This management's discussion and analysis should be read in conjunction with the other sections of this Form 10-K, including Part 1, "Item 1: Business"; Part II, "Item 1A: Risk Factors"; Part II, "Item 6: Selected Financial Data"; and

Where more than one significant factor contributed to changes in results from year to year, we have quantified these factors throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where practicable and material to understanding a material change included in the discussion.

OVERVIEW

We design, develop and market complex, high-performance semiconductors and storage systems. We provide silicon-to-system solutions that are used at the core of products that create, store, consume and transport digital information. We offer a broad portfolio of capabilities including custom and standard product integrated circuits used in hard disk drives, high-speed communication systems, computer servers, storage systems and personal computers. We also offer external storage systems and host bus adapter boards and software applications for attaching storage devices to computer servers and for storage area networks.

We operate in two segments - the Semiconductor segment and the Storage Systems segment. For the Semiconductor segment, we sell our integrated circuits for storage applications to makers of hard disk drives and computer servers. We sell our integrated circuits for networking applications principally to makers of devices used in computer and communications networks and, to a lesser extent, to makers of personal computers. For the Storage Systems segment, we sell our storage systems, host adapter boards and software applications for attaching storage devices to computer servers and for storage area networks to original equipment manufacturers, or OEMs, who resell those products to end customers under their own brand name. We also generate revenue by licensing other entities to use our intellectual property primarily in the Semiconductor segment.

Our revenues depend on market demand for these types of products and our ability to compete in highly competitive markets. We face competition not only from makers of products similar to ours, but also from competing technologies. For example, we see the development of solid state drives, based on flash memory rather than the spinning platters used in hard disk drives, as a long-term potential competitor to certain types of hard disk drives, and have begun focusing development efforts in that area.

Recently, the U.S. and global economies have experienced a significant downturn driven by a financial and credit crisis that could continue to challenge such economies for some period of time. In the fourth quarter of 2008, our revenues declined significantly as compared to our revenues in the third quarter due to the global economic downturn. As our outlook continued to deteriorate into January 2009, we took a number of actions to reduce our expenses, including a corporate-level restructuring designed to increase synergies across our semiconductor investment, a 5% reduction of our global workforce, reductions in employee compensation-related expenses and reductions in discretionary spending.

Our business is currently focused on providing integrated circuits for storage and networking applications and on providing storage systems and related boards and software, where we believe we have the scale, technology and customer relationships to be most successful. Since the beginning of 2007, we have completed the following actions as part of our efforts to focus on those areas:

• The acquisition of SiliconStor, Inc., a provider of semiconductor solutions for enterprise storage networks, in March 2007;

• The acquisition of Agere in April 2007 through the merger of Agere and a subsidiary of ours. Agere was a provider of integrated circuit solutions for a variety of communications and computing applications;

• The sale of our Consumer Products Group in July 2007;

• The sale of our Mobility Products Group in October 2007;

• The sale of, or discontinuation of operations at, our semiconductor and storage systems assembly and test facilities, and the transition of the work performed at those facilities to contract manufacturers between mid-2007 and mid-2008;

• The acquisition of Tarari, Inc., a maker of silicon and software that provides content and application awareness in packet and message processing, in October 2007; and

• The acquisition of the hard disk drive semiconductor business of Infineon Technologies AG in April 2008.

Our revenues for the year ended December 31, 2008 were $2,677.1 million, an increase of $73.5 million, compared to $2,603.6 million for the year ended December 31, 2007. The increase in revenues was primarily attributable to a full year of revenues from Agere in 2008 and increased demand for semiconductors used in storage and networking product applications, for our entry level storage systems and for our premium feature and direct-attached storage software products. The increase was offset by the absence of revenues from the Mobility and Consumer Product Groups.

We reported a net loss of $622.3 million, or $0.96 per diluted share, for the year ended December 31, 2008, as compared to a net loss of $2,486.8 million, or $3.87 per diluted share, for the year ended December 31, 2007. During the years ended December 31, 2008 and 2007, we recognized goodwill impairment charges of $364.1 million and $2,019.9 million in the Semiconductor segment in the respective years. In addition, we recognized $177.5 million and $1.6 million in charges for the impairment of other intangible assets in the Semiconductor segment for the years ended December 31, 2008 and 2007, respectively.

For the year ended December 31, 2008, we recorded restructuring of operations and other items, net of $43.7 million compared to $148.1 million for the year ended December 31, 2007. The 2007 restructuring of operations related primarily to the sale of the Mobility Products Group. For the year ended December 31, 2007, we recorded a $188.9 million charge for acquired in-process research and development primarily associated with the merger with Agere on April 2, 2007. We did not record any charge related to acquired in-process research and development during the year ended December 31, 2008.

Cash, cash equivalents and short-term investments were $1,119.1 million as of December 31, 2008, as compared to $1,397.6 million as of December 31, 2007. For the year ended December 31, 2008, we generated $278.1 million in cash from operating activities as compared to $295.0 million for the year ended December 31, 2007.

RESULTS OF OPERATIONS

Revenues

The following table summarizes our revenues by segment for the years ended
December 31, 2008, 2007 and 2006:


                                              Year Ended December 31,
                                         2008          2007          2006
                                                   (In millions)

             Semiconductor segment     $ 1,795.1     $ 1,778.9     $ 1,223.1
             Storage Systems segment       882.0         824.7         759.0

             Consolidated              $ 2,677.1     $ 2,603.6     $ 1,982.1

2008 compared to 2007:

Total consolidated revenues for 2008 increased $73.5 million or 2.8% as compared to 2007.

Semiconductor Segment:

Revenues for the Semiconductor segment increased $16.2 million or 0.9% in 2008 as compared to 2007. The increase was primarily attributable to:

• Increased demand for semiconductors used in storage and networking product applications, primarily the result of a full year of revenues from Agere in 2008; and

• Revenues from the HDD semiconductor business acquired from Infineon in April 2008.

The increase was partially offset by the absence of $213.1 million and $54.6 million of revenues from the Mobility Products Group and the Consumer Products Group, respectively.

Storage Systems Segment:

Revenues for the Storage Systems segment increased $57.3 million or 6.9% in 2008 as compared to 2007. The increase was primarily attributable to an increase in revenues for our entry level storage systems and a continued increase in demand for our premium feature and direct-attached storage software products, partially offset by a decline in the sales of our mid-range storage systems.

See Note 9 to our consolidated financial statements in Item 8 for information about our significant customers.

2007 compared to 2006:

Total consolidated revenues for 2007 increased $621.5 million or 31.4% as compared to 2006, primarily due to the merger with Agere in April 2007.

Semiconductor Segment:

Revenues for the Semiconductor segment increased $555.8 million or 45.4% in 2007 as compared to 2006. The increase was primarily due to revenues attributable to Agere of $821.5 million and, to a lesser extent, increased demand for semiconductors used in storage product applications associated with the ramping of our Serial Attached SCSI, or SAS, products.

The increase was partially offset by:

• A decrease in revenues from consumer products due to the sale of the Consumer Products Group;

• A decrease in demand for semiconductors used in consumer product applications such as digital audio players where our customer's solution was not included in the new generation of its customer's products and a decrease in demand for semiconductors used in DVD products and cable set-top box solutions;

• A decrease in demand for semiconductors used in storage interface connect products; and

• A decrease in demand for semiconductors used in communication product applications such as enterprise networking, telecommunications and printing.

Storage Systems Segment:

Revenues for the Storage Systems segment increased $65.7 million or 8.7% in 2007 as compared to 2006. The increase was primarily attributable to:

• An increase in sales due to the ramp of our entry level storage products, which were introduced in the fourth quarter of 2006;

• An increase in demand for our premium feature software products; and

• Continued strength in our mid-range storage systems.

The increase was partially offset by decreased revenues for our RAID storage adapters due to lower hardware sales.

Revenues by Geography

The following table summarizes our revenues by geography for the years ended
December 31, 2008, 2007 and 2006:


                                                Year Ended December 31,
                                           2008          2007          2006
                                                     (In millions)

            North America*               $   737.2     $   858.7     $   956.7
            Asia**                         1,359.8       1,401.3         797.1
            Europe and the Middle East       580.1         343.6         228.3

            Total                        $ 2,677.1     $ 2,603.6     $ 1,982.1

* Primarily the United States.

** Including Japan.

2008 compared to 2007:

Revenues in Europe and the Middle East increased 68.8% in 2008 compared to 2007. The increase was primarily attributable to increased revenues in storage systems and increased revenues in semiconductors used in storage product applications. The increase in European revenues for storage systems was primarily the result of a significant customer shifting order placements from our U.S. subsidiary to a subsidiary in Europe. Revenues in North America decreased 14.1%. The decrease in North America was primarily attributable to decreased revenues in storage systems primarily for the reason discussed above, offset by increased revenues from semiconductors used in storage and networking standard products.

2007 compared to 2006:

Revenues in Europe and the Middle East increased 50.5% in 2007 compared to 2006. The increase was primarily attributable to an increase in revenues associated with the merger with Agere, increased revenues in storage systems and increased revenues in semiconductors used in storage product applications. Revenues in Asia increased 75.8% in 2007. The increase in Asia was primarily attributable to revenues from Agere and increased revenues in semiconductors used in storage product applications, offset in part by a decrease in revenues from the Consumer Products Group and decreased revenues from semiconductors used in communication product applications. Revenues in North America decreased 10.2%. The decrease in North America was primarily attributable to decreased revenues from semiconductors used in consumer product applications, offset in part by increased storage system revenues, increased revenues from semiconductors used in storage product applications and revenues from Agere.

Gross Profit Margin

The following table summarizes our gross profit margins by segment for the years
ended December 31, 2008, 2007 and 2006:


                                                  Year Ended December 31,
                                               2008         2007        2006
                                                   (Dollars in millions)

            Semiconductor segment            $   736.9     $ 603.7     $ 561.7
            Percentage of segment revenues        41.1 %      33.9 %      45.9 %
            Storage Systems segment          $   332.1     $ 300.2     $ 261.5
            Percentage of segment revenues        37.7 %      36.4 %      34.5 %

            Consolidated                     $ 1,069.0     $ 903.9     $ 823.2

            Percentage of total revenues          39.9 %      34.7 %      41.5 %

Amortization of intangibles, which was previously reported as a separate component of operating expenses, has been reclassified to cost of revenues for the year ended December 31, 2006 for consistency.

2008 compared to 2007:

The consolidated gross profit margin as a percentage of total revenues increased to 39.9% in 2008 from 34.7% in 2007.

Semiconductor Segment:

The gross profit margin as a percentage of segment revenues for the Semiconductor segment increased to 41.1% in 2008 from 33.9% in 2007. The increase in 2008 was primarily attributable to:

• Increased sales of products with higher gross profit margins in 2008;

• An inventory charge of $47.9 million recorded in the second quarter of 2007 related to fair valuing the inventory in the acquisition of Agere;

• A decrease in inventory provisions from 2007 to 2008 primarily as a result of improvements in supply chain management; and

• $19.0 million in charges recorded in 2007 for a wafer supply agreement with ON Semiconductor resulting from a decline in demand.

Storage Systems Segment:

The gross profit margin as a percentage of segment revenues for the Storage Systems segment increased to 37.7% in 2008 from 36.4% in 2007. The increase was primarily driven by lower manufacturing costs across the product lines and higher demand for our premium feature and direct-attached storage software products, which have higher margins.

2007 compared to 2006:

The consolidated gross profit margin as a percentage of total revenues declined to 34.7% in 2007 from 41.5% in 2006. This primarily reflects a decrease in Semiconductor segment gross margins caused in large part by the merger with Agere.

Semiconductor Segment:

The gross profit margin as a percentage of segment revenues for the Semiconductor segment decreased to 33.9% in 2007 from 45.9% in 2006. The decline was primarily attributable to:

• An increase of $143.2 million in the amortization of intangible assets in 2007 primarily related to the acquisition of Agere;

• An inventory charge of $47.9 million in 2007 related to fair valuing the inventory in the acquisition of Agere; and

• $19.0 million in charges recorded in 2007 for a wafer supply agreement with ON Semiconductor resulting from a decline in demand.

Storage Systems Segment:

The gross profit margin as a percentage of segment revenues for the Storage Systems segment increased to 36.4% in 2007 from 34.5% in 2006. This increase was primarily driven by lower manufacturing costs across the mid-range product line and higher demand for premium feature and direct-attached storage software products, which have higher margins.

Research and Development

The following table summarizes our research and development, or R&D, expenses by
segment for the years ended December 31, 2008, 2007 and 2006:


                                                 Year Ended December 31,
                                               2008        2007        2006
                                                  (Dollars in millions)

            Semiconductor segment            $  534.0     $ 525.4     $ 315.9
            Percentage of segment revenues       29.7 %      29.5 %      25.8 %
            Storage Systems segment          $  138.5     $ 129.8     $  97.5
            Percentage of segment revenues       15.7 %      15.7 %      12.8 %

            Consolidated                     $  672.5     $ 655.2     $ 413.4

            Percentage of total revenues         25.1 %      25.2 %      20.9 %

2008 compared to 2007:

Consolidated R&D expenses increased $17.3 million or 2.6% in 2008 as compared to 2007.

Semiconductor Segment:

R&D expenses for the Semiconductor segment consist primarily of employee salaries, costs related to third party design tools and materials used in the design of custom silicon and standard products, as well as depreciation of capital equipment and facilities-related expenditures. In 2008, we focused our R&D efforts in the storage and networking markets.

R&D expenses for the Semiconductor segment increased by $8.6 million or 1.6% in 2008 as compared to 2007 and increased slightly as a percentage of segment revenues from 29.5% in 2007 to 29.7% in 2008. The increase was attributable to the merger with Agere, partially offset by reduced expenditures resulting from the sale of the Mobility and Consumer Product Groups, headcount reductions from our restructuring actions and decreased spending related to third party design tools used in the design of custom silicon and standard products.

Storage Systems Segment:

R&D expenses for the Storage Systems segment consist primarily of employee salaries and materials used in product development, as well as depreciation of capital equipment and facilities. In addition to the significant resources required to support hardware technology transitions, we devote significant resources to developing and enhancing software features and functionality to remain competitive.

R&D expenses for the Storage Systems segment increased $8.7 million or 6.7% in 2008 as compared to 2007. The increase was primarily attributable to increased compensation-related expenditures as well as increased material spending for R&D projects associated with new product development. R&D expenses as a percentage of segment revenues remained flat at 15.7% in 2008 and 2007.

2007 compared to 2006:

Consolidated R&D expenses increased $241.8 million or 58.5% in 2007 as compared to 2006. This reflects increases in R&D expenditures, both in dollar amounts and as a percentage of revenues, in both segments, primarily as a result of the Agere acquisition.

Semiconductor Segment:

R&D expenses for the Semiconductor segment increased $209.5 million or 66.3% in 2007 as compared to 2006 and increased as a percentage of segment revenues to 29.5% in 2007 from 25.8% in 2006. The increase was primarily attributable to the acquisition of Agere, SiliconStor and Tarari during 2007. The increase was partially offset by reduced expenditures resulting from the sale of the Consumer Products Group and headcount reductions

from our restructuring actions during 2007. In 2007, we focused our R&D efforts in the storage and networking markets.

Storage Systems Segment:

R&D expenses for the Storage Systems segment increased by $32.3 million or 33.1% in 2007 as compared to 2006 and increased as a percentage of segment revenues to 15.7% in 2007 from 12.8% in 2006. The increase was primarily attributable to the acquisition of StoreAge and increased compensation-related expenditures due to an increase in headcount, increased spending for R&D projects associated with new product lines and expenses related to a contract with a significant customer.

Selling, General and Administrative

The following table summarizes our selling, general and administrative, or SG&A,
expenses by segment for the years ended December 31, 2008, 2007 and 2006:


                                                 Year Ended December 31,
                                               2008        2007        2006
                                                  (Dollars in millions)

            Semiconductor segment            $  278.6     $ 264.1     $ 157.4
            Percentage of segment revenues       15.5 %      14.8 %      12.9 %
            Storage Systems segment          $  128.3     $ 117.3     $  98.2
            Percentage of segment revenues       14.5 %      14.2 %      12.9 %

            Consolidated                     $  406.9     $ 381.4     $ 255.6

            Percentage of total revenues         15.2 %      14.6 %      12.9 %

2008 compared to 2007:

Consolidated SG&A expenses increased $25.5 million or 6.7% in 2008 as compared to 2007.

Semiconductor Segment:

SG&A expenses for the Semiconductor segment increased $14.5 million or 5.5% in 2008 as compared to 2007 and increased as a percentage of segment revenues from 14.8% in 2007 to 15.5% in 2008. The increase was attributable to the merger with Agere, partially offset by reduced expenditures resulting from the sale of the Mobility and Consumer Product Groups as well as headcount reductions from our restructuring actions.

Storage Systems Segment:

SG&A expenses for the Storage Systems segment increased $11.0 million or 9.4% in 2008 as compared to 2007 and increased as a percentage of segment revenues from 14.2% in 2007 to 14.5% in 2008. The increase was primarily attributable to an increase in sales and marketing expenditures to support higher revenues in 2008 compared to 2007.

2007 compared to 2006:

Consolidated SG&A expenses increased $125.8 million or 49.2% in 2007 as compared to 2006.

Semiconductor Segment:

SG&A expenses for the Semiconductor segment increased $106.7 million or 67.8% in 2007 as compared to 2006 and increased as a percentage of segment revenues to 14.8% in 2007 from 12.9% in 2006. The increase in the amount and as a percentage of segment revenues was primarily attributable to the merger with Agere, partially offset by reduced expenditures as a result of headcount reductions from our restructuring actions and decreased selling expenses due to the sale of the Consumer Products Group.

Storage Systems Segment:

SG&A expenses for the Storage Systems segment increased $19.1 million or 19.5% in 2007 as compared to 2006 and increased as a percentage of segment revenues to 14.2% in 2007 from 12.9% in 2006. The increase in the amount and as a percentage of revenues was primarily attributable to the additional expenses resulting from the acquisition of StoreAge, increased compensation-related expenses based on increased headcount and an increase in sales commissions due to increased revenues.

Restructuring of Operations and Other Items

A complete discussion of our restructuring actions in 2008, 2007 and 2006 is included in Note 2 to our consolidated financial statements in Item 8.

2008:

We recorded charges of $43.7 million in restructuring of operations and other items, net, for the year ended December 31, 2008, consisting of $35.5 million in charges for restructuring of operations and $8.2 million in charges for other items. Of these charges, $41.1 million were attributable to the Semiconductor segment and $2.6 million were attributable to the Storage Systems segment. The restructuring charges were largely related to severance and termination benefits for approximately 260 employees associated with a broad-based reorganization that was announced in January 2009 and lease termination costs. The charges were offset in part by a gain on the sale of land in Gresham, Oregon.

As a result of the recent restructuring action taken in January 2009, we expect to realize quarterly operating expense savings of approximately $7.0 million starting from the second quarter of 2009. Suspended depreciation amounted to $5.3 million for the period from January 1, 2008 to June 30, 2008 associated with holding the Singapore assembly and test facility for sale.

2007:

We recorded charges of $148.1 million in restructuring of operations and other items, net, for the year ended December 31, 2007, consisting of $142.9 million in charges for restructuring of operations and a charge of $5.2 million for other items. Of these charges, $143.4 million were recorded in the Semiconductor segment and $4.7 million were recorded in the Storage Systems segment. We completed the sale of our Consumer Products Group in the third quarter of 2007 and the sales of our semiconductor assembly and test operations in Thailand and our Mobility Products Group in the fourth quarter of 2007. We also announced the elimination of approximately 900 non-production positions, inclusive of the Consumer Products Group, across all business and functional areas worldwide in the second quarter of 2007, and in the third quarter of 2007 announced the elimination of approximately 2,100 production positions worldwide associated with the sale of our assembly and test operations in Thailand and our plan to transition assembly and test operations performed at our facilities in Singapore and Wichita, Kansas to current manufacturing partners.

2006:

We recorded a credit of $8.4 million in restructuring of operations and other items, net, for the year ended December 31, 2006. Of this amount, a credit of $9.6 million was recorded in the Semiconductor segment and a charge of $1.2 million was recorded in the Storage Systems segment. We sold the Gresham facility in the second quarter of 2006.

Goodwill and Other Intangible Asset Impairment Charges

We monitor the recoverability of goodwill and other intangible assets recorded in connection with acquisitions, by reporting unit, annually in our fourth quarter or sooner if events or changes in circumstances indicate that the . . .