UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-20784

TRIDENT MICROSYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		77-0156584 (I.R.S. Employer Identification Number)

1170 Kifer Road Sunnyvale, California (Address of principal executive offices)		94086-5303 (Zip Code)

(408)-962-5000
(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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

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

At October 31, 2010, the number of shares of the Registrant’s common stock outstanding was 176,865,131.

 

 

TRIDENT MICROSYSTEMS, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2010

INDEX

Part I. Financial Information			3
Item 1. Financial Statements			3
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009 (Unaudited)			3
Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009 (Unaudited)			4
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009 (Unaudited)			5
Notes to Condensed Consolidated Financial Statements (Unaudited)			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 3. Quantitative and Qualitative Disclosures About Market Risk			44
Item 4. Controls and Procedures			45
Part II. Other Information			45
Item 1. Legal Proceedings			45
Item 1A. Risk Factors			48
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			62
Item 3. Defaults Upon Senior Securities			62
Item 4. (Reserved)			62
Item 5. Other Information			62
Item 6. Exhibits			62
Signatures			64
Index to Exhibits			65
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TRIDENT MICROSYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In thousands, except per share data)		2010				2009				2010				2009
Net revenues		$	176,568			$	31,093			$	438,619			$	52,857
Cost of revenues			128,398				20,592				343,738				37,273
Gross profit			48,170				10,501				94,881				15,584
Operating expenses:
Research and development			44,709				16,350				131,426				43,586
Selling, general and administrative			19,459				8,837				61,906				19,884
Goodwill impairment			—				—				7,851				1,432
In-process research and development			—				—				—				697
Restructuring charges			2,301				1,508				15,166				1,557
Total operating expenses			66,469				26,695				216,349				67,156
Loss from operations			(18,299	)			(16,194	)			(121,468	)			(51,572	)
Gain (loss) on investment			(94	)			—				(303	)			19
Interest income			183				81				681				657
Gain on acquisition			—				—				43,402				—
Other income (expense), net			2,445				(614	)			2,797				(728	)
Loss before provision for income taxes			(15,765	)			(16,727	)			(74,891	)			(51,624	)
Provision for income taxes			1,749				429				219				3,211
Net loss			(17,514	)		$	(17,156	)			(75,110	)		$	(54,835	)
Net loss per share — basic and diluted		$	(0.10	)		$	(0.25	)		$	(0.47	)		$	(0.84	)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

TRIDENT MICROSYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

		September 30,				December 31,
(In thousands, except par values)		2010				2009
Assets
Current assets:
Cash and cash equivalents		$	102,711			$	147,995
Accounts receivable, net			96,106				4,582
Accounts receivable from related parties			9,085				—
Inventories			26,998				14,536
Notes receivable from related party			20,884				—
Prepaid expenses and other current assets			25,457				13,962
Total current assets			281,241				181,075
Property and equipment, net			30,776				26,168
Goodwill			—				7,851
Intangible assets, net			94,330				5,635
Receivable from related party			2,500				—
Other assets			15,026				7,764
Total assets		$	423,873			$	228,493
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	12,494			$	18,883
Accounts payable to related parties			28,364				2,401
Accrued expenses and other current liabilities			74,907				27,068
Income taxes payable			2,651				1,696
Total current liabilities			118,416				50,048
Long-term income taxes payable			23,495				22,262
Deferred income tax liabilities			94				94
Other long-term liabilities			6,024				—
Total liabilities			148,029				72,404
Commitments and contingencies (Note 5)
Stockholders’ equity:
Preferred stock, $0.001 par value; 500 shares authorized; .004 shares issued and outstanding at September 30, 2010			—				—
Common stock, $0.001 par value; 250,000 shares authorized; 176,760 and 70,586 shares issued and outstanding at September 30, 2010, and December 31, 2009, respectively			177				71
Additional paid-in capital			432,586				237,827
Accumulated deficit			(156,919	)			(81,809	)
Total stockholders’ equity			275,844				156,089
Total liabilities and stockholders’ equity		$	423,873			$	228,493

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

TRIDENT MICROSYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		Nine Months Ended
		September 30,
(In thousands)		2010				2009
Cash flows from operating activities:
Net loss		$	(75,110	)		$	(54,835	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation expense			4,763				7,306
Depreciation and amortization			20,239				8,500
Amortization of acquisition-related intangible assets			44,305				2,567
Impact of adjustment to preliminary purchase price			—				—
In-process research and development			—				697
Loss on disposal of property and equipment			4				126
Impairment of goodwill			7,851				1,432
Impairment of technology licenses and prepaid royalties			2,078				2,302
Severance paid by NXP			3,588				—
Impairment of prepaid royalty			—				—
Gain on acquisition			(43,402	)			—
Impairment loss on short-term investments			—				—
Loss on sales of investments			303				7
Deferred income taxes			(2,001	)			104
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable			(91,524	)			(11,781	)
Accounts receivable from related parties			(9,085	)			(5,289	)
Inventories			(920	)			(6,963	)
Notes receivable from related parties			11,281				—
Prepaid expenses and other assets			5,119				1,903
Accounts payable			(6,389	)			7,299
Accounts payable to related parties			24,963				2,030
Accrued expenses and other liabilities			33,634				3,914
Income taxes payable			2,188				503
Net cash used in operating activities			(78,353	)			(40,178	)
Cash flows from investing activities:
Purchases of property and equipment			(4,979	)			(1,351	)
Proceeds from sale of investments			—				2
Acquisition of businesses, net of cash acquired			46,380				(2,671	)
Proceeds from sale of property and equipment			37				120
Purchases of technology licenses			(8,436	)			(7,328	)
Net cash provided by (used in) investing activities			33,002				(11,228	)
Cash flows from financing activities:
Proceeds from issuance of common stock to employees			67				167
Net cash provided by financing activities			67				167
Net decrease in cash and cash equivalents			(45,284	)			(51,239	)
Cash and cash equivalents at beginning of the period			147,995				212,194
Cash and cash equivalents at end of the period		$	102,711			$	160,955
Non-cash investing activities
Common stock, preferred shares, and warrants issued in connection with acquisitions of businesses		$	188,610			$	12,100

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

The Condensed Consolidated Financial Statements include the accounts of Trident Microsystems, Inc., or Trident, and its subsidiaries (collectively the “Company”) after elimination of all intercompany accounts and transactions. In the opinion of the Company, the Condensed Consolidated Financial Statements reflect all adjustments, consisting only of normal recurring adjustments necessary for a fair statement of the financial position, operating results and cash flows for those periods presented. The Condensed Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC, and are not audited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been omitted pursuant to such rules and regulations. These Condensed Consolidated Financial Statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the six months ended December 31, 2009 included in the Company’s transition report on Form 10-KT, for the transition period ended December 31, 2009, filed with the SEC. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for any other period or for the entire fiscal year ending December 31, 2010.

Change in Fiscal Year End

On November 16, 2009, the Board of Directors approved a change in the fiscal year end from June 30 to December 31. The change became effective at the end of the December 31, 2009 quarter. All references to “years”, unless otherwise noted, refer to the twelve-month fiscal year, which prior to July 1, 2009, ended on June 30, and beginning with December 31, 2009, ends on December 31, of each year.

Business Combinations

On February 8, 2010, the Company and its wholly-owned subsidiary Trident Microsystems, (Far East), Ltd., or TMFE, a corporation organized under the laws of the Cayman Islands, completed the acquisition of the television systems and set-top box business lines from NXP B.V., a Dutch besloten vennootschap; or NXP. As a result of the acquisition, the Company issued 104,204,348 shares of Trident common stock to NXP, or Shares, equal to 60% of the Company’s total outstanding shares of Common Stock, after giving effect to the share issuance to NXP, in exchange for the contribution of selected assets and liabilities of the television systems and set-top box business lines from NXP and cash proceeds in the amount of $44 million. In accordance with U.S. generally accepted accounting principles, the closing price on February 8, 2010 was used to value Trident Microsystems common stock issued which is traded in an active market and considered a level 1 input. In addition, the Company issued to NXP four shares of a newly created Series B Preferred Stock or the “Preferred Shares.” The purchase price and fair value of the consideration transferred by Trident was $140.8 million. For details of the acquisition, see Note 12, “Business Combinations,” of Notes to Condensed Consolidated Financial Statements.

On May 14, 2009, the Company completed its acquisition of selected assets of the frame rate converter, or FRC, demodulator, or DRX, and audio decoder product lines from Micronas Semiconductor Holding AG, or Micronas, a Swiss corporation. In connection with the acquisition, the Company issued 7.0 million shares of its common stock and warrants to acquire up to 3.0 million additional shares of its common stock, with a combined fair value of approximately $12.1 million, and incurred approximately $5.2 million of acquisition-related transaction costs and liabilities, for a total purchase price of approximately $17.3 million. In connection with the acquisition, the Company established three new subsidiaries in Europe, Trident Microsystems (Europe) GmbH, or TMEU, Trident Microsystems Nederland B.V., or TMNM, and Trident Microsystems Holding B.V., or TMH, to primarily provide sales liaison, marketing and engineering services in Europe. TMEU is located in Freiburg, Germany and TMNM and TMH are located in Nijmegen, The Netherlands.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Critical Accounting Policies and Estimates

The preparation of the Company’s unaudited condensed consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company based these estimates and assumptions on historical experience and evaluates them on an on-going basis to ensure they remain reasonable under current conditions.

Actual results could differ from those estimates. Critical accounting policies and estimates are summarized below and are further discussed in detail in the audited consolidated financial statements and notes thereto in the Company’s Form 10-KT, for the six months ended December 31, 2009.

Revenue Recognition

The majority of the Company’s product revenues are recognized when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price is fixed or determinable, and (iv) the title has transferred or collection of resulting receivables is reasonably assured. Products sold to certain distributors are subject to specific rights of return, and revenue recognition is deferred until the distributor sells the product to a third-party because the selling price is not fixed and determinable. Consideration given to customers, when offered, is primarily in the form of discounts and rebates and is accounted for as reductions to revenues in the same period the related sale is made. The amount of these reductions is based on historical rebate claims, specific criteria included in rebate agreements, and other factors known at the time. Provisions for doubtful accounts and sales returns allowance are primarily based on historical experience; however, if activity for a particular fiscal period exceed historical rates, additional provisions might be required to properly reflect our estimated exposures. Should market or economic conditions deteriorate, our actual return experience could exceed our estimate.

Reclassifications

Prior period amounts presented in these Condensed Consolidated Financial Statements include reclassifications to conform to the current period presentation.

Recent Accounting Pronouncements

In April 2010, new accounting guidance was issued for the milestone method of revenue recognition. Under the new guidance, an entity can recognize revenue from consideration that is contingent upon achievement of a milestone in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. This guidance is effective prospectively for milestones achieved in fiscal years, and interim period within those years, beginning on or after June 15, 2010. The adoption of this guidance did not significantly impact the Company’s condensed consolidated financial statements. This guidance was incorporated into the Company’s recognition of revenue.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. BALANCE SHEET COMPONENTS

The following table provides details of selected balance sheet components:

		September 30,				December 31,
(Dollars in thousands)		2010				2009
Cash and cash equivalents:
Cash		$	62,915			$	86,382
Money market funds invested in U.S. Treasuries			39,796				61,613
Total cash and cash equivalents		$	102,711			$	147,995
Accounts receivable:
Accounts receivable, gross		$	97,004			$	4,902
Allowances for sales returns and for doubtful accounts			(898	)			(320	)
Total accounts receivable		$	96,106			$	4,582
Inventories:
Work in process		$	5,007			$	12,539
Finished goods			21,991				1,997
Total inventories		$	26,998			$	14,536
Prepaid expenses and other current assets:
Prepaid licenses		$	10,038			$	6,605
VAT receivable			8,226				3,886
Prepaid and deferred taxes			1,342				—
Prepaid insurance			584				—
Other			5,267				3,471
Total prepaid expenses and other current assets:		$	25,457			$	13,962
Property and equipment, net:
Machinery and equipment		$	28,711			$	15,427
Building and leasehold improvements			20,875				19,522
Software			2,944				4,096
Furniture and fixtures			3,410				2,296
			55,940				41,341
Accumulated depreciation and amortization			(25,164	)			(15,173	)
Total property and equipment, net		$	30,776			$	26,168
Accrued expenses and other current liabilities:
Compensation and benefits		$	19,007			$	4,482
Price rebate			11,900				5,913
Deferred revenues less cost of revenues			9,153				329
Wafer and substrate fees			4,997				2,227
VAT payable			3,632				1,256
Royalties			2,820				939
Contingent liabilities			2,757				4,336
Professional fees			2,244				2,912
Restructure accrual			2,154				—
Warranty accrual			1,240				—
Other			15,003				4,674
Accrued expenses and other current liabilities		$	74,907			$	27,068

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. GOODWILL AND INTANGIBLE ASSETS

Goodwill

The following table presents goodwill balance activity for the nine months ended September 30, 2010 and September 30, 2009:

		Nine Months Ended
		September 30,				September 30,
(In thousands)		2010				2009
Balance at beginning of period		$	7,851			$	—
Goodwill acquired			—				7,851
Impairment charge			(7,851	)			—
Balance at end of period		$	—			$	7,851

The Company assesses potential impairment of goodwill on an annual basis, and more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable. The Company performed its annual goodwill impairment analysis in the quarter ended June 30, 2010 and recorded an impairment charge of $7.9 million, due to the excess of the carrying value over the estimated market value for the television systems operating segment. The market approach method and the Company’s stock price at June 30, 2010, were used to determine the estimated market value of the television systems operating segment.

Intangible assets

The following table summarizes the components of intangible assets and related accumulated amortization, including impairment, for the periods presented:

		September 30, 2010												December 31, 2009
		Gross				Accumulated								Gross				Accumulated				Net
		Carrying				Amortization				Net Carrying				Carrying				Amortization				Carrying
(In thousands)		Amount				and Impairment				Amount				Amount				and Impairment				Amount
Intangible assets:
Core & developed		$	76,645			$	(36,290	)		$	40,355			$	28,645			$	(23,260	)		$	5,385
Customer relationships			25,535				(9,474	)			16,061				2,535				(2,359	)			176
Backlog			15,166				(15,166	)			—				166				(92	)			74
Patents			13,000				(1,866	)			11,134				—				—				—
In-process R&D			18,000				—				18,000				—				—				—
Service agreements			16,000				(7,220	)			8,780				—				—				—
Total		$	164,346			$	(70,016	)		$	94,330			$	31,346			$	(25,711	)		$	5,635

The following table presents details of the amortization of intangible assets included in net revenues, cost of revenues, research and development and selling, general and administrative expense categories for the periods presented:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In thousands)		2010				2009				2010				2009
Net revenues		$	—			$	37			$	—			$	55
Cost of revenues			11,612				937				38,799				2,040
Operating expenses:
Research and development			775				—				2,083				—
Selling, general and administrative			1,329				51				3,423				472
		$	13,716			$	1,025			$	44,305			$	2,567

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

As of September 30, 2010, the estimated future amortization expense of intangible assets in the table above is as follows, excluding in-process research and development intangible asset:

(In thousands)		Estimated
Fiscal Year Ending		Amortization
2010 (remaining 3 months)		$	10,917
2011			35,358
2012			23,754
2013			4,556
2014			1,745
Thereafter			—
Total		$	76,330

As of September 30, 2010, the status of in-process research and development is consistent with the Company’s expectation at the time the in-process research and development was acquired. Future period intangible assets amortization expense will include the amortization of in-process research and development, if and when the technology reaches technical feasibility. See Note 12, “Business Combinations,” of Notes to Condensed Consolidated Financial Statements for a further description of the Company’s in-process research and development.

4. WARRANTY

The Company provides for estimated future costs of warranty obligations in accordance with applicable accounting guidance, which requires an entity to disclose and recognize a liability for the fair value of the obligation it assumes upon issuance of a guarantee. The Company warrants its products against material defects for a period of time, usually between 90 days and one year. The Company replaces defective products that are expected to be returned by its customers under its warranty program. Prior to the NXP acquisition, the Company experienced immaterial warranty charges, and therefore, did not provide a warranty accrual.

The following table presents the changes in the Company’s warranty accrual for the three and nine months ended September 30, 2010 and 2009:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In thousands)		2010				2009				2010				2009
Balance at beginning of period		$	481			$	—			$	—			$	—
Warranty expense			759				—				1,240				249
Warranty claims paid			—				—				—				(249	)
Balance at end of period		$	1,240			$	—			$	1,240			$	—

5. COMMITMENTS AND CONTINGENCIES

Commitments

NXP Acquisition Related Commitments

On February 8, 2010, as a result of the acquisition of selected assets and liabilities of the television systems and set-top box business lines from NXP, the Company entered into a Transition Services Agreement, pursuant to which NXP provides to the Company, for a limited period of time, specified transition services and support. Depending on the service provided, the term for the majority of services range from three to eighteen months, and limited services could continue into the fourth quarter of 2011. The total remaining payment obligation under the Transition Services Agreement is approximately $4.2 million as of September 30, 2010. The Company

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

also entered into a Manufacturing Services Agreement pursuant to which NXP provides manufacturing services to the Company for a limited period of time. The term of the agreement ends on the readiness of the Company’s enterprise resource planning system which is estimated to be June 30, 2011.

The terms of the agreements allow the Company to cancel either or both the Transition Services Agreement and the Manufacturing Services Agreement with minimum notice periods. Also see Note 13, “Related Party Transactions,” of Notes to Condensed Consolidated Financial Statements.

Contingencies

Intellectual Property Proceedings

In March 2010, Intravisual Inc. filed complaints against Trident and multiple other defendants, including NXP, in the United States District Court for the Eastern District of Texas, No. 2:10-CV-90 TJW alleging that certain Trident video decoding products infringe a patent relating generally to compressing and decompressing digital video. The complaint seeks a permanent injunction against the Company as well as the recovery of unspecified monetary damages and attorneys’ fees. On May 28, 2010, Trident filed its answer, affirmative defenses and counterclaims. No date for trial has been set. The Company intends to contest this action vigorously. Because this action is in the very early stages, and due to the inherent uncertainty surrounding the litigation process, the Company is unable to reasonably estimate the ultimate outcome of this litigation at this time.

From time to time, the Company receives communications from third parties asserting patent or other rights allegedly covering its products and technologies. Based upon its evaluation, the Company may take no action or the Company may seek to obtain a license, redesign an accused product or technology, initiate a formal proceeding with the appropriate agency (e.g., the U.S. Patent and Trademark Office) and/or initiate litigation. There can be no assurance in any given case that a license will be available on terms the Company considers reasonable or that litigation can be avoided if the Company’s desire is to do so. If litigation does ensue, the adverse third party will likely seek damages (potentially including treble damages) and may seek an injunction against the sale of the Company’s products that incorporate allegedly infringed intellectual property or against the operation of its business as presently conducted, which could result in the Company having to stop the sale of some of its products or to increase the costs of selling some of its products. Such lawsuits could also damage the Company’s reputation. The award of damages, including material royalty payments, or the entry of an injunction against the sale of some or all of the Company’s products, could have a material adverse affect on the Company. Even if the Company were to initiate litigation, such action could be extremely expensive and time-consuming and could have a material adverse effect on the Company. The Company cannot assure that litigation related to its patent or other rights or the patent or other rights of others can always be avoided or successfully concluded.

Shareholder Derivative Litigation

Trident has been named as a nominal defendant in several shareholder derivative lawsuits concerning the granting of stock options. The federal court cases have been consolidated as In re Trident Microsystems Inc. Derivative Litigation, Master File No. C-06-3440-JF. A case also has been filed in State court, Limke v. Lin et al., No. 1:07-CV-080390. Plaintiffs in all cases allege that certain of the Company’s current or former officers and directors caused it to grant options at less than fair market value, contrary to the Company’s public statements (including its financial statements), and that this represented a breach of their fiduciary duties to the Company, and as a result those officers and directors are liable to the Company. The Company’s Board of Directors has appointed a Special Litigation Committee, or SLC, which has been composed solely of independent directors, to review and manage any claims that the Company may have relating to the stock option granting practices and related issues investigated by the SLC. The scope of the SLC’s authority includes the claims asserted in the derivative actions. In federal court, the Company moved to stay the case pending the assessment by the SLC that was formed to consider nominal plaintiffs’ claims.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

On March 26, 2010, the federal court approved settlements with all defendants other than Frank Lin, the Company’s former CEO, and all defendants other than Mr. Lin were dismissed with prejudice from the state and federal actions. In connection with the approved settlements, payments of approximately $2.5 million were made to the Company, by certain of the defendants, and recorded in other income (expense), net on the Company’s Condensed Consolidated Statement of Operations during the nine months ended September 30, 2010. The state court derivative action was dismissed following the approval of the settlement in the federal action. No particular amount of damages has been alleged in the federal action, and by the nature of the lawsuit no damages will be alleged against the Company. On June 8, 2010, Mr. Lin filed a counterclaim against Trident. In that counterclaim, Mr. Lin seeks recovery of payments he claims he was promised during the negotiations surrounding his eventual termination and also losses he claims he has suffered because he was not permitted to exercise his Trident stock options between January 2007 and March 2008.

The Company cannot predict whether the federal action against Mr. Lin and his counterclaims are likely to result in any material recovery by or expense to Trident. In addition, on July 1, 2010, the derivative plaintiffs filed an amended complaint in the federal action stating claims against Mr. Lin relating to his actions in connection with the Company’s stock option granting practices. On September 1, 2010, Mr. Lin and the Company filed separate motions to dismiss the plaintiffs’ amended complaint. Separately, on October 7, 2010, plaintiffs filed a motion seeking sanctions against Mr. Lin based on a claim of spoliation of evidence. The hearing on these motions is currently set for December 3, 2010.

The Company expects to continue to incur legal fees in responding to this lawsuit, including expenses for the reimbursement of certain legal fees of at least Mr. Lin under its advancement obligations. The expense of defending such litigation may be significant. The amount of time to resolve this and any additional lawsuits is unpredictable and these actions may divert management’s attention from the day-to-day operations of the Company’s business, which could adversely affect its business, results of operations and cash flows.

Regulatory Actions

As previously disclosed, the Company was subject to a formal investigation by the Securities and Exchange Commission, or “SEC,” in connection with its investigation into the Company’s historical stock option granting practices and related issues. On July 16, 2010, the Company entered into a settlement with the SEC regarding this investigation. The Company agreed to settle with the SEC without admitting or denying the allegations in the SEC’s complaint. The Company consented to entry of a permanent injunction against future violations of anti-fraud provisions, reporting provisions and the books and records requirements of the Securities Exchange Act of 1934 and the Securities Act of 1933. On July 19, 2010, the U.S. District Court for the District of Columbia entered a final judgment incorporating the judgment consented to by the Company. The final judgment did not require the Company to pay a civil penalty or other money damages. . Pursuant to the same judgment, the Company received a payment of $817,509 from Mr. Lin, representing $650,772 in disgorged profits gained as a result of conduct alleged by the SEC in its civil complaint against him, together with prejudgment interest thereon of $166,737. Although the Department of Justice, or “DOJ,” commenced an informal investigation relating to the same issues, the DOJ has not requested information from the Company since February 20, 2009 and the Company believes that the DOJ has concluded its investigation without taking any action against the Company. The Company believes that the settlement with the SEC concluded the government’s investigations into its historical stock option practices.

Indemnification Obligations

The Company indemnifies, as permitted under Delaware law and in accordance with its Bylaws, Company officers, directors and members of the Company’s senior management for certain events or occurrences, subject to certain limits, while they were serving at the Company’s request in such capacity. In this regard, the Company has received, or expects to receive, requests for advancement and indemnification by certain current and former officers, directors and employees in connection with the Company’s investigation of its historical stock option granting practices and related issues, and the related governmental inquiries and shareholder derivative litigation. The maximum amount of potential future advancement and indemnification is unknown and potentially unlimited; therefore, it cannot be estimated. The Company has directors’ and officers’ liability insurance policies that may enable it to recover a portion of such future advancement and indemnification claims paid, subject to coverage limitations of the policies, and plan to make

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

claim for reimbursement from the Company’s insurers of any potentially covered future indemnification payments. In certain circumstances, the Company also would have the right to seek to recover sums advanced to an indemnitee.

Commercial Litigation

In June 2010, Exatel Visual Systems, Ltd (“Exatel”) filed a complaint against the Company and NXP Semiconductors USA, Inc. (“NXP”), in Superior Court for the State of California, No. 1-10-CV-174333, alleging the following five counts: (1) breach of contract, (2) breach of implied covenant of good faith and fair dealing, (3) fraud by misrepresentation and concealment, (4) negligent misrepresentation, and (5) breach of fiduciary duty. The complaint arises from a series of alleged transactions between Exatel and NXP’s predecessor, Conexant Systems, Inc. pertaining to a joint product development project they undertook commencing in 2007. The Company and NXP have each tendered an indemnity claim to the other for damages and fees arising out of the lawsuit pursuant to a contractual indemnity agreement between them. Both have refused. The Company has filed a demurrer seeking to dismiss the lawsuit primarily on the grounds that the Company is not a party to any contract with Exatel. The Court is scheduled to hear the demurrer on December 7, 2010. In the meantime, Exatel dismissed NXP without prejudice from the lawsuit and has agreed to arbitration after NXP sought to compel arbitration for the claims against it pursuant to contractual arbitration provisions within the relevant contracts.

Because this action is in the very early stages, and due to the inherent uncertainty surrounding the litigation process, the Company is unable to reasonably estimate the ultimate outcome of this litigation at this time.

General

From time to time, the Company is involved in other legal proceedings arising in the ordinary course of its business. While the Company cannot be certain about the ultimate outcome of any litigation, management does not believe any pending legal proceeding will result in a judgment or settlement that will have a material adverse effect on the Company’s business, financial position, results of operation or cash flows.

6. EMPLOYEE STOCK PLANS

Voluntary stock option exchange program

On February 10, 2010, the Company commenced a voluntary stock option exchange program, or Exchange Program, previously approved by stockholders at the Company’s annual stockholder meeting on January 25, 2010. The Exchange Program offer period commenced on February 10, 2010 and concluded at 9:00 p.m., Pacific Standard Time, on March 10, 2010.

Under the Exchange Program, eligible employees were able to exchange certain outstanding options to purchase shares of the Company’s common stock having a per share exercise price equal to or greater than $4.69 for a lesser number of shares of restricted stock or restricted stock units. Eligible employees participating in the offer who were subject to U.S. income taxation received shares of restricted stock, while all other eligible employees participating in the offer received restricted stock units. Members of the Company’s Board of Directors and the Company’s executive officers and “named executive officers,” as identified in the Company’s definitive proxy statement filed on December 18, 2009, were not eligible to participate in the Exchange Program.

Pursuant to the terms and conditions of the Exchange Program, the Company accepted for exchange eligible options to purchase 1,637,750 shares of the Company’s common stock, representing 88.83% of the total number of options originally eligible for exchange. These surrendered options were cancelled on March 11, 2010 and in exchange therefore the Company granted a total of 120,001 new shares of restricted stock and a total of 198,577 new restricted stock units under the Trident Microsystems, Inc. 2010 Equity Incentive Plan, in accordance with the applicable Exchange Program conversion ratios. Under applicable accounting guidance, the exchange was accounted for as a modification and the incremental stock-based compensation expense recognized by the Company as a result of the Exchange Program was immaterial.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Employee Stock Incentive Plans

The Company grants nonstatutory and incentive stock options, restricted stock awards, restricted stock units and performance share awards to attract and retain officers, directors, and employees. For the nine months ended September 30, 2010, the Company granted awards under the 2010 Equity Incentive Plan, or 2010 Plan, which was approved by the Company’s stockholders on January 25, 2010. Options to purchase Trident’s common stock remain outstanding under the following incentive plans which have expired or been terminated: the 1992 Stock Option Plan, the 1994 Outside Directors Stock Option Plan, the 1996 Nonstatutory Stock Option Plan, or 1996 Plan, the 2002 Stock Option Plan, or 2002 Plan, and the 2006 Equity Incentive Plan, or 2006 Plan. In addition, options to purchase Trident’s common stock are outstanding as a result of the assumption by the Company of options granted to Trident Technologies, Inc., or TTI, officers, employees and consultants under the TTI 2003 Employee Option Plan, or TTI Plan. The options granted under the TTI Plan were assumed in connection with the acquisition of the minority interest in TTI on March 31, 2005 and converted into options to purchase Trident’s common stock. Except for the 1996 Plan, all of the Company’s equity incentive plans, as well as the assumption and conversion of options granted under the TTI Plan, have been approved by the Company’s stockholders.

The 2010 Plan provides for the grant of equity incentive awards, including stock options, stock appreciation rights, restricted stock purchase rights, restricted stock bonuses, restricted stock units, performance shares, performance units and cash-based and other stock based awards of up to 32,200,000 shares, subject to increase for unissued predecessor plan shares as set forth in the 2010 Plan.

For purposes of the total number of shares available for grant under the 2010 Plan, any shares that are subject to awards of stock options, stock appreciation rights or other awards that require the option holder to purchase shares for monetary consideration equal to their fair market value determined at the time of grant are counted against the available-for-grant limit as one share for every one share issued, and any shares issued in connection with any other awards, or “full value” awards, are counted against the available-for-grant limit as 1.2 shares for every one share issued. Stock options granted under the 2010 Plan generally must have an exercise price equal to the closing market price of the underlying stock on the grant date and generally expire no later than ten years from the grant date. Options generally become exercisable beginning one year after the date of grant and vest as to a percentage of shares annually over a period of three to four years following the date of grant. The 2010 Plan supersedes the 2006 Plan and the 2002 Plan. The 2006 Plan and 2002 Plan were terminated on January 26, 2010 following approval of the 2010 Plan by the Company’s stockholders.

Valuation of Employee Stock Options

The Company values its stock-based incentive awards granted using the Black-Scholes model, except for performance-based restricted stock awards with a market condition granted during the fiscal year ended June 30, 2008 and during the nine months ended September 30, 2010, for which the Company used a Monte Carlo simulation model to value the awards.

The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. The Black-Scholes model requires the input of certain assumptions. The Company’s stock options have characteristics significantly different from those of traded options, and changes in the assumptions can materially affect the fair value estimates for the three and nine months ended September 30, 2010 and 2009, the fair value of options granted were estimated at the date of grant using the Black-Scholes model with the following weighted average assumptions:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
Employee Incentive Plans		2010				2009				2010				2009
Expected term (in years)			5.03				4.74				4.78				4.27
Expected volatility			71.28	%			68.00	%			69.02	%			67.98	%
Risk-free interest rate			1.25	%			2.69	%			2.25	%			2.06	%
Expected dividend rate			—				—				—				—
Weighted average fair value at grant date		$	1.00			$	0.95			$	1.03			$	0.82

The expected term of stock options represents the weighted average period the stock options are expected to remain outstanding. The expected term is based on the observed and expected time to exercise and post-vesting cancellations of options by employees. The

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Company uses historical volatility in deriving its expected volatility assumption because it believes that future volatility over the expected term of the stock options is not likely to differ from the past. The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected term of options to purchase Trident common stock. The expected dividend assumption is based on the Company’s history and expectation of dividend payouts.

As stock-based compensation expense recognized in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience.

Stock-Based Compensation Expense

The following table summarizes Trident’s stock-based award activities for the three and nine months ended September 30, 2010 and 2009:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In thousands)		2010				2009				2010				2009
Cost of revenues		$	82			$	3			$	272			$	297
Research and development			845				719				2,627				3,769
Selling, general and administrative			938				521				1,864				3,240
Total stock-based compensation expense		$	1,865			$	1,243			$	4,763			$	7,306

The Company has not capitalized any stock-based compensation expense in inventory for the three and nine months ended September 30, 2010 and 2009 as such amounts were immaterial.

During the three and nine months ended September 30, 2010, total stock-based compensation expense recognized in income before taxes was $1.9 million and $4.8 million, respectively, with no related recognized tax benefit. Total stock-based compensation expense recognized in income before taxes for the nine months ended September 30, 2010, includes a $1.6 million reduction in a contingent liability that was recorded as a reduction in Selling, general and administrative expenses on the Company’s Condensed Consolidated Statement of Operations. This contingent liability related to the investigation by the Company’s Special Litigation Committee and is further described in the “Contingent Liabilities” section below. During the three and nine months ended September 30, 2009, total stock-based compensation expense recognized in income before taxes was $1.2 million and $7.3 million, respectively, with no related recognized tax benefit.

Stock Option Awards

The following table summarizes the Company’s stock option and restricted stock activities for the nine months ended September 30, 2010:

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

						Options Outstanding
														Weighted
														Average
														Remaining
		Shares								Weighted				Contractual
		Available for				Number of				Average				Term (in				Aggregate
(In thousands, except per share data and contractual term)		Grant				Shares				Exercise Price				years)				Intrinsic Value
Balance at December 31, 2009			1,682				6,690			$	7.48
Newly authorized (2010 Plan)			42,300
Plan shares expired			(4,123	)
Granted			(794	)			794			$	1.79
Exercised			—				(67	)		$	1.01
Cancelled, forfeited or expired			2,089				(2,089	)		$	13.55
Restricted stock granted (1)			(4,916	)			—
Restricted stock cancelled, forfeited or expired (1)			599				—
Balance at September 30, 2010			36,838				5,328			$	4.18				6.78			$	555
Vested and expected to vest at September 30, 2010							5,013			$	4.26				6.70			$	553
Exercisable at September 30, 2010							2,818			$	5.19				5.26			$	511

The aggregate intrinsic value represents the total pre-tax intrinsic value, which is computed based on the difference between the exercise price and Trident’s closing common stock price of $1.71 as of September 30, 2010, which would have been received by the option holders had all option holders exercised their options as of that date. Total unrecognized compensation cost of options granted but not yet vested as of September 30, 2010 was $2.7 million, which is expected to be recognized over the weighted average service period of 2.25 years.

Restricted Stock Awards and Restricted Stock Units

The following table summarizes the activity for Trident’s restricted stock awards (“RSA”) and restricted stock units (“RSU”) for the nine months ended September 30, 2010:

		Restricted Stock Awards and
						Weighted
						Average
		Number of				Grant Date
(In thousands, except per share data)		Shares				Fair Value
Restricted stock balance at December 31 2009			2,028			$	4.44
Granted			4,096			$	1.75
Vested			(1,033	)		$	1.48
Forfeited			(458	)		$	2.50
Restricted stock balance at September 30, 2010			4,633			$	2.91

Both RSAs and RSUs typically vest over a three or four year period. The fair value of the RSAs and RSUs was based on the closing market price of the Company’s common stock on the date of award. The table above includes an RSA of 110,000 performance-based shares with vesting subject to achievement of specific market conditions granted under the 2006 Plan. This RSA was issued to the Company’s Chief Executive Officer on October 23, 2007 as part of her initial new hire award. The award will vest in four equal tranches, with the vesting of each tranche requiring that Trident’s common stock price target, established by the Compensation Committee, be achieved on or after one of the first four anniversaries of her employment start date. The CEO needs to be employed with the Company as of each anniversary date in order for vesting to occur. The table above also includes performance-based RSU awards of 67,000 shares and 35,000 shares under the 2006 Plan, granted on October 4, 2009, to the Company’s Chief Executive Officer and Senior Vice President of Engineering, respectively. The RSUs vest subject to achievement of specific Company earnings during the year ending December 31, 2011. The units vest only if the performance goal has been met in full. The RSU award granted to the Vice President of Engineering was cancelled during January 2010 and an insignificant amount of expense was recognized for the nine month period ended September 30, 2010.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The table above also includes awards of 650,000 performance-based shares with market conditions and service conditions that were granted to certain Company executives during the nine months ended September 30, 2010. These awards vest subject to achievement of a minimum price for the Company’s stock for fiscal years 2011 through 2013.

The fair value of the performance share awards with market and service conditions was estimated at the grant date using a Monte Carlo simulation with the following weighted-average assumptions: volatility of Trident’s common stock of 72%; and a risk-free interest rate of 1.83%. The weighted-average grant-date fair value of the performance share awards was $1.11. During the three and nine months ended September 30, 2010, stock-based compensation expense of $0.1 million and $0.3 million was recorded, respectively for these performance share awards based on service conditions having been met. As of September 30, 2010, none of these performance share awards had vested.

The Company recognized expense for RSAs and RSUs, including performance share awards granted under the 2010 Plan, for the three and nine months ended September 30, 2010, of $1.5 million and $4.2 million, respectively. A total of $8.8 million of unrecognized compensation cost is expected to be recognized over a weighted average period of 2.24 years.

Modification of Certain Options

Extended Exercise

Effective at the close of trading on September 25, 2006, the Company temporarily suspended the ability of optionees to exercise vested options to purchase shares of the Company’s common stock until the Company became current in the filing of its periodic reports with the SEC and filed a Registration Statement on Form S-8 for the shares issuable under the 2006 Plan (“2006 Plan S-8”). This suspension continued in effect through August 22, 2007, the date of the filing of the registration statement on Form S-8 covering issuances under the 2006 Plan, which followed the Company’s filing, on August 21, 2007, of its Quarterly Reports on Form 10-Q for the periods ended September 30, 2006, December 31, 2006, and March 31, 2007.

As a result, the Company extended the exercise period of approximately 550,000 fully vested options held by 10 employees, who were terminated during the suspension period, giving them either 30 days or 90 days after the Company became current in the filings of its periodic reports with the SEC and filed the 2006 Plan S-8 in order to exercise their vested options. During the quarter ended September 30, 2007, eight of these ten former employees stated above exercised all of their vested options. However, on September 21, 2007, the Special Litigation Committee of the Board of Directors (“SLC”) decided that it was in the best interests of the Company’s stockholders not to allow the remaining two former employees, as well as the Company’s former CEO and two former non-employee directors, to exercise their vested options during the pendency of the SLC’s proceedings, and extended, until March 31, 2008, the period during which these five former employees could exercise approximately 428,000 of their fully vested options. Moreover, the SLC allowed one former employee to exercise all of his fully vested stock options and another former employee agreed to cancel all of such individual’s fully vested stock options during the second quarter of fiscal year ended June 30, 2008. On January 31, 2008, the SLC extended, until August 31, 2008, the period during which the two former non-employee directors could exercise their unexpired vested options. For the fiscal year ended June 30, 2008, the Company recorded aggregate incremental stock-based compensation expense totaling approximately $5.4 million related to the modifications of option exercise rights of the five former employees as described above, and the related expenses were included in “Selling, General and Administrative Expenses” in the Consolidated Statement of Operations as of that date.

Contingent Liabilities

As stated in the “Extended Exercise” section above, on September 21, 2007, the SLC decided not to allow the Company’s former CEO and two former non-employee directors to exercise their vested options until March 31, 2008. Moreover, on January 30, 2008, the SLC extended, until August 1, 2008, the period during which the two former non-employee directors could exercise their vested options. On March 31, 2008, the SLC entered into an agreement with the Company’s former CEO allowing him to exercise all of his fully vested stock options. Under this agreement, he agreed that any shares obtained through these exercises or net proceeds obtained through the sale of such shares would be placed in an identified securities brokerage account and not withdrawn, transferred or

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

otherwise removed without either (i) a court order granting him permission to do so or (ii) the written permission of the Company. On May 29, 2008, the SLC permitted one of the Company’s former non-employee directors to exercise his fully vested stock options without seeking the authorization of the SLC and entered into an agreement with the other former non-employee director on terms similar to the agreement entered into with the Company’s former CEO, allowing him to exercise all of his fully vested stock options without seeking the authorization from the SLC.

Because Trident’s stock price was lower than the prices at which the Company’s former CEO and each of the two former directors had desired to exercise their options, as indicated in previous written notices to the SLC, the Company recorded a contingent liability totaling $4.3 million, which was included in “Accrued expenses and other current liabilities” in the Condensed Consolidated Balance Sheets. On March 26, 2010, the claims by these two former non-employee directors against the Company, valued at approximately $1.6 million in the aggregate, were waived as part of a comprehensive settlement with the Company. Currently, the SLC investigation is still in progress only with respect to the Company’s former CEO. In June 2010, he filed a claim against the Company seeking compensation from the Company relating to the exercise of his fully vested stock options. As a result, as of September 30, 2010, the Company maintained a contingent liability totaling $2.8 million in “Accrued expenses and other current liabilities” in the Condensed Consolidated Balance Sheets. See Note 5, “Shareholder Derivative Litigation” in “Commitment and Contingencies,” of Notes to Condensed Consolidated Financial Statements.

7. INCOME TAXES

The Company accrued an insignificant amount for interest and penalties, following applicable accounting guidance, related to gross unrecognized tax benefits, which are included in the provision for income taxes for the nine months ended September 30, 2010. The Company included in its unrecognized tax benefit of $44.8 million at September 30, 2010, $23.5 million of tax benefits that, if recognized, would reduce the Company’s annual effective tax rate. It is reasonably possible that our unrecognized tax benefits could decrease by a range between zero and $2.9 million within the next twelve months, depending on the outcome of certain tax audits or statutes of limitations in foreign jurisdictions.

A provision for income taxes of $1.7 million and $0.2 million was recorded for the three and nine months ended September 30, 2010, respectively. A provision for income taxes of $0.4 million and $3.2 million was recorded for the three and nine months ended September 30, 2009, respectively. The effective income tax rate for the three months ended September 30, 2010 decreased by 8.5 percentage points compared to the three months ended September 30, 2009. The effective income tax rate for the nine months ended September 30, 2010 increased by 5.9 percentage points, compared to the nine months ended September 30, 2009. The changes in our effective tax rate were primarily due to the recognition of the tax benefit resulting from net operating losses in foreign jurisdictions, the release of tax reserves in a foreign jurisdiction associated with the measurement of an unrecognized tax benefit due to new information received in the period associated with legal guidance provided, and a lapse of a statute of limitation in the jurisdiction relevant to our business operations, as compared to tax expense incurred on a loss in the three and nine months ended September 30, 2009.

The Company’s ability to use federal and state net operating loss and credit carry forwards to offset future taxable income and future taxes, respectively, is subject to restrictions attributable to equity transactions that result from changes in ownership as defined by Internal Revenue Code (“IRC”) Sections 382 and 383. As discussed in Note 12, “Business Combinations”, on February 8, 2010, Trident issued 104,204,348 newly issued shares of Trident common stock to NXP, equal to 60% of the total outstanding shares of Trident common stock. The impact of this event reduced the Company’s availability of net operating loss and tax credit carry forwards for federal and state income tax purposes.

The Internal Revenue Service has initiated an examination of the Company’s U.S. corporate income tax returns for fiscal years ended June 30, 2008 and June 30, 2009. At this time, it is not possible to estimate the potential impact that the examination may have on income tax expense. Although timing of the resolution or closure on audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

8. BASIC AND DILUTED NET LOSS PER SHARE

The Company computes net loss per share in accordance with U.S. generally accepted accounting principles. Basic net loss per share is computed by dividing net loss attributable to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted net loss per share gives effect to all dilutive potential common shares outstanding during the period including stock options and warrants using the treasury stock method.

The following is a reconciliation of the weighted average number of common shares used to calculate basic net loss per share to the weighted average common and potential common shares used to calculate diluted net loss per share for the three and nine months ended September 30, 2010 and 2009 (in thousands, except per share data):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Numerator:
Net loss: basic and diluted		$	(17,514	)		$	(17,156	)		$	(75,110	)		$	(54,835	)
Denominator:
Total shares: basic and diluted			174,553				69,237				159,624				65,143
Net loss per share: basic and diluted		$	(0.10	)		$	(0.25	)		$	(0.47	)		$	(0.84	)

For the three and nine months ended September 30, 2010 and 2009, common stock warrants and employee stock options to purchase the following numbers of shares of common stock were excluded from the computation of diluted net loss per share as their effect would be anti-dilutive (in millions):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Shares excluded from the computation of diluted net income per share			7.1				5.9				6.6				6.5

9. FAIR VALUE MEASUREMENTS

The Company follows applicable accounting guidance for its fair value measurements. The guidance establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The guidance establishes three levels of inputs that may be used to measure fair value:

Level 1 — Quoted prices in active markets for identical assets or liabilities.

Level 2 — Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 — Unobservable inputs to the valuation methodology significant to the measurement of fair value of assets or liabilities.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Determination of fair value

Cash equivalents are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices.

Assets Measured at Fair Value on a Recurring Basis

The following table presents the Company’s financial assets, measured at fair value, as of September 30, 2010:

		Fair Value Measurement at Reporting Date
						Quoted Prices
						In Active				Significant				Significant
						Markets for				Observable				Unobservable
						Identical Assets				Inputs				Inputs
(In thousands)		Fair Value				(Level 1)				(Level 2)				(Level 3)
Israel, severance plan assets invested in insurance policies and mutual funds (1)		$	2,829			$	—			$	2,829			$	—
Money market funds invested in U.S. Treasuries (2)			39,796				39,796				—				—
Total		$	42,625			$	39,796			$	2,829			$	—

The Company’s insurance policies and mutual funds, that are used to fund the pension liability for our Israeli employees, are classified within Level 2, and are used as the market inputs to value these investments, and are observable, for example market yields, but the assets are not actively traded.

The following table presents the Company’s financial assets, measured at fair value, as of December 31, 2009:

		Fair Value Measurement at Reporting Date
						Quoted Prices
						In Active				Significant				Significant
						Markets for				Observable				Unobservable
						Identical Assets				Inputs				Inputs
(In thousands)		Fair Value				(Level 1)				(Level 2)				(Level 3)
Money market funds invested in U.S. Treasuries (2)		$	61,613			$	61,613			$	—			$	—
Total		$	61,613			$	61,613			$	—			$	—

10. RESTRUCTURING

During the first quarter of 2010, the Company began procedures to streamline its operations. As a result of this decision, the Company recorded for the three and nine months ended September 30, 2010, $2.3 million and $15.2 million, respectively, of restructuring expenses related to severance, related employee benefits and closure of certain facilities. Included in restructuring expenses for the three and nine months ended September 30, 2010 is $1.7 million and $6.5 million, respectively, of costs related to the closure of the Company’s Munich office. Current restructuring plans are expected to be substantially completed by the end of the calendar year; however, some restructuring activity is likely to extend into 2011. Restructuring charges are recorded under “Restructuring charges” in the Company’s Condensed Consolidated Statement of Operations.

Prior to the close of the Company’s acquisition of selected assets and liabilities of NXP’s television systems and set-top box business lines, NXP initiated a restructuring plan pursuant to which the employment of some NXP employees was terminated upon the close of the merger. The Company has determined that the restructuring plan was a separate plan from the business combination because the plan to terminate the employment of certain employees was made in contemplation of the acquisition. Therefore, a severance cost of $3.6 million was recognized by the Company as an expense on the acquisition date and is included in the total restructuring charge of $15.2 million for the nine months ended September 30, 2010. The $3.6 million of severance cost was paid by NXP after the close of

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

the acquisition, effectively reducing the purchase consideration transferred. See Note 12, “Business Combinations,” of Notes to Condensed Consolidated Financial Statements.

The following table presents the changes in the Company’s restructuring accrual for the three and nine months ended September 30, 2010 and 2009:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In thousands)		2010				2009				2010				2009
Restructuring liabilities, beginning of period		$	1,105			$	—			$	—			$	—
Severance and related charges			2,301				1,508				15,166				1,557
Net cash payments			(1,252	)			(1,469	)			(13,012	)			(1,518	)
Restructuring liabilities, end of period		$	2,154			$	39			$	2,154			$	39

11. GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS

The Company operates in one reportable segment called digital media solutions. The digital media solutions business segment designs, develops and markets integrated circuits for digital media applications, such as digital television, set-top boxes, and liquid crystal display, or LCD, television. The Company has determined its operating segments based on current applicable accounting literature. The Company has two operating segments, television systems and set-top boxes, aggregated as one reportable segment, because the integrated circuits designed, developed and marketed by the Company have similar economic characteristics and because the Company uses one reportable segment to allocate resources and assess performance.

Geographic Information

Revenues by region are classified based on the locations of the customer’s principal offices even though customers’ revenues are attributable to end customers that are located in a different location. The following is a summary of the Company’s net revenues by geographic operations for the periods presented:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In millions)		2010				2009				2010				2009
Revenues:
South Korea		$	55.2			$	13.6			$	155.2			$	18.9
Europe			45.7				8.6				110.3				12.3
Asia Pacific			35.2				5.3				86.9				10.3
Japan			22.8				3.3				56.2				10.6
Americas			17.7				0.3				30.0				0.7
Total revenues		$	176.6			$	31.1			$	438.6			$	52.9

Major Customers

The following table shows the percentage of the Company’s revenues during the three and nine months ended September 30, 2010 and 2009 that were derived from customers who individually, or through their Electronic Manufacturing Service providers accounted for more than 10% of revenues for those periods:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Revenues:
Samsung Electronics, Co., Ltd.			19.3	%			27.0	%			22.9	%			30.8	%
Philips Consumer Electronics International B.V.			14.7	%			11.0	%			13.6	%			10.3	%
LG Eletronics Inc.			*				15.0	%			*				15.0	%

As of September 30, 2010, the Company had a high concentration of accounts receivable with Samsung Electronics, Co., Ltd., representing 23% of net accounts receivable.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

12. BUSINESS COMBINATIONS

Acquisition of the television systems and set-top box business lines from NXP B.V.

On February 8, 2010, the Company and its wholly-owned subsidiary Trident Microsystems, (Far East), Ltd., or TMFE, a corporation organized under the laws of the Cayman Islands, completed the acquisition of the television systems and set-top box business lines from NXP B.V., a Dutch besloten vennootschap. As a result of the acquisition, the Company issued 104,204,348 shares of Trident common stock to NXP, equal to 60% of the Company’s total outstanding shares of Common Stock, after giving effect to the share issuance to NXP, in exchange for the contribution of selected assets and liabilities of the television systems and set-top box business lines from NXP and cash proceeds in the amount of $44 million. In accordance with U.S. generally accepted accounting principles, the closing price on February 8, 2010, of $1.81 per share, was used to value Trident Microsystems common stock issued which is traded in an active market and considered a level 1 input. In addition, the Company issued to NXP four shares of a newly created Series B Preferred Stock or the “Preferred Shares.”

The acquisition was accounted for using the purchase method of accounting, and the Company was deemed to be the acquirer in accordance with applicable accounting guidance. The determination that Trident was the accounting acquirer was based on a review of all pertinent facts and circumstances. The following key factors of the acquisition transaction were considered by the Company to conclude that Trident was the acquirer:

     The composition of the governing body of the combined entity — Major decisions require the approval of at least two-thirds of the members of Trident’s Board of Directors. Five of the nine members of the Board of Directors following the closing of the acquisition are legacy Trident directors.

     The composition of senior management of the combined entity — The senior management of the Company following the acquisition is primarily composed of members of the Company’s pre-acquisition senior management.

     The relative voting rights in the combined entity after the business combination — NXP’s voting rights are limited, such that if all outstanding shares of Common Stock of Trident not held by NXP (i.e., 40% of the Common Stock) vote all 40% in favor of a stockholder proposal, then NXP is limited to voting 30% of the outstanding shares against the proposal, and the remaining 30% of the Common Stock of Trident held by NXP must be voted either (a) in accordance with the non-NXP stockholders, in this case for such proposal, or (b) in accordance with the recommendation of the Board of Directors as approved by a majority of the non-NXP members of the Trident Board of Directors.

     The existence of a large minority voting interest in the combined entity if no other owner or organized group of owners has a significant voting interest — NXP may vote 30% of the outstanding shares freely, with the remaining 30% of shares owned by NXP restricted to voting either (a) in accordance with the recommendation of the Board of Directors as approved by a majority of the non-NXP directors, or (b) in the same proportion as the votes cast by all other stockholders.

     The terms of the exchange of equity interests — The acquisition represented the purchase of a relatively small portion of the total NXP business.

Based upon the analysis of all relevant facts and circumstances, most notably the factors described above, the Company determined that the preponderance of such factors indicated that Trident was the acquiring entity.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following is the consideration transferred by the Company representing the total purchase price:

						(In thousands)
		Shares				Amount
Issuance of Trident common shares to NXP			104,204,000			$	188,610
Issuance of Trident preferred shares to NXP			4				—
Purchase of Trident common shares by NXP							(30,000	)
Net cash payment by NXP							(14,235	)
Contingent returnable consideration (a)							(3,588	)
Acquisition date fair value of total consideration transferred						$	140,787

The final purchase price of $140.8 million was allocated to the net tangible and intangible assets acquired and liabilities assumed as follows:

		(In thousands)
		Amount
Assets acquired:
Cash		$	2,145
Prepaid expenses and other current assets			14,375
Inventory notes receivable (b)			39,900
Fixed assets (c)			10,487
Non-current assets			4,500
Service agreements (d)			16,000
Acquired intangible assets (e)			117,000
Deferred tax asset (f)			796
Liabilities assumed:
Accrued liabilities			(16,199	)
Non-current liabilities			(4,815	)
Fair market value of the net assets acquired			184,189
Gain on acquisition (g)			(43,402	)
Total purchase price		$	140,787

Under the purchase method of accounting, the total estimated purchase price is allocated to the net tangible and identifiable intangible assets acquired and liabilities assumed in connection with the acquisition based on their estimated fair value as of the closing of the acquisition. Total acquisition related expenses incurred through March 31, 2010, recorded as operating expenses, were approximately $11.7 million. Assets acquired in the acquisition as of February 8, 2010 were reviewed and adjusted, if required, to their estimated fair value.

The Company utilized a methodology referred to as the income approach, which discounts expected future cash flows to present value. The discount rate used in the present value calculations was derived from a weighted-average cost of capital analysis, adjusted to reflect additional risks.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(a)		Prior to the close of the Acquisition, NXP initiated a restructuring plan pursuant to which the employment of some NXP employees was terminated upon the close of the Acquisition. The Company has determined that the restructuring plan was a separate plan from the business combination because the plan to terminate the employment of certain employees was made in contemplation of the Acquisition. Therefore, the full severance cost of $3.6 million was recognized by the Company as an expense on the Acquisition close date. The entire severance cost was paid by NXP after the close of the Acquisition, was reflected under applicable accounting guidance as contingent returnable consideration, effectively reducing the purchase consideration transferred.
(b)		As of the effective date of the asset acquisition, the Company acquired two inventory notes receivable (the “Note” or “Notes”). The first Note is for $19.6 million and allowed the Company to purchase finished goods inventory on March 22, 2010.
		The second Note is for $20.3 million and allows the Company to purchase work-in-process inventory on the readiness of the Company’s enterprise resource planning system which is projected to be implemented in June 2011. For additional details related to notes receivable, see Note 13, “Related Party Transactions,” of Notes to Condensed Consolidated Financial Statements.
(c)		Fixed assets (property and equipment) were measured at fair value and could include assets that are not intended to be used in their highest and best use. The Company’s fixed assets were reduced by $1.4 million, resulting from new information received by the Company subsequent to filing the Company’s Form 10-Q for the three months ended March 31, 2010.
(d)		Service agreements were measured at fair value and these acquired assets are amortized over the remaining life of the agreement or up to 33 months from the closing date of the transaction. These service agreements include manufacturing and distributor agreements and other services from NXP. The other services include payroll processing, benefits administration, accounting, information technology and real estate administration.
(e)		Identifiable intangible assets were measured at fair value and could include assets that are not intended to be used in their highest and best use. Developed technology consisted of products which have reached technological feasibility. The value of the developed technology was determined by using the discounted income approach.
		Customer relationships relate to the Company’s ability to sell existing and future versions of products to existing NXP customers. The fair value of the customer relationships was determined by using the discounted income approach.
		Patents represent various patents previously owned by NXP. The fair value of patents was determined by using the royalty relief method and estimating a benefit from owning the asset rather than paying a royalty to a third party for the use of the asset.
		The backlog fair value relates represents the value of the standing orders for the products acquired in the acquisition as of the close of the acquisition.
		The acquired intangible assets, their fair values and estimated weighted average amortized lives, are as follows (dollars in thousands):

						Weighted
						Average
		Fair Value				Amortized Life
Backlog		$	15,000			0.5 years
Customer relationships			23,000			2.24 years
Developed technology			48,000			3.0 years
Patents			13,000			4.5 years
In-process research and development			18,000
		$	117,000

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

		In-process research and development, or IPR&D, consisted of the in-process set-top box projects awaiting completion development at the time of the acquisition. The value assigned to IPR&D was determined by considering the importance of products under development to the overall development plan, estimating costs to develop the purchased IPR&D into commercially viable products, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value. Acquired IPR&D assets were initially recognized at fair value and are classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. Efforts necessary to complete the in-process research and development include additional design, testing and feasibility analyses. As of September 30, 2010, the status of in-process research and development is consistent with the Company’s expectation at the time the in-process research and development was acquired.
		The values assigned to IPR&D were based upon discounted cash flows related to the future products’ projected income stream. The discount rate of 33.9% used in the present value calculations were derived from a weighted average cost of capital, adjusted upward to reflect the additional risks inherent in the development life cycle, including the useful life of the technology, profitability levels of the technology, and the uncertainty of technology advances that are known at the date of acquisition.

The following table summarizes the significant assumptions at the acquisition date underlying the valuations of IPR&D for the NXP acquisition completed on February 8, 2010:

						February 8, 2010
						Estimated				Expected
(In thousands)						Cost to				Commencement
Set-Top Box Development Projects		Fair Value				Complete				Date of Significant Cash Flows
Apollo/Shiner		$	8,856			$	1,400			November 2010
Kronos			7,731				1,800			February 2012
Other			1,413				2,700			February 2013
Total		$	18,000			$	5,900

(f)		The Company’s deferred tax assets were reduced by $3.7 million, resulting from new information received by the Company subsequent to filing the Company’s Form 10-Q for the three months ended March 31, 2010.
(g)		The preliminary purchase price allocation, associated with the acquisition of the television systems and set-top box business lines from NXP, assigned $48.5 million to gain on acquisition. Subsequently, in accordance with applicable accounting guidance, the gain on acquisition was reduced by $5.1 million and the Company’s deferred tax assets and fixed assets were reduced by $3.7 million and $1.4 million, respectively, resulting from new information received by the Company subsequent to filing the Company’s Form 10-Q for the three months ended March 31, 2010.
		The Company used the income approach methodology to determine fair value of the assets. The key factor that led to the recognition of a gain on acquisition was a decline of $54.2 million in the fair value of Trident’s common stock purchase consideration between the date that the definitive agreement was signed on October 4, 2009 (based on a closing price of $2.33 per share) and the acquisition date of February 8, 2010 (based on a closing price of $1.81 per share), as determined in accordance with applicable accounting guidance.

Acquisition of the Frame Rate Converter, Demodulator and Audio Decoder product lines of the Consumer Division of Micronas Semiconductor Holding AG

On May 14, 2009, the Company completed its acquisition of the selected assets of the FRC, DRX, and audio product lines of Micronas, or Micronas Assets. In connection with the acquisition, the Company issued 7.0 million shares of its common stock, representing approximately 10% of its outstanding common stock, and warrants to acquire up to 3.0 million additional shares of its

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

common stock, with a fair value of approximately $12.1 million and incurred approximately $5.2 million of acquisition-related costs and liabilities, for a total purchase price of approximately $17.3 million.

Due to the acquisition from Micronas on May 14, 2009, the Company entered into the following agreements with Micronas:

     • Service Level Agreement: Under this agreement, Micronas agreed to provide to the Company specified transition services and support, including intellectual property transitional services for a limited period of time. The transition services include certain manufacturing design, maintenance and support services, sales of inventory and newly-manufactured products and certain finance and administration, IT, infrastructure, warehousing and similar services.

     • Distributor Agreement: Under this agreement, Micronas served as the exclusive supplier and OEM to the Company on the FRC, DRX, and Audio Decoder product lines from May 15, 2009 to June 15, 2009.

     • Cross License Agreement: Under this agreement, Micronas granted to the Company a royalty-free, perpetual, irrevocable, fully assignable and transferable worldwide license, including the right to sublicense, to patents that are relevant to the acquired business. Ownership of these patents remains with Micronas following completion of the acquisition. The license is exclusive for the first three years, subject to certain exceptions, and is non-exclusive thereafter. The Company has granted to Micronas a royalty-free, perpetual, irrevocable, non-exclusive, fully assignable and transferable worldwide license, including the right to sublicense, to patents exclusively relevant to the FRC line of frame rate converters, the DRX line of demodulators and all of the audio processing product lines acquired in the acquisition. During the first three years, the license granted by the Company to Micronas is limited to use for products that are not a DRX, Audio or FRC Product. Following this three year period, Micronas may use the licensed rights on any product.

     • Stockholder Agreement: This agreement sets forth specified registration rights associated with the shares, including demand and piggyback registration rights, restrictions on transfer of the Shares and provides Micronas certain pre-emptive rights to acquire additional shares of its Common Stock. Under the Stockholders Agreement, Micronas has agreed to vote the Shares in support of acquisition proposals approved by the disinterested members of its Board of Directors, and together with the recommendation of the disinterested members of the Board of Director other stockholder proposals, and Micronas ability to engage in certain solicitations and activities encouraging support for or against proposals inconsistent with its voting agreements is restricted.

Micronas also agreed to sublease 17,000 square feet of the office spaces located in Munich, Germany to the Company. The Company used the office spaces for general and administration, research and engineering services. The Munich office was closed during the three months ended September 30, 2010 and the Company incurred a restructuring charge of $1.1 million representing the remaining lease payment obligation.

Unaudited Pro Forma Financial Information

The following unaudited pro forma information presents a summary of the results of operations of the Company assuming the acquisition of the television systems and set-top box business lines of NXP B.V. had occurred at the beginning of the period presented below, and that the acquisition of the Micronas assets had occurred on January 1, 2009. This pro forma financial information is for informational purposes only and does not reflect any operating efficiencies or inefficiencies which may result from the business combination and therefore is not necessarily indicative of results that would have been achieved had the businesses been combined during the periods presented (amounts in thousands, except per share date):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Pro forma net revenues		$	176,568			$	166,942			$	486,038			$	417,722
Pro forma net loss		$	(17,514	)		$	(42,993	)		$	(73,034	)		$	(214,632	)
Pro forma net loss per share — Basic		$	(0.10	)		$	(0.25	)		$	(0.46	)		$	(1.23	)
Shares used in computing pro forma net loss per share — Basic			174,553				173,441				159,624				174,171

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The Company recorded net revenues of approximately $131.0 million and $302.7 million and net operating income (losses) of approximately $15.4 million and $(15.9) million, from the acquisitions for the three and nine months ended September 30, 2010.

13. RELATED PARTY TRANSACTIONS

NXP

In connection with the NXP acquisition, the Company acquired two inventory notes receivable. The first Note bears interest at an annual interest rate of 2.75%, and the second Note bears interest at a rate per annum of 250 basis points in excess of the 3-month LIBOR rate. The Company settled the first Note, totaling $19.0 million, during the three months ended June 30, 2010, of which $11.6 million was settled in finished goods inventory, and $7.4 million was settled in cash. The Company received the cash during the quarter ended September 30, 2010. The Company expects the second Note to be settled by June 30, 2011.

Total purchases from NXP for the three and nine months ended September 30, 2010 were $134.6 million and $245.2 million, respectively. Total purchases for the three and nine months ended September 30, 2010 include approximately $5.3 million and $20.3 million of transition services, respectively, and approximately $129.3 million and $224.9 million of primarily product purchases, respectively. As of September 30, 2010, the outstanding accounts payable to NXP was $24.9 million, the outstanding accounts receivable from NXP was $8.8 million and the outstanding long-term receivable from NXP was $2.5 million. At September 30, 2010, the Company had a note receivable from NXP of $20.9 million associated with inventory purchases from NXP, of which the entire balance was a current asset, on the Company’s Condensed Consolidated Balance Sheet. During the period from February 8, 2010 to March 22, 2010, the Company and NXP had a commissionaire’s agreement whereby NXP acted on the Company’s behalf for product sales. Total revenue during this period was $52.0 million, all of which was paid by September 30, 2010. The accounts receivable from NXP of $8.8 million at September 30, 2010, was not related to the sales of product.

In connection with the Acquisition, the Company and NXP entered into the following agreements, each effective as of February 8, 2010:

     • Intellectual Property Transfer and License Agreement: Under this agreement, between TMFE and NXP, NXP has transferred to a newly formed Dutch besloten vennootschap acquired by TMFE, or Dutch Newco, certain patents, software and technology, including those exclusively related to the acquired business lines. Pursuant to the terms of the agreement, NXP has granted a license to Dutch Newco to certain patents, software and technology used in other parts of NXP’s business and Dutch Newco has granted a license back to NXP to certain of the patents, software and technology.

     • Stockholder Agreement: This agreement, between the Company and NXP, sets forth the designation of nominees to the Trident Board, providing certain restrictions on the right of NXP to freely vote its shares of Trident common stock received pursuant to the Share Exchange Agreement, and providing a two year lock up during which NXP cannot transfer its shares of Trident common stock, subject to certain exceptions, including transfers to affiliates. In addition, under this agreement, NXP has agreed to standstill restrictions for nine years, including restrictions on the future acquisition of Trident securities, participation in a solicitation of proxies, and effecting or seeking to effect a change of control of Trident. The NXP Stockholder Agreement also sets forth certain major decisions that may only be taken by the Trident Board upon a supermajority vote of two-thirds of the directors present. The NXP Stockholder Agreement provides NXP with certain demand and piggy-back registration rights related to the Shares, and grants certain preemptive rights to NXP with respect to future issuances of Trident common stock.

     • Transition Services Agreement: Under this agreement, NXP agrees to provide to Trident for a limited period of time specified transition services and support, including order fulfillment and delivery; accounting services and financial reporting services; human resources management (including compensation and benefit plan management, payroll services and training); pensions; office and infrastructure services (including access to certain facilities for a limited period of time); sales and marketing support; supply chain management (including logistics and warehousing); quality control; financial administration; ICT hardware and ICT software and

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

infrastructure; general IT services; export, customs and licensing services; and telecommunications. Depending on the service provided, the term ranges from three to 18 months, provided that the services for IT and ITC could continue into the fourth quarter of 2011.

     • Manufacturing Services Agreement: Under this agreement, contract manufacturing services are to be provided by NXP for a limited period of time for finished goods as well as certain front end, back end and other related manufacturing services for products acquired by Trident. The term of the agreement ends following the readiness of the Company’s enterprise resource planning system, which is currently projected to be implemented during June 2011.

     • Contract Services Agreement: Under this agreement, certain employees of NXP are to provide contract services to Trident for a limited period of time for services including R&D, IP development, design in support and account management, as well as support for the transition of these activities to Trident personnel. Depending on the service provided, the term ranges from 2 to 12 months.

The total remaining payment obligation for services through the end of the terms of these agreements was approximately $4.2 million as of September 30, 2010.

Micronas

Total purchases from Micronas for the three and nine months ended September 30, 2010, were $7.2 million and $24.6 million, respectively. As of September 30, 2010, the outstanding accounts payable to Micronas was $3.5 million. Total purchases from Micronas for the six months ended December 31, 2009, were $16.2 million. As of December 31, 2009, the outstanding accounts payable to Micronas was $2.4 million, and the outstanding accounts receivable from Micronas was $0.3 million.

See Note 12, “Business Combinations,” of Notes to Condensed Consolidated Financial Statements, which provides a summary of the related party agreements entered into with Micronas due to the acquisition of the FRC, DRX, and Audio Decoder product lines from Micronas on May 14, 2009.

14. EMPLOYEE BENEFIT PLANS

The Company’s Israeli subsidiary has a pension and severance investment plan pursuant to which the Company is required to make pension and severance payments to its retired or former Israeli employees, and in certain circumstances, other Israeli employees whose employment is terminated. The Company’s severance investment plan liability is calculated based on the salary of employees multiplied by years of service, and the resulting balance is included in accrued expenses and other current liabilities on the Company’s Condensed Consolidated Balance Sheets. A corresponding asset is included in prepaid and other current assets, on the Company’s Condensed Consolidated Balance Sheets. The severance investment plan underfunded balance was $0.2 million as of September 30, 2010.

15. DEFERRED REVENUES AND COST OF REVENUES

We recognize revenues for our largest distributors at the point these distributors ship to end customers (sell-through basis), representing approximately 87% of shipments made to distributors for the nine months ended September 30, 2010. For the three and nine months ended September 30, 2010, distribution revenue recognized on a sell-through basis was 26% and 23% of total revenues, respectively.

TRIDENT MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents deferred revenues, cost of revenues and gross profit as of September 30, 2010 and December 31, 2009:

		September 30,				December 31,
(In thousands)		2010				2009
Deferred revenues		$	18,697			$	709
Deferred cost of revenues			9,544				380
Deferred gross profit		$	9,153			$	329

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

Forward-looking Statements

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying consolidated condensed financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows.

Various sections of this MD&A contain a number of forward-looking statements. Words such as “expects,” “goals,” “plans,” “believes,” “continues,” “may,” “will,” and variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Such statements are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing (see also “Risk Factors” in Part II, Item 1A of this Form 10-Q). Our actual results may differ materially, for the three and nine months ended September 30, 2010.

Our MD&A is organized as follows:

	•		Overview. Discussion of our business.
	•		Recent Acquisitions. Discussion of our recent acquisition of the NXP product lines and the Micronas product lines.
	•		Outlook and Challenges. Discussion of our business and overall analysis of financial and other highlights affecting the company in order to provide context for the remainder of MD&A.
	•		Critical Accounting Policies. Accounting estimates that we believe are most important to understanding the assumptions and judgments incorporated in our reported financial results and forecasts.
	•		Results of Operations. An analysis of our financial results comparing the three and nine months ended September 30, 2010 to the three and nine months ended September 30, 2009.
	•		Liquidity and Capital Resources. An analysis of changes in our balance sheets and cash flows, and discussion of our financial condition and potential sources of liquidity.

Overview

Trident Microsystems, Inc. (including our subsidiaries, referred to collectively in this Report as “Trident,” “we,” “our” and “us”) is a provider of high-performance multimedia semiconductor solutions for the digital home entertainment market. We design, develop and market integrated circuits, or ICs, and related software for processing, displaying and transmitting high quality audio, graphics and images in home consumer electronics applications such as digital TVs (DTV), PC and analog TVs, and set-top boxes. Our product line includes system-on-a-chip, or SoC, semiconductors that provide completely integrated solutions for processing and optimizing video, audio and computer graphic signals to produce high-quality and realistic images and sound. Our products also include frame rate converter, or FRC, demodulator or DRX and audio decoder products, DOCSISR modems, interface devices and media processors. Trident’s customers include many of the world’s leading original equipment manufacturers, or OEMs, of consumer electronics, computer display and set-top box products. Our goal is to become a leading provider for the “connected home,” with innovative semiconductor solutions that make it possible for consumers to access their entertainment and content (music, pictures, internet, data) anywhere and at anytime throughout the home.

Recent Acquisitions

On February 8, 2010, we and our wholly-owned subsidiary Trident Microsystems, (Far East), Ltd., or TMFE, a corporation organized under the laws of the Cayman Islands, completed the acquisition of the television systems and set-top box business lines from NXP B.V., a Dutch besloten vennootschap; or NXP. As a result of the acquisition, we issued 104,204,348 shares of Trident common stock to NXP, or Shares, equal to 60% of our total outstanding shares of Common Stock, after giving effect to the share issuance to NXP, in exchange for the contribution of selected assets and liabilities of the television systems and set-top box business lines from NXP and

cash proceeds in the amount of $44 million. In accordance with U.S. generally accepted accounting principles, the closing price on February 8, 2010 was used to value Trident common stock issued which is traded in an active market and considered a level 1 input. In addition, we issued to NXP four shares of a newly created Series B Preferred Stock or the “Preferred Shares.”

The purchase price and fair value of the consideration transferred by Trident was $140.8 million. For details of the acquisition, see Note 12, “Business Combinations,” of Notes to Condensed Consolidated Financial Statements.

On May 14, 2009, we completed our acquisition of selected assets of the frame rate converter, or FRC, demodulator, or DRX, and audio decoder product lines from Micronas Semiconductor Holding AG, or Micronas, a Swiss corporation. In connection with the acquisition, we issued 7.0 million shares of our common stock and warrants to acquire up to 3.0 million additional shares of our common stock, with a combined fair value of approximately $12.1 million, and incurred approximately $5.2 million of acquisition-related transaction costs and liabilities, for a total purchase price of approximately $17.3 million. In connection with the acquisition, we established three new subsidiaries in Europe, Trident Microsystems (Europe) GmbH, or TMEU, Trident Microsystems Nederland B.V., or TMNM, and Trident Microsystems Holding B.V., or TMH, to primarily provide sales liaison, marketing and engineering services in Europe. TMEU is located in Freiburg, Germany and TMNM and TMH are located in Nijmegen, The Netherlands.

Outlook and Challenges

Our results of operations were as follows:

(In thousands)		Q3 2010				Q2 2010				Q3 2009
Net revenue		$	176,568			$	171,648			$	31,093
Gross margin		$	48,170			$	32,926			$	10,501
Operating loss		$	(18,299	)		$	(51,359	)		$	(16,194	)
Net loss		$	(17,514	)		$	(48,817	)		$	(17,156	)

The scale of our business has expanded significantly as a result of the acquisition of the NXP TV and Set Top Box product lines in February 2010 and the Micronas Frame Rate Converter, Demodulator, and Audio Decoder product lines in May 2009. This is reflected in prior-year comparisons of most operating metrics for the three and nine month periods ended September 30, 2010.

Revenues for the third quarter ended September 30, 2010 increased to $176.6 million, which compares with $171.7 million in the second quarter ended June 30, 2010 and $31.1 million in the quarter ended September 30, 2009. Third quarter revenues increased over the prior sequential quarter as a result of increased sales of our products for set top box and TV. Third quarter revenues increased over the comparable period one year ago primarily as a result of revenue contributions from the acquired NXP products. In addition, in 2010 we have generated incremental sales of our TV solution to our largest customer as a result of a design win awarded in late 2009.

Net loss for the third quarter was $17.5 million, or $0.10 per share. This compares with a net loss of $48.8 million, or $0.28 per share, in the prior sequential quarter and a net loss of $17.2 million, or $0.25 per share, in the quarter ended September 30, 2009. The reduced loss compared with the prior sequential quarter is primarily the result of improved gross margins related to a better mix of products, reduced amortization of intangible assets, and significantly lower operating expenses, particularly costs related to transitional support services from NXP.

In our fourth quarter ended December 31, 2010, we expect our revenues to decline 20 to 25 percent from the levels achieved in the third quarter ended September 30, 2010. The decline is primarily attributable to typical seasonal weakness in the calendar fourth quarter for our TV business, as well as softness related to high inventories throughout the TV channel and share losses with our largest customer as a result of supply constraints earlier in 2010. We expect the decline in TV to be partially offset by modest increases in our set top box revenues related to the ramp of certain customer programs. We expect to be cash flow neutral in the fourth quarter as the decline in revenues is offset by further spending reductions from our acquisition-related restructuring activities. Further, based on a preliminary view of 2011 demand and design wins, we currently expect the TV industry softness to continue into the seasonally weak first quarter, while we expect our full year 2011 revenues to be similar to 2010 and operations to be cash flow positive for the year.

We ended the third quarter of 2010 with cash and cash equivalents of $102.7 million, consisting of cash and money market funds invested in U.S. treasuries. Our cash and cash equivalents increased from the second quarter by $6.7 million.

Critical Accounting Policies

References included in this Quarterly Report on Form 10-Q to “accounting guidance” means U.S. generally accepted accounting principles, or GAAP. The preparation of our financial statements and related disclosures in conformity with GAAP, requires us to make estimates, assumptions, and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Company’s critical accounting policies are based on historical experience and on various other factors that we believe are reasonable under the circumstances. We periodically review our critical accounting policies and make adjustments when facts and circumstances dictate. Our critical accounting policies that are affected by estimates, assumptions, and judgments, and are used in used in the preparation of the Company’s condensed consolidated financial statements, could differ from actual results and have a material financial impact on the Company’s reported financial condition and results of operations. The Company’s critical accounting policies include revenue recognition, long-lived assets, inventories and income taxes. Below is a summary of the Company’s critical accounting policies. A further discussion of these critical accounting policies can also be found in the Management’s Discussion & Analysis of Financial Condition and Results of Operations section included in our Transition Report on Form 10-KT for the six months ended December 31, 2009.

Revenue Recognition

The majority of our product revenues are recognized when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price is fixed or determinable, and (iv) the title has transferred and collection of resulting receivables is reasonably assured. Products sold to certain distributors are subject to specific rights of return, and revenue recognition is deferred until the distributor sells the product to a third-party because the selling price is not fixed and determinable. Consideration given to customers, when offered, is primarily in the form of discounts and rebates and is accounted for as reductions to revenues in the same period the related sale is made. The amount of these reductions is based on historical rebate claims, specific criteria included in rebate agreements, and other factors known at the time. Provisions for doubtful accounts and sales returns allowance are primarily based on historical experience; however, if activity for a particular fiscal period exceed historical rates, additional provisions might be required to properly reflect our estimated exposures. Should market or economic conditions deteriorate, our actual return experience could exceed our estimate.

Impairment and Useful Lives of Long-Lived Assets

We reviewed our long-lived assets, such as fixed assets and intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Events that would trigger an impairment review include a change in the use of the asset or forecasted negative cash flows related to the asset. When such events occur, we compare the carrying amount of the asset to the undiscounted expected future cash flows related to the asset. If this comparison indicates that impairment is present, the amount of the impairment is calculated as the difference between the carrying amount and the fair value of the asset. If a readily determinable market price does not exist, fair value is estimated using discount expected cash flows attributable to the asset. The estimates required to apply this accounting policy include forecasted usage of the long-lived assets, the useful lives of these assets and expected future cash flows. Changes in these estimates could materially impact results from operations.

Inventories

Inventories are computed using the lower of cost or market, which approximates actual cost. We write down our inventory value for excess and for estimated obsolescence for the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. These factors are impacted by market and economic conditions, technology changes, new product introductions and changes in strategic direction and require estimates that may include uncertain elements. Actual demand may differ from forecasted demand, and such differences may have a material effect on recorded inventory values.

Income Taxes

We account for income taxes in accordance with applicable accounting guidance, which requires that deferred tax assets and liabilities be recognized by using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. We also have to assess the likelihood that we will be able to realize our deferred tax assets. If realization is not more likely than not, we are required to record a valuation allowance against the deferred tax assets that we estimate we will not ultimately realize. Under GAAP, we are required to make certain estimates and judgments in determining income tax expense for financial statement purposes. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations.

Because we are required to determine the probability of various possible outcomes, such estimates are inherently difficult and subjective. We reevaluate these uncertain tax positions on a quarterly basis based on factors including, but not limited to, changes in facts or circumstances and changes in tax law. A change in recognition or measurement would result either in the recognition of a tax benefit or in an additional charge to the tax provision for the period.

Recent Accounting Standards

For a description of the recent accounting standards, including the expected dates of adoption and estimated effects, if any, on our consolidated condensed financial statements, see “Note 1: “Basis of Presentation” in the Notes to Consolidated Condensed Financial Statements of this Form 10-Q.

Results of Operations

Financial Data for the Three and Nine Months Ended September 30, 2010 Compared to the Three and Nine Months Ended September 30, 2009

Net revenues, gross profit, research and development expenses, and selling, general and administrative expenses all increased substantially in the three and nine months ended September 30, 2010, as compared to the same three and nine month periods in the prior year, as a result of the NXP acquisition.

Net Revenues

Our revenue has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, market demand; supply constraints, including manufacturing capacity at the foundries that are our primary source for manufacturing our products; capabilities of our products relative to market requirements and the timeliness of our products relative to our customers’ design-in windows; and competitive factors, including product pricing.

From time to time, our key customers may cancel purchase orders with us, we may lose market share at a customer to a competitor, or we may win new business at key customers, thereby causing our net revenues to fluctuate significantly. Our products are manufactured primarily by two foundries, Taiwan Semiconductor Manufacturing Corp., or TSMC, and United Microelectronics Corporation, or UMC. We also use certain other manufacturing capabilities that currently are provided by Micronas and NXP.

Digital media solutions revenues represented all of our revenues for the three and nine months ended September 30, 2010 and 2009. Net revenues are revenues less reductions for rebates and allowances for sales returns.

As a result of the acquisition of the television systems and set-top box business lines from NXP, net revenues increased in all regions for the three and nine months ended September 30, 2010, compared to the three and nine months ended September 30, 2009. In addition, our low-end design win at Samsung contributed to revenue growth in Korea for the both the three- and nine-month periods.

Net revenues comparison by percentage of total net revenues

		Three Months Ended																Nine Months Ended
(In millions)		September 30,																September 30,
										Dollar				Percent												Dollar				Percent
Revenues by region (1)		2010				2009				Variance				Variance				2010				2009				Variance				Variance
South Korea		$	55.2			$	13.6			$	41.6				306	%		$	155.2			$	18.9			$	136.2				720	%
Europe			45.7				8.6				37.2				433	%			110.3				12.3				98.1				800	%
Asia Pacific (2)			35.2				5.3				29.9				567	%			86.9				10.3				76.6				742	%
Japan			22.8				3.3				19.5				584	%			56.2				10.6				45.6				429	%
Americas			17.7				0.3				17.4				5529	%			30.0				0.7				29.2				4102	%
Total net revenues		$	176.6			$	31.1			$	145.5				468	%		$	438.6			$	52.9			$	385.7				730	%