---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



---



FORM 10-Q



---



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



For the quarterly period ended December 31, 2005



OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



For the transition period from  to



Commission File No. 0-14225



---



EXAR CORPORATION

(Exact Name of Registrant as specified in its charter)



---



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 94-1741481                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



48720 Kato Road,
Fremont, CA 94538

(Address of principal executive offices, zip code)



(510) 668-7000

(Registrants telephone number, including area code)



---



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



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



Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes ̈No  x



As of February 3, 2006, 35,535,745 shares of the Registrants Common
Stock, par value $0.0001, were issued and outstanding, net of 8,267,110 treasury shares.



---



---

EXAR CORPORATION AND SUBSIDIARIES



INDEX TO



QUARTERLY REPORT ON FORM 10-Q



FOR THE QUARTER ENDED DECEMBER 31, 2005



|           |  |                                                                                       |  |     
|---------- |  | ------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                       |  | Page
|           |  | PART I  FINANCIAL INFORMATION                                                        |  |     
|           |  |                                                                                      
|Item 1.    |  | Financial Statements (unaudited)                                                      |  |     
|           |  |                                                                                      
|           |  | Condensed Consolidated Balance Sheets                                                 |  | 3   
|           |  |                                                                                      
|           |  | Condensed Consolidated Statements of Operations                                       |  | 4   
|           |  |                                                                                      
|           |  | Condensed Consolidated Statements of Cash Flows                                       |  | 5   
|           |  |                                                                                      
|           |  | Notes to Condensed Consolidated Financial Statements                                  |  | 6   
|           |  |                                                                                      
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 18  
|           |  |                                                                                      
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 40  
|           |  |                                                                                      
|Item 4.    |  | Controls and Procedures                                                               |  | 41  
|           |  |                                                                                      
|           |  | PART II  OTHER INFORMATION                                                           |  |     
|           |  |                                                                                      
|Item 1.    |  | Legal Proceedings                                                                     |  | 42  
|           |  |                                                                                      
|Item 2.    |  | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities      |  | 43  
|           |  |                                                                                      
|Item 6.    |  | Exhibits                                                                              |  | 44  
|           |  |                                                                                      
|Signatures |  |                                                                                       |  | 45  



2



---

ITEM 1. FINANCIAL STATEMENTS



EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)



|                                                                                      |  |                  |          |   |               |   |         |  
|------------------------------------------------------------------------------------- |  | ---------------- | -------- | - | ------------- | - | ------- | -
|                                                                                      |  | December 31,2005 |          |   | March 31,2005 |  
|                                                                                      |  | (unaudited)      |          |   |               |  
|ASSETS                                                                                |  |                  |          |   |               |   |         |  
|                                                                                      |  |                 
|Current assets:                                                                       |  |                  |          |   |               |   |         |  
|Cash and cash equivalents                                                             |  | $                | 176,845  |   |               | $ | 258,378 |  
|Short-term marketable securities                                                      |  |                  | 143,798  |   |               |   | 187,907 |  
|Accounts receivable (net of allowances of $1,003 and $858)                            |  |                  | 6,383    |   |               |   | 3,899   |  
|Inventories                                                                           |  |                  | 4,877    |   |               |   | 3,659   |  
|Interest receivable and prepaid expenses                                              |  |                  | 4,704    |   |               |   | 3,645   |  
|Deferred income taxes                                                                 |  |                  | 2,695    |   |               |   | 2,695   |  
|                                                                                      |  |                  |          |   |               |   |         |  
|Total current assets                                                                  |  |                  | 339,302  |   |               |   | 460,183 |  
|Property, plant and equipment, net                                                    |  |                  | 28,738   |   |               |   | 27,317  |  
|Long-term investments                                                                 |  |                  | 2,663    |   |               |   | 3,978   |  
|Deferred income taxes                                                                 |  |                  | 11,343   |   |               |   | 11,130  |  
|Goodwill and intangible assets, net                                                   |  |                  | 10,260   |   |               |   |        |  
|Other non-current assets                                                              |  |                  | 1,085    |   |               |   | 1,672   |  
|                                                                                      |  |                  |          |   |               |   |         |  
|Total assets                                                                          |  | $                | 393,391  |   |               | $ | 504,280 |  
|                                                                                      |  |                  |          |   |               |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                  |  |                  |          |   |               |   |         |  
|                                                                                      |  |                 
|Current liabilities:                                                                  |  |                  |          |   |               |   |         |  
|Accounts payable                                                                      |  | $                | 2,450    |   |               | $ | 2,199   |  
|Accrued compensation and related benefits                                             |  |                  | 3,305    |   |               |   | 4,074   |  
|Accrued sales commissions                                                             |  |                  | 686      |   |               |   | 646     |  
|Other accrued expenses                                                                |  |                  | 1,496    |   |               |   | 1,360   |  
|Income taxes payable                                                                  |  |                  | 6,320    |   |               |   | 4,612   |  
|                                                                                      |  |                  |          |   |               |   |         |  
|Total current liabilities                                                             |  |                  | 14,257   |   |               |   | 12,891  |  
|                                                                                      |  |                 
|Long-term obligations                                                                 |  |                  | 1,303    |   |               |   | 1,342   |  
|                                                                                      |  |                  |          |   |               |   |         |  
|Total liabilities                                                                     |  |                  | 15,560   |   |               |   | 14,233  |  
|                                                                                      |  |                  |          |   |               |   |         |  
|Commitments and contingencies (Note 10 and 11)                                        |  |                  |          |   |               |   |         |  
|                                                                                      |  |                 
|Stockholders equity:                                                                 |  |                  |          |   |               |   |         |  
|Preferred stock; $.0001 par value; 2,250,000 shares authorized; no shares outstanding |  |                  |         |   |               |   |        |  
|Common stock; $.0001 par value; 100,000,000 shares authorized;                        |  |                  |          |   |               |   |         |  
|43,441,782 and 42,507,031 shares outstanding (includes treasury stock)                |  |                  | 423,813  |   |               |   | 417,077 |  
|Accumulated other comprehensive loss                                                  |  |                  | (545     | ) |               |   | (1,070  | )
|Retained earnings                                                                     |  |                  | 87,277   |   |               |   | 82,354  |  
|Treasury stock, 8,267,110 and 497,110 shares of common stock at cost                  |  |                  | (132,714 | ) |               |   | (8,314  | )
|                                                                                      |  |                  |          |   |               |   |         |  
|Total stockholders equity                                                            |  |                  | 377,831  |   |               |   | 490,047 |  
|                                                                                      |  |                  |          |   |               |   |         |  
|Total liabilities and stockholders equity                                            |  | $                | 393,391  |   |               | $ | 504,280 |  
|                                                                                      |  |                  |          |   |               |   |         |  



See accompanying
Notes to Condensed Consolidated Financial Statements.



3



---

EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)



|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|----------------------------------------------------- |  | ------------------------------ | ------ | - | ----------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                      |  | Three Months EndedDecember 31, |        |   | Nine Months EndedDecember 31, |  
|                                                      |  | 2005                           |        |   | 2004                          |   |        | 2005 |  |   | 2004   |  
|Net sales                                             |  | $                              | 17,009 |   |                               | $ | 13,245 |      |  | $ | 49,449 |   |  | $ | 43,713 |  
|                                                      |  |                                |        |  
|Cost of sales:                                        |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Product cost of sales                                 |  |                                | 5,280  |   |                               |   | 4,441  |      |  |   | 15,634 |   |  |   | 14,219 |  
|Amortization of purchased intangible assets           |  |                                | 240    |   |                               |   |       |      |  |   | 680    |   |  |   |       |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Total cost of sales                                   |  |                                | 5,520  |   |                               |   | 4,441  |      |  |   | 16,314 |   |  |   | 14,219 |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Gross profit                                          |  |                                | 11,489 |   |                               |   | 8,804  |      |  |   | 33,135 |   |  |   | 29,494 |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:                                   |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Research and development                              |  |                                | 6,178  |   |                               |   | 5,304  |      |  |   | 18,432 |   |  |   | 16,334 |  
|Selling, general and administrative                   |  |                                | 5,187  |   |                               |   | 4,962  |      |  |   | 15,816 |   |  |   | 15,524 |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                              |  |                                | 11,365 |   |                               |   | 10,266 |      |  |   | 34,248 |   |  |   | 31,858 |  
|                                                      |  |                                |        |  
|Gain on legal settlement                              |  |                                |       |   |                               |   |       |      |  |   |       |   |  |   | 1,208  |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) from operations                         |  |                                | 124    |   |                               |   | (1,462 | )    |  |   | (1,113 | ) |  |   | (1,156 | )
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Interest income and other, net                        |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Interest income and other, net                        |  |                                | 2,902  |   |                               |   | 2,296  |      |  |   | 9,136  |   |  |   | 5,835  |  
|Other than temporary loss on long-term investments    |  |                                | (1,215 | ) |                               |   |       |      |  |   | (1,215 | ) |  |   |       |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Total other income, net                               |  |                                | 1,687  |   |                               |   | 2,296  |      |  |   | 7,921  |   |  |   | 5,835  |  
|                                                      |  |                                |        |  
|Income before income taxes                            |  |                                | 1,811  |   |                               |   | 834    |      |  |   | 6,808  |   |  |   | 4,679  |  
|Provision for income taxes                            |  |                                | 702    |   |                               |   |       |      |  |   | 1,885  |   |  |   | 673    |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Net income                                            |  | $                              | 1,109  |   |                               | $ | 834    |      |  | $ | 4,923  |   |  | $ | 4,006  |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Earnings per share:                                   |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Basic earnings per share                              |  | $                              | 0.03   |   |                               | $ | 0.02   |      |  | $ | 0.13   |   |  | $ | 0.10   |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Diluted earnings per share                            |  | $                              | 0.03   |   |                               | $ | 0.02   |      |  | $ | 0.12   |   |  | $ | 0.09   |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Shares used in the computation of earnings per share: |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Basic                                                 |  |                                | 35,202 |   |                               |   | 41,639 |      |  |   | 39,045 |   |  |   | 41,433 |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Diluted                                               |  |                                | 35,347 |   |                               |   | 42,539 |      |  |   | 39,466 |   |  |   | 42,385 |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  



See accompanying
Notes to Condensed Consolidated Financial Statements.



4



---

EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                           |  |                               |          |   |      |   |          |  
|-------------------------------------------------------------------------- |  | ----------------------------- | -------- | - | ---- | - | -------- | -
|                                                                           |  | Nine Months EndedDecember 31, |         
|                                                                           |  | 2005                          |          |   | 2004 |  
|Cash flows from operating activities:                                      |  |                               |          |   |      |   |          |  
|Net income                                                                 |  | $                             | 4,923    |   |      | $ | 4,006    |  
|Reconciliation of net income to net cash provided by operating activities: |  |                               |          |   |      |   |          |  
|Depreciation and amortization                                              |  |                               | 4,325    |   |      |   | 3,559    |  
|Non-cash stock based compensation expense                                  |  |                               | 102      |   |      |   |         |  
|Provision for sales returns and allowances                                 |  |                               | 145      |   |      |   | 115      |  
|Other than temporary decline in the value of long-term investments         |  |                               | 1,215    |   |      |   |         |  
|Changes in operating assets and liabilities:                               |  |                               |          |   |      |   |          |  
|Accounts receivable                                                        |  |                               | (2,629   | ) |      |   | 3,278    |  
|Inventories                                                                |  |                               | (1,218   | ) |      |   | 288      |  
|Prepaid expenses and other assets                                          |  |                               | (255     | ) |      |   | (3,447   | )
|Accounts payable                                                           |  |                               | 251      |   |      |   | (671     | )
|Accrued compensation and related benefits                                  |  |                               | (633     | ) |      |   | (66      | )
|Accrued sales commissions and other accrued expenses                       |  |                               | 1        |   |      |   | (684     | )
|Income taxes payable                                                       |  |                               | 1,499    |   |      |   | 322      |  
|                                                                           |  |                               |          |   |      |   |          |  
|Net cash provided by operating activities                                  |  |                               | 7,726    |   |      |   | 6,700    |  
|                                                                           |  |                               |          |   |      |   |          |  
|Cash flows from investing activities:                                      |  |                               |          |   |      |   |          |  
|Purchases of property, plant and equipment                                 |  |                               | (4,670   | ) |      |   | (2,310   | )
|Purchases of short-term marketable securities                              |  |                               | (44,617  | ) |      |   | (813,757 | )
|Proceeds from sales and maturities of short-term marketable securities     |  |                               | 89,213   |   |      |   | 809,620  |  
|Distribution of (contribution to) long-term investments, net               |  |                               | (116     | ) |      |   | (364     | )
|Acquisition of ON business from Infineon                                   |  |                               | (11,420  | ) |      |   |         |  
|                                                                           |  |                               |          |   |      |   |          |  
|Net cash provided by (used in) investing activities                        |  |                               | 28,390   |   |      |   | (6,811   | )
|                                                                           |  |                               |          |   |      |   |          |  
|Cash flows from financing activities:                                      |  |                               |          |   |      |   |          |  
|Proceeds from issuance of common stock                                     |  |                               | 6,634    |   |      |   | 5,978    |  
|Repurchases of common stock                                                |  |                               | (124,400 | ) |      |   | (3,664   | )
|                                                                           |  |                               |          |   |      |   |          |  
|Net cash provided by (used in) financing activities                        |  |                               | (117,766 | ) |      |   | 2,314    |  
|                                                                           |  |                              
|Effect of exchange rate changes on cash                                    |  |                               | 117      |   |      |   | 71       |  
|                                                                           |  |                               |          |   |      |   |          |  
|Net increase (decrease) in cash and cash equivalents                       |  |                               | (81,533  | ) |      |   | 2,274    |  
|                                                                           |  |                              
|Cash and cash equivalents at the beginning of period                       |  |                               | 258,378  |   |      |   | 15,090   |  
|                                                                           |  |                               |          |   |      |   |          |  
|Cash and cash equivalents at the end of period                             |  | $                             | 176,845  |   |      | $ | 17,364   |  
|                                                                           |  |                               |          |   |      |   |          |  



See accompanying
Notes to Condensed Consolidated Financial Statements.



5



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION



Description of Business Exar Corporation and subsidiaries (Exar or the Company) designs,
develops and markets high-performance, high-bandwidth physical interface and access control solutions for use in the worldwide communications infrastructure. The Companys current IC products for the communications market are designed to
respond to the demand for cost effective line card solutions based on transmission standards such as T/E carrier, ATM and SONET/SDH. The Company also designs, develops, and markets IC products that address the needs of the serial communications
market and offers a family of clock and timing devices. In addition, the Company designs, develops and markets IC products that address select applications for the video and imaging markets.



Basis of Presentation and Use of Management Estimates  The accompanying
unaudited Condensed Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States. This financial information reflects all adjustments, which are, in the opinion of the Company,
of a normal and recurring nature and necessary to present fairly the statements of financial position, results of operations and cash flows for the dates and periods presented. The March 31, 2005 Condensed Consolidated Balance Sheet was derived
from the audited financial statements at that date. All significant inter-company transactions and balances have been eliminated.



The financial statements include managements estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and material effects on operating results and financial position may result.



Certain amounts in prior periods have been reclassified to conform to the three and nine
months ended December 31, 2005 presentation. The most significant reclassifications were as follows:



Auction Rate Securities in the Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Cash Flows



The Company reclassified auction rate securities as of December 31, 2004 and
March 31, 2004 having a stated or contractual maturity date for the underlying security in excess of ninety days in its balance sheets to short-term marketable securities from cash and cash equivalents. The impact of this reclassification was
to increase short- term marketable securities by $257.9 million and $284.1 million at December 31, 2004 and March 31, 2004, respectively, and reduce cash and cash equivalents by the same amount. For the nine months ended December 31,
2004, the Company reflected the purchases and sales of such securities in cash flows from investing activity in its Condensed Consolidated Statements of Cash Flows, which decreased cash used in investing activities by $26.2 million. Previously, the
Company had classified these types of securities as cash and cash equivalents.



These Condensed Consolidated Financial Statements should be read in conjunction with the Companys audited consolidated financial statements for the fiscal year ended March 31, 2005 included in its Annual Report on Form 10-K, as
filed on June 14, 2005 with the U.S. Securities and Exchange Commission (the SEC). The results of operations for the three and nine months ended December 31, 2005 are not necessarily indicative of the results to be expected for
any future periods.



NOTE 2. ACQUISITION OF INFINEONS OPTICAL
NETWORKING BUSINESS



On April 6, 2005, Exar entered into a Purchase
Agreement with Infineon Technologies North America Corp., a subsidiary of Infineon Technologies AG (Infineon), under which Exar agreed to purchase a significant part of Infineons Optical Networking Business Unit (ON).
On April 14, 2005, Exar completed the purchase of such assets for $11,050,000 in cash. The acquisition included assets relating to multi-rate TDM framer products, Fiber Channel over SONET/SDH, and Resilient Packet Ring (RPR), as well as certain
intellectual property for data over SONET products. The acquisition expanded Exars SONET/SDH product portfolio.



The acquisition has been accounted for as a business combination. Assets acquired were recorded at their fair values as of April 14, 2005. The total purchase price
of $11.42 million includes cash paid to Infineon of $11.05 million and acquisition related transaction costs of $0.37 million. ON related transaction costs included legal and accounting fees, and other external costs directly related to the
acquisition.



6



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



Purchase price allocation



Under business combination accounting, the total purchase price was allocated to ONs tangible and identifiable intangible assets based
on their estimated fair values as of April 14, 2005 as set forth below. The excess of the purchase price over the tangible and identifiable intangible assets was recorded as goodwill. The purchase price allocation was as follows (in thousands):



|                                       |  |   |       
|-------------------------------------- |  | - | ------
|Property acquired at fair value        |  | $ | 480   
|Intangible assets-purchased technology |  |   | 5,750 
|Goodwill                               |  |   | 5,190 
|                                       |  |   |       
|Total purchase price                   |  | $ | 11,420
|                                       |  |   |       



Intangible assets



The intangible assets recognized, apart from goodwill, represented contractual or other
legal rights of the acquisition and those intangible assets of the acquisition that could be clearly identified. These intangible assets were identified and valued through interviews and analysis of data provided by ON concerning development
projects, their stage of development, the time and resources needed to complete them and, if applicable, their expected income generating ability. There were no other contractual or other legal rights of ON clearly identifiable by management, other
than those discussed below.



Purchased technology of approximately $5.8 million
consists of intellectual property related to the acquired technology as well as incremental value associated with existing customer relationships. At the date of acquisition, the developedSONET technology had reached technological feasibility.
Any development costs to be incurred in the future relating to the ongoing maintenance of the developed SONET technology will be expensed as incurred. To estimate the fair value of the developed SONET technology, an income approach was used, which
included an analysis of future cash flows and the risks associated with achieving such cash flows.



The purchased SONET technology is amortized to cost of revenues on a straight-line basis over its estimated lives of six years. Amortization expense for this intangible asset was $240,000 and $680,000 for the three
months and nine months ended December 31, 2005, while no amortization expense was recorded in the same periods a year ago. The balances of purchased technology and related amortization were as follows (in thousands):



|                              |  |              |       |   |      |   |  
|----------------------------- |  | ------------ | ----- | - | ---- | - | -
|                              |  | December 31,
|                              |  | 2005         |       |   | 2004
|Purchased technology          |  | $            | 5,750 |   |      | $ | 
|Less accumulated amortization |  |              | (680  | ) |      |   | 
|                              |  |              |       |   |      |   |  
|Purchased technology, net     |  | $            | 5,070 |   |      | $ | 
|                              |  |              |       |   |      |   |  



The aggregate estimated future annual
intangible amortization expense through fiscal year ending March 31, 2012, is as follows (in thousands):



7



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



|                                      |  |   |      
|------------------------------------- |  | - | -----
|Amortization Expense (by fiscal
year)
|2006                                  |  | $ | 238  
|2007                                  |  |   | 958  
|2008                                  |  |   | 958  
|2009                                  |  |   | 958  
|2010                                  |  |   | 958  
|Thereafter                            |  |   | 1,000
|                                      |  |   |      
|                                      |  | $ | 5,070
|                                      |  |   |      



Goodwill



Of the total purchase price, approximately $5.2 million was allocated to goodwill. Goodwill
represents the excess of the purchase price over the estimated fair value of the underlying net tangible and identifiable intangible assets acquired. The Company accounts for goodwill in accordance with Statement of Financial Accounting Standards
No. 142, Goodwill and Intangible Assets (SFAS 142). In accordance with SFAS 142, goodwill will not be amortized, but instead will be tested for impairment at least annually and more frequently if certain indicators are
present. As of December 31, 2005, the Company determined that no impairment existed.



Pro Forma Financial Information



The
unaudited financial information in the table below summarizes the combined results of operations of Exar and ON, on a pro forma basis, as though the operations had been combined as of the beginning of each of the periods presented. The pro forma
financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of each of the periods presented. The pro forma
financial information for periods presented includes the business combination accounting effect of adjustments to depreciation on acquired property, amortization charges from acquired intangible assets, adjustments to interest income for cash paid
to Infineon in connection with the ON acquisition, and related tax effects.



The unaudited pro forma financial information for the nine months ended December 31, 2005 combines the historical results of the Company for the nine months ended December 31, 2005 and the historical results for ON for the period
from April 1, 2005 to April 14, 2005. The unaudited pro forma financial information for the three and nine months ended December 31, 2004 combines the historical results of the Company with the historical results for ON for the three
and nine months ended December 31, 2004.



8



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



|                                              |  |                                |        |      |                               |        |      |  |      |        |  |   |        |  
|--------------------------------------------- |  | ------------------------------ | ------ | ---- | ----------------------------- | ------ | ---- |  | ---- | ------ |  | - | ------ | -
|                                              |  | Three Months EndedDecember 31, |        |      | Nine Months EndedDecember 31, |       
|(in thousands, except per share amounts)      |  | 2005                           |        | 2004 |                               |        | 2005 |  | 2004 |       
|Net sales                                     |  | $                              | 17,009 |      | $                             | 14,092 |      |  | $    | 49,506 |  | $ | 46,260 |  
|Net income (loss)                             |  | $                              | 1,109  |      | $                             | (1,522 | )    |  | $    | 4,650  |  | $ | (5,078 | )
|Basic and diluted net income (loss) per share |  | $                              | 0.03   |      | $                             | (0.04  | )    |  | $    | 0.12   |  | $ | (0.12  | )



NOTE 3. STOCK-BASED COMPENSATION



The Company accounts for stock-based employee compensation using the
intrinsic value method under the Financial Accounting Standards Board (FASB) Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB 25), and related interpretations, and
complies with the disclosure provisions of Statements of Financial Accounting Standards No. 123 and 148, (SFAS 123 and SFAS 148, respectively). SFAS 123 requires the disclosure of pro forma net income and earnings per
share. Under SFAS 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without
vesting restrictions, which significantly differ from the Companys stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the
calculated values. Because the Companys employee options have characteristics that are significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect the
Companys estimate of the fair value of those options, it is the Companys opinion that the existing valuation models, including Black-Scholes, are not reliable single measures and may misstate the fair value of the Companys employee
options.



The Companys calculations for its stock options were made using
the Black-Scholes Option-Pricing Model with the following weighted average assumptions for options granted:



|                                 |  |                                |   |  |      |  
|-------------------------------- |  | ------------------------------ | - |  | ---- | -
|                                 |  | Three Months EndedDecember 31, |  
|                                 |  | 2005                           |   |  | 2004 |  
|Risk-free interest rate          |  | 4.4                            | % |  | 3.5  | %
|Expected term of options (years) |  | 4.08                           |   |  | 4.50 |  
|Expected volatility              |  | 39.1                           | % |  | 64.3 | %
|Expected dividend yield          |  |                               |   |  |     |  



Under SFAS 123, pro forma compensation
cost is calculated for the fair market value of the shares under the Employee Stock Participation Plan (ESPP). The fair value of each stock purchase right granted under the ESPP is estimated using the Black-Scholes Option-Pricing Model
with the following weighted average assumptions:



|                                 |  |                                |   |  |      |  
|-------------------------------- |  | ------------------------------ | - |  | ---- | -
|                                 |  | Three Months EndedDecember 31, |  
|                                 |  | 2005                           |   |  | 2004 |  
|Risk-free interest rate          |  | 4.1                            | % |  | 2.2  | %
|Expected term of options (years) |  | 0.25                           |   |  | 0.25 |  
|Expected volatility              |  | 26.2                           | % |  | 27.8 | %
|Expected dividend yield          |  |                               |   |  |     |  



The Companys calculations are
based on a single option valuation approach and forfeitures are recognized as they occur. For purposes of pro forma disclosures, the estimated fair value of stock options is amortized over the options vesting periods.



9



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



The pro forma information for the three and nine months ended December 31, 2005 and 2004 is not indicative of
future period pro forma amounts (in thousands, except per share amounts):



|                                                                  |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|----------------------------------------------------------------- |  | ------------------------------ | ------ | - | ----------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                  |  | Three Months EndedDecember 31, |        |   | Nine Months EndedDecember 31, |  
|                                                                  |  | 2005                           |        |   | 2004                          |   |        | 2005 |  |   | 2004   |  
|Net income - as reported                                          |  | $                              | 1,109  |   |                               | $ | 834    |      |  | $ | 4,923  |   |  | $ | 4,006   |  
|Add: Stock-based employee compensation expense included           |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|in reported net income, net of tax                                |  |                                | 25     |   |                               |   |       |      |  |   | 76     |   |  |   |        |  
|Deduct : Total stock-based employee compensation determined under |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|the fair value basis, method for all awards, net of tax           |  |                                | (1,631 | ) |                               |   | (5,550 | )    |  |   | (6,505 | ) |  |   | (13,826 | )
|                                                                  |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Net loss - Pro forma                                              |  | $                              | (497   | ) |                               | $ | (4,716 | )    |  | $ | (1,506 | ) |  | $ | (9,820  | )
|                                                                  |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Reported:                                                         |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Earnings per share - Basic                                        |  | $                              | 0.03   |   |                               | $ | 0.02   |      |  | $ | 0.13   |   |  | $ | 0.10    |  
|Earnings per share - Diluted                                      |  |                                | 0.03   |   |                               |   | 0.02   |      |  |   | 0.12   |   |  |   | 0.09    |  
|Pro forma:                                                        |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Loss per share - Basic and Diluted                                |  | $                              | (0.01  | ) |                               | $ | (0.11  | )    |  | $ | (0.04  | ) |  | $ | (0.24   | )



NOTE 4. INVENTORIES



Inventories are recorded at the lower of cost or market, determined on a first-in,
first-out basis. Cost is computed using standard cost, which approximates average actual cost. The Company generally records provision for obsolete inventories and inventories in excess of six-month demand for each specific part.



Inventories consist of the following (in thousands):



|                |  |                  |       |               |   |      
|--------------- |  | ---------------- | ----- | ------------- | - | -----
|                |  | December 31,2005 |       | March 31,2005
|Work-in-process |  | $                | 3,510 |               | $ | 1,909
|Finished goods  |  |                  | 1,367 |               |   | 1,750
|                |  |                  |       |               |   |      
|Inventories     |  | $                | 4,877 |               | $ | 3,659
|                |  |                  |       |               |   |      



10



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



NOTE 5. PROPERTY, PLANT AND EQUIPMENT



Property, plant and equipment consists of the following (in thousands):



|                                          |  |                  |         |   |               |   |         |  
|----------------------------------------- |  | ---------------- | ------- | - | ------------- | - | ------- | -
|                                          |  | December 31,2005 |         |   | March 31,2005 |  
|Land                                      |  | $                | 6,660   |   |               | $ | 6,584   |  
|Building                                  |  |                  | 14,168  |   |               |   | 13,743  |  
|Machinery and equipment                   |  |                  | 53,103  |   |               |   | 48,369  |  
|Construction-in-progress                  |  |                  |        |   |               |   | 307     |  
|                                          |  |                  |         |   |               |   |         |  
|                                          |  |                  | 73,931  |   |               |   | 69,003  |  
|Accumulated depreciation and amortization |  |                  | (45,193 | ) |               |   | (41,686 | )
|                                          |  |                  |         |   |               |   |         |  
|Total                                     |  | $                | 28,738  |   |               | $ | 27,317  |  
|                                          |  |                  |         |   |               |   |         |  



NOTE 6. EARNINGS PER SHARE



Basic earnings per share (EPS) excludes dilution and is
computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted EPS reflects the potential dilution that would occur if outstanding options to purchase common stock were
exercised or converted into common stock.



A summary of the Companys
earnings per share for the three and nine months ended December 31, 2005 and 2004 is as follows (in thousands, except per share amounts):



|                                                                                                    |  |                               |        |                              |   |        |  |      |        |  |   |       
|--------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------ | ---------------------------- | - | ------ |  | ---- | ------ |  | - | ------
|                                                                                                    |  | Three Months EndedDecember 31 |        | Nine Months EndedDecember 31
|                                                                                                    |  | 2005                          |        | 2004                         |   | 2005   |  | 2004
|Net Income                                                                                          |  | $                             | 1,109  |                              | $ | 834    |  | $    | 4,923  |  | $ | 4,006 
|                                                                                                    |  |                               |        |                              |   |        |  |      |        |  |   |       
|Shares used in computation:                                                                         |  |                               |        |                              |   |        |  |      |        |  |   |       
|Weighted average shares of common stock outstanding used in computation of basic earnings per share |  |                               | 35,202 |                              |   | 41,639 |  |      | 39,045 |  |   | 41,433
|Dilutive effect of stock options                                                                    |  |                               | 145    |                              |   | 900    |  |      | 421    |  |   | 952   
|                                                                                                    |  |                               |        |                              |   |        |  |      |        |  |   |       
|Shares used in computation of diluted earnings per share                                            |  |                               | 35,347 |                              |   | 42,539 |  |      | 39,466 |  |   | 42,385
|                                                                                                    |  |                               |        |                              |   |        |  |      |        |  |   |       
|Earnings per share - Basic                                                                          |  | $                             | 0.03   |                              | $ | 0.02   |  | $    | 0.13   |  | $ | 0.10  
|                                                                                                    |  |                               |        |                              |   |        |  |      |        |  |   |       
|Earnings per share - Diluted                                                                        |  | $                             | 0.03   |                              | $ | 0.02   |  | $    | 0.12   |  | $ | 0.09  
|                                                                                                    |  |                               |        |                              |   |        |  |      |        |  |   |       



For the three months ended
December 31, 2005 and 2004, options to purchase 6,767,538 and 5,442,545 shares of common stock, respectively, at exercise prices ranging from $12.78 to $59.31 and $14.55 to $59.31 respectively, were outstanding but not included in the
computation of diluted earnings per share because the options exercise prices were greater than the average market price of the shares of common stock as of such dates and, therefore, would be anti-dilutive under the treasury stock method. For
the nine months ended December 31, 2005 and 2004, options to purchase 5,849,150 and 4,805,467 shares of common stock, respectively, at exercise prices ranging from $12.78 to $59.31 and $14.13 to $59.31, respectively, were outstanding but not
included in the computation of diluted net income per share because the options exercise prices were greater than the average market price of the common shares as of such dates and, therefore, would be anti-dilutive under the treasury stock
method.



NOTE 7. COMMON STOCK REPURCHASES



Since the inception of the Companys repurchase program announced in March of 2001, the
Company has repurchased a total of 767,110 shares of the Companys common stock for an aggregate cost of $11.9 million.



11



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



During the nine months ended December 31, 2005, the Company repurchased 270,000 shares for $3.6 million. The
Company has $28.1 million remaining under its current $40.0 million stock repurchase program.



In addition to the above, during the three months ended September 30, 2005, the Company completed its Modified Dutch Auction Self Tender Offer and repurchased 7,500,000 (including the Companys
authorized over-allotment) shares of its common stock at a purchase price of $16.00 per share, resulting in aggregate payments of $120.0 million plus costs of approximately $809,000.



NOTE 8. COMPREHENSIVE INCOME



Comprehensive income is as follows (in thousands):



|                                                             |  |                                |       |      |                               |      |      |  |      |       |  |   |       |  
|------------------------------------------------------------ |  | ------------------------------ | ----- | ---- | ----------------------------- | ---- | ---- |  | ---- | ----- |  | - | ----- | -
|                                                             |  | Three Months EndedDecember 31, |       |      | Nine Months EndedDecember 31, |     
|                                                             |  | 2005                           |       | 2004 |                               |      | 2005 |  | 2004 |      
|Net income                                                   |  | $                              | 1,109 |      | $                             | 834  |      |  | $    | 4,923 |  | $ | 4,006 |  
|                                                             |  |                                |       |      |                               |      |      |  |      |       |  |   |       |  
|Other comprehensive income:                                  |  |                                |       |      |                               |      |      |  |      |       |  |   |       |  
|Cumulative translation adjustments                           |  |                                | 46    |      |                               | 62   |      |  |      | 70    |  |   | 43    |  
|Unrealized gain (loss), on marketable securities, net of tax |  |                                | 112   |      |                               | (250 | )    |  |      | 455   |  |   | (822  | )
|                                                             |  |                                |       |      |                               |      |      |  |      |       |  |   |       |  
|Total other comprehensive income (loss)                      |  |                                | 158   |      |                               | (188 | )    |  |      | 525   |  |   | (779  | )
|                                                             |  |                                |       |      |                               |      |      |  |      |       |  |   |       |  
|Comprehensive income                                         |  | $                              | 1,267 |      | $                             | 646  |      |  | $    | 5,448 |  | $ | 3,227 |  
|                                                             |  |                                |       |      |                               |      |      |  |      |       |  |   |       |  



NOTE 9. LONG-TERM INVESTMENTS



Long-term investments are as follows (in thousands):



|                      |  |                  |       |               |   |      
|--------------------- |  | ---------------- | ----- | ------------- | - | -----
|                      |  | December 31,2005 |       | March 31,2005
|TechFarm Fund         |  | $                | 600   |               | $ | 1,815
|Skypoint Fund         |  |                  | 2,063 |               |   | 2,163
|                      |  |                  |       |               |   |      
|Long-term investments |  | $                | 2,663 |               | $ | 3,978
|                      |  |                  |       |               |   |      



TechFarm Ventures L.P.



Exar became a limited partner in TechFarm Ventures (Q), L.P. (the
TechFarm Fund) in May 2001. This partnership is a venture capital fund, managed by TechFarm Ventures Management L.L.C., the general partner of the TechFarm Fund, a Delaware limited partnership, and focuses its investment activities on
seed and early stage technology companies. Effective May 31, 2002, in connection with the amendment of the partnership agreement, the Company and TechFarm Ventures Management L.L.C. agreed to reduce the Companys capital commitment in the
TechFarm Fund to approximately $4.0 million, or approximately 5% of the TechFarm Funds total committed capital. Additionally, the Company and TechFarm Ventures Management L.L.C. agreed to change the Companys status from a limited partner
to that of an assignee having fewer rights and less status than a limited partner. Because of these modifications, the Company changed its method of accounting for this investment from the equity method to the cost basis method as of May 31,
2002. The Company has fulfilled its capital contribution commitment and, therefore, will not be required to fund additional amounts.



In December 2005, the Company assessed the value of certain discontinued companies and the remaining portfolio companies within the TechFarm Fund. The Company believed
that these changes permanently impaired the carrying value of its investment in the TechFarm Fund. As a result, Exar recorded an impairment charge against its earnings



12



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



of $1.2 million, thereby reducing its carrying value in the TechFarm Fund to $0.6 million. If the Companys assessed value of its investment were to
fall below the carrying value on the Companys Condensed Consolidated Balance Sheet, the Company would be required to recognize impairment to the asset, which would result in additional expense in the Companys Condensed Consolidated
Statements of Operations.



Skypoint Telecom Fund II



In July 2001, Exar became a limited partner in Skypoint Telecom Fund II (US), L.P. (the
Skypoint Fund), a venture capital fund focused on investments in communications infrastructure companies. The investment provides the Company with the opportunity to align itself with potential strategic partners in emerging technologies
within the telecommunications and/or networking industry. Exar is obligated to contribute $5.0 million, which represents approximately 5% of the Skypoint Funds total capital commitments. Of the $5.0 million obligation, Exar funded $2.7
million as of December 31, 2005 and is contractually obligated to contribute the remaining capital of $2.3 million as requested by the Skypoint Funds General Partner prior to June 18, 2007. During the nine months ended
December 31, 2005, the Company funded $0.5 million to the Skypoint Fund. In September 2005, the Company recorded a $0.6 million distribution from the venture capital fund related to a sale of a company within the funds portfolio. In
accordance with Financial Accounting Standards Boards (FASB), Accounting Principles Bulletin 18 (APB 18), The Equity Method of Accounting for Investments in Common Stock, the Company recorded the
distribution on the cost basis and reduced the carrying value of its investment in the Skypoint fund. The $2.1 million carrying value of the Skypoint Fund investment as of December 31, 2005 reflects contributions to date of $2.7 million less
the $0.6 million distribution.



NOTE 10. COMMITMENTS AND CONTINGENCIES



In 1986, Micro Power Systems Inc., one of the Companys subsidiaries
that the Company had acquired in June 1994, identified low-level groundwater contamination at its principal manufacturing site. Although the area and extent of the contamination appear to have been defined, the source of the contamination has not
been identified. The Company reached an agreement with another entity to participate in the cost of ongoing site investigations and the operation of remedial systems to remove subsurface chemicals, which is expected to continue for approximately
four to five more years from the three months ended December 31, 2005. The Company believes that its site closure costs pertaining to the capping of wells and removal of the filtering system will be immaterial. Management estimates that its
accrual of $244,000 included in the accrued liabilities as of December 31, 2005 is sufficient to cover the remaining four to five years of continued remediation activities and post-remediation site closure activities.



In July 2001, Exar became a limited partner in Skypoint Telecom Fund II (US), L.P. (the
Skypoint Fund), a venture capital fund focused on investments in communications infrastructure companies. The investment provides the Company with the opportunity to align itself with potential strategic partners in emerging technologies
within the telecommunications and/ or networking industry. Exar is obligated to contribute $5.0 million, which represents approximately 5% of the Skypoint Funds total capital commitments. Of the $5.0 million obligation, Exar has funded $2.7
million as of December 31, 2005 and is contractually obligated to contribute the remaining capital of $2.3 million as requested by the Skypoint Funds General Partner prior to June 18, 2007.



The Company warrants all of its products against defects in materials and workmanship for a
period of at least ninety days and up to one year from the delivery date. The Companys sole liability is limited to either replacing, repairing or issuing credit, at its option, for the product if it has been paid for. The warranty does not
cover damage which results from accident, misuse, abuse, improper line voltage, fire, flood, lightning or other damage resulting from modifications, repairs or alterations performed other than by the Company, or resulting from failure to comply with
the Companys written operating and maintenance instructions. Historically, the Companys warranty expense has been immaterial.



Additionally, the Companys sales agreements indemnify its customers for any direct expenses or liability resulting from alleged or claimed infringements of any
United States letter patents of third parties. However, the Company is not liable for any collateral, incidental or consequential damages arising out of patent infringement. The terms of these indemnification agreements are generally perpetual
commencing after execution of the agreement. The maximum amount of potential future indemnification is unlimited. However, to date, the Company has not paid any claims or been required to defend any lawsuits with respect to any such indemnity claim.



13



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



The Companys commitments are comprised of the following:



As of December 31, 2005(in thousands)



|                                 |  |             |       |      |   |       |  |      |     |      |   |            |  |       |    |  |   |    |  |   |      
|-------------------------------- |  | ----------- | ----- | ---- | - | ----- |  | ---- | --- | ---- | - | ---------- |  | ----- | -- |  | - | -- |  | - | -----
|                                 |  | Fiscal Year |       |      |   |      
|                                 |  | 2006        |       | 2007 |   | 2008  |  | 2009 |     | 2010 |   | Thereafter |  | Total
|Contractual Obligations          |  |             |       |      |   |       |  |      |     |      |   |            |  |       |    |  |   |    |  |   |      
|Purchase Obligations(1)          |  | $           | 3,640 |      | $ | 908   |  | $    | 560 |      | $ | 420        |  | $     |   |  | $ |   |  | $ | 5,528
|Long-term Investment Commitments |  |             |       |      |   |       |  |      |     |      |   |            |  |       |    |  |   |    |  |   |      
|(Skypoint Fund)(2)               |  |             | 2,317 |      |   |      |  |      |    |      |   |           |  |       |   |  |   |   |  |   | 2,317
|Remediation commitment(3)        |  |             | 13    |      |   | 53    |  |      | 53  |      |   | 53         |  |       | 53 |  |   | 19 |  |   | 244  
|Lease Obligations                |  |             | 31    |      |   | 40    |  |      | 19  |      |   | 19         |  |       | 5  |  |   |   |  |   | 114  
|                                 |  |             |       |      |   |       |  |      |     |      |   |            |  |       |    |  |   |    |  |   |      
|Total                            |  | $           | 6,001 |      | $ | 1,001 |  | $    | 632 |      | $ | 492        |  | $     | 58 |  | $ | 19 |  | $ | 8,203
|                                 |  |             |       |      |   |       |  |      |     |      |   |            |  |       |    |  |   |    |  |   |      

---

|(1) | The Company places purchase orders with wafer foundries and other vendors as part of its normal course of business. The Company expects to receive and pay for
wafers, capital equipment and various service contracts over the next 12 to 18 months from its existing cash balances.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The commitment related to the Skypoint Fund does not have a set payment schedule and thus will become payable upon the request from the Funds General
Partner through June 18, 2007.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | The commitment relates to the environmental clean-up at Micro Power Systems Inc.
|--- | --------------------------------------------------------------------------------



NOTE 11. LITIGATION



On November 16, 2004, Ericsson Wireless Communications, Inc. initiated a lawsuit against Exar Corporation in San Diego Superior Court. In its first and second
amended complaints, Ericsson asserts causes of action for negligence, strict product liability, and unfair competition against Exar. Through its complaint, Ericsson seeks unspecified monetary damages and unspecified injunctive relief. The case
is based on Ericssons purchase of allegedly defective products from Vicor Corporation, a former customer of Exar to whom Exar sold untested semi-custom wafers. Exar answered Ericssons Second Amended Complaint on March 21,
2005. The Court has set a trial date of September 29, 2006 and discovery is continuing. Exar disputes the allegations in Ericssons first and second amended complaints and intends to defend the lawsuit vigorously. At this
stage of the litigation and without additional information, Exar is unable to determine the probability that the claim asserted by Ericsson will result in liability. As of the date of this report, Exar does not believe that the litigation will
have a material impact on its financial condition, results of operations, or liquidity.



On April 15, 2005, Vicor filed a cross-complaint against Exar in San Diego Superior Court. In the cross-complaint, Vicor alleged, among other things, that Exar sold it integrated circuits that were defective, that failed to meet
agreed-upon specifications, and that Exar intentionally concealed material facts regarding the specifications of the integrated circuits that Vicor alleges it bought from Exar. In its cross-complaint, Vicor alleges that it is entitled to
indemnification from Exar for any damages that Vicor must pay to Ericsson as a result of the causes of action asserted by Ericsson against Vicor. Vicor asserted causes of action against Exar for breach of contract, breach of express contract
warranty, breach of implied warranties of merchantability and fitness, breach of the covenant of good faith and fair dealing, fraud, negligence, strict liability, implied contractual indemnity, and equitable indemnity. On May 9, 2005, Exar
filed a demurrer to all but one of the indemnity causes of action in Vicors Cross-Complaint. On June 17, 2005, the San Diego Superior Court sustained Exars demurrer to all of Vicors causes of action except the claims for
implied contractual indemnity and equitable indemnity without leave to amend. Exar answered the two remaining causes of action on July 5, 2005. Trial on the cross-complaint asserted by Vicor is scheduled for September 29, 2006. Exar
disputes the allegations in Vicors cross-complaint and intends to defend the lawsuit vigorously. At this stage of the litigation and without additional information, Exar is unable to determine the probability that the claim asserted by
Vicor will result in liability. As of the date of this report, Exar does not believe that the litigation will have a material impact on its financial condition, results of operations, or liquidity.



14



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



On March 4, 2005, Exar filed a complaint in Santa Clara Superior Court against Vicor. In the complaint,
Exar sought a declaration regarding the respective rights and obligations, including warranty and indemnity rights and obligations, under the written contracts between Exar and Vicor for the sale of untested, semi-custom wafers. In addition,
Exar sought a declaration that it was not responsible for any damages that Vicor must pay to Ericsson or any other customer of Vicor arising from claims that Vicor sold allegedly defective products.



On March 17, 2005, Vicor filed a cross-complaint against Exar and Rohm Device USA, LLC
and Rohm Co., Ltd, the owners and operators of the foundry which supplied the untested, semi-custom wafers that Exar sold to Vicor. In the cross-complaint, Vicor alleged, among other things, that Exar sold it integrated circuits that were
defective, that failed to meet agreed-upon specifications, and that Exar intentionally concealed material facts regarding the specifications of the integrated circuits that Vicor alleges it bought from Exar. In its cross-complaint, Vicor also
alleges that it is entitled to indemnification from Exar for any damages that Vicor must pay to Ericsson and other Vicor customers as a result of the causes of action asserted by Ericsson in the San Diego case discussed above and any other claims
that may be made against Vicor. In the cross-complaint, Vicor asserted causes of action against Exar for breach of contract, breach of express contract warranty, breach of implied warranties of merchantability and fitness, breach of covenant of
good faith and fair dealing, fraud, negligence, strict liability, implied contractual indemnity, and equitable indemnity. On May 23, 2005, Exar filed a demurrer to each cause of action in Vicors cross-complaint in Santa Clara
County. On July 15, 2005, the Santa Clara Superior Court sustained Exars demurrer to each of the causes of action asserted by Vicor. The Court granted Vicor leave to amend the cross-complaint to assert a cause of action for
declaratory relief only. On August 1, 2005, Vicor filed its amended cross-complaint seeking a declaration of the parties respective rights and obligations, including warranty and indemnity rights, under the alleged contracts between Exar and
Vicor for the sale of untested, semi-custom wafers. In addition, Vicor sought a declaration that Exar was obligated to indemnify it for any damages resulting from claims brought against Vicor by its customers. No trial date has been set in the
matter. Exar disputes the allegations in Vicors cross-complaint and intends to defend the lawsuit vigorously. At this stage of the litigation and without additional information, Exar is unable to determine the probability that the
claim asserted by Vicor will result in liability. As of the date of this report, Exar does not believe that the litigation will have a material impact on its financial condition, results of operations, or liquidity.



NOTE 12. INDUSTRY AND SEGMENT INFORMATION



The Company operates in one reportable segment and is engaged in the design, development and
marketing of a variety of analog and mixed-signal application-specific integrated circuits for use in communications, industrial and video and imaging applications. The nature of the Companys products and production processes as well as type
of customers and distribution channels is consistent among all of the Companys products. Revenue by product line for the three and nine months ended December 31, 2005 and 2004, respectively, are as follows (in thousands):



|                         |  |                               |        |                              |   |        |  |      |        |  |   |       
|------------------------ |  | ----------------------------- | ------ | ---------------------------- | - | ------ |  | ---- | ------ |  | - | ------
|                         |  | Three Months EndedDecember 31 |        | Nine Months EndedDecember 31
|                         |  | 2005                          |        | 2004                         |   | 2005   |  | 2004
|Net sales:               |  |                               |        |                              |   |        |  |      |        |  |   |       
|Communications           |  | $                             | 16,291 |                              | $ | 12,013 |  | $    | 47,146 |  | $ | 39,798
|Video, Imaging and Other |  |                               | 718    |                              |   | 1,232  |  |      | 2,303  |  |   | 3,915 
|                         |  |                               |        |                              |   |        |  |      |        |  |   |       
|Total                    |  | $                             | 17,009 |                              | $ | 13,245 |  | $    | 49,449 |  | $ | 43,713
|                         |  |                               |        |                              |   |        |  |      |        |  |   |       



The following table shows revenue by
geographic area for the three and nine months ended December 31, 2005 and 2004 (in thousands):



15



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



|                        |  |                                |        |                               |   |        |  |      |        |  |   |       
|----------------------- |  | ------------------------------ | ------ | ----------------------------- | - | ------ |  | ---- | ------ |  | - | ------
|                        |  | Three Months EndedDecember 31, |        | Nine Months EndedDecember 31,
|                        |  | 2005                           |        | 2004                          |   | 2005   |  | 2004
|Net sales:              |  |                                |        |                               |   |        |  |      |        |  |   |       
|United States           |  | $                              | 8,343  |                               | $ | 6,472  |  | $    | 24,389 |  | $ | 20,670
|China                   |  |                                | 2,158  |                               |   | 1,432  |  |      | 6,573  |  |   | 5,573 
|Asia (excludes China)   |  |                                | 2,472  |                               |   | 3,090  |  |      | 7,173  |  |   | 8,939 
|Italy                   |  |                                | 2,173  |                               |   | 879    |  |      | 6,287  |  |   | 2,841 
|Europe (excludes Italy) |  |                                | 1,828  |                               |   | 1,248  |  |      | 4,695  |  |   | 5,191 
|Rest of the World       |  |                                | 35     |                               |   | 124    |  |      | 332    |  |   | 499   
|                        |  |                                |        |                               |   |        |  |      |        |  |   |       
|Total                   |  | $                              | 17,009 |                               | $ | 13,245 |  | $    | 49,449 |  | $ | 43,713
|                        |  |                                |        |                               |   |        |  |      |        |  |   |       



For the three and nine months ended
December 31, 2005, Alcatel represented 11% and 12%, respectively, of the Companys net sales. For the three and nine months ended December 31, 2004, no one OEM customer accounted for 10% or greater of the Companys net sales.



Substantially all of the Companys long-lived assets at December 31,
2005 and 2004 were located in the United States.



NOTE 13. INCOME TAXES



The Company computes income taxes for interim reporting purposes using
estimates of the effective annual income tax rate for the entire fiscal year. During the third quarter of fiscal 2006, the Company revised its estimated income tax rate for fiscal year 2006 to 27% from the 25% rate used in the second
quarter of fiscal 2006 due to changes in estimated R&D credit benefits and state taxes.



As a result of discrete tax events during the third quarter, the Company is recording a quarterly effective tax rate of 39%. This is higher than the Companys core tax rate, since the Company did not
recognize a tax benefit for the $1.2 million asset impairment charge for TechFarm Ventures, recorded in the third quarter of fiscal 2006, due to the uncertainty surrounding whether the Company will have future capital gains to offset this capital
loss. This additional expense was partially offset by tax benefits claimed on tax filings during the third quarter and other tax refunds.



NOTE 14. RECENTLY ISSUED ACCOUNTING STANDARDS



In December 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123 (revised 2004), Share-Based Payment (SFAS
123R). This statement replaces SFAS 123, Accounting for Stock-Based Compensation and supersedes Accounting Principles Boards Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. SFAS
123R will require the Company to measure the cost of the Companys employee stock-based compensation awards granted after the effective date based on the grant date fair value of those awards and to record that cost as compensation expense over
the period, during which the employee is required to perform services in exchange for the award (generally over the vesting period of the award). SFAS 123R addresses all forms of share-based payments awards, including shares issued under employee
stock purchase plans, stock options, restricted stock and stock appreciation rights. In addition, the Company will be required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards
that remain outstanding at the date of adoption. SFAS 123R is effective for annual fiscal periods beginning after June 15, 2005. The Company, therefore, is required to implement the standard as of April 1, 2006. In addition, the SEC issued
Staff Accounting Bulletin No. 107, or SAB 107 in March 2005. SAB 107 includes interpretive guidance for the initial implementation of SFAS 123R.



As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using the intrinsic value method prescribed by APB 25 and, as such,
generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123R will have a significant impact on the Companys result of



16



---

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (continued)

(Unaudited)



operations, although it will have no negative impact on cash flow. However, the actual result of the adoption of SFAS 123R cannot be determined at this time
because it will depend on levels of share-based payments granted in the future.



In June 2005, the FASB decided not to provide additional guidance on the meaning of other-than-temporary impairment, and directed the staff to issue proposed FSP EITF 03-1-a, Implementation Guidance for the Application of Paragraph 16 of
EITF Issue No. 03-1, as final. The final FSP will supersede EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, and EITF Topic No. D-44, Recognition of Other-Than-Temporary
Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value. The final FSP (retitled FSP FAS No. 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments ) will replace the guidance set
forth in paragraphs 10-18 of EITF No. 03-1 with references to existing other-than-temporary impairment guidance, such as SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, SEC SAB No. 59, Accounting for
Noncurrent Marketable Equity Securities, and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. FSP FAS No. 115-1 will codify the guidance set forth in EITF Topic D-44 and clarify that an investor
should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. FSP FAS No. 115-1 will be effective April 1, 2006 for other-than-temporary impairment
analysis conducted by the Company. The Company does not believe the adoption of FSP FAS No. 115-1 will have a significant impact on its consolidated results of operations or financial position.



In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151,
Inventory Costs, an amendment to ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials
(spoilage) should be recognized as current period charges. In addition, SFAS 151 requires that the allocation of fixed production overheads to the cost of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective
for inventory costs incurred for fiscal years beginning after June 15, 2005. Therefore, the Company is required to adopt the standard effective April 1, 2006. The Company is currently assessing the impact but does not expect the adoption
of SFAS 151 to have a significant impact on its financial condition or results of operations.



In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS 154). SFAS No. 154 replaces APB Opinion No. 20, Accounting Changes and SFAS No. 3,
Reporting Accounting Changes in Interim Financial Statements. SFAS 154 requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. The Company does not expect the adoption of SFAS 154 to have a material impact on our consolidated financial statements.



17



---

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



The following Managements Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained in Risk Factors
below and elsewhere in this Report, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are not
guarantees of future performance and involve risks and uncertainties. These forward-looking statements apply only as of the date of this Quarterly Report (Report). The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future events or otherwise. Actual results may differ materially from those projected in the forward-looking statements as a result of various factors. These risks, uncertainties
and other factors include, among others, those identified under Risk Factors. Forward-looking statements are generally written in the future tense and/or are preceded by words such as will, may,
should, could, expect, suggest, believe, anticipate, intend, plan, continue, estimate, seek, or other similar words.
Forward-looking statements contained in this Quarterly Report include, among others, statements made in Financial Outlook for Fiscal Year 2006 and elsewhere regarding (1) market trends and the Companys belief that it should be
able to grow its revenue in line with end demand, (2) the Companys anticipation that revenue for the fourth quarter of fiscal year 2006 will be similar to that reported for the third quarter of fiscal year 2006, (3) the
Companys belief that broadband connectivity will grow and that carriers will increase their capital spending in both wire-line and wireless areas, (4) the Companys belief that the contribution of the SONET product acquired in the ON
acquisition will be accretive to earnings in fiscal 2006, (5) the Companys net sales, (6) the Companys gross profits, (7) industry spending and general economic conditions and their effect on the Companys operating
results, (8) the Companys research and development efforts and expenses, (9) the Companys interest income, (10) the Companys utilization of the its stock repurchase program, (11) competitive pressures,
(12) the Companys anticipation that it will continue to finance its operations with cash flows from operations, existing cash balances and the sale of short-term marketable securities, (13) the Companys belief that its cash and
cash equivalents, short-term marketable securities and cash flows from operations will be sufficient to satisfy working capital requirements, capital equipment acquisitions and share repurchase needs for at least the next 12 months (14) the
Companys selling, general and administrative expenses, (15) the impact of litigation on the Companys financial condition, results of operations and liquidity, (16) the possibility of future acquisitions and investments,
(17) the Companys expectation that the communications sector will grow over the long-term and (18) the Companys belief that international sales will likely continue to account for a significant portion of the Companys
revenues.



Overview



Exar Corporation and subsidiaries (Exar or the Company) designs,
develops and markets high-performance, high-bandwidth physical interface and access control solutions for use in the worldwide communications infrastructure. The Companys current IC products for the communications market are designed to
respond to the demand for cost effective line card solutions based on transmission standards such as T/E carrier, ATM and SONET/SDH. Also, the Company designs, develops, and markets IC products that address the needs of the serial communications
market and offers a family of clock and timing devices. In addition, the Company designs, develops and markets IC products that address select applications for the video and imaging markets. Exar uses its design methodologies to develop products
ranging from application specific standard products (ASSPs), designed for industry-wide applications, to custom solutions for specific customer applications.



In order to augment and complement the Companys SONET product offerings and strengthen its position at two OEM customers, on
April 14, 2005, the Company acquired from Infineon Technologies North America Corp. (Infineon) a significant part of Infineons Optical Networking (ON) Business Unit, including assets relating to the multi-rate TDM
framer products, Fiber Channel over SONET/SDH, and Resilient Packet Ring (RPR), as well as certain intellectual property for Data over SONET products.



These complementary products enable the Company to offer a range of solutions for its customers applications. Exar believes its
products offer its customers the following benefits:



| |  | increased bandwidth through the integration of multiple channels on a single device;
|- |  | ------------------------------------------------------------------------------------



| |  | reduced system power, board space and noise/jitter to improve data integrity;
|- |  | -----------------------------------------------------------------------------



18



---

| |  | seamless integration;
|- |  | ---------------------



| |  | reduced overall system cost through the integration of multiple functions on a single device; and
|- |  | -------------------------------------------------------------------------------------------------



| |  | accelerated time-to-market by allowing its customers to focus on their core competencies and outsource standards-based solutions.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------



The Companys OEM customers include, among others, Adtran Inc. (Adtran),
Alcatel, Cisco Systems Inc. (Cisco), Digi International, Inc. (Digi International), Fujitsu Limited (Fujitsu), Hewlett-Packard Company (Hewlett-Packard), Huawei Technologies Company, LTD.
(Huawei), ITT Industries, Inc. (ITT), Lucent Technologies, Inc. (Lucent), Marconi Corporation Plc (Marconi), Mitsubishi Electronic Corporation of Japan (Mitsubishi Electronics), NEC
Corporation (NEC), Nokia Corporation (Nokia), Plantronics, Inc. (Plantronics), Siemens A.G. (Siemens), and Tellabs, Inc. (Tellabs). For the three and nine months ended December 31,
2005, Alcatel represented 11% and 12%, respectively, of net sales. For the three and nine months ended December 31, 2004, no one OEM customer accounted for 10% or greater of the Companys net sales.



The Company markets its products in North and South America through independent sales
representatives and independent, non-exclusive distributors, as well as the Companys own direct sales organization. Additionally, the Company is represented in Europe and the Asia/Pacific region by its wholly-owned foreign subsidiaries,
independent sales representatives and independent, non-exclusive distributors.



The Companys international sales represented 50.9% and 50.7%, of net sales for the three and nine months ended December 31, 2005, respectively, as compared to 51.1% and 52.7% for the same periods a year ago. These international
sales consist primarily of export sales from the United States that are denominated in United States dollars. Foreign subsidiaries expenses associated with such sales expose the Company to fluctuations in currency exchange rates because the
Companys foreign subsidiaries expenses are denominated in local currency while its sales are denominated in United States dollars. Although international sales within certain countries or international sales comprised of certain products
may subject the Company to tariffs, the Companys profit margin on international sales of ICs, adjusted for differences in product mix, is not significantly different from that realized on the Companys sales to domestic customers. The
Companys operating results are subject to quarterly and annual fluctuations as a result of several factors that could materially and adversely affect the Companys future profitability, as described below in Risk
Factors.



Financial Outlook for Fiscal Year 2006



The Company believes that near term market trends are consistent with gradual improvement
in end demand and inventories at OEM customers and distributors appear to be in balance. Therefore, the Company believes that it should be able to grow its revenue in line with end demand. The Companys revenue growth over fiscal year 2005 has
been driven by sales of acquired SONET products and increased sales from its network and transmission and serial communications products. The Company believes the contribution of the SONET product acquired in the ON transaction will be accretive to
earnings in fiscal year 2006.



Alcatel is a significant customer; therefore
fluctuations in demand for its product could cause volatility in the Companys revenue. In addition, the Company completed final shipments of an older custom product line during the third quarter of fiscal year 2006. The Company anticipates
that revenue for the fourth quarter of fiscal year 2006 will be similar to that reported for the third quarter of fiscal year 2006.



In the near term, while booking trends support growth in revenue, the Company continues to operate in an environment of limited visibility and customers continue to place
orders with short manufacturing lead-times, thereby resulting in a high percentage of orders being placed and shipped in the same quarter. Looking forward to the medium to long term, the Company believes that broadband connectivity will grow and
that carriers will increase their capital spending in both wire-line and wireless areas.



The Companys net sales expectations are subject to change as customer demand and related customer component inventory levels change and the Companys future results of operations and financial condition may
be negatively impacted by such factors among others.



19



---

Critical Accounting Policies and Use of Estimates



The Companys financial statements and accompanying disclosures, which are prepared in conformity with the accounting principles
generally accepted in the United States, require that management use estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosures. Estimates and assumptions are reviewed
periodically, and the effects of revisions are reflected in the Condensed Consolidated Financial Statements in the period for which they are determined to be necessary. Management believes that the Company consistently applies these judgments and
estimates, and such consistent application fairly represents the Companys Condensed Consolidated Financial Statements and accompanying Notes for all periods presented.



Exars most critical accounting policies relate to: (1) net sales including allowance for distributor volume discounts and
distributor stock rotations; (2) provision for excess and obsolete inventories; (3) income taxes; and (4) investments in non-marketable equity securities. Should any of the estimates and judgments used in applying the Companys
accounting policies differ from actual results, the Companys Condensed Consolidated Financial Statements could be negatively impacted. A further discussion can be found in Item 7, Managements Discussion and Analysis of
Financial Condition and Results of Operations, of the Companys Annual Report on Form 10-K for the fiscal year ended March 31, 2005.



Results of Operations



For the periods indicated, the following table shows certain cost, expense and other income items as a percentage of net sales. The table and subsequent discussion should be read in conjunction with the Condensed
Consolidated Financial Statements and accompanying Notes thereto.



|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  
|------------------------------------------- |  | ------------------------------ | - |  | ----------------------------- | - |  | ---- | - |  | ---- | -
|                                            |  | Three Months EndedDecember 31, |   |  | Nine Months EndedDecember 31, |  
|                                            |  | 2005                           |   |  | 2004                          |   |  | 2005 |   |  | 2004 |  
|Net sales                                   |  | 100                            | % |  | 100                           | % |  | 100  | % |  | 100  | %
|Cost of sales:                              |  |                                |   |  |                               |   |  |      |   |  |      |  
|Product cost of sales                       |  | 31.1                           |   |  | 33.5                          |   |  | 31.6 |   |  | 32.5 |  
|Amortization of purchased intangible assets |  | 1.4                            |   |  |                              |   |  | 1.4  |   |  |     |  
|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  
|Total cost of sales                         |  | 32.5                           |   |  | 33.5                          |   |  | 33.0 |   |  | 32.5 |  
|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  
|Gross profit                                |  | 67.5                           |   |  | 66.5                          |   |  | 67.0 |   |  | 67.5 |  
|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  
|Operating expenses:                         |  |                                |   |  |                               |   |  |      |   |  |      |  
|Research and development                    |  | 36.3                           |   |  | 40.0                          |   |  | 37.3 |   |  | 37.4 |  
|Selling, general and administrative         |  | 30.5                           |   |  | 37.5                          |   |  | 32.0 |   |  | 35.5 |  
|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  
|Total operating expenses                    |  | 66.8                           |   |  | 77.5                          |   |  | 69.3 |   |  | 72.9 |  
|Gain on legal settlement                    |  |                               |   |  |                              |   |  |     |   |  | 2.8  |  
|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  
|Income (loss) from operations               |  | 0.7                            |   |  | (11.0                         | ) |  | (2.3 | ) |  | (2.6 | )
|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  
|Interest income and other, net              |  |                                |   |  |                               |   |  |      |   |  |      |  
|Interest income and other, net              |  | 17.0                           |   |  | 17.3                          |   |  | 18.5 |   |  | 13.3 |  
|Other than temporary loss on                |  | (7.1                           | ) |  |                              |   |  | (2.4 | ) |  |     |  
|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  
|Total other income, net                     |  | 9.9                            |   |  | 17.3                          |   |  | 16.1 |   |  | 13.3 |  
|Income before income taxes                  |  | 10.6                           |   |  | 6.3                           |   |  | 13.8 |   |  | 10.7 |  
|Provision for income taxes                  |  | 4.1                            |   |  |                              |   |  | 3.8  |   |  | 1.5  |  
|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  
|Net income                                  |  | 6.5                            | % |  | 6.3                           | % |  | 10.0 | % |  | 9.2  | %
|                                            |  |                                |   |  |                               |   |  |      |   |  |      |  



Net Sales



Net sales are comprised of product deliveries principally to OEMs or their contract
manufacturers and non-exclusive distributors. The Company recognizes revenue from product sales upon shipment and transfer of title, in accordance with shipping terms specified in the arrangement with the customer. The Company has agreements with
its non-exclusive domestic distributors that provide for estimated returns and allowances to these distributors. The Company records a reserve for sales returns and allowances at the time of shipment based upon historical patterns of returns and
other concessions.



20



---

The following table shows product line net sales in absolute dollars and as a percentage of net sales for the periods
indicated (in thousands).



|                         |  |                    |        |   |          |   |        |                   |  |   |          |   |  |      |        |   |         |   |        |   |  |   |        |  
|------------------------ |  | ------------------ | ------ | - | -------- | - | ------ | ----------------- |  | - | -------- | - |  | ---- | ------ | - | ------- | - | ------ | - |  | - | ------ | -
|                         |  | Three Months Ended |        |   |          |   |        | Nine Months Ended |  |   |          |  
|                         |  | December 31        |        |   | Variance |   |        | December 31       |  |   | Variance |  
|                         |  | 2005               |        |   | 2004     |   |        | Dollars           |  |   | 2005     |   |  | 2004 |        |   | Dollars |  
|Net sales:               |  |                    |        |   |          |   |        |                   |  |   |          |   |  |      |        |   |         |   |        |   |  |   |        |  
|Communications           |  | $                  | 16,291 |   |          | $ | 12,013 |                   |  | $ | 4,278    |   |  | $    | 47,146 |   |         | $ | 39,798 |   |  | $ | 7,348  |  
|Percentage of Net Sales  |  |                    | 95.8   | % |          |   | 90.7   | %                 |  |   |          |   |  |      | 95.3   | % |         |   | 91.0   | % |  |   |        |  
|Video, Imaging and Other |  | $                  | 718    |   |          | $ | 1,232  |                   |  | $ | (514     | ) |  | $    | 2,303  |   |         | $ | 3,915  |   |  | $ | (1,612 | )
|Percentage of Net Sales  |  |                    | 4.2    | % |          |   | 9.3    | %                 |  |   |          |   |  |      | 4.7    | % |         |   | 9.0    | % |  |   |        |  
|                         |  |                    |        |   |          |   |        |                   |  |   |          |   |  |      |        |   |         |   |        |   |  |   |        |  
|Total                    |  | $                  | 17,009 |   |          | $ | 13,245 |                   |  | $ | 3,764    |   |  | $    | 49,449 |   |         | $ | 43,713 |   |  | $ | 5,736  |  
|                         |  |                    |        |   |          |   |        |                   |  |   |          |   |  |      |        |   |         |   |        |   |  |   |        |  



Sales by Product Line



Communications



Communications net sales for the three and nine months ended December 31, 2005
increased 35.6% and 18.5%, respectively, compared to the same periods a year ago.



Net sales in the network and transmission market for the three months and nine months ended December 31, 2005 increased by $2.7 million, or 72.3%, and $5.0 million, or 39.4%, respectively, compared to the same periods a year ago. The
increase resulted from sales of SONET product acquired in the ON transaction and increased sales volumes in T/E products partially offset by price erosion on a limited number of T/E and SONET products.



Net sales in the serial communications market for the three and nine months ended
December 31, 2005 increased by $1.6 million, or 19.6%, and $2.3 million, or 8.7%, respectively, compared to the same periods a year ago. The increase resulted from increased sales volume of UART products and shipments of discontinued legacy
products partially offset by price erosion on a limited number of UART products.



Video, Imaging and Other



The decline in video, imaging and
other products sales during the three and nine months ended December 31, 2005, reflects reduced shipments to Hewlett-Packard and the completion of a customers older program.



For the three and nine months ended December 31, 2005, Alcatel represented 11% and 12%, respectively, of the Companys net sales.
For the three and nine months ended December 31, 2004, no one OEM customer accounted for 10% or greater of the Companys net sales.



21



---

Sales by Channel and Geography



The following table shows net sales by channel in absolute dollars and as a percentage of net sales for the periods indicated (in
thousands):



|                        |  |                    |        |   |          |   |                   |         |  |          |       |  |      |        |   |         |   |        |   |  |   |      
|----------------------- |  | ------------------ | ------ | - | -------- | - | ----------------- | ------- |  | -------- | ----- |  | ---- | ------ | - | ------- | - | ------ | - |  | - | -----
|                        |  | Three Months Ended |        |   |          |   | Nine Months Ended |         |  |         
|                        |  | December 31,       |        |   | Variance |   | December 31,      |         |  | Variance
|                        |  | 2005               |        |   | 2004     |   |                   | Dollars |  | 2005     |       |  | 2004 |        |   | Dollars
|Distributor             |  | $                  | 6,191  |   |          | $ | 4,540             |         |  | $        | 1,651 |  | $    | 19,675 |   |         | $ | 15,123 |   |  | $ | 4,552
|Percentage of Net Sales |  |                    | 36.4   | % |          |   | 34.3              | %       |  |          |       |  |      | 39.8   | % |         |   | 34.6   | % |  |   |      
|OEM                     |  | $                  | 10,818 |   |          | $ | 8,705             |         |  | $        | 2,113 |  | $    | 29,774 |   |         | $ | 28,590 |   |  | $ | 1,184
|Percentage of Net Sales |  |                    | 63.6   | % |          |   | 65.7              | %       |  |          |       |  |      | 60.2   | % |         |   | 65.4   | % |  |   |      



Net sales to the Companys
primary distributors, Future Electronics (Future) and Nu Horizons Electronics Corp. (Nu Horizons) for the three and nine months ended December 31, 2005, increased 36.4% and 30.1%, respectively, compared to the same
periods a year ago. The increases resulted from increased sales volume to a number of communications customers.



Net sales to OEMs and their subcontract manufacturers for the three and nine months ended December 31, 2005 increased 24.3% and 4.1%, respectively, compared to the
same periods a year ago. The increases were due to sales of the SONET product acquired in the ON transaction partially offset by a decline in sales volume of UART and video, imaging and other products and by price erosion on a limited number of UART
and T/E products.



The following table shows net sales by geography in absolute
dollars and as a percentage of net sales for the periods indicated (in thousands):



|                        |  |                                |       |   |          |   |                               |         |  |          |       |  |      |        |   |         |   |        |   |  |   |      
|----------------------- |  | ------------------------------ | ----- | - | -------- | - | ----------------------------- | ------- |  | -------- | ----- |  | ---- | ------ | - | ------- | - | ------ | - |  | - | -----
|                        |  | Three Months EndedDecember 31, |       |   | Variance |   | Nine Months EndedDecember 31, |         |  | Variance
|                        |  | 2005                           |       |   | 2004     |   |                               | Dollars |  | 2005     |       |  | 2004 |        |   | Dollars
|United States           |  | $                              | 8,343 |   |          | $ | 6,472                         |         |  | $        | 1,871 |  | $    | 24,389 |   |         | $ | 20,670 |   |  | $ | 3,719
|Percentage of Net Sales |  |                                | 49.1  | % |          |   | 48.9                          | %       |  |          |       |  |      | 49.3   | % |         |   | 47.3   | % |  |   |      
|International           |  | $                              | 8,666 |   |          | $ | 6,773                         |         |  | $        | 1,893 |  | $    | 25,060 |   |         | $ | 23,043 |   |  | $ | 2,017
|Percentage of Net Sales |  |                                | 50.9  | % |          |   | 51.1                          | %       |  |          |       |  |      | 50.7   | % |         |   | 52.7   | % |  |   |      



The growth in United States net sales
was attributable to the net sales growth in the distribution channel noted above. The growth in international net sales resulted from sales of the SONET product acquired in the ON transaction partially offset by decreased sales of video, imaging and
other products.



Gross Profit



The following table shows gross profit in absolute dollars and as a percentage of net sales
for the periods indicated (in thousands):



|                        |  |                                |        |   |          |   |                               |         |  |          |       |  |      |        |   |         |   |        |   |  |   |      
|----------------------- |  | ------------------------------ | ------ | - | -------- | - | ----------------------------- | ------- |  | -------- | ----- |  | ---- | ------ | - | ------- | - | ------ | - |  | - | -----
|                        |  | Three Months EndedDecember 31, |        |   | Variance |   | Nine Months EndedDecember 31, |         |  | Variance
|                        |  | 2005                           |        |   | 2004     |   |                               | Dollars |  | 2005     |       |  | 2004 |        |   | Dollars
|Gross Profit            |  | $                              | 11,489 |   |          | $ | 8,804                         |         |  | $        | 2,685 |  | $    | 33,135 |   |         | $ | 29,494 |   |  | $ | 3,641
|Percentage of Net Sales |  |                                | 67.5   | % |          |   | 66.5                          | %       |  |          |       |  |      | 67.0   | % |         |   | 67.5   | % |  |   |      



Gross profit represents net sales less
cost of sales. Cost of sales includes:



| |  | the cost of purchasing the finished silicon wafers manufactured by independent foundries;
|- |  | -----------------------------------------------------------------------------------------



| |  | costs associated with assembly, packaging, testing, quality assurance and product yields;
|- |  | -----------------------------------------------------------------------------------------



| |  | the cost of personnel and equipment associated with manufacturing support and manufacturing engineering;
|- |  | --------------------------------------------------------------------------------------------------------



22



---

| |  | the amortization of purchased intangible assets in connection with the ON acquisition; and
|- |  | ------------------------------------------------------------------------------------------



| |  | provisions for excess and obsolete inventory.
|- |  | ---------------------------------------------



The increase in gross profit as a percentage of net sales for the three months ended December 31, 2005 as compared to the same period a year ago was primarily due to
increased sales volume and the associated improvement in manufacturing efficiencies partially offset by the amortization of purchased intangible assets associated with the ON acquisition. The decrease in gross profit as a percentage of net sales for
nine months ended December 31, 2005 as compared to the same period a year ago was primarily due to the amortization of purchased intangible assets and the sales of the acquired SONET product which is sold at a lower gross margin than other
communications products. This decrease was partially offset by the continued product mix shift from lower margin video, imaging and other products to higher margin communications products and a reduced provision for excess and obsolete inventory.



The future amortization of purchased intangible assets associated with the ON
acquisition of $0.24 million per quarter will continue to affect gross profit through fiscal year 2012. The Company anticipates that gross profit will continue to fluctuate as a percentage of net sales due to future fluctuations in net sales,
fluctuations in manufacturing costs, competitive pricing, increased testing costs associated with the SONET product acquired in the ON transaction, changes in product mix, future amortization of any additional licensed technology and other factors.



Research and Development (R&D)



The following table shows research and development expenses in absolute dollars and as a
percentage of net sales for the periods indicated (in thousands):



|                               |  |                                |       |   |          |   |                               |         |  |          |     |  |      |        |   |         |   |        |   |  |   |      
|------------------------------ |  | ------------------------------ | ----- | - | -------- | - | ----------------------------- | ------- |  | -------- | --- |  | ---- | ------ | - | ------- | - | ------ | - |  | - | -----
|                               |  | Three Months EndedDecember 31, |       |   | Variance |   | Nine Months EndedDecember 31, |         |  | Variance
|                               |  | 2005                           |       |   | 2004     |   |                               | Dollars |  | 2005     |     |  | 2004 |        |   | Dollars
|Total Research and Development |  | $                              | 6,178 |   |          | $ | 5,304                         |         |  | $        | 874 |  | $    | 18,432 |   |         | $ | 16,334 |   |  | $ | 2,098
|Percentage of Net Sales        |  |                                | 36.3  | % |          |   | 40.0                          | %       |  |          |     |  |      | 37.3   | % |         |   | 37.4   | % |  |   |      



Research and development expenses
consist primarily of:



| |  | the salaries and related expenses of engineering employees engaged in product research, design and development activities;
|- |  | --------------------------------------------------------------------------------------------------------------------------



| |  | costs related to design tools, license expenses related to intellectual property, mask costs, supplies and services, and use of in-house test equipment and
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | facility expenses.
|- |  | ------------------



The increase in R&D expenses for the three and nine months ended December 31, 2005 as compared to the same periods a year ago, resulted from increases in labor-related expense associated with the ON
acquisition of approximately $0.3 million and $0.9 million, respectively, mask tooling costs, and increased depreciation and maintenance associated with purchases of new engineering design software and lab equipment and legal fees associated with
patent applications.



The Company believes that technological innovation is
critical to its long-term success, and it intends to continue to invest in R&D to enhance its product offerings to meet the current and future technological requirements of its customers and markets. Some aspects of the Companys R&D
efforts require significant short-term expenditures, such as mask tooling for advanced technology products, the timing of which may cause significant fluctuations in the Companys R&D expenses. The Company believes that R&D expenses in
the current fiscal year will likely increase in absolute dollars over last fiscal year due to increased costs associated with the ON business, the higher development costs of tooling products at 0.18u/0.13u technologies and more complex packaging
technologies. However, R&D expenses may decline as a percentage of net sales to the extent that net sales growth exceeds expected increases in R&D expenditures.



23



---

Selling, General and Administrative (SG&A)



The following table shows selling, general and administrative expenses in absolute dollars
and as a percentage of net sales for the periods indicated (in thousands):



|                        |  |                                |       |   |          |   |                               |         |  |          |     |  |      |        |   |         |   |        |   |  |   |    
|----------------------- |  | ------------------------------ | ----- | - | -------- | - | ----------------------------- | ------- |  | -------- | --- |  | ---- | ------ | - | ------- | - | ------ | - |  | - | ---
|                        |  | Three Months EndedDecember 31, |       |   | Variance |   | Nine Months EndedDecember 31, |         |  | Variance
|                        |  | 2005                           |       |   | 2004     |   |                               | Dollars |  | 2005     |     |  | 2004 |        |   | Dollars
|Total SG&A              |  | $                              | 5,187 |   |          | $ | 4,962                         |         |  | $        | 225 |  | $    | 15,816 |   |         | $ | 15,524 |   |  | $ | 292
|Percentage of net sales |  |                                | 30.5  | % |          |   | 37.5                          | %       |  |          |     |  |      | 32.0   | % |         |   | 35.5   | % |  |   |    



Selling, General and Administrative
expenses consist primarily of:



| |  | salaries and related expenses;
|- |  | ------------------------------



| |  | sales commissions;
|- |  | ------------------



| |  | professional fees; and
|- |  | ----------------------



| |  | facility expenses.
|- |  | ------------------



The increase in SG&A expenses for the three months ended December 31, 2005 as compared to the same period a year ago were primarily due to costs related to the Companys proxy solicitation efforts in
connection with its 2005 Annual Meeting of Stockholders of $0.2 million, higher audit fees and energy costs partially offset by lower labor-related costs. The increase in SG&A expenses for the nine months ended December 31, 2005 as compared
to the same period a year ago were primarily due to costs related to the Companys proxy solicitation efforts of $0.9 million partially offset by lower labor-related costs, insurance premiums and consulting fees to comply with Sarbanes-Oxley
internal control regulations. Additionally, SG&A expenses in the nine months ended December 31, 2004 reflects the Companys recovery of legal fees of $0.7 million in connection with a settlement agreement.



SG&A expenses may vary both in absolute dollars and as a percentage of net sales due to
sales commissions, audit fees, litigation costs and costs of any corporate governance or other activity under or at the direction of the Board of Directors. In the short term, many of the SG&A expenses are fixed, however, the Company expects
SG&A expense to fluctuate with litigation costs and the timing of employer payroll taxes.



Interest Income and Other, Net



The
following table shows other income, net in absolute dollars and as a percentage of net sales for the periods indicated (in thousands):



|                        |  |                                |       |   |          |   |                               |         |  |          |     |  |      |       |   |         |   |       |   |  |   |      
|----------------------- |  | ------------------------------ | ----- | - | -------- | - | ----------------------------- | ------- |  | -------- | --- |  | ---- | ----- | - | ------- | - | ----- | - |  | - | -----
|                        |  | Three Months EndedDecember 31, |       |   | Variance |   | Nine Months EndedDecember 31, |         |  | Variance
|                        |  | 2005                           |       |   | 2004     |   |                               | Dollars |  | 2005     |     |  | 2004 |       |   | Dollars
|Other income, net       |  | $                              | 2,902 |   |          | $ | 2,296                         |         |  | $        | 606 |  | $    | 9,136 |   |         | $ | 5,835 |   |  | $ | 3,301
|Percentage of Net Sales |  |                                | 17.1  | % |          |   | 17.3                          | %       |  |          |     |  |      | 18.5  | % |         |   | 13.3  | % |  |   |      



Interest Income and Other, Net
primarily consists of:



| |  | interest income; and
|- |  | --------------------



| |  | realized gains on marketable securities.
|- |  | ----------------------------------------



24



---

The increase in interest income and other, net during the three and nine months ended December 31, 2005 as compared
to the same periods a year ago was due to higher interest earned on cash and cash equivalents and short-term marketable securities as a result of increasing market interest rates partially offset by lower cash equivalents and marketable securities
due to the $120.8 million required to complete the Companys Modified Dutch Auction Self Tender Offer in the second quarter of fiscal 2006.



Other Than Temporary Loss on Long-Term Investments



In December 2005, the Company assessed the value of certain discontinued companies and the remaining portfolio companies within the TechFarm Fund. The Company believed
that these changes permanently impaired the carrying value of its investment in the TechFarm Fund. As a result, Exar recorded an impairment charge against its earnings of $1.2 million, thereby reducing its carrying value in the TechFarm Fund to $0.6
million.



Gain on Legal Settlement



During the nine months ended December 31, 2004, the Company recorded a gain on legal
settlement of $1.2 million arising from its entry into a settlement agreement.



Provision for Income Taxes



The Companys estimated
annual effective tax rate for fiscal year 2006 is 27%, up from the 15% rate for fiscal year 2005. This increase is primarily the result of higher pre-tax book income, less income from tax-favorable investments and lower utilization of
acquired-company losses. The tax rate for income taxes for the three and nine months ended December 31, 2005 differed from the statutory federal tax rate of 35% principally due to R&D credits, acquired-company NOL utilizations and the
non-recognition of a tax benefit for the $1.2 million asset impairment charge for TechFarm Ventures, due to the uncertainty surrounding whether the Company will have future capital gains to offset this capital loss, which were partially offset by
state income taxes.



Liquidity and Capital Resources



The Company does not have any off-balance sheet arrangements, investments in special purpose
entities, variable interest entities or undisclosed borrowings or debt. Additionally, the Company is not a party to any derivative contracts, nor does it have any synthetic leases. At December 31, 2005, the Company had no foreign currency
contracts outstanding.



The Companys principal sources of liquidity in
the nine months ended December 31, 2005 were cash and cash equivalents and short-term marketable securities, which, in the aggregate, decreased by $125.6 million to $320.6 million at December 31, 2005 from $446.3 million at March 31,
2005. Cash and cash equivalents decreased by $81.5 million during the nine months ended December 31, 2005 resulting primarily from net cash used in investing activities of $117.8 million partially offset by net cash provided by investing
activities of $28.4 million.



The Company generated net cash flows from
operating activities of $7.7 million and $6.7 million during the nine month periods ended December 31, 2005 and 2004, respectively. For the nine months ended December 31, 2005, net cash from operating activities resulted from net income of
$4.9 million and $5.8 million in non-cash charges for depreciation and amortization expense, an impairment charge and the provision for sales returns and allowances and an increase in income taxes payable of $1.5 million. These sources of cash were
partially offset by increases in accounts receivable and inventories of $2.6 million and $1.2 million, respectively.



Net cash provided by investing activities totaled $28.4 million during the nine months ended December 31, 2005 as compared to net cash used in investing activities
of $6.8 million in the nine months ended December 31, 2004. During the nine months ended December 31, 2005, the Companys investing activities included proceeds from the maturities of $89.2 million of short-term marketable securities
partially offset by purchases of $44.6 million in short-term marketable securities, $11.4 million for the purchase of assets in the ON acquisition, and purchases of property, plant and equipment of $4.7 million. During the nine months ended
December 31, 2004, the Companys investing activities included net purchase activity of short-term marketable securities of $4.1 million and $2.3 million in purchases of property, plant and equipment.



25



---

As of December 31, 2005, the Company had funded $2.7 million of its $5.0 million committed capital in the Skypoint
Telecom Fund II (US), L.P. (the Skypoint Fund). The Company is obligated to contribute its remaining committed capital of approximately $2.3 million by June 18, 2007 as requested by the Skypoint Funds General Partner per the
limited partnership agreement with the Skypoint Fund. To meet its capital commitment to the Skypoint Fund, the Company may need to use its existing cash, cash equivalents and/or short-term marketable securities.



Net cash used in financing activities totaled $117.8 million in the nine months ended
December 31, 2005, primarily due to the repurchase of $120.8 million in common stock and associated costs of completing the Companys Modified Dutch Auction Self Tender Offer and the repurchase of 270,000 shares of Exars
common stock for $3.6 million under the stock repurchase program authorized in March 2001. This was partially offset by the proceeds of $6.6 million from the issuance of shares of common stock, representing proceeds from the exercise of stock
options under the Companys stock option plans and the purchase of shares of common stock under the Companys Employee Stock Participation Plan. During the nine months ended December 31, 2004 net cash provided by financing activities
was $2.3 million, reflecting $6.0 million of proceeds from the issuance of shares of common stock upon the exercise of stock options under the Companys stock option plans and the purchase of shares of common stock under the Companys
Employee Stock Participation Plan partially offset by $3.6 million in stock repurchases by the Company.



To date, inflation has not had a significant impact on the Companys operating results.



In March 2001, the Board of Directors authorized a stock repurchase program to acquire
outstanding common stock in the open market due to the decrease in market price and to partially offset some dilution from the Companys stock option programs. Under this program, the Board of Directors authorized the acquisition of up to $40.0
million of Exars common stock. During the nine months ended December 31, 2005, the Company acquired 270,000 shares of its common stock for $3.6 million. At December 31, 2005, the Company had $28.1 million remaining under the
currently authorized $40.0 million stock repurchase program. In the future, the Company will, from to time to time, utilize the stock repurchase program to acquire additional shares of its outstanding common stock, which would reduce cash, cash
equivalents and/or short-term marketable securities available to fund future operations and meet other liquidity requirements.



The Company anticipates that it will continue to finance its operations with cash flows from operations, existing cash balances and the sale of short-term marketable
securities. The combination and the sources of capital will be determined by management based on the Companys then current needs and the prevailing market conditions. The Company believes that its cash and cash equivalents, short-term
marketable securities and cash flows from operations will be sufficient to satisfy its working capital requirements, capital equipment acquisition, and share repurchase needs for at least the next twelve months. From time to time, the Company
evaluates potential business arrangements and equity investments complementary to its design expertise and to accelerate various strategic initiatives. If the Company pursues or positions itself to pursue these transactions, the Company may seek
additional equity or debt financing. There can be no assurance that additional financing could be obtained on terms acceptable to the Company, if at all. The sale of additional equity or convertible debt could result in dilution to the
Companys stockholders.



Recent Pronouncements



In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123 (revised 2004), Share-Based Payment (SFAS 123R). This statement replaces SFAS 123, Accounting for Stock-Based Compensation and supersedes Accounting Principles Boards Opinion
No. 25 (APB 25), Accounting for Stock Issued to Employees. SFAS 123R will require the Company to measure the cost of the Companys employee stock-based compensation awards granted after the effective date based on
the grant date fair value of those awards and to record that cost as compensation expense over the period during which the employee is required to perform services in exchange for the award (generally over the vesting period of the award). SFAS 123R
addresses all forms of share-based payments awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. In addition, the Company will be required to record compensation expense
(as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at the date of adoption. SFAS 123R is effective for annual fiscal periods beginning after June 15, 2005. The Company, therefore,
is required to implement the standard as of April 1, 2006.



26



---

As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using the intrinsic value
method prescribed by APB 25 and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123R will have a significant impact on the Companys result of operations, although it will have
no negative impact on cash flow. However, the actual result of the adoption of SFAS 123R cannot be determined at this time because it will depend on levels of share-based payments granted in the future.



In June 2005, the FASB decided not to provide additional guidance on the meaning of
other-than-temporary impairment, and directed the staff to issue proposed FSP EITF 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1, as final. The final FSP will supersede EITF Issue No. 03-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, and EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value. The final FSP (retitled
FSP FAS No. 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments ) will replace the guidance set forth in paragraphs 10-18 of EITF No. 03-1 with references to existing other-than-temporary
impairment guidance, such as SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, SEC SAB No. 59, Accounting for Noncurrent Marketable Equity Securities, and APB Opinion No. 18, The Equity Method of
Accounting for Investments in Common Stock. FSP FAS No. 115-1 will codify the guidance set forth in EITF Topic D-44 and clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other than
temporary, even if a decision to sell has not been made. FSP FAS No. 115-1 will be effective April 1, 2006 for other-than-temporary impairment analysis conducted by the Company. The Company does not believe the adoption of FSP FAS
No. 115-1 will have a significant impact on its consolidated results of operations or financial position.



In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, Inventory Costs, and an amendment to ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 amends ARB
No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) should be recognized as current period charges. In addition, SFAS 151 requires that the allocation of fixed
production overheads to the cost of conversion be based on the normal capacity of the production facilities. The Company is required to adopt the standard as of April 1, 2006. The Company is currently assessing the impact but does not expect
the adoption of SFAS 151 to have a significant impact on its financial condition or results of operations.



In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS 154). SFAS No. 154 replaces APB Opinion No. 20, Accounting Changes and SFAS No. 3,
Reporting Accounting Changes in Interim Financial Statements. SFAS 154 requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. The Company does not expect the adoption of SFAS 154 to have a material impact on its consolidated financial statements.



RISK FACTORS



The Company is subject to a number of risks. Some of these risks are endemic to the high-technology industry and are the same or similar to those disclosed in the
Companys previous SEC filings, and some new risks may arise in the future. The reader should carefully consider all of these risks and the other information in this Quarterly Report before investing in the Company. The fact that certain risks
are endemic to the high-technology industry does not lessen the significance of these risks.



As a result of these risks, the Companys business, financial condition or results of operations could be materially and adversely affected. This could cause the trading price of the Companys common stock
to decline, and stockholders might lose some or all of their investment.



IF
THE COMPANY IS UNABLE TO GENERATE REVENUE ABOVE CURRENT LEVELS FROM THE SALE OF ITS COMMUNICATIONS PRODUCTS, OR ITS REVENUE FROM THESE PRODUCTS DECLINES, THE COMPANYS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS WILL BE MATERIALLY
AND ADVERSELY IMPACTED.



27



---

The Company continues to focus a significant portion of its research and sales resources on the communications market
with the expectation that the communications sector will grow over the long term. Given the Companys dependence on the communications market to support revenue growth, the Company must continue to generate additional sales from this market by
successfully introducing new products and securing design wins for them or by gaining market share. If the Company is unable to generate increased revenue from its communications products or its revenue from these products declines, the
Companys business, financial condition, and results of operations will be materially and adversely impacted.



THE UNCERTAINTY IN THE U.S. AND GLOBAL ECONOMIES, AS WELL AS THE COMMUNICATIONS EQUIPMENT MARKET, MAY CONTINUE TO MATERIALLY AND ADVERSELY AFFECT THE COMPANYS
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.



Periodic
declines or fluctuations in corporate profits, lower capital equipment spending, the impact of the conflicts throughout the world, terrorist acts, natural disasters, the outbreak of communicable diseases such as the Avian Flu and other geopolitical
factors have had, and may continue to have, a negative impact on the U.S. and global economies. The Companys revenue and profitability has generally followed the modest recovery of the communications equipment industry. This modest recovery
has affected carrier capital equipment spending, which in turn has affected the demand for the Companys customers products, thus affecting the Companys revenues and profitability. Communications service providers continue to
experience consolidation in their industry. Although there currently appears to be positive signs for growth, further delay or reduction in anticipated communications equipment spending levels may adversely affect the Companys business,
financial condition and results of operations.



The Company is unable to
predict the timing, strength or duration of the communications market recovery. If the sector does not continue to recover measurably, or declines, the Companys business, financial condition and results of operations may be materially and
adversely impacted.



IF THE COMPANY FAILS TO DEVELOP AND INTRODUCE NEW
PRODUCTS IN ITS CORE OR NEW MARKETS THAT MEET EVOLVING MARKET NEEDS, THE COMPANYS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY IMPACTED.



The markets for the Companys products are characterized by:



| |  | changing technologies;
|- |  | ----------------------



| |  | moderate to slow growth;
|- |  | ------------------------



| |  | competitive solutions;
|- |  | ----------------------



| |  | frequent product introductions and enhancements;
|- |  | ------------------------------------------------



| |  | increasing functional integration;
|- |  | ----------------------------------



| |  | increasing price pressure;
|- |  | --------------------------



| |  | capital equipment spending levels and/or deployment;
|- |  | ----------------------------------------------------



| |  | evolving and competing industry standards;
|- |  | ------------------------------------------



| |  | changing customer requirements;
|- |  | -------------------------------



| |  | changing competitive landscape (consolidation, financial conditions);
|- |  | ---------------------------------------------------------------------



| |  | long design-to-production cycles; and/or
|- |  | ----------------------------------------



| |  | increasing costs of product development.
|- |  | ----------------------------------------



28



---

The Companys success depends in part on the successful development of new products for the Companys core
markets. The Company must: (i) be able to anticipate customer and market requirements and changes in technology and industry standards; (ii) be able to accurately define and develop, on a timely basis, new products; (iii) be able to
gain access to and use technologies in a cost-effective manner; (iv) continue to expand its technical and design expertise; (v) be able to timely introduce and cost-effectively have manufactured new products; (vi) be able to
differentiate its products from its competitors offerings; and (vii) gain customer acceptance of its products. In addition, the Company must continue to have its products designed into its customers future products and maintain
close working relationships with key customers to develop new products that meet their evolving needs. Moreover, the Company must be able to respond to shifts in market demands, the trend towards increasing functional integration and other changes
in a rapid and cost-effective manner. Migration from older products to newer products may result in volatility of earnings during periods of transition of the products.



Products for communications applications are based on continually evolving industry standards and new technologies. The Companys
ability to compete will depend in part on its ability to identify and ensure compliance with these industry standards. The emergence of new standards could render the Companys products incompatible with systems developed by major
communications equipment manufacturers. As a result, the Company could be required to invest significant time, effort and expenses to develop and qualify new products to ensure compliance with industry standards.



The process of developing and supporting new products is complex, expensive and uncertain,
and if the Company fails to accurately understand its customers changing needs and emerging technological trends, the Companys business may be harmed. The Company cannot assure that it will be able to identify new product opportunities
successfully, develop and bring to market new products, achieve design wins, ensure when and which design wins actually get released to production, or respond effectively to technological changes or product announcements by its competitors. In
addition, the Company may not be successful in developing or using new technologies or may incorrectly anticipate market demand and develop products that achieve little or no market acceptance. The Companys pursuit of necessary technological
advances may require substantial time and expense and may ultimately prove unsuccessful. Failure in any of these areas may harm the Companys business, financial condition and results of operations.



IF THE COMPANY IS UNABLE TO CONVERT A SIGNIFICANT PORTION OF ITS DESIGN WINS INTO ACTUAL
REVENUE, THE COMPANYS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY IMPACTED.



The Company has secured a significant number of design wins for new and existing products. Such design wins are necessary for revenue growth. However, many of the
Companys design wins may never generate revenues if their end-customer projects are unsuccessful in the market place or the end-customer terminates the project, which may occur for a variety of reasons. Additionally, some of the Companys
design wins are with privately-held, early-stage companies that may fail to bring their product to market. If design wins do generate revenue, the time lag between the design win and meaningful revenue may be in excess of 18 months. If the Company
fails to convert a significant portion of its design wins into substantial revenue, the Companys business, financial condition and results of operations could be materially and adversely impacted.



THE COMPANYS FINANCIAL RESULTS MAY FLUCTUATE SIGNIFICANTLY BECAUSE OF A NUMBER OF
FACTORS, MANY OF WHICH ARE BEYOND THE COMPANYS CONTROL.



The
Companys financial results may fluctuate significantly. Some of the factors that affect the Companys financial results, many of which are difficult or impossible to control or predict, are:



| |  | the Companys difficulty predicting revenues due to limited visibility provided by customers and channel partners coupled with a high number of orders placed for products to be
shipped in the same quarter;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the reduction, rescheduling, cancellation or timing of orders by the Companys customers and channel partners;
|- |  | --------------------------------------------------------------------------------------------------------------



29



---

| |  | volatility of demand for equipment sold by the Companys large customers, which in turn, introduces demand volatility for the Companys products;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  | dependency on a single product with a single customer;
|- |  | ------------------------------------------------------



| |  | temporary disruption in customer demand as they change or modify their complex subcontract manufacturing supply chain;
|- |  | ----------------------------------------------------------------------------------------------------------------------



| |  | changes in sales and implementation cycles for the Companys products;
|- |  | ----------------------------------------------------------------------



| |  | the Companys or its channel partners ability to maintain adequate inventory levels;
|- |  | -------------------------------------------------------------------------------------



| |  | the Companys difficulty in ordering the correct mix of products from suppliers, whose lead time continue to grow, may be greater than the time span of visibility provided by
customers;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the availability and cost of materials and services, including foundry, assembly and test capacity, needed by the Company from its foundries and suppliers;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | discontinuance of wafer fabrication or packaging technologies by the Companys suppliers;
|- |  | -----------------------------------------------------------------------------------------



| |  | if wafer fabrications or packaging and test suppliers discontinue or experience extended disruption of supply, the Company may incur increased costs to obtain alternative suppliers
or investment in inventory to meet continuity of supply obligations to customers;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | temporary disruptions in the Companys or its customers supply chain due to natural disaster, fire, outbreak of communicable diseases such as the Avian Flu, or labor
disputes;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | fluctuations in the manufacturing output, yield capabilities, and capacity of the Companys suppliers;
|- |  | ------------------------------------------------------------------------------------------------------



| |  | fluctuation in suppliers capacity due to reorganization or shift in business focus;
|- |  | ------------------------------------------------------------------------------------

| |  | problems, costs, or delays that the Company may face in shifting its products to smaller geometry process technologies and in achieving higher levels of design and device
integration;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the ability of the Companys suppliers, customers and communications service providers to obtain financing or to fund capital expenditures;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  | changes in the mix of products that the Companys customers purchase;
|- |  | ---------------------------------------------------------------------



| |  | the Companys ability to successfully introduce and transfer into production new products and/or integrate new technologies;
|- |  | ----------------------------------------------------------------------------------------------------------------------------



| |  | risks associated with entering new markets should the Company decide to do so;
|- |  | ------------------------------------------------------------------------------



| |  | the announcement or introduction of products by the Companys competitors;
|- |  | --------------------------------------------------------------------------



| |  | loss of market share by the Companys customers;
|- |  | ------------------------------------------------



| |  | competitive pressures on selling prices or product availability;
|- |  | ----------------------------------------------------------------



| |  | increased competition in new markets the Company may enter;
|- |  | -----------------------------------------------------------



| |  | pressures on selling prices overseas due to foreign currency exchange fluctuations;
|- |  | -----------------------------------------------------------------------------------



| |  | erosion of average selling prices coupled with the inability to sell newer products with higher average selling prices, resulting in lower overall revenue and margins;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | increase in manufacturing costs;
|- |  | --------------------------------



30



---

| |  | increase in mask tooling costs associated with advanced technologies;
|- |  | ---------------------------------------------------------------------



| |  | the amount and timing of the Companys investment in research and development;
|- |  | ------------------------------------------------------------------------------



| |  | market and/or customer acceptance of the Companys products;
|- |  | ------------------------------------------------------------



| |  | consolidation among the Companys competitors, its customers and/or its customers customers;
|- |  | ---------------------------------------------------------------------------------------------



| |  | changes in the Companys customers end user concentration or requirements;
|- |  | ---------------------------------------------------------------------------



| |  | loss of one or more major customers;
|- |  | ------------------------------------



| |  | significant changes in ordering pattern by major customers;
|- |  | -----------------------------------------------------------



| |  | costs and business disruptions associated with shareholder or regulatory issues;
|- |  | --------------------------------------------------------------------------------



| |  | management of customer and/or channel inventory;
|- |  | ------------------------------------------------



| |  | the inability of the Companys customers to obtain components from their other suppliers;
|- |  | -----------------------------------------------------------------------------------------



| |  | disruption in the sales or distribution channels;
|- |  | -------------------------------------------------



| |  | the timing and amount of employer payroll tax to be paid on the Companys employees gains on stock options exercised;
|- |  | ----------------------------------------------------------------------------------------------------------------------



| |  | increasing costs and time associated with compliance with accounting rules or other regulatory requirements;
|- |  | ------------------------------------------------------------------------------------------------------------



| |  | changes in accounting or other regulatory rules, such as the future requirement to record expenses for employee stock option grants;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  | fluctuations in interest rates and/or market values of the Companys marketable securities;
|- |  | -------------------------------------------------------------------------------------------



| |  | litigation costs associated with the defense of suits brought or complaints made against the Company; and/or
|- |  | ------------------------------------------------------------------------------------------------------------



| |  | legislators desire or ability to renew favorable tax legislation in a timely manner, which may subject the Companys tax provision to volatility.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------



As a consequence, operating results for a particular future
period are difficult to predict and prior results are not necessarily indicative of results to be expected in the future. Any of the foregoing factors, or any other factors discussed elsewhere herein, may have a material adverse effect on the
Companys business, financial condition and results of operations.



THE
COMPANY HAS MADE AND MAY IN THE FUTURE MAKE ACQUISITIONS AND SIGNIFICANT STRATEGIC EQUITY INVESTMENTS, WHICH MAY INVOLVE A NUMBER OF RISKS. IF THE COMPANY IS UNABLE TO ADDRESS THESE RISKS SUCCESSFULLY, SUCH ACQUISITIONS AND INVESTMENTS COULD HAVE A
MATERIALLY ADVERSE IMPACT ON THE COMPANYS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.



The Company has undertaken a number of strategic acquisitions and investments in the past and may do so from time to time in the future. The risks involved with these acquisitions and investments include, among
others:



| |  | the possibility that the Company may not receive a favorable return on its investment or incur losses from its investment, or the original investment may become impaired;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | failure to satisfy the strategic objectives;
|- |  | --------------------------------------------



31



---

| |  | the Companys assumption of known or unknown liabilities or other unanticipated events or circumstances; and/or
|- |  | ---------------------------------------------------------------------------------------------------------------



| |  | the diversion of managements attention from normal daily operations of the business.
|- |  | -------------------------------------------------------------------------------------



Additional risks involved with acquisitions include, among others:



| |  | difficulties in integrating the operations, technologies, products and personnel of the acquired company or its assets;
|- |  | -----------------------------------------------------------------------------------------------------------------------



| |  | difficulty in supporting acquired products or technologies;
|- |  | -----------------------------------------------------------



| |  | difficulties or delays in the transfer of manufacturing flows and supply chains of products of acquired businesses;
|- |  | -------------------------------------------------------------------------------------------------------------------



| |  | failure to retain key personnel;
|- |  | --------------------------------



| |  | unexpected capital equipment outlays and related expenses;
|- |  | ----------------------------------------------------------



| |  | difficulties in entering markets in which the Company has limited or no direct prior experience and where competitors in such markets may have stronger market positions;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | insufficient revenues to offset increased expenses associated with acquisitions;
|- |  | --------------------------------------------------------------------------------



| |  | under-performance problems with an acquired company;
|- |  | ----------------------------------------------------



| |  | issuance of common stock that would dilute the Companys current stockholders percentage ownership;
|- |  | ----------------------------------------------------------------------------------------------------



| |  | recording of goodwill and non-amortizable intangible assets that will be subject to periodic impairment testing and potential impairment charges against the Companys future
earnings;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | incurring amortization expenses related to certain intangible assets;
|- |  | ---------------------------------------------------------------------



| |  | the opportunity cost associated with committing capital in such investments;
|- |  | ----------------------------------------------------------------------------



| |  | incurring large and immediate write-offs; and/or
|- |  | ------------------------------------------------



| |  | becoming subject to litigation.
|- |  | -------------------------------



Risks involved with strategic equity investments include, among others:



| |  | the possibility of litigation resulting from these types of investments;
|- |  | ------------------------------------------------------------------------



| |  | the possibility that the Company may not receive a favorable return on its investments or incur losses from these investments, or the original investment may become impaired;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a change or poorly executed strategic plan; and/or
|- |  | --------------------------------------------------



| |  | the opportunity cost associated with committing capital in such investments.
|- |  | ----------------------------------------------------------------------------



The Company cannot assure that it will be able to address these risks successfully without substantial expense, delay or other operational or financial problems. Any
delays or other such operations or financial problems could adversely impact the Companys business, financial condition and results of operations.



32



---

COMPETITION IN THE MARKETS IN WHICH THE COMPANY PARTICIPATES MAY MAKE IT MORE DIFFICULT FOR THE COMPANY TO BE
SUCCESSFUL.



The Company competes against an established group of
semiconductor companies that focus on similar markets. These competitors include Applied Micro Circuits Corporation, Integrated Device Technology Inc., Mindspeed Technologies Inc., PMC Sierra Inc., Royal Philips Electronics, Texas Instruments
Incorporated, TranSwitch Corporation, Vitesse Semiconductor Corporation and Wolfson Microelectronics LTD. Additionally, the Company is facing competition from other established companies and start-up businesses that seek to enter the markets in
which the Company participates.



The Company has experienced increased
competition at the design stage, where customers evaluate alternative solutions based on a number of factors, including price, performance, product features, technologies, and availability of long-term product supply and/or roadmap guarantee.
Additionally, the Company experiences, in some cases, severe pressure on pricing from some of its competitors or cost expectations from customers. Such circumstances may make some of the Companys products unattractive due to price or
performance measures. These circumstances may result in the Company losing design opportunities or may decrease its revenue and margins as a result of the price competition.



THE COMPANY DEPENDS ON THIRD-PARTY FOUNDRIES TO MANUFACTURE ITS ICs. ANY DISRUPTION IN OR LOSS OF THE FOUNDRIES CAPACITY TO
MANUFACTURE THE COMPANYS PRODUCTS SUBJECTS IT TO A NUMBER OF RISKS, INCLUDING THE POTENTIAL FOR AN INADEQUATE SUPPLY OF PRODUCTS AND HIGHER MATERIALS COSTS. THESE RISKS MAY LEAD TO DELAYED PRODUCT DELIVERY OR INCREASED COSTS, WHICH COULD
MATERIALLY AND ADVERSELY AFFECT THE COMPANYS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.



The Company does not own or operate a semiconductor fabrication facility (known as foundry). Most of the Companys products are based on Complementary
Metal Oxide Semiconductor (CMOS) processes. Chartered Semiconductor Manufacturing Ltd. (Chartered) located in Singapore, manufactures the majority of the CMOS wafers from which the Companys products are manufactured.
Chartered produces semiconductors for many other companies (many of which have greater requirements than the Company), and therefore the Company may not have access on a timely basis to sufficient capacity or certain process technologies. In
addition, the Company is reliant on Chartereds continued financial health and ability to continue to invest in smaller geometry manufacturing processes and fabs.



Many of the Companys new products are designed to take advantage of smaller geometry manufacturing processes. Due to the complexity
and increased cost of migrating to smaller geometries, the Company may experience problems, which could result in design and production delays of the Companys products. If such delays occur, the Companys products may have delayed market
acceptance or customers may select the Companys competitors products during the design process.



The Company does not have long-term wafer supply agreements with its foundries that would guarantee wafer or product quantities, prices, delivery or lead times. Rather, the foundries manufacture the Companys
products on a purchase order basis. The Company provides its foundries with rolling forecasts of its production requirements. However, the ability of the Companys foundries to provide wafers is limited by the foundries available
capacity. In addition, the Company cannot be certain that it will continue to do business with its foundries on terms as favorable as its current terms. Significant risks associated with the Companys reliance on third party foundries include:



| |  | the lack of assured process technology and wafer supply;
|- |  | --------------------------------------------------------



| |  | financial and operating stability of the foundries;
|- |  | ---------------------------------------------------



| |  | limited control over delivery schedules;
|- |  | ----------------------------------------



| |  | limited manufacturing capacity of the foundries;
|- |  | ------------------------------------------------



| |  | limited control over quality assurance, manufacturing yields and production costs; and/or
|- |  | -----------------------------------------------------------------------------------------



| |  | potential misappropriation of the Companys intellectual property.
|- |  | ------------------------------------------------------------------



33



---

The Company could experience a substantial delay or interruption in the shipment of its products or an increase in its
costs due to any of the following:



| |  | a manufacturing disruption experienced by foundries utilized by the Company or sudden reduction or elimination of any existing source or sources of semiconductor manufacturing
materials or processes, which might include the potential closure, change of ownership, change of management or consolidation by one of the Companys foundries;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | extended time required to identify, qualify and transfer to alternative manufacturing sources for existing or new products;
|- |  | ---------------------------------------------------------------------------------------------------------------------------



| |  | failure of the Companys suppliers to obtain the raw materials and equipment;
|- |  | -----------------------------------------------------------------------------



| |  | financial and operating stability of the foundry or any of its suppliers;
|- |  | -------------------------------------------------------------------------



| |  | acts of terrorism or civil unrest or an unanticipated disruption due to communicable diseases, political instability, natural disasters; and/or
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | a sudden, sharp increase in demand for semiconductor devices, which could strain the foundries manufacturing resources and cause delays in manufacturing and shipment of the
Companys products.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



IF THE COMPANYS FOUNDRIES
DISCONTINUE OR LIMIT THE AVAILABILITY OF THE MANUFACTURING PROCESSES NEEDED TO MEET THE COMPANYS DEMANDS OR ARE UNABLE TO PROVIDE THE TECHNOLOGIES NEEDED TO MANUFACTURE THE COMPANYS PRODUCTS, THE COMPANY MAY FACE PRODUCTION DELAYS, WHICH
COULD MATERIALLY AND ADVERSELY IMPACT THE COMPANYS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.



The Companys wafer requirements represent a small portion of the total production of the foundries that manufacture its products. As a result, the Company is
subject to the risk that a foundry may cease production of a wafer fabrication process required by the Company. Additionally, the Company cannot be certain that its foundries will continue to devote resources to the production of its products or
continue to advance the process design technologies on which the manufacturing of the Companys products are based. Each of these events could increase the Companys costs and harm its ability to deliver its products on time, or force it
to terminate affected products, thereby materially and adversely affecting the Companys business, financial condition and results of operations.



TO SECURE FOUNDRY CAPACITY, THE COMPANY MAY BE REQUIRED TO ENTER INTO FINANCIAL AND OTHER ARRANGEMENTS WITH FOUNDRIES, WHICH COULD RESULT IN THE DILUTION OF ITS
EARNINGS OR OTHERWISE HARM ITS OPERATING RESULTS.



Allocation of a
foundrys manufacturing capacity may be influenced by a foundry customers size, the existence of a long-term agreement with the foundry or other commitments. To address foundry capacity constraints, the Company and other semiconductor
companies that rely on third-party foundries have utilized various arrangements, including equity investments in or loans to foundries in exchange for guaranteed production capacity, joint ventures to own and operate foundries or take or
pay contracts that commit a company to purchase specified quantities of wafers over extended periods. While the Company is not currently a party to any of these arrangements, it may decide to enter into these arrangements in the future. The
Company cannot be sure, however, that these arrangements will be available to it on acceptable terms, if at all. Any of these arrangements could require the Company to commit substantial capital and, accordingly, could require it to reduce its cash
holdings, incur additional debt or secure equity financing. This could result in the dilution of its earnings or the ownership of its stockholders or otherwise harm its operating results. Furthermore, there can be no assurance that the Company will
be able to obtain sufficient foundry capacity in the future pursuant to such arrangements.



THE COMPANYS DEPENDENCE ON THIRD-PARTY SUBCONTRACTORS TO ASSEMBLE AND TEST ITS PRODUCTS SUBJECTS IT TO A NUMBER OF RISKS, INCLUDING THE POTENTIAL FOR AN INADEQUATE SUPPLY OF PRODUCTS AND HIGHER MATERIALS
COSTS. THESE RISKS MAY



34



---

LEAD TO DELAYED PRODUCT DELIVERY OR INCREASED COSTS, WHICH COULD MATERIALLY AND ADVERSELY AFFECT THE COMPANYS BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.



The Company depends on independent subcontractors
in Asia for all of the assembly and the majority of the testing of its products. The Companys reliance on these subcontractors involves the following risks:



| |  | the Companys reduced control over manufacturing yields, production schedules and product quality;
|- |  | --------------------------------------------------------------------------------------------------



| |  | the potential closure, change of ownership, change in business conditions or relationships, change of management or consolidation by one or more of the Companys
subcontractors;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | long term financial stability of the Companys subcontractors and their ability to invest in new capabilities and equipment;
|- |  | ----------------------------------------------------------------------------------------------------------------------------



| |  | disruption of services due to the outbreak of communicable diseases such as the Avian Flu, acts of terrorism, natural disasters, labor disputes, or civil unrest;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | disruption of manufacturing or test services due to relocation of subcontractor manufacturing facilities;
|- |  | ---------------------------------------------------------------------------------------------------------



| |  | failure of the Companys subcontractors to obtain the raw materials and equipment;
|- |  | ----------------------------------------------------------------------------------



| |  | entry into take-or-pay agreements;
|- |  | ------------------------------------



| |  | difficulties in selecting, qualifying and integrating new subcontractors;
|- |  | -------------------------------------------------------------------------



| |  | reallocation or limited manufacturing capacity of the subcontractors;
|- |  | ---------------------------------------------------------------------



| |  | a sudden, sharp increase in demand for semiconductor devices, which could strain the subcontractors manufacturing resources and cause delays in manufacturing and shipment of
the Companys products;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | limited warranties from the subcontractors for products assembled and tested for the Company;
|- |  | ---------------------------------------------------------------------------------------------



| |  | the possible unavailability of qualified assembly or test services;
|- |  | -------------------------------------------------------------------



| |  | the subcontractors may cease production on a specific package type used to assemble product required by the Company and the possible inability to obtain an alternate source to
supply the package;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | potential increases in assembly and test costs; and/or
|- |  | ------------------------------------------------------



| |  | the third party subcontractors abilities to transition to smaller package types and to new package compositions.
|- |  | ----------------------------------------------------------------------------------------------------------------



These risks may lead to shipment delays and supply constraints of the Companys products
or increased cost for the finished products, either of which could adversely affect the Companys business, financial condition or results of operations.



THE COMPANYS RELIANCE ON FOREIGN SUPPLIERS EXPOSES IT TO RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS, ANY OF WHICH COULD MATERIALLY AND ADVERSELY IMPACT
ITS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.



The Company
uses semiconductor wafer foundries and assembly and test subcontractors throughout Asia to manufacture the majority of its products. The Companys dependence on these subcontractors involves the following risks:



| |  | disruption of services due to political, civil, labor, and economic instability;
|- |  | --------------------------------------------------------------------------------



| |  | disruption of services due to natural disasters or outbreak of communicable diseases such as the Avian Flu;
|- |  | -----------------------------------------------------------------------------------------------------------



35



---

| |  | disruption of transportation to and from Asia;
|- |  | ----------------------------------------------



| |  | embargoes or other regulatory limitations affecting the availability of raw materials, equipment or services;
|- |  | -------------------------------------------------------------------------------------------------------------



| |  | changes in tax laws, tariffs and freight rates; and/or
|- |  | ------------------------------------------------------



| |  | compliance with local or international regulatory requirements.
|- |  | ---------------------------------------------------------------



These risks may lead to delays in product delivery or increased costs, either of which could harm the Companys profitability and customer relationships, thereby
materially and adversely impacting the Companys business, financial condition and results of operations.



THE COMPANY DEPENDS IN PART ON THE CONTINUED SERVICE OF ITS KEY ENGINEERING AND MANAGEMENT PERSONNEL AND ITS ABILITY TO IDENTIFY, HIRE, INCENT AND RETAIN QUALIFIED PERSONNEL. IF THE COMPANY LOST KEY EMPLOYEES OR
FAILED TO IDENTIFY, HIRE, INCENT AND RETAIN THESE INDIVIDUALS, THE COMPANYS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY IMPACTED.



The Companys future success depends, in part, on the continued service of its key design engineering, technical, sales, marketing and
executive personnel and its ability to identify, hire, incent, and retain other qualified personnel.



In the future, the Company may not be able to continue to attract and retain qualified personnel, including executive officers and other key management and technical personnel necessary for the management of its
business. Competition for skilled employees having specialized technical capabilities and industry-specific expertise continues to be a considerable risk inherent in the markets in which the Company competes. Volatility or lack of positive
performance in the Companys stock price and the ability to offer options to as many or in amounts consistent with past practices, as a result of regulations regarding the expensing of options, may also adversely affect the Companys
ability to retain key employees, all of whom have been granted stock options. The failure to retain and recruit, as necessary, key design engineers, technical, sales, marketing and executive personnel could harm the Companys business,
financial condition and results of operations.



RECENT RULEMAKING BY THE
FINANCIAL ACCOUNTING STANDARDS BOARD WILL REQUIRE THE COMPANY TO EXPENSE EQUITY COMPENSATION GIVEN TO EMPLOYEES AND WILL SIGNIFICANTLY HARM OPERATING RESULTS.



The Company historically has used stock options as a significant component of its employee compensation program in order to align
employees interests with the interests of the Companys stockholders, encourage employee retention, and provide competitive compensation packages. The Financial Accounting Standards Board has adopted changes that will require companies to
record a charge to earnings for employee stock option grants and other equity incentives, which will have a significant impact on the Companys results of operations. The Company is required to implement the standard as of April 1, 2006.
By causing the Company to incur significantly increased compensation costs, this accounting change will reduce the Companys reported earnings.



THE COMPANYS RELIANCE ON FOREIGN CUSTOMERS COULD CAUSE FLUCTUATIONS IN ITS OPERATING RESULTS, WHICH COULD MATERIALLY AND ADVERSELY IMPACT THE COMPANYS
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.



International
sales accounted for 50.7% and 52.7% of net sales for the nine months ended December 31, 2005 and December 31, 2004, respectively. International sales will likely continue to account for a significant portion of the Companys revenues,
which would subject the Company to the following risks:



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



| |  | tariffs and other barriers;
|- |  | ---------------------------



| |  | timing and availability of export or import licenses;
|- |  | -----------------------------------------------------



36



---

| |  | disruption of services due to political, civil, labor, and economic instability;
|- |  | --------------------------------------------------------------------------------



| |  | disruption of services due to natural disasters;
|- |  | ------------------------------------------------



| |  | disruptions to customer operations due to the outbreak of communicable diseases such as the Avian Flu;
|- |  | ------------------------------------------------------------------------------------------------------



| |  | difficulties in accounts receivable collections;
|- |  | ------------------------------------------------



| |  | difficulties in staffing and managing foreign subsidiary and branch operations;
|- |  | -------------------------------------------------------------------------------



| |  | difficulties in managing sales channel partners;
|- |  | ------------------------------------------------



| |  | difficulties in obtaining governmental approvals for communications and other products;
|- |  | ---------------------------------------------------------------------------------------



| |  | limited intellectual property protection;
|- |  | -----------------------------------------



| |  | foreign currency exchange fluctuations;
|- |  | ---------------------------------------



| |  | the burden of complying with foreign laws and treaties; and/or
|- |  | --------------------------------------------------------------



| |  | potentially adverse tax consequences.
|- |  | -------------------------------------



In addition, because sales of the Companys products have been denominated primarily in United States dollars, increases in the value of the United States dollar
could increase the relative price of the Companys products such that they become more expensive to customers in the local currency of a particular country. Increases in the value of the United States dollar could also evoke customers to apply
pricing pressures on the Companys products. Increased international activity in the future may result in increased foreign currency denominated sales. Furthermore, because some of the Companys customers purchase orders and
agreements are governed by foreign laws, the Company may be limited in its ability, or it may be too costly for the Company, to enforce its rights under these agreements and to collect damages, if awarded.



THE COMPLEXITY OF THE COMPANYS PRODUCTS MAY LEAD TO ERRORS, DEFECTS AND BUGS, WHICH
COULD SUBJECT IT TO SIGNIFICANT COSTS OR DAMAGES AND ADVERSELY AFFECT MARKET ACCEPTANCE OF THE COMPANYS PRODUCTS.



Although the Company, its customers and its suppliers rigorously test the Companys products, nonetheless they may contain undetected errors, defects or bugs when
first introduced or as new versions are released. If any of the Companys products contain production defects or reliability, quality or compatibility problems that are significant to its customers, the Companys reputation may be damaged
and customers may be reluctant to continue to buy the Companys products, which could adversely affect the Companys ability to retain customers and attract new customers. In addition, these defects or bugs could interrupt or delay sales
of affected products, which could adversely affect the Companys results of operations.



If defects or bugs are discovered after commencement of commercial production of a new product, the Company may be required to make significant expenditures of capital and other resources to resolve the problems. This
could result in significant additional development costs and the diversion of technical and other resources from the Companys other development efforts. The Company could also incur significant costs to repair or replace defective products.
These costs or damages could have a material adverse effect on the Companys financial condition and results of operations.



IF THE COMPANYS DISTRIBUTORS OR SALES REPRESENTATIVES STOP SELLING OR FAIL TO SUCCESSFULLY PROMOTE THE COMPANYS PRODUCTS, THE COMPANYS BUSINESS,
FINANCIAL CONDITION, AND RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED.



The Company sells many of its products through two non-exclusive distributors and numerous sales representatives. The Companys non-exclusive distributors and sales representatives may carry the Companys competitors
products, which could adversely impact or limit the sales of the Companys products. Additionally, they could



37



---

reduce or discontinue sales of the Companys products or may not devote the resources necessary to sell the Companys products in the volumes and
within the time frames that the Company expects. Moreover, the Company depends on the continued viability and financial resources of these distributors and sales representatives, some of which are small organizations with limited working capital. In
turn, these distributors and sales representatives are subject to general economic and semiconductor industry conditions. The Company believes that its success will continue to depend on these distributors and sales representatives. If some or all
of the Companys distributors and sales representatives experience financial difficulties, or otherwise become unable or unwilling to promote and sell the Companys products, the Companys business, financial condition and results of
operations could be adversely affected.



BECAUSE THE COMPANYS
COMMUNICATIONS ICs TYPICALLY HAVE LENGTHY SALES CYCLES, THE COMPANY MAY EXPERIENCE SUBSTANTIAL DELAYS BETWEEN INCURRING EXPENSES RELATED TO RESEARCH AND DEVELOPMENT AND THE GENERATION OF REVENUE DERIVED FROM THESE PRODUCTS.



Due to the communications IC equipment product development cycle, the Company has typically
experienced at least an eighteen month time lapse between its initial contact with a customer to realizing volume shipments. The Company first works with customers to achieve a design win, which may take nine months or longer. The Companys
customers then complete the design, testing and evaluation process and begin to ramp-up production, a period which typically lasts an additional nine months. The customers of communications equipment manufacturers may also require a period of time
for testing and evaluation, which may cause further delays. As a result, a significant period of time may elapse between the Companys research and development efforts and its realization of revenue, if any, from volume purchasing of the
Companys communications products by its customers. Due to length of the communication IC equipment product cycle, the risk of project cancellation by the customer is present for an extended period of time.



THE COMPANYS BACKLOG MAY NOT RESULT IN FUTURE REVENUE.



Due to the possibility of customer changes in delivery schedules and quantities actually
purchased, cancellation of orders, distributor returns or price reductions, the Companys backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. A reduction of the order backlog during any
particular period, or the failure of the Companys backlog to result in future revenue, could negatively impact the Companys business, financial condition and results of operations.



FIXED OPERATING EXPENSES AND THE COMPANYS PRACTICE OF ORDERING MATERIALS IN
ANTICIPATION OF FUTURE CUSTOMER DEMAND COULD MAKE IT DIFFICULT FOR THE COMPANY TO RESPOND EFFECTIVELY TO SUDDEN SWINGS IN DEMAND AND RESULT IN HIGHER THAN EXPECTED COSTS AND EXCESS INVENTORY. SUCH SUDDEN SWINGS IN DEMAND COULD THEREFORE HAVE A
MATERIALLY ADVERSE IMPACT ON THE COMPANYS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.



The Companys operating expenses are relatively fixed in the short to medium term, and, therefore, it has limited ability to reduce expenses quickly and sufficiently in response to any revenue shortfall. In
addition, the Company typically plans its production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. From time to time, in response to anticipated long lead times
to obtain inventory and materials from the Companys outside suppliers and foundries, the Company may order materials in advance of anticipated customer demand. This advance ordering may result in excess inventory levels or unanticipated
inventory write-downs if expected orders fail to materialize. This incremental cost could have a materially adverse impact on the Companys business, financial condition and results of operations.



THE COMPANY MAY BE UNABLE TO PROTECT ITS INTELLECTUAL PROPERTY RIGHTS, WHICH COULD HARM
THE COMPANYS COMPETITIVE POSITION.



The Companys ability to
compete is affected by its ability to protect its intellectual property rights. The Company relies on a combination of patents, trademarks, copyrights, mask work registrations, trade secrets, confidentiality procedures and non-disclosure and
licensing arrangements to protect its intellectual property rights. Despite these efforts, the Company may be unable to protect its proprietary information. Such intellectual property rights may not be recognized or if recognized, it may not be
commercially feasible to enforce. Moreover, the Company cannot be certain that its competitors will not independently develop technology that is substantially similar or superior to the Companys technology.



38



---

More specifically, the Company cannot be sure that its pending patent applications or any future applications will be
approved, or that any issued patents will provide it with competitive advantages or will not be challenged by third parties. Nor can the Company be sure that, if challenged, the Companys patents will be found to be valid or enforceable, or
that the patents of others will not have an adverse effect on the Companys ability to do business. Furthermore, others may independently develop similar products or processes, duplicate the Companys products or processes or design around
any patents that may be issued to the Company.



THE COMPANY COULD BE
REQUIRED TO PAY SUBSTANTIAL DAMAGES OR COULD BE SUBJECT TO VARIOUS EQUITABLE REMEDIES IF IT WERE PROVEN THAT IT INFRINGED THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS.



As a general matter, the semiconductor industry is characterized by substantial litigation regarding patents and other intellectual property
rights. If a third party were to prove that the Companys technology infringed a third partys intellectual property rights, the Company could be required to pay substantial damages for past infringement and could be required to pay
license fees or royalties on future sales of the Companys products. If the Company were required to pay such license fees whenever it sold its products, such fees could exceed the Companys revenue. In addition, if it were proven that the
Company willfully infringed a third partys proprietary rights; the Company could be held liable for three times the amount of the damages that the Company would otherwise have to pay. Such intellectual property litigation could also require
the Company to:



| |  | stop selling, incorporating or using its products that use the infringed intellectual property;
|- |  | -----------------------------------------------------------------------------------------------



| |  | obtain a license to make, sell or use the relevant technology from the owner of the infringed intellectual property, which license may not be available on commercially reasonable
terms, if at all; and/or
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | redesign the Companys products so as not to use the infringed intellectual property, which may not be technically or commercially feasible.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------



Furthermore, the defense of infringement claims and lawsuits, regardless of their outcome,
would likely be expensive to resolve and could require a significant portion of managements time. In addition, rather than litigating an infringement matter, the Company may determine that it is in the Companys best interests to settle
the matter. Terms of a settlement may include the payment of damages and the Companys agreement to license technology in exchange for a license fee and ongoing royalties. These fees could be substantial. If the Company were required to pay
damages or otherwise became subject to such equitable remedies, its business, financial condition and results of operations would suffer. Similarly, if the Company were required to pay license fees to third parties based on a successful infringement
claim brought against it, such fees could exceed the Companys revenue.



THE COMPANYS STOCK PRICE IS VOLATILE.



The market price
of the Companys common stock has fluctuated significantly to date. In the future, the market price of its common stock could be subject to significant fluctuations due to:



| |  | the Companys anticipated or actual operating results;
|- |  | ------------------------------------------------------



| |  | announcements or introductions of new products by the Company or its competitors;
|- |  | ---------------------------------------------------------------------------------



| |  | technological innovations by the Company or its competitors;
|- |  | ------------------------------------------------------------



| |  | product delays or setbacks by the Company, its customers or its competitors;
|- |  | ----------------------------------------------------------------------------



| |  | potential supply disruptions;
|- |  | -----------------------------



| |  | sales channel interruptions;
|- |  | ----------------------------



| |  | concentration of sales among a small number of customers;
|- |  | ---------------------------------------------------------



39



---

| |  | conditions in the communications and semiconductor markets;
|- |  | -----------------------------------------------------------



| |  | the commencement and/or results of litigation;
|- |  | ----------------------------------------------



| |  | changes in estimates of the Companys performance by securities analysts;
|- |  | -------------------------------------------------------------------------



| |  | decreases in the value of its investments, thereby requiring an asset impairment charge against earnings;
|- |  | ---------------------------------------------------------------------------------------------------------



| |  | the Companys repurchasing shares of its common stock;
|- |  | ------------------------------------------------------



| |  | announcements of merger or acquisition transactions;
|- |  | ----------------------------------------------------



| |  | the impact of expensing stock options; and /or
|- |  | ----------------------------------------------



| |  | general global economic and market conditions.
|- |  | ----------------------------------------------



In the past, securities and class action litigation has been brought against companies following periods of volatility in the market prices of their securities. The
Company may be the target of one or more of these class action suits, which could result in significant costs and divert managements attention, thereby harming the Companys business, results of operations and financial condition.



In addition, in recent years the stock market has experienced extreme price
and volume fluctuations that have affected the market prices of many high technology companies, including semiconductor companies, and that have often been unrelated or disproportionate to the operating performance of those companies. These
fluctuations may harm the market price of the Companys common stock.



EARTHQUAKES AND OTHER NATURAL DISASTERS MAY DAMAGE THE COMPANYS FACILITIES OR THOSE OF ITS SUPPLIERS.



The Companys corporate headquarters in Fremont, California is located near major earthquake faults that have experienced seismic activity. In addition, some of the
Companys customers and suppliers are located near fault lines. In the event of a major earthquake or other natural disaster near its headquarters, the Companys operations could be disrupted. Similarly, a major earthquake or other natural
disaster affecting one or more of the Companys major customers or suppliers could adversely impact the operations of those impacted, which could disrupt the supply of the Companys products and harm its business.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Foreign Currency Fluctuations. The Company is exposed to foreign currency fluctuations primarily through its foreign operations. This exposure is the result of foreign operating expenses being denominated in
foreign currency. Operational currency requirements are typically forecasted for a three-month period. If there is a need to hedge this risk, the Company may enter into transactions to purchase currency in the open market or enter into forward
currency exchange contracts.



If the Companys foreign operations
forecasts are overstated or understated during periods of currency volatility, the Company could experience unanticipated currency gains or losses. For the three and nine months ended December 31, 2005, the Company did not have significant
foreign currency denominated net assets or net liabilities, and had no foreign currency contracts outstanding.



Interest Rate Sensitivity.The Company maintains investment portfolio holdings of various issuers, types and maturity dates with various banks and investment banking institutions. The market value of these
investments on any given day during the investment term may vary as a result of market interest rate fluctuations. This exposure is not hedged because a hypothetical 10% movement in interest rates during the investment term would not likely have a
material impact on investment income. The actual impact on investment income in the future may differ materially from this analysis, depending on actual balances and changes in the timing and the amount of interest rate movements.



40



---

Both short-term and long-term investments are classified as available-for-sale securities and the cost of
securities sold is based on the specific identification method. At December 31, 2005, short-term investments consisted of government and corporate securities of $143.8 million. The Company did not have long-term investments at December 31,
2005. At December 31, 2005, the difference between the fair market value and the underlying cost of such investments was an unrealized loss of $1.3 million, before the effect of income taxes.



The Companys net income is dependent on, among other factors, interest income and
realized gains from the sale of marketable securities. If interest rates decline or the Company is unable to realize gains from the sale of marketable securities, the Companys net income may be negatively impacted.



ITEM 4. CONTROLS AND PROCEDURES



Disclosure Controls and Procedures.



Evaluation of
Disclosure Controls and Procedures (Disclosure Controls). The Company evaluated the effectiveness of the design and operation of its Disclosure Controls, as defined by the rules and regulations of the SEC (the
Evaluation), as of the end of the period covered by this Form 10-Q. This Evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer (CEO) and Chief Financial
Officer (CFO).



CEO and CFO Certifications. Attached
as Exhibits 31.1 and 31.2 of this Form 10-Q are the certifications of the CEO and the CFO in compliance with Section 302 of the Sarbanes-Oxley Act of 2002 (Certifications). This section of the Form 10-Q provides information
concerning the Evaluation referred to in the Certifications and should be read in conjunction with the Certifications.



Disclosure Controls. Disclosure Controls are controls and procedures designed to ensure that information required to be disclosed in the reports filed under
the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods as specified in the SECs rules and forms. In addition, Disclosure Controls are designed to allow for the accumulation and
communications of information to the Companys management, including the CEO and CFO, to allow timely decisions regarding required disclosures.



Effectiveness of Disclosure Controls. The Companys management, including the CEO and CFO, does not expect that the Disclosure Controls will prevent
all errors and all fraud. Disclosure Controls, no matter how well conceived, managed, utilized and monitored, can provide only reasonable assurance that the objectives of such controls are met. Therefore, because of the inherent limitation of the
Disclosure Controls, no evaluation of such controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.



Conclusion. Based on the Evaluation, the CEO and CFO have concluded that the Companys Disclosure Controls are effective.



Changes in Internal Control Over Financial Reporting.



Internal Control Over Financial Reporting. There was no change in the
Companys internal control over financial reporting that occurred during the period covered by this quarterly report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Companys internal control
over financial reporting.



41



---

PART II  OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



On
November 16, 2004, Ericsson Wireless Communications, Inc. initiated a lawsuit against Exar Corporation in San Diego Superior Court. In its first and second amended complaints, Ericsson asserts causes of action for negligence, strict product
liability, and unfair competition against Exar. Through its complaint, Ericsson seeks unspecified monetary damages and unspecified injunctive relief. The case is based on Ericssons purchase of allegedly defective products from Vicor
Corporation, a former customer of Exar to whom Exar sold untested semi-custom wafers. Exar answered Ericssons Second Amended Complaint on March 21, 2005. The Court has set a trial date of September 29, 2006 and discovery is
continuing. Exar disputes the allegations in Ericssons first and second amended complaints and intends to defend the lawsuit vigorously. At this stage of the litigation and without additional information, Exar is unable to determine
the probability that the claim asserted by Ericsson will result in liability. As of the date of this Report, Exar does not believe that the litigation will have a material impact on its financial condition, results of operations, or
liquidity.



On April 15, 2005, Vicor filed a cross-complaint against Exar
in San Diego Superior Court. In the cross-complaint, Vicor alleged, among other things, that Exar sold it integrated circuits that were defective, that failed to meet agreed-upon specifications, and that Exar intentionally concealed material
facts regarding the specifications of the integrated circuits that Vicor alleges it bought from Exar. In its cross-complaint, Vicor alleges that it is entitled to indemnification from Exar for any damages that Vicor must pay to Ericsson as a
result of the causes of action asserted by Ericsson against Vicor. Vicor asserted causes of action against Exar for breach of contract, breach of express contract warranty, breach of implied warranties of merchantability and fitness, breach of
the covenant of good faith and fair dealing, fraud, negligence, strict liability, implied contractual indemnity, and equitable indemnity. On May 9, 2005, Exar filed a demurrer to all but one of the indemnity causes of action in
Vicors Cross-Complaint. On June 17, 2005, the San Diego Superior Court sustained Exars demurrer to all of Vicors causes of action except the claims for implied contractual indemnity and equitable indemnity without leave
to amend. Exar answered the two remaining causes of action on July 5, 2005. Trial on the cross-complaint asserted by Vicor is scheduled for September 29, 2006. Exar disputes the allegations in Vicors cross-complaint and intends to
defend the lawsuit vigorously. At this stage of the litigation and without additional information, Exar is unable to determine the probability that the claim asserted by Vicor will result in liability. As of the date of this Report, Exar
does not believe that the litigation will have a material impact on its financial condition, results of operations, or liquidity.



On March 4, 2005, Exar filed a complaint in Santa Clara Superior Court against Vicor. In the complaint, Exar sought a declaration regarding the respective
rights and obligations, including warranty and indemnity rights and obligations, under the written contracts between Exar and Vicor for the sale of untested, semi-custom wafers. In addition, Exar sought a declaration that it was not responsible
for any damages that Vicor must pay to Ericsson or any other customer of Vicor arising from claims that Vicor sold allegedly defective products.



On March 17, 2005, Vicor filed a cross-complaint against Exar and Rohm Device USA, LLC and Rohm Co., Ltd, the owners and operators of the foundry which supplied the
untested, semi-custom wafers that Exar sold to Vicor. In the cross-complaint, Vicor alleged, among other things, that Exar sold it integrated circuits that were defective, that failed to meet agreed-upon specifications, and that Exar
intentionally concealed material facts regarding the specifications of the integrated circuits that Vicor alleges it bought from Exar. In its cross-complaint, Vicor also alleges that it is entitled to indemnification from Exar for any damages
that Vicor must pay to Ericsson and other Vicor customers as a result of the causes of action asserted by Ericsson in the San Diego case discussed above and any other claims that may be made against Vicor. In the cross-complaint, Vicor asserted
causes of action against Exar for breach of contract, breach of express contract warranty, breach of implied warranties of merchantability and fitness, breach of covenant of good faith and fair dealing, fraud, negligence, strict liability, implied
contractual indemnity, and equitable indemnity. On May 23, 2005, Exar filed a demurrer to each cause of action in Vicors cross-complaint in Santa Clara County. On July 15, 2005, the Santa Clara Superior Court sustained
Exars demurrer to each of the causes of action asserted by Vicor. The Court granted Vicor leave to amend the cross-complaint to assert a cause of action for declaratory relief only. On August 1, 2005, Vicor filed its amended
cross-complaint seeking a declaration of the parties respective rights and obligations, including warranty and indemnity rights, under the alleged contracts between Exar and Vicor for the sale of untested, semi-custom wafers. In addition, Vicor
sought a declaration that Exar was obligated to indemnify it for any damages resulting from claims brought against Vicor by its customers. No trial date has been set in the matter. Exar disputes the allegations in Vicors cross-



42



---

complaint and intends to defend the lawsuit vigorously. At this stage of the litigation and without additional information, Exar is unable to determine
the probability that the claim asserted by Vicor will result in liability. As of the date of this Report, Exar does not believe that the litigation will have a material impact on its financial condition, results of operations, or liquidity.



ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES



Issuer Purchases of Equity Securities



The following is a summary of share repurchase activity during the quarter ended December 31, 2005:



|                   |  |                                |  |                           |       |                                                                              |           |                                                                                              |   |       
|------------------ |  | ------------------------------ |  | ------------------------- | ----- | ---------------------------------------------------------------------------- | --------- | -------------------------------------------------------------------------------------------- | - | ------
|Period             |  | Total Numberof SharesPurchased |  | AveragePricePaid perShare |       | TotalNumber ofSharesPurchasedas Part ofPubliclyAnnouncedPlans orPrograms (1) |           | MaximumDollar Valueof Shares thatMay Yet BePurchasedUnder thePlans
orPrograms (in thousands)
|through 9/30/2005  |  |                               |  |                           |      |                                                                              | 8,097,110 |                                                                                              | $ | 30,344
|10/1/05 - 10/31/05 |  |                               |  |                           |      |                                                                              |          |                                                                                              |   |       
|11/1/05 - 11/30/05 |  | 170,000                        |  | $                         | 13.24 |                                                                              | 170,000   |                                                                                              | $ | 28,094
|12/1/05 - 12/31/05 |  |                               |  |                           |      |                                                                              |          |                                                                                              |   |       
|                   |  |                                |  |                           |       |                                                                              |           |                                                                                              |   |       
|Totals             |  | 170,000                        |  | $                         | 13.24 |                                                                              | 8,267,110 |                                                                                              | $ | 28,094
|                   |  |                                |  |                           |       |                                                                              |           |                                                                                              |   |       

---

|(1) | In March 2001, the Board of Directors authorized a stock repurchase program to acquire outstanding common stock in the open market. Under this program, the Board of Directors
authorized the acquisition of up to $40.0 million of Exars common stock. In the future, the Company may make additional purchases of its common stock under its stock repurchase program, which would reduce cash, cash equivalents and/or
short-term marketable securities available to fund future operations and meet other liquidity requirements.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



On July 25, 2005, the Company commenced a Modified Dutch Auction Self Tender Offer to acquire up to 7,500,000 (including the
Companys authorized over-allotment) shares of its common stock at a purchase price of not greater than $17.00 nor less than $15.00 per share, reserving the right to purchase up to an additional 2% of the Companys outstanding shares. Such
offer expired on August 23, 2005. In connection with such tender offer, the Company repurchased 7,500,000 shares (including the Companys authorized over-allotment) of its common stock at a purchase price of $16.00 per share, resulting in
aggregate payments of $120.0 million plus costs of approximately $809,000.



43



---

ITEM 6. EXHIBITS



| | (a) | Exhibits required by Item 601 of Regulation S-K
| | --- | -----------------------------------------------



Exhibits filed with the current Report on Form 10-Q for the quarter ended December 31, 2005 are as follows:



|              |  |                                                     
|------------- |  | ----------------------------------------------------
|ExhibitNumber |  | Description                                         
|31.1          |  | Section 302 Chief Executive Officer Certification   
|              | 
|31.2          |  | Section 302 Chief Financial Officer Certification   
|              | 
|32.1          |  | Section 906 Certification of Chief Executive Officer
|              | 
|32.2          |  | Section 906 Certification of Chief Financial Officer



44



---

SIGNATURES



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



|                 |  |                               |  |                                                                                                                                                   
|---------------- |  | ----------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|                 |  | EXAR CORPORATION (Registrant)
|                 |  |                              
|February 7, 2006 |  | By:                           |  | /s/ ROUBIK GREGORIAN                                                                                                                              
|                 |  |                               |  | (Roubik Gregorian) Chief Executive Officer, President, and Director (Principal Executive
Officer)                                                 
|                 |  |                              
|February 7, 2006 |  | By:                           |  | /s/ RONALD W. GUIRE                                                                                                                               
|                 |  |                               |  | (Ronald W. Guire) Executive Vice President, Chief Financial Officer, Assistant Secretary and Director
(Principal Financial and Accounting Officer)



45