Management's Discussion and Analysis of Financial Conditions and Results of Operations (MD&A) is provided to supplement the accompanying consolidated financial statements and notes in Item 8 to help provide an understanding of our financial condition, changes in our financial condition and results of operations. MD&A is organized as follows:

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

Overview. This section provides a general description of our business.

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

Results of operations. This section provides an analysis of our results of operations for the years ended December 31, 2008, 2007 and 2006. In addition, a brief description is provided of transactions and events that impact the comparability of the results.

Liquidity and capital resources. This section provides an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements. In this section, we also summarize related party transactions and recent accounting pronouncements not yet adopted by us.

Management's Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements that involve risks and uncertainties. When used in this report, the words, "intend," "anticipate," "believe," "estimate," "plan," "expect" and similar expressions as they relate to us are included to identify forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of factors, including those set forth under "Item 1A Risk Factors" and elsewhere in this report. You should read this discussion in conjunction with the consolidated financial statements and the notes thereto included in this report.

OVERVIEW

TranSwitch is a Delaware corporation incorporated on April 26, 1988. TranSwitch designs, develops and supplies innovative highly-integrated semiconductor solutions that provide core functionality for voice, data and video communications network equipment. TranSwitch end customers are the original equipment manufacturers ("OEMs") who supply wire-line and wireless network operators who provide voice, data and video services to end users such as consumers, corporations, municipalities etc. Our system-on-a-chip products incorporate digital and mixed-signal semiconductors and related embedded software. We serve the Voice over Internet Protocol (VoIP) and Fiber-To-The-Premises (FTTP), which is also known as optical networking, markets. We have over 200 active customers, including the leading global equipment providers, and our products are deployed in the networks of the major service providers around the world.

In addition to an extensive portfolio of standard integrated circuit products addressing voice, data, wireless and video markets, TranSwitch supplies a number of intellectual property core products for Ethernet and high definition video (HDMI protocol) applications and custom design services. Our combination of standard products, intellectual property cores and custom design services enables us to serve our customers needs more fully.

Our products and services are compliant with relevant communications network standards. We offer several products that combine multi-protocol capabilities on a single chip, enabling our customers to develop network equipment for triple play (voice, data and video) applications. A key attribute of our products is their inherent flexibility. Many of our products incorporate embedded programmable micro-processors, enabling us to rapidly accommodate new customer requirements or evolving network standards by modifying the functionality of the device via software instructions.

We bring value to our customers through our communications systems expertise, very large scale integration ("VLSI") design skills and commitment to excellence in customer support. Our emphasis on technical innovation results in defining and developing products that permit our customers to achieve faster time-to-market and to develop communications systems that offer a host of benefits such as greater functionality, improved performance, lower power dissipation, reduced system size and cost, and greater reliability for their customers.

Our revenues were $41.9 million in 2008, $32.6 million in 2007 and $38.9 million in 2006. 2008 was a successful year for TranSwitch. Our acquisition of Centillium further diversified our product portfolio to include rapidly growing Fiber-to-the-Home (FTTH) and Voice-over-Internet-Protocol (VoIP) solutions. The combination strengthens our leadership position in the next-generation communications semiconductor market. The combined companies will have greater scale, a significantly improved expense structure and a truly global reach.

We attained revenue growth in three of our four major product revenue categories as we continued to focus on the developing markets of Optical Transport, Broadband Access and Carrier Ethernet and VoIP. Part of this growth came from our acquisition of Centillium Communications, Inc., whose products are well positioned in the Broadband Access and VoIP markets. Our previous acquisitions of the ASIC Design Center Division of Data - JCE and Mysticom, Ltd. continue to provide successful diversification in the areas of ASIC customer specific telecom / non-telecom products and High Definition video processing, respectively. In addition to growing our revenue streams, we are focusing on improving our gross margin both by reducing costs on lower margin products and working to increase sales of higher margin products.

We continued our move toward profitability by reducing our operating loss from 2007 both in a dollar amount and as a percentage of revenue. This was achieved through strict cost control measures and the implementation of a force reduction plan in both TranSwitch and Centillium. We were also able to enter into an agreement with certain holders of our 2010 Notes to purchase $15.0 million of the aggregate principal amount for $9.9 million in cash, plus accrued and unpaid interest. This enabled us to reduce our long term debt by 60% and also realize a $4.5 million gain.

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

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

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

(1) recognizing net revenues, cost of revenues and gross profit;

(2) estimating allowances for doubtful accounts;

(3) estimating the derivative liability associated with our 5.45% Convertible Plus Cash Notes due 2007;

(4) estimating stock-based compensation;

(5) estimating values for goodwill and long-lived assets;

(6) estimating excess inventories;

(7) estimating restructuring liabilities; and

(8) estimating values of investments in non-publicly traded companies.

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

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

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

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

We warranty our products for up to one year from the date of shipment. Warranty expense is insignificant to all periods presented.

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

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

We also recognize revenue from royalties upon notification of sale by our licensees. The terms of the royalty agreements generally require licensees to give us notification and to pay royalties within 45 days of the end of the quarter during which the sales by the licensees take place.

Estimated Allowances for Doubtful Accounts. We record allowances for doubtful accounts for estimated losses based upon specifically identified amounts that we believe to be uncollectible along with our assessment of the general financial condition of our customer base. If our actual collections experience changes, revisions to our allowances may be required. We have a limited number of customers with individually large amounts due at any given balance sheet date. Any unanticipated change in one of those customers' creditworthiness or other matters affecting the collectibility of amounts due from such customers could have a material effect on our results of operations in the period in which such changes or events occur.

Derivative Liability Associated with our 5.45% Convertible Plus Cash Notes due 2007. In accordance with Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended (SFAS 133), the holder's conversion right contained in the terms governing our 5.45% Convertible Plus Cash Notes due 2007 (the "Plus Cash Notes") was not clearly and closely related to the characteristics of the Plus Cash Notes upon issuance. Accordingly, this feature qualified as an embedded derivative instrument and, because it does not qualify for any scope exception within SFAS 133, it is required by SFAS 133 to be accounted for separately from the debt instrument and recorded as a derivative financial instrument.

During the year ended December 31, 2008, there were no Plus Cash Notes outstanding. During the years ended December 31, 2007 and 2006, we recorded other income of $1.0 million and $5.1 million, respectively, all of which related to the holder's conversion right, to reflect the change in fair value of our derivative liability.

We adjust the derivative financial instruments to their estimated fair value and analyze the instruments to determine their classification as a liability or equity. As of December 31, 2008 and 2007, the estimated fair value of our derivative liability was zero as these Plus Cash Notes due 2007 were no longer outstanding. On July 6, 2007, the Company exchanged approximately $21.2 million aggregate principal amount of its outstanding Plus Cash Notes for an equivalent principal amount of a new series of 5.45% Convertible Notes due September 30, 2010 (the "2010 Notes"). The remaining $8.9 million balance of the Plus Cash Notes was redeemed at par value at the end of September, 2007. The estimated fair value of the holder's conversion right was determined using a lattice (trinomial) option-pricing model, while it was estimated.

Stock-based Compensation. Determining the amount of stock-based compensation for awards granted includes selecting an appropriate model to calculate fair value at the grant date. We have used the Black-Scholes option valuation model to value employee stock option awards. Certain inputs to this valuation model require considerable judgment. These inputs include estimating the volatility of our stock, the expected life of the option awarded and the forfeiture rate. We have estimated volatility, the expected life and the forfeiture rate based on historical data. Volatility is estimated over a term that approximates the expected life of the option awarded.

Goodwill and Long-Lived Assets. Our goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. We perform impairment reviews using a fair-value method based on management's judgments and assumptions. The fair value represents the amount at which an entity could be bought or sold in a current transaction between willing parties on an arms-length basis. In estimating fair value, we use our common's stock market price to determine fair value. Quoted market prices are the best evidence of fair value, and the market capitalization based on the Company's common stock price is apportioned based on revenue to the entity being tested for impairment. The estimated fair value is then compared with the carrying amount of the entity, including goodwill. In the case where an entities' estimated fair value would be lower than its carrying value, we would perform discounted cash flow analysis on the entity to determine fair value. If after a discounted cash flow analysis the entities estimated fair value is lower than its carrying value, we would retain independent appraisers to perform additional fair value calculations. We are subject to financial statement risk to the extent that the carrying amount exceeds the estimated fair value. The impairment testing performed by us at October 1, 2008 indicated that the estimated fair value of entities tested exceeded their corresponding carrying amount. As such, there was no impairment. Indefinite lived intangible assets are subject to annual impairment testing, as well. On an annual basis, the fair value of the indefinite lived assets is evaluated by us to determine if an impairment charge is required. We have only nominal amounts of indefinite lived assets.

We review long-lived assets for impairment when events or changes in business circumstances indicate the carrying amount of the assets may not be fully recoverable. If such indicators are present, we perform undiscounted operating cash flow analyses to determine if impairment exists. If impairment is determined to exist, any related impairment loss is calculated based on fair value.

A considerable amount of management judgment and assumptions are required in performing the impairment test. While we believe that our judgments and assumptions were reasonable, different assumptions could change the estimated fair values and, therefore, impairment charges could be required.

Estimated Excess Inventories. We periodically review our inventory levels to determine if inventory is stated at the lower of cost or net realizable value. The telecommunications and data communications industries have experienced a significant downturn during the past few years and, as a result, we have had to evaluate our inventory position based on known backlog of orders, projected sales and marketing forecasts, shipment activity and inventory held at our significant distributors. We recorded charges for excess and obsolete inventories totaling approximately $0.3 million in 2008, $0.4 million in 2007 and zero in 2006. Most of these products have not been disposed of and remain in our inventory.

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

Estimated Restructuring Liabilities. During 2008, 2007 and 2006, we recorded restructuring charges and asset impairments totaling $3.8 million, $1.5 million and $0.4 million, respectively, related to employee termination benefits and costs to exit certain facilities, net of sub-lease benefits. At December 31, 2008 and 2007, the restructuring liabilities were $25.4 million and $21.1 million, respectively, on our consolidated balance sheets. Restructuring liabilities at December 31, 2008 include approximately $22.5 million of liabilities for facility lease costs (Refer to Note 14 - Restructuring and Asset Impairment Charges of the Notes to Consolidated Financial Statements). These facility operating leases expire through 2017. The future cash outlays for all of our operating lease commitments are discussed in Note 15 of the Notes to Consolidated Financial Statements. Certain assumptions are used by us to derive this estimate, including future maintenance costs, price escalation and sublease income derived from these facilities. Should we negotiate additional sublease rental income agreements or reach a settlement with our lessors to be released from our existing obligations, we could realize a favorable benefit to our results of future operations. Should future lease, maintenance or other costs related to these facilities exceed our estimates, we could incur additional expenses in future periods.

Valuation of Investments in Non-Publicly Traded Companies. Since 1999, we have been making strategic equity investments in non-publicly traded companies that develop technologies that are complementary to our product road map. Depending on our level of ownership and whether or not we have the ability to exercise significant influence, we account for these investments on either the cost or equity method, and review such investments periodically for impairment. The appropriate reductions in carrying values are recorded when, and if, necessary. The process of assessing whether a particular investment's net realizable value is less than its carrying cost requires a significant amount of judgment. In making this judgment, we carefully consider the investee's cash position, projected cash flows (both short and long-term), financing needs, most recent valuation data, the current investing environment, management / ownership changes, and competition. This evaluation process is based on information that we request from these privately held companies. This information is not subject to the same disclosure and audit requirements as the reports required of U.S. public companies, and as such, the reliability and accuracy of the data may vary. Based on our evaluations, we recorded impairment charges related to our investments in non-publicly traded companies of zero, $0.1 million and zero during 2008, 2007 and 2006, respectively. The total investment in non-public companies was $3.0 million and $2.9 million as of December 31, 2008 and 2007, respectively. (For further discussion, please refer to Note 4. Investments in Non-Publicly Traded Companies and Venture Capital Funds in our Consolidated Financial Statements). We used the modified equity method of accounting to determine the impairment loss for certain investments, as it was determined that no better current evidence of the value of our cost method investments existed and we believe that this gives us the best basis for our estimate given the historic negative cash flows of these companies. The modified equity method of accounting results in recording an impairment loss on a cost method investment equal to the investor's proportionate share of the investee's losses as its contributed capital is consumed to fund operating losses of the investee from the inception of the investor's investment.

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

                                                     Years ended December 31,
                                                  2008           2007        2006

Net revenues:
Product revenues                                      95 %          90 %        93 %
Service revenues                                       5 %          10 %         7 %

Total net revenues                                   100 %         100 %       100 %
Cost of revenues:
Product cost of revenues                              40 %          32 %        24 %
Provision for excess and obsolete inventories          1 %           1 %         - %
Service cost of revenues                               2 %           5 %         3 %

Total cost of revenues                                43 %          38 %        27 %

Gross profit                                          57 %          62 %        73 %

Operating expenses:
Research and development                              58 %          67 %        55 %
Marketing and sales                                   21 %          32 %        30 %
General and administrative                            16 %          17 %        16 %
Restructuring charge and asset impairment, net         9 %           4 %         1 %

Total operating expenses 104 % 120 % 102 %

Operating loss (47 ) % (58 ) % (29 ) %

Comparison of Fiscal Years 2008 and 2007

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

                                          Year Ended                        Year Ended
(Tabular dollars in thousands)         December 31, 2008                 December 31, 2007             Percentage
                                                   Percent of                        Percent of         Increase
                                                     Total                             Total          (Decrease) in
                                  Revenues          Revenues        Revenues          Revenues          Revenues

Optical Transport                $    20,258                48 %   $    18,055                56 %                12 %

Broadband Access                      15,512                37 %         7,731                24 %               101 %

Carrier Ethernet and VOIP              3,348                 8 %         2,431                 7 %                38 %

Non-Telecommunications                   885                 2 %         1,093                 3 %               (19 )%

Sub-total product revenues            40,003                95 %        29,310                90 %                36 %

Service revenues                       1,931                 5 %         3,255                10 %               (41 )%

Total                            $    41,934               100 %   $    32,565               100 %                29 %

Total product sales in 2008 were $40.0 million as compared to $29.3 million in 2007, an increase of $10.7 million or 36%. The increase in net product revenue . . .