**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 
| **ý**                                       | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                             | ** ** | ** **                                                                                    |
| **For  the fiscal year ended December 31, 2005** |
| ** **                                       |
| **OR**                                           |
|                                             | ** ** | ** **                                                                                    |
| **o**                                            | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition period from                     to                  .**

 

**Commissionfile number 001-16047**

 

**ADVANCEDPOWER TECHNOLOGY, INC.**

(Exact name of registrant as specified in its charter)

* *

| **Delaware**                                                         | ** ** | **93-0875072**                                |
|----------------------------------------------------------------------|------------|-----------------------------------------------|
| (State or other jurisdiction of  incorporation or organization) | ** ** | (I.R.S. Employer  Identification Number) |

 

**405SW Columbia Street, Bend, Oregon 97702**

(Address of principal executive offices and zip code)

 

**(541)382-8028**

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

**None**

 

Securities registered pursuant to Section 12(g) of the Act:

**CommonStock, par value $.01 per share**

 

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Indicateby check mark if the registrant is a well-known seasoned issuer, as defined byRule 405 of the Securities Act. Yes  o  No  ý

 

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Act. Yes  o   No  ý

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to the filingrequirements for the past 90 days. Yes  ý  No  o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or in any amendment to thisForm 10-K.  ý

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 
| Large  accelerated filer o |   | Accelerated  filer ý |   | Non-accelerated  filer o |
|----------------------------|--------|---------------------------|--------|--------------------------|

 

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  o  No  ý

 

The aggregate marketvalue of the voting stock held by non-affiliates of the Registrant as of June30, 2005, the last trade date for the end of our most recent fiscal secondquarter, was $49 million based upon the composite closing price of theRegistrant’s Common Stock on the Nasdaq National Market System on that date.

 

The number of shares ofthe Registrant’s Common Stock outstanding as of February 21, 2006 was 11,056,852shares.

 

 

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**ADVANCEDPOWER TECHNOLOGY, INC.**

**FORM10-K**

**TABLEOF CONTENTS**

 
|         |   |                                                                                                                | ** ** |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------|------------|
|         |   |                                                                                                                |       |
| **Part I**   |   |                                                                                                                |       |
| Item 1.      |   | Business                                                                                                            |       |
| Item 1A.     |   | Risk Factors                                                                                                        |       |
| Item 1B.     |   | Unresolved Staff Comments                                                                                           |       |
| Item 2.      |   | Properties                                                                                                          |       |
| Item 3.      |   | Legal Proceedings                                                                                                   |       |
| Item 4.      |   | Submission of Matters to a  Vote of Security Holders                                                                |       |
| **Part II**  |   |                                                                                                                |       |
| Item 5.      |   | Market for Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  Securities |       |
| Item 6.      |   | Selected Financial Data                                                                                             |       |
| Item 7.      |   | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                         |       |
| Item 7A.     |   | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       |
| Item 8.      |   | Financial  Statements and Supplementary Data                                                                        |       |
| Item 9.      |   | Changes in  and Disagreements With Accountants on Accounting and Financial Disclosure                               |       |
| Item 9A.     |   | Controls and  Procedures                                                                                            |       |
| Item 9B.     |   | Other Information                                                                                                   |       |
| **Part III** |   |                                                                                                                |       |
| Item 10.     |   | Directors  and Executive Officers of the Registrant                                                                 |       |
| Item 11.     |   | Executive  Compensation                                                                                             |       |
| Item 12.     |   | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |       |
| Item 13.     |   | Certain  Relationships and Related Transactions                                                                     |       |
| Item 14.     |   | Principal  Accountant Fees and Services                                                                             |       |
| **Part IV**  |   |                                                                                                                |       |
| Item 15.     |   | Exhibits,  Financial Statement Schedules                                                                            |       |
|         |   | Signatures                                                                                                          |       |
|         |   | Exhibits                                                                                                            |       |

 

1

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**PART I**

 

**ITEM 1. BUSINESS.**

 

*AdvancedPower Technology, Inc. was incorporated in Delaware in 1984. Except asexpressly indicated or unless the context otherwise requires, the “Company”, “APT”,“we”, “our” or “us” means Advanced Power Technology, Inc. and its subsidiaries.Additional information about our Company, including access to periodic andcurrent reports are available free of charge on our website as soon asreasonably practicable after such material is electronically filed with, orfurnished to, the SEC. Our website address is www.advancedpower.com*

 

**CompanyOverview**

 

We are a leadingdesigner, manufacturer and marketer of high-performance RF and switching powersemiconductors. We are primarily focused on the high-power, high-speed segmentof the power semiconductor market. Power semiconductors function as poweramplifiers and power switches. They increase system efficiency and reliabilityby precisely managing and regulating electricity and converting it into theform required by electrical and electronic products. Our products permit thedesign of more compact end products and improve system features andfunctionality. Our products are found in diverse applications, such as F-22fighter cockpits, the Boeing 777 back-up power system, the International SpaceStation, air traffic control radar systems, semiconductor capital equipment,MRI systems, arc welding equipment, industrial lasers, solar power inverters andwireless communications base stations.

 

Powersemiconductors generally dissipate more than one watt of power and have a broadrange of frequency capabilities. We primarily focus on high-power, high-speeddevices that dissipate at least several hundred watts of power and requireoperating frequencies greater than 20 kHz, or 20,000 cycles per second (e.g.,the product may switch on and off up to 20,000 times per second).

 

Our RF power semiconductorsare transistors used as amplifiers for electrical signals and as high-frequencyelectronic switches. Our RF transistors are used in power amplifierapplications, such as radio transmitters or receivers for communications, radarand avionics. Our RF transistors are also used in RF power sources forinduction heating, dielectric heating, plasma generation and illumination.

 

Our switchingpower semiconductors include transistors and diodes, each of which control theflow of electricity. Our switching power semiconductors are typically used inpower converters/supplies to provide power to electronic equipment in therequired format. This typically involves converting electrical power fromalternating current (AC) to direct current (DC), converting one DC voltage toanother or converting DC power to AC power. As an example, the microprocessorand memory chips in a computer server require a power converter because theytypically operate at less than five volts DC while a standard electrical walloutlet supplies 110 to 220 volts AC.

 

We provide a widevariety of standard products as well as highly customized solutions for ourcustomers, depending on their requirements. Our products are available asdiscrete components or as modules, which are integrated solutions that combinemany discrete components to provide a complete power function. We sell ourproducts directly to OEMs and through distributors. Markets for our products,typical applications and examples of customers and end users include:

 

•                  *Military and aerospace.* We supply manufacturers of systems such as radar and avionics equipment,including The Boeing Company, Lockheed Martin Corporation, Raytheon Company andRockwell Collins;

 

•                  *Semiconductor capital equipment.* We supply manufacturers of equipment such as thin film deposition andplasma etch semiconductor capital equipment, including customers such as AdvancedEnergy Industries (AEIS)and MKS Instruments, and end users such as AppliedMaterials, Inc. and Novellus Systems, Inc.;

 

•                  *Medical and industrial.* We supply manufacturers of products such as MRI systems, implantabledefibrillators and arc welding equipment, including customers such as Analogic,Fronius, Guidant, Microsemi and Siemens Medical, and end users such as GuidantCorporation and St. Jude Medical, Inc.; and

 

•                  *Communications and data processing.* We supply manufacturers of computer servers, data storage equipment andwireless communications infrastructure, including Emerson, IBM, L-3 andMotorola.

 

2

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On November 2,2005, we entered into an agreement with Microsemi Corporation under which weand Microsemi will combine our respective businesses into a single entity. Assumingthat the merger closes, we would become a wholly-owned subsidiary of Microsemi.Our business, strategy and results would be combined with those of Microsemi,and our shareholders will become shareholders of Microsemi. The process ofobtaining the approval of our shareholders necessary to proceed with the mergeris pending. While we continue to believe that we will secure all of thenecessary approvals and that the merger will be completed in a timely manner,except where otherwise noted, the information presented in this report reflectsour business, strategy, results and other information on a stand alone basis. Formore information about the merger, see “Part II. Item 7. Managements Discussionand Analysis of Financial Condition and Results of Operations – RecentDevelopments - Pending Merger” below.

 

**MarketOverview and Key Trends**

 

Our high-performanceRF and switching products serve a portion of the large and growing high-speed,high-power subset of the overall power semiconductor market. Statisticspublished by the Semiconductor Industry Association (SIA) report in November of2005 reflect that the worldwide market for all discrete components for powersemiconductors for 2006 is expected to increase compared to 2005 byapproximately 3% and increase by approximately 19% from $15.9 billion in 2006to $18.9 billion in 2008. APT’s product lines serve a collection of nichemarkets which make up a subset of the overall power semiconductor markets referencedabove, focusing on high power and high frequency applications. We focus onparts of the overall power semiconductor market where we believe that ouradvanced technology is best suited to meet the needs of customers. Industrystatistics related to APT’s specific markets are not generally available andcannot be reasonably estimated.

 

We believe demandis being driven by the emergence of new applications that require higher power,higher frequency semiconductors that more precisely manage power, and also bythe need to increase performance and improve power quality for existingapplications. Within each of our markets, we expect the following key trends todrive demand:

 

•                  *Military and aerospace.* Security concerns, increasing domestic and international air trafficvolumes and national defense are becoming catalysts for purchases of advancedradar and avionics, such as collision-avoidance equipment, that requireprecise, high-performance power management solutions. In addition, RF powersemiconductors are being used in radar systems as a replacement for vacuumtubes, enhancing the performance and reducing the size of those systems.

 

•                  *Semiconductor capital equipment.* According to the SIA, the worldwide semiconductor market is expected togrow in 2006 by approximately 8% and grow from $245.5 billion in 2006 to$309.2 billion in 2008, or approximately 26%. Gartner Dataquest also projectsa strengthening of the market from 2006-2008, forecasting that semiconductordevice manufacturers will increase purchases of semiconductor capital equipmentby a total of 45% from 2006 to 2008. In addition to overall market expansion,advancements in thin film deposition and plasma etching processes areincreasing the need for high-performance, high-power, high-speed powersemiconductors.

 

•                  *Medical and industrial.* Advanced medical technology increasingly requires manufacturers ofelectronic components to improve functionality and decrease size. For example,implantable defibrillators have critical power regulation requirements and sizeconstraints. In the industrial markets, new applications that utilize the sametechnologies used in semiconductor processing to produce flat panel displaysand optical and glass coatings are expected to drive significant future growthfor high-performance, high-power, high-speed power semiconductors. We believedemand is also being driven by the need for more efficient energy use resultingfrom rising energy costs, government mandates and environmental concerns.

 

•                  *Communications and data processing.* As voice, video and data continue to converge into one digital stream,the power demands of traditional and emerging transmission systems arechanging. Communications service providers and equipment manufacturers arelooking to modify and supplement existing infrastructures to address these newdemands for data transmission and storage. High-performance powersemiconductors give providers and manufacturers improved flexibility inaddressing these demands.

 

**OurCompetitive Strengths**

 

Our extensiveexperience as a supplier of high-performance, high-power, high-speed powersemiconductors has enabled us to develop the following key strengths, which webelieve differentiate us from our competitors:

 

3

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***Technologicalleadership in the market for high-performance power semiconductors***

 

We are a pioneerin our industry and have been designing and manufacturing power semiconductordevices since 1984. As of December 31, 2005, we have received 26 U.S. patentsand 21 foreign patents on our core technology, with applications pending for 27additional U.S. and foreign patents. In 1989 we introduced our core Power MOSproduct line, which is now in its fourth generation. Our technology providesamong the highest frequency and power capabilities available. Our RF productline was introduced in 1996, was bolstered by two acquisitions in 2002 and providesamong the highest operating voltages available. Our focus has positioned us asa technology leader in certain key applications such as MRI systems,semiconductor capital equipment, avionics and L-band and S-band radar systems.

 

***Fullsuite of high-performance RF and switching power semiconductors***

 

We provide ourcustomers with a broad portfolio of RF and switching power semiconductorsolutions, which are available in thousands of configurations. Our RF productsare available in voltage and speed configurations ranging from 12 to 250 voltsand 1 MHz to 4 GHz frequencies. Our switching products are availablein voltage and speed configurations ranging from 100 to 1400 volts and20 kHz to 1 MHz frequencies. Our products are available as standardor customized solutions and are offered as discrete components or modules thatmay consist of more than 500 components.

 

***Closecollaboration with and support for our customers***

 

We typicallycollaborate closely with our customers in order to optimize their use of our powersemiconductor products. We believe that the work of our team of product andapplication engineers enables us to strengthen our relationship with thesecustomers. For example, significant cooperative efforts with Microsemi andcertain of the leading implantable medical device manufacturers have earned usdesign wins for devices manufactured by Guidant and St. Jude Medical. Our engineeringteam ensures that our products are deployed correctly and continue to meet orexceed customer expectations.

 

***Diversifiedend markets that provide opportunities for growth and a defense againstcyclical business environments***

 

For the year endedDecember 31, 2005, the revenue from each of our markets were 32.2% militaryand aerospace, 15.2% semiconductor capital equipment, 28.5% medical andindustrial, 22.5% communications and data processing, and 1.6% other. Given thebroad range of applications for our products and the increased demand for high-performance,high-power, high-speed power semiconductors in our target markets, we believethese markets provide continued opportunities for growth. Furthermore, becausethe markets we serve are diversified, we believe that this provides amitigating factor for the cyclical effects of any one industry on our business.For example, military spending has been relatively stable for applicationscontaining our products, which may moderate the peaks and troughs of highlycyclical businesses, such as semiconductor capital equipment.

 

***Longproduct lifecycles with frequent sole-source supply relationships***

 

The manufacturerswe supply tend to produce infrastructure equipment or complex systems that haverelatively long product life cycles. Generally, once a manufacturer hasincorporated our products in a system, they remain a component of the manufacturer’sequipment until it is redesigned, which is often many years later. In addition,we are a sole-source supplier for many of our customers’ applications as aresult of our technological advantages and our close collaboration in thedesign phase with our customers.

 

***Networkof leading distributors, OEM customers and end users***

 

Throughout ourhistory, we have developed relationships with many key distributors, largeOEMs and end users that are leaders in their respective markets. Examplesof the manufacturers we supply are described in  “Item 1. Business— Company Overview.” Webelieve that the strength of this network reflects the quality of ourtechnology and service and provides opportunities for growth.

 

***Provenmanagement and strong Board of Directors***

 

Patrick Sireta,our President, Chief Executive Officer and Chairman of the Board, joined us in1985, and other key members of senior management have been with us for morethan 15 years, including Russell Crecraft, our Chief Operating Officer,Greg Haugen, our Chief Financial Officer, Dah Wen Tsang, our Vice President ofEngineering, Research and Development, and 

 

4

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Thomas Loder, our VicePresident of Sales and Marketing. Members of our Board also have extensivesemiconductor industry experience and include the current Chairman of the Boardof AEIS and the former Chief Executive Officer of VLSI Technology.

 

**OurStrategy**

 

Our goal is to bethe world leader in providing high-performance power semiconductors for high-power,high-speed applications. To achieve our goal, we intend to:

 

***Increaseour penetration of core markets and customers and expand globally***

 

We intend toincrease revenue by further expanding our customer base and our core marketsand further penetrating key customers. For example, we added a leading Japanesesemiconductor capital equipment vendor as a customer and have secured a numberof new design wins with existing customers. We will continue to seek newcustomers in Asia and Europe and leverage our technology to penetrate new andadjacent market opportunities. For example, a leading German manufacturerselected our products for use in alternative energy solar panels, and we wereawarded a $4.0 million purchase order for an Asian radar system, which wedelivered in the third and fourth quarter of 2004.

 

***Continueto develop and commercialize leading-edge technology for new and existingapplications***

 

Our expertise inserving the high-performance, high-power, high-speed power semiconductor markethas enabled us to establish a strong foundation of core technologies. We intendto increase the scope of this portfolio by improving our core platform and bydeveloping and commercializing new technologies. For example, we have releaseda family of RF products designed for use in S-band radar systems, which is agrowing area within the military and aerospace market. In addition, in order todecrease certain of our customers’ time to market and product costs, we introduceda line of standard switching modules that offer industry standard packageoutlines and footprints but utilize our proprietary technology. We have alsoannounced new discrete and module products using silicon carbide, or SiC, andSchottky diodes that offer our customers faster switching speeds and reducedpower consumption.

 

***Continueto optimize manufacturing operations***

 

We plan tocontinue to optimize and rationalize our manufacturing operations in efforts toreduce and control costs. For example, we consolidated our internal manufacturingoperations, largely by transferring the wafer fabrication processes located atour Montgomeryville, Pennsylvania site to our Bend, Oregon facilities. We alsointend to utilize lower cost offshore subcontractors for both foundry servicesand assembly and testing to reduce our overall product manufacturing costs. In2004, we transferred more of our RF assembly and testing from our subcontractorin Mexico to our Malaysian provider, which also reduced our manufacturingcosts. Other initiatives, which include shipping products directly to customersfrom our subcontractors when possible and increasing the use of lower costplastic packaging, may also reduce our future expenses. We will continue tomonitor our manufacturing operations and needs to identify other potentialefficiencies and costs savings.

 

***Seekto enhance growth through selective acquisitions***

 

Our strategyincludes acquiring and integrating additional technological capabilities andcomplementary product lines through selective acquisitions and strategicinvestments. We are particularly focused on opportunities in RF powersemiconductors.

 

In 2002, wedemonstrated this by acquiring GHz Technology and the product lines and certainassets of Microsemi RF Products to help us further penetrate the markets for RFdevices. We believe that these acquisitions have positioned us as a leadingsupplier in bipolar RF power transistors and added substantial RF technology,engineering, manufacturing and marketing capabilities.

 

In 2004, we acquired the assets, including prototypeinventories, equipment, patents, and other intellectual property from adevelopment stage business, Zeus Semiconductor, Inc. In January 2005, weacquired PowerSicel, Inc. PowerSicel’s and Zeus Semiconductor’s combined expertisein silicon carbide and other compound semiconductor technology and productscomplement APT’s current portfolio of RF products which operate at frequenciesranging from 1 MHz to 4 GHz and are sold into applications such assemiconductor capital equipment, medical imaging, radar, avionics and wirelesscommunications. We believe these acquisitions add valuable developmentcapability to APT’s core capability in RF power transistors allowing APT tobetter serve its current markets and to expand into new markets.

 

5

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**Products**

 

Our powersemiconductor products combine innovative proprietary and patentedsemiconductor technology, designs, processes and packaging solutions that areoptimized for our customers’ applications. They can be broadly categorized intotwo categories: RF and switching power semiconductors. The following tablesummarizes our major product offerings:

 
| **Product   Group** | ** ** | **Product   Family** | ** ** | **Product**    | ** ** | **Voltage** | ** ** | **Frequency**    | ** ** | **Typical End   Applications** | ** ** |
|--------------------------|------------|---------------------------|------------|----------------|------------|-------------|------------|------------------|------------|------------------------------------------|------------|
| RF                       |       | Transistors               |       | Bipolar        |       | 12 - 50     |       | 1 MHz - 4 GHz    |       | Avionics, Radar,                         |       |
|                     |       |                      |       |           |       | 100 - 250   |       | 1 MHz - 200 MHz  |       | MRI, Plasma                              |       |
|                     |       | Transistors               |       | MOSFETs        |       | 28 - 50     |       | 1 MHz - 500 MHz  |       | Generation, Lasers,                      |       |
|                     |       |                      |       |           |       | 28          |       | 1 GHz - 2 GHz    |       | Two-way Radios                           |       |
|                     |       | Modules                   |       | Power Function |       | 100 - 250   |       | 1 MHz - 13 MHz   |       |                                     |       |
| Switching                |       | Transistors               |       | MOSFETs        |       | 100 - 1400  |       | 20 kHz - 1 MHz   |       | Cellular Base                            |       |
|                     |       |                      |       | IGBTs          |       | 300 - 1200  |       | 20 kHz - 200 kHz |       | Stations, Sonar,                         |       |
|                     |       | Diodes                    |       | FREDs          |       | 200 - 1200  |       | 20 kHz - 200 kHz |       | Defibrillators, Solar                    |       |
|                     |       |                      |       | Schottky       |       | 200 - 1200  |       | 20 kHz - 1 MHz   |       | Power, Arc Welding,                      |       |
|                     |       | Modules                   |       | Power Function |       | 100 - 1200  |       | 20 kHz - 1 MHz   |       | Plasma Generation                        |       |

 

“IGBT” stands for aninsulated gate bipolar transistor.

 

“FRED” stands for a fastrecovery epitaxial diode.

 

“MOSFET” stands for ametal oxide semiconductor field effect transistor.

 

***RFPower Semiconductors***

 

RF powersemiconductors are typically used as amplifiers of electrical signals or ashigh-frequency electronic switches. Our RF products span the frequency rangefrom 1 MHz to 4 GHz with operating voltages from as low as a fewvolts to as high as 250 volts. RF power semiconductors are used in virtuallyall of our end markets and share many of the same customers as our switchingpower semiconductors. With these products we are positioned to serve such applicationsas communication radios, non-cellular base stations, MRI systems, semiconductorcapital equipment, radar, avionics and military communications.

 

Our RF powersemiconductor products include:

 

•                  *Bipolar transistors.* These products are primarily used in military and aerospace and non-cellularcommunication applications and were acquired as part of our two acquisitions in2002; and

 

•                  *MOSFETs.* We introduced our first RF MOSFETs in 1996, and bolstered this capabilitywith two acquisitions in 2002.

 

***SwitchingPower Semiconductors***

 

Switching powersemiconductors are generally used as electronic switches in power supplies forthe highly efficient and precise control of electrical power. These powersupplies are the dominant type of power supply used for high power applicationsand are deployed in virtually all of our end markets. Our switching productsspan the frequency range from 20 kHz to 1 MHz with operating voltages fromas low as 100 volts to as high as 1400 volts.

 

Our switchingpower semiconductor products include:

 

•                  *MOSFETs.* Based on our original core proprietary and patented technology, ourMOSFET products include Power MOS IV introduced in 1989, Power MOS V introducedin 1999, Power MOS VI introduced in 1999 and Power MOS 7 introduced in 2000.Each succeeding generation offers performance improvements over the precedinggeneration allowing us to continue to provide leading-edge products to ourcustomers.

 

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•                  *IGBTs.* Our IGBTs are basedon our core MOSFET technologies and are used as lower cost alternatives toMOSFETs in a number of applications.

 

•                  *Diodes.* Our FRED and Schottky diodes are complementary products to ourtransistors since most applications require both transistors and diodes. Diodescontrol current flow in circuits by allowing current to pass in one directionbut not in the other. Transistor performance is often affected by theperformance of the diode in the power circuit and our diodes are optimized totake maximum advantage of our advanced transistor technologies.

 

***Packaging***

 

We typically packageour discrete products in plastic packages. Plastic packaged products are morecost effective and represent the majority of our unit volumes.

 

We also packageour solutions as modules, which combine a number of single components togetherto provide a complete power function. These modules cover a wide range ofintegration and complexity, from relatively simple functions integrating lessthan ten components to fully integrated functions integrating more than 500components in a single power module. These modules can often provideperformance, size, cost and time to market advantages over discrete powersemiconductors. For customer-specific applications we offer customizedApplication Specific Power Modules, or ASPMs. In addition, we recentlyintroduced a line of standard modules that offer industry standard packageoutlines and footprints but utilize our proprietary technology.

 

**Researchand Development**

 

Our research anddevelopment efforts focus on improving and developing new core technologies andproducts. We continually focus on internal improvements in our technology, suchas reducing feature size, to improve the efficiency and speed of our products,and on incorporating outside technological advances, for example, in packagingprocesses and materials, to ensure that our products meet our high performancestandards. We also spend significant engineering time deriving new productsfrom our core products in order to address specific customer or market needs.

 

Our RFsemiconductor research and development takes place at our Bend, Oregon, SantaClara, California and Montgomeryville, Pennsylvania facilities. Our discreteswitching power semiconductor research and development takes place at our Bend,Oregon facility. Power module research and development takes place at ourBordeaux, France facility. Research and development efforts on silicon carbideand other compound semiconductor technology and products for wide band gapapplications take place at our Boulder, Colorado facility.

 

**Sales,Marketing and Distribution**

 

We sell ourproducts to most of our OEM customers through a network of independent salesrepresentatives that are managed by our internal sales organization. As ofDecember 31, 2005, we had 33 independent sales representatives.

 

We generally usedistributors to develop and service our smaller volume accounts worldwide andas our primary sales channels in several countries. We have two globaldistributors, four national distributors in North America, and 22 singlecountry distributors who cover Western Europe and Asia. Currently, RichardsonElectronics is our leading distributor based on revenue. In 2003, we addedFuture Electronics as a worldwide distributor. Our distributors not only enhanceour ability to meet the needs of our smaller volume customers, but also permitincreased revenue to large manufacturing customers by freeing up sales andsupport resources. Our distributors have certain stock rotation rights whichallow them to rotate up to 5% of their products every six months in exchangefor an order of an equal amount of new product. We monitor inventory levels atour key distributors on a monthly basis. In certain circumstances we may electto give product-specific price protection to our distributors.

 

Our applicationengineering, product engineering and product marketing organizations providetechnical support for the sales force. We employ 30 engineers in theseorganizations, as well as support staff. Customer service for all of ouraccounts is handled by our customer service organizations in each of ourlocations. Our website gives our customers access to information about us andour products, enables them to request quotations or technical assistance andprovides links to our local sales channels worldwide.

 

**SalesProcess**

 

We work closelywith our OEM customers, and often the end customers of our distributors, inidentifying opportunities for system designs using our products. The customer’sdecision to use our product in its system design is based upon product features

 

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and performance, breadthof product line, customer service and support, quality and reliability andcompetitive pricing. Typically, a customer’s design engineers will thencollaborate with our application and product engineering organizations todesign and test the end product before finalizing a decision.

 

Once an end userbegins production of a system, it will typically continue to incorporate ourproducts for several years, since these systems usually have long lifecycles.Our sales managers monitor products through this cycle for changes ordevelopments with our end users. We are often a sole-source supplier for manyof our customers’ applications, particularly in the military and aerospace,semiconductor capital equipment and medical markets.

 

**Orders**

 

As of December 31,2005, our twelve month backlog, representing booked orders with delivery datesscheduled within the next twelve months, was $23.8 million, compared to $17.2million as of December 31, 2004. The amount of the backlog shippable in thefirst quarter of 2006 was $15.5 million compared to $10.5 million for the firstquarter of 2005. This represents 65% and 61% of booked backlog at December 31,2005 and 2004, respectively. Our business is characterized by short-term ordersand shipment schedules, and customer orders typically can be canceled orrescheduled without penalty to the customer.

 

**Customers**

 

For the year endedDecember 31, 2005, our largest volume OEM customers were AEIS, MKS Instruments,Copley Controls, Rockwell Collins, and Emerson. In 2005, approximately 62.4% ofour revenue was from customers in North America, 17.6% from customers inEurope, and 20.0% from customers in Asia and the rest of the world.

 

Revenue from ourfive largest OEM and distributor customers accounted for 37.7%, 46.6%, and 38.0%of our total revenue in 2005, 2004, and 2003, respectively. RichardsonElectronics accounted for 19.7% of our revenue in 2005, 21.9% of our revenue in2004, and 15.8% of our revenue in 2003. The 2004 increase for RichardsonElectronics in the overall percentage of our revenue is primarily due to utilizingRichardson to import products to certain key Asian customers. No other customerexceeded 10.0% of our revenue during these periods. We generally provide ourcustomers a 12-month repair or replacement warranty.

 

Geographic informationregarding our revenue is included in Note 13 of the Notes to ConsolidatedFinancial Statements of this Report.

 

**Manufacturingand Facilities**

 

***RFPower Semiconductors***

 

Wafer fabricationfor our RF semiconductor products is performed in our internal waferfabrication sites located in Bend, Oregon, and Santa Clara, California. Packageassembly and testing of these products is performed in our own domesticfacilities located in Santa Clara, California and Montgomeryville,Pennsylvania, in addition to subcontractors in Malaysia. In 2005, we moved moreassembly and testing of RF products to our subcontractor in Malaysia, which weexpect will reduce our manufacturing costs. Manufacturing of our military andaerospace products for avionics and radar applications, where state-of-the-artRF performance and repeatability are critical, will continue in Santa Clara,California at our automated assembly and test line.

 

***SwitchingPower Semiconductors***

 

Wafer fabricationfor switching power semiconductor products is performed in our internal waferfabrication site located in Bend, Oregon, and by our manufacturing partners,Infineon Technologies in Austria, Episil Technologies in Taiwan, and CSMCManufacturing in China.

 

Our currentmanufacturing strategy is to expand our use of these foundries to provide forthe manufacturing needs to support our growth. Our agreements with Infineon andEpisil extend indefinitely and require a two-year notice of termination. Episilis located in close proximity to our subcontract assembly and test partners andour expanding customer base in Asia. This close proximity provides for reducedcycle times and improved customer service.

 

In 2005, weentered into a wafer production agreement with CSMC Manufacturing Co., Ltd. forthe provision of foundry services to be performed by CSMC Technologies Fab 1Co., Ltd., a subsidiary located in Wuxi, Jiangsu Province, China. CSMCTechnologies Fab 1 Co., Ltd. will produce and supply wafers to the Company. Thecontract does not have an expiration date and is cancelable upon twenty-fourmonths prior written notice to terminate the agreement.

 

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We have agreementswith Team Pacific and PSI Technologies, subcontractors in the Philippines, forassembly and testing of most of our plastic encapsulated discrete products. Oursubcontractors currently electrically test the majority of the products thatthey manufacture for us. The products not tested by subcontractors are shippedto us for testing. We manufacture and assemble all of our discrete hermeticpackages in our facility located in Bend, Oregon.

 

***Modules***

 

Our modules aremanufactured at our own facilities in Bordeaux, France and Bend, Oregon as wellas on a captive manufacturing line located at one of our subcontractor’sfacilities in the Philippines. During 2005, we transferred additional moduleassembly and testing, to our captive line in the Philippines, which we expectto result in lower production costs.

 

***Qualityand Reliability***

 

Our manufacturingprocesses emphasize quality and reliability, and involve testing at variousstages of the manufacturing process. We, together with our subcontractors, test100% of our products. Our Bend and Santa Clara facilities are certified toISO-9001-2000 standards and to U.S. military specifications.

 

***RawMaterials***

 

We rely on rawmaterials to manufacture our products, including silicon, various chemicals,gases and compounds. In particular, we obtain silicon wafers and ceramicpackaging through limited sources of supply. We monitor our sources of supplyand consider our current portfolio of suppliers to be adequate to meet theneeds of the business.

 

**Competition**

 

We encountervarying degrees of competition for our products, depending on the nature of theproduct and the particular market served. The power semiconductor industry ishighly competitive and subject to price erosion. Many of our competitors arelarger companies with greater financial resources. There are a number ofcompanies that manufacture products that compete directly with our products.For our RF products, our principal competitors include Integra, MA/Com, Philipsand ST Microelectronics. For our switching products, our principal competitorsinclude Fairchild Semiconductor, International Rectifier, IXYS and STMicroelectronics.

 

We believe thatthe primary elements of competition in our markets are product features andperformance, breadth of product line, customer service and support, quality,reliability and competitive pricing. We believe that we compete effectively inour markets.

 

**IntellectualProperty Matters**

 

As of December 31,2005, we have received 26 U.S. patents and 21 foreign patents and haveapplications pending for 27 additional U.S. and foreign patents on differentaspects of our core technology. We rely on patents, trade secrets and otherintellectual property laws, as well as confidentiality and intellectualproperty assignment agreements with our employees to protect our proprietaryrights. Three U.S. patents and five corresponding foreign patents on importantaspects of our core technology will expire in 2007 to 2008 and 2008 to 2009,respectively. We regard certain of our processes, information and knowledgethat we have developed and use to design and manufacture our products asproprietary. We have also registered trademarks for Power MOS IV, Power MOS V,Power MOS VI, Power MOS 7, T-MAX and ASPM.

 

We have licensed aportion of our intellectual property for commercialization in certain foreignmarkets. In 1990, we entered into two non-exclusive, non-transferable licensesand technology transfer agreements for the manufacture of our products inJapan. In 1991, we entered into a similar arrangement with a manufacturer inthe United Kingdom for sales in Europe. Each of these agreements resulted inone-time payments to us and entitles us to certain royalties over the life ofthe licenses. To date, on-going royalties from these licensing arrangementshave not been material.

 

**Employees**

 

As of December 31,2005, we had 286 permanent employees. Of these, 159 were at our facilities inBend, Oregon, 25 at our facility in Bordeaux, France, 60 at our facility inSanta Clara, California, 31 at our facility in Montgomeryville, Pennsylvania,and 11 at our facility in Boulder, Colorado. Our continued success dependsheavily on our ability to attract and retain qualified 

 

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personnel. We considerour relations with our employees to be good. None of our employees arerepresented by a union; however, our employees in Bordeaux, France arerepresented by an employee works council pursuant to French industrialrelations law.

 

**EnvironmentalRegulation**

 

While we believewe are in material compliance with present environmental regulations, increasedpublic attention has been focused on the environmental impact of semiconductoroperations. In the conduct of our manufacturing operations, we have handled anddo handle materials that are considered hazardous, toxic or volatile underenvironmental laws; therefore, we are subject to regulations related to theuse, storage, discharge and disposal of materials. The risk of accidentalrelease of such materials cannot be completely eliminated, and if such arelease occurs, we could be held financially responsible for the clean up orother consequences of the release. Along with the rest of the semiconductorindustry, we are subject to variable interpretations and governmentalpriorities concerning environmental laws and regulations. Environmentalstatutes have been interpreted to provide for joint and several liability andstrict liability regardless of actual fault. We may be required to incur coststo comply with current or future environmental laws or regulations, and ouroperations, business or financial condition could be adversely affected by suchrequirements.

 

**ITEM 1A. RISK FACTORS.**

 

**RiskFactors Affecting Business and Results of Operations**

 

Some of thestatements under “Risk Factors Affecting Business and Results of Operations,” “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” “Business”and elsewhere in this report constitute forward-looking statements within themeaning of Section 27A of the Securities Act and Section 21E of theSecurities Exchange Act.

 

In some cases, youcan identify forward-looking statements by terminology such as “may,” “will,” “should,”“could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,”“potential” or “continue” or the negative of such terms or other comparableterminology. For example, we make statements regarding:

 

•                  Future growth of the semiconductor capital equipment, industrial andmedical equipment and military and aerospace markets, and the factors affectingsuch growth;

•                  Increased production volume from our manufacturing facilities and itsrelated margin impact;

•                  Favorable changes in our gross profit margins and increased sales of ourRF products as part of overall sales;

•                  Implementation of our restructuring plans;

•                  Our prospects for future long term profitability;

•                  Our future tax expenses and effective tax rate;

•                  Our expectations with regard to research and development expenses;

•                  Our expectations for funding future liquidity needs; and

•                  Potential acquisitions and equity investments.

 

These and otherforward looking statements involve known and unknown risks, uncertainties andother factors that may cause our actual results, levels of activity, performanceor achievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by these forward-lookingstatements. These factors include, among other things, those listed under “RiskFactors Affecting Business and Results of Operations” and elsewhere in thisreport.

 

Although webelieve that the expectations reflected in the forward-looking statements arereasonable, we cannot guarantee future results, levels of activity, performanceor achievements. Moreover, neither we nor any other person assumesresponsibility for the accuracy and completeness of such statements. We areunder no duty to update any of the forward-looking statements after the date ofthis report.

 

In addition, youshould consider the risks associated with the merger, which are discussed below.See “Part II. Item 7. Managements Discussion and Analysis of FinancialCondition and Results of Operations – Recent Developments - Pending Merger”.

 

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***BusinessRisks***

 

**Thesemiconductor industry is very cyclical, and an industry downturn could reduceour revenue.**

 

The semiconductorindustry is characterized by:

•                  rapid technological change;

•                  cyclical market patterns;

•                  significant price erosion;

•                  periods of over-capacity and production shortages;

•                  variations in manufacturing costs and yields; and

•                  significant expenditures for capital equipment and product development.

 

The semiconductorindustry has from time to time experienced depressed business conditions. Inthe past, business conditions in this industry have rapidly changed fromperiods of strong demand to periods of weak demand. For example, according tothe SIA, the semiconductor industry declined 31.9% in 2001, after growing 36.9%in 2000. Any future downturn in the industry could harm our business and causeour operating results to suffer. We cannot assure you that we will notexperience substantial period-to-period fluctuations in operating results dueto general semiconductor industry conditions or other factors beyond ourcontrol.

 

**Certainof the markets we serve are cyclical and our ability to grow and sustain growthlevels may be adversely affected by a slowdown in the global economy.**

 

We serve customersand end users in the military and aerospace, semiconductor capital equipment,medical and industrial, and communications and data processing markets. Theslowdown in the global economy during the early part of this decade generallyreduced capital spending and consumer confidence, and caused us to experienceweakness in our end markets and reduced our profitability. Slowdowns in thesemiconductor and telecommunications industries were particularly severe andadversely affected the sales of our products used in these applications. Shouldthe demand for our products in any of our primary target markets decline in thefuture, our business, financial condition and results of operations may beadversely affected.

 

**We havehistorically experienced fluctuations in our operating results and we expectthese fluctuations to continue, which may cause our common stock price todecline.**

 

Our quarterly andannual operating results are affected by a wide variety of factors that couldmaterially and adversely affect our net revenue, gross profits and operatingresults. These factors include:

•                  the volume and timing of orders received;

•                  market acceptance of our products and the products of our customers;

•                  competitive pricing pressures;

•                  our ability to expand manufacturing output to meet increasing demand;

•                  the cyclical needs of our customers;

•                  the timing of goodwill impairments or restructuring or other accounting-relatedcharges;

•                  the timing and extent of our research and development expenses;

•                  the timing and extent of significant capital equipment purchases;

•                  fluctuations in manufacturing yields; and

•                  litigation expenses.

 

Our business ischaracterized by short-term orders and shipment schedules, and customer orderstypically can be canceled or rescheduled without penalty to the customer.Because most of our backlog is cancelable without penalty, we typically planour production and inventory levels based on internal forecasts of customerdemand, which is highly unpredictable and can fluctuate substantially. Inaddition, because of our fixed costs, we are limited in our ability to reducecosts quickly in response to any revenue shortfalls. As a result of theforegoing factors, or the other risk factors discussed in this prospectus, wemay experience material adverse fluctuations in our future operating results ona quarterly or annual basis. We cannot assure you that we will be profitable ona quarterly or annual basis in future periods.

 

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**We haveincurred significant losses in certain recent periods, and there can be noassurance that we will be able to sustain profitability in the future.**

 

We recorded netlosses in three of the last five full fiscal years. We may incur losses insubsequent periods. Our ability to maintain profitability on a quarterly orfiscal year basis in the future will depend on a variety of factors, includingour ability to increase net revenue, expand gross margins, introduce newproducts on a timely basis, secure sufficient fabrication capacity and controloperating expenses.

 

**If wecannot introduce new products on a timely basis, our financial results maysuffer.**

 

The markets forour products are characterized by rapid technological change and frequent newproduct introductions. Historically in the semiconductor industry, averageselling prices of products have decreased over time. If we are unable tointroduce new proprietary products with higher margins or reduce manufacturingcosts to offset anticipated decreases in the prices of our existing products,then our operating results will be harmed. Our success depends upon our abilityto develop improved power semiconductors for new and existing markets, tointroduce these products in a timely manner, and to have these products gainmarket acceptance. The development of new power semiconductors is highlycomplex and from time to time we have experienced delays in developing andintroducing new products. Successful product development and introductiondepends on a number of factors, including:

•                  proper new product definition;

•                  timely completion of design and testing of new products;

•                  cost-effectiveness;

•                  achievement of acceptable manufacturing yields; and

•                  market acceptance of our products and the products of our customers.

 

We cannot assureyou we will be able to meet these challenges or adjust to changing marketconditions as quickly and cost-effectively as necessary to competesuccessfully. Due to the complexity and variety of power semiconductors, thelimited number of qualified development engineers and the limited effectivenessof computer-aided design systems in the design of such circuits, we cannotassure you that we will be able to successfully develop and introduce newproducts on a timely basis. We cannot assure you that any products introducedby us will be adopted by existing or potential customers, or that any productsinitially accepted by our customers will become industry standard products. Ourfailure to develop and introduce new products successfully could significantlyharm our business and cause our operating results to suffer.

 

**If wecannot optimize our mix of product sales, our financial results may suffer.**

 

If we are unableto optimize the mix of sales of relatively higher margin but lower volumeproducts and relatively higher volume but lower margin products, our operatingresults may be harmed. In order to improve our margins through sales of highermargin products it is important that in the future they represent a greaterpercentage of our net revenue, requiring us to develop, introduce and marketnew proprietary products. We cannot assure you that we will be successful indeveloping new proprietary products with the features and functionality thatcustomers in our key markets will demand.

 

**Ourrevenue depends upon our products being designed into our customers’ products.**

 

We generally workclosely with our customers in the design stage and as a result of thiscollaboration from time to time we will be notified that some of our newproducts are incorporated into customers’ products or systems. Assuming webelieve some volume of our products is likely to be purchased, we typicallyrefer to this event as a design win. The value of any design win largelydepends upon the customer’s decision to manufacture the designed product inproduction quantities, the commercial success of the customer’s product and onthe extent to which the design of the customer’s system also accommodatesincorporation of components manufactured by our competitors. In addition, ourcustomers could subsequently redesign their products or systems so that they nolonger require our products. For these or other reasons, we may not achievedesign wins or our design wins may not result in future revenue.

 

**Strongcompetition in the power semiconductor market may reduce the demand for ourproducts or the prices of our products, which could reduce our revenue and harmour business.**

 

The powersemiconductor industry is highly competitive. Significant competitive factorsin the power semiconductor market include:

•                  product features and performance;

 

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•                  product quality;

•                  product reliability;

•                  technical knowledge;

•                  breadth of product line;

•                  competitive pricing; and

•                  customer service and support.

 

Because the marketfor power semiconductors is diverse and highly fragmented, we encounterdifferent competitors in our various product markets. Our principal competitorsin one or more of our product areas include Fairchild Semiconductor, Integra,International Rectifier, IXYS, MA/COM, Philips and ST Microelectronics. Many ofour competitors have substantially greater technical, financial and marketingresources and greater name recognition than we do and may be on more approvedvendor lists than we are. We expect intensified competition from existing powersemiconductor suppliers and the possible entry of new competitors. Increasedcompetition could harm our business. We cannot assure you that we will be ableto compete successfully in the future or that competitive pressures will notharm our financial condition or our operating results. Competitive pressurescould reduce market acceptance of our products and result in price reductionsand increases in expenses that could harm our business and our financialcondition.

 

**Ourfinancial results could be harmed if we were to lose one of our major customersor key distributors.**

 

Several of ourmajor customers account for a significant portion of our net sales each year.During 2005, our top five customers accounted for 37.7% of our net revenue, andone distributor, Richardson Electronics, accounted for 19.7% of our netrevenue. If we lost Richardson Electronics or one of our other major customers,or if one of them reduced or canceled significant orders, our net income andoperating results could be harmed. If our relationship with RichardsonElectronics were discontinued, or if Richardson Electronics should fail toprovide adequate service to our customers, we could lose revenue and ouroperating results would suffer.

 

**We relyheavily on our key subcontractors. If they fail to produce needed goods andservices, our business and results of operations may suffer.**

 

We increasinglyrely on third party subcontractors in Europe and Asia to manufacture, assembleand test most of our products. We rely on Infineon Technologies, an outsidefoundry located in Europe, and Episil Technologies, located in Taiwan, whichcollectively produce a significant percentage of our wafers. In addition, weentered into a wafer production agreement in 2005 with CSMC Manufacturing Co.,Ltd., located in China. Production is expected to begin the second half of2006. The contract does not have an expiration date and is cancelable upontwenty-four months prior written notice to terminate the agreement. Ouragreement with Infineon provides for fixed prices and a guaranteed purchasecommitment and may be terminated upon two years’ notice. In addition, we relyon Siltronic to supply silicon wafers. We also rely on Team Pacific and PSITechnologies, subcontractors in the Philippines, to assemble and test most ofour switching power semiconductor products. In addition, we rely onSemiconductor Assembler & Manufacturer in Malaysia to assemble andpackage our RF products. We also rely on Kyocera as our sole source of ceramicpackaging for certain discrete RF power semiconductors. We do not have long-termfixed price contracts with any of these key subcontractors other than Infineon.Disruption or termination of these arrangements or any capacity constraintsthat our subcontractors experience could harm our business and operatingresults. Political instability, labor disputes, natural disasters and otherfactors could disrupt the operations of our subcontractors. If any of oursubcontractors experience financial, operational, production or quality assurancedifficulties resulting in a reduction or interruption in supply to us, ouroperating results could suffer. Additionally, our subcontractors may not beable to maintain the technological capability to meet our future needs. Workingwith such subcontractors may lead to reduced control over product quality anddelivery schedules. In addition, our subcontractors also manufacture andpackage products for our competitors, and there is a risk that oursubcontractors could allocate less of their production capacity and resourcesto our needs or demand price increases. If our subcontractors fail to provideneeded products and services in a timely and cost effective manner, ourrevenue, business and results of operations may suffer.

 

**Interruptionsin wafer production may harm our operating results.**

 

Any prolongedinability to utilize our Bend, Oregon, Santa Clara, California or third partyfoundries as a result of fire, natural disaster or otherwise could harm ourfinancial condition and cause our operating results to suffer. While we docarry business interruption insurance, there is no assurance that it would beavailable or sufficient in the event that one of our facilities was renderedunavailable. Also, at times, there are shortages of foundry capacity in theindustry. For example, in 2000, our sales were limited by the wafer fabricationcapacity available to us. If we are not able to obtain additional foundrycapacity as required, our relationships with our customers may be harmed andour sales would likely be limited. We may not be able to make 

 

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arrangements foradditional foundry capacity in a timely fashion or at all, and sucharrangements, if any, may not be on terms favorable to us, and could entail significantdelay and additional expense. In addition, qualifying a new foundry couldrequire the consent of or requalification by our customers. Moreover, if we areable to secure additional foundry capacity, we may be obligated to utilize allof that capacity or incur penalties. These penalties may be expensive and couldharm our operating results.

 

**Intellectualproperty litigation may harm our business.**

 

The semiconductorindustry in general is characterized by frequent litigation regarding patentand other intellectual property rights. This may require us to defend againstassertions of intellectual property infringement or misappropriation raised byour competitors. If we are unable to successfully defend against suchassertions, we may be exposed to substantial liability for damages, need toobtain licenses from the intellectual property owners, discontinue or changeour processes or products, and/or expend significant resources to develop oracquire non-infringing technologies (if at all possible). We cannot be certainthat licenses would be available under reasonable terms or that we couldsuccessfully develop or acquire non-infringing technologies. Moreover, any suchefforts would likely be time-consuming and consume significant management andfinancial resources. Thus, any involvement in intellectual property litigationcould harm our operating results and financial condition.

 

We also havecertain indemnification obligations to customers with respect to theinfringement of third party intellectual rights by our products. No assurancecan be provided that future assertions of infringement or misappropriation willnot occur, or that claims for indemnification by customers of our products willnot be made, or that assertions of infringement or misappropriation (especiallyif proven to be true) will not harm our business.

 

**If wecannot adequately protect our technologies and intellectual property rights,our financial results may suffer.**

 

Our successdepends on our ability to obtain and maintain protection of certain proprietarytechnologies used in our principal products. We rely on a combination ofpatents, trade secret laws and contractual provisions to protect ourtechnologies. Our competitors may independently develop technologies that areas good as or better than ours, and absent patent protection, we would beunable to stop their use of such independently developed technologies.

 

The process ofseeking patent protection can be long and expensive, and we cannot assure youthat our current patents are or any new patents that may be issued will be ofsufficient scope or strength to provide any meaningful protection or anycompetitive advantage to us. Although none of our patents or other intellectualproperty rights has been successfully challenged to date, we cannot assure youthat any patent owned by us will not be invalidated, circumvented orchallenged.

 

In addition, wehave licensed a portion of our intellectual property rights to European andJapanese entities and entered into two joint ventures and licensing andtechnology transfer agreements in China. The China agreements were subsequentlyterminated. We cannot assure you that these foreign entities have at all timesremained within the scope of their contractual obligations with respect to ourtechnology and intellectual property, or that other foreign entities have notinfringed or misappropriated our intellectual property. Intellectual propertylaw and practice differs in foreign jurisdictions, and it may prove difficultfor us to protect our rights in foreign countries.

 

If we are unableto protect our technology and intellectual property rights, whether in the U.S.or abroad, we could face increased competition in the market for our productsand technologies, or possibly even exclusion from the market. This wouldnegatively affect our ability to maintain or expand our business, and thus ourrevenue.

 

**If ourmanufacturing processes become obsolete, our margins and profitability may beharmed.**

 

Semiconductordesign and process methodologies are subject to rapid technological change,requiring large expenditures for research and development in order to improveproduct performance and increase manufacturing yields. Our current processtechnology is likely to become obsolete at some point in the future. If we areunable to develop or obtain access to advanced silicon wafer processingtechnologies as they become needed, our future operating results may suffer.

 

**Ourbusiness is subject to risks associated with operations in foreign countries.**

 

In 2005, approximately37% of our revenue was from customers located outside of the U.S. In addition,some of our manufacturing operations are not in the U.S. The following are someof the risks inherent in doing business on an international level:

•                  economic and political instability;

•                  foreign currency fluctuations;

 

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•                  transportation delays;

•                  trade restrictions;

•                  work stoppages;

•                  disruption of local labor supply and/or transportation services;

•                  inflexible employee contracts in the event of business downturns;

•                  government and license requirements governing the transfer of technologyand products abroad;

•                  the burden and cost of complying with import and export regulations;

•                  risks of conflict and terrorism;

•                  diseases such as SARS; and

•                  the laws, including tax laws of, and the policies of the United Statestoward, countries in which we manufacture our products.

 

In addition, wehave supply agreements, assembly agreements, and other relationships withforeign companies that are subject to similar risks. These risks couldnegatively affect our results of operation.

 

**We dependon the availability of raw materials to manufacture our products, and adisruption in supply could harm our operating results.**

 

We rely on raw materialsto manufacture our products, including silicon, various chemicals, gases andcompounds. In particular, we obtain silicon wafers and ceramic packagingthrough limited sources of supply, and in the event of a shortage, we may beforced to locate alternative sources and be forced to pay higher prices. Asevere shortage or an increase in the price of silicon wafers or packaging mayharm our gross margins and our ability to deliver our products on a timelybasis, if at all.

 

**Ourfoundries may experience lower than expected yields, which could adverselyaffect our business.**

 

The manufacture ofpower semiconductors is a highly complex and technically demanding process.Production yields and device reliability can be affected by a large number offactors. As is typical in the semiconductor industry, our foundries have fromtime to time experienced lower than anticipated manufacturing yields and devicereliability problems, particularly in connection with the introduction of newproducts and changes in processing steps. There can be no assurance that ourfoundries will not experience lower than expected manufacturing yields ordevice reliability problems in the future, which could materially and adverselyaffect our business and operating results.

 

**Ourbusiness may be harmed by acts of terrorism.**

 

Acts of terrorismcould interrupt or restrict our business in several ways. For example, we relyextensively on the use of air transportation to move our inventory to and fromour vendors and to ship finished products to our customers. If terrorist actscause air transportation to be grounded or interrupted, our business could beharmed.

 

In addition, actsof terrorism could cause existing export regulations to be changed, which couldlimit the extent to which we are allowed to export our products. To the extentthat acts of terrorism also reduce customer confidence and create generaleconomic weakness, our business could also be harmed.

 

**Anaccident at our manufacturing facilities could cause serious damage for which wecould be responsible.**

 

Our manufacturingoperations involve high voltage equipment, explosive gases and hazardouschemicals. An accident at our manufacturing facilities could result in seriouspersonal injury or property damage for which we could be held financiallyresponsible and could interrupt our operations, potentially for an extendedperiod of time. Any losses in excess of available insurance, and any long-termeffects of disrupted operations, could harm our financial results.

 

**Ourproducts are complex and could contain defects, which could reduce sales ofthose products or result in claims against us.**

 

We develop complexand evolving products. Despite testing by us and our customers, defects orother performance problems may be found in existing or new products. This couldresult in loss of revenue, loss of market share or failure to achieve marketacceptance. These defects may also cause us to incur significant warranty,support and repair costs, divert the attention of our engineering personnel fromour product development efforts and harm our relationships with our customers.Any defects or other problems with our products could result in financial orother damages to our customers who could seek damages from us for their losses.

 

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We may be subjectto product liability claims with respect to our products. Our products areincorporated into highly expensive equipment such as aircraft, and intoproducts where a failure may have severe consequences, such as defibrillators.Our product liability insurance coverage may be insufficient to pay any suchclaims. Product liability insurance may become too costly for us or may becomeunavailable to us in the future. We may not have sufficient resources to satisfyany product liability claims not covered by insurance which would materiallyand adversely affect our financial position. Even an unsuccessful productliability claim would likely be time-consuming and costly to defend.

 

**Ourmanufacturing operations involve hazardous substances, and the costs ofcomplying with applicable environmental laws could harm our financial results.**

 

Our manufacturingoperations are subject to various federal, state, local and foreignenvironmental laws and regulations relating to the management, disposal andremediation of hazardous substances and the emission and discharge ofpollutants into the air, water and soil. In the conduct of our manufacturingoperations, we have handled and do handle materials that are considered hazardous,toxic or volatile under federal, state, local and foreign laws. The risk ofaccidental release of such materials cannot be completely eliminated, and ifsuch an accidental release occurs, we could be held financially responsible forclean-up costs and other consequences of the release. In addition, ifenvironmental laws become more stringent over time, or existing laws are morestringently enforced, we could incur greater compliance costs and be subject toincreased risks and penalties for violations. We could be held liable forsignificant damages for violating environmental laws and could lose certainlicenses or permits, which could harm our financial results.

 

**Failureto attract and retain key technical and management personnel could harm ouroperating results.**

 

Our successdepends upon the continued service of our executive officers and other keymanagement and technical personnel, particularly our development engineers, andon our ability to continue to attract, retain and motivate qualified personnel,particularly experienced development engineers, applications engineers andsales managers. There is intense competition for the services of engineers inour industry. The loss of the services of one or more of our executiveofficers, development engineers or other key personnel or our inability torecruit replacements for such personnel or to otherwise attract, retain andmotivate qualified personnel could harm our business. We do not currently carrylife insurance payable to us with respect to any of our employees.

 

**If wefail to manage our growth effectively, we may lose business and experiencereduced profitability or increased losses.**

 

We have at timesexperienced rapid revenue growth, and we anticipate future growth if demandincreases in the markets for our products. To manage this growth successfully,we will need to manage increased production requirements, attract, retain andtrain new employees, including engineers and management, improve ouroperational and administrative systems, and manage multiple relationships withcustomers and suppliers. We may be unable to accomplish any of theserequirements, and our failure to do so could harm our operating results.

 

**We maynot be able to consummate future acquisitions or integrate acquisitions successfullyinto our business**.

 

We have made fouracquisitions since we became a public company in August 2000, and we plan topursue additional acquisitions of related businesses. The expense incurred inconsummating the future acquisition of related businesses, or our failure tointegrate such businesses successfully into our existing businesses, couldresult in our company incurring unanticipated expenses and losses. In addition,we may not be able to identify or finance additional acquisitions or realize anyanticipated benefits from acquisitions we do complete. In the event of futureacquisitions, we could:

•                  use a significant portion of our available cash;

•                  issue equity securities that would dilute current stockholders’ percentageownership;

•                  incur substantial debt; or

•                  assume contingent liabilities.

 

Should wesuccessfully acquire another business, the process of integrating acquiredoperations into our existing operations may result in unforeseen operatingdifficulties and may require significant financial resources that wouldotherwise be available for the ongoing development or expansion of existingoperations. Some of the risks associated with acquisitions include:

•                  difficulties in the assimilation of acquired operations, technologies orproducts;

•                  unanticipated costs associated with an acquisition or joint venture;

•                  potential asset write-downs;

•                  adverse effects on existing business relationships with customers; and

•                  potential loss of key employees of acquired organizations.

 

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Our ability tosuccessfully manage these risks could be limited by the small size of ourmanagement team. The occurrence of any of these risks may result in a decreasein the value of our assets and may harm our business and results of operations.

 

**Ourreported financial results may be harmed by changes in U.S. generally acceptedaccounting principles.**

 

We prepare our financial statements in conformity with U.S. generally accepted accounting principles, or GAAP. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to create and interpret accounting policies. A change in these policies or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change. For example, while current accounting rules allow us to exclude the expense of stock options from our financial statements, the Financial Accounting Standards Board finalized SFAS No. 123R “Share Based Payment” in December 2004, which will require us to expense stock options. We are currently evaluating the provisions of FAS 123R and expect that the adoption will have a material impact on the Company’s consolidated results of operations. This new accounting policy will be effective in the first quarter of 2006.

 

**Recentlyenacted and proposed changes in securities laws and regulations may increaseour costs.**

 

The Sarbanes-OxleyAct of 2002 that became law in July 2002, as well as rules subsequentlyimplemented by the Securities and Exchange Commission and the Nasdaq StockMarket, have required changes to some of our accounting and corporategovernance practices, including a report on our internal controls as requiredby Section 404 of the Sarbanes-Oxley Act of 2002. We expect these rulesand regulations to continue to create additional costs and overhead absent therequirement. These rules and regulations have made, and we expect will continueto make, it more difficult and more expensive for us to obtain director andofficer liability insurance, and we may be required to accept reduced coverageor incur substantially higher costs to obtain coverage. These additionalexpenses have and may continue to reduce our profits or increase our losses.These rules and regulations could also make it more difficult for us to attractand retain qualified executive officers and qualified members of our board ofdirectors, particularly to serve on our audit committee.

 

***InvestmentRisks***

 

**The priceof our common stock may fluctuate widely in the future.**

 

The trading priceof our common stock has been and is expected to be subject to wide fluctuationsin response to:

•                  quarter-to-quarter variations in our operating results;

•                  general conditions or cyclicality in the semiconductor industry or the endmarkets that we serve;

•                  new or revised earnings estimates by us or industry analysts;

•                  comments or recommendations issued by analysts who follow us, ourcompetitors or the semiconductor industry;

•                  aggregate valuations and movement of stocks in the broader semiconductorindustry;

•                  announcements of new products, strategic relationships or acquisitions byus or our competitors;

•                  increases or decreases in available wafer, assembly or test capacity;

•                  governmental regulations, trade laws and import duties;

•                  announcements related to future or existing litigation involving us or anyof our competitors;

•                  announcements of technological innovations by us or our competitors;

•                  additions or departures of senior management; and

•                  other events or factors, many of which are beyond our control.

 

In addition, stockmarkets have experienced extreme price and trading volume volatility in recentyears. This volatility has had a substantial effect on the market prices ofsecurities of many technology companies for reasons frequently unrelated to theoperating performance of specific companies. These broad market fluctuationsmay adversely affect the market price of our common stock.

 

**Five membersof management, as a group, own a significant interest in our common stock.**

 

As of December 31,2005, five members of our senior management (Messrs. Sireta, Crecraft,Haugen, Loder and Tsang) beneficially owned approximately 34.2% of ouroutstanding shares of common stock. As a result, these members of managementexercise significant influence over all matters requiring stockholder approval.The concentrated holdings of management may result in a delay of, or serve as adeterrent to, possible attempts to take us over, which may reduce the marketprice of our common stock.

 

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**Ourarticles of incorporation and Delaware law contain provisions that may hinderor prevent a change in the control of our company.**

 

The authorization ofundesignated preferred stock makes it possible for our board of directors toissue preferred stock with voting or other rights or preferences that couldimpede the success of any attempt to take us over. Also, we are subject toprovisions of Delaware law that may have similar effects. For example, we aregoverned by Section 203 of the Delaware General Corporate Law, which mayprohibit certain business combinations with stockholders owning 15% or more ofour outstanding voting stock. These and other provisions in our articles ofincorporation or under Delaware law may defer hostile takeovers or delaychanges in control or management, which could reduce our stock price.

 

**ITEM 1B. UNRESOLVED STAFFCOMMENTS.**

 

None.

 

**ITEM 2. PROPERTIES.**

 

Our primary facilitiesare as follows:

 

•                  Welease a 41,000 square foot building in Bend, Oregon where our internal waferfab is located, as well as our engineering and research and developmentorganization. We manufacture four-inch wafers in this facility.

•                  Welease an 18,000 square foot building in Bend, Oregon that houses some of ouradministrative functions, as well as some assembly, testing and shipping,

•                  Welease 4,125 square feet in an additional building in Bend, Oregon which housesadditional administrative functions.

•                  Welease a 10,250 square foot facility in Bordeaux, France that houses our ASPM®manufacturing, shipping and warehousing functions, as well as theadministrative and product development staff for our European operation.

•                  Welease a 19,700 square foot building in Santa Clara, California forsemiconductor manufacturing, shipping and warehousing, research and development,and administrative functions.

•                  Weown a 20,600 square foot building in Montgomeryville, Pennsylvania. Thefacility houses assembly and test operations, shipping, warehousing, researchand development, and administrative functions for the operation.

•                  Welease 7,641 square feet in a building in Boulder, Colorado. This facilityhouses primarily research and development functions.

 

**ITEM 3. LEGAL PROCEEDINGS.**

 

From time to time theCompany is involved in various legal matters that arise out of the ordinaryconduct of our business, including those related to litigation overintellectual property rights, commercial transactions, contracts, productliability, environmental, safety and health, and employment matters. TheCompany is not currently involved in any legal proceedings. The Company accruesloss contingencies in connection with its litigation when it is probable that aloss has occurred and the amount of the loss can be reasonably estimated.

 

**ITEM 4. SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS.**

 

No matters were submittedto security holders for a vote during the fourth quarter endedDecember 31, 2005.

 

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**PART II**

 

**ITEM 5. MARKETFOR THE REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES.**

 

Our common stock istraded on the Nasdaq National Market under the symbol “APTI.” Our common stockbegan trading on August 8, 2000. The high and low sales prices as reportedon the Nasdaq National Market for the two most recent fiscal years ended December31, 2004 and December 31, 2005 were as follows:

 
| ** **            | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------|------------|----------|------------|---------|------------|
|                  |       |     |       |    |       |
| **Fiscal  year 2005** |       |     |       |    |       |
| Quarter 4             |       | $        | 14.30      |    | $          | 8.81 |   |
| Quarter 3             |       | 8.65     |       | 6.80    |       |
| Quarter 2             |       | 7.37     |       | 5.73    |       |
| Quarter 1             |       | 8.09     |       | 6.93    |       |
| **Fiscal  year 2004** |       |     |       |    |       |
| Quarter 4             |       | $        | 9.34       |    | $          | 5.97 |   |
| Quarter 3             |       | 12.36    |       | 6.56    |       |
| Quarter 2             |       | 14.52    |       | 8.99    |       |
| Quarter 1             |       | 11.75    |       | 8.58    |       |

 

As of February 21, 2006,the last reported sale price of our common stock on the Nasdaq National Marketwas $14.97 per share, and there were approximately 105 stockholders of recordand we estimate approximately 1,800 beneficial stockholders of our commonstock.

 

We have not declared orpaid any cash dividends on our capital stock, and we do not anticipate doing soin the foreseeable future. We currently intend to retain future earnings, ifany, to operate and expand our business. We did not repurchase any of our stockin 2005 and do not have any repurchase plans or programs.

 

**ITEM 6. SELECTED FINANCIAL DATA.**

 
| ** **                                      | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                      | ** ** | **2005 (5)**                                | ** ** | **2004 (4)** | ** ** | **2003 (2)** | ** ** | **2002 (1)** | ** ** | **2001** | ** ** |
| ** **                                      | ** ** | **(In  thousands, except per share data)**  | ** ** |
|                                            |       |                                        |       |   |   |   |   |   |   |   |   |
| **Consolidated  Statement of Operations Data:** |       |                                        |       |   |   |   |   |   |   |   |   |
| Revenue, net                                    |       | $                                           | 64,976     |   | $ | 67,837 |   | $ | 48,892 |   | $ | 43,425 |   | $ | 36,855 |   |
| Gross profit                                    |       | 20,561                                      |       | 24,425 |   | 15,512 |   | 12,237 |   | 11,832 |   |
| Net income  (loss)                              |       | (4,662                                      | )          | 3,056 |   | (3,330 | ) | (3,687 | ) | 1,796 |   |
| Basic net income  (loss) per share              |       | (0.43                                       | )          | 0.29 |   | (0.32 | ) | (0.36 | ) | 0.21 |   |
| Diluted net  income (loss) per share            |       | (0.43                                       | )          | 0.27 |   | (0.32 | ) | (0.36 | ) | 0.19 |   |
| **Consolidated  Statement of Cash Flows Data:** |       |                                        |       |   |   |   |   |   |   |   |   |
| Cash flow from  operations                      |       | $                                           | 5,787      |   | $ | 3,694 |   | $ | 2,261 |   | $ | 5,074 |   | $ | 1,067 |   |
| Capital  expenditures (3)                       |       | 2,090                                       |       | 3,690 |   | 4,828 |   | 2,649 |   | 2,335 |   |
| **Consolidated  Balance Sheet Data:**           |       |                                        |       |   |   |   |   |   |   |   |   |
| Working capital                                 |       | $                                           | 36,031     |   | $ | 36,375 |   | $ | 31,780 |   | $ | 33,181 |   | $ | 45,508 |   |
| Total assets                                    |       | 75,667                                      |       | 78,482 |   | 74,503 |   | 76,948 |   | 58,075 |   |
| Stockholders’  equity                      |       | 68,770                                      |       | 72,038 |   | 68,210 |   | 71,172 |   | 53,948 |   |

 

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(1) In 2002, we acquiredGHz Technology, Inc. (effective January 25) and the product lines and certainassets of Microsemi RF Products, Inc. (effective May 24). As a result of thesetransactions, during fiscal 2002 we recorded acquisition related charges for 

 

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purchased in-process researchand development (IPR&D), amortization of intangible assets, inventory fairvalue adjustments and deferred compensation amortization of $4,330, of which$1,974 was included in costs of goods sold and $2,356 in operating expenses. Thetotal amount of these items net of taxes was $3,544.

 

(2) As a result of the prioracquisitions made, we recorded acquisition related charges for amortization ofintangible assets and deferred compensation amortization of $1,168, of which$1,118 was included in costs of goods sold and $50 in operating expenses during2003. Also recorded in 2003 was $645 of restructuring related charges includedin operating expenses. During 2003 we acquired the administrative building weleased in Santa Clara, California in order to avoid future lease payments whichwere substantially above market rate. The building is reported as assets heldfor sale, and accordingly we took a $350 impairment charge to adjust thecarrying value to fair market value. Also included in restructuring charges isseverance related to downsizing and organizational changes. During 2003 werecorded a tax expense for a valuation allowance against our net deferred taxassets for $846. The total amount for these items net of taxes was $2,659.

 

(3) Capital expendituresin 2003 included the purchase of the building in Santa Clara for $1,332.Capital expenditures other than the building purchase were $3,496.

 

(4) As a result of theprior acquisitions made, we recorded acquisition related charges foramortization of intangible assets and deferred compensation amortization of$1,098, of which $1,086 was included in costs of goods sold and $12 inoperating expenses during 2004. In 2004, we acquired the assets, includingprototype inventories, equipment, patents, and other intellectual property froma development stage business, Zeus Semiconductor, Inc. As a result of thistransaction, during 2004 we recorded acquisition related charges for purchasedIPR&D of $170. Also recorded in 2004 was $558 of restructuring related chargesincluded in operating expenses. These charges included severance related todownsizing and organizational changes we began in 2003. The charges alsoinclude an additional impairment charge on the administrative building wepurchased in 2003 as explained in note (2) above, as well as costs to exitcertain production activities. The latter charges relate to accelerateddepreciation on certain production related equipment to be abandoned aftershutdown and contractual closing costs. During 2004 we also incurred $225 ofcharges in connection with the filing and subsequent withdrawal of aregistration statement. The total amount of these items net of taxes was $2,028.

 

(5) In 2005, we recordedacquisition related charges for amortization of intangible assets and deferredcompensation amortization of $1,302, of which $1,076 was included in cost ofgoods sold and $226 in operating expenses. In connection with our January 2005acquisition of PowerSicel, Inc., we recorded in-process research anddevelopment charges of $4,868. Also recorded in 2005 was $250 of restructuringrelated charges, of which $196 was included in operating expenses and $54 wasincluded in cost of goods sold. Of the total restructuring related charges, $45was associated with additional severance related to downsizing andorganizational changes we began in 2003, and $205 was related to plansannounced in July 2005 to continue consolidating manufacturing operations, movecertain production activities offshore and disengage from a small low growth productline currently with onshore production. In connection with our merger agreementwith Microsemi Corporation (see Note 12), we recorded $296 of merger-relatedexpenses which are included in selling, general, and administrative expenses. Thetotal charges for these items net of tax were $6,709.

 

**ITEM 7. MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

**Business Overview**

 

We are a leadingdesigner, manufacturer and marketer of high-performance RF and switching powersemiconductors. We are primarily focused on the high-power, high-speed segmentof the power semiconductor market. Power semiconductors function as poweramplifiers and power switches. They increase system efficiency and reliabilityby precisely managing and regulating electricity and converting it into theform required by electrical and electronic products. Our products permit thedesign of more compact end products and improve system features andfunctionality. Our products are found in diverse applications, such as F-22fighter cockpits, the Boeing 777 back-up power system, the International SpaceStation, air traffic control radar systems, semiconductor capital equipment,MRI systems, arc welding equipment, industrial lasers, solar power invertersand base stations for wireless communications.

 

Powersemiconductors generally dissipate more than one watt of power and have a broadrange of frequency capabilities. We primarily focus on high-power, high-speeddevices that dissipate at least several hundred watts of power and requireoperating frequencies greater than 20 kHz, or 20,000 cycles per second (e.g.,the product may switch on and off up to 20,000 times per second).

 

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Certainmarkets we serve, such as the semiconductor capital equipment andcommunications and data processing markets, have historically been quitecyclical. During periods of contraction in these cyclical markets, we haveexperienced downward pressure on our revenue and gross margins. We haveattempted to reduce this volatility through acquisitions and productdevelopment in less cyclical markets, such as the military aerospace andmedical equipment markets, and by rigorously managing our operating expenses aswell as reducing the fixed portion of our manufacturing costs through increasedoffshore production.

 

We sell ourproducts in North America, Europe, and Asia primarily pursuant to customerpurchase orders. We sell through a network of independent sales representativesand distributors. We recognize revenue upon shipment of our products. APT isheadquartered in Bend, Oregon and has operations and offices in North America,France, and China. We also make use of subcontract manufacturers for thefabrication of our wafers and for assembly and test operations. Our locationsare more fully described in “Business—Properties.”

 

In 2002, weacquired GHz Technology and the product lines and certain assets of MicrosemiRF Products to help us further penetrate the markets for RF devices. We believethat these acquisitions have positioned us as a leading supplier in bipolar RFpower transistors and added substantial RF technology, engineering,manufacturing and marketing capabilities.

 

In 2004, we acquired the assets, including prototypeinventories, equipment, patents, and other intellectual property from adevelopment stage business, Zeus Semiconductor, Inc., for $175 paid in cashfrom operations. In January 2005, we acquired PowerSicel, Inc. forapproximately $5.4 million in cash from operations in exchange for all of theexisting shares of PowerSicel, 63,525 APT stock options in exchange for thePowerSicel stock options and 19,402 APT stock options for the retention of keyemployees. PowerSicel’s and Zeus Semiconductor’s combined expertise in siliconcarbide and other compound semiconductor technology and products complement APT’scurrent portfolio of RF products which operate at frequencies ranging from 1MHz to 4 GHz and are sold into applications such as semiconductor capitalequipment, medical imaging, radar, avionics and wireless communications. Webelieve these acquisitions add valuable development capability to APT’s corecapability in RF power transistors allowing APT to better serve its currentmarkets and to expand into new markets.

 

In 2003, as a result ofthe 2002 acquisitions made, we recorded acquisition related charges foramortization of intangible assets and deferred compensation amortization of$1,168, of which $1,118 was included in costs of goods sold and $50 inoperating expenses. Also recorded in 2003 was $645 of restructuring relatedcharges included in operating expenses. During 2003 we acquired theadministrative building we leased in Santa Clara, California in order to avoidfuture lease payments which were substantially above market rate. The buildingis reported as assets held for sale, and accordingly we took a $350 impairmentcharge to adjust the carrying value to fair market value. Also included inrestructuring charges is severance related to downsizing and organizationalchanges. During 2003 we recorded a tax expense for a valuation allowanceagainst our net deferred tax assets for $846. The total amount for these itemsnet of taxes was $2,659.

 

In 2004, as result of the2002 acquisitions made, we recorded acquisition related charges foramortization of intangible assets and deferred compensation amortization of$1,098, of which $1,086 was included in costs of goods sold and $12 inoperating expenses. In 2004, we acquired the assets, including prototypeinventories, equipment, patents, and other intellectual property from adevelopment stage business, Zeus Semiconductor, Inc. As a result of thistransaction, during 2004 we recorded acquisition related charges for purchasedIPR&D of $170. Also recorded in 2004 was $558 of restructuring relatedcharges included in operating expenses. These charges included severancerelated to downsizing and organizational changes we began in 2003. The chargesalso include an additional impairment charge on the administrative building wepurchased in 2003 as explained above, as well as costs to exit certainproduction activities. The latter charges relate to accelerated depreciation oncertain production related equipment to be abandoned after shutdown andcontractual closing costs. During 2004 we also incurred $225 of charges inconnection with the filing and subsequent withdrawal of a registrationstatement. The total amount of these items net of taxes was $2,028.

 

In 2005, werecorded acquisition related charges for amortization of intangible assets anddeferred compensation amortization of $1,302, of which $1,076 was included incost of goods sold and $226 in operating expenses. In connection with ourJanuary 2005 acquisition of PowerSicel, Inc., we recorded in-process researchand development charges of $4,868. Also recorded in 2005 was $250 ofrestructuring related charges, of which $196 was included in operating expensesand $54 was included in cost of goods sold. Of the total restructuring relatedcharges, $45 was associated with additional severance related to downsizing andorganizational changes we began in 2003, and $205 was related to plansannounced in July 2005 to continue consolidating manufacturing operations, movecertain production activities offshore and disengage from a small low growthproduct line currently with onshore production. In connection with our mergeragreement with Microsemi Corporation (see Note 12), we recorded $296 inmerger-related expenses. The total charges for these items net of tax were$6,709.

 

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The followingdiscussion should be read in conjunction with the consolidated financialstatements provided under Part II, Item 8 of this Annual Report onForm 10-K. Certain statements contained herein may constitute forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995. These statements involve a number of risks, uncertainties and otherfactors that could cause actual results to differ materially, as discussed morefully herein. In addition, the following discussion should be read inconjunction with the discussion regarding the proposed merger with Microsemi,which is set forth below. See “Recent Developments - Pending Merger.”

 

**RecentDevelopments**

 

***Pending Merger with Microsemi***

 

*Overview*

 

OnNovember 2, 2005, we announced that we and Microsemi Corporation (‘Microsemi”)had agreed to combine our respective businesses into a consolidated group ofcorporations (the “Merger”) pursuant to the terms of an Agreement and Plan ofMerger dated November 2, 2005 (the “Merger Agreement”). In order to completethe Merger, Company stockholders holding a majority of the outstanding sharesof Company common stock must vote to approve the Merger Agreement and theMerger.

 

Aspecial meeting of the Company’s stockholders will be held for the purposes ofsoliciting the approval of the Merger Agreement and Merger. The Company’s Boardof Directors has determined that the Merger is in the best interests of theCompany and its stockholders and has recommended to Company stockholders tovote in favor of the Merger and Merger Agreement. In connection with thisdetermination, the Company’s Board of Directors received the written opinion ofHoulihan Lokey Howard and Zukin Capital, Inc., which concludes that theconsideration to be paid by Microsemi in the Merger is fair, from a financialpoint of view, to the Company’s stockholders.

 

Uponthe consummation of the Merger, each outstanding share of Company common stockwill convert into the right to receive 0.435 of a share of Microsemi commonstock and $2.00 in cash, with payment of cash in lieu of a fractional share ofMicrosemi common stock. For each one share of APT common stock, the APTstockholders could, in addition to $2.00 in cash, receive more than 0.435 of ashare of Microsemi common stock, but not less. A maximum of up to 5,377,285shares of Microsemi common stock will be issued to Company stockholders in thetransaction in exchange for cancellation of the maximum number of shares ofCompany common stock that may be outstanding as of immediately before theMerger, calculated assuming the prior exercise of all outstanding options andwarrants to purchase Company common stock.

 

Followingthe closing of the Merger, the Company will be the surviving corporation andwill continue to exist under Delaware law as a wholly owned subsidiary ofMicrosemi.

 

Inconnection with the Merger, the Company and Microsemi have filed a proxystatement/prospectus with the U. S. Securities and Exchange Commission. The partiesare awaiting resolution of certain issues raised by the SEC and the subsequentissuance by the SEC of an order of registration. Once the order of registrationis issued, the proxy statement/prospectus will be distributed to Companystockholders. The special meeting of stockholders will be held approximatelyone month following distribution of the proxy statement/prospectus. The Companyexpects to receive the requisite shareholder approval at the special meetingand to consummate the Merger shortly thereafter.

 

*Conversionof Securities*

 

At theeffective time of the Merger (the “Effective Time”), each share of Companycommon stock, issued and outstanding immediately prior to the Effective Time(other than any shares of Company common stock owned by the Company as treasuryshares or by Microsemi or any direct or indirect wholly-owned subsidiary of theCompany or Microsemi) will be canceled and extinguished and be convertedautomatically into the right to receive the sum of two dollars ($2.00) in cash(the “Cash Component”), without interest, plus 0.435 of a share (the “ExchangeRatio”) of common stock, par value $.20 per share, of Microsemi with payment ofcash in lieu of a fractional share of Microsemi common stock (together with theCash Component, the “Merger Consideration”). The aggregate amount of cashreceived by Company stockholders who exchange Company common stock forMicrosemi common stock in the Merger, however, may not exceed twenty percent(20%) of the 

 

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Merger Consideration, and the number of shares ofMicrosemi common stock will be increased so as to prevent such a result. Theexchange formula was agreed to in arm’s-length negotiations betweenrepresentatives of Microsemi and the Company.

 

*Reasons for the Merger*

 

TheCompany believes that the Merger represents a unique opportunity to ourstockholders to realize significant value for their shares, as well as anopportunity to continue to participate in the high-speed, high-power segment ofthe power semiconductor market through an investment in an industry leader inhigh performance analog and mixed-signal integrated circuits and highreliability semiconductors. Microsemi believes that the merger will result in astrong value proposition for its stockholders because of an expanded productportfolio of analog and mixed-signal products, including radio frequency (“RF”)products as well as high reliability products to address the needs of thedefense/aerospace and medical markets. In addition to the strategic opportunityprovided by the Merger, Microsemi believes the Merger presents potentialconsolidation opportunities to improve operational and manufacturingefficiencies.

 

*Merger Expenses and Termination Fees and Expenses*

 

Eachparty is generally responsible for paying any expenses it incurs in connectionwith the Merger, except for the filing expenses under the federalHart-Scott-Rodino Act, which will be shared equally. If the Merger is notcompleted, the Company may be required to pay Microsemi a “break-up” fee of$4,000,000 under limited conditions.

 

*Risks Relating to the Merger*

 

Themerger could cause the Company to lose key personnel, which could materiallyaffect the Company’s business and require the Company to incur substantialcosts to recruit replacements for lost personnel.

 

Inorder to be successful, during the period before the Merger is completed, theCompany must continue to retain and motivate executives and other keyemployees. Company employees may experience uncertainty about their future rolewith the Microsemi consolidated group until or after strategies with regard tothe Microsemi consolidated group are announced or executed. The Company faces arisk that employees expected to be employed by the Company until and followingthe Merger may elect not to continue employment. Personnel with the necessaryexpertise are scarce and competition for personnel with proper skills isintense. Also, attrition in personnel can result from, among other things,changes related to acquisitions, as well as retirement or disability. If theCompany is unable to continue to retain existing executive officers or otherkey employees, its financial condition and results of operations could bematerially and adversely affected.

 

TheMerger may not be consummated, which could adversely affect the Company.

 

Thereis a general uncertainty whether a complex business transaction, like theMerger, will be completed at all. If the Merger is not consummated, the Companycould be subject to a number of adverse consequences:

 

•                  the Company would incur significant transaction costs and devoteconsiderable resources and management attention to the Merger but not realizethe benefits of the proposed Merger;

 

•                  under specified circumstances described in the proxy statement/prospectusentitled “*Merger Expenses and Termination Fees and Expenses*”,the Company may be required to pay Microsemi a termination fee, or Microsemi’scosts and expenses plus interest pursuant to the Merger Agreement;

 

•                  the trading price of Company common stock may decline to the extentthat the market price of Company common stock reflects a market assumption thatthe Merger would be completed; and

 

•                  the Company may incur additional costs to replace key employees thatleft their employment in anticipation of the Merger.

 

Theoccurrence of any of these events individually or in combination could have amaterial adverse affect on the Company’s results of operations and the price ofits common stock.

 

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*PotentialConflicts of Interest of Management in the Merger*

 

TheCompany’s officers and directors have interests in the merger that are inaddition to or different from your interests as stockholders. The Board ofDirectors was aware of and considered these interests when it considered andapproved the Merger Agreement and the Merger. These interests includepost-closing employment opportunities as well as the right of these officersand directors to indemnification with respect to acts and omissions in their capacitiesas officers and directors of the Company.

 

Thefollowing are summaries of various agreements which may give rise to conflictsof interest on behalf of APT management in connection with the merger:

 

EmploymentAgreements

 

Inconnection with the Merger, Greg Haugen, Vice President and Chief FinancialOfficer, Thomas Loder, Vice President of Sales and Marketing, Dah Wen Tsang,Vice President of Engineering and Research and Development of Switching PowerProducts, and Russell Crecraft, Chief Operating Officer, each agreed to enterinto an Employment Agreement (each, an “Employment Agreement” and collectively,the “Employment Agreements”) as of the effective date of the Merger (the “EffectiveDate”). Under the Employment Agreements, each of Messrs. Haugen, Loder, Tsangand Crecraft agree to devote all of their professional time to the affairs ofthe Company for six (6) months in the case of Mr. Haugen and two (2) years inthe case of each of Messrs. Loder, Tsang and Crecraft. Each of Messrs. Haugen,Loder, Tsang and Crecraft also will be reimbursed for expenses incurred onbehalf of the Company and agreed to provisions protecting the confidentialinformation of the Company, assigned all of their rights to such intellectualproperty to the Company, agreed for two (2) years not to compete with theCompany and not to solicit any employee or customer of the Company to ceasedoing business with or working for the Company. The term of the EmploymentAgreement for each of Messrs. Loder, Tsang and Crecraft is two (2) years unlesssooner terminated in accordance with the terms of their respective EmploymentAgreements and each will be eligible to participate in the Company’s benefitsplan and receive four (4) weeks vacation annually.

 

Inexchange for his services, which will not exceed eighty (80) hours per month,and will terminate not later than the six-month anniversary of the commencementof his employment, Mr. Haugen will be paid $359,788, payable on the EffectiveDate. The Company also will provide Mr. Haugen with directors’ and officers’insurance coverage on the terms and subject to the conditions set forth in theMerger Agreement.

 

Forhis service, Mr. Loder will be paid $138,000 per year as Base Salary and beeligible to participate in the Company’s incentive bonus plan, under which hewould be paid a bonus equal to thirty-five percent (35%) of his base salaryupon achieving certain performance goals established for Mr. Loder personallyand for Microsemi (including all subsidiaries) as a corporation. Mr. Loder willbe paid a retention bonus of $50,000 twenty-four (24) months following thecommencement of his employment following the Effective Date. In addition toretaining options to acquire shares of Microsemi common stock, Mr. Loder willbe granted options to purchase 20,000 shares of Microsemi common stock underMicrosemi’s stock plan. The exercise price will be the closing price ofMicrosemi’s common stock on the Nasdaq National Market and will vest in equalinstallments over four (4) years. Mr. Loder holds options to acquire 32,535shares of the Company’s common stock at an average exercise price of $1.40.Assuming Mr. Loder exercised his options on November 25, 2005 and sold theshares on the same day he would receive gross proceeds, net of exercise price,of $405,182.50, based on the closing price of Microsemi’s common stock on thatdate.

 

Forhis services, Mr. Tsang will be paid $160,000 per year as a base salary and beeligible to participate in the Company’s incentive bonus plan, under which hewould be paid a bonus equal to thirty-five percent (35%) of his base salaryupon achieving certain performance goals established for Mr. Tsang personallyand for Microsemi (including all subsidiaries) as a corporation. Mr. Tsang willbe paid a retention bonus of $90,000 twenty-four (24) months following thecommencement of his employment following the Effective Date. In addition toretaining the options Mr. Tsang has to purchase shares of Company common stock,which will be converted into options to acquire shares of Microsemi commonstock, Mr. Tsang will be granted options to purchase 30,000 shares of Microsemicommon stock under Microsemi’s stock plan. The exercise price will be theclosing price of Microsemi’s common stock on the Nasdaq National Market andwill vest in equal installments over four (4) years. Mr. Tsang holds options toacquire 61,405 shares of Company common stock at an average exercise price of$1.40. Assuming Mr. Tsang exercised his options on November 25, 2005, and soldthe shares on the same date, he would receive gross proceeds, net of exerciseprice, of $764,722.50, based on the closing price of Microsemi’s common stockon that date.

 

Forhis services, Mr. Crecraft will be paid $169,680 per year as a base salary andbe eligible to participate in the Company’s incentive bonus plan, under whichhe would be paid a bonus equal to forty percent (40%) of his base salary upon 

 

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achieving certain performance goals established forMr. Crecraft personally and for Microsemi (including all subsidiaries) as acorporation. Mr. Crecraft will be paid a retention bonus of $100,000twenty-four (24) months following the commencement of his employment followingthe Effective Date. Mr. Crecraft will be granted options to purchase 50,000shares of Microsemi common stock under Microsemi’s stock plan. The exerciseprice will be the closing price of Microsemi’s common stock on the NasdaqNational Market and will vest in equal installments over four (4) years.

 

By wayof comparison to the base salaries earned by Mr. Haugen, Mr. Loder, Mr. Tsang,and Mr. Crecraft, respectively, during fiscal year 2005, Mr. Haugen willreceive $359,788 for services rendered for not more than a six (6) month periodfollowing the commencement of his employment with Microsemi, as compared to hisformer salary of $133,177; Mr. Loder will be paid $138,000, as compared to hisformer salary of $128,965; Mr. Tsang will be paid $160,000, as compared to hisformer salary of $142,070; and Mr. Crecraft will receive a base salary of$169,680, as compared to his former salary of $158,450. In addition, Mr. Loder,Mr. Tsang and Mr. Crecraft will be paid retention bonuses of $50,000, $90,000and $100,000, respectively, twenty-four (24) months following the commencementof their employment with Microsemi.

 

Lock-upAgreements

 

Eachof Messrs. Sireta (holder of investment power over 2,124,531 shares of Companycommon stock), Haugen (holder of investment power over 386,500 shares ofCompany common stock), Crecraft (holder of investment power over 369,800 sharesof Company common stock), Loder (holder of investment power over 360,000 sharesand options to purchase 32,535 shares of Company common stock), and Tsang(holder of investment power over 364,400 shares and options to purchase 61,405shares of company common stock) agreed, as a condition to Microsemi enteringinto the Merger Agreement, to enter into a Lock-up Agreement. Under the termsof the Lock-up Agreement, each of Messrs. Sireta, Haugen, Crecraft, Loder andTsang agreed not to (i) sell the shares of Microsemi common stock they receivein the merger for ninety (90) days, and not to sell in excess of fifty percent(50%) of those shares for one hundred eighty (180) days, or (ii) grant proxiesor powers of attorney, deposit the shares into a voting trust and enter into anagreement to do any of the foregoing for a period of ninety (90) days followingthe Effective Date. Certain transfers, including those to family members, orentities under their control, are permitted provided that the transferees enterinto a similar Lock-up Agreement. In addition, to the extent that they are anaffiliate of the Company before or after the Effective Date, each of Messrs.Sireta, Haugen, Crecraft, Loder and Tsang may be subject to furtherrestrictions on the transfer of their shares under Rule 145 of the SecuritiesAct of 1933, as amended.

 

Non-competitionAgreement

 

As acondition to entering into the Merger Agreement, Mr. Sireta was required toenter into a Non-competition Agreement with Microsemi. Under the terms of theNon-competition Agreement, Mr. Sireta agreed that for a two (2) year periodfollowing the Effective Date, he will not engage in or have any ownershipinterest in or participate in the financing, operation, management or controlof a business that engages in the same business as the Company has historicallyparticipated.

 

VotingAgreements

 

Messrs.Sireta (President, Chief Executive Officer and largest Company stockholder),Crecraft, Haugen, Loder and Tsang, who on an aggregate basis own approximately33.5% of the outstanding Company common stock, entered into voting agreementswith Microsemi and granted Microsemi an irrevocable proxy with respect to alloutstanding shares of Company common stock that they beneficially own orsubsequently acquire.

 

***2006Restructuring Actions***

 

On February 17, 2006 theCompany finalized its decision and announced to employees the planned closureof its facility in Montgomeryville, Pennsylvania. The business managementfunctions and remaining manufacturing activities currently located inMontgomeryville will be transferred to our facility in Santa Clara, California.This action is in addition to the actions announced on July 21, 2005 in oursecond quarter 2005 earnings release, which included the increased use ofoffshore manufacturing subcontractors. We expect that this restructuring actionwill be completed over the next twelve months and will lead to an additionalreduction of approximately 8% of our total workforce. We estimate that thisrestructuring action will result in pretax restructuring charges ofapproximately $440 over the 12 month time frame. The charges will includeone-time severance costs of approximately $320 to be settled in cash, andnon-cash charges related to other exit costs of $120. Once these restructuringactions are fully completed, we estimate the annual savings will beapproximately $1.6 million.

 

***NorthropGrumman Systems License Agreement***

 

On February 22, 2006,Advanced Power Technology, Inc. (APT) entered into a license agreement with theElectronic 

 

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Systems’ sector ofNorthrop Grumman Systems Corporation (Northrop) in which Northrop will licensetheir silicon carbide technology to APT, and APT will be the exclusive foundrysupplier of certain silicon carbide products to Northrop. In addition, theagreement allows APT to use the licensed technology to manufacture and sellother silicon carbide products for commercial purposes. Royalties will be dueto Northrop upon the sale of such products to customers other than Northrop. Thecontract is effective until the expiration of the last to expire of the patentsincluded in the agreement, unless the agreement is extended by the parties.

 

**OurMarkets**

 

We operate on aworldwide basis. As such, our operations are affected by global, regional andindustry-specific economic and political factors. In 2005, 62.4% of our revenuewas from customers in North America, 17.6% from customers in Europe, and 20.0%from customers in Asia and the rest of the world. We allocate revenuegeographically based on the location to which we ship our products. The marketsfor our products are diversified, and include military and aerospace,semiconductor capital equipment, medical and industrial, and communications anddata processing.

 

We believe demandis being driven by the emergence of new applications for higher power, higherfrequency semiconductors that more precisely manage power, and also by the needto increase performance and improve power quality for existing applications. Inparticular, demand in our target markets is being driven by the cyclical upturnin the semiconductor capital equipment market and a recovery in thecommunications and data processing market, as well as growth in demand forcomplex medical equipment and military and commercial radar equipment. Webelieve demand is also being driven by the need for more efficient energy useresulting from rising energy costs, government mandates and environmentalconcerns.

 

**Business Strategies**

 

Our goal is to be the world leader in providinghigh-performance power semiconductors for high-power, high-speed applications. Toachieve our goal, we intend to:

 

•                  Increase ourpenetration of core markets and customers and expand globally;

 

•                  Continue todevelop and commercialize leading-edge technology for new and existingapplications;

 

•                  Capitalize onand expand our RF expertise;

 

•                  Continue tooptimize manufacturing operations; and

 

•                  Seek to enhancegrowth through selective acquisitions

 

**CriticalAccounting Policies and Estimates**

 

The discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with U.S. generally accepted accountingprinciples. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenue and expenses, and related disclosures of contingent assetsand liabilities. On an on-going basis, we evaluate our estimates, includingthose related to product returns and warranty obligations, allowance fordoubtful accounts, excess and obsolete inventories, income taxes, valuation ofgoodwill and intangible assets with indefinite lives, valuation of long-livedassets, and contingencies and litigation. We base our estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances, the results of which form the basis for making judgmentsabout the carrying values of assets and liabilities and the timing of revenuerecognition that are not readily apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions.

 

We believe the following critical accounting policiesinvolve more significant judgments and estimates used in the preparation of ourconsolidated financial statements.

 

***RevenueRecognition, Sales Allowances, Returns and Warranty Obligations***

 

We recognize revenue when products are shipped and thecustomer takes ownership and assumes risk of loss, collection of the relevantreceivable is probable, persuasive evidence of an arrangement exists, and thesales price is fixed or determinable. In general, we provide for a one-year repairor replacement warranty on our products. We use independent distributors tosell 

 

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some of our products. Our distributors have certain stock rotationrights which allow them to rotate, every six months, their products ininventory for a value up to 5% of their purchases over the preceding six monthperiod in exchange for an order of an equal amount of new product. In additionwe may elect to give price protections or other allowances to our distributors.Price protections may be offered for distributor inventory on hand when weupdate our price list. Additional price allowances may be offered to ourdistributors in certain competitive bidding situations in which we may furtherdiscount the price. These price allowances are evaluated as requested by thedistributor on a case by case basis. Upon shipment, we record an allowance forthe estimated cost that may be incurred for product warranty, sales returns,price allowances and contractual requirements with our distributors based onhistorical experience.

 

While we engage in extensive product quality programsand processes, including actively monitoring and evaluating the quality of ourcomponent suppliers, our warranty obligation is affected by product non-conformancerates, material usage and service delivery costs incurred in correcting aproduct non-conformance. Should actual product non-conformance rates, materialusage, service delivery costs, or distributor returns differ from ourestimates, revisions to the estimated revenue provision would be required.

 

***Allowance forDoubtful Accounts***

 

We maintain an allowance for doubtful accounts forestimated losses resulting from the inability of our customers to make requiredpayments. We regularly review the adequacy of the allowance after consideringthe size of the accounts receivable balance, historical bad debts, the customer’sexpected ability to pay and our collection history with each customer. Wereview significant individual accounts that are past due to determine whetheran allowance should be made based on these factors. If the financial conditionof our customers were to deteriorate, resulting in an impairment of theirability to make payments, additional allowances may be required.

 

***Excess and ObsoleteInventories***

 

Inventories are stated at the lower of standard cost(approximates actual cost on a first-in, first-out basis) or market (netrealizable value). We adjust inventory costs for estimated unmarketable(excess) or obsolete inventory to estimated net realizable value based uponassumptions about future demand and market conditions. We establish reservesfor excess component order cancellation costs based on estimated net realizablevalue of the components purchased and any additional cancellation charges. Weevaluate historical usage of the product, current customer demand, purchasecommitments and forecasted usage of the product. If actual market conditionsare less favorable than those projected by management, additional adjustmentsor reserves may be required.

 

***Income Taxes***

 

We record a valuation allowance to reduce our deferredtax assets to the amount that is more likely than not to be realized. Weconsider future taxable income and ongoing prudent and feasible tax planningstrategies in assessing the need for the valuation allowance. In the event wewere to determine that we would be able to realize our deferred tax assets inthe future in excess of our net recorded amount, an adjustment to decrease thevaluation allowance would increase income in the period such determination wasmade. Should we determine that we would not be able to realize all or part ofour net deferred tax asset in the future, an adjustment to increase thevaluation allowance would be charged to income in the period such determinationwas made. As of December 31, 2005, we had a full valuation allowance recordedagainst our deferred tax assets, net of certain deferred tax liabilities.

 

***Valuation ofGoodwill and Intangible Assets with Indefinite Lives***

 

We value goodwill and intangible assets withindefinite lives in accordance with Statement of Financial Accounting StandardsNo. (SFAS) 142 “Goodwill and Other Intangible Assets.” Currently we carry agoodwill balance in connection with previous acquisitions, but have no otherintangible assets with indefinite lives. We annually review goodwill forimpairment and when events or circumstances indicate the carrying value of theasset might exceed its current fair value. We determine fair value usingdiscounted cash flow analysis and other acceptable valuation methodologies suchas market multiples and comparable transactions. This requires us to makeassumptions and estimates regarding industry economic factors and futureprofitability. It is our policy to conduct impairment testing based on our mostcurrent business plans, which reflect changes we anticipate in the economy andindustry. If actual results are not consistent with our assumptions andjudgments, we could be exposed to a material impairment charge as a result ofwriting down the carrying value of goodwill.

 

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***Valuation ofLong-Lived Assets***

 

We value long-lived assets, including intangibleassets with finite lives, in accordance with SFAS 144 “Accounting for theImpairment or Disposal of Long-Lived Assets.” We evaluate our long-lived assetsfor impairment whenever events or changes in circumstances indicate that thecarrying amount may not be recoverable. We determine the potential impairmentusing undiscounted cash flow analysis, which requires us to make certainassumptions and estimates regarding industry economic factors and futureprofitability. It is our policy to conduct impairment testing based on our mostcurrent business plans, which reflect changes we anticipate in the economy andindustry. If actual results are not consistent with our assumptions andjudgments, we could be exposed to a material impairment charge as a result ofwriting down the carrying value of long-lived assets. If the asset group isdetermined to be unable to recover the carrying amount of its assets, thenintangible assets are written down first, followed by the other long-livedassets of the operation, to fair value. Fair value is determined based ondiscounted cash flows or appraised values, depending on the nature of theassets. Long-lived assets considered held for sale are valued at the lower ofhistorical cost or fair value less costs to sell. Such assets are notdepreciated while so classified.

 

***Contingencies andLitigation***

 

We are subject to thepossibility of various loss contingencies arising in the ordinary course ofbusiness. We consider the likelihood of loss or impairment of an asset or theincurrence of a liability, as well as our ability to reasonably estimate theamount of loss in determining loss contingencies. An estimated loss contingencyis accrued when it is probable that an asset has been impaired or a liabilityhas been incurred and the amount of loss can be reasonably estimated. Weregularly evaluate current information available to us to determine whethersuch accruals should be adjusted.

 

**Resultsof Operations**

 

The following tablepresents our consolidated statement of operations data for the periodsindicated as a percentage of net revenue:

 

 
| ** **                                           | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                 |       |                                        |       |   |   |   |   |
| Revenue, net                                         |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Cost of goods  sold                                  |       | 66.7                                        |       | 62.4 |   | 66.0 |   |
| Amortization of  technology rights and other charges |       | 1.7                                         |       | 1.6 |   | 2.3 |   |
| Total cost of  goods sold                            |       | 68.4                                        |       | 64.0 |   | 68.3 |   |
| Gross profit                                         |       | 31.6                                        |       | 36.0 |   | 31.7 |   |
| Operating  expenses:                                 |       |                                        |       |   |   |   |   |
| Research and  development                            |       | 7.6                                         |       | 5.6 |   | 6.1 |   |
| Selling, general  and administrative                 |       | 23.7                                        |       | 24.8 |   | 30.2 |   |
| Restructuring  charges                               |       | 0.3                                         |       | 0.8 |   | 1.3 |   |
| In-process  research & development               |       | 7.5                                         |       | 0.3 |   | — |   |
| Total operating  expenses                            |       | 39.1                                        |       | 31.5 |   | 37.6 |   |
| Income (loss)  from operations                       |       | (7.5                                        | )          | 4.5 |   | (5.9 | ) |
| Other income  (expense):                             |       |                                        |       |   |   |   |   |
| Interest income,  net                                |       | 0.5                                         |       | 0.3 |   | 0.4 |   |
| Other, net                                           |       | (0.1                                        | )          | (0.2 | ) | — |   |
| Income (loss)  before income taxes                   |       | (7.1                                        | )          | 4.6 |   | (5.5 | ) |
| Income tax  (benefit) expense                        |       | 0.1                                         |       | 0.1 |   | 1.3 |   |
| Net income  (loss)                                   |       | (7.2                                        | )%         | 4.5 | % | (6.8 | )% |

 

**YearsEnded December 31, 2005 and 2004**

 

*Revenue.*Ourrevenue for 2005 was $65.0 million, compared to $67.8 million in 2004, a 4.2%decrease. This decrease was due to a decline in shipments to our semiconductorcapital equipment customers which was partially offset by year over yearrevenue growth in our communications and data processing market, ourmilitary/aerospace market and our industrial/medical 

 

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market. Ourrevenue into the cyclical semiconductor capital equipment market declined from$17.0 million in 2004 to $9.9 million in 2005, a decrease of 41.9%. Thisdecline was primarily due to an inventory correction at our customers duringthe first half of 2005 and to reduced customer consumption rates resulting fromlower end market demand. Our communications and data processing revenueincreased 4.2% from $14.0 million to $14.6 million, reflecting improved demandfrom some of our Asian telecom customers. Our military/aerospace revenue grewfrom $19.0 million to $20.9 million, an increase of 10.2%. New customerprograms moving into production during the second half of 2005 for radar,avionics and defense communication applications contributed to ourmilitary/aerospace revenue growth in 2005. Our industrial/medical revenue grew4.4% from $17.8 million to $18.6 million.

 

In 2005, our revenue by market was 22.5%, 15.2%,28.5%, 32.2%, and 1.6% compared to 20.7%, 25.1%, 26.2%, 28.0%, and 0.0% in2004, in the communications and data processing, semiconductor capitalequipment, industrial/medical, and military/aerospace markets, and other, respectively.Overall, our revenue by geographic area for 2005 was 62.4% in North America, 17.6%in Europe, and 20.0% in Asia and the rest of the world. This compared to 65.3%in North America, 15.3% in Europe and 19.4% in Asia and the rest of the worldin 2004. We allocate revenue geographically based on the location to which weship our products.

 

                *Gross Profit.*Ourgross profit margin was 31.6% in 2005 compared to 36.0% in 2004, a decrease of4.4%. Included in our costs of goods sold in 2005 and 2004, was $1.1 million ofamortization of technology rights assets. The decline in gross profit marginover the prior year was primarily due to reduced fixed cost absorption on lowerproduction volumes at our Bend, Oregon facility, and to customer return andproduction yield issues. The decrease in production volumes and lower fixedcost absorption at our Bend, Oregon facility contributed approximately 4.4% tothe decline in gross margin and was primarily due to lower sales to thesemiconductor capital equipment market, as mentioned in the *Revenue* section above. In 2005 the volume of production atour Bend wafer fabrication facility declined by more than 50% compared to 2004for semiconductor related products. These declines were partially offset byimproved gross margins on our RF products produced at our Montgomeryville,Pennsylvania facility and at our Santa Clara, California facility. The grossmargins improved at our Montgomeryville, Pennsylvania facility as we began tobenefit from restructuring actions that resulted in the transfer of waferproduction activities from our Montgomeryville operation to our Bend facility,while both Montgomeryville and Santa Clara experienced year over yearimprovement in the overall product mix.

 

 *Researchand Development Expense.*Our 2005 research and development expenseswere $4.9 million or 7.6% of revenue, compared to $3.8 million in 2004, or 5.6%of revenue. During 2005, our payroll related costs for additional personneldedicated to research and development activities increased by approximately $717,000compared to 2004. Higher spending on supplies and materials also contributed tothe increase in year over year expense. The increase in the research anddevelopment expense as a percentage of revenue was primarily due to higher expenselevels on slightly lower revenue in 2005. The Company plans to continue itsresearch and development programs leading to the introduction of new productsfor use in both switching and RF applications.

 

 *Selling,General and Administrative Expense.*Our 2005 selling, general andadministrative expenses were $15.4 million in 2005 or 23.7% of revenue,compared to $16.9 million in 2004, or 24.8% of revenue. The decrease in spendinglevel was primarily attributable to $2.0 million in legal fees incurred in 2004associated with a resolved patent litigation matter, $434,000 lowerpayroll-related costs, and $231,000 lower commissions reflecting lower 2005revenue compared to 2004. The decrease in selling, general, and administrativeexpenses was partially offset by $235,000 of additional costs associated withour new office in Shenzen China, $588,000 of additional expenses from our firstquarter acquisition of PowerSicel, Inc. in Boulder, Colorado and $296,000 ofcosts associated with our planned merger with Microsemi Corporation. The lowerpayroll costs were primarily due to a decrease in payments for the managementcash bonus incentive plan compared to 2004.

 

*Restructuring Charges.* Total 2005restructuring charges were $250,000 compared to $558,000 in 2004. Of the$250,000 2005 restructuring charges, $196,000 was included in operatingexpenses, and $54,000 was included in cost of goods sold. The 2004restructuring charges of $558,000 were included entirely in operating expenses.The year over year change in restructuring charges reflects changes in thespending levels of our restructuring actions announced in 2003 and 2005, asdescribed below and in more detail in Note (3) of the consolidated financialstatements of this Form 10-K.

 

As part of management’s strategic plans, the Companyannounced in November of 2003 restructuring actions intended to improvemanufacturing efficiencies and lower administrative costs. The actions includedconsolidation of certain administrative functions, rationalization of internaland external assembly and test manufacturing, and the reduction of rent expensethrough the purchase and resale of one of the two buildings utilized by theCompany’s Santa Clara, California subsidiary. These announced actions were inaddition to previously disclosed plans to consolidate our wafer fabricationplant in Montgomeryville, Pennsylvania to Bend, Oregon. Total restructuringcharges related to these actions announced in 2003 (“2003 Actions”) were $45,000and 

 

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$558,000 in 2005 and 2004, respectively. We do not expect to incur anymore costs associated with the 2003 Actions.

 

In July 2005, the Companyannounced that it would continue consolidating manufacturing operations andmove certain production activities offshore and that it would disengage fromits hermetic package products, a low growth product line currently with onshoreproduction. We estimate that these restructuring actions will be completed bythe end of 2006 and will lead to a reduction of approximately 9 percent of ourtotal work force. Total restructuring charges recognized in 2005 related tothese actions were $151,000. Approximately $530,000 of additional restructuringcharges is expected to be recognized as these actions occur in 2006.

 

*In-Process Research and Development Charges.*Total in-process research and development charges for 2005 were $4,868,000,compared to $170,000 in 2004. The 2005 charges of $4,868,000 related to ouracquisition of PowerSicel, Inc., and the 2004 charges of $170,000 related toour acquisition of the assets of Zeus Semiconductor, Inc. See Note (4) of theconsolidated financial statements for more information on these acquisitions.

 

 *OtherIncome (Expense), Net.* Other income (expense), net, which includesinterest income, interest expense and other expense, was a net income of $213,000in 2005 compared to a net income of $100,000 in 2004. Interest income in 2005was $337,000 compared to $226,000 in 2004. The increase in interest income foryear over year is due to higher interest rates on our marketable securities. Interestexpense was $17,000 in 2004 and 2005. Other income (expense), net was anexpense of $107,000 in 2005 compared to an expense of $109,000 in 2004. In2005, net other expense primarily included foreign exchange losses associatedwith our subsidiary in Bordeaux, France. In 2004, net other expense primarily includedlegal and accounting fees associated with the filing and subsequent withdrawalof the Company’s S-3 registration statement.

 

                *Income Taxes.*TheCompany recorded a tax expense of $30,000 in 2005 and $82,000 in 2004, both forfederal alternative minimum tax (AMT) and various state income taxes owed.

 

 As of December 31, 2005, we had a fullvaluation allowance recorded against our deferred tax assets, net of certaindeferred tax liabilities. In assessing the valuation of deferred tax assets,SFAS No. 109 “Accounting for Income Taxes,” requires a more likely than notstandard. The ultimate realization of deferred tax assets is dependent on thegeneration of future domestic taxable income during the periods in which theassociated temporary differences become deductible. Management considers thescheduled reversals of deferred tax liabilities, projected future taxableincome, and tax planning strategies in making this assessment. Although theCompany anticipates future long term profitability, SFAS No. 109 requires thatrecent historical operating performance weigh more heavily in assessing thevaluation of deferred tax assets. The more likely than not assessment wasprincipally based upon the losses generated during 2002 and 2003 and thecyclical nature of the industry which make projections of industry trendsdifficult. While the Company has sufficient net operating loss carry-forwards(NOL’s) to offset federal taxable income for regular tax purposes, the Company’suse of its NOL’s for AMT purposes are limited to 90% of its AMT income (AMTI).Therefore, the Company expects to pay AMT of approximately 20% on the remainingAMTI, resulting in an approximate effective tax rate of 2% on domestic taxableincome, in addition to certain miscellaneous state taxes. However, at such timethe Company is able to determine if it is more likely than not that it will beable to utilize its net operating losses, the reserve against the net deferredtax asset would be reversed. As of December 31, 2005, APT has federal and statenet operating loss carry forwards of $3.5 million and $4.8 million,respectively, with $2.3 million recorded through income and $1.2 million to berecorded through additional paid in capital, which expire beginning in years2020 through 2023.

 

**YearsEnded December 31, 2004 and 2003**

 

*Revenue.*Ourrevenue for 2004 was $67.8 million, compared to $48.9 million in 2003, or a38.7% increase. Overall we experienced year over year growth in each of thefour markets we serve. Communications and data processing revenue increased by49.9%, semiconductor capital equipment increased by 65.1%, military/aerospaceincreased by 25.0% and industrial/medical increased by 27.0%. Improved demandin the wireless base station and other communications infrastructureapplications contributed to our year over year growth in the communications anddata processing markets, particularly in Asia. Our revenue for thesemiconductor capital equipment market grew sequentially each quarter from thefourth quarter of 2003 through the second quarter of 2004, but then declined inthe second half of the year due to an inventory correction underway at ourcustomers and weakened market conditions. Our year over year growth in thesemiconductor equipment market was a result of strong market conditions in thefirst half of 2004 and the geographical expansion of our customer base intoJapan. Revenue for our industrial and medical market grew sequentially eachquarter from the fourth quarter of 2003 through the third quarter of 2004, butdeclined into the fourth quarter of 2004. During 2004 our military andaerospace revenue benefited from the shipment of products related to a largeradar systems order which was received in the fourth quarter of 2003.

 

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Overall, our revenue by geographic area for 2004 was65.3% in North America, 15.3% in Europe, and 19.4% in Asia and the rest of theworld. This compares to 65.3% in North America, 18.5% in Europe and 16.2% inAsia and the rest of the world in 2003. We allocate revenue geographicallybased on the location to which we ship our products.

 

Overall, we experienced a record revenue year in 2004at $67.8 million. The growth and strength came from a broad base of endmarkets, applications, and customers, as we continue to pursue opportunities ineach of our end markets, which helps us to diversify our product portfolio. In2004, our revenue by market was 20.7%, 25.1%, 26.2%, and 28.0% versus 19.2%,21.1%, 28.7%, and 31.0% in 2003, in the communications and data processing,semiconductor capital equipment, industrial/medical, and military/aerospacemarkets, respectively.

 

                *Gross Profit.*Ourgross profit margin was 36.0% in 2004 compared to 31.7% in 2003, or an increaseof 4.3%. Included in our costs of goods sold in 2004 and 2003 was $1.1 millionof amortization of technology rights assets. Increased production volumes andthe resulting increased factory utilization at all of our domestic facilitiesresulted in improved factory overhead absorption in 2004 compared to 2003. OurBend wafer production increased by over 60% in 2004 from 2003, contributingapproximately 3.7% to our improved gross margin. While our Santa Clara facilityproduction volume also increased, it was offset by higher costs associated withthe acceleration of a production ramp-up for a major RF customer and a lessprofitable overall product mix. The overall impact of the Santa Clara facilitycontributed a slight decline to consolidated gross margin. During 2004 we idledour wafer fabrication facility in Montgomeryville, Pennsylvania as we moved theproduction of these wafers to our Bend, Oregon facility, resulting in lowermanufacturing spending at the Pennsylvania location. The lower manufacturingcosts at our Montgomeryville, Pennsylvania facility contributed to a slightincrease to consolidated gross margin, essentially offsetting the decline fromSanta Clara. During 2004 we also completed a reduction in work force at ourBordeaux, France facility and moved more of the production to lower costsubcontractors. At the volumes experienced in 2004, this did not have asignificant impact on consolidated gross margin.

 

 *Researchand Development Expense.*Our research and development expenses were$3.8 million in 2004 compared to $3.0 million in 2003, or approximately 5.6%and 6.1% of revenue, respectively. During 2004, our spending on materials andsupplies increased by approximately $450,000 compared to 2003. During 2003,fewer resources were used for pre-production and prototype lots as many of thenew products we introduced utilizing our MOS7® technology moved into fullproduction, resulting in lower spending in 2003 on materials and supplies. Inaddition, in 2004, we continued our spending on materials and supplies indeveloping both new RF and switching power products. In 2004 our spending onpayroll costs increased by approximately $306,000 compared to 2003. This wasdue to the addition of new personnel and also to the reallocation of existingpersonnel to research and development activities. New personnel accounted forapproximately half of the payroll spending increase. The decrease in theresearch and development expense as a percentage of revenue is also due to ourhigher revenue levels in 2004.

 

 *Selling,General and Administrative Expense.*Our selling, general andadministrative expenses totaled $16.9 million in 2004 compared to $14.8 millionin 2003, or approximately 24.8% and 30.2% of revenue in 2004 and 2003,respectively. The increase in expenses over the prior year is partiallyattributable to higher legal costs in connection with a patent litigationmatter. In 2004 these legal expenses were $2.0 million, compared to $1.1million in 2003. As previously announced in June, 2004, the United StatesDistrict Court of the Northern District of California has granted summaryjudgment in favor of APT, dismissing IXYS Corporation’s claims of patentinfringement against APT. Therefore our legal costs decreased substantially inthe second half of 2004. A portion of the increase over 2003 was also due toadditional sales commission expense of $495,000 on higher overall revenue andhigher payroll costs of $620,000 primarily due to the management cash bonusincentive plan.

 

*Restructuring Charges.* As part ofmanagement’s strategic plans, the Company announced in November of 2003restructuring actions intended to improve manufacturing efficiencies and loweradministrative costs. The actions include consolidation of certainadministrative functions, rationalization of internal and external assembly andtest manufacturing, and the reduction of rent expense through the purchase andresale of one of the two buildings currently occupied by the Company’s SantaClara, California subsidiary. These announced actions were in addition topreviously disclosed plans to consolidate our wafer fabrication plant inMontgomeryville, Pennsylvania to Bend, Oregon. Total restructuring relatedcharges recognized in 2004 and 2003 were $558,000 and $645,000, respectively.

 

The total severancerelated charges recognized in 2004 and 2003 were $103,000 and $295,000,respectively. The severance charges related to already separated personnel andpersonnel costs associated with benefits expected to be paid upon completion ofcertain eligible transfer activities. The building purchase was reported as anasset held for sale and sold in September 2005, as APT no longer required thespace. In accordance with SFAS 144, an asset held for sale is carried atestimated net fair value. As such, APT recorded an impairment charge for the buildingof approximately $80,000 and $350,000 in 2004 and 2003, respectively. Fairvalue was estimated based on comparable sales data of similar commercial spacein the area. The net carrying value of the building as of December 31, 2004 wasapproximately $930 and is included as a component 

 

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of other current assets.Additional restructuring costs of $375,000 associated with costs to exitcertain production activities were also recognized in 2004. The charges relateto accelerated depreciation on certain production related equipment to beabandoned after shutdown and contractual closing costs.

 

*In-Process Research and Development Charges.*Total in-process research and development charges for 2004 were $170,000, whichrelated to our acquisition of the assets of Zeus Semiconductor, Inc. See Note (4)(a)of the consolidated financial statements for more information on theacquisition.

 

 *Interestand Other Income (Expense).* Interest income in 2004 was $226,000 comparedto $246,000 in 2003. Overall, our invested cash and prevailing interest rateswere comparable between 2004 and 2003. Interest expense was $17,000 in 2004compared to $29,000 in 2003. Other income (expense), net was an expense of$109,000 in 2004 compared to an expense of $29,000 in 2003. In 2004, theCompany expensed approximately $225,000 in professional costs associated withthe filing and subsequent withdrawal of our registration statement on form S-3for a securities offering.

 

                *Income Taxes.*In2004, the Company recorded a tax expense of $82,000, for an effective rate of2.6%. The Company recorded a full valuation allowance against its remaining netdeferred tax assets in the fourth quarter of 2003. In assessing the valuationof deferred tax assets, SFAS No. 109 “Accounting for Income Taxes,” requires amore likely than not standard. The ultimate realization of deferred tax assetsis dependent on the generation of future domestic taxable income during theperiods in which the associated temporary differences become deductible.Management considers the scheduled reversals of deferred tax liabilities,projected future taxable income, and tax planning strategies in making thisassessment. Although the Company anticipates future long term profitability,SFAS No. 109 requires that recent historical operating performance weigh moreheavily in assessing the valuation of deferred tax assets. The more likely thannot assessment was principally based upon the losses generated during 2002 and2003 and the cyclical nature of the industry which make projections of industrytrends difficult. As of December 31, 2004, APT had federal and state netoperating loss carry forwards of $3.0 million and $4.4 million, respectively,which expire beginning in years 2020 through 2023.

 

In 2003, we recorded atax expense of approximately 23% on our net loss of $2.7 million. Our effectivetax rate in 2003 differs from the federal statutory rate primarily due to therecording of a non-cash charge of $846,000 to establish a full valuationreserve against our net deferred tax assets, offset by a reduction in our taxespayable by $225,000.

 

**Liquidityand Capital Resources**

 

Managementassesses the Company’s liquidity in terms of its ability to generate cash tofund its operating, investing, and financing activities. Significant factorsaffecting the management of liquidity are: cash flows from operatingactivities, capital expenditures, investments in businesses, and access to bankcredit when required and at reasonable rates. The Company’s key cash flowmetrics for the last five years are presented in Part I, Item 6, “SelectedFinancial Data” of this report.

 

*Operating Cash Flows:* In 2005, we generated approximately $5.8 million from operatingactivities. This resulted from our net loss of $4.7 million offset by non-cashcharges for depreciation, amortization, and provisions totaling $4.9 million, inprocess research and development costs of $4.9 million, the loss on disposal ofproperty and equipment of $88,000, and a net increase in working capital of $544,000.Our collections from customers were approximately $63.6 million in 2005compared to $65.4 million in 2004. Accounts receivable was higher at year endfor 2005 compared to year end 2004, reflecting higher fourth quarter 2005 revenuecompared to fourth quarter 2004 revenue. The higher accounts receivable wasoffset by a decrease in inventory and prepaid expenses and other assets and anincrease in accounts payable balances.

 

*InvestingCash Flows:* In 2005, we used $8.6 million in investingactivities which primarily consisted of our acquisition of PowerSicel, Inc. andthe net purchases from the sale and purchase of marketable securities of $2.4million, partially offset by the net proceeds of $0.9 million from the sale ofa building at our Santa Clara, California facility, as explained further in Note(3) of the consolidated financial statements of this Form 10-K. The acquisitionof PowerSicel consumed approximately $5.0 million of cash and direct costsduring the period, net of $460,000 cash acquired. In addition, we issued APTstock options valued at $570,000 for the acquisition. We also purchased $2.1million of property, plant, and equipment in 2005, compared to $3.7 million in 2004. The decrease in the purchase ofproperty, plant, and equipment in 2005 was primarily due to expenditures in2004 for the expansion of our wafer fabrication facility at our Bend, Oregonplant.

 

*FinancingCash Flows:* In 2005, we generated approximately $747,000 fromfinancing activities, which primarily consisted of proceeds from the exerciseof stock options.

 

As of December 31, 2005, wehad $36.0 million in working capital. Our trade accounts receivable balance was$11.4 

 

32

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million reflecting a dayssales outstanding ratio of 60 days, compared to trade accounts receivable of $10.0million at December 31, 2004, reflecting a days sales outstanding ratio of 47days. Based on the geographic mix of our customers and the credit terms weextend, management expects our days sales outstanding ratio to range from 50 to60 days. Our inventory balance was $12.9 million reflecting inventory turns of 3.2times per year, compared to an inventory balance of $14.6 million at December31, 2004 and inventory turns of 3.2 times per year. The Company continues topursue actions to monitor inventory levels and improve inventory turns. Thecalculations above are based on yearly average balances of trade accountsreceivable and inventory.

 

On March 31, 2005, weentered into a loan and security agreement with Silicon Valley Bank. Theagreement is for a $10 million revolving line of credit that bears interest, atthe election of the Company, at either the Silicon Valley Bank prime rate plusa margin or the LIBOR rate plus a margin. The margin for either rate isdependent on the adjusted quick ratio of the Company as defined in theagreement. The Company paid commitment fees of 20 basis points upon closing andwill pay 20 basis points per year on the unused portion of the line of credit,payable quarterly. Amounts borrowed under the credit agreement are secured bycertain tangible and intangible assets of the Company. The credit agreementexpires on June 30, 2006, at which time all amounts borrowed and relatedinterest are immediately payable if the agreement is not renewed. We currentlyhave no advances under this line of credit.

 

We currently expect tofund expenditures for capital requirements as well as liquidity needs from acombination of available cash balances, internally generated funds, and ourline of credit with Silicon Valley Bank. As of December 31, 2005, APT had$17.3 million in cash and cash equivalents and available-for-salesecurities. APT’s investment policy is to invest in short term, high-gradeliquid investments with the goal of capital preservation. APT’s ability togenerate positive cash flow from operations may be affected by marketconditions as well as other risk factors described below. We expect from timeto time to evaluate potential acquisitions and equity investments complementaryto our market strategy. To the extent we pursue such transactions, we couldrequire additional equity or debt financing to fund such activities or to fundour working capital requirements in the event of an industry downturn or an unexpectedadverse change in our business operations. To the extent we require additionalcapital we cannot be certain that we will be able to obtain such financing onterms favorable to us, or at all.

 

**Off Balance Sheet Arrangements &Commitments**

 

As of December 31, 2005and 2004 the Company did not have any unconsolidated entities or off balancesheet financial arrangements, guarantees or similar commitments with suchentities. A summary of the Company’s contractual obligations and commitments asof December 31, 2005 is presented in the table below. Purchase obligationsinclude amounts committed under legally enforceable contracts or purchaseorders.

 
| ** **                     | ** ** | **Payments due by period** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **Total**                                 | ** ** | **Less than   one year** | ** ** | **1-3 Years** | ** ** | **3-5 years** | ** ** | **More than 5  years** | ** ** |
|                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Long term debt                 |       | $                                         | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Operating leases               |       | 5,278                                     |       | 1,210 |   | 2,214 |   | 1,716 |   | 138 |   |
| Capital leases                 |       | —                                    |       | — |   | — |   | — |   | — |   |
| Purchase  obligations          |       | 14,522                                    |       | 8,894 |   | 4,909 |   | 442 |   | 277 |   |
| Other long term  liabilities   |       | —                                    |       | — |   | — |   | — |   | — |   |
| Total  contractual obligations |       | $                                         | 19,800     |   | $ | 10,104 |   | $ | 7,123 |   | $ | 2,158 |   | $ | 415 |   |

 

**RecentAccounting Pronouncements**

 

InDecember 2004, the Financial Accounting Standards Board (FASB)issued Statement of Financial AccountingStandards (SFAS) 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), whichis a revision of SFAS 123. SFAS 123R supersedes APB 25 and amends FASBStatement No. 95, “Statement of Cash Flows”, see Note 1(k) in the notes tothe consolidated financial statements for further discussion.

 

In November 2004, theFASB issued (SFAS) No. 151, “Inventory Costs, an amendment of ARB No. 43,Chapter 4” (SFAS 151). SFAS 151 clarifies that abnormal inventory costs such ascosts of idle facilities, excess freight and handling costs, and wasted materials(spoilage) are required to be recognized as current period charges. The Companyearly adopted SFAS 151 in the second quarter of 2005. The adoption of thispronouncement did not have a material impact on the Company’s financialposition, results of operations or cash flows.

 

33

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In March 2005, the FASB issued FASBInterpretation No. 47, “Accounting for Conditional Asset RetirementObligations” (FIN 47). FIN 47 clarifies that a conditional asset retirementobligation, as used in SFAS No. 143, “Accounting for Asset RetirementObligations,” refers to a legal obligation to perform an asset retirementactivity in which the timing and/or method of the settlement are conditional ona future event that may or may not be within the control of the entity.FIN 47 requires an entity to recognize a liability for the fair value of aconditional asset retirement obligation when incurred if the liability’s fairvalue can be reasonably estimated. This interpretation is effective for theCompany for the year ended December 31, 2005. FIN 47 did not have amaterial impact on the Company’s financial position, results of operations orcash flows.

 

In May 2005, FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”(SFAS 154). SFAS 154 requires retrospective application of a voluntarychange in accounting principle to prior period financial statements unless itis impracticable. This Statement also requires that a change in method ofdepreciation, amortization, or depletion for long-lived, non-financial assetsbe accounted for as a change in accounting estimate that is affected by achange in accounting principle and requires retrospective application to priorperiod financial statements. SFAS 154 replaces APB Opinion 20, “Accounting Changes”, and SFAS 3, “Reporting Accounting Changes in InterimFinancial Statements”. The Company does not anticipate that the adoptionof this standard will have a material impact on its consolidated financialstatements. SFAS 154 is effective for accounting changes and corrections oferrors made in fiscal years beginning after December 15, 2005, andaccordingly, the Company will adopt SFAS 154 in the first quarter of 2006.

 

**ITEM 7A. QUANTITATIVE AND QUALITATIVEDISCLOSURE ABOUT MARKET RISK.**

 

We do not use derivative financialinstruments in our investment portfolio. Due to the short duration andconservative nature of our cash equivalents, and the high quality andconservative nature of our long-term investments, we do not expect any materialloss with respect to our investment portfolio.

 

Currently less than 2% of our revenue istransacted in local currencies, primarily Euros. As a result, our internationalresults of operations have limited exposure to foreign exchange ratefluctuations. We do not currently hedge against foreign currency ratefluctuations. Most of our export revenue and revenue by APT Europe are in U.S.dollars, and most of our foreign currency revenue is from operations withsignificant expenses in the same currency. As a result, gains and losses fromsuch fluctuations have not been material to our consolidated results ofoperations.

 

**ITEM 8. FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA.**

 

The information required by this item isincluded in Note 14 of Notes to Consolidated Financial Statements and aslisted in Item 15 of Part IV of this Report.

 

**ITEM 9. CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.**

 

None.

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls andProcedures**

 

As required by new Rule 13a-15 under the Securities Exchange Act of1934, the Company carried out an evaluation under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures, as ofthe end of the period covered by this report. Based upon that evaluation, theChief Executive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures are effective to ensure that informationrequired to be disclosed by the Company in the reports it files or submitsunder the Exchange Act is recorded, processed, summarized and reported, withinthe time periods specified in the Securities and Exchange Commission’s rules andforms.

 

34

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**Changes in Internal Controls over Financial Reporting**

 

No change in our internal control overfinancial reporting (as defined in Rule 13a-15(f) under the Exchange Act)occurred during the fourth quarter of our fiscal year ended December 31, 2005that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**Management’s Report on Internal Control OverFinancial Reporting**

 

Management is responsible for establishing andmaintaining adequate internal control over financial reporting as defined inRule 13a-15(f) under the Securities Exchange Act of 1934. We have performed anevaluation under the supervision and with the participation of our management,including our CEO and CFO, of the effectiveness of our internal control overfinancial reporting. Our management used the framework *Internal Control*—*Integrated Framework* issued by theCommittee of Sponsoring Organizations (COSO) to perform the evaluation. Basedon that evaluation our CEO and CFO concluded that our internal control overfinancial reporting was effective as of December 31, 2005.

 

Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

Management’s assessment of the effectiveness of ourinternal control over financial reporting as of December 31, 2005 has beenaudited by KPMG LLP, an independent registered public accounting firm, asstated in their report. KPMG LLP also performed an audit of our financialstatements as of December 31, 2005 and provided their report thereon. A copy ofboth reports is included in this Annual Report on Form 10-K.

 

**ITEM 9B. OTHER INFORMATION**

 

None.

 

35

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** **

**PART III**

 

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OFTHE REGISTRANT.**

 

**Directors**

 

The following table and subsequent paragraphsprovide information about each member of our Board of Directors. There are nofamily relationships among any of the directors and executive officers ofAdvanced Power Technology, Inc.

 
| **Director**         | ** ** | **Age** | ** ** | **Director  Since** | ** ** |
|----------------------|------------|---------|------------|---------------------|------------|
|                 |       |    |       |                |       |
| Patrick P.H.  Sireta |       | 60      |       | 1995                |       |
| Robert C.  Pearson   |       | 70      |       | 2000                |       |
| James E.  Petersen   |       | 66      |       | 1995                |       |
| Douglas S.  Schatz   |       | 60      |       | 1995                |       |
| Alfred J.  Stein     |       | 73      |       | 2000                |       |
| Ronald F.  McKenna   |       | 65      |       | 2004                |       |

 

**Patrick P.H. Sireta.**Mr. Siretajoined APT as its President and Chief Executive Officer in 1985, and was namedChairman of the Board in 1995. Before joining APT, Mr. Sireta held severalpositions with Texas Instruments, including Financial Director, TexasInstruments France; General Manager, Texas Instruments Portugal; GeneralManager, Texas Instruments France; and Vice President and General Manager, CMOSDivision, Texas. He holds a Master’s Degree in Engineering from Ecole Centralede Paris and a Ph.D. in Statistics from Paris University.

 

**Robert C. Pearson.**Mr. Pearsonwas elected as a Director in August 2000. He has over 30 years offinancial experience in the semiconductor and high technology industry.Mr. Pearson is currently a Senior Vice President with Renaissance CapitalGroup, Inc., an investment advisor. Mr. Pearson held severalpositions with Texas Instruments during his 25-year tenure, including VicePresident-Finance from 1982 to 1985. In addition, Mr. Pearson currently servesas Director of two private company and the following public companies:Laserscope Inc., Global Axcess Corp, Simtek Corporation, and Caminosoft, Inc.

 

**James E. Petersen**. Mr. Petersenwas elected as a Director in 1995. He also serves as outside general counsel toAPT. Mr. Petersen is a partner with the firm of Karnopp Petersen, LLP, ofBend, Oregon. Mr. Petersen also serves as a Director of Cascade Bancorp, apublic bank holding company. Mr. Petersen received his BA Degree and JurisDoctor from the University of Oregon.

 

**Douglas S. Schatz.**Mr. Schatzwas elected as a Director in 1995. He is a co-founder and has been the Chairmanof the Board of Advanced Energy Industries, Inc. since its incorporationin 1981. He was also Chief Executive Officer through 2005, and until July 1999,he served as President of Advanced Energy Industries, Inc. In March 2001, hewas reappointed as President. From September 2002 until February 2003, heserved as interim Chief Operating Officer.

 

**Alfred J. Stein.**Mr. Steinwas elected as a Director in December 2000. He has over 40 years ofexecutive management experience in the semiconductor and high technologyindustry. Mr. Stein served as Chairman of the Board and Chief ExecutiveOfficer of VLSI Technology from 1982 until its acquisition by PhilipsElectronics in 1999. Mr. Stein has served on the Board of Directors ofApplied Materials, Radio Shack, and also as the Chairman of the Board for theSemiconductor Industry Association. He currently serves on the Board of twoother public companies and three private companies.

 

**Ronald F. McKenna.**Mr. McKennawas elected as a Director in 2004. Mr. McKenna served as President of HamiltonSundstrand from 1999 through 2004 and Chairman of the Board for the year 2005. HamiltonSundstrand is a major and multi-billion dollar division of United TechnologiesCorporation (UTC). He directed Hamilton Sundstrand’s worldwide operations,including its aerospace and industrial businesses. In 1995 he became vicepresident of Aerospace Business Development. In 1996, he was appointedcorporate executive vice president and chief operating officer, Aerospace, forSundstrand. Upon the 1999 acquisition of Sundstrand by United Technologies, hebecame President of Hamilton Sundstrand. Mr. McKenna is also on the board ofdirectors for Crane Co, a diversified manufacturer of engineered industrialproducts. Mr. McKenna earned a bachelor’s degree in mechanical engineering fromFarleigh Dickinson University in 1962, a master’s degree in mechanical engineeringfrom the University of Southern California in 1966, and a master’s in businessadministration from Northern Illinois University in 1973.

 

36

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**Executive Officers**

 

The following table sets forth the names,ages and positions of our executive officers:

 
| **Name**               | ** ** | **Age** | ** ** | **Position**                                                                        |
|------------------------|------------|---------|------------|-------------------------------------------------------------------------------------|
|                   |       |    |       |                                                                                |
| Patrick P.H. Sireta    |       | 60      |       | President, Chief Executive Officer and  Chairman of the Board of Directors          |
| Russell J. Crecraft    |       | 45      |       | Executive Vice President & Chief  Operating Officer                             |
| Greg M. Haugen         |       | 49      |       | Vice President, Finance and Administration,  Chief Financial Officer and Secretary  |
| Thomas A. Loder        |       | 51      |       | Vice President, Sales and Marketing                                                 |
| Dah Wen Tsang          |       | 58      |       | Vice President, Engineering and Research  and Development                           |
| Charles C. Leader, III |       | 54      |       | Vice President & General Manager, APT  RF Military, Avionics and Radar Products |
| George J. Krausse, III |       | 60      |       | Vice President, Commercial RF Products                                              |

 

**Patrick P.H. Sireta.**Information concerning Mr. Sireta is included under Directors above.

 

**Russell J. Crecraft.**Mr.Crecraft was appointed Executive Vice President & Chief Operating Officerin May 2004. Prior to that he served as Vice President & Chief OperatingOfficer, Discrete Power Products since 2003, Vice President & ChiefOperating Officer, Power Products since 2002 and Vice President ofManufacturing Operations since 1995. He joined APT in 1986, and held severalsupervisory positions in product management and assembly/test operations. Priorto joining APT, he worked with Texas Instruments where he held productengineering and management positions. Mr. Crecraft has a BSEE inElectrical Engineering from Texas A&M University.

 

**Greg M. Haugen.**Mr. Haugenwas appointed Vice President, Finance and Administration, Chief FinancialOfficer and Secretary in 1995. Mr. Haugen joined APT in 1985. Prior tojoining APT, he worked for the accounting firm of KPMG LLP and was on thecorporate accounting staff of Evans Products Company. Mr. Haugen graduatedwith a BS Degree from Lewis and Clark College and has passed the CPAexamination.

 

**Thomas A. Loder.**Mr. Loderwas appointed Vice President, Sales and Marketing in 1999. Mr. Loderjoined APT in 1988 as Regional Sales Manager for the southern U.S., andsubsequently served as Worldwide Sales Manager, Vice President of Marketing andSales and Vice President, Discrete Power Products. Prior to joining APT,Mr. Loder was Area Sales Manager for Unitrode Corporation, Regional SalesManager for Silicon General and ION Associates, Product Sales Manager forElmwood Sensors, and Branch Manager for Newark Electronics. Mr. Loder hasa BA in Biology from Brown University.

 

**Dah Wen Tsang.**Dr. Tsangwas appointed Vice President, Engineering and Research and Development in 1987.Previously, he was Director of Research at Theta-J, and worked in Hewlett-Packard’spower MOSFET program. Dr. Tsang’s papers have been published by technicaljournals, including the Journal of Applied Physics and IEEE Transactions.Dr. Tsang has BES and MS Degrees from Brigham Young University, and aPh.D. from the University of California at Berkeley.

 

**Charles C. Leader, III.**Mr. Leader has served as Vice President for APT’s Military, Avionics and RadarProducts group since February 2003. He is responsible for APT’s operationslocated in Santa Clara, California which serves both the commercial andmilitary markets with VHF, UHF and microwave power transistors and assemblies.Prior to his current responsibilities, Mr. Leader served as Vice President ofOperations for GHz Technology, acquired by APT in February 2001. Mr. Leaderformerly served in various senior management positions with AgilentTechnologies and Hewlett Packard Corporation including operations in Californiaand Asia Pacific. He holds a BSBA in Operations Research from Arizona StateUniversity.

 

**George J. Krausse, III.**GeorgeKrausse joined Advanced Power Technology in January 2004, as Vice President,Commercial RF Products. Prior to that, he founded Directed Energy Inc (DEI) in1985 and served as DEI’s Chief Technical Officer until becoming its Presidentin 2003. From 1972 to 1985 he worked at the Los Alamos National Laboratory assenior technologist and from 1965 to 1972 served in the United States AirForce. Mr. Krausse authored a number of technical papers and made severalinventions which have been patented, all primarily in the fields of RF devicesand RF amplifiers.

 

**Code of Ethics**

 

The Company has adopted a code of ethics thatapplies to all its directors, officers, employees and representatives. 

 

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This code is publicly availableon the Company’s website at www.advancedpower.com. Amendments to the code ofethics and any grant of waiver from a provision of the code requiringdisclosure under applicable SEC rules will be disclosed on the Company’s website.

 

**Section 16(a) Beneficial Ownership ReportingCompliance**

 

Section 16(a) of the Securities ExchangeAct of 1934, as amended (Exchange Act) requires our directors and executiveofficers, and persons who own more than ten percent of a registered class ofour equity securities (Reporting Persons), to file initial reports of ownershipand changes in beneficial ownership of Common Stock and other equity securitiesof the Company with the Securities and Exchange Commission and the NASDAQ StockMarket, Inc. Copies of these reports are also required to be delivered tothe Company.

 

To our knowledge, based solely on review ofthe copies of such reports furnished to the Company and written representationsfrom certain Reporting Persons, during the year ended December 31, 2004,all of the Reporting Persons complied with applicable Exchange Act filingrequirements.

 

**ITEM 11. EXECUTIVE COMPENSATION**.

 

**Summary Compensation**

 

The following table contains information insummary form concerning the compensation paid to our chief executive officerand the four other most highly compensated executive officers whose totalsalary and bonus exceeded $100,000 during the year ended December 31, 2005(Named Executive Officers).

 
| ** **                                                                                  | ** **    | **Annual  Compensation** | ** ** | **Long-Term  Compensation** | ** ** | ** **            | ** ** |
|---------------------------------------------------------------------------------------------|---------------|--------------------------|------------|-----------------------------|------------|-----------------------|------------|
| **Name and Principal Position**                                                             | ** **    | **Year**                 | ** ** | **Salary ($)**              | ** ** | **Bonus ($)**         | ** ** | **Securities  Underlying  Options (#)** | ** ** | **(1)  All Other  Compensation ($)** | ** ** |
|                                                                                        |          |                     |       |                        |       |                  |       |   |   |   |   |
| Patrick P.H.  Sireta,*   Chairman, President and CEO                                        |          | 2005

2004

2003         |       | $                           | 211,412    |                  | $          | 53,769 |   | —

—

— |   | $ | 255 |   |
| 215,919 204,533                                                                             | 123,849 9,509 | 303  307                 |
| Russell J.  Crecraft,*  Executive VP & Chief Operating Officer                          |          | 2005

2004

2003         |       | 158,450 154,611 133,957     |       | 22,549 51,637 

3,703 |       | —

—

— |   | 248

 287

 281 |   |
| Dah Wen  Tsang,*   VP, Engineering, Research & Development                         |          | 2005

 2004 

2003  |       | 142,070 144,692 133,354     |       | 20,036 47,780 

3,686 |       | —

—

— |   | 224

 271

 281 |   |
| Charles C.  Leader, III,   VP, Military, Avionics and Radar   Products                      |          | 2005 

2004 

2003       |       | 150,462 150,690 143,111     |       | 17,082 33,466 

1,914 |       | 5,000

5,000

10,000 |   | 234

 271

 262 |   |
| Greg M.  Haugen,*   VP, Finance and Administration,   Chief Financial Officer and Secretary |          | 2005 

2004 

2003       |       | 133,178 133,388 121,760     |       | 19,000 44,122

3,370  |       | —

—

— |   | 206

 249

 255 |   |
|                                                                                             |               |                          |            |                             |            |                       |            |  |  |  |  |  |  |  |

 

----

* Denotes Named Executive Officer who was part of the 1995 and 1998management buyout.

 

(1)          Consists of term life insurance premiums paidby APT for the executive’s benefit.

 

38

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**Employment Agreements and Other Arrangements**

 

We have entered into employment agreementswith each of our executive officers, under which each officer can be dismissedwithout cause, with severance pay equal to one month’s salary. These agreementsobligate each officer other than Thomas Loder to not compete with us for aperiod of 18 months after termination.

 

**Stock Option Grants in Fiscal 2005**

 

Due to the fact that the Named ExecutiveOfficers who participated in the 1995 and 1998 management buyout (denoted by *above) collectively own a significant percentage of the Company’s outstandingshares of Common Stock, (see “Security Ownership of Certain Beneficial Ownersand Management”) they do not participate in the Company’s long-term stock-basedincentive compensation programs. Only one of the other Named Executive Officersabove was not part of the 1995 and 1998 management buyout. Stock option grantactivity for this officer in 2005 is shown in the table below.

 
| ** **               | ** ** | **Options Granted** | ** ** | ** **         | ** ** | ** **      | ** ** |
|--------------------------|------------|---------------------|------------|--------------------|------------|-----------------|------------|
| ** **               | ** ** | **Number  of**      | ** ** | ** **         | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | **Potential  Realizable Value at** | ** ** |
| ** **               | ** ** | **Securities**      | ** ** | **Percentage  of** | ** ** | ** **      | ** ** | **Market** | ** ** | ** ** | ** ** | **Assumed  Annual Rates of Stock** | ** ** |
| ** **               | ** ** | **Underlying**      | ** ** | **Total  Options** | ** ** | ** **      | ** ** | **Price on** | ** ** | ** ** | ** ** | **Price  Appreciation for Option** | ** ** |
| ** **               | ** ** | **Options**         | ** ** | **Granted  to**    | ** ** | **Exercise**    | ** ** | **Date of** | ** ** | ** ** | ** ** | **Term** | ** ** |
| ** **               | ** ** | **Granted**         | ** ** | **Employees  in**  | ** ** | **Price  (Per** | ** ** | **Grant  (Per** | ** ** | **Expiration** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Name**                 | ** ** | **(Shares)**        | ** ** | **Fiscal  2005**   | ** ** | **Share)**      | ** ** | **Share)** | ** ** | **Date** | ** ** | **5%** | ** ** | **10%** | ** ** |
| ** **               | ** ** | ** **          | ** ** | ** **         | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Charles C.   Leader, III |       | 5,000               |       | 2.50               | %          | $               | 7.30       |   | $ | 7.30 |   | 3/23/2015 |   | $ | 22,955 |   | $ | 58,172 |   |
|                          |            |                     |            |                    |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

**Aggregate Option Exercises in Fiscal 2005 andFiscal Year-End Option Values**

 

The following table provides summaryinformation, as to the Named Executive Officers, concerning stock optionsexercised during 2005 and the number of shares subject to both exercisable andunexercisable stock options as of December 31, 2005.

 

**AggregatedOption Exercises in Last Fiscal Yearand Fiscal Year-End Option Values**

 
| ** **              | ** ** | **Shares**       | ** ** | ** **       | ** ** | **Number of Securities  Underlying Options at** | ** ** | **Value of Unexercised  In-the-Money Options at** | ** ** |
|-------------------------|------------|------------------|------------|------------------|------------|-------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **              | ** ** | **Acquired on**  | ** ** | **Value**        | ** ** | **Fiscal Year-End (#)**                         | ** ** | **Fiscal Year-End ($)(1)**                        | ** ** |
| **Name**                | ** ** | **Exercise (#)** | ** ** | **Realized ($)** | ** ** | **Exercisable**                                 | ** ** | **Unexercisable**                                 | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
|                    |       |             |       |             |       |                                            |       |                                              |       |   |   |   |   |
| Patrick P.H.  Sireta    |       | —           |       | $                | —     |                                            | —     |                                              | —     |   | $ | — |   | $ | — |   |
| Russell J.  Crecraft    |       | —           |       | —           |       | —                                          |       | —                                            |       | — |   | — |   |
| Dah Wen  Tsang          |       | —           |       | —           |       | 61,405                                          |       | —                                            |       | 750,983 |   | — |   |
| Charles C.  Leader, III |       | —           |       | —           |       | 54,760                                          |       | 12,440                                            |       | 339,256 |   | 102,162 |   |
| Greg M.  Haugen         |       | —           |       | —           |       | —                                          |       | —                                            |       | — |   | — |   |
|                         |            |                  |            |                  |            |                                                 |            |                                                   |            |  |  |  |  |  |  |  |

----

(1)           The value ofunexercised in-the-money options is calculated based on the closing price ofour Common Stock on December 31, 2005, $13.63 per share. Amounts reflectedare based on the assumed value minus the exercise price and do not necessarilyindicate that the optionee sold such stock.

 

39

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**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTAND RELATED STOCKHOLDER MATTERS.**

 

The following table sets forth the beneficialownership of our Common Stock as of February 21, 2006, by:

 

•                  each person orgroup of affiliated persons known by us to own beneficially more than 5% of theoutstanding shares of our Common Stock;

•                  each of ourdirectors;

•                  each of ourexecutive officers; and

•                  all directorsand executive officers as a group.

 
| **Name and Address of Beneficial  Owner (1)**                                                                        | ** ** | **Number of  Shares   Beneficially  Owned (2)** | ** ** | **Shares  Acquirable  Within 60  Days (3)** | ** ** | **Total  Beneficial  Ownership** | ** ** | **Percentage of  Shares   Beneficially  Owned (4)** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------|------------|
|                                                                                                                 |       |                                            |       |                                        |       |                             |       |                                                |       |
| *Directors  and Executive Officers*                                                                                  |       |                                            |       |                                        |       |                             |       |                                                |       |
| Patrick P.H. Sireta (5)                                                                                              |       | 2,124,531                                       |       | —                                      |       | 2,124,531                        |       | 19.2                                                | %          |
| Russell J. Crecraft                                                                                                  |       | 369,800                                         |       | —                                      |       | 369,800                          |       | 3.3                                                 |       |
| Greg M. Haugen                                                                                                       |       | 386,500                                         |       | —                                      |       | 386,500                          |       | 3.5                                                 |       |
| Thomas A. Loder                                                                                                      |       | 360,000                                         |       | 32,535                                      |       | 392,535                          |       | 3.6                                                 |       |
| Dah Wen Tsang                                                                                                        |       | 364,400                                         |       | 61,405                                      |       | 425,805                          |       | 3.9                                                 |       |
| Charles C. Leader, III                                                                                               |       | —                                          |       | 55,760                                      |       | 55,760                           |       | *                                                   |       |
| George J. Krausse, III                                                                                               |       | —                                          |       | —                                      |       | —                           |       | *                                                   |       |
| Robert C. Pearson                                                                                                    |       | 9,000                                           |       | 55,000                                      |       | 64,000                           |       | *                                                   |       |
| James E. Petersen                                                                                                    |       | 8,750                                           |       | 58,000                                      |       | 66,750                           |       | *                                                   |       |
| Douglas S. Schatz (6)                                                                                                |       | 138,000                                         |       | 55,000                                      |       | 193,000                          |       | 1.7                                                 |       |
| Alfred J. Stein                                                                                                      |       | 10,000                                          |       | 54,038                                      |       | 64,038                           |       | *                                                   |       |
| Ronald F. McKenna                                                                                                    |       | 10,610                                          |       | 30,500                                      |       | 41,110                           |       | *                                                   |       |
|                                                                                                                 |       |                                            |       |                                        |       |                             |       |                                                |       |
| All directors and executive officers as a  group (12 persons, consisting of 7 officers and 5 non-employee directors) |       | 3,781,591                                       |       | 402,238                                     |       | 4,183,829                        |       | 37.8                                                | %          |
|                                                                                                                 |       |                                            |       |                                        |       |                             |       |                                                |       |
| *5%  Shareholders*                                                                                                   |       |                                            |       |                                        |       |                             |       |                                                |       |
| Microsemi Corporation (7)  2381 Morse Avenue Irvine, California 92614                                                |       | 3,664,831                                       |       | —                                      |       | 3,664,831                        |       | 33.1                                                |       |
| Dimensional Fund Advisors, Inc. (8)  1299 Ocean Avenue, 11th floor Santa Monica, California 90401                    |       | 662,236                                         |       | —                                      |       | 662,236                          |       | 6.0                                                 |       |

 

----

*                                         Lessthan 1% of the outstanding Common Stock.

 

(1)          Unless otherwise indicated, the address ofeach beneficial owner listed is c/o Advanced Power Technology, Inc.,405 SW Columbia Street, Bend, Oregon 97702.

 

(2)          For each person, the “Number of SharesBeneficially Owned” column may include shares of Common Stock attributable tothe person because of that person’s voting or investment power or otherrelationship.

 

(3)          The number of shares of Common Stockbeneficially owned by each person is determined under rules promulgated by theSecurities and Exchange Commission. Under these rules, a person is deemed tohave “beneficial ownership” of any shares over which that person has or sharesvoting or investment power, plus any shares that the person may acquire within60 days, including through the exercise of stock options. As such, beneficialshares in the table above include those shares covered by stock options thatmay be exercised within 60 days of February 21, 2006. Unless otherwiseindicated, each person in the table has sole voting and investment power overthe shares listed. The inclusion in the table of any shares, 

 

40

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however, doesnot constitute an admission of beneficial ownership of those shares by thenamed shareholder.

 

(4)          The percent ownership for each shareholder onFebruary 21, 2006 is calculated by dividing (1) the total number of sharesbeneficially owned by the shareholder plus any shares acquirable within 60 daysafter February 21, 2006 by (2) 11,056,852 shares, the number of shares of ourCommon Stock outstanding on February 21, 2006.

 

(5)          Mr. Sireta owns 900,000 of his shares throughSireta, LLC.

 

(6)          138,000 of these shares are beneficiallyowned by Advanced Energy Industries, Inc. Mr. Schatz is the Chairmanof the Board of Advanced Energy Industries, Inc. and may be deemed toshare voting or investment control with respect to these shares.Mr. Schatz disclaims beneficial ownership of such shares.

 

(7)          The information as to beneficial ownership isbased on a Schedule 13D filed with the Securities and Exchange Commissionby Microsemi Corporation on January 5, 2006, reflecting its beneficialownership of Common Stock as of December 31, 2005. The Schedule 13Dstates that Microsemi Corporation has shared voting power with respect to3,664,831 shares of Common Stock as such shares are covered by voting agreementsin the merger agreement between APT and Microsemi Corporation, dated November2, 2005. Microsemi does not have any dispositive power with respect to theshares. Each of the stockholders covered by the voting agreements has agreed tovote all shares of APT common stock in favor of the merger and has also agreednot to solicit any proposals or offers relating to any other merger or businesscombination. For more information on the proposed merger, see Note 12 of theNotes to Consolidated Financial Statements of this Form 10-K.

 

(8)          The information as to beneficial ownership isbased on a Schedule 13G filed with the Securities and Exchange Commissionby Dimensional Fund Advisors, Inc. on February 6, 2006, reflecting itsbeneficial ownership of Common Stock as of December 31, 2005. TheSchedule 13G states Dimensional Fund Advisors, Inc. has sole voting powerwith respect to 662,236 shares of Common Stock and sole dispositive power withrespect to 662,236 shares of Common Stock.

 

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS.**

 

In 2005, 2004, and 2003, revenue fromAdvanced Energy Industries, Inc. was approximately $3.9 million, $6.6million, and $4.5 million, respectively and accounted for 6.1%, 9.7%, and9.3%, respectively of our net revenues. Douglas Schatz, who is Chairman of theBoard and a substantial shareholder of Advanced Energy Industries Inc.,serves as a director of the Company, and beneficially owns approximately 1.7%of our outstanding Common Stock.

 

**ITEM 14. PRINCIPAL ACCOUNTANT FEES ANDSERVICES.**

 

**Fees Paid**

 

The following table presents the aggregatefees billed for services rendered by KPMG LLP for the fiscal years endedDecember 31, 2005 and 2004 were as follows:.

 
| ** **          | ** ** | **Years ended December 31,** | ** ** |
|---------------------|------------|------------------------------|------------|
| ** **          | ** ** | **2005**                     | ** ** | **2004** | ** ** |
|                |       |                         |       |   |   |
| Audit Fees          |       | $                            | 506,000    |   | $ | 587,000 |   |
| Audit  Related Fees |       | 15,000                       |       | 14,000 |   |
| Tax Fees            |       | —                       |       | 34,000 |   |
| All Other  Fees     |       | —                       |       | — |   |
| Total               |       | $                            | 521,000    |   | $ | 635,000 |   |

 

*Audit Fees:* Auditfees consisted of professional services in connection with the audit of theCompany’s annual financial statements for the fiscal years ended December 31,2005 and 2004, respectively and the reviews of the financial statementsincluded in the Company’s Form 10-Qs for the 2005 and 2004 fiscal quarters. Theaudit fees also include additional audit procedures required under Section 404of the Sarbanes-Oxley Act of 2002, which was effective for the Company as ofyear end 2004, and fees related to other regulatory filings.

 

41

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*Audit Related Fees:*Audit related fees consisted of fees for the audit of the financial statementsof our employee benefit plan.

 

*Tax Fees:* Tax feesconsist of professional fees for tax compliance and advisory services.

 

*All Other Fees:*During the years presented, no other fees were paid by the Company to KPMG LLP.

 

**Audit Committee’s Pre-approval Policy andProcedures**

 

The Audit Committee has adopted policies andprocedures for the pre-approval of audit and non-audit services for the purposeof maintaining the independence of our independent registered public accountingfirm. Management may not engage the independent auditors to render any audit ornon-audit service unless the service is approved in advanced by the AuditCommittee.

 

42

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** **

**PART IV**

 

**ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 

1. Index toFinancial Statements

 
| Reports of  KPMG LLP, Independent Registered Public Accounting Firm                                                                          |   |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Report on audit of financial statements                                                                                                      |   |
| Report on audit of internal control over  financial reporting                                                                                |   |
| Consolidated Balance Sheets as of December  31, 2005 and 2004                                                                                |   |
| Consolidated Statements of Operations for  the years ended December 31, 2005, 2004, and 2003                                                 |   |
| Consolidated Statements of Stockholders’ Equity  and Comprehensive Income (Loss) for the years ended December 31, 2005, 2004,  and 2003 |   |
| Consolidated Statements of Cash Flows for  the years ended December 31, 2005, 2004, and 2003                                                 |   |
| Notes to Consolidated Financial Statements                                                                                                   |   |

 

2. FinancialStatement Schedules

 

Schedules have been omitted because theinformation required to be set forth therein is not applicable or is includedin the Consolidated Financial Statements or notes thereto.

 

3. Index toExhibits

 

The following exhibits are filed with, orincorporated by reference into, this Annual Report on Form 10-K:

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 2.1                 |       | Agreement and Plan of Merger dates as of  December 6, 2001, among Advanced Power Technology, Inc., a Delaware  corporation (“Parent”), GHz Acquisition, Inc., a Delaware corporation and a  wholly owned subsidiary of Parent (“Merger Sub”), and GHz Technology, Inc. a  California corporation (the “Company”), incorporated by reference to Exhibits  to the 8K filed January 25, 2002.                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 2.2                 |       | Amendment to Agreement and Plan of Merger  dated as of January 10, 2002 among Advanced Power Technology, Inc. a Delaware  corporation, (“Parent”), GHz Acquisition, Inc., a Delaware corporation and a  wholly owned subsidiary of Parent (“Merger Sub”), and GHz Technology, Inc. a  California corporation (the “Company”), incorporated by reference to Exhibits  to the 8K filed January 25, 2002.                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 2.3                 |       | Asset Purchase Agreement as of May 7, 2002  by and between Microsemi RF Products, Inc., a Delaware corporation (the  “Seller”, a wholly owned subsidiary of Microsemi Corporation, a Delaware  corporation (“Microsemi”) and RF Acquisition Sub, Inc. (the “Purchaser”), a  Delaware corporation and a wholly owned subsidiary of Advanced Power  Technology, Inc. a Delaware corporation (“APT”), incorporated by reference to  Exhibits to the 8K filed May 31, 2002. |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 2.4                 |       | Merger Agreement dated November 2, 2005  between Microsemi Corporation, a Delaware corporation (“Microsemi”) and its  newly formed, wholly-owned subsidiary, APT Acquisition Corp., a Delaware  corporation (“Merger Subsidiary”) and Advanced Power Technology, Inc., a  Delaware corporation, incorporated by reference to Exhibits to the 10-Q filed  November 9, 2005.                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 3.1                 |       | Amended and Restated Certificate and  Articles of Incorporation, incorporated by reference to Exhibits to the  Company’s Registration Statement on Form S-1, as amended, effective August 8,  2000, Registration No. 333-38418, (“the S-1”).                                                                                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 3.2                 |       | Amended and Restated Bylaws, incorporated  by reference to Exhibits to the S-1.                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.1                 |       | Form of Common Stock Certificate,  incorporated by reference to Exhibits to the S-1.                                                                                                                                                                                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.3                 |       | Registration Rights Agreement by and among  Advanced Power Technology, Inc., a Delaware corporation, and the  investors listed on Exhibit A, thereto, incorporated by reference to Exhibits  to the 8K filed January 25, 2002.                                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.4                 |       | Escrow Agreement by and among Advanced  Power Technology, Inc., a Delaware corporation (“APT”), GHz Technology, Inc.,  a Delaware corporation (“GHz”), Frank Schneider, solely in his capacity as  Shareholder Representative (“Shareholder Representative”), and Silicon Valley  Bank (the “Escrow Agent”), incorporated by reference to Exhibits to the 8K  filed January 25, 2002.                                                                              |

 

43

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| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                                                                     |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.5                 |   | Form of Common Stock Purchase Warrant  between Advanced Power Technology, Inc. and Mark Gates, incorporated by  reference to Exhibits to the 8K filed January 25, 2002.                                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.1*               |   | Stock Option Plan dated December 31,  1995, as amended, incorporated by reference to Exhibits to the S-1.                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.2*               |   | Employment Agreement: Patrick P.H. Sireta,  incorporated by reference to Exhibits to the S-1.                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.3*               |   | Employment Agreement: Russell J. Crecraft,  incorporated by reference to Exhibits to the S-1.                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.4*               |   | Employment Agreement: Greg M. Haugen,  incorporated by reference to Exhibits to the S-1.                                                                                                                                                                                                                                            |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.6*               |   | Employment Agreement: Thomas A. Loder,  incorporated by reference to Exhibits to the S-1.                                                                                                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.7*               |   | Employment Agreement: Dah Wen Tsang,  incorporated by reference to Exhibits to the S-1.                                                                                                                                                                                                                                             |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.71**             |   | Lock-up Agreement pursuant to Microsemi  Merger Agreement: Patrick P.H. Sireta.                                                                                                                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.72**             |   | Lock-up Agreement pursuant to Microsemi  Merger Agreement: Russell J. Crecraft.                                                                                                                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.73**             |   | Lock-up Agreement pursuant to Microsemi  Merger Agreement: Greg M. Haugen.                                                                                                                                                                                                                                                          |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.74**             |   | Lock-up Agreement pursuant to Microsemi  Merger Agreement: Thomas A. Loder.                                                                                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.75**             |   | Lock-up Agreement pursuant to Microsemi  Merger Agreement: Dah Wen Tsang.                                                                                                                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.76**             |   | Non-Competition Agreement pursuant to  Microsemi Merger Agreement: Patrick P.H. Sireta.                                                                                                                                                                                                                                             |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.8                |   | Lease Agreement between Shevlin No. One and  Advanced Power Technology, Inc. dated as of March 21, 1985, as  amended, incorporated by reference to Exhibits to the S-1.                                                                                                                                                   |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.9                |   | Commercial Lease between Glassow Ventures,  L.L.C. and Advanced Power Technology, Inc. dated March 6, 1996, incorporated  by reference to Exhibits to the S-1.                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.11†         |   | Manufacturing Agreement by and between  Siemens AG and Advanced Power Technology, Inc. dated October 14, 1997,  incorporated by reference to Exhibits to the S-1.                                                                                                                                                              |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.12†         |   | Agreement for Wafer Production and Testing  by and between Advanced Power Technology, Inc. and Siemens Aktiengesellschaft  dated February 11, 1998, as amended, incorporated by reference to Exhibits to  the S-1.                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.19               |   | Agreement for Wafer Production and Testing  between APT and Episil Technologies, Inc., incorporated by reference to  Exhibits to the 10Q for the third quarter of 2001.                                                                                                                                                             |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.20*              |   | Employment Agreement: George J. Krausse,  III, incorporated by reference to Exhibits to the 10-K filed March 8, 2005.                                                                                                                                                                                                               |
| 10.21               |   | Amendments to Stock Option Plan dated  December 31, 1995, as amended, incorporated by reference to Exhibits to  the 10-K filed March 8, 2005.                                                                                                                                                                                  |
| 10.22               |   | Amendments to Lease Agreement between  Shevlin No. One and Advanced Power Technology, Inc. dated as of  March 21, 1985, as amended, incorporated by reference to Exhibits to the  10-K filed March 8, 2005.                                                                                                               |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.23†         |   | North America Distributor Agreement between  Richardson Electronics, Ltd. and Advanced Power Technology, Inc. dated as of  August 1, 2002, incorporated by reference to Exhibits to the 10-K filed March  8, 2005.                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.24†         |   | Amendment to Manufacturing Agreement by and  between Siemens AG and Advanced Power Technology, Inc. dated October 14,  1997, incorporated by reference to Exhibits to the 10-K filed March 8, 2005.                                                                                                                            |
| 10.25†         |   | Amendments to Agreement for Wafer  Production and Testing by and between Advanced Power Technology, Inc. and  Siemens Aktiengesellschaft dated February 11, 1998, as amended.                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.26†         |   | Document of Understanding between Advanced  Energy Industries, Inc. and Advanced Power Technology, Inc. dated  January 15, 2001, incorporated by reference to Exhibits to the 10-K filed  March 8, 2005.                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.27†         |   | Supply Contract between Siltronic  Corporation and Advanced Power Technology, Inc. dated September 15, 2004.                                                                                                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.28†         |   | Subcontract Agreement between Team Pacific  Corporation and Advanced Power Technology, Inc. dated January 26, 2000,  as amended, incorporated by reference to Exhibits to the 10-K filed March 8,  2005.                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.29†         |   | Worldwide Distributor Agreement between Future  Electronics and Advanced Power Technology, Inc. dated as of October 30, 2003,  incorporated by reference to Exhibits to the 10-K filed March 8, 2005.                                                                                                                               |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.30               |   | Lease Agreement between 3000 Oakmead  Village Drive, LTD and GHz Technology, Inc. dated as of June 17, 1991, as  amended, incorporated by reference to Exhibits to the 10-K filed March 8,  2005.                                                                                                                                   |
| 10.31               |   | Loan and Security Agreement between Silicon  Valley Bank and Advanced Power Technology, Inc., Advanced Power Technology  RF, Inc., Advanced Power Technology Colorado, Inc., and Advanced Power  Technology RF-Pennsylvania, Inc. dated as of March 31, 2005, incorporated by  reference to Exhibits to the 8K filed April 4, 2005. |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.32*              |   | Incentive Bonus Plan of Advanced Power  Technology, Inc., incorporated by reference to Exhibits to the 8K filed April  7, 2005.                                                                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.33*              |   | Summary of Non-Employee Director  Compensation of Advanced Power Technology, Inc., incorporated by reference to  Exhibits to the 8K filed April 7, 2005.                                                                                                                                                                            |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.34†         |   | Supply Contract between Siltronic  Corporation and Advanced Power Technology, Inc. dated April 26, 2005,  incorporated by reference to Exhibits to the 8K filed April 29, 2005.                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.35               |   | 2005 Equity Incentive Plan dated May 3rd,  2005, incorporated by reference to Exhibits to the 8K filed May 6, 2005.                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                                                                |
| 10.36†         |   | Agreement for Wafer Production between CSMC  Manufacturing Co., Ltd. And Advanced Power Technology, Inc. dated June 22,  2005, incorporated by reference to Exhibits to the 8K filed June 28, 2005.                                                                                                                                 |

 

44

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| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                   |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.37†         |   | Amendment dated September 9, 2005, to  Agreement for Wafer Production and Testing by and between Advanced Power  Technology, Inc. and Siemens Aktiengesellschaft dated February 11, 1998, as  amended, incorporated by reference to Exhibits to the 8K filed September 15,  2005. |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.38               |   | Manufacturing Services Agreement between  Semiconductor Assembler & Manufacturer Sdn Bhd and Advanced Power  Technology, Inc. dated November 1, 2005, incorporated by reference to  Exhibits to the 8K filed November 2, 2005.                                                |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.40†         |   | Supply Contract between Siltronic  Corporation and Advanced Power Technology, Inc. dated December 30, 2005,  incorporated by reference to Exhibits to the 8K filed January 6, 2006.                                                                                               |
|                |   |                                                                                                                                                                                                                                                                              |
| 21.1**              |   | Subsidiaries of Advanced Power Technology,  Inc.                                                                                                                                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                                              |
| 23.1**              |   | Consent of KPMG LLP, Independent Registered  Public Accounting Firm.                                                                                                                                                                                                              |
|                |   |                                                                                                                                                                                                                                                                              |
| 31**                |   | Rule13a-14(a)/15d-14(a) Certifications, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                    |
|                |   |                                                                                                                                                                                                                                                                              |
| 32**                |   | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                          |

 

----

†                                          Confidentialtreatment has been requested with respect to certain portions of theseagreements. The omitted portions have been filed separately with the Securitiesand Exchange Commission.

 

*                                         ThisExhibit constitutes a management contract or compensatory plan or arrangement.

 

**           Submittedelectronically herewith

 

45

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**SIGNATURES**

 

Pursuant to the requirements of Sections 13or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized on March 1, 2006.

 
|   | ADVANCED POWER TECHNOLOGY, INC. |
|--------|--------------------------------------|
|   | By:                                  | /s/ GREG M.  HAUGEN  |   |
|   |                                 |    Greg M. Haugen  |
|   |                                 | Vice President, Finance and Administration,  Chief Financial Officer and Secretary |
|        |                                      |  |  |  |

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below onMarch 1, 2006 by the following persons on behalf of the Registrant and inthe capacities indicated.

 
| **Signature** | ** **              | **Title**  |
|---------------|-------------------------|------------|
| ** **    | ** **              | ** ** |
|          | /s/ PATRICK P.H. SIRETA |       | Chairman, President and Chief Executive  Officer (Principal Executive Officer) |
|          | Patrick P.H.  Sireta    |       |   |
|          |                    |       |   |
|          | /s/ GREG M.  HAUGEN     |       | Vice President, Finance and Administration,  Chief Financial Officer and Secretary |
|          | Greg M. Haugen          |       | (Principal Financial and Accounting  Officer) |
|          |                    |       |   |
|          | /s/ ROBERT C. PEARSON   |       | Director |
|          | Robert C.  Pearson      |       |   |
|          |                    |       |   |
|          | /s/ JAMES E. PETERSEN   |       | Director |
|          | James E.  Petersen      |       |   |
|          |                    |       |   |
|          | /s/ DOUGLAS S.  SCHATZ  |       | Director |
|          | Douglas S. Schatz       |       |   |
|          |                    |       |   |
|          | /s/ ALFRED J. STEIN     |       | Director |
|          | Alfred J.  Stein        |       |   |
|          |                    |       |   |
|          | /s/ RONALD F. MCKENNA   |       | Director |
|          | Ronald F.  McKenna      |       |   |
|               |                         |            |  |  |

 

46

----

 

**Report of Independent Registered Public Accounting Firm**

 

The Board of Directors and Shareholders

Advanced Power Technology, Inc.:

 

We have audited the accompanying consolidatedbalance sheets of Advanced Power Technology, Inc. and subsidiaries as ofDecember 31, 2005 and 2004, and the related consolidated statements ofoperations, stockholders’ equity and comprehensive income (loss), and cashflows for each of the years in the three-year period ended December 31, 2005.These consolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the consolidated financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of Advanced Power Technology, Inc. and subsidiaries as ofDecember 31, 2005 and 2004, and the results of their operations and their cashflows for each of the years in the three-year period ended December 31, 2005,in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theeffectiveness of Advanced Power Technology Inc.’s internal control overfinancial reporting as of December 31, 2005, based on criteria established in *Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (COSO)*, and ourreport dated March 1, 2006 expressed an unqualified opinion on management’sassessment of, and the effective operation of, internal control over financialreporting.

 
|   | **/s/ KPMG LLP** |   |
|--------|------------------|--------|

 

Portland, Oregon

March 1, 2006

 

F-1

----

** **

**Report of Independent Registered Public Accounting Firm**

 

The Board of Directors and Shareholders

Advanced Power Technology, Inc.:

 

We have audited management’s assessment,included in the accompanying Management’s Report on Internal Control OverFinancial Reporting, that Advanced Power Technology, Inc. maintained effectiveinternal control over financial reporting as of December 31, 2005, based oncriteria established in *InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO)*. Advanced PowerTechnology, Inc.’s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of theCompany’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

 

A company’s internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reporting includesthose policies and procedures that (1) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

 

Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

In our opinion, management’s assessment thatAdvanced Power Technology, Inc. maintained effective internal control overfinancial reporting as of December 31, 2005, is fairly stated, in all materialrespects, based on criteria established in *InternalControl—Integrated Framework issued by the Committee of Sponsoring Organizationsof the Treadway Commission (COSO)*. Also, in our opinion, AdvancedPower Technology, Inc. maintained, in all material respects, effective internalcontrol over financial reporting as of December 31, 2005, based on criteriaestablished in *Internal Control—Integrated Framework issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO)*.

 

We also have audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets of Advanced Power Technology, Inc. and subsidiariesas of December 31, 2005 and 2004, and the related consolidated statements ofoperations, stockholders’ equity and comprehensive income (loss), and cashflows for each of the years in the three-year period ended December 31, 2005,and our report dated March 1, 2006, expressed an unqualified opinion on thoseconsolidated financial statements.

 
|   | **/s/ KPMG LLP** |   |
|--------|------------------|--------|

 

Portland, Oregon

March 1, 2006

 

F-2

----

** **

**ADVANCEDPOWER TECHNOLOGY, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share amounts)**

 
| ** **                                                                                                                                                                             | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                                                                                                                                                                   |       |             |       |   |   |
| **Assets**                                                                                                                                                                             |       |             |       |   |   |
| Current  assets:                                                                                                                                                                       |       |             |       |   |   |
| Cash and cash equivalents                                                                                                                                                              |       | $                | 2,127      |   | $ | 4,149 |   |
| Short-term investments in available-for-sale  securities                                                                                                                               |       | 15,150           |       | 11,675 |   |
| Accounts receivable, net                                                                                                                                                               |       | 11,403           |       | 10,044 |   |
| Inventories, net                                                                                                                                                                       |       | 12,893           |       | 14,647 |   |
| Prepaid expenses and other current assets                                                                                                                                              |       | 1,116            |       | 2,196 |   |
| Total current assets                                                                                                                                                                   |       | 42,689           |       | 42,711 |   |
| Property and  equipment, net                                                                                                                                                           |       | 10,544           |       | 11,357 |   |
| Long-term  investments in available-for-sale securities                                                                                                                                |       | —           |       | 1,000 |   |
| Other assets                                                                                                                                                                           |       | 58               |       | 110 |   |
| Intangible  assets, net                                                                                                                                                                |       | 6,806            |       | 7,734 |   |
| Goodwill                                                                                                                                                                               |       | 15,570           |       | 15,570 |   |
| Total assets                                                                                                                                                                           |       | $                | 75,667     |   | $ | 78,482 |   |
|                                                                                                                                                                                   |       |             |       |   |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                         |       |             |       |   |   |
| Current  liabilities:                                                                                                                                                                  |       |             |       |   |   |
| Accounts payable                                                                                                                                                                       |       | $                | 3,745      |   | $ | 4,143 |   |
| Accrued expenses                                                                                                                                                                       |       | 2,913            |       | 2,193 |   |
| Total current liabilities                                                                                                                                                              |       | 6,658            |       | 6,336 |   |
| Other long  term liabilities                                                                                                                                                           |       | 239              |       | 108 |   |
| Total liabilities                                                                                                                                                                      |       | 6,897            |       | 6,444 |   |
| Commitments  and contingencies                                                                                                                                                         |       |             |       |   |   |
| Stockholders’  equity:                                                                                                                                                            |       |             |       |   |   |
| Preferred stock, par value $.001, 1,000,000  shares authorized; no shares issued and outstanding                                                                                       |       | —           |       | — |   |
| Common stock, par value $.01, 19,000,000  shares authorized; 11,109,079 shares issued and 10,992,229 outstanding in  2005, 10,804,620 shares issued and 10,687,770 outstanding in 2004 |       | 111              |       | 108 |   |
| Additional paid-in capital                                                                                                                                                             |       | 90,462           |       | 89,138 |   |
| Treasury stock, at cost, 116,850 shares in  2005 and 2004                                                                                                                              |       | (1,761           | )          | (1,761 | ) |
| Deferred stock compensation                                                                                                                                                            |       | (26              | )          | — |   |
| Accumulated other comprehensive income                                                                                                                                                 |       | 638              |       | 545 |   |
| Accumulated deficit                                                                                                                                                                    |       | (20,654          | )          | (15,992 | ) |
| Total stockholders’ equity                                                                                                                                                        |       | 68,770           |       | 72,038 |   |
| Total liabilities and stockholders’ equity                                                                                                                                        |       | $                | 75,667     |   | $ | 78,482 |   |

 

See accompanying notes toconsolidated financial statements.

 

F-3

----

** **

**ADVANCEDPOWER TECHNOLOGY, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inthousands, except per share amounts)**

 
| ** **                                                                                 | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                       |       |                         |       |   |   |   |   |
| Revenue, net                                                                               |       | $                            | 64,976     |   | $ | 67,837 |   | $ | 48,892 |   |
| Cost of goods sold                                                                         |       | 43,339                       |       | 42,326 |   | 32,262 |   |
| Amortization of technology rights and other  charges                                       |       | 1,076                        |       | 1,086 |   | 1,118 |   |
| Total cost  of goods sold                                                                  |       | 44,415                       |       | 43,412 |   | 33,380 |   |
| Gross profit                                                                               |       | 20,561                       |       | 24,425 |   | 15,512 |   |
| Operating  expenses:                                                                       |       |                         |       |   |   |   |   |
| Research and development                                                                   |       | 4,943                        |       | 3,804 |   | 3,001 |   |
| Selling, general and administrative                                                        |       | 15,399                       |       | 16,855 |   | 14,763 |   |
| Restructuring charges                                                                      |       | 196                          |       | 558 |   | 645 |   |
| In-process research and development charges                                                |       | 4,868                        |       | 170 |   | — |   |
| Total  operating expenses                                                                  |       | 25,406                       |       | 21,387 |   | 18,409 |   |
| Income  (loss) from operations                                                             |       | (4,845                       | )          | 3,038 |   | (2,897 | ) |
| Other income  (expense), net:                                                              |       |                         |       |   |   |   |   |
| Interest income, net                                                                       |       | 320                          |       | 209 |   | 217 |   |
| Other (expense), net                                                                       |       | (107                         | )          | (109 | ) | (29 | ) |
| Total other  income                                                                        |       | 213                          |       | 100 |   | 188 |   |
| Income  (loss) before income taxes                                                         |       | (4,632                       | )          | 3,138 |   | (2,709 | ) |
| Income tax  expense                                                                        |       | 30                           |       | 82 |   | 621 |   |
| Net income  (loss)                                                                         |       | $                            | (4,662     | ) | $ | 3,056 |   | $ | (3,330 | ) |
|                                                                                       |       |                         |       |   |   |   |   |
| Net income  (loss) per share:                                                              |       |                         |       |   |   |   |   |
| Basic                                                                                      |       | $                            | (0.43      | ) | $ | 0.29 |   | $ | (0.32 | ) |
| Diluted                                                                                    |       | (0.43                        | )          | 0.27 |   | (0.32 | ) |
| Weighted average number of shares used in  the computation of net income (loss) per share: |       |                         |       |   |   |   |   |
| Basic                                                                                      |       | 10,774                       |       | 10,620 |   | 10,410 |   |
| Diluted                                                                                    |       | 10,774                       |       | 11,202 |   | 10,410 |   |

 

See accompanying notes toconsolidated financial statements.

 

F-4

----

 

**ADVANCEDPOWER TECHNOLOGY, INC.**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVEINCOME (LOSS)**

**(Inthousands, except share amounts)**

** **
| ** **                                     | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Deferred Stock   Compensation** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Comprehensive  Income (Loss)** | ** ** | **Accumulated  Deficit** | ** ** | **Total**  | ** ** |
|------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|----------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|------------|------------|
| **Shares**                                     | ** ** | **Amount**            | ** ** | **Shares**              | ** ** | **Amount**                       | ** ** |
| ** **                                     | ** ** | ** **            | ** ** | ** **              | ** ** | ** **                       | ** ** | ** **                                  | ** ** | ** **                                                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                           |       |                  |       |                    |       |                             |       |                                        |       |                                                      |       |                                  |       |                     |       |       |       |   |   |   |   |
| Balance, December 31, 2002                     |       | 10,503,219            |       | $                       | 105        |                             | (108,857   | )                                           | $          | (1,700                                                    | )          | $                                     | 88,490     |                     | $          | (171       | )          | $ | 166 |   |   |   | $ | (15,718 | ) | $ | 71,172 |   |
| Exercise of stock options                      |       | 33,496                |       | —                  |       | —                           |       | —                                      |       | 75                                                        |       | —                                |       | —                   |       |       |       | — |   | 75 |   |
| Exercise of stock warrants                     |       | 43,215                |       | 1                       |       | (7,993                           | )          | (61                                         | )          | 60                                                        |       | —                                |       | —                   |       |       |       | — |   | — |   |
| Amortization of deferred stock compensation    |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | 150                                   |       | —                   |       |       |       | — |   | 150 |   |
| Net loss                                       |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | —                                |       | —                   |       | $          | (3,330     | ) | (3,330 | ) | (3,330 | ) |
| Unrealized loss on investments                 |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | —                                |       | (3                       | )          | (3         | )          | — |   | (3 | ) |
| Foreign currency translation                   |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | —                                |       | 146                      |       | 146        |       | — |   | 146 |   |
| Comprehensive loss                             |       |                  |       |                    |       |                             |       |                                        |       |                                                      |       |                                  |       |                     |       | $          | (3,187     | ) |   |   |   |   |
| Balance, December 31, 2003                     |       | 10,579,930            |       | 106                     |       | (116,850                         | )          | (1,761                                      | )          | 88,625                                                    |       | (21                                   | )          | 309                      |       |       |       | (19,048 | ) | 68,210 |   |
| Exercise of stock options                      |       | 224,690               |       | 2                       |       | —                           |       | —                                      |       | 507                                                       |       | —                                |       | —                   |       |       |       | — |   | 509 |   |
| Stock compensation                             |       | —                |       | —                  |       | —                           |       | —                                      |       | 6                                                         |       | —                                |       | —                   |       |       |       | — |   | 6 |   |
| Amortization of deferred stock compensation    |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | 21                                    |       | —                   |       |       |       | — |   | 21 |   |
| Net income                                     |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | —                                |       | —                   |       | $          | 3,056      |   | 3,056 |   | 3,056 |   |
| Unrealized loss on investments                 |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | —                                |       | (3                       | )          | (3         | )          | — |   | (3 | ) |
| Foreign currency translation                   |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | —                                |       | 239                      |       | 239        |       | — |   | 239 |   |
| Comprehensive income                           |       |                  |       |                    |       |                             |       |                                        |       |                                                      |       |                                  |       |                     |       | $          | 3,292      |   |   |   |   |   |
| Balance, December 31, 2004                     |       | 10,804,620            |       | 108                     |       | (116,850                         | )          | (1,761                                      | )          | 89,138                                                    |       | —                                |       | 545                      |       |       |       | (15,992 | ) | 72,038 |   |
| Exercise of stock options                      |       | 304,459               |       | 3                       |       | —                           |       | —                                      |       | 746                                                       |       | —                                |       | —                   |       |       |       | — |   | 749 |   |
| Issuance of stock options for acquisition      |       | —                |       | —                  |       | —                           |       | —                                      |       | 570                                                       |       | —                                |       | —                   |       |       |       | — |   | 570 |   |
| Stock compensation                             |       | —                |       | —                  |       | —                           |       | —                                      |       | 8                                                         |       | —                                |       | —                   |       |       |       | — |   | 8 |   |
| Deferred stock compensation due to acquisition |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | (66                                   | )          | —                   |       |       |       | — |   | (66 | ) |
| Amortization of deferred compensation          |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | 40                                    |       | —                   |       | —     |       | 40 |   |   |   |
| Net loss                                       |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | —                                |       | —                   |       | $          | (4,662     | ) | (4,662 | ) | (4,662 | ) |
| Unrealized gain on investments                 |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | —                                |       | 3                        |       | 3          |       | — |   | 3 |   |
| Foreign currency translation                   |       | —                |       | —                  |       | —                           |       | —                                      |       | —                                                    |       | —                                |       | 90                       |       | 90         |       | — |   | 90 |   |
| Comprehensive loss                             |       |                  |       | —                  |       |                             |       |                                        |       |                                                      |       |                                  |       |                     |       | $          | (4,569     | ) | — |   |   |   |
| Balance, December 31, 2005                     |       | 11,109,079            |       | $                       | 111        |                             | (116,850   | )                                           | $          | (1,761                                                    | )          | $                                     | 90,462     |                     | $          | (26        | )          | $ | 638 |   |   |   | $ | (20,654 | ) | $ | 68,770 |   |

 

See accompanying notes toconsolidated financial statements.

 

F-5

----

 

**ADVANCEDPOWER TECHNOLOGY, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

** **
| ** **                                                                                | ** **   | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|--------------|------------------------------|------------|
| ** **                                                                                | ** **   | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows from operating activities:                                                     |         |                         |       |   |   |   |   |
| Net income (loss)                                                                         |         | $                            | (4,662     | ) | $ | 3,056 |   | $ | (3,330 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |         |                         |       |   |   |   |   |
| Depreciation                                                                              |         | 3,362                        |       | 3,193 |   | 3,079 |   |
| Amortization of intangibles                                                               |         | 1,262                        |       | 1,076 |   | 1,077 |   |
| Inventory provision                                                                       |         | 290                          |       | 807 |   | 454 |   |
| In-process research and development charges                                               |         | 4,868                        |       | 170 |   | — |   |
| Net loss on disposal of property and  equipment                                           |         | 88                           |       | 146 |   | 4 |   |
| Deferred taxes                                                                            |         | 33                           |       | — |   | 846 |   |
| Deferred gain on sale-leaseback                                                           |         | (17                          | )          | (17 | ) | (17 | ) |
| Building impairment charge                                                                |         | —                       |       | 80 |   | 350 |   |
| Amortization of deferred stock based compensation                                         |         | 48                           |       | 27 |   | 150 |   |
| Amortization of investment discount                                                       |         | 4                            |       | 6 |   | 14 |   |
| Changes in operating assets and  liabilities, net of effects of acquisitions:             |         |                         |       |   |   |   |   |
| Accounts receivable, net                                                                  |         | (1,318                       | )          | (2,430 | ) | (526 | ) |
| Inventories                                                                               |         | 1,310                        |       | (2,983 | ) | (726 | ) |
| Prepaid expenses and other assets                                                         |         | 205                          |       | 301 |   | 178 |   |
| Accounts payable and accrued expenses                                                     |         | 314                          |       | 262 |   | 708 |   |
| Net cash provided by operating activities                                                 |         | 5,787                        |       | 3,694 |   | 2,261 |   |
| Cash flows from investing activities:                                                     |         |                         |       |   |   |   |   |
| Purchases of available-for-sale securities                                                |         | (23,101                      | )          | (13,360 | ) | (17,350 | ) |
| Proceeds from available-for-sale securities                                               |         | 20,625                       |       | 13,575 |   | 18,833 |   |
| Acquisitions, net of cash acquired                                                        |         | (4,985                       | )          | (231 | ) | — |   |
| Purchase of property and equipment                                                        |         | (2,090                       | )          | (3,690 | ) | (4,828 | ) |
| Proceeds from sale of property and  equipment                                             |         | 924                          |       | — |   | — |   |
| Net cash used by investing activities                                                     |         | (8,627                       | )          | (3,706 | ) | (3,345 | ) |
| Cash flows from financing activities:                                                     |         |                         |       |   |   |   |   |
| Payments on capital lease obligations                                                     |         | (2                           | )          | (6 | ) | (63 | ) |
| Exercise of stock options                                                                 |         | 749                          |       | 509 |   | 75 |   |
| Net cash provided by financing activities                                                 |         | 747                          |       | 503 |   | 12 |   |
| Effects of exchange rate changes on cash                                                  |         | 71                           |       | (6 | ) | (22 | ) |
| Net change in cash and cash equivalents                                                   |         | (2,022                       | )          | 485 |   | (1,094 | ) |
| Cash and cash equivalents at beginning of  year                                           |         | 4,149                        |       | 3,664 |   | 4,758 |   |
| Cash and cash equivalents at end of year                                                  |         | $                            | 2,127      |   | $ | 4,149 |   | $ | 3,664 |   |
|                                                                                      |         |                         |       |   |   |   |   |
| Supplemental disclosure of cash flow  information:                                        |         |                         |       |   |   |   |   |
| Cash paid (received) during the year for:                                                 | Interest     |                         | $          | 16 |   | $ | 17 |   | $ | 32 |   |
|                                                                                      | Income taxes |                         | (45        | ) | 163 |   | (197 | ) |
| Supplemental disclosure of non-cash  activities:                                          |         |                         |       |   |   |   |   |
| Issuance of stock and options for  acquisitions                                           |         | 570                          |       | — |   | — |   |
| Unrealized gain (loss) on short-term and  long-term investments                           |         | 3                            |       | (3 | ) | (3 | ) |

 

See accompanying notes toconsolidated financial statements.

 

F-6

----

 

**ADVANCEDPOWER TECHNOLOGY, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Inthousands, except share and per share amounts)**

 

**(1) Summary of Significant AccountingPolicies**

 

***(a)Company Background***

 

We are a leading designer,manufacturer and marketer of high-performance RF and switching powersemiconductors. We are primarily focused on the high-power, high-speed segmentof the power semiconductor market. Power semiconductors function as poweramplifiers and power switches. They increase system efficiency and reliabilityby precisely managing and regulating electricity and converting it into theform required by electrical and electronic products. Our products permit thedesign of more compact end products and improve system features andfunctionality. Our products are found in diverse applications, such as F-22fighter cockpits, the Boeing 777 back-up power system, the International SpaceStation, air traffic control radar systems, semiconductor capital equipment,MRI systems, arc welding equipment, industrial lasers, solar power invertersand wireless communications base stations.

 

Power semiconductors generallydissipate more than one watt of power and have a broad range of frequency capabilities.We primarily focus on high-power, high-speed devices that dissipate at leastseveral hundred watts of power and require operating frequencies greater than20 kHz, or 20,000 cycles per second (e.g., the product may switch on and off upto 20,000 times per second).

 

We sell our products in NorthAmerica, Europe, and Asia primarily pursuant to customer purchase orders. Wesell through a network of independent sales representatives and distributors.We recognize revenue upon shipment of our products. We have operations in Bend,Oregon, Santa Clara, California, Montgomeryville, Pennsylvania, Boulder,Colorado, and Bordeaux, France. Each site has production, research anddevelopment and administrative activities. We also make use of subcontractmanufacturers for the fabrication of our wafers and for assembly and testoperations.

 

***(b)Principles of Consolidation***

 

The accompanying consolidated financialstatements include the accounts of APT and its wholly-owned subsidiaries,Advanced Power Technology Europe, SAS, Advanced Power Technology RF, Inc.,Advanced Power Technology RF Pennsylvania, Inc. and Advanced Power TechnologyColorado, Inc. All inter-company balances have been eliminated in theconsolidated financial statements.

 

***(c)Revenue Recognition, Sales Returns and Allowances***

 

APT complies with the revenue recognition guidance summarized in StaffAccounting Bulletin (SAB) No. 101, “Revenue Recognition in FinancialStatements,” as updated by SAB No. 104 “Revenue Recognition, corrected copy.”We recognize revenue when products are shipped and the customer takes ownershipand assumes risk of loss, collection of the relevant receivable is probable,persuasive evidence of an arrangement exists, and the sales price is fixed ordeterminable. In general, we provide for a one-year repair or replacementwarranty on our products. We use independent distributors to sell some of ourproducts. Our distributors have certain stock rotation rights which allow themto rotate, every six months, their products in inventory for a value up to 5%of their purchases over the preceding six month period in exchange for an orderof an equal amount of new product. In addition we may elect to give priceprotections or other allowances to our distributors. Price protections may be offeredfor distributor inventory on hand when we update our price list. Additionalprice allowances may be offered to our distributors in certain competitivebidding situations in which we may further discount the price. These priceallowances are evaluated as requested by the distributor on a case by casebasis. Upon shipment, we record an allowance for the estimated cost that may beincurred for product warranty, sales returns, price allowances and contractualrequirements with our distributors based on historical experience. The reservefor warranties and sales returns was $975, $716 and $431 as ofDecember 31, 2005, 2004 and 2003, respectively. The changes in the reservefor warranties and sales returns for the years ended December 31, 2005, 2004, and2003 are as follows:

 

F-7

----

 
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|------------------|------------|
| ** **                      | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                            |       |             |       |   |   |   |   |
| Balance—beginning  of year |       | $                | 716        |   | $ | 431 |   | $ | 351 |   |
| Provision                       |       | 3,029            |       | 1,626 |   | 1,055 |   |
| Charge offs                     |       | (2,770           | )          | (1,341 | ) | (975 | ) |
| Balance—end  of year       |       | $                | 975        |   | $ | 716 |   | $ | 431 |   |

 

***(d)Cash Equivalents and Investments***

 

APT classifies highly liquid investmentspurchased with an original maturity of three months or less as cashequivalents. Short-term investments consist of U.S. government debt securitiesand other highly liquid investments with original maturities in excess of threemonths, but less than one year, as well as other securities available to beused in the normal operating cycle. Long-term investments consist of highlyliquid debt securities with maturities greater than one year. Our investmentpolicy establishes a maximum maturity of less than two years for any securityin our portfolio. Investments are classified as available-for-sale inaccordance with Statement of Financial Accounting Standards (SFAS) 115, “Accountingfor Certain Investments in Debt and Equity Securities.” Investments are carriedat fair market value with unrealized gains and losses reported in stockholders’equity as a component of other comprehensive income. There were no grossunrealized gains and losses as of December 31, 2005. Total gross unrealizedgains and losses as of December 31, 2004 were zero and $3, respectively. Thefollowing is a summary of cash, cash equivalents and investments.

 
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|------------------|------------|
| ** **                       | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                             |       |             |       |   |   |
| Cash and  cash equivalents:      |       |             |       |   |   |
| Money market fund                |       | $                | 750        |   | $ | 2,988 |   |
| Cash                             |       | 1,377            |       | 1,161 |   |
| Total cash  and cash equivalents |       | $                | 2,127      |   | $ | 4,149 |   |
|                             |       |             |       |   |   |
| Short-term  investments:         |       |             |       |   |   |
| Municipal bonds and notes        |       | $                | 15,150     |   | $ | 10,875 |   |
| Commercial paper                 |       | —           |       | 800 |   |
| Total  short-term investments    |       | $                | 15,150     |   | $ | 11,675 |   |
|                             |       |             |       |   |   |
| Long-term  investments:          |       |             |       |   |   |
| Municipal bonds and notes        |       | —           |       | $ | 1,000 |   |
| Total  long-term investments     |       | —           |       | $ | 1,000 |   |

 

***(e)Trade Accounts Receivable and Allowance for Doubtful Accounts***

 

Trade accounts receivable are recorded at theinvoiced amount and do not bear interest. The allowance for doubtful accountsis APT’s best estimate of the amount of probable credit losses in the existingaccounts receivable. APT determines the allowance based on historical write-offexperience, evaluation of the customer credit condition and general economicdata. The allowance for doubtful accounts is reviewed monthly. Past duebalances over 60 days and other specified accounts as necessary are reviewedindividually. Account balances are charged off against the allowance after allmeans of collection have been exhausted and the potential for recovery isconsidered remote. APT does not have any off-balance sheet credit exposure withits customers. The following table presents a roll forward of the allowance fordoubtful accounts for the indicated periods:

 

F-8

----

 
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|------------------|------------|
| ** **                      | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                            |       |             |       |   |   |   |   |
| Balance—beginning  of year |       | $                | 192        |   | $ | 213 |   | $ | 70 |   |
| Provision  (reduction)          |       | 18               |       | 92 |   | 243 |   |
| Charge offs                     |       | —           |       | (113 | ) | (100 | ) |
| Balance—end  of year       |       | $                | 210        |   | $ | 192 |   | $ | 213 |   |

 

***(f) Inventories***

 

Inventories are stated at the lower ofstandard cost (approximates actual cost on a first-in, first-out basis) ormarket (net realizable value). Inventory is typically sold to customers with30-60 day payment terms. The cash flow from the sale of inventory and thechange in associated trade receivables is reported in operating cash flows onthe statement of cash flow.

 

***(g)Property, Equipment, and Long-Lived Assets***

 

Property and equipment are recorded at cost.Machinery and equipment under capital lease are stated at the lower of thepresent value of the minimum lease payments at the beginning of the lease termor the fair value of the leased assets at the inception of the lease.

 

Depreciation is provided using thestraight-line method over estimated useful lives, five to seven years formachinery, furniture and equipment. Leased assets and leasehold improvementsare amortized over the shorter of the estimated life of the asset or the termof the related lease, ranging from three to ten years. Depreciation begins onassets in process at the time the related assets are placed in service.Maintenance and repairs are expensed as incurred.

 

As required by SFAS 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” management reviews long-livedassets and intangible assets for impairment whenever events or changes incircumstances indicate the carrying amount of the assets may not berecoverable. Recoverability of these assets is determined by comparing theforecasted undiscounted net cash flows of the operation to which the assetsrelate, to the carrying amount including associated intangible assets of theoperation. If the operation is determined to be unable to recover the carryingamount of its assets, then intangible assets are written down first, followedby the other long-lived assets of the operation, to fair value. Fair value isdetermined based on discounted cash flows or appraised values, depending on thenature of the assets. Long-lived assets considered held for sale are valued atthe lower of historical cost or fair value less costs to sell. Such assets arenot depreciated while so classified.

 

***(h)Goodwill and Intangible Assets***

 

APT values goodwill and intangible assets in accordance with SFAS 142, “Goodwilland Other Intangible Assets.” The costs of internally developed intangibleassets are expensed as incurred. The costs of acquired intangible assets arerecorded at fair value at acquisition. Intangible assets with finite lives areamortized using the straight-line method over their estimated useful lives, themajority of which is estimated at ten years, and evaluated for impairment inaccordance with SFAS 144. Amortization of technology rights was $1,262, $1,076,and $1,077 for 2005, 2004, and 2003, respectively. Accumulated amortization oftechnology rights was $4,292 and $3,030 as of December 31, 2005 and 2004,respectively. Excluding the impact of any future acquisitions, amortization ofintangible assets will be approximately $1,150 in 2006 and 2007, and $1,076 in2008 through 2010.

 

Goodwill and intangible assets withindefinite lives are carried at fair value and reviewed at least annually forimpairment, or more frequently if events and circumstances indicate that theasset might be impaired, in accordance with SFAS 142. An impairment loss isrecognized to the extent that the carrying amount exceeds the asset’s fairvalue. This determination is made at the reporting unit level and consists oftwo steps. APT is currently considered one reporting unit. First, the Companydetermines the fair value of the reporting unit and compares it to its carryingamount. Second, if the carrying amount of a reporting unit exceeds its fairvalue, an impairment loss is recognized for any excess of the carrying amountof the reporting unit’s goodwill over the implied fair value of that goodwill.The implied fair value of goodwill is determined by allocating the fair valueof the reporting unit in a manner similar to a purchase price allocation, inaccordance with SFAS 141, “Business Combinations.” The residual fair valueafter this allocation is the implied fair value of the reporting unit goodwill.We have not recorded any impairment of goodwill in 2005, 2004, or 2003.

 

F-9

----

 

***(i)Income Taxes***

 

Income taxes are accounted for under theasset and liability method. Under the asset and liability method, deferred taxassets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases. Deferred taxassets and liabilities are measured using enacted tax rates expected to applyto taxable income in the years in which those temporary differences areexpected to be recovered or settled. The effect on deferred tax assets andliabilities of a change in tax rates is recognized in income in the period thatincludes the enactment date. A valuation allowance is established whennecessary to reduce deferred tax assets to the amount expected to be realized.During the fourth quarter of 2003, the Company determined that a full valuationallowance should be recorded against its net deferred tax assets. As ofDecember 31, 2005, the Company still maintains a full valuation allowanceagainst its deferred tax assets, net of certain deferred tax liabilities.

 

***(j)Research and Product Development Expenses***

 

APT expenses the cost of research anddevelopment as incurred. Research and development expenses principally consistof payroll and related costs, facilities and equipment costs, and the costs ofprototypes.

 

***(k)Stock-Based Compensation***

 

SFAS 123, “Accounting for Stock-BasedCompensation,” as amended by SFAS 148, “Accounting for Stock Based Compensation– Transition and Disclosure an amendment of FASB Statement No. 123,” defines afair value based method of accounting for employee stock options or similarinstruments. Under the fair value based method, compensation cost is measuredat the grant date based on the value of the award and is recognized over theservice period, which is usually the vesting period. However, SFAS 123also allows an entity to continue to measure compensation cost using theintrinsic value based method of accounting prescribed by APB OpinionNo. 25 (“Opinion 25”), “Accounting for Stock Issued to Employees.” Underthe intrinsic value based method, compensation cost is the excess, if any, ofthe quoted market price of the stock at grant date or other measurement dateover the amount an employee must pay to acquire the stock. Entities electing toremain with the accounting in Opinion 25 must make pro forma disclosures of netincome (loss) and, if presented, earnings per share, as if the fair value basedmethod had been applied.

 

APT has elected to continue to apply theprescribed accounting in Opinion 25 and provide the required disclosures perSFAS 123 and SFAS 148. APT accounts for equity instruments issued tonon-employees in accordance with the provisions of SFAS 123 and EmergingIssues Task Force consensus on Issue No. 96-18, “Accounting for EquityInstruments that are Issued to Other than Employees, for Acquiring or inConjunction with Selling Goods or Services.”

 

In December 2004, the FASB finalized SFAS No.123R “Share Based Payment,” which will be effective for annual reportingperiods beginning after December 15, 2005. The new standard will require us toexpense stock based compensation. Under SFAS No. 123R, we must evaluateand determine the appropriate fair value model to be used for valuingshare-based payments, the amortization method for compensation cost and thetransition method to be used at the date of adoption. We are currentlyevaluating the provisions of FAS 123R and expect that the adoption on January1, 2006 will have a material impact on the Company’s consolidated results ofoperations and earnings per share, as the stock based compensation expense willbe charged directly against our reported earnings. We do not expect theaccounting change to materially affect our liquidity as equity-basedcompensation is a non-cash expense.

 

On July 22, 2005, the Company announced thatit accelerated the vesting of certain unvested stock options awarded to itsemployees, officers and directors under its stock option plans. Theacceleration applies only to those options with an exercise price of $8.00 orgreater, which were out-of-the-money at the time of the modification. Theclosing sales price of APTI stock on the NASDAQ National Market on July 22,2005 was $7.97. As a result of this action, options to purchase approximately244,000 shares became exercisable on July 22, 2005. In accordance with APB 25,the modification of these grants did not result in any charge to income 2005.The Company believes that this action will result in lower compensation expenserecorded in our results from operations once the provisions of SFAS 123R gointo effect beginning January 1, 2006 for APT. The impact of this action was anadditional $385 of stock compensation expense in our pro forma disclosures for2005. The financial impact in 2006, 2007, 2008, and 2009 will be to reduce thecompensation expense recorded by $260, $84, $34, and $7, respectively.

 

APT applies Opinion 25 in accounting for itsPlan. Had APT determined compensation cost based on the fair value at the grantdate for its stock options under SFAS 123, APT’s net income (loss) wouldhave been the pro forma amounts indicated in the 

 

F-10

----

 

table below.

 
| ** **                                                                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                      |       |                         |       |   |   |   |   |
| Net income (loss):                                                                        |       |                         |       |   |   |   |   |
| As reported                                                                               |       | $                            | (4,662     | ) | $ | 3,056 |   | $ | (3,330 | ) |
| Add: Stock based compensation included in  reported net income (loss)                     |       | 48                           |       | 27 |   | 150 |   |
| Deduct: Stock based compensation determined  under fair value based method for all awards |       | (1,370                       | )          | (1,170 | ) | (1,822 | ) |
| Pro forma net income (loss)                                                               |       | $                            | (5,984     | ) | $ | 1,913 |   | $ | (5,002 | ) |
|                                                                                      |       |                         |       |   |   |   |   |
| Earnings (loss) per share:                                                                |       |                         |       |   |   |   |   |
| Basic – as reported                                                                  |       | $                            | (0.43      | ) | $ | 0.29 |   | $ | (0.32 | ) |
| Basic – pro forma                                                                    |       | $                            | (0.56      | ) | $ | 0.18 |   | $ | (0.48 | ) |
|                                                                                      |       |                         |       |   |   |   |   |
| Diluted – as reported                                                                |       | $                            | (0.43      | ) | $ | 0.27 |   | $ | (0.32 | ) |
| Diluted – pro forma                                                                  |       | $                            | (0.56      | ) | $ | 0.17 |   | $ | (0.48 | ) |
|                                                                                      |       |                         |       |   |   |   |   |

 

The effects of applying SFAS 123 in thispro forma disclosure are not indicative of future amounts and additional awardsanticipated in future years. The fair value of compensation costs reflected inthe above pro forma amounts were determined using the Black-Scholes optionpricing model and the following weighted average assumptions:

 
| ** **               | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------|------------|------------------------------|------------|
| ** **               | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                     |       |                         |       |   |   |   |   |
| Risk-free  interest rate |       | 4.0 — 4.4               | %          | 3.0 - 3.7 | % | 2.6 - 3.2 | % |
| Expected  dividend yield |       | 0                            | %          | 0 | % | 0 | % |
| Expected  life           |       | 6.4 - 6.7 years              |       | 5 years |   | 5 years |   |
| Volatility               |       | 68 - 82                      | %          | 100 | % | 100 | % |

 

***(l)Foreign Currency***

 

The local currency of APT’s foreignsubsidiary is the functional currency. Assets and liabilities of APT’s foreignoperation are translated into U.S. dollars using exchange rates in effect atthe translation date, and revenue and expenses are translated into U.S. dollarsusing average exchange rates. The effects of foreign currency translationadjustments are included as a component of stockholders’ equity (deficit).Gains and losses from foreign currency transactions are included in theconsolidated statements of operations in other income (expense).

 

***(m)Net Income (Loss) per Share***

 

Basic net income (loss) per share is computed using the weightedaverage number of shares of common stock outstanding for the period. Dilutednet income per share is computed using the weighted average number of shares ofcommon stock and dilutive potential common shares related to stock options andwarrants outstanding during the period. Anti-dilutive potential common sharesare excluded from the diluted net income share calculation. Dilutive net lossper share excludes all potential common shares from the calculation as theimpact would be anti-dilutive.

 

Incremental dilutive shares included in the calculation of diluted netincome (loss) per share and incremental anti-dilutive shares that were excludedfrom the calculation of diluted net income (loss) per share for years endedDecember 31, 2005, 2004 and 2003 are summarized below:

 

F-11

----

 
| ** **                                                                               | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                     |       |                         |       |   |   |   |   |
| Incremental dilutive shares included in  diluted net income (loss) per share calculation |       | —                       |       | 582,000 |   | — |   |
|                                                                                     |       |                         |       |   |   |   |   |
| Anti-dilutive shares excluded from diluted  net income (loss) per share calculation      |       | 1,198,000                    |       | 582,000 |   | 1,221,000 |   |

 

***(n)Risk of Technological Change***

 

The markets in which APT competes or seeks tocompete are subject to rapid technological change, frequent new product introductions,changing customer requirements for new products and features, and evolvingindustry standards. The introduction of new technologies and the emergence ofnew industry standards could render APT’s products less desirable or obsolete,which could harm its business.

 

***(o)Management Estimates***

 

The preparation of financial statements inconformity with U.S. generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenue andexpenses during the reporting period. Actual results could differ from thoseestimates. Significant estimates and judgments made by management include thoserelated to product returns and warranty obligations, allowance for doubtfulaccounts, excess and obsolete inventories, income taxes, valuation ofintangible assets including goodwill, valuation of long-lived assets, contingenciesand litigation, and excess component order cancellation costs.

 

***(p)Fair Value of Financial Instruments***

 

The carrying amount of cash and cashequivalents, short-term investments, accounts receivable and accounts payableapproximate fair value due to the short-term nature of these instruments. Thecarrying amount of long-term investments approximates fair value based onquoted market rates.

 

***(q)Concentration of Suppliers***

 

APT relies on external subcontractors for themanufacture of wafers and substantially all the assembly and packaging ofcertain products. The failure to perform by one of these suppliers could have amaterial impact on APT’s growth and results of operations.

 

***(r) Leases***

 

APT leases its facilities, except for the Montgomeryville, Pennsylvaniasite, and certain office equipment under non-cancelable operating leases, whichexpire over the next six years. We record operating lease expense for leaseswith escalating rents on a straight-line basis over the life of the lease. TheCompany amortizes leasehold improvements in an operating lease over the shorterof their economic lives or the lease term.

 

***(s) Contingencies and Legal Costs***

 

From time to time the Company is involved in variouslegal matters that arise out of the ordinary conduct of our business, includingthose related to litigation over intellectual property rights, commercialtransactions, contracts, product liability, environmental, safety and health,and employment matters. The Company is not currently involved in any legal proceedings.The Company accrues loss contingencies in connection with its litigation whenit is probable that a loss has 

 

F-12

----

 

occurred and the amount of theloss can be reasonably estimated. The Company records legal costs associatedwith litigation as incurred in the period in which the services are provided.

 

**(2) Balance Sheet Components**

 

***(a)Inventories***

 

Inventories consist of the following:

 
| ** **        | ** ** | **December 31,** | ** ** |
|-------------------|------------|------------------|------------|
| ** **        | ** ** | **2005**         | ** ** | **2004** | ** ** |
|              |       |             |       |   |   |
| Raw  materials    |       | $                | 2,918      |   | $ | 3,003 |   |
| Work in  process  |       | 6,840            |       | 7,061 |   |
| Finished  goods   |       | 3,135            |       | 4,583 |   |
| Inventories,  net |       | $                | 12,893     |   | $ | 14,647 |   |

 

***(b)Property and Equipment***

 

Property and equipment consist of thefollowing:

 
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|------------------|------------|
| ** **                                      | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                            |       |             |       |   |   |
| Property, machinery,  furniture and equipment   |       | $                | 28,005     |   | $ | 23,947 |   |
| Leasehold  improvements                         |       | 2,353            |       | 1,219 |   |
| Assets in  process                              |       | 632              |       | 3,185 |   |
|                                            |       | 30,990           |       | 28,351 |   |
| Less  accumulated depreciation and amortization |       | (20,446          | )          | (16,994 | ) |
| Property and  equipment, net                    |       | $                | 10,544     |   | $ | 11,357 |   |

 

***(c)Accrued Expenses***

 

Accrued expenses consist of the following:

 
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|------------------|------------|
| ** **                             | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                   |       |             |       |   |   |
| Payroll and  related liabilities       |       | $                | 486        |   | $ | 361 |   |
| Vacation  accrual                      |       | 754              |       | 693 |   |
| Income and  other taxes payable        |       | 74               |       | 144 |   |
| Restructuring  reserve                 |       | 130              |       | 60 |   |
| Reserve for  warranty and sales return |       | 975              |       | 716 |   |
| Other                                  |       | 494              |       | 219 |   |
|                                   |       | $                | 2,913      |   | $ | 2,193 |   |

 

F-13

----

 

**(3) Restructuring Charges**

 

Restructuring costs are accounted for inaccordance with SFAS 146, “Accounting for Costs Associated with Exit orDisposal Activities.” A liability for a cost associated with an exit ordisposal activity is recognized and measured at fair value in the period theliability is incurred, except for liabilities related to ongoing servicerequirements which are recognized over the service period. All otherrestructuring charges are directly expensed in the period they are paid.

 

***2003 Actions***

 

As part of management’s strategic plans, the Company announced in Novemberof 2003 restructuring actions intended to improve manufacturing efficienciesand lower administrative costs. The actions included consolidation of certainadministrative functions, rationalization of internal and external assembly andtest manufacturing, and the reduction of rent expense through the purchase andresale of one of the two buildings utilized by the Company’s Santa Clara,California subsidiary. These announced actions were in addition to previouslydisclosed plans to consolidate our wafer fabrication plant in Montgomeryville,Pennsylvania to Bend, Oregon. Total restructuring charges related to theseactions announced in 2003 (“2003 Actions”) were $45, $558 and $645 in 2005,2004 and 2003, respectively.

 

The total severance related charges inconnection with the 2003 Actions recognized in 2005, 2004 and 2003 were $45,$103 and $295, respectively. The severance charges related to already separatedpersonnel and personnel costs associated with benefits expected to be paid uponcompletion of certain eligible transfer activities.

 

The building purchase was reported as anasset held for sale and was sold in September of 2005. In accordance with SFAS144, an asset held for sale is carried at estimated net fair value less sellingcosts. As such, APT recorded an impairment charge for the building ofapproximately $80 and $350 in 2004 and 2003, respectively. Fair value wasestimated based on comparable sales data of similar commercial space in thearea. Net proceeds from the sale of the building were $924, resulting in nogain or loss on the transaction.

 

Additional restructuring costs of $375associated with costs to exit certain production activities were alsorecognized in 2004. The charges relate to accelerated depreciation on certainproduction related equipment to be abandoned after shutdown and contractualclosing costs.

 

The Company estimates that the annual savingsfrom the 2003 Actions are approximately $2.2 million with $1.4 million for costof goods sold and $800 for selling, general and administrative costs. The costsavings were realized gradually from the inception of the restructuring actions.The savings in cost of goods sold reached the estimated annual run rate of $350per quarter in the fourth quarter of 2004, and the savings in selling, generaland administrative costs reached the full annualized run rate of $200 perquarter in the third quarter of 2004.

 

***2005 Actions***

 

In July 2005, the Company announced that itwould continue consolidating manufacturing operations and move certain productionactivities offshore and that it would disengage from its hermetic packageproducts, a low growth product line currently with onshore production. Weestimate that these restructuring actions will be completed by the end of 2006and will lead to a reduction of approximately 9 percent of our total workforce. As a result of restructuring actions, $151of severance pay relatedcharges and $54 of charges for the write-off of inventory related to thediscontinued low growth product line was recognized 2005. The inventorywrite-off of $54 was included in cost of goods sold. Approximately $530 ofadditional restructuring charges is expected to be recognized as these actionsoccur. The charges will include severance costs of approximately $405 to besettled in cash, and the non-cash write-off or acceleration of depreciation ofcertain equipment of approximately $125. Once these restructuring actions arefully completed, we estimate the annual savings will be approximately $800.

 

See Note 12 of the consolidated financial statements for a 2006subsequent event regarding further restructuring actions.

 

The table below summarizes the actual restructuring charges, estimatedtotal charges, and total estimated savings for our each of our restructuringactions.

 

F-14

----

 
| ** **                                                       | ** ** | **Years ended December 31,** | ** ** | **Estimated total future** | ** ** | **Estimated Annual** | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|----------------------------|------------|----------------------|------------|
| **Restructuring Action**                                         | ** ** | **2005**                     | ** ** | **2004**                   | ** ** | **2003**             | ** ** | **costs** | ** ** | **Savings** | ** ** |
|                                                             |       |                         |       |                       |       |                 |       |   |   |   |   |
| 2003 Actions                                                     |       |                         |       |                       |       |                 |       |   |   | $ | 2,200 |   |
| Severance-related                                                |       | $                            | 45         |                       | $          | 103                  |       | $ | 295 |   | $ | — |   |   |   |
| Purchase & resale of building                                |       | —                       |       | 80                         |       | 350                  |       | — |   |   |   |
| Exit certain production activities                               |       | —                       |       | 375                        |       | —               |       | — |   |   |   |
| Total  Restructuring Charges for 2003 Actions                    |       | $                            | 45         |                       | $          | 558                  |       | $ | 645 |   | — |   |   |   |
|                                                             |       |                         |       |                       |       |                 |       |   |   |   |   |
| 2005 Actions                                                     |       |                         |       |                       |       |                 |       |   |   | $ | 800 |   |
| Severance-related                                                |       | $                            | 151        |                       | $          | —               |       | $ | — |   | $ | 405 |   |   |   |
| Non-cash write-off of inventory, included  in cost of goods sold |       | 54                           |       | —                     |       | —               |       | — |   |   |   |
| Exit certain production activities                               |       | —                       |       | —                     |       | —               |       | 125 |   |   |   |
| Total  Restructuring Charges for 2005 Actions                    |       | $                            | 205        |                       | $          | —               |       | $ | — |   | $ | 530 |   |   |   |
| Total  Restructuring Charges for All Actions                     |       | $                            | 250        |                       | $          | 558                  |       | $ | 645 |   | $ | 530 |   | $ | 3,000 |   |
|                                                             |       |                         |       |                       |       |                 |       |   |   |   |   |

 

The changes in the reserve for restructuringbalance for 2005, 2004 and 2003 are shown in the table below. Certain of therestructuring charges were expensed as incurred and therefore are not includedin the provision.

 
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|------------------|------------|
| ** **                      | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                            |       |             |       |   |   |   |   |
| Balance—beginning  of year |       | $                | 60         |   | $ | 178 |   | $ | — |   |
| Provision                       |       | 124              |       | 191 |   | 295 |   |
| Payments                        |       | (54              | )          | (309 | ) | (117 | ) |
| Balance—end  of year       |       | $                | 130        |   | $ | 60 |   | $ | 178 |   |
|                            |       |             |       |   |   |   |   |   |   |   |
| Provision                       |       | $                | 124        |   | $ | 191 |   | $ | 295 |   |
| Direct  expenses                |       | 72               |       | 23 |   | — |   |
| Non-cash  charges               |       | 54               |       | 344 |   | 350 |   |
| Total  restructuring charges    |       | $                | 250        |   | $ | 558 |   | $ | 645 |   |

 

**(4) Acquisitions**

 

***(a) Zeus Semiconductor, Inc.***

 

During the third quarter of 2004, APTacquired the assets, including prototype inventories, equipment, patents, andother intellectual property from a development stage business, ZeusSemiconductor, Inc. The acquisition price was $175, paid in cash. The purchaseprice was allocated to in-process research and development (IPR&D) of $170and fixed assets of $5. The value assigned to IPR&D related to researchprojects for which technological feasibility had not yet been established andfor which there was no other feasible alternative use for the technology. Thevalue of the IPR&D was determined based on the consideration paid as themost reliable measure. The acquisition was made to enhance APT’s productdevelopment capability.

 

***(b) PowerSicel, Inc.***

 

On December 22, 2004Advanced Power Technology, Inc. (APT) entered into a definitive agreement andplan of merger with PowerSicel, Inc. The acquisition was completed onJanuary 7, 2005 and the company was re-named as Advanced Power TechnologyColorado, Inc.

 

Under the terms of the agreement, APT paidapproximately $5.4 million in cash from operations in exchange for all of theexisting shares of PowerSicel, issued 63,525 APT stock options in exchange forthe PowerSicel stock options and issued 19,402 APT stock options for theretention of key employees. PowerSicel Inc. was determined to be a developmentstage 

 

F-15

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company, in accordance withEITF 98-3 “Determining Whether a Nonmonetary Transaction Involves Receipt ofProductive Assets or of a Business.” Therefore, the transaction was considereda purchase of tangible and intangible assets, which were accounted for inaccordance with SFAS 142 “Goodwill and Other Intangible Assets.”  APT obtained a third party valuation study toestimate the fair value of the acquired intangible assets. APT began toconsolidate the financial results of PowerSicel on January 7, 2005. Thepurchase price for accounting purposes was derived as follows:

 
| ** **            | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
|-----------------------|------------|------------|------------|----------------|------------|
| Cash paid at  closing |       |       |       |           | $          | 5,387 |   |
| Exchanged  options    |       | 63,525     |       | 458            |       |
| Retention  options    |       | 19,402     |       | 112            |       |
| Direct costs          |       |       |       | 113            |       |
| Total  purchase price |       |       |       | $              | 6,070      |   |
|                       |            |            |            |                |            |  |  |  |

 

All vested and unvestedPowerSicel options exchanged for APT options and retention options issued byAPT are included as part of the purchase price based on their fair value. Theestimated fair value of the options is based upon the Black-Scholes model usingthe following assumptions:

 
| ** **               | ** ** | **Exchanged   Options** | ** ** | **Retention   Options** | ** ** |
|--------------------------|------------|-------------------------|------------|-------------------------|------------|
| Expected  life           |       | 3.0 years               |       | 6.25 years              |       |
| Expected  volatility     |       | 69                      | %          | 82                      | %          |
| Risk-free  interest rate |       | 3.4                     | %          | 4.0                     | %          |
| Expected  dividend yield |       | 0.0                     | %          | 0.0                     | %          |

 

PowerSicel’s expertise in silicon carbide and othercompound semiconductor technology and products complement APT’s currentportfolio of RF products which operate at frequencies ranging from 1 MHz to 4GHz and are sold into applications such as semiconductor capital equipment,medical imaging, radar, avionics and wireless communications. The acquisitionadds valuable development capability to APT’s core capability in switching andRF power transistors allowing APT to better serve its current markets and toexpand into new markets.

 

Theallocation of purchase price was as follows:

 
| Working capital                                          |   | $     | 483    |   |
|----------------------------------------------------------|--------|-------|--------|--------|
| Property and  equipment                                  |   | 319   |   |
| Deferred  compensation on unvested stock options assumed |   | 66    |   |
| Acquired  in-process research and development            |   | 4,868 |   |
| Acquired  intangible assets                              |   | 334   |   |
| Allocated  purchase price                                |   | $     | 6,070  |   |
|                                                          |        |       |        |        |  |

 

In connection with this acquisition, APT originallyrecorded a charge of $4,896 for the write-off of in-process research anddevelopment (IPR&D), which was reduced in the second quarter of 2005 by $28upon finalization of the purchase price allocation. The value assigned toIPR&D related to research projects for which technological feasibility hadnot yet been established and for which there was no other feasible alternativeuse for the technology. In addition, APT recorded intangible assets of $223 and$111 for PowerSicel’s assembled workforce and for certain employment contractsof key PowerSicel executives, respectively. The assembled workforce intangibleasset will be amortized over three years and the employment contractsintangible asset will be amortized over one year, reflecting the expected lifeof the assets. The IPR&D and intangible asset amounts are not deductiblefor tax purposes.

 

The value of IPR&D was determined by estimatingthe net cash flows from the sale of products with silicon carbide technologyand discounting the net cash flows back to their present value using a riskadjusted interest rate of 30%. The estimated net cash flows were based onmanagement’s estimates of related revenue, costs of goods sold, operatingexpenses, income taxes, and additional costs to completion for the in-process technology.

 

The value of the assembled workforce was determined byestimating the cost to independently recruit, hire, and train the acquiredPowerSicel workforce. The value of the employment contracts was determined bycalculating the difference between 

 

F-16

----

 

estimated net cash flows withand without the employment contracts over a two year period. The net cash flowswere discounted back to their present value using a risk adjusted interest rateof 23%.

 

The nature of the efforts to develop the in-process technology intocommercially viable products principally relate to the completion of alldesigning, prototyping, verification and testing activities that are necessaryto establish that the product can be produced to meet its designspecifications, including function, features, and technical performancerequirements. PowerSicel had one main product group under development at theacquisition date that met the minimum development requirements for IPR&Dprojects. The project included the commercialization of silicon carbidetransistors. The project was approximately 80% complete at the time of theacquisition and was expected to be complete within nine to twelve months. Theestimated aggregate cost to complete the project was $260. As of December 31,2005, we estimate that the project is approximately 85% complete, withestimated remaining spending of $175.

 

**(5) Leases**

 

APT leases its facilities, except for theMontgomeryville, Pennsylvania site, and certain office equipment undernon-cancelable operating leases, which expire over the next six years. Rentalexpense was $1,167, $1,154, and $1,389, for the years ended December 31,2005, 2004, and 2003, respectively.

 

Future minimum lease payments undernon-cancelable operating leases (with initial or remaining lease terms inexcess of one year) are as follows as of December 31, 2005:

 
| **Years ended December 31:** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|------------|------------|------------|
| 2006                         |       | $          | 1,210      |       |
| 2007                         |       | 1,160      |       |
| 2008                         |       | 1,054      |       |
| 2009                         |       | 875        |       |
| 2010                         |       | 841        |       |
| Thereafter                   |       | 138        |       |
| Total                        |       | $          | 5,278      |       |
|                              |            |            |            |            |  |  |

 

During 1996, APT sold its fabricationfacility in Bend, Oregon for $1,550 and leased it back under a fifteen-yearoperating lease agreement. The transaction produced a gain of approximately$259 that is being deferred and amortized over the fifteen-year lease period.

 

**(6) Taxes**

 

Domestic and foreign pre-tax income (loss)consists of the following:

 
| ** ** | ** ** | **Years Ended December 31,** | ** ** |
|------------|------------|------------------------------|------------|
| ** ** | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|       |       |                         |       |   |   |   |   |
| Domestic   |       | $                            | (4,696     | ) | $ | 4,048 |   | $ | (2,026 | ) |
| Foreign    |       | 64                           |       | (910 | ) | (683 | ) |
|       |       | $                            | (4,632     | ) | $ | 3,138 |   | $ | (2,709 | ) |
|            |            |                              |            |  |  |  |  |  |  |  |  |

 

F-17

----

 

Income tax expense (benefit) consists of the following:

 
| ** ** | ** ** | **Years Ended December 31,** | ** ** |
|------------|------------|------------------------------|------------|
| ** ** | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|       |       |                         |       |   |   |   |   |
| Current:   |       |                         |       |   |   |   |   |
| Federal    |       | $                            | (7         | ) | $ | 68 |   | $ | (186 | ) |
| State      |       | 4                            |       | 14 |   | (39 | ) |
| Foreign    |       | —                       |       | — |   | — |   |
|       |       | (3                           | )          | 82 |   | (225 | ) |
| Deferred:  |       |                         |       |   |   |   |   |
| Federal    |       | 7                            |       | — |   | 700 |   |
| State      |       | 26                           |       | — |   | 146 |   |
|       |       | 33                           |       | — |   | 846 |   |
| Total      |       | $                            | 30         |   | $ | 82 |   | $ | 621 |   |

 

The actual income tax expense (benefit)differs from the expected tax expense (benefit) computed by applying the U.S.federal corporate income tax rate of 34% to income (loss) before income taxesas follows:

 
| ** **                                  | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                        |       |                         |       |   |   |   |   |
| Expected  income tax expense (benefit)      |       | (34                          | )%         | 34 | % | (34 | )% |
| Tax-exempt  municipal interest              |       | (2                           | )          | (2 | ) | (2 | ) |
| Change in  valuation allowance              |       | 2                            |       | (32 | ) | 70 |   |
| State income  taxes, net of federal benefit |       | —                       |       | 4 |   | (4 | ) |
| Non deductible IPR&D charges            |       | 36                           |       | — |   | — |   |
| Other                                       |       | (1                           | )          | (1 | ) | (7 | ) |
| Actual  income tax (benefit) expense        |       | 1                            | %          | 3 | % | 23 | % |

 

The income tax effect of temporarydifferences and carry forwards which give rise to significant portions ofdeferred tax assets and liabilities are as follows:

 
| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|------------------|------------|
| ** **                                | ** ** | **2005**         | ** ** | **2004** | ** ** |
| Deferred tax  assets:                     |       |             |       |   |   |
| Reserves and allowances                   |       | $                | 1,307      |   | $ | 1,149 |   |
| Accrued vacation pay                      |       | 198              |       | 177 |   |
| Net operating loss carry forwards         |       | 3,093            |       | 3,230 |   |
| R&E and other credit carry forwards   |       | 868              |       | 772 |   |
| Other                                     |       | 94               |       | 107 |   |
| Total gross  deferred tax assets          |       | 5,560            |       | 5,435 |   |
| Less  valuation allowance                 |       | (3,492           | )          | (3,020 | ) |
| Net deferred  tax asset                   |       | 2,068            |       | 2,415 |   |
| Depreciation and amortization differences |       | (2,215           | )          | (2,415 | ) |
| Net deferred  tax liability               |       | $                | (147       | ) | $ | — |   |
|                                           |            |                  |            |  |  |  |  |  |

 

The net changes in the valuation allowancefor the years ended December 31, 2005, 2004, and 2003, were increases of$472 and $182 and $1,998, respectively. As of December 31, 2005 and 2004, wehad a full valuation allowance recorded against our deferred tax assets, net ofcertain deferred tax liabilities. The portion of the valuation allowance for deferredtax assets for which subsequently recognized tax benefits will be applieddirectly to contributed capital is $1,242. This amount is attributable todifferences between financial and tax reporting of employee stock optiontransactions.

 

F-18

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As of December 31, 2005, APT has federal andstate net operating loss carry forwards of $3,551 and $4,774, respectively,which expire beginning in years 2020 through 2023. In addition, APT has federaland state research and experimentation credit carry forwards of $924 whichexpire beginning in years 2019 through 2024. APT also has foreign net operatingloss carry forwards for tax purposes available to offset future income of APTEurope of approximately (Euros) EUR3,828 ($4,533) based on the exchange rate asof December 31, 2005; all of which are available indefinitely.

 

**(7) Stockholders’ Equity**

 

***(a)Stock Option Plan***

 

The 1995 Stock Option Plan (the Plan)provides for the granting of stock options to employees, directors andconsultants to purchase up to 2,400,000 shares of common stock. Options grantedunder the Plan are generally granted with exercise prices equal to the stockmarket price on the date of grant, must generally be exercised while theindividual is an employee and within ten years of the date of grant. Optionsgranted typically vest at a rate of 20% per year for five years. The 1995 StockOption Plan expired on December 31, 2005. In 2005, Management proposed, and theboard of directors and shareholders approved, the adoption of the 2005 EquityIncentive Plan with a share reserve of 1,500,000 shares. The 2005 EquityIncentive Plan has essentially the same provisions as the 1995 Stock OptionPlan: options are generally granted with exercise prices equal to the stockmarket price on the date of grant, must generally be exercised while theindividual is an employee and within ten years of the date of grant, andtypically vest at a rate of 20% per year for five years. The plan also allowsfor the granting of a maximum of 500,000 shares of restricted stock out of the1,500,000 total authorized shares. As of December 31, 2005 no restricted shareshad been granted.

 

Under the Black-Scholes option pricing model,the weighted average fair value of options granted during the year endedDecember 31, 2005 and 2004 were $5.82 and $7.19, respectively. All optionsissued in 2004 and 2003 had exercise prices equal to the market price of thestock on the date of grant. The weighted average fair value of options grantedduring the year ended December 31, 2005 was $7.21 for options withexercise prices that were less than market price of the stock on date of grantand $5.15 for all other options which had exercise prices equal to stock marketprice at the time of grant. During 2005, 63,525 options were issued withexercise prices that were less than the stock market price on the date of grantin connection with the acquisition of PowerSicel, Inc and the correspondingexchange of outstanding PowerSicel, Inc. options (see Note 4(b)).

 

Stock option activity was as follows:

 
| ** **                                | ** ** | **Number  of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|--------------------------------------|------------|
|                                      |       |                  |       |                                 |       |
| Options  outstanding at December 31, 2002 |       | 1,576,172             |       | $                                    | 6.61       |   |
| Granted                                   |       | 54,750                |       | 6.79                                 |       |
| Exercised                                 |       | (33,496               | )          | 2.26                                 |       |
| Forfeited                                 |       | (10,984               | )          | 8.63                                 |       |
| Options  outstanding at December 31, 2003 |       | 1,586,442             |       | 6.69                                 |       |
| Granted                                   |       | 167,200               |       | 9.50                                 |       |
| Exercised                                 |       | (224,690              | )          | 2.26                                 |       |
| Forfeited                                 |       | (35,421               | )          | 8.61                                 |       |
| Options  outstanding at December 31, 2004 |       | 1,493,531             |       | 7.63                                 |       |
| Granted                                   |       | 201,327               |       | 5.53                                 |       |
| Exercised                                 |       | (304,459              | )          | 2.46                                 |       |
| Forfeited                                 |       | (17,488               | )          | 9.37                                 |       |
| Options  outstanding at December 31, 2005 |       | 1,372,911             |       | 8.44                                 |       |
|                                           |            |                       |            |                                      |            |  |

 

F-19

----

 

The following table summarizes informationabout stock options as of December 31, 2005:

 
| ** **                               | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                     | ** ** |
|------------------------------------------|------------|-------------------------|------------|-------------------------------------------------------------|------------|
| **Range of  Exercise Prices  Per Share** | ** ** | **Number of  Options**  | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** |
|                                     |       |                    |       |                                                        |       |   |   |   |   |   |   |
| $ 1.40-3.60                         |       | 268,448                 |       | 2.3                                                         |       | $ | 1.41 |   | 263,650 |   | $ | 1.41 |   |
| 3.61-10.80                               |       | 572,501                 |       | 7.4                                                         |       | 7.60 |   | 397,169 |   | 7.96 |   |
| 10.81 - 14.40                            |       | 425,912                 |       | 5.9                                                         |       | 11.82 |   | 420,412 |   | 11.81 |   |
| 14.41 - 36.00                            |       | 106,050                 |       | 5.0                                                         |       | 17.17 |   | 106,050 |   | 17.17 |   |
|                                     |       | 1,372,911               |       | 5.7                                                         |       | 8.44 |   | 1,187,281 |   | 8.69 |   |
|                                          |            |                         |            |                                                             |            |  |  |  |  |  |  |  |  |

 

As of the December 31, 2004 and 2003 therewere 1,053,440 and 1,021,753 stock options exercisable with a weighted averageexercise price per share of $7.02 and $5.55, respectively.

 

***(b)Warrants***

 

On January 25, 2002 in connection with thepurchase of GHz Technology, Inc., APT issued warrants to purchase 5,000 sharesof common stock at $1.16 in exchange for an existing outstanding warrant forGHz Technology, Inc. shares. The deemed fair value of the warrant issued wasimmaterial as determined by applying the Black-Scholes methodology, and wascapitalized as part of the acquisition costs. The warrant is exercisablethrough July 31, 2006. As of December 31, 2005, this is the only warrantoutstanding.

 

**(8) Retirement Benefit Plan**

 

APT has a defined contribution 401(k) plan(401k). Employees in the United States who are at least eighteen years old andhave six months of service are eligible to participate in the 401k.Participants may defer up to 15% of eligible compensation. The Company’s policyis to match 25% of the employees’ contributions up to 6% of eligiblecompensation if the Company meets certain performance criteria. During 2005, wecontributed $63 to the plan. The Company did not provide any matchingcontributions to the plan for 2004 and 2003.

 

**(9) Related Party Transactions**

 

The chief executive officer of AdvancedEnergy Industries, Inc (Advanced Energy), who is a substantial shareholder ofAdvanced Energy, serves as a director of APT. For the years endedDecember 31, 2005, 2004, and 2003, revenue from Advanced Energy wasapproximately $3,948, $6,560, and $4,530, respectively. Accounts receivablefrom Advanced Energy were $353 and $138 at December 31, 2005 and 2004,respectively.

 

**(10) Line of Credit**

 

On March 31, 2005, we obtained a $10 million revolvingline of credit with Silicon Valley Bank. We currently have no advancesoutstanding under this line of credit. The Company paid commitment fees of 20basis points upon closing and will pay 20 basis points per year on the unused portionof the line of credit, payable quarterly. Amounts borrowed under the creditagreement are secured by certain tangible and intangible assets of the Company.The credit agreement expires on June 30, 2006, at which time all amountsborrowed and related interest are immediately payable if the agreement is notrenewed.

 

**(11) Commitments and Contingencies**

 

From time to time the Company is involved in variouslegal matters that arise out of the ordinary conduct of our business, includingthose related to litigation over intellectual property rights, commercialtransactions, contracts, product liability, environmental, safety and health,and employment matters. The Company is not currently involved in any legalproceedings. The Company accrues loss contingencies in connection with itslitigation when it is probable that a loss has occurred and the amount of theloss can be reasonably estimated.

 

F-20

----

 

We have certain indemnificationobligations to customers with respect to the infringement of third partyintellectual rights by our products. No assurance can be provided that futureassertions of infringement or misappropriation will not occur, or that claimsfor indemnification by customers of our products will not be made, or thatassertions of infringement or misappropriation (especially if proven to betrue) will not harm our business.

 

On June 22, 2005, we entered into a waferproduction agreement with CSMC Manufacturing Co., Ltd. for the provision offoundry services to be performed by CSMC Technologies Fab 1 Co., Ltd. (CSMC), asubsidiary located in Wuxi, Jiangsu Province, China. CSMC will produce andsupply wafers to the Company according to the terms and conditions of thecontract. There are no financial commitments from the contract until productionbegins, which is expected in the second half of 2006.

 

APT has agreements with foundry partners inEurope, Taiwan, and China to process wafers. APT also has agreements withsubcontractors in the Philippines and Malaysia for assembly and testing of mostof its plastic encapsulated products. In addition, APT enters purchase orderobligations in the normal course of business for the purchase of raw materials,capital equipment, and other supplies. APT’s total commitments at December 31,2005 under these purchase obligations were approximately $14,522.

 

**(12) Subsequent Events**

 

***Merger with Microsemi Corporation***

 

On November 2, 2005, Advanced Power Technology, Inc.,a Delaware corporation (the “Company”), announced that it had entered into adefinitive agreement and plan of merger (the “Merger Agreement”) with MicrosemiCorporation, a Delaware corporation (“Microsemi”) and its newly formed,wholly-owned subsidiary, APT Acquisition Corp., a Delaware corporation (“MergerSubsidiary”).

 

Under the terms of the Merger Agreement,Microsemi will pay the equivalent of $12.20 for each share of the Company’soutstanding common stock, based on closing prices on November 2, 2005. Shareholdersof the Company will receive $2.00 in cash, plus 0.435 shares of Microsemicommon stock, for each share of the Company’s common stock. As of November 2,2005, the Company had 10,826,064 common shares outstanding and 11,176,003shares outstanding on a fully diluted basis. Pursuant to the Merger Agreement,the Company will merge into the Merger Subsidiary (the “Merger”), whereupon theseparate existence of the Company shall cease. The Merger is subject toregulatory approvals and the approval of the Company’s shareholders and otherclosing conditions. The merger is expected to close in the second quarter of2006.

 

***2006 Restructuring Actions***

 

On February 17, 2006 the Company finalizedits decision and announced to employees the planned closure of its facility inMontgomeryville, Pennsylvania. The business management functions and remainingmanufacturing activities currently located in Montgomeryville will betransferred to our facility in Santa Clara, California. This action is inaddition to the actions announced on July 21, 2005 in our second quarter 2005earnings release, which included the increased use of offshore manufacturingsubcontractors. We expect that this restructuring action will be completed overthe next twelve months and will lead to an additional reduction ofapproximately 8% of our total workforce. We estimate that this restructuringaction will result in pretax restructuring charges of approximately $440 overthe 12 month time frame. The charges will include one-time severance costs ofapproximately $320 to be settled in cash, and non-cash charges related to otherexit costs of $120. Once these restructuring actions are fully completed, weestimate the annual savings will be approximately $1.6 million.

 

***Northrop Grumman Systems License Agreement***

 

On February 22, 2006, Advanced Power Technology,Inc. (APT) entered into a license agreement with the Electronic Systems’ sectorof Northrop Grumman Systems Corporation (Northrop) in which Northrop willlicense their silicon carbide technology to APT, and APT will be the exclusivefoundry supplier of certain silicon carbide products to Northrop. In addition,the agreement allows APT to use the licensed technology to manufacture and sellother silicon carbide products for commercial purposes. Royalties will be dueto Northrop upon the sale of such products to customers other than Northrop. Thecontract is effective until the expiration of the last to expire of the patentsincluded in the agreement, unless the agreement is extended by the parties.

 

F-21

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**(13) Segment Information**

 

APT operates in one segment and is engaged in themanufacture and marketing of high-performance power semiconductors and modulesfor switching and RF applications.

 

***(a)Geographic Information***

 

APT’s geographic revenue, operating income(loss) and identifiable assets are summarized as follows:

 
| ** **                | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------|------------|-----------------------------------|------------|
| ** **                | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|                      |       |                              |       |   |   |   |   |
| Geographic  revenue:      |       |                              |       |   |   |   |   |
| United States             |       | $                                 | 40,594     |   | $ | 44,319 |   | $ | 31,768 |   |
| China                     |       | 8,334                             |       | 9,205 |   | 4,144 |   |
| Germany                   |       | 2,561                             |       | 3,959 |   | 2,517 |   |
| United Kingdom            |       | 1,927                             |       | 1,875 |   | 1,976 |   |
| Austria                   |       | 1,447                             |       | 1,564 |   | 1,967 |   |
| Other                     |       | 10,113                            |       | 6,915 |   | 6,520 |   |
|                      |       | $                                 | 64,976     |   | $ | 67,837 |   | $ | 48,892 |   |
|                      |       |                              |       |   |   |   |   |
| Operating  income (loss): |       |                              |       |   |   |   |   |
| United  States            |       | $                                 | (5,075     | ) | $ | 4,027 |   | $ | (2,282 | ) |
| France                    |       | 230                               |       | (989 | ) | (615 | ) |
|                      |       | $                                 | (4,845     | ) | $ | 3,038 |   | $ | (2,897 | ) |
|                           |            |                                   |            |  |  |  |  |  |  |  |  |  |

 
| ** **          | ** ** | **December 31,** | ** ** |
|---------------------|------------|------------------|------------|
| ** **          | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                |       |             |       |   |   |   |   |
| Long-lived  assets: |       |             |       |   |   |   |   |
| United  States      |       | $                | 9,843      |   | $ | 10,754 |   | $ | 10,314 |   |
| France              |       | 701              |       | 603 |   | 688 |   |
|                |       | $                | 10,544     |   | $ | 11,357 |   | $ | 11,002 |   |
|                     |            |                  |            |  |  |  |  |  |  |  |  |  |

 

***(b)Significant Customers***

 

For the year ended December 31,2005, our largest volume OEM customers were AEIS, Rockwell Collins, MKSInstruments, Copley Controls, and Emerson. In 2005, approximately 62.4% of ourrevenue was from customers in North America, 17.6% from customers in Europe,and 20.0% from customers in Asia and the rest of the world.

 

Revenue from our five largestOEM and distributor customers accounted for 37.7%, 46.6%, and 38.0% of ourtotal revenue in 2005, 2004, and 2003, respectively. Richardson Electronicsaccounted for 19.7% of our revenue in 2005, 21.9% of our revenue in 2004, and15.8% of our revenue in 2003. The 2004 increase for Richardson Electronics inthe overall percentage of our revenue is primarily due to utilizing Richardsonto import products to certain key Asian customers. No other customer exceeded10.0% of our revenue during these periods. We generally provide our customers a12-month repair or replacement warranty.

 

F-22

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** **

**(14) Quarterly Financial Data (Unaudited)**

 
| ** **                           | ** ** | **Year Ended December 31, 2005**          | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                           | ** ** | **1st Qtr**                               | ** ** | **2nd Qtr** | ** ** | **3rd Qtr** | ** ** | **4th Qtr** | ** ** |
|                                 |       |                                      |       |   |   |   |   |   |   |
| Revenue, net                         |       | $                                         | 14,132     |   | $ | 15,176 |   | $ | 16,843 |   | $ | 18,825 |   |
| Gross profit  (3)                    |       | 3,753                                     |       | 4,725 |   | 5,753 |   | 6,330 |   |
| Operating  income (loss) (3)         |       | (6,314                                    | )          | (241 | ) | 742 |   | 968 |   |
| Net income  (loss) (3)               |       | (6,340                                    | )          | (237 | ) | 828 |   | 1,087 |   |
| Basic net  income (loss) per share   |       | $                                         | (0.59      | ) | $ | (0.02 | ) | $ | 0.08 |   | $ | 0.10 |   |
| Diluted net  income (loss) per share |       | $                                         | (0.59      | ) | $ | (0.02 | ) | $ | 0.07 |   | $ | 0.10 |   |

 
| ** **                              | ** ** | **Year Ended December 31, 2004**          | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                              | ** ** | **1st Qtr**                               | ** ** | **2nd Qtr** | ** ** | **3rd Qtr** | ** ** | **4th Qtr** | ** ** |
|                                    |       |                                      |       |   |   |   |   |   |   |
| Revenue, net                            |       | $                                         | 15,093     |   | $ | 18,061 |   | $ | 18,660 |   | $ | 16,023 |   |
| Gross profit  (2)                       |       | 5,452                                     |       | 6,872 |   | 6,312 |   | 5,789 |   |
| Operating  income (2)                   |       | 249                                       |       | 844 |   | 1,344 |   | 601 |   |
| Net income  (2)                         |       | 283                                       |       | 869 |   | 1,228 |   | 676 |   |
| Basic and  diluted net income per share |       | $                                         | 0.03       |   | $ | 0.08 |   | $ | 0.11 |   | $ | 0.06 |   |

 
| ** **                            | ** ** | **Year Ended December 31, 2003**          | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                            | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                            | ** ** | **1st Qtr**                               | ** ** | **2nd Qtr** | ** ** | **3rd Qtr** | ** ** | **4th Qtr** | ** ** |
|                                  |       |                                      |       |   |   |   |   |   |   |
| Revenue, net                          |       | $                                         | 11,159     |   | $ | 12,487 |   | $ | 12,708 |   | $ | 12,538 |   |
| Gross profit  (1)                     |       | 3,123                                     |       | 4,430 |   | 4,067 |   | 3,892 |   |
| Operating  income (loss) (1)          |       | (1,641                                    | )          | 59 |   | (155 | ) | (1,160 | ) |
| Net loss (1)                          |       | (1,009                                    | )          | (119 | ) | (338 | ) | (1,864 | ) |
| Basic and  diluted net loss per share |       | $                                         | (0.10      | ) | $ | (0.01 | ) | $ | (0.03 | ) | $ | (0.18 | ) |

 

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(1)          As a result of the 2002 acquisition of GHzTechnology, Inc. and certain assets of Microsemi RF Products, Inc., during theyear ended 2003 we recorded acquisition related charges for amortization ofintangible assets and deferred compensation amortization of $1,168, of which$1,118 was included in costs of goods sold and $50 in operating expenses. Alsorecorded in 2003 was $645 of restructuring related charges included inoperating expenses. During 2003 we acquired the administrative building weleased in Santa Clara, California in order to avoid future lease payments whichwere above market. The building is reported as assets held for sale, andaccordingly we took a $350 impairment charge to adjust the carrying value tofair market value. Also included in restructuring charges is severance relatedto downsizing and organizational changes. During 2003 we recorded a tax expensefor a valuation allowance against our net deferred tax assets for $846. Thetotal amount for these items net of taxes was $2,659. The total charges byquarter were pre-tax $541, $294, $289, $689 and after tax $346, $191, $587,$1,535 in the first, second, third and fourth quarters, respectively. Werecorded a tax benefit of $480 in the first and second quarter of 2003 whichwas reversed in the third quarter of 2003. The remaining deferred tax asset wasfully reserved in the fourth quarter of 2003.

 

(2)          As result of the prior acquisitions made, werecorded in 2004 acquisition related charges for amortization of intangibleassets and deferred compensation amortization of $1,098, of which $1,086 wasincluded in costs of goods sold and $12 in operating expenses. In 2004, weacquired the assets, including prototype inventories, equipment, patents, andother intellectual property from a development stage business, ZeusSemiconductor, Inc. As a result of this transaction, during the third quarterof 2004 we recorded acquisition related charges for purchased IPR&D of$170. Also recorded in 2004 was $558 of restructuring related charges includedin operating expenses. These charges included severance related to downsizingand organizational changes we began in 2003. The charges also include an additionalimpairment charge on the administrative building we purchased in 2003 asexplained in note (2) above, as well as costs to exit certain productionactivities. The latter charges relate to accelerated depreciation on certainproduction related equipment to be abandoned after shutdown and contractualclosing costs. During the third and fourth quarters of 2004 we also incurred$225 of 

 

F-23

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charges in connection with the filing and subsequent withdrawal of a registrationstatement. The total amount of these items net of taxes was $2,028. The totalcharges by quarter were pre-tax $486, $395, $658, $512 and after tax $486,$395, $645, $502, in the first, second, third, and fourth quarters,respectively.

 

(3)          In 2005, we recordedacquisition related charges for amortization of intangible assets and deferredcompensation amortization of $1,302, of which $1,076 was included in cost ofgoods sold and $226 in operating expenses. In connection with our January 2005acquisition of PowerSicel, Inc., we recorded in-process research anddevelopment charges of $4,868. Also recorded in 2005 was $250 of restructuringrelated charges, of which $196 was included in operating expenses and $54 wasincluded in cost of goods sold. Of the total restructuring related charges, $45was associated with additional severance related to downsizing andorganizational changes we began in 2003, and $205 was related to plansannounced in July 2005 to continue consolidating manufacturing operations, movecertain production activities offshore and disengage from a small low growthproduct line currently with onshore production. In connection with our mergeragreement with Microsemi Corporation (see Note 12), we recorded $296 inmerger-related expenses. The total charges for these items net of tax were$6,709. The total charges by quarter were pre-tax $5,266, $422, $326, $702 andafter tax $5,259, $422, $326, $702, in the first, second, third, and fourthquarters of 2005, respectively.

 

F-24

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