The following Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained in "Part II, Item 1A. Risk Factors" below and elsewhere in this Quarterly Report on Form 10-Q, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are generally written in the future tense and/or may generally be identified by words such as "will," "may," "should," "could," "expect," "suggest," "believe," "anticipate," "intend," "plan," or other similar words. Forward-looking statements contained in this Quarterly Report include, among others, statements regarding (1) our revenue growth, (2) our future gross profits, (3) our future research and development efforts and related expenses, (4) our future selling, general and administrative expenses, (5) our cash and cash equivalents, short-term marketable securities and cash flows from operations being sufficient to satisfy working capital requirements and capital equipment needs for at least the next 12 months,
(6) our ability to continue to finance operations with cash flows from operations, existing cash and investment balances, and some combination of long-term debt and/or lease financing and sales of equity securities, (7) the possibility of future acquisitions and investments, (8) our ability to accurately estimate our assumptions used in valuing stock-based compensation,
(9) our ability to estimate and reconcile distributors' reported inventories to their activities, (10) our ability to estimate future cash flows associated with long-lived assets, (11) the weak global economic and financial market conditions, and (12) anticipated results in connection with the acquisition of hi/fn, inc. ("Hifn") and Galazar Networks Inc. ("Galazar"). Actual results may differ materially from those projected in the forward-looking statements as a result of various factors. Factors that could cause actual results to differ materially from those stated herein include, but are not limited to: the information contained under the captions "Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Part II, Item 1A. Risk Factors." We disclaim any obligation to update information in any forward-looking statement.

The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the condensed consolidated financial statements and notes thereto, included in this Quarterly Report on Form 10-Q, and our audited consolidated financial statements for the fiscal year ended March 29, 2009 included in our Annual Report on Form 10-K, as filed with the Securities and Exchange Commission ("SEC"). Our results of operations for the three and six months ended September 27, 2009 are not necessarily indicative of results to be expected for any future period.

BUSINESS OVERVIEW

Exar Corporation and its subsidiaries ("Exar" or "we") is a fabless semiconductor company that designs, sub-contracts manufacturing of and sells highly differentiated silicon, software and subsystem solutions for industrial, datacom and storage applications. We use our extensive knowledge of end-user markets along with our underlying analog, mixed signal and digital technology to provide customers with innovative solutions designed to meet the needs of the evolving connected world. Our product portfolio includes power management and interface components, datacom products, storage optimization solutions, network security and applied service processors. Applying both analog and digital technologies, our products are deployed in a wide array of applications such as portable electronic devices, set top boxes, digital video recorders, telecommunication systems, servers, enterprise storage systems and industrial automation equipment. We provide customers with a breadth of component products and subsystem solutions based on advanced mixed signal silicon integration.

We market our products worldwide with sales offices and personnel located throughout the Americas, Europe, and Asia. Our products are sold in the United States through a number of manufacturers' representatives and distributors. Internationally, our products are sold through various regional and country specific distributors with locations in thirty-three countries around the globe. In addition to our sales offices, we also employ a worldwide team of field application engineers to work directly with our customers.

Our international sales consist of sales that are denominated in U.S. dollars. Our international related operations expenses expose us to fluctuations in currency exchange rates because our foreign operating expenses are denominated in foreign currency while our sales are denominated in U.S. dollars. Although foreign sales within certain countries or foreign sales comprised of certain products may subject us to tariffs, our gross profit margin on international sales, adjusted for differences in product mix, is not significantly different from that realized on our sales to domestic customers. Our operating results are subject to quarterly and annual fluctuations as a result of several factors that could materially and adversely affect our future profitability as described in "Part II, Item 1A. Risk Factors-Our Financial Results May Fluctuate Significantly Because Of A Number Of Factors, Many Of Which Are Beyond Our Control."

Our fiscal year ends on the Sunday closest to March 31 and our fiscal quarters end on the Sunday closest to the end of the corresponding calendar quarter. The second quarter of each of fiscal 2010 and fiscal 2009 included 91 days from June 29, 2009 to September 27, 2009 and June 30, 2008 to September 28, 2008, respectively.

Business Outlook

During the first half of fiscal year 2010, the economy and our industry have begun to show signs of a slow recovery, but our visibility to end customer demand and to our business continues to be limited. Net sales for the second quarter of fiscal 2010 increased $0.7 million, or 2%, when compared to the immediate preceding quarter. We believe we have completed the integration of Hifn and Galazar and are on track to release new products. We are cautiously optimistic about the second half of fiscal year 2010 while still managing expenses company-wide.

Business Combinations

On June 17, 2009, we completed the acquisition of Galazar for approximately $4.95 million in cash. Galazar, based in Ottawa, Canada, is a fabless semiconductor and software supplier focused on carrier grade transport over telecom networks. Galazar's product portfolio addresses transport of a wide range of datacom and telecom services including Ethernet, SAN, TDM and video over SONET/SDH, PDH and OTN networks.

On April 3, 2009, we completed the acquisition of Hifn, a fabless semiconductor company that was founded in 1996, spun off from Stac, Inc. in 1999 and traded on the NASDAQ under the symbol "HIFN" since 1999, for a total consideration of approximately $59.6 million, which consist of approximately 430,000 shares of Exar's common stock with an estimated fair value of approximately $2.8 million and $56.8 million in cash. The acquisition of Hifn expands and complements our product offerings in the enterprise storage, networking and telecom markets where we have had a significant base of business for more than 10 years. The Hifn technology adds world class compression and data deduplication products used in storage applications to optimize data and speed up data backup and retrieval. Hifn has also been a leading provider in security acceleration technology by providing encryption and compression products to the leading networking and telecom system manufacturers. The Hifn products complement the existing Exar connectivity solutions and provide us with a more significant product offering to our customers.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of our financial statements and accompanying disclosures in conformity with GAAP requires estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the condensed consolidated financial statements and the accompanying notes. The SEC has defined a company's critical accounting policies as policies that are most important to the portrayal of a company's financial condition and results of operations, and which require a company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified our most critical accounting policies and estimates to be as follows: (1) revenue recognition; (2) valuation of inventories; (3) income taxes; (4) stock-based compensation; (5) goodwill;
(6) long-lived assets; and (7) valuation of business combinations. Although we believe that of our estimates, assumptions and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates if the assumptions, judgments and conditions upon which they are based turn out to be inaccurate. A further discussion of our critical accounting policies can be found in "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended March 29, 2009.

RESULTS OF OPERATIONS

We acquired Hifn on April 3, 2009 and Galazar on June 17, 2009 and consequently, our results of operations for the three and six months ended September 27, 2009 include the results of those entities from the reported acquisition dates.

Net Sales by Product Line

Our net sales by product line in dollars and as a percentage of net sales were
as follows for the fiscal periods presented (in thousands):



                                                  Three Months Ended                                          Six Months Ended
                                         September 27,          September 28,                       September 27,          September 28,
                                             2009                   2008             Change             2009                   2008             Change
Net Sales:
Datacom                                $    11,181    35 %    $     8,426    26 %        33 %     $    24,164    39 %    $    15,322    24 %        58 %
Interface                                   14,852    47 %         17,954    55 %       (17 )%         27,874    44 %         36,479    56 %       (24 )%
Power Management                             5,555    18 %          6,368    19 %       (13 )%         10,412    17 %         13,158    20 %       (21 )%

Total                                  $    31,588   100 %    $    32,748   100 %                 $    62,450   100 %    $    64,959   100 %

Datacom

Datacom products include network access, transmission and storage products, as well as encryption, data reduction and packet processing products from the Hifn acquisition and network transport products from the Galazar acquisition.

For the three months ended September 27, 2009, net sales of datacom products increased $2.8 million as compared to the same period a year ago and included $7.3 million of additional sales from Hifn and Galazar products. Net of this effect, net sales of network access, transmission and storage products for the second quarter of fiscal 2010 decreased $4.6 million, primarily due to decreased volume of our SONET and optical products.

For the six months ended September 27, 2009, net sales of datacom products increased $8.8 million as compared to the same period a year ago and included $13.1 million of additional sales from Hifn and Galazar products. Net of this effect, net sales of network access, transmission and storage products for the six months ended September 27, 2009 decreased $4.3 million, primarily due to decreased volume of our SONET products.

Interface

Interface products include Universal Asynchronous Receiver/Transmitter ("UARTs") and serial transceiver products.

For the three months ended September 27, 2009, net sales of interface products decreased $3.1 million as compared to the same period a year ago, primarily due to decreased volume of UARTs and serial transceiver.

For the six months ended September 27, 2009, net sales of interface products decreased $8.6 million as compared to the same period a year ago, primarily due to primarily due to decreased volume of UARTs and serial transceiver sales.

Power Management

Power management products include DC-DC regulators and LED drivers.

For the three months ended September 27, 2009, net sales of power management products decreased $0.8 million as compared to the same period a year ago, primarily due to decreased volumes and price erosion on a limited number of power management products.

For the six months ended September 27, 2009, net sales of power management products decreased $2.7 million as compared to the same period a year ago, primarily due to decreased volumes.

Net Sales by Channel

Our net sales by channel in dollars and as a percentage of net sales were as
follows for the fiscal periods presented (in thousands):



                                                  Three Months Ended                                          Six Months Ended
                                         September 27,          September 28,                       September 27,          September 28,
                                             2009                   2008             Change             2009                   2008             Change
Net Sales:
Sell-through distributors              $    15,562    49 %    $    19,097    58 %       (19 )%    $    30,859    49 %    $    38,445    59 %       (20 )%
Direct and others                           16,026    51 %         13,651    42 %        17 %          31,591    51 %         26,514    41 %        19 %

Total                                  $    31,588   100 %    $    32,748   100 %                 $    62,450   100 %    $    64,959   100 %

For the three months ended September 27, 2009, net sales to our distributors for which we recognize revenue on the sell-through method included $0.3 million in sales of Hifn and Galazar products. Net sales to direct customers and other distributors for the second quarter of fiscal 2010 included $7.1 million in sales of Hifn and Galazar products.

For the six months ended September 27, 2009, net sales to our distributors for which we recognize revenue on the sell-through method included $0.5 million in sales of Hifn and Galazar products. Net sales to direct customers and other distributors for the first half of fiscal 2010 included $12.7 million in sales of Hifn and Galazar products.

Net Sales by Geography

Our net sales by geography in dollars and as a percentage of net sales were as
follows for the fiscal periods presented (in thousands):



                                                 Three Months Ended                                          Six Months Ended
                                        September 27,          September 28,                       September 27,          September 28,
                                            2009                   2008             Change             2009                   2008             Change
Net Sales:
Americas                              $     8,567    27 %    $     8,562    26 %        -  %     $    15,883    25 %    $    16,605    26 %        (4 )%
Asia                                       19,139    61 %         17,602    54 %         9 %          37,801    61 %         34,728    53 %         9 %
Europe                                      3,882    12 %          6,584    20 %       (41 )%          8,766    14 %         13,626    21 %       (36 )%

Total                                 $    31,588   100 %    $    32,748   100 %                 $    62,450   100 %    $    64,959   100 %

For the three months ended September 27, 2009, net sales in the Americas, Asia and Europe included $3.3 million, $3.9 million and $0.2 million, respectively, of sales of Hifn and Galazar products.

For the six months ended September 27, 2009, net sales in the Americas, Asia and Europe included $5.5 million, $6.9 million and $0.8 million, respectively, of sales of Hifn and Galazar products.

Gross Profit

Our gross profit in dollars and as a percentage of net sales was as follows for
the fiscal periods presented (in thousands):



                                                 Three Months Ended                                        Six Months Ended
                                        September 27,         September 28,                      September 27,         September 28,
                                             2009                  2008            Change             2009                  2008            Change
Net Sales                              $    31,588           $    32,748                        $    62,450           $    64,959
Cost of sales:
Cost of sales                               15,484   49 %         16,788   51 %        (8 )%         30,374   49 %         33,574   52 %       (10 )%
Fair value adjustment of acquired
inventories                                    447    1 %             -    -  %       100 %           2,234    3 %             -    -  %       100 %
Amortization of acquired intangible
assets                                        1567    5 %            955    3 %        64 %           2,907    5 %          1,910    3 %       (52 )%

Gross profit                           $    14,090   45 %    $    15,005   46 %                 $    26,935   43 %    $    29,475   45 %

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

• the cost of purchasing finished silicon wafers manufactured by independent foundries;

• the costs associated with assembly, packaging, test, quality assurance and product yields;

• the cost of personnel and equipment associated with manufacturing support and manufacturing engineering;

• the cost of stock-based compensation associated with manufacturing engineering and support personnel;

• the amortization of purchased intangible assets;

• the amortization of inventory fair value of inventories acquired; and

• the provision for excess and obsolete inventory.

The decrease in gross profit, as a percentage of net sales, for the three and six months ended September 27, 2009 as compared to prior periods, was primarily due to the amortization of the fair value of inventories acquired from Hifn and Galazar and manufacturing inefficiencies associated with shipping lower product volume as compared to the prior year, partially offset by higher margins on Hifn and Galazar products, improved margins on serial transceiver and power management products and a lower provision for excess and obsolete inventory.

Other Costs and Expenses



                                                      Three Months Ended                                       Six Months Ended
                                             September 27,         September 28,                     September 27,         September 28,
                                                  2009                  2008            Change            2009                  2008            Change
Net Sales                                   $    31,588           $    32,748                       $    62,450           $    64,959
R&D expense:
R&D-base                                    $    10,713   34 %    $     7,389   23 %        45 %    $    21,376   34 %    $    14,860   23 %        44 %
Stock-based compensation                            748    2 %            481    1 %        56 %          1,234    2 %            839    1 %        47 %
Amortization expense-acquired intangibles           635    2 %            263    1 %       141 %          1,223    2 %            526    1 %       133 %
Acquisition related costs                           192    1 %             -    -  %       100 %            749    1 %             -    -  %       100 %

Total R&D expense                           $    12,288   39 %    $     8,133   25 %        51 %    $    24,582   39 %    $    16,225   25 %        52 %

SG&A expense:
SG&A-base                                   $     9,809   31 %    $     9,149   28 %         7 %    $    20,146   32 %    $    18,938   29 %         6 %
Stock-based compensation                            767    2 %            435    1 %        76 %          1,474    2 %          1,244    2 %        18 %
Amortization expense-acquired intangibles           179    1 %            162    1 %        10 %            321    1 %            324   -  %        (1 )%
Acquisition related costs                           620    2 %             -    -  %       100 %          4,546    7 %            541    1 %       740 %

Total SG&A expense                          $    11,375   36 %    $     9,746   30 %        17 %    $    26,487   42 %    $    21,047   32 %        26 %

Research and Development ("R&D")

Our R&D costs consist primarily of:

• the salaries, stock-based compensation, and related expenses of employees engaged in product research, design and development activities;

• costs related to engineering design tools, mask tooling costs, software amortization, test hardware, engineering supplies and services, and use of in-house test equipment;

• facilities expenses.

For the three and six months ended September 27, 2009, base R&D expenses increased $3.3 million and $6.5 million, respectively, as compared to the same periods a year ago, primarily due to incremental labor-related expenses, higher mask tooling costs and software amortization and equipment depreciation due to the growth of our company as a result of the acquisition of Hifn and Galazar partially offset by $1.7 million and $2.4 million, respectively, in the reimbursement of certain costs under a research and development contract.

Stock-based compensation expense recorded in R&D expenses was $0.7 million and $1.2 million for the three and six months ended September 27, 2009, respectively, as compared to $0.5 million and $0.8 million, respectively, for the same periods a year ago. The increase in stock-based compensation expense as compared to the same period a year ago was primarily due to new stock option and restricted stock unit ("RSU") grants made in connection with the Hifn and Galazar acquisitions and the incremental costs associated with the employee stock option swap in November 2008.

The growth in amortization expense-acquired intangibles for both the three and six months ended September 27, 2009 relates to the amortization of a R&D reimbursement contract associated with the Hifn acquisition.

Acquisition related costs for the six months ended September 27, 2009 are primarily associated with accelerated depreciation relating to shortened remaining lives of equipment of $0.5 million acquired from Hifn and employee severance costs.

Selling, General and Administrative ("SG&A")

SG&A expenses consist primarily of:

• salaries, stock-based compensation and related expenses;

• sales commissions;

• professional and legal fees;

• amortization of acquired intangible assets such as distributor relationships, tradenames/trademarks and customer relationships; and

• acquisition related costs.

For the three and six months ended September 27, 2009, base SG&A expenses increased $0.7 million and $1.2 million, respectively, as compared to the same periods a year ago, primarily due to incremental labor-related expenses and equipment depreciation due to the growth of our company as a result of the acquisition of Hifn, and to a lesser extent, Galazar.

Stock-based compensation expense recorded in SG&A expenses was $0.8 million and $1.5 million for the three and the six months ended September 29, 2009, respectively, as compared to $0.4 million and $1.2 million, respectively, for the same periods a year ago. The increase in stock-based compensation expense as compared to the same period a year ago was primarily due to new stock option and restricted stock unit ("RSU") grants made in connection with the Hifn and Galazar acquisitions and the incremental costs associated with the employee stock option exchange in November 2008.

Acquisition related costs for the three months ended September 27, 2009 are primarily related to professional fees in connection with the ongoing efforts to integrate the acquired companies.

Acquisition related costs for the six months ended September 27, 2009 primarily consist of $2.2 million in investment banker, printing, legal and other professional fees that are recorded as expenses related to business combinations and the accelerated depreciation relating to shortened remaining lives of equipment of $0.8 million acquired from Hifn and employee separation costs of $0.6 million, and building exit and moving costs of $0.3 million related to the Hifn Los Gatos facility.

Other Income and Expenses, Net



                                                   Three Months Ended                                            Six Months Ended
                                          September 27,           September 28,                        September 27,           September 28,
                                              2009                    2008              Change             2009                    2008              Change
Net Sales                               $  31,588               $  32,748                            $  62,450               $  64,959

Interest income and other, net              1,700       5 %         2,535       8 %        (33 )%        3,454       6 %         5,205       8 %        (34 )%
Interest expense                             (326 )    (1 )%         (330 )    (1 )%        (1 )%         (650 )    (1 )%         (661 )    (1 )%        (2 )%
Impairment charges on investments            (245 )    (1 )%       (1,454 )    (4 )%       (83 )%         (317 )    (1 )%       (1,454 )    (2 )%       (78 )%

Interest Income and Other, Net

Interest income and other, net primarily consists of:

• interest income;

• sublease income;

• foreign exchange gains or losses; and

• gains or losses on the sale or disposal of equipment.

For the three and six months ended September 27, 2009, interest income and other, net decreased $0.8 million and $1.8 million as compared to the same periods a year ago, primarily attributable to a decrease in interest income as a . . .