of the fair market value at
either the date of enrollment or the date of purchase, whichever is less. The
1995 Employee Stock Purchase Plan was closed effective December 31,
2004.  On May 19, 2005 the Company’s shareholders approved the 2005
Employee Stock Purchase Plan (the 2005 ESPP). Under the 2005 ESPP, the Company
is authorized to issue 1,000,000 shares of common stock. Shares issued under the
2005 ESPP in 2008, 2007, and 2006 were 82,191, 101,844, and 89,077
respectively.
 
 Stock
Option and Award Plans
  As of
December 31, 2008, the Company has three stock options plans: the 1995 Stock
Plan, as amended (the “1995 Plan”), 2000 Stock Option Plan as amended (the “2000
Plan”), and the 2008 Equity Incentive Plan (the ‘2008 Plan”). The 1995
Non-Employee Director Stock Option Plan, as amended (the “Director Plan”)
expired during 2005.
  Under the
1995 Plan, 31,400,000 shares of the Company’s common stock are available to
grant to employees in the form of incentive stock options.  Also,
non-qualified stock options and stock awards may be granted to employees,
consultants and directors.  The terms of the options granted are
subject to the provisions of the 1995 Plan, as determined by the Compensation
Committee of the Board of Directors.  The exercise price of options
under the 1995 Plan must be equal to the fair market value of the common stock
on the date of grant.  Options granted under the 1995 Plan are
generally nontransferable. The 1995 Plan, as amended, expires March 15,
2010.  In connection with the adoption of the 2008 Plan on May 22,
2008, shares are no longer available for grant under the 1995 Plan.
  70
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 The 2000
Plan provides for the granting of non-qualified options to employees and
consultants to purchase up to an aggregate of 10,000,000 shares of common
stock.  No member of the Board of Directors or executive officers
appointed by the Board of Directors is eligible for grants of options under the
2000 Plan. The terms of the options granted are subject to the provisions of the
2000 Plan, as determined by the Compensation Committee of the Board of
Directors. Each non-qualified stock option shall either be fully exercisable on
the date of grant or shall become exercisable thereafter in such installments as
the Board of Directors may specify. The 2000 Plan will terminate in 2010. No
option granted under the 2000 Plan may be exercised after the expiration of
seven years from the date of grant. The exercise price of options under the 2000
Plan must be equal to the fair market value of the common stock on the date of
grant. Options granted under the 2000 Plan are generally nontransferable. In
connection with the adoption of the 2008 Plan on May 22, 2008, shares are no
longer available for grant under the 2000 Plan.
 
 The
2008 Plan was approved by shareholders at the shareholder meeting held on May
22, 2008.  The purpose of this plan is to provide stock options, stock
issuances, and other equity interests in the Company to employees, officers,
directors, consultants, and advisors to the Company and its subsidiaries or any
future parent corporation. The 2008 Plan is to be administered by the Board of
Directors of the Company who will have sole discretion and authority to
interpret and correct the provisions of the Plan and any Award. The Board will
also have sole authority to determine the terms and provisions of the respective
Stock Option Agreements and Awards, which need not be identical.  The
aggregate number of shares of Common Stock of the Company that may be issued
pursuant to the 2008 Plan is 15,000,000. As of December 31, 2008, there were
4,317,261 shares available for grant under the 2008 Plan.
  Information
regarding stock options follows:
  Number
                      of options
                      outstanding
                    
                    
                    Weighted average
                      exercise price
                      per shareOutstanding
      at December 31, 2005
                    
                    
                    25,441,094
                    
                    
                    $
                    8.09Granted
      and assumed
                    
                    
                    2,814,959
                    
                    
                    
                    1.80Exercised
                    
                    
                    (1,790,287
                    )
                    
                    
                    1.30Canceled,
      forfeited or expired
                    
                    
                    (2,215,577
                    )
                    
                    
                    10.09Outstanding
      at December 31, 2006
                    
                    
                    24,250,189
                    
                    
                    
                    7.69Granted
      and assumed
                    
                    
                    1,954,243
                    
                    
                    
                    1.49Exercised
                    
                    
                    (1,051,225
                    )
                    
                    
                    1.17Canceled,
      forfeited or expired
                    
                    
                    (5,636,359
                    )
                    
                    
                    17.49Outstanding
      at December 31, 2007
                    
                    
                    19,516,848
                    
                    
                    
                    4.58Granted
                    
                    
                    4,495,352
                    
                    
                    
                    0.51Assumed
                    
                    
                    6,762,866
                    
                    
                    
                    1.66Exercised
                    
                    
                    (100,626
                    )
                    
                    
                    0.69Canceled,
      forfeited or expired
                    
                    
                    (7,725,397
                    )
                    
                    
                    7.66Outstanding
      at December 31, 2008
                    
                    
                    22,949,043
                    
                    
                    $
                    1.92
  Information
regarding restricted stock awards follows:
 
 Outstanding
      at December 31, 2007
                      
                      
                      -
                      
                      
                      
                      0.000Granted
                      
                      
                      -
                      
                      
                      
                      0.001Assumed
                      
                      
                      1,456,815
                      
                      
                      
                      0.001Released
                      
                      
                      (17,076
                      )
                      
                      
                      0.001Canceled,
      forfeited or expired
                      
                      
                      (335,441
                      )
                      
                      
                      0.001Outstanding
      at December 31, 2008
                      
                      
                      1,104,298
                      
                      
                      $
                      0.001
  71
  TRANSWITCH CORPORATION AND
SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 The
Company has, in connection with the acquisitions of various companies, assumed
the stock option plans of each acquired company.  The related options
are included in the preceding table
 
 Options
outstanding and exercisable at December 31, 2008 follow:
  Options Outstanding
                                                        
                                                        
                                                        Options ExercisableRange of
                                                          Exercise prices
                                                        
                                                        Number
                                                          Outstanding
                                                        
                                                        
                                                        Weighted
                                                          Average
                                                          Remaining
                                                          Contractual
                                                          Life
                                                        
                                                        
                                                        Weighted
                                                          average
                                                          exercise
                                                          price
                                                        
                                                        
                                                        Number
                                                          Exercisable
                                                        
                                                        
                                                        Weighted
                                                          average
                                                          exercise
                                                          price$
                                                        0.28  to   1.12
                                                        
                                                        
                                                        6,736,663
                                                        
                                                        
                                                        
                                                        5.31
                                                        
                                                        
                                                        $
                                                        0.64
                                                        
                                                        
                                                        
                                                        2,935,670
                                                        
                                                        
                                                        $
                                                        0.831.14  to   1.50
                                                        
                                                        
                                                        4,085,037
                                                        
                                                        
                                                        
                                                        3.63
                                                        
                                                        
                                                        
                                                        1.38
                                                        
                                                        
                                                        
                                                        3,568,903
                                                        
                                                        
                                                        
                                                        1.391.53  to   1.65
                                                        
                                                        
                                                        3,670,225
                                                        
                                                        
                                                        
                                                        3.96
                                                        
                                                        
                                                        
                                                        1.60
                                                        
                                                        
                                                        
                                                        3,325,071
                                                        
                                                        
                                                        
                                                        1.601.66  to   2.47
                                                        
                                                        
                                                        5,030,070
                                                        
                                                        
                                                        
                                                        3.67
                                                        
                                                        
                                                        
                                                        1.92
                                                        
                                                        
                                                        
                                                        4,845,269
                                                        
                                                        
                                                        
                                                        1.922.50  to   3.39
                                                        
                                                        
                                                        1,467,211
                                                        
                                                        
                                                        
                                                        3.81
                                                        
                                                        
                                                        
                                                        3.08
                                                        
                                                        
                                                        
                                                        1,464,894
                                                        
                                                        
                                                        
                                                        3.083.80  to   8.54
                                                        
                                                        
                                                        983,008
                                                        
                                                        
                                                        
                                                        0.17
                                                        
                                                        
                                                        
                                                        4.73
                                                        
                                                        
                                                        
                                                        983,008
                                                        
                                                        
                                                        
                                                        4.738.70
      to 11.04
                                                        
                                                        
                                                        973,829
                                                        
                                                        
                                                        
                                                        0.37
                                                        
                                                        
                                                        
                                                        9.42
                                                        
                                                        
                                                        
                                                        973,829
                                                        
                                                        
                                                        
                                                        9.4251.25
      to 51.25
                                                        
                                                        
                                                        3,000
                                                        
                                                        
                                                        
                                                        0.71
                                                        
                                                        
                                                        
                                                        51.25
                                                        
                                                        
                                                        
                                                        3,000
                                                        
                                                        
                                                        
                                                        51.25$
                                                        0.28  to 51.25
                                                        
                                                        
                                                        22,949,043
                                                        
                                                        
                                                        
                                                        3.91
                                                        
                                                        
                                                        $
                                                        1.92
                                                        
                                                        
                                                        
                                                        18,099,644
                                                        
                                                        
                                                        $
                                                        2.24
  Stock
options generally expire five, seven or ten years from the date of grant and
generally vest ratably over periods ranging from immediately to four
years.
 
 As of
December 31, 2008 both the fair value of options outstanding and the fair value
of options exercisable were less than the exercise price.
 
 Stock
compensation charged to operations was $1.5 million in 2008, $2.0 million in
2007, and $2.4 million in 2006. Further, no compensation cost was capitalized as
part of inventory, and no income tax benefit was recognized in those years.
Lastly, no equity awards were settled in cash.
  Stock-Based
Compensation Fair Value Disclosures
  The fair
value of each option granted is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions:
  2008
                    
                    
                    2007
                    
                    
                    2006Risk-free
      interest rate
                    
                    
                    1.82
                    %
                    
                    
                    4.62
                    %
                    
                    
                    4.83
                    %Expected
      life in years
                    
                    
                    2.95
                    
                    
                    
                    3.38
                    
                    
                    
                    3.46Expected
      volatility
                    
                    
                    68.21
                    %
                    
                    
                    91.98
                    %
                    
                    
                    94.52
                    %Expected
      dividend yield
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
  The
weighted average fair value of stock options granted, calculated using the
Black-Scholes option-pricing model, is $0.12, $0.93 and $1.15 for 2008, 2007 and
2006, respectively. The total intrinsic value of the options exercised was $0.02
million, $0.5 million, and $1.2 million for 2008, 2007 and 2006, respectively.
In 2008, restricted stock units released had an intrinsic value of approximately
five thousand dollars.
 
 72
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 The
Company recognized compensation expense related to stock options granted to
non-employees of $0.03 million in 2008, $0.1 million in 2007 and less than $0.1
million in 2006.
 
 In
December 2005, the Company’s Board of Directors approved the acceleration of the
vesting of certain stock options held by current non-officer employees with two
or more years of employment with the Company. As a result, stock options to
purchase approximately 1.5 million shares that would have vested from time to
time to December 2009 became immediately exercisable. As such, the Company
recorded compensation expense of approximately $0.3 million in the fourth
quarter of 2005. The accelerated vesting reduces the amount of compensation
expense that the Company would have otherwise been required to recognize in 2006
and later upon the adoption effective January 1, 2006 of SFAS 123R. The
reduction in compensation expense for 2006 was approximately $0.5
million.
 
 Employee 401(k)
Plan
  The
TranSwitch Corporation 401(k) Retirement Plan (the “Plan”) provides tax-deferred
salary deductions for eligible employees. Employees may contribute an annual
maximum amount as set periodically by the Internal Revenue Service. The Company
provides matching contributions equal to 50% of the employees’ contributions, up
to a maximum of 6% of the employee’s annual compensation. Company contributions
begin vesting after two years and are fully vested after three years.
Contribution expense related to the Plan was $0.2 million, $0.2 million and $0.3
million for 2008, 2007 and 2006, respectively.
 
 Note
13.    Convertible Notes
 
 In 2006,
the Company issued an aggregate of 1,500,000 shares of the Company’s common
stock plus approximately $22.2 million cash in exchange for $24.6 million
aggregate original principal amount of its then outstanding 5.45%
Convertible Plus Cash Notes due September 30, 2007 (the “Plus Cash Notes”) and
accrued interest. As a result of these exchanges, the Company recorded an
extinguishment loss of approximately $3.1 million in 2006, including non-cash
write-offs of unamortized debt discount and deferred debt issuance
costs.
 
 On July
6, 2007, the Company exchanged approximately $21.2 million aggregate principal
amount of its outstanding Plus Cash Notes for an equivalent principal
amount of a new series of 5.45% Convertible Notes due September 30, 2010 (the
“2010 Notes”). The remaining $8.9 million balance of the 2007 Plus Cash
Notes were redeemed at par value for cash at the end of September, 2007. In
connection with the exchange the Company recorded an extinguishment loss of
approximately $0.4 million, including a non-cash write-off of unamortized debt
discount and deferred debt issuance costs.
 
 Also on
July 6, 2007, the Company issued for an equal amount of cash an additional $3.8
million aggregate principal amount of 2010 Notes.  At December 31,
2007, the Company had $25.0 million of the 2010 Notes outstanding.
 
 On
December 24, 2008, the Company entered into an agreement with certain holders of
its 2010 Notes to purchase $15.0 million aggregate principal amount of
the 2010 Notes for $9.9 million in cash, plus accrued and unpaid
interest.  As a result of this transaction, the Company recorded an
extinguishment gain of $4.5 million, net of a non-cash write-off of unamortized
deferred debt issuance costs.  As of December 31, 2008, $10.0 million of
the 2010 Notes remained outstanding.
 
 The
2010 Notes are redeemable at par value by the Company at any time after July 6,
2009, provided that the closing price per share of the Company’s common stock as
reported on the Nasdaq Capital Market exceeds 150% of the conversion price for
at least 20 trading days within a period of 30 consecutive trading days, and the
Company provides notice of redemption to the holders of the 2010
Notes.
  Upon the
occurrence of a change of control, as defined, each of the holders of
the 2010 Notes has the right to require the Company to repurchase
all or a portion of such holder’s 2010 Notes at a purchase price equal
to 100% of the principal amount plus interest, accrued and unpaid to the date
of such repurchase.   Also, prior to July 6, 2010, if the 2010
Notes are converted in connection with a change of control, where 10% or more of
the consideration paid for the Company’s common stock consists of cash or
securities that are not traded or scheduled to be traded on a United States
national securities exchange, then in addition to the shares of the
Company's common stock that such holder would be entitled to receive
upon such conversion, the Company is required to pay a make-whole payment in
cash to such holder.
  73
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 Upon the
occurrence of certain events of default, the trustee or the holders of at least
25% in principal amount of the then-outstanding 2010 Notes may declare the
principal of, and accrued but unpaid interest on the 2010 Notes immediately due
and payable. Certain such events of default include failure to make payments of
principal, failure to make payments of interest, failure to comply with certain
covenants and agreements, failure to file certain periodic reports, and certain
events of bankruptcy or insolvency. The
Indenture governing the terms of the 2010 Notes also contains certain covenants
that limit, among other things, the Company’s ability to incur additional
debt.
  Initially,
each $1,000 principal amount of the 2010 Notes is convertible into 472 common
shares or $2.118 per share of common stock. The conversion rate is subject to
adjustment upon the occurrence of certain events, including, the issuance of a
common stock or cash dividend or distribution of securities, cash or assets,
certain subdivisions and combinations of the Company’s common stock, where the
fair market value of a tender or exchange offer exceeds certain amounts, or if
the Company’s September 30, 2008 trailing twelve month net income was less than
$0.00.  The Company may increase the conversion rate by any amount for
any period of time if the period is at least twenty (20) days and the Board of
Directors has made the determination that such increase would be in the
Company’s best interest. Under no circumstances, may the conversion rate be
adjusted to less than $1.83.
 
 Note
14.    Restructuring and Asset Impairment
Charges
  During 2008 the Company implemented
restructuring plans that resulted in total restructuring costs of approximately
$7.2 million, of which approximately $3.8 million was recorded as restructuring
charges in its Consolidated Statements of Operations and $3.4 million was
recorded as a liability assumed in the acquisition of
Centillium.  These restructuring plans included the elimination of
approximately 76 positions, primarily in the Company’s Shelton, Connecticut,
Bedford, Massachusetts, Fremont, California, Eclubens, Switzerland, New Delhi,
India and Bangalore, India locations.  As a result, the Company
recorded restructuring charges in its Consolidated Statements of Operations of
approximately $1.7 million related to employee termination benefits, $0.8
million related to asset impairments, $0.7 million related to excess facility
costs net of anticipated sublease income and $0.8 million in other restructuring
charges.  These
2008 charges were partially offset by approximately $0.2
million of benefits related to adjustments to certain sublease agreements
relating to the Company’s excess facilities in Shelton,
Connecticut
  In
connection with the restructuring events of 2008, the Company expects that
approximately $6.3 million of the $7.2 million in restructuring costs will
require cash expenditures. In 2008, the Company made payments of approximately
$2.9 million in connection with these plans. The Company expects future cash
expenditures to be made as follows: $3.3 million in 2009 and $0.1 million in
2010.
  During
2007 the Company recorded restructuring charges of approximately $1.5 million
related to workforce reductions.
 
 During
2006the Company
recorded restructuring charges of approximately $0.4 million including $0.2
million of additional costs for changes in estimates for restructuring actions
taken at the Company’s European design centers in 2004 and 2005, and $0.2
million for changes in estimates relating to subleases at the Company’s
facilities in Shelton, Connecticut.
 
 A summary
of the restructuring liabilities and activity follows:
 
 2008 ActivityRestructuring
                                      Liabilities
                                      December 31,
                                      2007
                                  
                                  
                                  Liabilities
                                    assumed in
                                    acquisition of
                                    business
                                  
                                  
                                  Restructuring
                                    Charges
                                  
                                  
                                  Cash Payments
                                  
                                  
                                  Non-cash
                                    asset
                                    write-offs
                                  
                                  
                                  Adjustments
                                    and Changes
                                    to Estimates
                                  
                                  
                                  Restructuring
                                      Liabilities
                                      December 31,
                                      2008Employee
      Termination Benefits
                                  
                                  $
                                  235
                                  
                                  
                                  $
                                  3,071
                                  
                                  
                                  $
                                  1,740
                                  
                                  
                                  $
                                  (3,080
                                  )
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  (36
                                  )
                                  
                                  $
                                  1,930Facility
      lease costs
                                  
                                  
                                  20,731
                                  
                                  
                                  
                                  1,686
                                  
                                  
                                  
                                  728
                                  
                                  
                                  
                                  (346
                                  )
                                  
                                  
                                  —
                                  
                                  
                                  
                                  (265
                                  )
                                  
                                  
                                  22,534Asset
      impairments
                                  
                                  
                                  —
                                  
                                  
                                  
                                  42
                                  
                                  
                                  
                                  835
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  (877
                                  )
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —Other
                                  
                                  
                                  124
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  783
                                  
                                  
                                  
                                  (1
                                  )
                                  
                                  
                                  —
                                  
                                  
                                  
                                  19
                                  
                                  
                                  
                                  925Totals
                                  
                                  $
                                  21,090
                                  
                                  
                                  $
                                  4,799
                                  
                                  
                                  $
                                  4,086
                                  
                                  
                                  $
                                  (3,427
                                  )
                                  
                                  $
                                  (877
                                  )
                                  
                                  $
                                  (282
                                  )
                                  
                                  $
                                  25,389
  74
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 2007 ActivityRestructuring
                                    Liabilities
                                    December 31,
                                    2006
                                
                                
                                Restructuring
                                    Charges
                                
                                
                                Cash Payments
                                
                                
                                Non-cash
                                  asset
                                  write-offs
                                
                                
                                Adjustments
                                  and Changes
                                  to Estimates
                                
                                
                                Restructuring
                                    Liabilities
                                    December 31,
                                    2007Employee
      TerminationBenefits
                                
                                $
                                —
                                
                                
                                $
                                1,482
                                
                                
                                $
                                (1,193
                                )
                                
                                $
                                —
                                
                                
                                $
                                (54
                                )
                                
                                $
                                235Facility
      lease costs
                                
                                
                                21,370
                                
                                
                                
                                —
                                
                                
                                
                                (600
                                )
                                
                                
                                —
                                
                                
                                
                                (39
                                )
                                
                                
                                20,731Other
                                
                                
                                143
                                
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                (58
                                )
                                
                                
                                39
                                
                                
                                
                                124Totals
                                
                                $
                                21,513
                                
                                
                                $
                                1,482
                                
                                
                                $
                                (1,793
                                )
                                
                                $
                                (58
                                )
                                
                                $
                                (54
                                )
                                
                                $
                                21,090
 
 Note
15.    Commitments and Contingencies
  Lease
Agreements
  The
Company leases buildings and equipment at its headquarters in Shelton,
Connecticut as well as at its subsidiaries’ locations
worldwide.  Rental expense under all operating lease agreements was
$2.0 million in 2008, $1.7 million in 2007 and $1.7 million in 2006.
 
 The
following table summarizes as of December 31, 2008 future minimum operating
lease commitments, including contractually obligated building operating
commitments that have remaining, non-cancelable lease terms in excess of one
year and future anticipated sublease income:
 Operating
                      Commitments
                    
                    
                    Less:
                      Sublease
                      Agreements
                    
                    
                    Net
                      Commitments2009
                    
                    $
                    6,178
                    
                    
                    $
                    2,132
                    
                    
                    $
                    4,0462010
                    
                    
                    5,600
                    
                    
                    
                    1,344
                    
                    
                    
                    4,2562011
                    
                    
                    4,667
                    
                    
                    
                    683
                    
                    
                    
                    3,9842012
                    
                    
                    4,632
                    
                    
                    
                    521
                    
                    
                    
                    4,1112013
                    
                    
                    3,523
                    
                    
                    
                    -
                    
                    
                    
                    3,523Thereafter
                    
                    
                    9,615
                    
                    
                    
                    -
                    
                    
                    
                    9,615$
                    34,215
                    
                    
                    $
                    4,680
                    
                    
                    $
                    29,535
  75
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 Refer
to Note 19 of the Notes to Consolidated Financial Statements, which provides
information on subsequent events that will have an impact on the Company’s
future minimum operating lease commitments.
 
 Patent
Indemnity
  Under the
terms of substantially all of its sales agreements, the Company has agreed to
indemnify its customers for costs and damages arising from claims against such
customer based on, among other things, allegations that the Company’s products
infringed upon the intellectual property rights of a third party. In the event
of an infringement claim, the Company retains the right to (i) procure for the
customer the right to continue using the product; (ii) replace the product with
a non-infringing item which shall give equally good service; (iii) modify the
product so that it becomes non-infringing; or (iv) remove the product and, on
return of the product to the Company, the Company shall refund the buyers
purchase price. Due to the nature of these indemnification agreements, the
maximum potential future payments the Company could be required to make under
these guarantees, when and if such claims may arise, cannot be reliably
determined. No amounts have been accrued for any estimated losses with respect
to these guarantees for customer indemnifications since it is not probable that
a loss will be incurred. No claims have been made under these indemnity
provisions.
 
 Purchase
Commitments
 
 In the
normal course of business, the Company makes various commitments to purchase
goods or services from specific suppliers, including those related to capital
expenditures. As of December 31, 2008, the Company had purchase commitments
totaling $6.4 million
 
 Note
16.    Supplemental Cash Flow Information
  Supplemental
cash flow information follows:
  Years Ended December 31,2008
                        
                        
                        2007
                        
                        
                        2006Cash
      paid for interest
                        
                        $
                        1,554
                        
                        
                        $
                        1,705
                        
                        
                        $
                        2,136Cash
      paid for income taxes
                        
                        $
                        340
                        
                        
                        $
                        373
                        
                        
                        $
                        322
  Non-cash investing and financing
activities include:
 
 Common
      stock issued in acquisitions
                    
                    $
                    24,950
                    
                    
                    $
                    5,541
                    
                    
                    $
                    4,832Common
      stock issued upon conversion of Plus Cash Notes
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    2,714
  Note
17.    Issuance of Common Stock
 
 During
2008, in connection with the Centillium acquisition, the Company issued
25,000,000 shares of its common stock with an approximate fair value of $25.0
million.
 
 In
connection with the ASIC Design Center acquisition in 2007 the Company issued
3,746,713 shares of its common stock with an approximate fair value of $5.5
million.
 
 Note
18.   Stock Repurchase Program
  On February 13, 2008 the Company
announced that its Board of Directors authorized a stock repurchase program
under which the Company may repurchase up to $10 million of its outstanding
common stock.  The share repurchase program authorizes the Company to
repurchase shares through February 2010, from time to time, through transactions
in the open market or in privately negotiated transactions.  The
number of shares to be purchased and the timing of the purchases will be based
on market conditions and other factors.  The stock repurchase program
does not require the Company to repurchase any specific dollar value or number
of shares, and the Company may terminate the repurchase program at any
time.
  76
  TRANSWITCH
CORPORATION AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Tabular
dollars in thousands, except share and per share amounts)
 
 During
2008, the Company purchased 166,350 shares of its outstanding common stock at an
average price of $0.68 per share or approximately $0.1 million, excluding
commissions.
 
 Note
19.    Subsequent Events
  On March
2, 2009, the Company issued a press release reporting that it has reached an
agreement to reduce its leased office space by 24,000 square feet by amending
its lease covering the company’s principal executive offices at 3 Enterprise
Drive, Shelton, Connecticut.  The lease amendment will result in
a cash savings of the Company’s lease obligation, through November
2012, by approximately $1.5 million.
  On March
6, 2009, the Company announced that it entered into a sublease agreement (the
“Sublease Agreement”) on March 3, 2009 with an unaffiliated party to sublease
92,880 square feet of the Company’s office space in Shelton, Connecticut (the
“Sublease Premises”). The term of the Sublease Agreement shall commence on
a date no later than August 14, 2009 (the “Commencement Date”).  The
initial term of the Sublease Agreement shall expire sixty-one (61) full months
after the Commencement Date.  Base rent for the Subleased Premises is
One Hundred Twelve Thousand, Two Hundred Thirty Dollars ($112,230.00) per
month. As a result of the Sublease Agreement, the Company expects to
reverse approximately $6.7 million of its previously accrued restructuring
liability during the first quarter of the fiscal year ending December 31,
2009.
 
 Note
20.    Quarterly Information (Unaudited)
  The table
below shows selected unaudited quarterly information of operating results. The
Company believes that this information reflects all normal recurring adjustments
necessary for a fair presentation of the information for the periods presented.
Interim operating results are not necessarily indicative of future period
results.
 
 First
                                    Quarter
                                  
                                  
                                  Second
                                    Quarter
                                  
                                  Third
                                    Quarter
                                  
                                  
                                  Fourth
                                    Quarter
                                  
                                  
                                  Full
                                    YearYear
      ended December 31, 2008Net
      revenues
                                  
                                  $
                                  7,520
                                  
                                  
                                  $
                                  8,891
                                  
                                  $
                                  10,498
                                  
                                  
                                  $
                                  15,025
                                  
                                  
                                  $
                                  41,934Cost
      of revenues
                                  
                                  
                                  2,935
                                  
                                  
                                  
                                  3,549
                                  
                                  
                                  4,517
                                  
                                  
                                  
                                  7,039
                                  
                                  
                                  
                                  18,040Gross
      profit
                                  
                                  
                                  4,585
                                  
                                  
                                  
                                  5,342
                                  
                                  
                                  5,981
                                  
                                  
                                  
                                  7,986
                                  
                                  
                                  
                                  23,894Net
      loss
                                  
                                  
                                  (5,494
                                  )
                                  
                                  
                                  (4,320
                                  )
                                  
                                  (2,956
                                  )
                                  
                                  
                                  (4,276
                                  )
                                  
                                  
                                  (17,046
                                  )Net
      loss per common share (1):Basic
                                  
                                  $
                                  (0.04
                                  )
                                  
                                  $
                                  (0.03
                                  )
                                  $
                                  (0.02
                                  )
                                  
                                  $
                                  (0.03
                                  )
                                  
                                  $
                                  (0.12
                                  )Diluted
                                  
                                  $
                                  (0.04
                                  )
                                  
                                  $
                                  (0.03
                                  )
                                  $
                                  (0.02
                                  )
                                  
                                  $
                                  (0.03
                                  )
                                  
                                  $
                                  (0.12
                                  )Year
      ended December 31, 2007Net
      revenues
                                  
                                  $
                                  9,286
                                  
                                  
                                  $
                                  8,875
                                  
                                  $
                                  7,234
                                  
                                  
                                  $
                                  7,170
                                  
                                  
                                  $
                                  32,565Cost
      of revenues
                                  
                                  
                                  3,165
                                  
                                  
                                  
                                  3,530
                                  
                                  
                                  2,553
                                  
                                  
                                  
                                  3,146
                                  
                                  
                                  
                                  12,394Gross
      profit
                                  
                                  
                                  6,121
                                  
                                  
                                  
                                  5,345
                                  
                                  
                                  4,681
                                  
                                  
                                  
                                  4,024
                                  
                                  
                                  
                                  20,171Net
      loss
                                  
                                  
                                  (5,216
                                  )
                                  
                                  
                                  (4,405
                                  )
                                  
                                  (4,480
                                  )
                                  
                                  
                                  (5,611
                                  )
                                  
                                  
                                  (19,712
                                  )Net
      loss per common share (1):Basic
                                  
                                  $
                                  (0.04
                                  )
                                  
                                  $
                                  (0.03
                                  )
                                  $
                                  (0.03
                                  )
                                  
                                  $
                                  (0.04
                                  )
                                  
                                  $
                                  (0.15
                                  )Diluted
                                  
                                  $
                                  (0.04
                                  )
                                  
                                  $
                                  (0.03
                                  )
                                  $
                                  (0.03
                                  )
                                  
                                  $
                                  (0.04
                                  )
                                  
                                  $
                                  (0.15
                                  )
 
 (1)
                  The sum of quarterly per share
      amounts may not equal per share amounts reported for year-to-date periods
      due to changes in the number of weighted average shares outstanding and
      the effects of rounding.
 (2)
                  The
      reported net loss for 2008 and 2007 reflects stock-based compensation
      expense of $1.5 million (Q1 of $0.4 million, Q2 of $0.3 million, Q3 of
      $0.3 million and Q4 of $0.5 million) and $2.0 million (Q1 of $0.4 million,
      Q2 of $0.7 million, Q3 of $0.4 million and Q4 of $0.5 million),
      respectively.
  77
  SCHEDULE
II
  TRANSWITCH
CORPORATION
  VALUATION
AND QUALIFYING ACCOUNTS
 (in
thousands)
  AdditionsDescription
                                            
                                            Balance at
                                              Beginning
                                              of Year
                                            
                                            
                                            Charges to
                                              Costs and
                                              Expenses
                                            
                                            
                                            Charges
                                              to Other
                                              Accounts
                                            
                                            
                                            Deductions
                                            
                                            
                                            Balance at End
                                              of YearYear
      ended December 31, 2008:Allowance
      for losses on:Accounts
      receivable
                                            
                                            $
                                            623
                                            
                                            
                                            $
                                            (3
                                            )
                                            
                                            $
                                            17
                                            
                                            
                                            $
                                            (101
                                            )
                                            
                                            $
                                            536Sales
      returns and allowances
                                            
                                            
                                            99
                                            
                                            
                                            
                                            261
                                            
                                            
                                            
                                            151
                                            
                                            
                                            
                                            (360
                                            )
                                            
                                            
                                            151Stock
      rotation
                                            
                                            
                                            60
                                            
                                            
                                            
                                            27
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (43
                                            )
                                            
                                            
                                            44Deferred
      income tax assets valuation allowance
                                            
                                            
                                            148,250
                                            
                                            
                                            
                                            9,263
                                            
                                            
                                            
                                            72,073
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            229,586$
                                            149,032
                                            
                                            
                                            $
                                            9,548
                                            
                                            
                                            $
                                            72,241
                                            
                                            
                                            $
                                            (504
                                            )
                                            
                                            $
                                            230,317Year
      ended December 31, 2007:Allowance
      for losses on:Accounts
      receivable
                                            
                                            $
                                            473
                                            
                                            
                                            $
                                            118
                                            
                                            
                                            $
                                            32
                                            
                                            
                                            $
                                            —
                                            
                                            
                                            $
                                            623Sales
      returns and allowances
                                            
                                            
                                            37
                                            
                                            
                                            
                                            322
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (260
                                            )
                                            
                                            
                                            99Stock
      rotation
                                            
                                            
                                            75
                                            
                                            
                                            
                                            34
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (49
                                            )
                                            
                                            
                                            60Deferred
      income tax assets valuation allowance
                                            
                                            
                                            142,791
                                            
                                            
                                            
                                            5,459
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            148,250$
                                            143,376
                                            
                                            
                                            $
                                            5,933
                                            
                                            
                                            $
                                            32
                                            
                                            
                                            $
                                            (309
                                            )
                                            
                                            $
                                            149,032Year
      ended December 31, 2006:Allowance
      for losses on:Accounts
      receivable
                                            
                                            $
                                            446
                                            
                                            
                                            $
                                            27
                                            
                                            
                                            $
                                            —
                                            
                                            
                                            $
                                            —
                                            
                                            
                                            $
                                            473Sales
      returns and allowances
                                            
                                            
                                            45
                                            
                                            
                                            
                                            542
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (550
                                            )
                                            
                                            
                                            37Stock
      rotation
                                            
                                            
                                            671
                                            
                                            
                                            
                                            (523
                                            )
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (73
                                            )
                                            
                                            
                                            75Warranty
                                            
                                            
                                            150
                                            
                                            
                                            
                                            (150
                                            )
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —Deferred
      income tax assets valuation allowance
                                            
                                            
                                            141,029
                                            
                                            
                                            
                                            1,762
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            142,791$
                                            142,341
                                            
                                            
                                            $
                                            1,658
                                            
                                            
                                            $
                                            —
                                            
                                            
                                            $
                                            (623
                                            )
                                            
                                            $
                                            143,376
 
 Item
9.    Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure
 
 None.
 
 Item
9A.    Controls and
Procedures
  Conclusion
Regarding the Effectiveness of Disclosure Controls and Procedures
  Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined
under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934,
as amended. Based upon that evaluation, our principal executive officer and
principal financial officer concluded that, as of the evaluation date, our
disclosure controls and procedures are effective to ensure that information
required to be disclosed in the reports that we file or submit under the
Securities Exchange Act of 1934 are recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission’s rules and forms.
  78
  Management’s
Annual Report on Internal Control over Financial Reporting
 
 Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act
Rules 13a-15(f). Under the supervision and with the participation of our
management, including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework in Internal Control - Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on our evaluation under the framework in Internal Control — Integrated
Framework, our management concluded that our internal control over
financial reporting was effective as of December 31, 2008.
 
 The
independent registered public accounting firm of the Company has issued a report
on its assessment of the effectiveness of the Company’s internal control over
financial reporting as of December 31, 2008.  That report appears
under Item 8.
 
 Changes
in Internal Control over Financial Reporting
  No
change in our internal control over financial reporting occurred during the
quarter ended December 31, 2008, that materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.
 
 Item
9B.    Other
Information
 
 None.
  79
  PART
III
  Item
10.    Directors, Executive Officers and
Corporate Governance
 
 Information
with respect to directors, the Audit Committee of the Board of Directors, Audit
Committee financial experts and named executive officers is incorporated herein
by reference to the section entitled Proposal No. 1 “Election of Directors”,
“Audit Committee Report” and “Compensation and Other Information Concerning
Named Executive Officers”, respectively, contained in our definitive proxy
statement for the annual meeting of shareholders of the Company to be held on
May 21, 2009, which is to be filed with the Securities and Exchange Commission
not later than 120 days after the close of the year ended December 31,
2008.Information
concerning Section 16(a) compliance is incorporated by reference to the section
of our definitive proxy statement entitled “Section 16(a) Beneficial Ownership
Reporting Compliance.”
 
 Code
of Ethics
  The
Company has a code of ethics that applies to all its directors, officers,
employees and representatives. This code is publicly available at the investor
relations section of the Company’s website located at http://www.transwitch.com.
Amendments to the code of ethics and any grant of a waiver from a provision of
the code requiring disclosure under applicable SEC rules will be disclosed
within the investor relations section of the Company’s website located at http://www.transwitch.com.   These
materials may also be requested in print by writing to the Company’s Investor
Relations Department at TranSwitch Corporation, Attention: Investor Relations,
Three Enterprise Drive, Shelton, CT 06484.
 
 Corporate
Governance Principles and Charters
 
 The
Company’s corporate governance principles and the charters of its Board of
Directors’ Audit and Finance Committee, Nominations and Corporate Governance
Committee and Compensation Committee are available at the investor relations
section of the Company’s website at http://www.transwitch.com.
These materials may also be requested in print by writing to the Company’s
Investor Relations Department at TranSwitch Corporation, Attention: Investor
Relations, Three Enterprise Drive, Shelton, CT 06484.
 
 Section
16(a) Beneficial Ownership Reporting Compliance
 
 Section
16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s
directors, executive officers, and persons who own more than ten percent of a
registered class of the Company’s equity securities to file reports of ownership
and changes in ownership with the SEC, and such persons are also required by SEC
regulations to furnish the Company with copies of all Section 16(a) forms they
file.  Based solely on its review of the copies of such forms received
by it, the Company believes that during fiscal 2008 all executive officers,
board members and greater than ten percent stockholders of the Company complied
with all applicable filing requirements, with the exception of Thomas Baer, who
filed a Form 4 on May 28, 2008 to report a stock option grant on becoming a
director of the Company on May 22, 2008. This Form 4 was due on May 27, 2008 and
was late due to delays in registering with the Securities and Exchange
Commission.
  Item
11.    Executive
Compensation
  Information
with respect to executive compensation is incorporated herein by reference to
the section entitled “Compensation and Other Information Concerning Named
Executive Officers” contained in our definitive proxy statement for the annual
meeting of shareholders of the Company to be held on May 21, 2009 which is to be
filed with the Securities and Exchange Commission not later than 120 days after
the close of the year ended December 31, 2008.
 
 Item
12.    Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder
Matters
  Information
regarding security ownership of certain beneficial owners, directors and
executive officers is incorporated herein by reference to the information in the
section entitled “Security Ownership of Certain Beneficial Owners and
Management”, “Related Party Transactions” and “Indemnification Matters”
contained in our definitive proxy statement for the annual meeting of
shareholders of the Company to be held on May 21, 2009 which is to be filed with
the Securities and Exchange Commission not later than 120 days after the close
of the year ended December 31, 2008.
  80
  Item
13.    Certain Relationships and Related
Transactions, and Director Independence
  Information
regarding certain relationships and related transactions of the Company is
incorporated herein by reference to the sections entitled “Compensation
Committee Interlocks and Insider Participation” and “Related Party Transactions”
contained in our definitive proxy statement for the annual meeting of
shareholders of the Company to be held on May 21, 2009 which is to be filed with
the Securities and Exchange Commission not later than 120 days after the close
of the year ended December 31, 2008.
  Item
14.    Principal Accountant Fees and
Services
  Information
regarding principal accountant fees and services is incorporated herein by
reference to the section entitled, under the headings “Information about the
Corporation’s Independent Auditors” contained in our definitive proxy statement
for the annual meeting of shareholders of the Company to be held on May 21,
2009, which is to be filed with the Securities and Exchange Commission not later
than 120 days after the close of the year ended December 31, 2008.
 
 81
  PART
IV
 
 Item
15.    Exhibits and Financial Statement
Schedules
  (a)(1)
                The
      following financial statements of TranSwitch Corporation are filed as part
      of this Form 10-K under Item 8 “Financial Statements and Supplementary
      Data.”
 
 FINANCIAL STATEMENTS
                        
                        PAGEConsolidated
      Balance Sheets – December 31, 2008 and 2007
                        
                        
                        52Consolidated
      Statements of Operations – Years ended December 31, 2008, 2007 and
      2006
                        
                        
                        53Consolidated
      Statements of Stockholders’ Equity and Comprehensive Loss – Years ended
      December 31, 2008, 2007 and 2006
                        
                        
                        54Consolidated
      Statements of Cash Flows – Years ended December 31, 2008, 2007 and
      2006
                        
                        
                        55Notes
      to Consolidated Financial Statements
                        
                        
                        56Schedule
      II
                        
                        
                        78
 
 (a)(2)
              All
      other schedules are omitted because they are either not applicable, not
      required or because the information is presented in the Consolidated
      Financial Statements and Financial Statement Schedule or the notes
      thereto.
  (a)(3)    Exhibits
  3.1
                  
                  Amended
      and Restated Certificate 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 March 31, 2005 and incorporated herein by
      reference).3.2
                  
                  Second
      Amended and Restated By-Laws, (previously filed as Exhibit 3.1 to
      TranSwitch Corporation’s Current Report on Form 8-K as filed with the SEC
      on October 17, 2007 and incorporated herein by
  reference).4.1
                  
                  Specimen
      certificate representing the common stock of TranSwitch Corporation(previously filed as Exhibit 4.1 to
      TranSwitch’s Quarterly Report on Form 10-Q for the quarter ended September
      30, 2001 and incorporated herein by reference).4.2
                  
                  Rights
      Agreement, dated as of October 1, 2001, between TranSwitch Corporation and
      EquiServe Trust Company, N.A., which includes the form of Rights
      Certificate and the Summary of Rights to Purchase Preferred Shares
      (previously filed as Exhibit 1 to TranSwitch Corporation’s Registration
      Statement No. 0-25996 on Form 8-A filed on October 2, 2001 and
      incorporated by reference herein).4.3
                  
                  Indenture
      dated July 6, 2007 by and between TranSwitch Corporation and U.S. Bank
      National Association, as trustee (previously filed as Exhibit 4.1 to
      TranSwitch Corporation’s Current Report on Form 8-K as filed with the SEC
      on July 6, 2007 and incorporated herein by reference).4.4
                  
                  Amendment
      No. 1 to the Rights Agreement, between TranSwitch Corporation and
      Computershare Trust Company, N.A. (formerly known as Equiserve Trust
      Company, N.A) as Rights Agent, dated as of February 24,
      2006.  (previously filed as Exhibit 4.1 to TranSwitch
      Corporation’s Current Report on Form 8-K as filed on February 28, 2006 and
      incorporated herein by reference).4.5
                  
                  2005
      Employee Stock Purchase Plan (filed as Exhibit 4.2 to the Company’s
      registration statement on Form S-8 (File No. 333-126129) and incorporated
      herein by reference).*4.6
                  
                  Form
      of Employee Stock Purchase Plan Enrollment Authorization Form (previously
      filed as Exhibit 4.3 to the Company’s registration statement on Form S-8
      (File No. 333-126129) and incorporated herein by
    reference).4.7
                  
                  Form
      of Employee Stock Purchase Plan Change / Withdrawal Authorization Form
      (previously filed as Exhibit 4.4 to the Company’s registration statement
      on Form S-8 (File No. 333-126129) and incorporated herein by
      reference).4.8
                  
                  2008
      Equity Incentive Plan (previously filed as Exhibit 4.2 to TranSwitch
      Corporation’s Registration Statement on Form S-8 (File No. 333-151113) and
      incorporated herein by reference).*4.9
                  
                  Form
      of 2008 Equity Incentive Plan Stock Option Award Agreement (previously
      filed as Exhibit 4.3 to TranSwitch Corporation’s Registration Statement on
      Form S-8 (File No. 333-151113) and incorporated herein by
      reference).
  82
  4.10
                        
                        Form
      of 2008 Equity Incentive Plan 102 Stock Option Award Agreement (previously
      filed as Exhibit 4.4 to TranSwitch Corporation’s Registration Statement on
      Form S-8 (File No. 333-151113) and incorporated herein by
      reference).4.11
                        
                        Form
      of Restricted Stock Award Agreement under the 2008 Equity Incentive Plan
      (previously filed as Exhibit 4.5 to TranSwitch Corporation’s Registration
      Statement on Form S-8 (File No. 333-151113) and incorporated herein by
      reference).4.12
                        
                        Form
      of Restricted Stock 102 Award Agreement under the 2008 Equity Incentive
      Plan (previously filed as Exhibit 4.6 to TranSwitch Corporation’s
      Registration Statement on Form S-8 (File No. 333-151113) and incorporated
      herein by reference).4.13
                        
                        Form
      of Non-Qualified Stock Option Award to Director Agreement under the 2008
      Equity Incentive Plan (previously filed as Exhibit 4.7 to TranSwitch
      Corporation’s Registration Statement on Form S-8 (File No. 333-151113) and
      incorporated herein by reference).4.14
                        
                        Form
      of 2008 Equity Incentive Plan 102 Stock Award Agreement (previously filed
      as Exhibit 4.8 to TranSwitch Corporation’s Registration Statement on Form
      S-8 (File No. 333-151113) and incorporated herein by
      reference).10.1
                        
                        Third
      Amended and Restated 1995 Stock Option Plan, as amended (previously filed
      as an exhibit to TranSwitch Corporation’s Current Report on Form 8-K as
      filed on May 23, 2005).*10.2
                        
                        1995
      Non-Employee Director Stock Option Plan, as amended (previously filed as
      Exhibit 4.4 to the TranSwitch Corporation’s Registration Statement on Form
      S-8 (File No. 333-89798) and incorporated herein by
      reference).*10.3
                        
                        Form
      of Incentive Stock Option Agreement under the 1995 Stock Plan (previously
      filed as an exhibit to the TranSwitch Corporation’s Registration Statement
      on Form S-8 (File No. 33-94234) and incorporated herein by
      reference).10.4
                        
                        Form
      of Non-Qualified Stock Option Agreement under the 1995 Stock Plan
      (previously filed as an exhibit to the TranSwitch’s Registration Statement
      on Form S-8 (File No. 33-94234) and incorporated herein by
      reference).10.5
                        
                        Form
      of Non-Qualified Stock Option Agreement under the 1995 Non-Employee
      Director Stock Option Plan (previously filed as an exhibit to the
      TranSwitch Corporation’s Registration Statement on Form S-8 (File No.
      33-94234) and incorporated herein by reference).10.6
                        
                        Lease
      Agreement, as amended, with Robert D. Scinto (previously filed as Exhibit
      10.14 to the TranSwitch Corporation’s Annual Report on Form 10-K for the
      fiscal year ended December 31, 1997 and incorporated herein by
      reference).10.7
                        
                        2000Stock Option Plan (previously filed
      as Exhibit 4.2 to TranSwitch Corporation’s Registration Statement on Form S-8 (File No. 333-75800)
      and incorporated by reference herein).10.8
                        
                        Form
      of Non-Qualified Stock Option Agreement under the 2000 Stock Option Plan
      (previously filed as Exhibit 4.3 to TranSwitch Corporation’s Registration Statement on Form S-8 (File No. 333-75800)
      and incorporated by reference herein).10.9
                        
                        1999
      Stock Incentive Plan of Onex Communications Corporation (previously filed
      as Exhibit 4.2 to TranSwitch Corporation’s Registration Statement on Form
      S-8 (File No. 333-70344) and incorporated by reference
      herein).10.10
                        
                        Form
      of Incentive Stock Option Agreement under the 1999 Stock Incentive Plan of
      Onex Communications Corporation (previously filed as Exhibit 4.3 to
      TranSwitch Corporation’s Registration Statement on Form S-8 (File No.
      333-70344) and incorporated by reference herein).10.11
                        
                        Form
      of Director Non-Qualified Stock Option Agreement under the Third Amended
      and Restated 1995 Stock Option Plan, as amended (previously filed as
      Exhibit 10.1 to TranSwitch Corporation’s Current Report on Form 8-K as
      filed with the SEC on May 25, 2007 and incorporated herein by
      reference).10.12
                        
                        Registration
      Rights Agreement dated July 6, 2007 by and among TranSwitch Corporation
      and the Initial Purchasers named therein (previously filed as Exhibit 10.2
      to TranSwitch Corporation’s Current Report on Form 8-K as filed with the
      SEC on July 6, 2007 and incorporated herein by
  reference).10.13
                        
                        Agreement
      and Plan of Merger by and among TranSwitch Corporation, Centillium
      Communications, Inc., Sonnet Acquisition Corporation and Haiku Acquisition
      Corporation, dated as of July 9, 2008 (previously filed as Exhibit 2.1 to
      TranSwitch Corporation’s Current Report on Form 8-K as filed with the
      Securities and Exchange Commission on July 11, 2008 and incorporated
      herein by
reference).
  83
  10.14
                  
                  Purchase
      Agreement dated as of December 24, 2008 by and among TranSwitch
      Corporation, QVT Fund LP and Quintessence Fund L.P. (filed
      herewith).11.1
                  
                  Computation
      of Loss Per Share (filed herewith).12.1
                  
                  Computation
      of Ratio of Earnings to Fixed Charges (filed herewith).21.1
                  
                  Subsidiaries
      of the Company (filed herewith).23.1
                  
                  Consent
      of Independent Registered Public Accounting Firm (filed
      herewith).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).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).32.1
                  
                  CEO
      Certification pursuant to Rule 13a-14(b) and Rule 15d-14(b) of the
      Securities Exchange Act of 1934, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002 (filed herewith).32.2
                  
                  CFO
      Certification pursuant to Rule 13a-14(b) and Rule 15d-14(b) of the
      Securities Exchange Act of 1934, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002 (filed
herewith).
 
 *
                Indicates
      management contract or compensatory plan, contract or arrangement
      identified as required in Item 15(a)(3) of
    Form 10-K
 
 (b)    Exhibits
  We hereby
file as exhibits to this Form 10-K those exhibits listed in Item 15 (a) (3)
above.
  (c)    Financial
Statement Schedule
  TranSwitch
files as a financial statement schedule to this Form 10-K, the financial
statement schedule listed in Item 8 and 15(a) (2) above.
  84
  SIGNATURES
  Pursuant to the requirements of
Section 13 or 15(d) 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.
  TranswitchCorporationBy:
                    
                    /s/    Dr. Santanu DasDr.
      Santanu Das
                      President
      and Chief Executive
Officer
 March 13,
2009
  POWER
OF ATTORNEY AND SIGNATURES
  We, the
undersigned named executive officers and directors of TranSwitch Corporation,
hereby severally constitute and appoint Dr. Santanu Das and Mr. Robert A. Bosi,
and each of them singly, our true and lawful attorneys, with full power to them
and each of them singly, to sign for us in our names in the capacities indicated
below, all amendments to this report, and generally to do all things in our
names and on our behalf in such capacities to enable TranSwitch Corporation to
comply with the provisions of the Securities Exchange Act of 1934, as amended
and all requirements of the Securities and Exchange Commission.
  Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
 
 Name
      and Signature
                      
                      Title(s)
                      
                      Date/s/
      Dr. Santanu Das
                        Dr.
      Santanu Das
                      
                      President
      and Chief Executive Officer (principal executive officer)
                      
                      March
      13, 2009/s/
      Mr. Robert A. Bosi
                        Mr.
      Robert A. Bosi
                      
                      Vice
      President and Chief Financial Officer (principal financial and accounting
      officer)
                      
                      March
      13, 2009/s/
      Mr. Gerald F. Montry
                        Mr.
      Gerald F. Montry
                      
                      Director
      and Chairman of the Board
                      
                      March
      13, 2009/s/
      Mr.
      Faraj Aalaei
                        Mr.
      Faraj Aalaei
                      
                      Director
                      
                      March
      13, 2009/s/
      Mr. Thomas Baer
                        Mr. Thomas
      Baer
                      
                      Director
                      
                      March
      13, 2009/s/
      Mr. Alfred F. Boschulte
                        Mr.
      Alfred F. Boschulte
                      
                      Director
                      
                      March
      13, 2009/s/
      Mr. Herbert Chen
                        Mr.
      Herbert Chen
                      
                      Director
                      
                      March
      13, 2009/s/
      Mr. Michael Crawford
                        Mr.
      Michael Crawford
                      
                      Director
                      
                      March
      13, 2009/s/
      Dr. Hagen Hultzsch
                        Dr.
      Hagen Hultzsch
                      
                      Director
                      
                      March
      13, 2009/s/
      Mr. James M. Pagos
                        Mr.
      James M. Pagos
                      
                      Director
                      
                      March
      13, 2009/s/
      Dr. Albert E. Paladino
                        Dr.
      Albert E. Paladino
                      
                      Director
                      
                      March
      13, 2009/s/
      Mr. Sam Srinivasan
                        Mr.
      Sam Srinivasan
                      
                      Director
                      
                      March
      13, 2009
  85