**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-Q**

 

**(MARKONE)**
| **ý**                                                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                          |       | ** **                                                                                              |
| **FOR THE  QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005**                                                                                                                                                                                                                                                                                                                                                                   |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                    |
| **OR**                                                                                                                                                                                                                                                                                                                                                                                                                        |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                    |
| **o**                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                                                                                                                                          |       |                                                                                                    |
| **FOR THE  TRANSITION PERIOD FROM                                  TO                                ** |
|                                                                                                                                                                                                                                                                                                                                                                                                                          |
| **COMMISSION  FILE NUMBER: 1-7935**                                                                                                                                                                                                                                                                                                                                                                                           |
|                                                                                                                                                                                                                                                                                                                                                                                                                               |            |                                                                                                         |  |  |

 

**International Rectifier Corporation**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 
| **DELAWARE**                                                                       |   | **95-1528961**                        |
|------------------------------------------------------------------------------------|--------|---------------------------------------|
| (STATE OR OTHER JURISDICTION OF  INCORPORATION OR ORGANIZATION)                    |   | (IRS EMPLOYER IDENTIFICATION  NUMBER) |
|                                                                               |   |                                  |
| **233 KANSAS STREET  EL SEGUNDO, CALIFORNIA**                                      |   | **90245**                             |
| (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                                           |   | (ZIP CODE)                            |
|                                                                               |   |                                  |
| REGISTRANT’S  TELEPHONE NUMBER, INCLUDING AREA CODE:  **(310) 726-8000** |

 

INDICATE BY CHECK MARKWHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILESUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FORTHE PAST 90 DAYS.    YES ý  NO  o

 

INDICATE BY CHECK MARKWHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12B-2 OF THEEXCHANGE ACT).     YES ý  NO  o

 

INDICATE BY CHECK MARKWHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN RULE 12B-2 OF THEEXCHANGE ACT).     YES o  NO  ý

 

THERE WERE 70,794,310SHARES OF THE REGISTRANT’S COMMON STOCK, PAR VALUE $1.00 PER SHARE, OUTSTANDINGON NOVEMBER 8, 2005.

 

 

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**Table of Contents**

 
| ** **        |                                                                                                                    | **Page  Reference** |
|-------------------|-------------------------------------------------------------------------------------------------------------------------|---------------------|
| **PART I.**  | **FINANCIAL  INFORMATION**                                                                                              |                |
|              |                                                                                                                    |                |
| **ITEM  1.**      | **Financial  Statements**                                                                                               |                |
|              |                                                                                                                    |                |
|              | Unaudited Consolidated  Statements of Income for the Three Months Ended September 30, 2005  and 2004               | 3                   |
|              |                                                                                                                    |                |
|              | Unaudited Consolidated  Statements of Comprehensive Income for the Three Months Ended  September 30, 2005 and 2004 | 4                   |
|              |                                                                                                                    |                |
|              | Unaudited  Consolidated Balance Sheets as of September 30, 2005 and June 30,  2005                            | 5                   |
|              |                                                                                                                    |                |
|              | Unaudited Consolidated  Statements of Cash Flows for the Three Months Ended September 30, 2005  and 2004           | 6                   |
|              |                                                                                                                    |                |
|              | Notes  to Unaudited Consolidated Financial Statements                                                                   | 7                   |
|              |                                                                                                                    |                |
| **ITEM  2.**      | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**                         | 30                  |
|              |                                                                                                                    |                |
| **ITEM 3.**       | **Quantitative  and Qualitative Disclosures about Market Risk**                                                         | 56                  |
|              |                                                                                                                    |                |
| **ITEM 4.**       | **Controls and  Procedures**                                                                                            | 59                  |
|              |                                                                                                                    |                |
| **PART II.** | **OTHER INFORMATION**                                                                                                   |                |
|              |                                                                                                                    | 60                  |
| **ITEM 2.**       | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                                        |                |
|              |                                                                                                                    |                |
| **ITEM  6.**      | **Exhibits**                                                                                                            | 61                  |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1.  Financial Statements.**

 

**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITED CONSOLIDATED STATEMENTSOF INCOME**

**(In thousands except per share amounts)**

 
| ** **                                                                            | ** ** | **Three Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
|                                                                                  |       |                                       |       |   |   |
| Revenues                                                                              |       | $                                          | 272,573    |   | $ | 312,225 |   |
| Cost of sales                                                                         |       | 161,680                                    |       | 178,788 |   |
| Gross profit                                                                          |       | 110,893                                    |       | 133,437 |   |
|                                                                                  |       |                                       |       |   |   |
| Selling and administrative expense                                                    |       | 45,166                                     |       | 46,415 |   |
| Research and development expense                                                      |       | 25,212                                     |       | 25,366 |   |
| Amortization of acquisition-related intangibles                                       |       | 1,453                                      |       | 1,439 |   |
| Impairment of assets, restructuring and severance  charges                            |       | 4,293                                      |       | 6,691 |   |
| Other expense (income), net                                                           |       | 124                                        |       | (36 | ) |
| Interest (income) expense, net                                                        |       | (1,552                                     | )          | 1,717 |   |
| Income before income taxes                                                            |       | 36,197                                     |       | 51,845 |   |
|                                                                                  |       |                                       |       |   |   |
| Provision for income taxes                                                            |       | 9,954                                      |       | 14,265 |   |
| Net income                                                                            |       | $                                          | 26,243     |   | $ | 37,580 |   |
|                                                                                  |       |                                       |       |   |   |
| Net income per common share – basic                                              |       | $                                          | 0.37       |   | $ | 0.56 |   |
|                                                                                  |       |                                       |       |   |   |
| Net income per common share – diluted                                            |       | $                                          | 0.36       |   | $ | 0.53 |   |
|                                                                                  |       |                                       |       |   |   |
| Average common shares outstanding – basic                                        |       | 70,329                                     |       | 66,516 |   |
|                                                                                  |       |                                       |       |   |   |
| Average common shares and potentially dilutive  securities outstanding – diluted |       | 72,277                                     |       | 75,711 |   |

 

The accompanying notes are an integral part of these statements.

 

3

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITED CONSOLIDATED STATEMENTSOF**

**COMPREHENSIVE INCOME**

**(In thousands)**

 
| ** **                                                                                                                        | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                        | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
|                                                                                                                              |       |                                       |       |   |   |
| Net income                                                                                                                        |       | $                                          | 26,243     |   | $ | 37,580 |   |
|                                                                                                                              |       |                                       |       |   |   |
| Other  comprehensive (loss) income:                                                                                               |       |                                       |       |   |   |
| Foreign currency  translation adjustments                                                                                         |       | (5,136                                     | )          | 139 |   |
|                                                                                                                              |       |                                       |       |   |   |
| Unrealized  (losses) gains on securities:                                                                                         |       |                                       |       |   |   |
| Unrealized  holding losses on available-for-sale securities, net of tax effect of $1,686  and $5,521, respectively                |       | (2,872                                     | )          | (9,401 | ) |
| Unrealized  holding gains on foreign currency forward contract, net of tax effect of  ($154) and ($477), respectively             |       | 263                                        |       | 811 |   |
| Less:  Reclassification adjustments of net (gains) losses on available-for-sale  securities and foreign currency forward contract |       | (23                                        | )          | 216 |   |
|                                                                                                                              |       |                                       |       |   |   |
| Other  comprehensive loss                                                                                                         |       | (7,768                                     | )          | (8,235 | ) |
|                                                                                                                              |       |                                       |       |   |   |
| Comprehensive  income                                                                                                             |       | $                                          | 18,475     |   | $ | 29,345 |   |

 

The accompanying notesare an integral part of these statements.

4

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(In thousands)**

 
| ** **                                                       | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                       | ** ** | **2005**               | ** ** | **2005**          | ** ** |
| ** **                                                       | ** ** | **(Unaudited)**        | ** ** | ** **        | ** ** |
| **ASSETS**                                                       |       |                   |       |              |       |
| Current assets:                                                  |       |                   |       |              |       |
| Cash and cash  equivalents                                       |       | $                      | 359,138    |              | $          | 359,978 |   |
| Short-term cash  investments                                     |       | 224,499                |       | 278,157           |       |
| Trade accounts  receivable, less allowance for doubtful accounts |       | 159,685                |       | 158,510           |       |
| Inventories, net                                                 |       | 193,781                |       | 177,560           |       |
| Deferred income  taxes                                           |       | 33,982                 |       | 34,784            |       |
| Prepaid expenses  and other receivables                          |       | 64,952                 |       | 53,387            |       |
|                                                             |       |                   |       |              |       |
| Total current  assets                                            |       | 1,036,037              |       | 1,062,376         |       |
| Long-term cash investments                                       |       | 348,311                |       | 302,585           |       |
| Property, plant and equipment, net                               |       | 502,517                |       | 488,204           |       |
| Goodwill                                                         |       | 152,329                |       | 152,457           |       |
| Acquisition-related intangible assets, net                       |       | 33,862                 |       | 35,354            |       |
| Long-term deferred income taxes                                  |       | 74,038                 |       | 76,158            |       |
| Other assets                                                     |       | 103,756                |       | 106,410           |       |
| Total assets                                                     |       | $                      | 2,250,850  |              | $          | 2,223,544 |   |
|                                                             |       |                   |       |              |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                   |       |                   |       |              |       |
| Current liabilities:                                             |       |                   |       |              |       |
| Bank loans                                                       |       | $                      | 20,437     |              | $          | 18,168 |   |
| Long-term debt,  due within one year                             |       | 47                     |       | 163               |       |
| Accounts payable                                                 |       | 78,157                 |       | 81,893            |       |
| Accrued  salaries, wages and commissions                         |       | 29,353                 |       | 33,344            |       |
| Other accrued  expenses                                          |       | 82,415                 |       | 91,328            |       |
| Total current  liabilities                                       |       | 210,409                |       | 224,896           |       |
| Long-term debt, less current maturities                          |       | 542,322                |       | 547,259           |       |
| Other long-term liabilities                                      |       | 25,188                 |       | 26,186            |       |
|                                                             |       |                   |       |              |       |
| Stockholders’ equity:                                       |       |                   |       |              |       |
| Common stock                                                     |       | 70,736                 |       | 69,826            |       |
| Capital  contributed in excess of par value of shares            |       | 882,388                |       | 854,045           |       |
| Retained  earnings                                               |       | 461,388                |       | 435,145           |       |
| Accumulated  other comprehensive income                          |       | 58,419                 |       | 66,187            |       |
| Total  stockholders’ equity                                 |       | 1,472,931              |       | 1,425,203         |       |
| Total  liabilities and stockholders’ equity                 |       | $                      | 2,250,850  |              | $          | 2,223,544 |   |

 

The accompanying notes are an integral part of these statements.

5

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Three Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
|                                                                               |       |                                       |       |   |   |
| Cash flow from operating activities:                                               |       |                                       |       |   |   |
| Net income                                                                         |       | $                                          | 26,243     |   | $ | 37,580 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                       |       |   |   |
| Depreciation and  amortization                                                     |       | 20,043                                     |       | 16,922 |   |
| Amortization of  acquisition-related intangible assets                             |       | 1,453                                      |       | 1,439 |   |
| Stock  compensation expense                                                        |       | 491                                        |       | — |   |
| Unrealized  (gains) losses on swap transactions                                    |       | (1,175                                     | )          | 773 |   |
| Deferred income  taxes                                                             |       | 4,270                                      |       | (4,681 | ) |
| Tax benefit from  options exercised                                                |       | 6,980                                      |       | 1,063 |   |
| Change in  operating assets and liabilities, net                                   |       | (44,477                                    | )          | (30,019 | ) |
| Net cash provided by operating activities                                          |       | 13,828                                     |       | 23,077 |   |
|                                                                               |       |                                       |       |   |   |
| Cash flow from investing activities:                                               |       |                                       |       |   |   |
| Additions to  property, plant and equipment                                        |       | (37,009                                    | )          | (28,514 | ) |
| Proceeds from  sale of property, plant and equipment                               |       | 2                                          |       | 32 |   |
| Acquisition of  business                                                           |       | —                                     |       | (41,468 | ) |
| Sale or  maturities of cash investments                                            |       | 110,987                                    |       | 101,103 |   |
| Purchase of cash  investments                                                      |       | (105,277                                   | )          | (78,437 | ) |
| Change in other  investing activities, net                                         |       | (3,785                                     | )          | (1,990 | ) |
| Net cash used in investing activities                                              |       | (35,082                                    | )          | (49,274 | ) |
|                                                                               |       |                                       |       |   |   |
| Cash flow from financing activities:                                               |       |                                       |       |   |   |
| Proceeds from  short-term debt, net                                                |       | 2,457                                      |       | 2,924 |   |
| Repayments of  capital lease obligations, net                                      |       | (59                                        | )          | (57 | ) |
| Proceeds from  exercise of stock options and stock purchase plan                   |       | 21,782                                     |       | 5,084 |   |
| Other, net                                                                         |       | (4,492                                     | )          | 588 |   |
| Net cash provided by financing activities                                          |       | 19,688                                     |       | 8,539 |   |
|                                                                               |       |                                       |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                      |       | 726                                        |       | 48 |   |
| Net decrease in cash and cash equivalents                                          |       | (840                                       | )          | (17,610 | ) |
| Cash and cash equivalents, beginning of period                                     |       | 359,978                                    |       | 339,024 |   |
|                                                                               |       |                                       |       |   |   |
| Cash and cash equivalents, end of period                                           |       | $                                          | 359,138    |   | $ | 321,414 |   |

 

The accompanying notes are an integral part of these statements.

 

6

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATEDFINANCIAL STATEMENTS**

**September 30, 2005**

 

1.                           Basisof Consolidation

 

Theconsolidated financial statements include the accounts of InternationalRectifier Corporation and its subsidiaries (“the Company”), which are locatedin North America, Europe and Asia. Intercompany transactions have been eliminated in consolidation.

 

Theconsolidated financial statements included herein are unaudited; however, theycontain all normal recurring adjustments which, in the opinion of the Company’smanagement, are necessary to state fairly the consolidated financial positionof the Company at September 30, 2005, and the consolidated results ofoperations and the consolidated cash flows for the three months ended September 30,2005 and 2004.  The results of operationsfor the three months ended September 30, 2005 are not necessarilyindicative of the results to be expected for the full year.

 

Theaccompanying unaudited consolidated financial statements should be read inconjunction with the Annual Report on Form 10-K for the fiscal year ended June 30,2005.

 

TheCompany operates on a 52-53 week fiscal year under which the three months endedSeptember 2005 and 2004 consisted of 13 weeks ending October 2, 2005 andOctober 3, 2004, respectively.  Forease of presenting the accompanying consolidated financial statements, thefiscal quarter-end for all periods presented is shown as September 30 or June 30.  Fiscal 2006 will consist of 52 weeks ending July 2,2006.

 

Certain reclassifications have been made to the September 30,2004 (i) cash flow from investing activities, (ii) net decrease incash and cash equivalents, and (iii) ending cash and cash equivalents, asa result of reclassification of auction rate securities (“ARS”) from cash andcash equivalents to short-term investments. Previously, the Company’s investments in ARS were recorded in cash andcash equivalents rather than short-term cash investments.  The Company reclassified ARS from cash and cashequivalents to short-term investments because the underlying instruments havematurity dates exceeding ninety days. As a result of the reclassifications, theCompany’s consolidated cash flows were affected as follows:

 

•                  net cash used for the purchase of cashinvestments decreased by $51.0 million for the three months ended September 30,2004; and

 

•                  net change in cash and cash equivalents increasedby $51.0 million for the three months ended September 30, 2004.

 

The reclassifications had no impact on the Company’stotal current assets, stockholders’ equity, cash flows provided by operatingactivities or total

 

7

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consolidated results reported in any periodpresented.  At September 30, 2005and June 30, 2005, the Company had no investments in these securities.

 

2.                           NetIncome Per Common Share

 

Netincome per common share - basic is computed by dividing net income available tocommon stockholders (the numerator) by the weighted average number of commonshares outstanding (the denominator) during the period. The computation of netincome per common share - diluted is similar to the computation of net incomeper common share - basic except that the denominator is increased to includethe number of additional common shares that would have been outstanding for theexercise of stock options using the treasury stock method and the conversion ofthe Company’s convertible subordinated notes using the if-convertedmethod.  The Company’s use of thetreasury stock method reduces the gross number of dilutive shares by the numberof shares purchasable from the proceeds of the options assumed to beexercised.  The Company’s use of theif-converted method increases reported net income by the interest expenserelated to the convertible subordinated notes when computing net income percommon share – diluted.

 

Thefollowing table provides a reconciliation of the numerator and denominator ofthe basic and diluted per-share computations for the three months ended September 30,2005 and 2004 (in thousands except per share amounts):

 
| ** **                                  | ** ** | **Net Income**  | ** ** | **Shares**        | ** ** | **Per Share  Amount** | ** ** |
|---------------------------------------------|------------|-----------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** | ** **            | ** ** |
| Three months ended September 30, 2005: |       |            |       |              |       |                  |       |
|                                        |       |            |       |              |       |                  |       |
| Net income per common share – basic    |       | $               | 26,243     |              | 70,329     |                  | $          | 0.37 |   |
| Effect of dilutive securities:              |       |            |       |              |       |                  |       |
| Stock options                               |       | —          |       | 1,948             |       | (0.01                 | )          |
|                                        |       |            |       |              |       |                  |       |
| Net income per common share – diluted  |       | $               | 26,243     |              | 72,227     |                  | $          | 0.36 |   |
|                                        |       |            |       |              |       |                  |       |
| Three months ended September 30, 2004: | ** ** | ** **      | ** ** | ** **        | ** ** | ** **            | ** ** |
|                                        | ** ** | ** **      | ** ** | ** **        | ** ** | ** **            | ** ** |
| Net income per common share – basic    |       | $               | 37,580     |              | 66,516     |                  | $          | 0.56 |   |
| Effect of dilutive securities:              |       |            |       |              |       |                  |       |
|                                        |       |            |       |              |       |                  |       |
| Stock options                               |       | —          |       | 1,756             |       | (0.01                 | )          |
| Conversion of  subordinated notes           |       | 2,386           |       | 7,439             |       | (0.02                 | )          |
|                                        |       |            |       |              |       |                  |       |
| Net income per common share – diluted  |       | $               | 39,966     |              | 75,711     |                  | $          | 0.53 |   |

 

Theconversion effect of the Company’s outstanding convertible subordinated notesinto 7,439,000 shares of common stock was not included in the computation ofdiluted income per share for the three months ended September 30, 2005, sincesuch effect would be anti-dilutive.

 

8

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3.                           Cashand Investments

 

The Company classifiesall highly liquid investments purchased with original or remaining maturitiesof ninety days or less at the date of purchase as cash equivalents.  The cost of these investments approximatesfair value.

 

The Company investsexcess cash in marketable securities consisting primarily of commercial paper,corporate notes, corporate bonds and U.S. government securities.  At September 30, 2005 and June 30, 2005,all of the Company’s marketable securities are classified asavailable-for-sale.  In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 115, “Accountingfor Certain Investments in Debt and Equity Securities”, unrealized gains andlosses on these investments are included in accumulated other comprehensiveincome, a separate component of stockholders’ equity, net of any related taxeffect.  Realized gains and losses anddeclines in value considered to be other than temporary are included ininterest income and expense.  At September 30,2005 and June 30, 2005, no investment was in a material loss position forgreater than one year.

 

Cash, cash equivalentsand cash investments as of September 30, 2005 and June 30, 2005 aresummarized as follows (in thousands):

 
| ** **                                         | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                         | ** ** | **2005**               | ** ** | **2005**          | ** ** |
| Cash and cash equivalents                          |       | $                      | 359,138    |              | $          | 359,978 |   |
| Short-term cash investments                        |       | 224,499                |       | 278,157           |       |
| Long-term cash investments                         |       | 348,311                |       | 302,585           |       |
| Total cash, cash  equivalents and cash investments |       | $                      | 931,948    |              | $          | 940,720 |   |

 

Available-for-salesecurities as of September 30, 2005 are summarized as follows (inthousands):

 

*Short-Term Cash Investments:*

 
| ** **                              | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Net  Unrealized  Loss** | ** ** | **Market  Value** | ** ** |
|-----------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|---------------------------|------------|-------------------|------------|
| Corporate debt                          |       | $                   | 155,359    |                        | $          | 2                           |       | $                         | (1,220     | )                 | $          | (1,218 | ) | $ | 154,141 |   |
| U.S. government  and agency obligations |       | 70,237              |       | —                      |       | (322                        | )          | (322                      | )          | 69,915            |       |
| Other debt                              |       | 443                 |       | —                      |       | —                      |       | —                    |       | 443               |       |
| Total short-term  cash investments      |       | $                   | 226,039    |                        | $          | 2                           |       | $                         | (1,543     | )                 | $          | (1,541 | ) | $ | 224,499 |   |
|                                         |            |                     |            |                             |            |                             |            |                           |            |                   |            |  |  |  |  |  |  |

 

9

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*Long-Term Cash Investments:*

 
| ** **                              | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Net  Unrealized Loss** | ** ** | **Market  Value** | ** ** |
|-----------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|--------------------------|------------|-------------------|------------|
| Corporate debt                          |       | $                   | 144,813    |                        | $          | 8                           |       | $                        | (654       | )                 | $          | (646 | ) | $ | 144,167 |   |
| U.S. government  and agency obligations |       | 130,171             |       | 54                          |       | (597                        | )          | (543                     | )          | 129,628           |       |
| Other debt                              |       | 74,729              |       | 26                          |       | (239                        | )          | (213                     | )          | 74,516            |       |
| Total long-term  cash investments       |       | $                   | 349,713    |                        | $          | 88                          |       | $                        | (1,490     | )                 | $          | (1,402 | ) | $ | 348,311 |   |
|                                         |            |                     |            |                             |            |                             |            |                          |            |                   |            |  |  |  |  |  |  |

 

Available-for-salesecurities as of June 30, 2005 are summarized as follows (in thousands):

 

*Short-Term Cash Investments:*

 
| ** **                             | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Net  Unrealized  Loss** | ** ** | **Market  Value** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|---------------------------|------------|-------------------|------------|
| Corporate debt                         |       | $                   | 179,372    |                        | $          | 6                           |       | $                         | (1,477     | )                 | $          | (1,471 | ) | $ | 177,901 |   |
| U.S. government and agency obligations |       | 99,728              |       | —                      |       | (576                        | )          | (576                      | )          | 99,152            |       |
| Other debt                             |       | 1,105               |       | —                      |       | (1                          | )          | (1                        | )          | 1,104             |       |
| Total long-term  cash investments      |       | $                   | 280,205    |                        | $          | 6                           |       | $                         | (2,054     | )                 | $          | (2,048 | ) | $ | 278,157 |   |
|                                        |            |                     |            |                             |            |                             |            |                           |            |                   |            |  |  |  |  |  |  |

 

*Long-Term Cash Investments:*

 
| ** **                             | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Net  Unrealized  (Loss) Gain** | ** ** | **Market  Value** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------------|------------|-------------------|------------|
| Corporate debt                         |       | $                   | 124,727    |                        | $          | 249                         |       | $                                | (355       | )                 | $          | (106 | ) | $ | 124,621 |   |
| U.S. government and agency obligations |       | 116,082             |       | 239                         |       | (134                        | )          | 105                              |       | 116,187           |       |
| Other debt                             |       | 61,765              |       | 131                         |       | (119                        | )          | 12                               |       | 61,777            |       |
| Total long-term  cash investments      |       | $                   | 302,574    |                        | $          | 619                         |       | $                                | (608       | )                 | $          | 11 |   | $ | 302,585 |   |

 

TheCompany holds as strategic investments the common stock of two publicly-tradedJapanese companies, one of which is Nihon Inter Electronics Corporation(“Nihon”), a related party as further disclosed in Note 15.  The Company accounts for theseavailable-for-sale investments under SFAS 115. These stocks are traded on the Tokyo Stock Exchange.  The market values of the equity investmentsat September 30, 2005 and June 30, 2005 were $66.6 million and $71.2million, respectively, comparedto their purchased cost of $24.2 million.  Mark-to-market losses, net of tax, of $2.9 millionand $9.8 million for the three months ended September 30, 2005 and 2004,respectively, were included in accumulated other comprehensive income, aseparate component of equity.

 

10

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Theamortized cost and estimated fair value of cash investments at September 30,2005, by contractual maturity, are as follows (in thousands):

 
| ** **              | ** ** | **Amortized  Cost** | ** ** | **Estimated Fair  Value** | ** ** |
|-------------------------|------------|---------------------|------------|---------------------------|------------|
| Due in 1 year or less   |       | $                   | 226,039    |                      | $          | 224,499 |   |
| Due in 1-2 years        |       | 176,052             |       | 175,121                   |       |
| Due in 2-5 years        |       | 138,657             |       | 138,277                   |       |
| Due after 5 years       |       | 35,004              |       | 34,913                    |       |
|                    |       |                |       |                      |       |
| Total cash  investments |       | $                   | 575,752    |                      | $          | 572,810 |   |
|                         |            |                     |            |                           |            |  |  |  |

 

Inaccordance with the Company’s investment policy which limits the length of timethat cash may be invested, the expected disposal dates may be less than thecontractual maturity dates as indicated in the table above.

 

Grossrealized gains were $0.01 million and gross realized losses were $0.3 millionfor the three months ended September 30, 2005.  Gross realized gains were $0.01 million andgross realized losses were $0.05 million for the three months ended September 30,2004.  The cost of marketable securitiessold is determined by the weighted average cost method.

 

4.                           DerivativeFinancial Instruments

 

*ForeignCurrency Risk*

 

The Company conductsbusiness on a global basis in several foreign currencies, and at various times,is exposed to fluctuations with the British Pound Sterling, the Euro and theJapanese Yen.  The Company’s risk to theEuropean currencies is partially offset by the natural hedge of manufacturingand selling goods in both U.S. dollars and the European currencies.  Considering its specific foreign currencyexposures, the Company has the greatest exposure to the Japanese Yen, since ithas significant yen-based revenues without the yen-based manufacturingcosts.  The Company has established aforeign-currency hedging program using foreign exchange forward contracts,including the Forward Contract described below, to hedge certain foreigncurrency transaction exposures.  To protectagainst reductions in value and volatility of future cash flows caused bychanges in currency exchange rates, it has established revenue, expense andbalance sheet hedging programs.  Currencyforward contracts and local Yen and Euro borrowings are used in these hedgingprograms.  The Company’s hedging programsreduce, but do not always eliminate, the impact of currency exchange ratemovements.

 

InMarch 2001, the Company entered into a five-year foreign exchange forwardcontract (the “Forward Contract”) for the purpose of reducing the effect ofexchange rate fluctuations on forecasted intercompany purchases by the Company’ssubsidiary in Japan. The Company has designated the Forward Contract as a cashflow hedge under which mark-to-market adjustments are recorded in accumulatedother comprehensive income, a separate component of stockholders’ equity, untilthe forecasted transactions are recorded in earnings.  Under the terms of the Forward Contract, the Companyis required to exchange

 

11

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1.2billion yen for $11.0 million on a quarterly basis from June 2001 to March 2006.  At September 30, 2005, two quarterlypayments of 1.2 billion yen remained to be swapped at a forward exchange rateof 109.32 yen per U.S. dollar.  Themarket value of the forward contract was $0.5 million and $0.1 million at September 30,2005 and June 30, 2005, respectively. Mark-to-market gains,included in other comprehensive income, net of tax, were $0.3 million and $0.8million for the three months ended September 30, 2005 and 2004,respectively.  At September 30, 2005,based on effectiveness tests comparing forecasted transactions through theForward Contract expiration date to its cash flow requirements, the Companydoes not expect to incur a material charge as a result of the Forward Contract toincome during the next six months through its maturity.

 

TheCompany had approximately $111.7 million and $75.9 million in notional amountsof forward contracts not designated as accounting hedges under SFAS No. 133at September 30, 2005 and June 30, 2005, respectively.  Net realized and unrealized foreign-currencynet gains recognized in earnings were lessthan $1 million for the three months ended September 30, 2005 and 2004.

 

*InterestRate Risk*

 

In December 2001, the Company entered into aninterest rate swap transaction (the “Transaction”) with an investment bank, JPMorgan Chase Bank (the “Bank”), to modify the Company’s effective interestpayable with respect to $412.5 million of its $550 million outstandingconvertible debt (the “Debt”) (see Note 8, “Bank Loans and Long-TermDebt”).   In April 2004, the Companyentered into an interest rate swap transaction (the “April 2004Transaction”) with the Bank to modify the effective interest payable withrespect to the remaining $137.5 million of the Debt.  The Company will receive from the Bank fixedpayments equal to 4.25 percent of the notional amount, payable on January 15and July 15.  In exchange, theCompany will pay to the Bank floating rate payments based upon the London InterBankOffered Rate (“LIBOR”) multiplied by the notional amount.  At the inception of the Transaction, interestrates were lower than that of the Debt and the Company believed that interestrates would remain lower for an extended period of time.  The variable interest rate paid since theinception of the swaps has averaged 2.36 percent, compared to a coupon of 4.25percent on the Debt.  During the threemonths ended September 30, 2005 and 2004, this arrangement reducedinterest expense by $0.9 million and $2.2 million, respectively.

 

Accounted for as fair value hedges under SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities”, themark-to-market adjustments of the Transaction and April 2005 Transactionwere offset by the mark-to-market adjustments on the Debt, resulting in nomaterial impact to earnings.  The marketvalue of the Transaction was a liability of $3.9 million and $0.3 million at September 30,2005 and June 30, 2005, respectively. The market value of the April 2005 Transaction was a liability of $3.8million and a $3.4 million at September 30, 2005 and June 30, 2005,respectively.

 

Both Transactionsterminate on July 15, 2007 (“Termination Date”), subject to certain earlytermination provisions.  On or after July 18,2004 and prior to July 14, 2007, if the ten-day average closing price ofthe Company’s common stock equals or exceeds $77.63, both transactions willterminate.  Depending on the timing of

 

12

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the early terminationevent, the Bank would be obligated to pay the Company an amount equal to theredemption premium called for under the terms of the Debt.

 

In support of theCompany’s obligation under the two transactions, the Company is required toobtain irrevocable standby letters of credit in favor of the Bank, totaling $7.5million plus a collateral requirement for the Transaction and the April 2005Transaction, as determined periodically. At September 30, 2005, $15.8 million in letters of credit wereoutstanding related to both transactions.

 

The Transaction and the April 2005Transaction qualify as fair value hedges under SFAS No. 133.  To test effectiveness of the hedge,regression analysis is performed quarterly comparing the change in fair valueof the two transactions and the Debt. The fair values of the Transaction, the April 2005 Transaction andthe Debt are calculated quarterly as the present value of the contractual cashflows to the expected maturity date, where the expected maturity date is basedon probability-weighted analysis of interest rates relating to the five-yearLIBOR curve and the Company’s stock prices. For the three months ended September 30, 2005 and 2004, the hedgeswere highly effective and therefore, the ineffective portion did not have a materialimpact on earnings.

 

In April 2002, theCompany entered into an interest rate contract (the “Contract”) with aninvestment bank, Lehman Brothers (“Lehman”), to reduce the variable interestrate risk of the Transaction.  Thenotional amount of the Contract is $412.0 million, representing approximately75 percent of the Debt.  Under the termsof the Contract, the Company has the option to receive a payout from Lehmancovering its exposure to LIBOR fluctuations between 5.5 percent and 7.5 percentfor any four designated quarters.  Themarket value of the Contract at September 30, 2005 and June 30, 2005,was $0.2 million and $0.1 million, respectively, and was included in otherlong-term assets.  Mark-to-market gains(losses) of $0.1 million and ($0.3) million for the three months ended September 30,2005 and 2004, respectively, were charged to interest expense.

 

5.                           Inventories

 

Inventoriesare stated at the lower of cost (principally first-in, first-out) ormarket.  Inventories are reviewed forexcess and obsolescence based upon demand forecast within a specific timehorizon and reserves are established accordingly.  Inventories at September 30, 2005 and June 30,2005 were comprised of the following (in thousands):

 
| ** **         | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|--------------------|------------|------------------------|------------|-------------------|------------|
| ** **         | ** ** | **2005**               | ** ** | **2005**          | ** ** |
| Raw materials      |       | $                      | 36,322     |              | $          | 33,328 |   |
| Work-in-process    |       | 82,727                 |       | 82,802            |       |
| Finished goods     |       | 74,732                 |       | 61,430            |       |
|               |       |                   |       |              |       |
| Total  inventories |       | $                      | 193,781    |              | $          | 177,560 |   |
|                    |            |                        |            |                   |            |  |  |  |  |

 

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6.                           Goodwilland Acquisition-Related Intangible Assets

 

The Company accountsfor goodwill and acquisition-related intangible assets in accordance with SFAS No. 141,“Business Combinations”, and SFAS No. 142, “Goodwill and Other IntangibleAssets”.  The Company classifies thedifference between the purchase price and the fair value of net assets acquiredat the date of acquisition as goodwill. The Company classifies intangible assets apart from goodwill if theassets have contractual or other legal rights or if the assets can be separatedand sold, transferred, licensed, rented or exchanged.  Depending on the nature of the assetsacquired, the amortization period may range from four to twelve years for thoseacquisition-related intangible assets subject to amortization.

 

The Company evaluates the carrying value of goodwilland acquisition-related intangible assets, including the related amortizationperiod, in the fourth quarter of each fiscal year.  In evaluating goodwill and intangible assetsnot subject to amortization, the Company completes the two-step goodwillimpairment test as required by SFAS No. 142.  The Company identified its reporting unitsand determined the carrying value of each reporting unit by assigning theassets and liabilities, including the existing goodwill and intangible assets,to those reporting units, in order to assess goodwill for impairment.  A reporting unit is the lowest level of theCompany for which there is discrete information and whose results are regularlyreviewed by the Company.

 

In the first of a two-step impairment test, theCompany determined the fair value of these reporting units using a discountedcash flow valuation model.  The Companycompared the discounted cash flows for the reporting unit to its carrying value.  If the fair value of a reporting unit exceedsits carrying value, goodwill of the reporting unit is considered not impairedand no further testing is required.  Ifthe fair value does not exceed the carrying value, the second step of thegoodwill impairment test shall be performed to measure the amount of impairmentloss, if any.  The second step comparedthe implied fair value of the reporting unit with the carrying amount of thatgoodwill.  Based on its annual impairmenttest in the fourth quarter of fiscal year ended June 30, 2005, the Companydetermined that goodwill was not impaired.

 

At September 30, 2005and June 30, 2005 acquisition-related intangible assets included thefollowing (in thousands):

 
| ** **                                   | ** ** | ** **                         | ** ** | **September 30, 2005** | ** ** | **June 30, 2005**        | ** ** |
|----------------------------------------------|------------|------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                                   | ** ** | **Amortization  Periods  (Years)** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Acquisition-related  intangible assets:      |       |                               |       |                        |       |                          |       |   |   |   |   |
| Complete  technology                         |       | 4 – 12                        |       | $                           | 35,962     |                          | $          | (11,948 | ) | $ | 36,665 |   | $ | (11,859 | ) |
| Distribution  rights and customer lists      |       | 5 – 12                        |       | 15,667                      |       | (7,634                        | )          | 15,667 |   | (7,243 | ) |
| Intellectual  property and other             |       | 5 – 12                        |       | 7,313                       |       | (5,498                        | )          | 7,313 |   | (5,189 | ) |
| Total  acquisition-related intangible assets |       |                               |       | $                           | 58,942     |                          | $          | (25,080 | ) | $ | 59,645 |   | $ | (24,291 | ) |

 

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As of September 30, 2005, estimatedamortization expense for the next five years is as follows (in thousands): remainderof fiscal 2006: $3,015; fiscal 2007: $2,899; fiscal 2008: $2,527; fiscal 2009:$2,489, fiscal 2010: $2,489 and fiscal 2011: $1,710.

 

The carrying amount ofgoodwill by business segment as of September 30, 2005, is as follows (inthousands):

 
| ** **                   | ** ** | **September 30, 2005** | ** ** |
|------------------------------|------------|-----------------------------|------------|
| Energy-Saving Products       |       | $                           | 70,310     |   |
| Aerospace and Defense        |       | 45,765                      |       |
| Computing and Communications |       | 28,803                      |       |
| Non-Aligned Products         |       | 4,190                       |       |
| Intellectual Property        |       | 3,261                       |       |
|                         |       |                        |       |
| Total goodwill               |       | $                           | 152,329    |   |

 

Asof September 30, 2005 and June 30, 2005, $43.3 million of goodwill isdeductible for income tax purposes.

 

The changes in thecarrying amount of goodwill for the period ended September 30, 2005 and June 30,2005 are as follows (in thousands):

 
| ** **                       | ** ** | **Goodwill** | ** ** |
|----------------------------------|------------|--------------|------------|
| Balance, June 30, 2004      |       | $            | 139,919    |   |
| New acquisition                  |       | 12,958       |       |
| Foreign exchange impact          |       | (420         | )          |
| Balance, June 30, 2005      |       | $            | 152,457    |   |
| Foreign exchange impact          |       | (128         | )          |
|                             |       |         |       |
| Balance, September 30, 2005 |       | $            | 152,329    |   |

 

New acquisitions in the fiscal year ended June 30,2005, primarily relates to the acquisition of the specialty silicon epitaxialservices business from Advanced Technology Materials, Inc.  The goodwill associated with this acquisitionhas been assigned to the Computing and Communications, Energy-Saving Productsand Intellectual Property segments based on revenues.

 

7.                           Otheraccrued expenses

 

Other accrued expensesat September 30, 2005 and June 30, 2005 were comprised of thefollowing (in thousands):

 
| ** **              | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|-------------------------|------------|------------------------|------------|-------------------|------------|
| ** **              | ** ** | **2005**               | ** ** | **2005**          | ** ** |
| Accrued taxes           |       | $                      | 41,165     |              | $          | 46,704 |   |
| Other accrued expenses  |       | 41,250                 |       | 44,624            |       |
|                    |       |                   |       |              |       |
| Total accrued  expenses |       | $                      | 82,415     |              | $          | 91,328 |   |

 

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8.                           BankLoans and Long-Term Debt 

 

A summary of the Company’slong-term debt and other loans at September 30, 2005 and June 30, 2005is as follows (in thousands):

 
| ** **                                                                                                                                                                                                          | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                          | ** ** | **2005**               | ** ** | **2005**          | ** ** |
| Convertible  subordinated notes at 4.25% due in 2007 ($550,000 principal amount, plus  accumulated fair value adjustment of ($8,351) and ($3,360) at September 30, 2005  and June 30, 2005, respectively) |       | $                      | 541,649    |              | $          | 546,640 |   |
| Other loans and  capitalized lease obligations                                                                                                                                                                      |       | 3,069                  |       | 782               |       |
| Debt, including  current portion of long-term debt ($47 and $163 at September 30, 2005  and June 30, 2005, respectively)                                                                                  |       | 544,718                |       | 547,422           |       |
| Foreign  revolving bank loans at rates from 1.38% to 3.88%                                                                                                                                                          |       | 18,088                 |       | 18,168            |       |
|                                                                                                                                                                                                                |       |                   |       |              |       |
| Total debt                                                                                                                                                                                                          |       | $                      | 562,806    |              | $          | 565,590 |   |
|                                                                                                                                                                                                                     |            |                        |            |                   |            |  |  |  |  |

 

In July 2000, theCompany sold $550 million principal amount of 4.25 percent ConvertibleSubordinated Notes due 2007. The interest rate is 4.25 percent per year on theprincipal amount, payable in cash in arrears semi-annually on January 15and July 15.  The notes aresubordinated to all of the Company’s existing and future debt. The notes areconvertible into shares of the Company’s common stock at any time on or before July 15,2007, at a conversion price of $73.935 per share, subject to certainadjustments.  The Company may redeem anyof the notes, in whole or in part, subject to certain call premiums on or afterJuly 18, 2004, as specified in the notes and related indentureagreement.  In December 2001 and April 2005,the Company entered into two transactions with JP Morgan Chase Bank for $412.5million and $137.5 million in notional amounts, respectively, which had theeffect to the Company of converting the interest rate to variable and requiringthat the convertible notes be marked to market (see Note 4, “DerivativeFinancial Instruments”).

 

In November 2003, the Company entered into athree-year syndicated multi-currency revolving credit facility, led by BNPParibas, expiring in November 2006 (the “Facility”).  The Facility provides a credit line of $150million of which up to $150 million may be used for standby letters ofcredit.  The Facility bears interest at (i) localcurrency rates plus (ii) a margin between 0.75 percent and 2.0 percent forbase rate advances and a margin of between 1.75 percent and 3.0 percent foreuro-currency rate advances.  Otheradvances bear interest as set forth in the credit agreement.  The annual commitment fee for the Facility issubject to a leverage ratio as determined by the credit agreement and was 0.375percent of the unused portion of the total facility at each period-end.  The Company pledged as collateral shares ofcertain of its subsidiaries.  TheFacility also contains certain financial and other covenants, with which theCompany was in compliance at September 30, 2005.  At September 30, 2005, the Company had $16.9million borrowings and $20.2 million letters of credit outstanding under theFacility.  At June 30, 2005, theCompany had $17.1 million borrowings and $16.4 million letters of creditoutstanding under the Facility.  Of theletters of credit outstanding, $15.8

 

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million and $12.0 million were related to theinterest rate swap transactions (see Note 3) at September 30, 2005 and June 30,2005, respectively.

 

At September 30,2005, the Company had $166.6 million in total revolving lines of credit, ofwhich $38.2 million had been utilized, consisting of $20.2 million in lettersof credit and $18.0 million in foreign revolving bank loans, which are includedin the table above.

 

9.                           Impairmentof Assets, Restructuring and Severance

 

During fiscal 2003 second quarter ended December 31,2002, the Company announced its restructuring initiatives. Under theseinitiatives, the goal was to reposition the Company to better fit the marketconditions and de-emphasize its commodity business. The Company’s restructuringplan included consolidating and closing certain manufacturing sites, upgradingequipment and processes in designated facilities and discontinuing productionin a number of others that cannot support more advanced technology platforms orproducts within its Focus Product segments. The Company also planned to lower overhead costs across its support organizations.  The Company has substantially completed theserestructuring activities as of September 30, 2005.  The Company expects to complete the remainingactivities, primarily the closing of a fabrication line at El Segundo,California by fiscal year end 2006 or sooner.

 

Total charges associated with the December 2002initiatives are expected to be approximately $280 million. These charges willconsist of approximately $220 million for asset impairment, plant closure andother charges, $6 million of raw material and work-in-process inventory, and$54 million for severance-related costs.

 

For the three months ended September 30, 2005, the Company recorded $4.3million in total restructuring-related charges, consisting of: $3.1 million forasset impairment, plant closure costs and other charges, and $1.2 million forseverance-related costs.  For the threemonths ended September 30, 2004, the Company recorded $6.7 million in total restructuring-related charges,consisting of: $4.9 million for impairment, plant closure costs and othercharges, and $1.8 million for severance-related costs.  Restructuring-related costswere charged as incurred in accordance with SFAS No. 146, “Accounting forthe Costs Associated with Exit or Disposal Activities”.  Asset impairments were calculated inaccordance with SFAS No. 144, “Accounting for Impairment or Disposal ofLong-Lived Assets”.  In determining theasset groups, the Company grouped assets at the lowest level for whichindependent identifiable cash flows were available. In determining whether anasset was impaired the Company evaluated undiscounted future cash flows andother factors such as changes in strategy and technology. The undiscounted cashflows from the Company’s initial analyses were less than the carrying amountfor certain of the asset groups, indicating impairment losses.  Based on this, the Company determined thefair value of these asset groups using the present value technique, by applyinga discount rate to the estimated future cash flows that was consistent with therate used when analyzing potential acquisitions.

 

As of September 30, 2005, the Company had recorded $265.7 million intotal charges, consisting of: $213.2 million for asset impairment, plantclosure costs and

 

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other charges, $6.0 million for raw material and work-in-process inventorycharges, and $46.5 million for severance-related costs.  Components of the $213.2 million assetimpairment, plant closure and other charges included the following items:

 

•                  As the Companyemphasizes more advanced generation planar products, it expects the futurerevenue stream from its less advanced facilities in Temecula, California todecrease significantly.  These facilitieshad a net book value of $138.3 million and were written down by $77.7 million.  It is expected that these facilities willcontinue in use until approximately December 2007 and the remaining basisis being depreciated over units of production during this period. It is assumedthat salvage value will equal disposition costs.

 

•                  As the Companyemphasizes more advanced generation trench products, it expects the futurerevenue stream from its less advanced facility in El Segundo, California todecrease significantly. This facility had a net book value of $59.5 million andwas written down by $57.2 million.  Thisfacility had significantly reduced production as of fiscal year ended June 30,2003 and is used primarily for research and development activities.

 

•                  As the Companyemphasizes more advanced generation Schottky products, it expects the futurerevenue stream from its less advanced facility in Borgaro, Italy to decreasesignificantly. This facility had a net book value of $20.5 million and waswritten down by $13.5 million.  It isexpected that this facility will continue in use until approximately December 2007and the remaining basis is being depreciated over units of production duringthis period.  It is assumed that salvagevalue will equal disposition costs.

 

•                  The Companyrestructured its manufacturing activities in Europe.  Based on a review of its Swansea, Walesfacility, a general-purpose module facility, the Company determined in the December 2002quarter that this facility would be better suited to focus only on automotiveapplications.  The general-purpose moduleassets at this facility, with a net book value of $13.6 million, were writtendown by $8.2 million.  In addition, theCompany has completed the move of its manufacturing activities from itsautomotive facility in Krefeld, Germany to its Swansea, Wales and Tijuana, Mexicofacilities as of September 30, 2005. The Company has also moved theproduction from its Venaria, Italy facility to its Borgaro, Italy and Mumbai,India facilities, which was completed as of December 31, 2003.  The Company stopped manufacturing products atits Oxted, England facility as of September 30, 2003.

 

•                  The Company haseliminated the manufacturing of its non-space military products in its SantaClara, California facility as of July 31, 2004. Currently, subcontractorshandle the Company’s non-space qualified products previously manufactured inthis facility. The Company is also transitioning the assembly and test ofnon-space Power Components from its Leominster, Massachusetts facility to itsTijuana, Mexico facility, and expects to complete this activity by calendaryear end 2005.  Associated with thesereductions in manufacturing activities, certain assets with a net book value of$4.0 million were written down by $2.0 million.

 

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•                  $54.6 million in othermiscellaneous items were charged, including $45.8 million in relocation costsand other impaired asset charges and $8.8 million in contract termination andsettlement costs.

 

As a result of the restructuring initiatives, certain raw material andwork-in-process inventories were impaired, including products that could not becompleted in other facilities, materials that were not compatible with theprocesses used in the alternative facilities, and materials such as gases andchemicals that could not readily be transferred. Based on these factors theCompany wrote down these inventories, with a carrying value of $98.2 million,by $6.0 million. For the three months ended September 30, 2005 and 2004,the Company disposed of $0 and $0.5 million, respectively, of theseinventories, which did not have a material impact on gross margin for the periodsthen ended.  As of September 30,2005, $1.2 million of these inventories remained to be disposed.

 

As of September 30, 2005, the Company hasrecorded $46.5 million in severance-related charges:  $41.3 million in severance termination costsrelated to approximately 1,200 administrative, operating and manufacturingpositions, and $5.1 million in pension termination costs at its manufacturingfacility in Oxted, England.  Theseverance charges associated with the elimination of positions, which includedthe persons notified to date, had been and will continue to be recognized overthe future service period, as applicable, in accordance with SFAS No. 146.  The Company measured the total terminationbenefits at the communication date based on the fair value of the liability asof the termination date.  A changeresulting from a revision to either the timing or the amount of estimated cashover the future service period will be measured using the credit-adjustedrisk-free rate that was used to initially measure the liability.  The cumulative effect of the change will berecognized as an adjustment to the liability in the period of the change.

 

During fiscal 2002, the Company had recorded anestimated $5.1 million in severance costs associated with the acquisition ofTechnoFusion GmbH in Krefeld, Germany. In fiscal 2003, the Company finalized its plan and determined that totalseverance would be approximately $10 million, and accordingly, the Companyadjusted purchased goodwill by $4.8 million. The Company communicated the plan and the elimination of approximately250 positions primarily in manufacturing to its affected employees at thattime.  The associated severance isexpected to be paid by calendar year end 2005.

 

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Thefollowing summarizes the Company’s severance accrual related to the June 2001restructuring, the TechnoFusion acquisition and the December 2002 restructuringplan for the three months ended September 30, 2005 and the fiscal yearended June 30, 2005.  Severanceactivity related to the elimination of 29 administrative and operatingpersonnel as part of the previously reported restructuring in the fiscal quarterended June 30, 2001, is also disclosed. The remaining June 2001 severance relates primarily to certainlegal accruals associated with that restructuring, which will be paid orreleased as the outcome is determined (in thousands):

 
| ** **                                                                                          | ** ** | **June  2001  Restructuring** | ** ** | **December  2002  Restructuring** | ** ** | **TechnoFusion  Severance  Liability** | ** ** | **Total  Severance  Liability** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|----------------------------------------|------------|---------------------------------|------------|
| Accrued  severance, June 30, 2004                                                              |       | $                             | 697        |                              | $          | 7,180                                  |       | $                               | 6,067      |   | $ | 13,944 |   |
| Costs incurred  or charged to “impairment of assets, restructuring and severance charges” |       | —                        |       | 8,677                             |       | —                                 |       | 8,677                           |       |
| Costs paid                                                                                          |       | (326                          | )          | (7,810                            | )          | (3,770                                 | )          | (11,906                         | )          |
| Foreign exchange  impact                                                                            |       | —                        |       | 77                                |       | (190                                   | )          | (113                            | )          |
|                                                                                                |       |                          |       |                              |       |                                   |       |                            |       |
| Accrued  severance, June 30, 2005                                                              |       | $                             | 371        |                              | $          | 8,124                                  |       | $                               | 2,107      |   | $ | 10,602 |   |
| Costs incurred  or charged to “impairment of assets, restructuring and severance”         |       | —                        |       | 1,231                             |       | —                                 |       | 1,231                           |       |
| Costs paid                                                                                          |       | (64                           | )          | (3,055                            | )          | (406                                   | )          | (3,525                          | )          |
| Foreign exchange  impact                                                                            |       | —                        |       | (14                               | )          | (14                                    | )          | (28                             | )          |
| Accrued  severance, September 30, 2005                                                         |       | $                             | 307        |                              | $          | 6,286                                  |       | $                               | 1,687      |   | $ | 8,280 |   |

 

10.                     Segmentand Geographic Information

 

Revenues for the threemonths ended September 30, 2005 and 2004, by the three broad productcategories, are as follows (in thousands):

 
| ** **                                        | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Power Management ICs and Advanced Circuit Devices |       | $                            | 175,360    |                         | $          | 169,782 |   |
| Power Components                                  |       | 54,874                       |       | 99,586                       |       |
| Power Systems                                     |       | 31,899                       |       | 32,838                       |       |
| Total product  revenues                           |       | 262,133                      |       | 302,206                      |       |
| Intellectual Property                             |       | 10,440                       |       | 10,019                       |       |
|                                              |       |                         |       |                         |       |
| Total  consolidated revenues                      |       | $                            | 272,573    |                         | $          | 312,225 |   |
|                                                   |            |                              |            |                              |            |  |  |  |

 

20

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Segment results for thethree months ended September 30, 2005 and 2004 and as of September 30,2005 and June 30, 2005, are as follows (in thousands except percentages):

 
| ** **                   | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Business Segment**         | ** ** | **Revenues**                 | ** ** | **Gross  Profit**            | ** ** | **Revenues** | ** ** | **Gross  Profit** | ** ** |
| Computing and Communications |       | $                            | 89,640     |                         | 41.6       | % | $ | 105,991 |   | 43.7 | % |
| Energy-Saving Products       |       | 72,386                       |       | 52.4                         |       | 73,151 |   | 53.6 |   |
| Aerospace and Defense        |       | 29,401                       |       | 43.8                         |       | 32,277 |   | 41.3 |   |
| Intellectual Property        |       | 10,440                       |       | 100.0                        |       | 10,019 |   | 100.0 |   |
|                         |       |                         |       |                         |       |   |   |   |   |
| Subtotal Focus  Products     |       | 201,867                      |       | 48.8                         |       | 221,438 |   | 49.2 |   |
|                         |       |                         |       |                         |       |   |   |   |   |
| Commodity Products           |       | 42,152                       |       | 19.3                         |       | 59,524 |   | 30.9 |   |
| Non-Aligned Products         |       | 28,554                       |       | 14.6                         |       | 31,263 |   | 19.6 |   |
| Subtotal Non-Focus  Products |       | 70,706                       |       | 17.4                         |       | 90,787 |   | 27.0 |   |
|                         |       |                         |       |                         |       |   |   |   |   |
| Consolidated  total          |       | $                            | 272,573    |                         | 40.7       | % | $ | 312,225 |   | 42.7 | % |
|                              |            |                              |            |                              |            |  |  |  |  |  |  |  |

 

Product revenues fromunaffiliated customers are based on the location in which the sale originated.The Company includes in long-lived assets, all long-term assets excludinglong-term cash investments, long-term deferred income taxes, goodwill andacquisition-related intangibles.

 

Geographicinformation for the Company on an aggregate basis, for the three months ended September 30,2005 and 2004, is presented below (in thousands):

 
| **Revenues from Unaffiliated  Customers** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| North America, primarily United States    |       | $                            | 74,611     |                         | $          | 91,977 |   |
| Asia                                      |       | 129,628                      |       | 140,686                      |       |
| Europe                                    |       | 57,894                       |       | 69,543                       |       |
|                                      |       |                         |       |                         |       |
| Subtotal                                  |       | 262,133                      |       | 302,206                      |       |
| Unallocated royalties                     |       | 10,440                       |       | 10,019                       |       |
|                                      |       |                         |       |                         |       |
| Total                                     |       | $                            | 272,573    |                         | $          | 312,225 |   |

 
| **Long-Lived Assets**                  | ** ** | **September 30,  2005** | ** ** | **June 30,  2005** | ** ** |
|----------------------------------------|------------|------------------------------|------------|-------------------------|------------|
| North America, primarily United States |       | $                            | 348,306    |                    | $          | 347,892 |   |
| Asia                                   |       | 27,500                       |       | 23,598                  |       |
| Europe                                 |       | 230,467                      |       | 223,124                 |       |
|                                   |       |                         |       |                    |       |
| Total                                  |       | $                            | 606,273    |                    | $          | 594,614 |   |
|                                        |            |                              |            |                         |            |  |  |  |

 

21

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No single original equipment manufacturer (“OEM”),customer, distributor or subcontract manufacturer accounted for more than tenpercent of the Company’s consolidated revenues for the three months ended September 30,2005 or 2004.  For its Focus Productsegments as a whole, the Company primarily sells direct to OEM customers.  Three distributors accounted forapproximately 41 percent of Computing and Communications segment revenues forthe three months ended September 30, 2005. One distributor accounted for approximately 17 percent of CommodityProducts segment revenues for the three months ended September 30,2005.  Two OEM customers, individuallyaccounting for greater than 10 percent of Non-Aligned Products (“NAP”)revenues, accounted for approximately 35 percent of NAP revenues for the threemonths ended September 30, 2005.  Nosingle OEM customer, distributor or subcontract manufacturer accounted for morethan ten percent of the Company’s other reportable segments revenues for thequarter.  No customer accounted for morethan 10 percent of the Company’s accounts receivable at September 30, 2005and June 30, 2005.

 

11.                     Stock-Based Compensation

 

For the three monthsended September 30, 2005, equity-based compensation awards were grantedunder one of two stock option plans:  the1997 Employee Stock Incentive Plan (“1997 Plan”) and the 2000 Incentive Plan (“2000Plan”). Options granted before November 22, 2004, generally becameexercisable in annual installments of 25 percent beginning on the firstanniversary date, and expire after seven years. Options granted after November 22, 2004, generally becameexercisable in annual installments of 33 percent beginning on the firstanniversary date, and expire after five years.

 

Under the 1997 Plan, options to purchase shares ofthe Company’s common stock may be granted to the Company’s employees andconsultants.  In addition, other stock-basedawards (e.g., restricted stock units (“RSUs”), SARs and performance shares) mayalso be granted.  During the three monthsended September 30, 2005 and 2004, non-qualified options and RSUs wereissued under the 1997 Plan. As noted below, on November 22, 2004, theCompany’s stockholders approved an amendment to the 2000 Plan to increase theauthorized number of shares from 7,500,000 to 12,000,000, at which point noawards may be granted under the 1997 Plan.

 

Under the 2000 Plan, options to purchase shares ofthe Company’s common stock and other stock-based awards may be granted to theCompany’s employees, consultants, officers and directors.  The terms of the 2000 Plan were substantiallysimilar to those under the 1997 Plan. On November 22, 2004, the Company’sshareholders approved an amendment to the 2000 Plan which increased theauthorized number of shares to be granted from 7,500,000 to 12,000,000.  The amendment changed the options expirationterm on future grants to five years, and contained certain limitations on themaximum number of shares that may be awarded to an individual. No awards may begranted under the 2000 Plan after August 24, 2014. As of September 30,2005, there were 4,097,698 shares available for future grants.

 

22

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The following table summarizes the stock optionactivities for the period ended September 30, 2005 (in thousands exceptper share data):

 
| ** **                           | ** ** | **Shares** | ** ** | **Weighted  Average  Option  Exercise  Price Per  Share** | ** ** | **Weighted  Average  Grant Date  Fair  Value Per  Share** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------|------------|------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding, June 30, 2005      |       | 13,558     |       | $                                                         | 38.01      |                                                      | —     |                            | $          | 149,290 |   |
| Granted                              |       | 580        |       | $                                                         | 48.16      |                                                      | $          | 13.27                           |       | — |   |
| Exercised                            |       | (922       | )          | $                                                         | 23.86      |                                                      | —     |                            | $          | 21,339 |   |
| Expired or  canceled                 |       | (114       | )          | $                                                         | 40.65      |                                                      | —     |                            | —     |   |
|                                 |       |       |       |                                                      |       |                                                      |       |                            |       |
| Outstanding, September 30, 2005 |       | 13,102     |       | $                                                         | 39.51      |                                                      | —     |                            | $          | 100,692 |   |
|                                      |            |            |            |                                                           |            |                                                           |            |                                 |            |  |  |  |

 

The following table summarizes the RSU activitiesfor the period ended September 30, 2005 (in thousands except per sharedata):

 
| ** **                           | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair  Value Per  Share** | ** ** |
|--------------------------------------|------------|------------|------------|-----------------------------------------------------------|------------|
| Outstanding, June 30, 2005      |       | 24         |       | —                                                    |       |
| Granted                              |       | 6          |       | $                                                         | 48.10      |   |
|                                 |       |       |       |                                                      |       |
| Outstanding, September 30, 2005 |       | 30         |       | —                                                    |       |
|                                      |            |            |            |                                                           |            |  |

 

The following table summarizes the non-vested stockoption and RSU activities for the period ended September 30, 2005 (inthousands):

 
| ** **                                 | ** ** | **Stock  Options** | ** ** | **Restricted  Stock Units** | ** ** |
|--------------------------------------------|------------|--------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | ** **         | ** ** | ** **                  | ** ** |
| Non-vested shares, June 30, 2005      |       | 137                |       | 24                          |       |
| Granted                                    |       | 580                |       | 6                           |       |
|                                       |       |               |       |                        |       |
| Non-vested shares, September 30, 2005 |       | 717                |       | 30                          |       |

 

23

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The following table summarizes the stock options and RSUsoutstanding at September 30, 2005, and related weighted average price andlife information (in thousands except years and price data):

 
| ** **                             | ** ** | **September 30, 2005** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **Outstanding**             | ** ** | **Exercisable** | ** ** |
| **Range of Exercise  Price per Share** | ** ** | **Number  Outstanding**     | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $0.00 to $15.38                        |       |                        | 490        |   | 3.43 |   | $ | 11.07 |   | 461 |   | $ | 11.79 |   |
| $15.62 to $25.35                       |       |                        | 2,095      |   | 3.60 |   | $ | 20.63 |   | 2,095 |   | $ | 20.63 |   |
| $26.00 to $35.90                       |       |                        | 1,484      |   | 5.69 |   | $ | 33.93 |   | 1,484 |   | $ | 33.93 |   |
| $36.39 to $45.87                       |       |                        | 6,539      |   | 4.65 |   | $ | 42.78 |   | 6,530 |   | $ | 42.78 |   |
| $46.50 to $54.69                       |       |                        | 1,530      |   | 4.85 |   | $ | 50.52 |   | 822 |   | $ | 52.41 |   |
| $55.31 to $63.88                       |       |                        | 994        |   | 5.15 |   | $ | 62.01 |   | 993 |   | $ | 62.01 |   |
|                                   |       | 13,132                      |       | 4.61 |   | $ | 39.42 |   | 12,385 |   | $ | 39.00 |   |

 

Additional information relating to the stock optionplans, including employee stock options and RSUs, at September 30, 2005and June 30, 2005 is as follows (in thousands):

 
| ** **                                                 | ** ** | **September 30, 2005** | ** ** | **June 30,  2005** | ** ** |
|------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Options exercisable                                        |       | 12,385                      |       | 13,422                  |       |
| Options available for grant                                |       | 4,098                       |       | 4,632                   |       |
| Total reserved common stock shares for stock option  plans |       | 17,229                      |       | 18,214                  |       |

 

Beginning in the fiscal year 2006, the Company adopted SFASNo. 123(R), “Share-Based Payments” (“SFAS No. 123(R)”) on a modifiedprospective transition method to account for its employee stock options.  The adoption of SFAS No. 123(R) did notaffect the stock-based compensation associated with the Company’s RSUs, which werealready based on the market price of the stock at date of grant and recognizedover the service period.  Under the modified prospective transitionmethod, fair value of new and previously granted but unvested equity awards arerecognized as compensation expense in the income statement, and prior periodresults are not restated.  As a result ofthe adoption, the Company’s income from continuing operations, which is thesame as income before income taxes, decreased by $0.4 million, net income wasdecreased by $0.3 million, and basic and diluted earnings per share werenegatively impacted by $0.01.

 

For the three months ended September 30, 2005,stock-based compensation expense recognized in the income statement is asfollows (in thousands):

 
| ** **                              | ** ** | **September 30, 2005** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | ** **                  | ** ** |
| Selling and administrative expense      |       | $                           | 258        |   |
| Research and development expense        |       | 82                          |       |
| Cost of sales                           |       | 30                          |       |
|                                    |       |                        |       |
| Total  stock-based compensation expense |       | $                           | 370        |   |

 

24

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The total compensation expense for outstanding stockoptions and RSUs was $7.9 million as of September 30, 2005, which will berecognized over a weighted average of approximately three years. The fair valueof the options associated with the above compensation expense for the threemonths ended September 30, 2005, was determined at the date of the grantusing the Black-Scholes option pricing model with the following weightedaverage assumptions:

 
| ** **              | ** ** | **September 30,  2005** | ** ** |
|-------------------------|------------|------------------------------|------------|
| Expected life           |       | 3.5 years                    |       |
| Risk free interest rate |       | 3.8                          | %          |
| Volatility              |       | 30.0                         | %          |
| Dividend yield          |       | 0.0                          | %          |

 

In March 2005, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 107 (“SAB No. 107”)that provided the Staff’s views regarding valuation of share-based paymentspursuant to SFAS No. 123(R).  Withrespect to volatility, SAB No. 107 clarified that there is not aparticular method of estimating volatility and to the extent that the Companyhas traded financial instruments from which it can derive the impliedvolatility, it may be appropriate to use only implied volatility in its assumptions.  The Company has certain financial instrumentsthat are publicly traded from which it can derive the implied volatility.  Therefore, beginning in January 2005,the Company used implied volatility for valuing its stock options, whereaspreviously, it had used historical volatility. The Company believes implied volatility is a better indicator ofexpected volatility because it is generally reflective of both historicalvolatility and expectations of how future volatility will differ fromhistorical volatility.

 

SAB No. 107 alsoprovided certain “simplified” method for determining expected life in valuingstock options.  To the extent that anentity cannot rely on its historical exercise data to determine the expectedlife, SAB No. 107 has prescribed a simplified “plain-vanilla”formula.  Subsequent to the 2000 Planamendments on November 22, 2004, the Company issued stock options havingfive-year expiration with generally a three-year annual vesting term, whereas,prior to then, the Company granted stock options having seven or ten-yearexpiration with generally a four or five-year annual vesting term.   Therefore, beginning in January 2005,the Company applied SAB No. 107 “plain-vanilla” method for determining theexpected life, whereas previously, it had used historical exercise data todetermine the expected life.

 

25

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Hadthe Company accounted for stock-based compensation plans using the fair valuebased accounting method described by SFAS No. 123 for the periods prior tofiscal year 2006, the Company’s diluted net income per common share–basic anddiluted for the three months ended September 30, 2004, would haveapproximated the following (in thousands except per share data):

 
| ** **                                                                                                                  | ** ** | **September 30,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
|                                                                                                                        |       |                         |       |
| Net income                                                                                                                  |       | $                            | 37,580     |   |
| Less: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of tax |       | (13,243                      | )          |
| Pro forma net  income                                                                                                       |       | $                            | 24,337     |   |
|                                                                                                                        |       |                         |       |
| Net income per  common share-basic, as reported                                                                             |       | $                            | 0.56       |   |
| Net income per  common share-basic, pro forma                                                                               |       | $                            | 0.37       |   |
|                                                                                                                        |       |                         |       |
| Net income per  common share-diluted, as reported                                                                           |       | $                            | 0.53       |   |
| Net income per  common share-diluted, pro forma                                                                             |       | $                            | 0.35       |   |

 

OnApril 17, 2005, the Company accelerated the vesting of all then outstandingequity awards, including employee stock options and restricted stock units,primarily to avoid recognizing in its income statement approximately $108million in associated compensation expense in future periods, of whichapproximately $60 million would have been recognized in fiscal year 2006 uponthe adoption of SFAS No. 123(R). As a result of the accelerated vesting,the Company recorded $6.0 million in non-cash compensation charge, of which$3.9 million is related to the excess of the intrinsic value over the fairmarket value of the Company’s stock on the acceleration date of those optionsthat would have been forfeited or expired unexercised had the vesting not beenaccelerated, and $2.1 million is related to the recognition of outstandingRSUs, including $0.3 million for the excess of the intrinsic value over thefair market value of the Company’s stock on the acceleration date.  Indetermining the forfeiture rates of the stock options, the Company reviewed theunvested options’ original life, time remaining to vest and whether theseoptions were held by officers and directors of the Company.  Thecompensation charge is adjusted in future period financial results as actualforfeitures are realized.  For the threemonths ended September 30, 2005, there were no material changes in actualforfeitures from estimates.

 

26

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12.                     EnvironmentalMatters

 

Federal, state, foreign and local laws andregulations impose various restrictions and controls on the storage, use anddischarge of certain materials, chemicals and gases used in semiconductormanufacturing processes. The Company does not believe that compliance with suchlaws and regulations as now in effect will have a material adverse effect onthe Company’s results of operations, financial position or cash flows.

 

However, under some of these laws and regulations, the Company could beheld financially responsible for remedial measures if properties arecontaminated or if waste is sent to a landfill or recycling facility thatbecomes contaminated. Also, the Company may be subject to common law claims ifit releases substances that damage or harm third parties. The Company cannotmake assurances that changes in environmental laws and regulations will notrequire additional investments in capital equipment and the implementation ofadditional compliance programs in the future, which could have a materialadverse effect on the Company’s results of operations, financial position orcash flows, as could any failure by the Company to comply with environmentallaws and regulations.

 

The Company and Rachelle Laboratories, Inc. (“Rachelle”),a former operating subsidiary of the Company that discontinued operations in1986, were each named a potentially responsible party (“PRP”) in connectionwith the investigation by the United States Environmental Protection Agency (“EPA”)of the disposal of allegedly hazardous substances at a major superfund site inMonterey Park, California (“OII Site”). Certain PRPs who settled certain claimswith the EPA under consent decrees filed suit in Federal Court in May 1992against a number of other PRPs, including the Company, for cost recovery andcontribution under the provisions of the Comprehensive Environmental Response,Compensation and Liability Act (“CERCLA”). IR has settled all outstandingclaims that have arisen against it out of the OII Site.  No claims against Rachelle have beensettled.  The Company has taken theposition that none of the wastes generated by Rachelle were hazardous.

 

Counselfor Rachelle received a letter dated August 2001 from the U.S. Departmentof Justice, directed to all or substantially all PRPs for the OII Site,offering to settle claims against such parties for all work performed throughand including the final remedy for the OII Site.  The offer required a payment from Rachelle inthe amount of approximately $9.3 million in order to take advantage of thesettlement.  Rachelle did not accept theoffer.

 

In as much as Rachelle has not accepted thesettlement, the Company cannot predict whether the EPA or others would attemptto assert an action for contribution or reimbursement for monies expended toperform remedial actions at the OII Site. The Company cannot predict the likelihood that the EPA or such others wouldprevail against Rachelle in any such action. It remains the position of Rachelle that its wastes were nothazardous.  The Company’s insurer has notaccepted liability, although it has made payments for defense costs for thelawsuit against the Company.  The Companyhas made no accrual for potential loss, if any; however, an adverse outcomecould have a material adverse effect on the Company’s results of operations andcash flows.

 

27

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The Company received aletter in June 2001 from a law firm representing UDT Sensors, Inc.relating to environmental contamination (chlorinated solvents such astrichlorethene) assertedly found in UDT’s properties in Hawthorne,California.  The letter alleges that theCompany operated a manufacturing business at that location in the 1970’s and/or1980’s and that it may have liability in connection with the claimedcontamination.  The Company has made noaccrual for any potential losses since there has been no assertion of specificfacts on which to form the basis for determination of liability.

 

13.                     Litigation

 

In June 2000, the Company filed suit in FederalDistrict Court in Los Angeles, California against IXYS Corporation, alleginginfringement of its key U.S. patents 4,959,699; 5,008,725 and 5,130,767.  The suit sought damages and other reliefcustomary in such matters.  The FederalDistrict Court entered a permanent injunction, effective on June 5, 2002,barring IXYS from making, using, offering to sell or selling in, or importinginto the United States, MOSFETs (including IGBTs) covered by the Company’s U.S.patents 4,959,699; 5,008,725 and/or 5,130,767. In August 2002, the Court of Appeals for the Federal Circuit stayedthat injunction, pending appeal on the merits. In that same year, following trial on damages issues, a Federal DistrictCourt jury awarded the Company $9.1 million in compensatory damages.  The Federal District Court subsequentlytripled the damages, increasing the award from $9.1 million to approximately $27.2million, and ruled that the Company is entitled to an additional award ofreasonable attorney’s fees for a total monetary judgment of about $29.5million.  In March 2004, the U.S.Court of Appeals for the Federal Circuit reversed the summary judgment grantedthe Company by the Federal District Court in Los Angeles of infringement byIXYS of the Company’s U.S. patents 4,959,699; 5,008,725 and 5,130,767. TheFederal Circuit reversed in part and vacated in part infringement findings ofthe District Court, granted IXYS the right to present certain affirmativedefenses, and vacated the injunction against IXYS entered by the DistrictCourt. The ruling by the Federal Circuit had the effect of vacating the damagesjudgment obtained against IXYS. The Federal Circuit affirmed the District Court’srulings in the Company’s favor regarding the validity and enforceability of thethree Company patents. Following remand, a federal court jury in Los Angeles,California held on September 15, 2005, that IXYS elongated octagonalMOSFETs and IGBTs infringed the Company’s 4,959,699 patent but did not infringethe Company’s 5,008,725 and 5,130,767 patents. On October 6, 2005 the juryawarded the Company $6.2 million in damages. Further proceedings are requiredin the trial court before final judgment can be entered. The Companyanticipates that IXYS will appeal the judgment. No amount has been recognized in the income statement from the pendinglitigation for the three months ended September 30, 2005.

 

14.                     IncomeTaxes

 

The Company’s effective tax provision for the three monthsended September 30, 2005 and 2004 was 27.5 percent and 24.0 percent,respectively, rather than the U.S. federal statutory tax provision of 35percent as a result of lower statutory tax rates in certain foreignjurisdictions, the benefit of foreign tax credits and research

 

28

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and development credits,partially offset by state taxes and certain foreign losses without foreign taxbenefit.

 

In December 2004, theFASB issued FASB Staff Position No. 109-2, “Accounting and DisclosureGuidance for the Foreign Earnings Repatriation Provision within the AmericanJobs Creations Act of 2004”, which introduces a limited time 85 percentdividends received deduction on the repatriation of certain foreign earnings toa U.S. tax payer (“repatriation provision”), provided certain criteria aremet.  The Company is currently evaluatingthe range of possible amounts of unremitted earnings that may be repatriated asa result of the repatriation provision; the related range of income tax effectsof such repatriation cannot be reasonably estimated at this time.

 

15.                     Related PartyTransactions

 

Asdiscussed in Note 3, the Company holds as strategic investment common stock ofNihon Inter Electronics Corporation (“Nihon”), a related party.  At September 30, 2005 and June 30,2005, the Company owned approximately 17.5 percent of the outstanding shares ofNihon.  As previously reported, theCompany’s Chief Financial Officer was the Chairman of the Board and a directorof Nihon until June 28, 2005.  Inaddition, the general manager of the Company’s Japan subsidiary is a directorof Nihon.  Although the Company has amember on the Board of Directors of Nihon, it does not exercise significant influence,and accordingly, the Company records its interest in Nihon based on readilydeterminable market values in accordance with SFAS No. 115 (see Note 3,“Cash and Investments”).

 

16.                     SubsequentEvent

 

On November 1, 2005, the Company’s Board ofDirectors authorized and the Company announced a stock repurchase program,under which up to $100 million of the Company’s common shares may berepurchased without prior notice, through block trades or otherwise.  The Company intends that any sharesrepurchased will be held as treasury shares that may be used for generalcorporate purposes.  From the date of therepurchase through the following thirty days, no amounts under the Company’s$150 million credit facility will be available. Shares repurchased will be paid with the Company’s existing cash andcash investments.  As of November 11,2005, no shares had been repurchased under the program.

 

29

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

 

The following discussion of our financial condition and results ofoperations should be read together with the consolidated financial statementsand notes to consolidated financial statements included elsewhere in this Form 10-Q.  Except for historic information containedherein, the matters addressed in this Item 2 constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended.  Forward-looking statementsmay be identified by the use of terms such as “anticipate,” “believe,” “expect,”“intend,” “project,” “will,” and similar expressions.  Such forward-looking statements are subjectto a variety of risks and uncertainties, including those discussed under theheading “Statement of Caution Under the Private Securities Litigation ReformAct of 1995” and elsewhere in this Quarterly Report on Form 10-Q, thatcould cause actual results to differ materially from those anticipated by theCompany.  We undertake no obligation toupdate these forward-looking statements to reflect events or circumstancesafter the date of this report or to reflect actual outcomes.

 

**Overview of Results of Operations for the Three Months Ended September 30,2005**

 

We report our results in six segments: Computing and Communications (“C&C”),Energy-Saving Products (“ESP”), Aerospace and Defense (“A&D”), IntellectualProperty (“IP”), Commodity Products (“CP”) and Non-Aligned Products (“NAP”).  We include our C&C, ESP, A&D and IPsegments in our Focus Product group, and our CP and NAP segments in ourNon-Focus Product group.

 

For the three months ended September 30, 2005, consolidatedrevenues were $272.6 million compared to $312.2 million in the prior year threemonths ended September 30, 2004. Revenues for our Focus Products were $201.9 million (74.1 percent ofrevenues) and $221.4 million (70.9 percent of revenues) for the three monthsended September 30, 2005 and 2004, respectively.  Revenues for our Non-Focus Products were$70.7 million (25.9 percent of revenues) and $90.8 million (29.1 percent ofrevenues) for the three months ended September 30, 2005 and 2004,respectively.  Revenues for the three months ended September 30,2005 were lower than the prior year. Some of the factors that adversely affected revenues for the quarterended September 30, 2005 included price pressure on certain componentproducts, changes in distributor purchasing patterns and a logisticsbottleneck that delayed certain shipments at the end of the fiscal quarter in our A&D segment.  Additionally, in our C&C and ESPsegments, revenues were inhibited by and lower due to capacity constraints andan inventory mix that was different than the demand for certain products.  For the three months ended December 31,2005, we expect our overall revenues to increase by only one to four percent, inpart, reflecting continuing capacity limitations in our C&C and ESP segments.

 

Forthe quarter ended September 30, 2005, total inventory increased by $16.2million to $193.8 million from $177.6 million at June 30, 2005.  Finished goods increased by $13.3 million asa result of an inventory build that was different than the demand for certainproducts principally within our C&C and ESP segments in the fiscal firstquarter.

 

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Forthe three months ended September 30, 2005, gross profit margin was 40.7percent compared to 42.7 percent for the prior year three months ended September 30,2004.  Gross profit margin for our FocusProducts were 48.8 percent and 49.2 percent for the three months ended September 30,2005 and 2004, respectively.  Gross profitmargin for our Non-Focus Products was 17.4 percent and 27.0 percent for thethree months ended September 30, 2005 and 2004, respectively.  The gross profit margin declined primarily dueto price declines, product mix, and profit sharing and employee stock optionexpense.  We expect our overall Company grossmargin for the three months ended December 31, 2005 to be approximatelytwo percentage points lower than the three months ended September 30,2005, largely due to pricing pressures, product mix and costs associated with ourNewport, Wales facility.

 

Revenuesas a percentage of total product revenues based on sales location wereapproximately 28 percent, 50 percent and 22 percent for North America(primarily United States), Asia and Europe, respectively, for the three monthsended September 30, 2005.  Revenuesas a percentage of total product revenues based on sales location wereapproximately 30 percent, 47 percent and 23 percent for North America(primarily United States), Asia and Europe, respectively, for the three monthsended September 30, 2004.

 

Asof September 30, 2005, we have substantially completed our restructuringactivities previously announced in 2002 and 2003.  For the three months ended September 30,2005, we recorded $4.3 million in total restructuring-related charges,consisting of: $3.1 million for asset impairment, plant closure costs and othercharges and $1.2 million for severance-related costs.  We estimate that charges associated with therestructuring will be approximately $280 million.  These charges will consist of approximately$220 million for asset impairment, plant closure costs and other charges, $6million of raw material and work-in-process inventory, and approximately $54million for severance-related charges.  Of the $280 million in total charges, weexpect cash charges to be approximately $110 million.  As ofSeptember 30, 2005, we have realized annualized savings of approximately$80 million from the restructuring activities, with approximately 70 percent ofthat savings affecting cost of goods sold. We are also continuing with our plan to review product lines andproducts not aligned with our long-term objectives to increase our overall grossmargins.

 

Asof September 30, 2005, demand for our Focus Products, primarily thosereported in our C&C and ESP segments, exceeded our worldwide capacity.  To help address our capacity limitations, we arestarting production on our new eight-inch sub-micron wafer fabrication facilityin Newport, Wales in the December 2005 quarter.  During the three months ended September 30,2005, we spent $37.0 million in capital expenditure, of which $13.9 million wasat the Newport, Wales facility.  Weanticipate that nearly 70 percent of capital expenditures for fiscal year 2006will be in the first half of the year.

 

Weadopted Statement of Financial Accounting Standards No. 123(R), “Share-BasedPayment” (“SFAS No. 123(R)”) that became effective for us in the fiscalfirst quarter ended September 30, 2005. SFAS No. 123(R) required that we recognize the fair value of equityawards granted to our employees as compensation expense in the income statementover the requisite service period.  Forthe three months ended September 30, 2005, we recognized $0.4 million instock-based compensation expense as a result of the adoption of SFAS No. 123(R).  As a consequence of SFAS No. 123(R), we havereduced

 

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thenumber of employees who will receive stock options.  To offset the impact of the option grantreduction and to continue to attract and retain the industry’s best qualifiedtechnical, sales, marketing and managerial personnel, we have established a newprofit sharing plan that became effective beginning in the fiscal year 2006.  For the three months ended September 30,2005, we recognized $2.8 million in profit sharing plan expense.

 

During the threemonths ended September 30, 2005, operating activities generated cash flowof $13.8 million.  Our cash, cashequivalents and cash investments totaled $931.9 million at September 30,2005.  Additionally, we have $128.3million in unused credit facilities for operating needs.

 

On November 1,2005, our Board of Directors authorized and we announced a stock repurchaseprogram, under which up to $100 million of our common shares may be repurchasedwithout prior notice, through block trades or otherwise.  We intend that any shares repurchased will beheld as treasury shares that may be used for general corporate purposes.  As of November 11, 2005, no shares hadbeen repurchased under the program.

 

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**Resultsof Operations for the Three Months Ended September 30, 2005 Compared withthe Three Months Ended September 30, 2004**

 

Thefollowing table sets forth certain items as a percentage of revenues (inmillions except percentages):

 
| ** **                                                 | ** ** | **Three Months Ended  September 30,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Revenues                                                   |       | $                                          | 272.6      |   | 100.0 | % | $ | 312.2 |   | 100.0 | % |
| Cost of sales                                              |       | 161.7                                      |       | 59.3 |   | 178.8 |   | 57.3 |   |
|                                                       |       |                                       |       |   |   |   |   |   |   |
| Gross profit                                               |       | 110.9                                      |       | 40.7 |   | 133.4 |   | 42.7 |   |
| Selling and  administrative expense                        |       | 45.2                                       |       | 16.7 |   | 46.4 |   | 14.9 |   |
| Research and  development expense                          |       | 25.2                                       |       | 9.2 |   | 25.4 |   | 8.1 |   |
| Amortization of  acquisition-related intangible assets     |       | 1.5                                        |       | 0.5 |   | 1.4 |   | 0.5 |   |
| Impairment of  assets, restructuring and severance charges |       | 4.3                                        |       | 1.6 |   | 6.7 |   | 2.1 |   |
| Other expense  (income), net                               |       | 0.1                                        |       | 0.0 |   | (0.0 | ) | (0.0 | ) |
| Interest  (income) expense, net                            |       | (1.6                                       | )          | (0.6 | ) | 1.7 |   | 0.5 |   |
|                                                       |       |                                       |       |   |   |   |   |   |   |
| Income before  income taxes                                |       | 36.2                                       |       | 13.3 |   | 51.8 |   | 16.6 |   |
| Provision for  income taxes                                |       | 10.0                                       |       | 3.7 |   | 14.2 |   | 4.6 |   |
|                                                       |       |                                       |       |   |   |   |   |   |   |
| Net income                                                 |       | $                                          | 26.2       |   | 9.6 | % | $ | 37.6 |   | 12.0 | % |

 

Revenues and Gross Margin

 

Forthe three months ended September 30, 2005, consolidated revenues decreasedby 12.7 percent from the prior year three months ended September 30,2004.  Revenues for the three monthsended September 30, 2005 were lower than the prior year, due to combinationof price pressure on certain component products, changes in distributorpurchasing patterns, and a logistics bottleneck that delayed certain shipmentsat the end of the fiscal quarter in our A&D segment.  Additionally, in our C&C and ESPsegments, revenues were inhibited by and lower due to capacity constraints andan inventory mix that was different than the demand for certain products.  Gross profit margin was 40.7 percent for thethree months ended September 30, 2005, compared to 42.7 percent in theprior year three months ended September 30, 2004.  The gross profit margin declined primarilydue to price declines, product mix, profit sharing and employee stock optionsexpense.  In general, our wafermanufacturing facilities serve all business units as necessary and theiroperating costs are reflected in the segments’ cost of revenues on the basis ofproduct cost.  General manufacturingoverhead and variances are allocated to the segments based on the percentage oftotal revenues.

 

Forthe quarter ended September 30, 2005, total inventory increased by $16.2million to $193.8 million from $177.6 million at June 30, 2005.  Finished goods increased by $13.3 million asa result of an inventory build that was different than the demand for certainproducts principally within our C&C and ESP segments in the fiscal firstquarter.

 

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Revenuesas a percentage of total product revenues based on sales location wereapproximately 28 percent, 50 percent and 22 percent for North America(primarily United States), Asia and Europe, respectively, for the three monthsended September 30, 2005.  Revenuesas a percentage of total product revenues based on sales location wereapproximately 30 percent, 47 percent and 23 percent for North America(primarily United States), Asia and Europe, respectively, for the three monthsended September 30, 2004.

 

Revenues for our Focus Products were $201.9million (74.1 percent of revenues) and $221.4 million (70.9 percent ofrevenues) for the three months ended September 30, 2005 and 2004,respectively.  Revenues for our Non-FocusProducts were $70.7 million (25.9 percent of revenues) and $90.8 million (29.1percent of revenues) for the three months ended September 30, 2005 and2004, respectively.

 

Revenues and gross margin by business segments are as follows (inthousands except percentages):

 
| ** **                    | ** ** | **Three Months Ended**      | ** ** |
|-------------------------------|------------|-----------------------------|------------|
| ** **                    | ** ** | **September 30, 2005** | ** ** | **September 30, 2004** | ** ** |
| **Business Segment**          | ** ** | **Revenues**                | ** ** | **Percentage  of Total** | ** ** | **Gross  Margin** | ** ** | **Revenues** | ** ** | **Percentage  of Total** | ** ** | **Gross  Margin** | ** ** |
| Computing and  Communications |       | $                           | 89,640     |   | 32.9 | % | 41.6 | % | $ | 105,991 |   | 33.9 | % | 43.7 | % |
| Energy-Saving  Products       |       | 72,386                      |       | 26.6 |   | 52.4 |   | 73,151 |   | 23.4 |   | 53.6 |   |
| Aerospace and  Defense        |       | 29,401                      |       | 10.8 |   | 43.8 |   | 32,277 |   | 10.4 |   | 41.3 |   |
| Intellectual  Property        |       | 10,440                      |       | 3.8 |   | 100.0 |   | 10,019 |   | 3.2 |   | 100.0 |   |
|                          |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Subtotal Focus Products       |       | 201,867                     |       | 74.1 |   | 48.8 |   | 221,438 |   | 70.9 |   | 49.2 |   |
|                          |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Commodity  Products           |       | 42,152                      |       | 15.4 |   | 19.3 |   | 59,524 |   | 19.1 |   | 30.9 |   |
| Non-Aligned  Products         |       | 28,554                      |       | 10.5 |   | 14.6 |   | 31,263 |   | 10.0 |   | 19.6 |   |
| Subtotal Non-Focus Products   |       | 70,706                      |       | 25.9 |   | 17.4 |   | 90,787 |   | 29.1 |   | 27.0 |   |
|                          |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated total            |       | $                           | 272,573    |   | 100.0 | % | 40.7 | % | $ | 312,225 |   | 100.0 | % | 42.7 | % |

 

*Computing and Communications (“C&C”)*

 

Our Computing and Communication segment iscomprised of our Power Management ICs, Advanced Circuit Devices, includingiPowirTM multi-chip modules and DirectFETTM solutions, andPower Components (primarily MOSFET Power Components) that address servers andhigh-end desktops, notebooks, communications networking, and digitally-orientedconsumer products like game consoles. Our C&C products are also used in digital television, liquid crystaldisplays (“LCDs”), portable handheld devices and cellular phones.

 

C&C revenues declined by $16.4 million, 15.4percent, compared to the prior year three months ended September 30, 2004,primarily reflecting price pressures on certain of our component products and changesin our distributor purchasing patterns. Additionally, C&C revenues were inhibited by and lower due to capacityconstraints and an inventory mix that was different than the demand for certainproducts.  To help address our capacitylimitations, we are starting production

 

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on our new eight-inch sub-micron waferfabrication facility in Newport, Wales in the December 2005 quarter.

 

Gross margin for C&C was 41.6 percent forthe three months ended September 30, 2005, compared to 43.7 percent forthe prior year three months ended September 30, 2004.  Gross margin declined reflecting pricedeclines, product mix, profit sharing and employee stock options expense, partiallyoffset by increased sales of higher margin DirectFETs and FlipFETs into thecomputing and communications market.

 

*Energy-SavingProducts (“ESP”)*

 

Our Energy-Saving Product segment iscomprised of our Power Management ICs, Advanced Circuit Devices and PowerComponents (primarily HEXFET and IGBT Power Components) that provide solutionsfor variable speed motion control in energy-saving appliances (such as washingmachines, refrigerators and air conditioners), and industrial systems (such asfans, pumps and compressors), advanced lighting products (including fluorescentlamps, high intensity discharge (“HID”) lamps, cold cathode fluorescent (“CCFL”)tubes and light emitting diodes (“LED”) lighting), advanced automotivesolutions (primarily diesel injection, electric-gasoline hybrid and electricpower steering systems), and consumer applications (for example, plasma TVs anddigital-audio units).

 

ESP revenues for the three months ended September 30,2005, declined by $0.8 million, 1.0 percent, compared to the prior year threemonths ended September 30, 2004, primarily due to price pressures oncertain of our component products and changes in our distributor purchasingpatterns.  Additionally, ESP revenueswere inhibited bycapacity constraints and an inventory mix that was different than the demand.  The negative impact on the ESP segment’s revenuesfrom these factors was partially offset by increased sales of our high voltageICs into the consumer and automotive markets.

 

Gross margin for ESP was 52.4 percent for thethree months ended September 30, 2005, compared to 53.6 percent for the threemonths ended September 30, 2004. The gross margin decline reflected primarily price declines, productmix, profit sharing and employee stock options expense.

 

*Aerospaceand Defense (“A&D”)*

 

The Aerospace and Defense segment iscomprised of advanced power management solutions, such as radiation-hardenedpower management modules, radiation-hardened Power Components, and otherhigh-reliability Power Components that address power management requirements insatellites, launch vehicles, aircrafts, ships, submarines and other defense andhigh-reliability applications.  Revenuesfor the three months ended September 30, 2005, declined by $2.9 million, 8.9percent, from the three months ended September 30, 2004, primarilyreflecting a logistics bottleneck that delayed shipments at the end of thefiscal quarter.  This revenue is includedin the fiscal second quarter ending December 31, 2005 operating results,and we expect A&D revenues to increase from the September 2005quarter.

 

Gross margin for the A&D segment increasedto 43.8 percent for the fiscal quarter ended September 30, 2005, from 41.3percent in the comparable prior year period,

 

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reflecting manufacturing efficiencies and restructuringcost savings.  Gross margin improvementwas partially offset by profit sharing and employee stock option expense.

 

*IntellectualProperty (“IP”)*

 

**The Intellectual Property segmentreports our royalty income from licensing our intellectual property to thirdparties, which may include claims settlement from successful defense of our licenses.  Our licensed MOSFET patents expire between2005 and 2010, with the broadest remaining in effect until 2007 and 2008.  We continue to commit to research anddevelopment to generate new patents and other intellectual property andconcentrate on incorporating our technologies into our Focus Products.**

** **

**IP revenues were $10.4 million and$10.0 million for the three months ended September 30, 2005 and 2004,respectively.**

 

*CommodityProducts (“CP”)*

 

The Commodity Product segment is comprisedprimarily of older-generation Power Components that are sold with marginsgenerally below our strategic targets and are typically commodity in nature.  These products have widespread use throughoutthe power management products industry and are often complementary to many ofour Focus Products offerings or allow us to provide a full range of customer orapplication offerings.  We often offerthese products to take advantage of cross-selling opportunities for our otherproduct families.

 

For the three months ended September 30,2005, CP revenues were $42.2 million, down 29.1 percent from $59.5 million forthe three months ended September 30, 2004, reflecting a one-month shutdown at one of our European facilities in the current year versus a one-week shutdown in the prior year quarter, changes in our distributor purchasing patterns,price pressures on our component products and discontinuation of certainbusiness opportunities since the prior year.

 

Gross margin for CP was 19.3 percent for thefiscal quarter ended September 30, 2005, compared to 30.9 percent in the comparableprior year quarter, reflecting price pressures, profit sharing and employeestock option expense.

 

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*Non-AlignedProducts (“NAP”)*

 

**The Non-Aligned Product segmentincludes businesses, product lines or products that we are targeting forrealignment, whether by changing the business model for how we participate inthe business, or by divestiture or other strategic transactions, such as jointventure or partnership.  We plan tosupport our Non-Focus Products to the extent we believe appropriate, to manage,maintain or increase their value in line with our long-term goals for thosesegments.  Currently, product linesreported in this segment include certain modules, rectifiers, diodes andthyristors used in the automotive, industrial, welding and motor controlapplications.**

** **

**Revenues for the three months endedSeptember 30, 2005 were $28.6 million, decreasing 8.7 percent from $31.2million in the three months ended September 30, 2004, reflecting negativeimpacts from the restructuring of certain of our European facilities and the Eurosforeign currency fluctuations.**

** **

Gross margin for our NAP segment was 14.6percent for the three months ended September 30, 2005, compared to 19.6 percentfor the three months ended September 30, 2004, reflecting lowermanufacturing efficiency and product mix.

 

Sellingand Administrative Expense

 

For the three months ended September 30,2005, selling and administrative expense was $45.2 million (16.6 percent ofrevenues), compared to $46.4 million (14.9 percent of revenues) for the threemonths ended September 30, 2004. The increase in the selling and administrative expense ratio primarilyreflected a lower revenue base in the current year.  The absolute selling and administrativeexpense decreased reflecting lower sales commissions and other variable costs paidon a lower revenue base, partially offset by higher Sarbanes-Oxley Rule 404compliance, profit sharing and employee stock options expense. 

 

Researchand Development Expenses

 

For the three months ended September 30,2005 and 2004, research and development expense was $25.2 million and $25.4 million (9.2 percentand 8.1 percent of revenues), respectively, reflecting primarily continueddevelopment activities on our Focus Products.

 

Impairment ofAssets, Restructuring and Severance

 

Duringfiscal 2003 second quarter ended December 31, 2002, we announced ourrestructuring initiatives.  Under ourrestructuring initiatives, our goal was to reposition us to better fit themarket conditions and de-emphasize the commodity business.  Our restructuring plan included consolidatingand closing certain manufacturing sites, upgrading equipment and processes indesignated facilities and discontinuing production in a number of others thatcannot support more advanced technology platforms or products.  We also planned to lower overhead costsacross our support organizations.  Wehave substantially completed these restructuring activities as of September 30,2005.  We expect to complete theremaining activities, primarily the closing of a fabrication line at ElSegundo, California by fiscal year end 2006 or sooner.

 

Weestimate that charges associated with the restructuring will be approximately$280 million.  These charges will consistof approximately $220 million for asset impairment,

 

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plantclosure costs and other charges, $6 million of raw material and work-in-processinventory, and approximately $54 million for severance.  Of the $280 million in total charges, weexpect cash charges to be approximately $110 million.  As of September 30, 2005,we have realized annualized savings of approximately $80 million from therestructuring activities, with approximately 70 percent of that savingsaffecting cost of goods sold.

 

For the three months ended September 30, 2005, we recorded$4.3 million in total restructuring-related charges, consisting of: $3.1million for asset impairment, plant closure costs and other charges and $1.2million for severance-related costs.  Forthe three months ended September 30, 2004, we recorded $6.7 million in total restructuring-related charges,consisting of: $4.9 million for impairment, plant closure costs and othercharges, and $1.8 million for severance-related costs.  Restructuring-related costswere measured in accordance with SFAS No. 146, “Accounting for the CostsAssociated with Exit or Disposal Activities”. Asset impairments were calculated in accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”.  In determining the asset groups, we groupedassets at the lowest level for which independent identifiable cash flowsinformation was available.  Indetermining whether an asset was impaired we evaluated undiscounted future cashflows and other factors such as changes in strategy and technology.  The undiscounted cash flows from our initialanalyses were less than the carrying amount for certain of the asset groups,indicating impairment losses.  Based onthis, we determined the fair value of these asset groups using the presentvalue technique, by applying a discount rate to the estimated future cash flowsthat is consistent with the rate used when analyzing potential acquisitions.

 

As of September 30, 2005, we had recorded $265.7 millionin total charges, consisting of: $213.2 million for asset impairment, plantclosure costs and other charges, $6.0 million for raw material andwork-in-process inventory charges, and $46.5 million for severance-relatedcosts.  Components of the $213.2 millionasset impairment, plant closure and other charges included the following items:

 

•                  As we emphasize more advancedgeneration planar products, we expect the future revenue stream from our lessadvanced facilities in Temecula, California to decrease significantly.  These facilities had a net book value of$138.3 million and were written down by $77.7 million.  It is expected that these facilities willcontinue in use until approximately December 2007 and the remaining basisis being depreciated over units of production during this period.  It is assumed that salvage value will equaldisposition costs.

 

•                  As we emphasize more advancedgeneration trench products, we expect the future revenue stream from our lessadvanced facility in El Segundo, California to decrease significantly.  This facility had a net book value of $59.5 millionand was written down by $57.2 million. This facility had significantly reduced production as of fiscal yearended June 30, 2003, and is being used primarily for research anddevelopment activities.

 

•                  As we emphasize more advancedgeneration Schottky products, we expect the future revenue stream from our lessadvanced facility in Borgaro, Italy to decrease significantly.  This facility had a net book value of $20.5million and was written down by $13.5 million. It is expected that this facility will continue in use untilapproximately

 

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December 2007 and the remaining basis is beingdepreciated over units of production during this period.  It is assumed that salvage value will equaldisposition costs.

 

•                  We are restructuring ourmanufacturing activities in Europe. Based on a review of our Swansea, Wales facility, a general-purposemodule facility, we determined in the December 2002 quarter that thisfacility would be better suited to focus only on automotive applications.  The general-purpose assembly assets in thisfacility, with a net book value of $13.6 million, were written down by $8.2million.  In addition, we have completedthe move of our manufacturing activities at our automotive facility in Krefeld,Germany to our Swansea, Wales and Tijuana, Mexico facilities as of September 30,2005.  We have also moved the productionfrom our Venaria, Italy facility to our Borgaro, Italy and Mumbai, Indiafacilities, which was completed as of December 31, 2003.  We stopped manufacturing activities in ourOxted, England facility as of September 30, 2003.

 

•                  We have eliminated themanufacturing of our non-space military products in our Santa Clara, Californiafacility as of July 31, 2004. Currently, subcontractors handle ournon-space qualified products formerly manufactured in this facility.  We are also transitioning the assembly andtest of non-space Power Components from our Leominster, Massachusetts facilityto our Tijuana, Mexico facility, and expect to complete this activity bycalendar year end 2005.  Associated withthis reduction in manufacturing activities, certain assets with a net bookvalue of $4.0 million were written down by $2.0 million.

 

•                  $54.6 million in othermiscellaneous items were charged, including $45.8 million in relocation costsand other impaired asset charges and $8.8 million in contract termination andsettlement costs.

 

As a result of the restructuring initiatives, certain rawmaterial and work-in-process inventories were impaired, including products thatcould not be completed in other facilities, materials that were not compatiblewith the processes used in the alternative facilities, and materials such asgases and chemicals that could not readily be transferred.  Based on these factors we wrote down theseinventories, with a carrying value of $98.2 million, by $6.0 million.  For the three months ended September 30,2005 and 2004, we had disposed of $0 and $0.5 million, respectively, of theseinventories, which did not have a material impact on gross margin for the threemonths then ended.  As of September 30,2005, $1.2 million of these inventories remained to be disposed.

 

Ourrestructuring activities are expected to result in severance charges ofapproximately $54 million through June 2006.  Below is a table of approximate severancecharges by major activity and location:

 
| **Location**                                           | ** ** | **Activity**                                                  | ** ** | **Amount** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------------|------------|------------|------------|
|                                                   |       |                                                          |       |       |       |
| El Segundo, California                                 |       | Close manufacturing facilities                                |       | $          | 10 million |   |
| Santa Clara, California and  Leominster, Massachusetts |       | Eliminate certain manufacturing activities                    |       | 4 million  |       |
| Oxted, England                                         |       | Close manufacturing facility                                  |       | 9 million  |       |
| Venaria, Italy                                         |       | Move manufacturing to India and discontinue certain  products |       | 11 million |       |
| Company-wide                                           |       | Realign business  processes                                   |       | 20 million |       |
| Total                                                  |       |                                                          |       | $          | 54 million |   |
|                                                        |            |                                                               |            |            |            |  |  |

 

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Todate, of the $54 million noted above, we have recorded $46.5 million inseverance-related charges: $41.4 million in severance termination costs relatedto approximately 1,200 administrative, operating and manufacturing positions,and $5.1 million in pension termination costs at our manufacturing facility inOxted, England.  The severance chargesassociated with the elimination of positions, which included the 1,200 personsnotified to date, had been and will continue to be recognized over the futureservice period, as applicable, in accordance with SFAS No. 146, “Accountingfor the Costs Associated with Exit or Disposal Activities”.  We measured the total termination benefits atthe communication date based on the fair value of the liability as of thetermination date.  A change resultingfrom a revision to either the timing or the amount of estimated cash over thefuture service period will be measured using the credit-adjusted risk-free ratethat was used to initially measure the liability.  The cumulative effect of the change will berecognized as an adjustment to the liability in the period of the change.

 

Infiscal 2002, we had recorded an estimated $5.1 million in severance costsassociated with the acquisition of TechnoFusion GmbH in Krefeld, Germany.  In fiscal 2003, we finalized our plan anddetermined that total severance would be approximately $10 million, andaccordingly, we adjusted purchased goodwill by $4.8 million.  We communicated the plan and the eliminationof approximately 250 positions primarily in manufacturing to its affectedemployees at that time.  The associatedseverance is expected be paid by calendar year end 2005.

 

Thefollowing summarizes our severance accrued related to the June 2001restructuring, the TechnoFusion acquisition and the December 2002restructuring plan for the three months ended September 30, 2005 and thefiscal year ended June 30, 2005. Severance activity related to the elimination of 29 administrative andoperating personnel as part of the previously reported restructuring in thefiscal quarter ended June 30, 2001, is also disclosed.  The remaining June 2001 severancerelates primarily to certain legal accruals associated with that restructuring,which will be paid or released as the outcome is determined (in thousands):

 
| ** **                                                                                          | ** ** | **June  2001  Restructuring** | ** ** | **December  2002  Restructuring** | ** ** | **TechnoFusion  Severance  Liability** | ** ** | **Total  Severance  Liability** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|----------------------------------------|------------|---------------------------------|------------|
|                                                                                                |       |                          |       |                              |       |                                   |       |                            |       |
| Accrued  severance, June 30, 2004                                                              |       | $                             | 697        |                              | $          | 7,180                                  |       | $                               | 6,067      |   | $ | 13,944 |   |
| Costs incurred or charged to “impairment of assets,  restructuring and severance charges” |       | —                        |       | 8,677                             |       | —                                 |       | 8,677                           |       |
| Costs paid                                                                                          |       | (326                          | )          | (7,810                            | )          | (3,770                                 | )          | (11,906                         | )          |
| Foreign exchange  impact                                                                            |       | —                        |       | 77                                |       | (190                                   | )          | (113                            | )          |
|                                                                                                |       |                          |       |                              |       |                                   |       |                            |       |
| Accrued  severance, June 30, 2005                                                              |       | $                             | 371        |                              | $          | 8,124                                  |       | $                               | 2,107      |   | $ | 10,602 |   |
| Costs incurred or charged to “impairment of assets,  restructuring and severance”         |       | —                        |       | 1,231                             |       | —                                 |       | 1,231                           |       |
| Costs paid                                                                                          |       | (64                           | )          | (3,055                            | )          | (406                                   | )          | (3,525                          | )          |
| Foreign exchange  impact                                                                            |       | —                        |       | (14                               | )          | (14                                    | )          | (28                             | )          |
| Accrued  severance, September 30, 2005                                                         |       | $                             | 307        |                              | $          | 6,286                                  |       | $                               | 1,687      |   | $ | 8,280 |   |

 

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Other Income and Expenses

 

Otherincome (expense) income was $0.1 million and ($0.04) million for the threemonths ended September 30, 2005 and 2004, respectively.

 

Interest Income and Expenses

 

Interest income was $7.1 million and $3.3 million for the three monthsended September 30, 2005 and 2004, respectively, reflecting higherprevailing interest rates on higher average cash and cash investment balance inthe current year.

 

Interestexpense was $5.5 million and $5.1 million for the three months ended September 30,2005 and 2004, respectively, primarily reflecting higher effective interestrate payable on our $550 million convertible subordinated notes outstanding,partially offset by higher income from the mark-to-market adjustments on ourinterest rate swaps (see Notes 4, “Derivative Financial Instruments” and 8, “BankLoans and Long-Term Debt” of theNotes to the unaudited consolidated financial statements, regarding themodification of the effective interest payable on our convertible notes).

 

Income Taxes

 

Our effective tax provision for the three months ended September 30,2005 and 2004 was 27.5 percent and 24.0 percent, respectively, rather than theU.S. federal statutory tax provision of 35 percent, as a result of lowerstatutory tax rates in certain foreign jurisdictions, the benefit of foreigntax credits and research and development credits, partially offset by statetaxes and certain foreign losses without foreign tax benefits.

 

In December 2004,the FASB issued FASB Staff Position No. 109-2, “Accounting and DisclosureGuidance for the Foreign Earnings Repatriation Provision within the AmericanJobs Creations Act of 2004”, which introduces a limited time 85 percentdividends received deduction on the repatriation of certain foreign earnings toa U.S. tax payer (“repatriation provision”), provided certain criteria aremet.  We are currently evaluating therange of possible amounts of unremitted earnings that may be repatriated as aresult of the repatriation provision; the related range of income tax effectsof such repatriation cannot be reasonably estimated at this time.

 

**Liquidity and Capital Resources**

 

At September 30, 2005,we had cash and cash equivalent balances of $359.1 million and cash investmentsin marketable debt securities of $572.8 million.  We also have $128.3 million in unused creditfacilities.  Our investment portfolioconsists of available-for-sale fixed-income, principally investment-gradesecurities as of September 30, 2005.

 

For the three months ended September 30, 2005, cash provided byoperating activities was $13.8 million compared to $23.1 million in thecomparable prior year three months ended September 30, 2004.  Depreciation and amortization adjusted cashflows from operations by $21.5 million. Changes in operating assets and liabilities decreased cash by $44.5 millionduring the three months ended September 30, 2005.  The increase in working capital reflected theincrease in our inventory balance as a result of the build up of inventory thatwas different than the demand for certain products principally within ourC&C and

 

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ESP segments during the fiscal first quarter, and the timing of accountsand other receivable collections, and taxes, salaries, wages and other accrued expensepayments.

 

For the three months ended September 30, 2005, cash used ininvesting activities was $35.1 million.  We purchased $105.3million and sold $111.0 million of cash investments.  Certain prior year’s amounts have been reclassified toconform to the current-year presentation. Auction rate securities are now classified as available-for-salesecurities and reported as short-term cash investments instead of cash and cashequivalents, for all periods presented.  Forthe three months ended September 30, 2004, proceeds from the sale of auctionrate securities decreased net cash used in investing activities by $49.6million.

 

Duringthe three months ended September 30, 2005, we spent $37.0 million incapital expenditure, of which $13.9 million was at the Newport, Wales facility. We anticipate that nearly 70 percent ofcapital expenditures for fiscal year 2006 will be in the first half of theyear.  As of September 30, 2005,demand for our Focus Products exceeded our worldwide capacity.  To help address our capacity limitations, we arestarting production on our new eight-inch sub-micron wafer fabrication facilityin Newport, Wales in the December 2005 quarter.  Purchase order commitments for capitalexpenditures were $26.0 million as of September 30, 2005.  We intend to fund capital expenditures andworking capital requirements through cash and cash equivalents on hand,anticipated cash flow from operations and available credit facilities.

 

Financing activities forthe three months ended September 30, 2005 generated $19.7 million. Proceedsfrom the exercise of employee stock options and stock participation plancontributed $21.8 million.  As of September 30,2005, we had revolving, equipment and foreign credit facilities of $166.6 million,against which $38.2 million had been used. As discussed in Note 4 of the unaudited consolidated financial statements,we are required to obtain irrevocable standby letters of credit in favor of JPMorgan Chase Bank, for $7.5 million plus the collateral requirement for theinterest rate swap transactions, as determined periodically.  At September 30, 2005, $15.8 million inletters of credit were outstanding related to the transactions.  The collateral requirement of the transactionsmay be adversely affected by an increase in the five-year LIBOR curve, adecrease in our stock price, or both.  Wecannot predict what the collateral requirement of the transactions and theletter of credit requirement will be over time. To illustrate the potential impact, had a 10 percent increase in thefive-year LIBOR curve and a 10 percent decrease in our stock price occurred atthe close of the fiscal quarter ended September 30, 2005, our letter ofcredit commitment would have increased by $4.9 million to $20.7 million.  We do not have any off balance sheet arrangements as of September 30,2005.

 

On November 1, 2005,our Board of Directors authorized and we announced a stock repurchase program,under which up to $100 million of our common shares may be repurchased withoutprior notice, through block trades or otherwise.  Any shares repurchased will be paid with ourexisting cash and cash investments.

 

Our $550 million convertiblesubordinated notes are due in July 2007. We anticipate that this debt will be refinanced through public orprivate offerings of debt or equity, or be paid down with our existing cash andcash investments.

 

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We believe that our currentcash and cash investment balances, cash flows from operations and borrowingcapacity, including unused amounts under the $150 million Credit Facility asdiscussed in Note 8 of the unaudited consolidated financial statements, will besufficient to meet our operations in the next twelve months.  Although we believe that our current financialresources will be sufficient for normal operating activities, we may alsoconsider the use of funds from other external sources, including, but notlimited to, public or private offerings of debt or equity.

 

**RecentAccounting Pronouncements**

 

On October 18, 2005, the Financial Accounting Standards Board (“FASB”)issued FASB Staff Position onFinancial Accounting Standard No. 123(R)-2 (“FSP FAS No. 123(R)-2”).FSP FAS No. 123(R)-2 provides guidance on the application of grant date asdefined in FASB Statement No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”).  As apractical accommodation, in determining the grant date of an award, assumingall other criteria in the grant date definition have been met, FSP FAS No. 123(R)-2provides that a mutual understanding of the key terms and conditions of anaward to an individual employee shall be presumed to exist at the date theaward is approved in accordance with the relevant corporate governancerequirements (that is, by the Board or management with the relevant authority)if both of the following conditions are met:

 

a. The award is a unilateralgrant and, therefore, the recipient does not have the ability to negotiate thekey terms and conditions of the award with the employer.

 

b. The key terms and conditions of the award are expected to becommunicated to an individual recipient within a relatively short time period1from the date of approval.

 

The guidance in this FSP iseffective upon initial adoption of SFAS No. 123(R) or if an entity hasadopted SFAS No. 123(R) prior to the issuance of this FSP and did notapply the provisions of FSP FAS 123(R)-2, this FSP will be effective in thefirst reporting period after October 18, 2005, the date the FSP was postedto the FASB website.  We have applied theprovisions under FSP FAS 123(R)-2 in accounting for our equity awards as of July 4,2005, the start of our fiscal year 2006.

 

**CriticalAccounting Policies and Estimates**

 

The consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States which require us to makeestimates and assumptions that affect the reported amounts of assets andliabilities at the date of the consolidated financial statements and revenuesand expenses during the periods reported.  Actual results could differ from thoseestimates.  Information with respect toour critical accounting policies which we believe could have the mostsignificant effect on our reported results and require subjective or complexjudgments is contained in Item 7, Management’s Discussion and Analysis ofFinancial Condition and Results of Operations, of our Annual Report on Form 10-Kfor the fiscal year ended June 30, 2005. We believe that at September 30, 2005, there has been no materialchange to this information.

 

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**Statement of Caution Under the Private SecuritiesLitigation Reform Act of 1995**

 

ThisQuarterly Report on Form 10-Q includes some statements and otherinformation that are not historical facts but are “forward-looking statements”as that term is defined in the Private Securities Litigation Reform Act of1995.  The materials presented can beidentified by the use of forward-looking terminology such as “anticipate,” “believe,”“estimate,” “expect,” “may,” “should,” “view,” or “will” or the negative orother variations thereof.  We cautionthat such statements are subject to a number of uncertainties, and actualresults may differ materially.  Factorsthat could affect our actual results include those set forth below under “Factorsthat May Affect Future Results” and other uncertainties disclosed in ourreports filed from time to time with the Securities and ExchangeCommission.  Unless required by law, weundertake no obligation to publicly update or revise any forward lookingstatements, to reflect new information, future events or otherwise.

 

**Factorsthat May Affect Future Results**

 

***Changes in end market demand ordownturns in the highly cyclical semiconductor industry could affect ouroperating results and the value of our business.***

 

Wemay experience significant changes in our profitability as a result ofvariations in sales, changes in product mix sought by customers, seasonality,price competition for orders and the costs associated with the introduction ofnew products and start-up of new facilities and additional capacity lines.  The markets for our products depend oncontinued demand with the product technological platforms and in the mix weplan for and produce in the information technology, consumer, industrial,aerospace and defense and automotive markets. Changes in the demand mix, needed technologies and these end markets mayadversely affect our ability to match our products, inventory and capacity tomeet customer demand and could adversely affect our operating results andfinancial condition.

 

Inaddition, the semiconductor industry is highly cyclical and the value of ourbusiness may decline during the down portion of these cycles.  We have experienced these conditions in ourbusiness in the recent past and we cannot predict when we may experience suchdownturns in the future.  Futuredownturns in the semiconductor industry, or any failure of the industry torecover fully from its recent downturns could seriously impact our revenues andharm our business, financial condition and results of operations.  Although markets for our semiconductors appearstable, we cannot assure you that they will continue to be stable or that ourmarkets will not experience renewed, possibly more severe and prolonged,downturns in the future.

 

***Consumer and/or corporate spendingfor the end market applications which incorporate our products may be reduceddue to increased oil prices or otherwise.***

 

Ourrevenues and gross margin guidance is dependent on certain level of consumerand/or corporate spending for the specific mix of products we produce and havethe capacity to produce If our projections of these expenditures fail tomaterialize, or materialize in a mix different from that for which weanticipate and build inventory, whether due to reduced consumer or corporatespending from increased oil prices or otherwise, our revenues and gross margincould be adversely impacted.

 

***We maintain backlog of customerorders that is subject to cancellation, reduction or delay in deliveryschedules, which may result in lower than expected revenues.***

 

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Withcertain exceptions related to products within our Aerospace and Defense andNon-Aligned Product segments, we manufacture primarily pursuant to purchaseorders for current delivery or to forecast, rather than pursuant to long-termsupply contracts.  The semiconductorindustry is subject to rapid changes in customer outlooks or unexpected buildups of inventory in the supply channel as a result of shifts in end marketdemand generally or in the mix of that demand. Accordingly, many of these purchase orders or forecasts may be revisedor canceled without penalty.  As aresult, we must commit resources to the manufacturing of products, and aspecific mix of products, without any advance purchase commitments from customers.  Our inability to sell products after wedevote significant resources to build them could have a material adverse effecton our levels of inventory, our revenues and our operating results generally.

 

***We build and maintain inventory inorder to meet our historic and projected needs, but cannot guarantee that ourinventory will be adequate to meet our needs or will be usable at a futuredate.***

 

Atthe end of fiscal quarter ended September 30, 2005, we reported netinventories of approximately $194 million.  We build and maintain inventory in order tomeet our historic and projected needs, but cannot guarantee that the inventorywe build will be adequate or the right mix of products to meet marketdemand.  If we do not project and buildthe proper mix and amount of inventory, our revenues and gross margins may beadversely affected.  Additionally, if weproduce or have produced inventory that does not meet current or future demand,we may determine at some point that certain of the inventory may only be sold ata discount or may not be sold at all, resulting in the reduction in thecarrying value of our inventory and an adverse effect on our financialcondition and operating results.

 

***The semiconductor business is highlycompetitive and increased competition could adversely affect the price of ourproducts and otherwise reduce the value of an investment in our company.***

 

Thesemiconductor industry, including the sectors in which we do business, ishighly competitive.  Competition is basedon price, product performance, technology platform, product availability,quality, reliability and customer service.  Price pressures often emerge as competitorsattempt to gain a greater market share by lowering prices or by offering a moredesirable technological solution. Pricing and other competitive pressures canadversely affect our revenues and gross margin, and hence, ourprofitability.  We also compete invarious markets with companies of various sizes, many of which are larger andhave greater financial and other resources than we have, and thus they may bebetter able to withstand adverse economic or market conditions.  In addition, companies not currently in directcompetition with us may introduce competing products in the future.

 

***Failure to timely complete our expansionplans for our wafer fabrication facility could adversely affect our revenuegrowth and ability to achieve our margin targets.***

 

Weare operating in the mid to high 90s percent of our worldwide semiconductorfabrication and assembly/module manufacturing capacities, without taking intoaccount subcontract or foundry capacity. We are also expanding our most advanced wafer fabrication facility inNewport, Wales to provide additional capacity to support the growth of ourFocus Products. We expect to start production on certain of such new facilitiesby the end of the December 2005 quarter, and expect to complete our expansionof that facility in about calendar year 2006. If we fail to timely execute onthose plans in advance of demand for our products, that failure could adverselyaffect our revenue

 

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growthand ability to achieve our margin targets. We cannot assure you that we will complete our plans timely, that theramp-up of the expanded facilities will occur effectively and without error ordelay, or that sufficient third party sources would be available to satisfy ourability to meet customer demand.  Even ifwe fully execute and implement our plans, we cannot guarantee that we will havesufficient worldwide semiconductor fabrication and assembly/modulemanufacturing capacities to meet demand and there may be unforeseen factorsthat could adversely impact our operating results.

 

***Delays in initiation ofproduction at new facilities, implementing new production techniques orresolving problems associated with technical equipment malfunctions couldadversely affect our manufacturing efficiencies***.

 

Ourmanufacturing efficiency has been and will be an important factor in our futureprofitability, and we may not be able to maintain or increase our manufacturingefficiency.  Our manufacturing andtesting processes are complex, require advanced and costly equipment and arecontinually being modified in our efforts to improve yields and productperformance.  Difficulties in themanufacturing process can lower yields. Technical or other problems could lead to production delays, ordercancellations and lost revenue.  Inaddition, any problems in achieving acceptable yields, construction delays, orother problems in upgrading or expanding existing facilities, building newfacilities, problems in bringing other new manufacturing capacity to fullproduction or changing our process technologies, could also result in capacityconstraints, production delays and a loss of future revenues andcustomers.  Our operating results alsocould be adversely affected by any increase in fixed costs and operatingexpenses related to increases in production capacity if net sales in theappropriate mix do not increase proportionately, or in the event of a declinein demand for some or all of our products.

 

***If we are unable to implement ourbusiness strategy, our revenues and profitability may be adversely affected.***

 

Ourfuture financial performance and success are largely dependent on our abilityto implement our business strategy successfully of transforming our business toone led by our Focus Products and succeeding on our plans to restructure ourcompany.  We cannot assure you that wewill continue to successfully implement our business strategy or thatimplementing our strategy will sustain or improve our results of operations.

 

***The failure to execute on our plansto divest or discontinue product lines that are not consistent with ourbusiness objectives, and replace those revenues with higher-margin productsales could adversely affect our operating results.***

 

Wehave announced the divestiture, discontinuation or change in business model ofcertain of our Non-Focus Products that are not consistent with our businessobjectives or margin targets.  Our planis to replace the divested or discontinued revenues with (or change thebusiness model to achieve) higher-margin product sales and target gross marginof greater 50 percent.  We cannot assureyou that we will complete our plans or achieve our target gross margin.  The activities involved with the divestiture,discontinuation and re-alignment of product sales could involve changes tovarious aspects of our business which could adversely affect our profitabilityto an extent we have not anticipated. Even if we fully execute and implement our plans, there may beunforeseen factors that could adversely impact our operating results.

 

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***The failure to implement andcomplete our restructuring programs and accomplish planned cost reductionscould adversely affect our business.***

 

InDecember 2002, we announced a number of restructuring initiatives.  Our goal was to reposition our company tobetter fit the market conditions, de-emphasize our commodity business andaccelerate the move to what we categorize as our proprietary products, whichrefer to our Power Management ICs, Advanced Circuit Devices, and PowerSegments.  The restructuring includesconsolidating and closing certain manufacturing sites, upgrading equipment andprocesses in designated facilities and discontinuing production in a number ofothers that cannot support more advanced technology platforms or products.  The restructuring also includes loweringoverhead costs across our support organization.  We cannot assure you that these restructuringinitiatives will achieve their goals, accomplish the cost reductions planned,or be accomplished within our expectations as to the amount of charges to betaken in connection with that activity. Additionally, because our restructuring activities involve changes tomany aspects of our business, the activities could adversely affectproductivity and sales to an extent we have not anticipated.  Even if we fully execute and implement theserestructuring activities, and they generate the anticipated cost savings, theremay be other unforeseen factors that could result in the amount of charges tobe taken in connection with our restructuring activities or otherwise adverselyimpact our profitability and business.

 

***Our products may be found to be defective and, as aresult, product claims may be asserted against us, which may harm our businessand our reputation with our customers and significantly adversely affect ourresults and financial condition.***

 

Ourproducts are typically sold at prices that are significantly lower than thecost of the equipment or other goods in which they are incorporated.  Although we maintain rigorous quality controlsystems, we shipped large quantities of semiconductor devices in 2004 to a widerange of customers around the world, in a variety of high profile and criticalapplications.  In the ordinary course ofour business we receive warranty claims for some of these products that aredefective, or that do not perform to published specifications.  Since a defect or failure in our productscould give rise to failures in the end products that incorporate them (andconsequential claims for damages against our customers from their customersdepending on applicable law and contract), we often need to defend againstclaims for damages that are disproportionate to the revenues and profits wereceive from the products involved.  Inaddition, our ability to reduce such liabilities may be limited by the laws orthe customary business practices of the countries where we do business.  Even in cases where we do not believe we havelegal liability for such claims, we may choose to pay for them to retain acustomer’s business or goodwill or to settle claims to avoid protractedlitigation.  Our results of operationsand business would be adversely affected as a result of a significant allegedquality or performance issues in our products, if we are required or choose topay for the damages that result. Although we currently have product liability and other types ofinsurance, we have certain deductibles and exclusions to such policies and maynot have sufficient insurance coverage.  Wealso may not have sufficient resources to satisfy all possible productliability claims.  In addition, anyperception that our products are defective would likely result in reduced salesof our products, loss of customers and harm to our business and reputation.

 

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***While we attempt to monitor the credit worthinessof our customers, we may from time to time be at risk due to the adversefinancial condition of one or more customers.***

 

Wehave established procedures for the review and monitoring of the creditworthiness of our customers and/or significant amounts owing from customers.  However, from time to time, we may find thatdespite our efforts one or more of our customers become insolvent or facebankruptcy proceedings (Delphi, one of our largest OEM customers, is currentlyone such customer). Such events could have an adverse effect on our operatingresults if our receivables applicable to that customer become uncollectible inwhole or in part, or if our customers’ financial situation result in reductionsin whole or in part of our ability to continue to sell our products or servicesto such customers at the same levels or at all.

 

***If some original equipmentmanufacturers (“OEMs”) do not design our products into their equipment, aportion of our revenue may be adversely affected.***

 

A“design win” from a customer does not guarantee future sales to that customer.  We also are unable to guarantee that we willbe able to convert design wins into sales for the life of any particularprogram, or at all, or that the revenues from such wins would be significant.  We also cannot guarantee that we will achievethe same level of design wins as we have in the past, or at all.  Without design wins from OEMs, we would onlybe able to sell our products to these OEMs as a second source, if at all.  Once an OEM designs another supplier’s semiconductorinto one of its product platforms, it is more difficult for us to achievefuture design wins with that OEM’s product platform because changing suppliersinvolves significant cost, time, effort and risk.  Achieving a design win with a customer doesnot ensure that we will receive significant revenue from that customer and wemay be unable to convert design wins into actual sales.

 

***Corporate investment andexpenditures in the Information Technology sector and in Information Technologypurchases may not materialize as we have planned.***

 

Ourrevenues and gross margin guidance is dependent on a certain level of corporateinvestment and expenditures in the Information Technology sector and inInformation Technology purchases.  If ourprojections of these expenditures fail to materialize, whether due to increasedoil prices or otherwise, our revenues and gross margin could be adverselyimpacted.

 

***New technologies could result in thedevelopment of new products and a decrease in demand for our products, and wemay not be able to develop new products to satisfy changes in demand.***

 

Ourfailure to develop new technologies or react to changes in existingtechnologies could materially delay our development of new products, whichcould result in decreased revenues and a loss of market share to ourcompetitors.  Rapidly changingtechnologies and industry standards, along with frequent new productintroductions, characterize the semiconductor industry.  As a result, we must devote significantresources to research and development.  Ourfinancial performance depends on our ability to design, develop, manufacture,assemble, test, market and support new products and enhancements on a timelyand cost-effective basis.  We cannotassure you that we will successfully identify new product opportunities anddevelop and bring new products to market in a timely and

 

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cost-effectivemanner, or that products or technologies developed by others will not renderour products or technologies obsolete or noncompetitive.  A fundamental shift in technologies in ourproduct markets could have a material adverse effect on our competitiveposition within the industry.  Inaddition, to remain competitive, we must continue to reduce die sizes andimprove manufacturing yields.  We cannotassure you that we can accomplish these goals.

 

***Our failure to obtain or maintainthe right to use certain technologies may negatively affect our financialresults.***

 

Ourfuture success and competitive position may depend in part upon our ability toobtain or maintain certain proprietary technologies used in our principalproducts, which is achieved in part by defending and maintaining the validityof our patents and defending claims by our competitors of intellectual propertyinfringement.  We license certain patentsowned by others.  We have also beennotified that certain of our products may infringe the patents of thirdparties.  Although licenses are generallyoffered in such situations, we cannot eliminate the risk of litigation allegingpatent infringement.  We are currently adefendant in intellectual property claims and we could become subject to otherlawsuits in which it is alleged that we have infringed upon the intellectualproperty rights of others.

 

Ourinvolvement in existing and future intellectual property litigation couldresult in significant expense, adversely affect sales of the challenged productor technologies and divert the efforts of our technical and managementpersonnel, whether or not such litigation is resolved in our favor.  If any such infringements exist, arise or areclaimed in the future, we may be exposed to substantial liability for damagesand may need to obtain licenses from the patent owners, discontinue or changeour processes or products or expend significant resources to develop or acquirenon-infringing technologies.  We cannotassure you that we would be successful in such efforts or that such licenseswould be available under reasonable terms.  Our failure to develop or acquirenon-infringing technologies or to obtain licenses on acceptable terms or theoccurrence of related litigation itself could have a material adverse effect onour operating results and financial condition.

 

***Our ongoing protection and relianceon our intellectual property assets expose us to risks and continued levels ofrevenues in our IP segment is subject to our ability to maintain currentlicenses, licensee and market factors not within our control and our ability toobtain new licenses.***

 

Wehave traditionally relied on our patents and proprietary technologies.  Patent litigation settlements and royaltyincome substantially contribute to our financial results.  Enforcement of our intellectual propertyrights is costly, risky and time-consuming.  We cannot assure you that we can successfullycontinue to protect our intellectual property rights, especially in foreignmarkets.  Our key MOSFET patents expirebetween 2005 and 2010, although our broadest MOSFET patents expire in 2007 and2008.

 

Ourroyalty income is largely dependent on the following factors: the remainingterms of our MOSFET patents; the continuing introduction and acceptance ofproducts that are not covered by our patents; remaining covered under unexpiredMOSFET patents; the defensibility and enforceability of our patents; changes inour licensees’ unit sales, prices or die sizes; the terms, if any, upon whichexpiring license agreements are renegotiated; and our ability to obtainrevenues from new licensing opportunities.  Market conditions and

 

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mixof licensee products, as well as sales of non-infringing devices cansignificantly adversely affect royalty income. We also cannot guarantee that we can obtain new licenses to offsetreductions in royalties from existing licenses.  While we try to predict the effects of thesefactors and efforts, often there are variations or factors that cansignificantly affect results different from that predicted.  Accordingly, we cannot guarantee that our predictionsof our IP segment revenues will be consistent with actual results.  We also cannot guaranty that our royaltyincome will continue at levels consistent with prior periods.  Any decrease in our royalty income could havea material adverse effect on our operating results and financial condition.

 

***Our international operations exposeus to material risks.***

 

We expect revenues from foreign markets tocontinue to represent a significant portion of total revenues.  We maintain or contract with significantoperations in foreign countries.  Amongothers, the following risks are inherent in doing business internationally:changes in, or impositions of, legislative or regulatory requirements,including tax laws in the United States and in the countries in which wemanufacture or sell our products; trade restrictions; transportation delays;work stoppages; economic and political instability; and foreign currencyfluctuations.

 

Inaddition, certain of our operations and products are subject to restrictions orlicensing under U.S. export laws.  Ifsuch laws or the implementation of these restrictions change, or if in thecourse of operating under such laws we become subject to claims, we cannotassure you that such factors would not have a material adverse effect on ourfinancial condition and operating results.

 

Inaddition, it is more difficult in some foreign countries to protect ourproducts or intellectual property rights to the same extent as is possible inthe United States.  Therefore, the riskof piracy or misuse of our technology and products may be greater in theseforeign countries.  Although we have notexperienced any material adverse effect on our operating results as a result ofthese and other factors, we cannot assure you that such factors will not have amaterial adverse effect on our financial condition and operating results in thefuture.

 

***Delays in initiation of productionat new facilities, implementing new production techniques or resolving problemsassociated with technical equipment malfunctions could adversely affect ourmanufacturing efficiencies.***

 

Ourmanufacturing efficiency will be an important factor in our futureprofitability, and we cannot assure you that we will be able to maintain orincrease our manufacturing efficiency to the same extent as our competitors.  Our manufacturing processes are highlycomplex, require advanced and costly equipment and are continuously beingmodified in an effort to improve yields and product performance.  Impurities, defects or other difficulties inthe manufacturing process can lower yields.

 

Inaddition, as is common in the semiconductor industry, we have from time to timeexperienced difficulty in beginning production at new facilities or ineffecting transitions to new manufacturing processes.  As a consequence, we have experienced delaysin product deliveries and reduced yields.  We may experience manufacturing problems inachieving acceptable yields or experience product delivery delays in the futureas a result of, among other things, capacity constraints, construction delays,upgrading or expanding

 

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existingfacilities or changing our process technologies, any of which could result in aloss of future revenues.  Our operatingresults could also be adversely affected by the increase in fixed costs andoperating expenses related to increases in production capacity if revenues donot increase proportionately.

 

Weare transferring manufacturing from our Krefeld, Germany to our Swansea, Walesand Tijuana, Mexico facilities.  We areramping up our Newport, Wales facility, and anticipate to transfer our ElSegundo manufacturing to the Newport, Wales facility by fiscal year end June 2006or sooner.  We have experienced somedelays and/or technical problems in moving our various facilities.  Continued delays and/or technical problems incompleting the remaining transfers could lead to increased costs, reducedyields, delays in product deliveries, order cancellations and/or lost revenue.

 

***Interruptions, delays or costincreases affecting our materials, parts or equipment may impair ourcompetitive position and our operations.***

 

Ourmanufacturing operations depend upon obtaining adequate supplies of materials,parts and equipment, including silicon, mold compounds and leadframes, on atimely basis from third parties.  Ourresults of operations could be adversely affected if we were unable to obtainadequate supplies of materials, parts and equipment in a timely manner from ourthird party suppliers or if the costs of materials, parts or equipment increasesignificantly.  From time to time,suppliers may extend lead times, limit supplies or increase prices due tocapacity constraints or other factors.  Wehave a limited number of suppliers for some materials, parts and equipment, andany interruption could materially impair our operations.

 

Wemanufacture a substantial portion of our wafer product at our Temecula,California and Newport, Wales facilities.  Any disruption of operations at thosefacilities could have a material adverse effect on our business, financialcondition and results of operations.

 

Also,some of our products are assembled and tested by third party subcontractors.  We do not have any long-term assemblyagreements with these subcontractors.  Asa result, we do not have immediate control over our product delivery schedulesor product quality.  Due to the amount oftime often required to qualify assemblers and testers and the high cost ofqualifying multiple parties for the same products, we could experience delaysin the shipment of our products if we are forced to find alternative thirdparties to assemble or test them.  Anyproduct delivery delays in the future could have a material adverse effect onour operating results and financial condition.  Our operations and ability to satisfy customerobligations could be adversely affected if our relationships with thesesubcontractors were disrupted or terminated.

 

***We must commit resources to productmanufacturing prior to receipt of purchase commitments and could lose some orall of the associated investment.***

 

Wesell products primarily pursuant to purchase orders for current delivery or toforecast, rather than pursuant to long-term supply contracts.  Many of these purchase orders or forecasts maybe revised or canceled without penalty.  Asa result, we must commit resources to the manufacturing of products without anyadvance purchase commitments from customers.  Our inability to sell products after we devotesignificant resources to them could have a material adverse effect on ourlevels of inventory and our business, financial condition and results ofoperations.

 

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***We receive a significant portion ofour revenues from a small number of customers and distributors.***

 

Historically,a significant portion of our revenues has come from a relatively small numberof customers and distributors.  The lossor financial failure of any significant customer or distributor, any reductionin orders by any of our significant customers or distributors, or thecancellation of a significant order, could materially and adversely affect ourbusiness.

 

***We may fail to attract or retain thequalified technical, sales, marketing and managerial personnel required tooperate our business successfully.***

 

Ourfuture success depends, in part, upon our ability to attract and retain highlyqualified technical, sales, marketing and managerial personnel.  Personnel with the necessary semiconductorexpertise are scarce and competition for personnel with these skills isintense.  We cannot assure you that wewill be able to retain existing key technical, sales, marketing and managerialemployees or that we will be successful in attracting, assimilating orretaining other highly qualified technical, sales, marketing and managerialpersonnel in the future.  If we areunable to retain existing key employees or are unsuccessful in attracting newhighly qualified employees, our business, financial condition and results ofoperations could be materially and adversely affected.

 

***We are acquiring and may continue toacquire other companies and may be unable to successfully integrate suchcompanies with our operations.***

 

Wehave acquired several companies over the past three years.  We may continue to expand and diversify ouroperations with additional acquisitions.  If we are unsuccessful in integrating thesecompanies with our operations, or if integration is more difficult thananticipated, we may experience disruptions that could have a material adverse effecton our business, financial condition and results of operations.

 

***The price of our common stock hasfluctuated widely in the past and may fluctuate widely in the future.***

 

Ourcommon stock, which is traded on The New York Stock Exchange, has experiencedand may continue to experience significant price and volume fluctuations thatcould adversely affect the market price of our common stock without regard toour operating performance.  In addition,we believe that factors such as quarterly fluctuations in financial results,earnings below analysts’ estimates and financial performance and otheractivities of other publicly traded companies in the semiconductor industrycould cause the price of our common stock to fluctuate substantially.  In addition, in recent periods, our commonstock, the stock market in general and the market for shares of semiconductorindustry-related stocks in particular have experienced extreme pricefluctuations which have often been unrelated to the operating performance ofthe affected companies.  Any similarfluctuations in the future could adversely affect the market price of ourcommon stock.

 

***Our investments in certainsecurities expose us to market risks.***

 

Weinvest excess cash in marketable securities consisting primarily of commercialpaper, corporate notes, corporate bonds and governmental securities.  We also hold as strategic investments thecommon stock of two publicly-traded Japanese companies, one of

 

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whichis Nihon Inter Electronics Corporation. The value of these investments is subject to market fluctuations, whichif adverse, could have a material adverse effect on our operating results andfinancial condition.

 

***If we fail to maintain an effectivesystem of internal controls or discover material weaknesses in our internalcontrols over financial reporting, we may not be able to report our financialresults accurately or detect fraud, which could harm our business and thetrading price of our stock.***

 

Effectiveinternal controls are necessary for us to produce reliable financial reportsand are important in our effort to prevent financial fraud.  We are required to periodically evaluate theeffectiveness of the design and operation of our internal controls.  These evaluations may result in the conclusionthat enhancements, modifications or changes to our internal controls arenecessary or desirable.  While managementevaluates the effectiveness of our internal controls on a regular basis, wecannot provide absolute assurance that these controls will always be effective. There are inherent limitations on theeffectiveness of internal controls including collusion, management override,and failure of human judgment.  Becauseof this, control procedures are designed to reduce rather than eliminatebusiness risks.  If we fail to maintainan effective system of internal controls or if management or our independentregistered public accounting firm were to discover material weaknesses in ourinternal controls, we may be unable to produce reliable financial reports orprevent fraud and it could harm our financial condition and results ofoperations and result in loss of investor confidence and a decline in our stockprice.

 

***Large potential environmentalliabilities, including those relating to a former operating subsidiary, mayadversely impact our financial position.***

 

Federal,state, foreign and local laws and regulations impose various restrictions andcontrols on the discharge of materials, chemicals and gases used in our semiconductormanufacturing processes.  In addition,under some laws and regulations, we could be held financially responsible forremedial measures if our properties are contaminated or if we send waste to alandfill or recycling facility that becomes contaminated, even if we did notcause the contamination.  Also, we may besubject to common law claims if we release substances that damage or harm thirdparties.  Further, we cannot assure youthat changes in environmental laws or regulations will not require additionalinvestments in capital equipment or the implementation of additional complianceprograms in the future.  Any failure tocomply with environmental laws or regulations could subject us to serious

 

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liabilitiesand could have a material adverse effect on our operating results and financialcondition.

 

***Some of our facilities are locatednear major earthquake fault lines.***

 

Ourcorporate headquarters, one of our manufacturing facilities, one of our researchfacility and certain other critical business operations are located near majorearthquake fault lines.  We could bematerially and adversely affected in the event of a major earthquake.  Although we maintain earthquake insurance, wecan give you no assurance that we have obtained or will maintain sufficientinsurance coverage.

 

***There can be no assurance that wewill have sufficient capital resources to make necessary investments inmanufacturing technology and equipment.***

 

Thesemiconductor industry is capital intensive.  Semiconductor manufacturing requires aconstant upgrading of process technology to remain competitive, as new andenhanced semiconductor processes are developed which permit smaller, moreefficient and more powerful semiconductor devices.  We maintain certain of our own manufacturing,assembly and test facilities, which have required and will continue to requiresignificant investments in manufacturing technology and equipment.  We are also attempting to add the appropriatelevel and mix of capacity to meet our customers’ future demand.  There can be no assurance that we will havesufficient capital resources to make necessary investments in manufacturingtechnology and equipment.  Although webelieve that anticipated cash flows from operations, existing cash reserves andother equity or debt financings that we may obtain will be sufficient tosatisfy our future capital expenditure requirements, there can be no assurancethat this will be the case or that alternative sources of capital will beavailable to us on favorable terms or at all.

 

***Unforeseen changes in marketconditions, tax laws and other factors could impact our judgment about therealizability of our deferred tax assets.***

 

Wehave made certain judgments regarding the realizability of our deferred taxassets.  In accordance with SFAS No. 109,“Accounting for Income Taxes”, the carrying value of the net deferred taxassets is based on the belief that it is more likely than not that we willgenerate sufficient future taxable income in certain jurisdictions to realizethese deferred tax assets, after considering all available positive andnegative evidence.  If our assumptionsand estimates change in the future given unforeseen changes in market conditions,tax laws or other factors, then the valuation allowances established may beincreased, resulting in increased income tax expense.  Conversely, if we are ultimately able to useall or a portion of the deferred tax assets for which a valuation allowance hasbeen established, then the related portion of the valuation allowance will bereleased to income as a credit to income tax expense.

 

***Final outcomes from the various taxauthorities’ audits are difficult to predict and an unfavorable finding maynegatively impact our financial results.***

 

Asis common with corporations of our size, we are from time to time under auditby various taxing authorities.  It isoften difficult to predict the final outcome or the timing of resolution of anyparticular tax matter.  We have providedcertain tax reserves which have been included in the determination of ourfinancial results.  However, unpredicted

 

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unfavorablesettlements may require additional use of cash and negatively impact ourfinancial position or results of operations.

 

***Terrorist attacks, such as thosethat took place on September 11, 2001, or threats or occurrences of otherterrorist activities whether in the United States or internationally may affectthe markets in which our common stock trades, the markets in which we operateand our profitability.***

 

Terroristattacks, such as those that took place on September 11, 2001, or threatsor occurrences of other terrorist or related activities, whether in the UnitedStates or internationally, may affect the markets in which our common stocktrades, the markets in which we operate and our profitability.  Future terrorist or related activities couldaffect our domestic and international sales, disrupt our supply chains andimpair our ability to produce and deliver our products.  Such activities could affect our physicalfacilities or those of our suppliers or customers, and make transportation ofour supplies and products more difficult or cost prohibitive.  Due to the broad and uncertain effects that terroristattacks have had on financial and economic markets generally, we cannot provideany estimate of how these activities might affect our future results.

 

***Natural disasters, like thoserelated to Hurricanes Katrina and Wilma, or occurrences of other naturaldisasters whether in the United States or internationally may affect themarkets in which our common stock trades, the markets in which we operate andour profitability.***

 

Naturaldisasters, like those related to Hurricanes Katrina and Wilma, or threats oroccurrences of other similar events, whether in The United States orinternationally, may affect the markets in which our common stock trades, themarkets in which we operate and our profitability.  Such events could affect our domestic andinternational sales, disrupt our supply chains, and impair our ability toproduce and deliver our products.  Whilewe do not have facilities located near the affected areas, such activitiescould affect physical facilities, primarily for raw materials and processchemicals and gases of our suppliers or customers, and make transportation ofour supplies and products more difficult or cost prohibitive.  Due to the broad and uncertain effects thatnatural events have had on financial and economic markets generally, we cannotprovide any estimate of how these activities might affect our future results.

 

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**ITEM 3.****                                         Quantitativeand Qualitative Disclosures about Market Risk**

 

We are exposed to variousrisks, including fluctuations in interest and foreign currency rates.  In the normal course of business, we also facerisks that are either non-financial or non-quantifiable.  Such risks principally include country risk,credit risk and legal risk and are not discussed or quantified in the followinganalyses, as well as risks set forth under the heading “Factors that May AffectFuture Results” in this Quarterly Report on Form 10-Q and in our Annual Reporton Form 10-K for the fiscal year ended June 30, 2005.

 

*InterestRate Risk*

 

Our financial assets andliabilities subject to interest rate risk are cash investments, convertibledebt, credit facilities and interest rate swaps.  Our primary objective is to preserveprincipal while maximizing yield without significantly increasing risk.  At September 30, 2005, we evaluated theeffect that near-term changes in interest rates would have had on thesetransactions.  A change of as much as tenpercent in the London InterBank Offered Rate (“LIBOR”) would have had a favorableimpact of approximately $0.4 million on net interest income/expense for thecurrent quarter since the interest income on our cash and cash investmentswould have outweighed additional interest expense on our outstanding debt. For our interest rate contract with Lehman Brothers, an increase of tenpercent in interest rates would have had a favorable impact of $0.3 million,and a decrease of ten percent in interest rates would have had an adverseimpact of ($0.1) million, on net interest income/expense.  These changes would not have had a materialimpact on our results of operations, financial position or cash flows.

 

In December 2001,we entered into an interest rate swap transaction (the “Transaction”) with JPMorgan Chase Bank (the “Bank”), to modify our effective interest payable withrespect to $412.5 million of our $550 million outstanding convertible debt (the“Debt”) (see Notes 4, “Derivative Financial Instruments,” and 8, “Bank Loansand Long-Term Debt”).  At the inceptionof the Transaction, interest rates were lower than that of the Debt and webelieved that interest rates would remain lower for an extended period oftime.  In April 2005, we enteredinto an interest rate swap transaction (the “April 2005 Transaction”) withthe Bank to modify the effective interest payable with respect to the remaining$137.5 million of the Debt.  The variableinterest rate we have paid since the inception of the swap has averaged 2.36 percent,compared to a coupon of 4.25 percent on the Debt.  During the three months ended September 30,2005 and 2004, this arrangement reduced interest expense by $0.9 million and $2.2million, respectively.

 

Accounted for as fairvalue hedges under SFAS No. 133, the mark-to-market adjustments of the twoTransactions were offset by the mark-to-market adjustments on the Debt,resulting in no material impact to earnings. To measure the effectiveness of the hedge relationship, we used aregression analysis.  To evaluate the relationshipof the fair value of the two transactions and the changes in fair value of theDebt attributable to changes in the benchmark rate, we discounted the estimatedcash flows by the LIBOR swap rate that corresponds to the Debt’s expectedmaturity date.  In addition, our abilityto call the Debt was considered in assessing the effectiveness of the hedgingrelationship.  For those years that wereprojected to include at least a portion of redemption of the convertibledebentures, we employed a valuation model known as a Monte Carlo simulation.  This simulation allowed us to projectprobability-weighted

 

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contractual cash flowsdiscounted at the LIBOR swap rate that corresponded to the Debt’s expectedmaturity date.  The market value of the December 2001Transaction was a liability of $3.9 million and $0.3 million at September 30,2005 and June 30, 2005, respectively. The market value of the April 2005 Transaction was a liability of $3.8million and $3.4 million at September 30, 2005 and June 30, 2005,respectively.

 

In April 2002, weentered into an interest rate contract (the “Contract”) with an investmentbank, Lehman Brothers (“Lehman”), to reduce the variable interest rate risk ofthe Transaction.  The notional amount ofthe Contract is $412.0 million, representing approximately 75 percent of theDebt. Under the terms of the Contract, we have the option to receive a payoutfrom Lehman covering our exposure to LIBOR fluctuations between 5.5 percent and7.5 percent for any four designated quarters. The market value of the Contract at September 30, 2005 and June 30,2005, respectively, was $0.2 million and $0.1 million, respectively, and wasincluded in other long-term assets.  Mark-to-marketgains (losses) of $0.1 million and ($0.3) million for the three months ended September 30,2005 and 2004, respectively, were charged to interest expense.

 

*ForeignCurrency Risk*

 

We conduct business on aglobal basis in several foreign currencies, and at various times, we havecurrency exposure related to the British Pound Sterling, the Euro and theJapanese Yen.  Our risk to the Europeancurrencies is partially offset by the natural hedge of manufacturing andselling goods in both U.S. dollars and the European currencies.  Considering our specific foreign currencyexposures, we have the greatest exposure to the Japanese Yen, since we have significantyen-based revenues without the yen-based manufacturing costs.  We have established a foreign-currencyhedging program using foreign exchange forward contracts, including the ForwardContract described below, to hedge certain foreign currency transactionexposures.  To protect against reductionsin value and volatility of future cash flows caused by changes in currencyexchange rates, we have established revenue, expense and balance sheet hedgingprograms.  Currency forward contracts andlocal Yen and Euro borrowings are used in these hedging programs.  Our hedging programs reduce, but do notalways eliminate, the impact of currency exchange rate movements.  We considered an adverse near-term change in exchangerates of ten percent for the British Pound Sterling, the Euro and the JapaneseYen.  Such a change, after taking intoaccount our derivative financial instruments and offsetting positions, wouldhave resulted in an annualized adverse impact on income before taxes of lessthan $1 million for the three months ended September 30, 2005 and 2004.

 

In March 2001, weentered into a five-year foreign exchange forward contract (the “ForwardContract”) for the purpose of reducing the effect of exchange rate fluctuationson forecasted intercompany purchases by our subsidiary in Japan.  We have designated the Forward Contract as acash flow hedge under which mark-to-market adjustments are recorded inaccumulated other comprehensive income of stockholders’ equity, until theforecasted transactions are recorded in earnings.  Under the terms of the Forward Contract, weare required to exchange 1.2 billion Yen for $11.0 million on a quarterly basisfrom June 2001 to March 2006.  AtSeptember 30, 2005, two quarterly payments of 1.2 billion Yen remained tobe swapped at a forward exchange rate of 109.32 Yen per U.S. dollar.  The market value of the forward contract was$0.5 million and $0.1 million at September 30, 2005 and June 30,2005, respectively, and was included in other long-term assets.  Mark-to-market gains (losses), included inother

 

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comprehensive income,net of tax, were $0.3 million and $0.8 million for the three months ended September 30,2005 and 2004, respectively.  At September 30,2005, based on effectiveness tests comparing forecasted transactions throughthe Forward Contract expiration date to its cash flow requirements, we do notexpect to incur a material charge to income during the next six months throughits maturity.

 

We had approximately $111.7million and $75.9 million in notional amounts of forward contracts notdesignated as accounting hedges under SFAS No. 133 at September 30, 2005and June 30, 2005, respectively.  Net realized and unrealized foreign-currencygains recognized in earnings were less than $1 million for the three months endedSeptember 30, 2005 and 2004.

 

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**ITEM 4.****                                         CONTROLSAND PROCEDURES**

 

(a)          Evaluationof disclosure controls and procedures

 

The term “disclosure controls and procedures” refersto the controls and other procedures of a company that are designed to ensurethat information required to be disclosed by the company in the reports that itfiles under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded,processed, summarized and reported, within required time periods.  Our management, with the participation of ourChief Executive Officer, Alexander Lidow, and Chief Financial Officer, MichaelP. McGee, carried out an evaluation of the effectiveness of our disclosurecontrols and procedures pursuant to Exchange Act Rule 13a-15(b).  Based on that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of the end of the periodcovered by this report, such controls and procedures are effective at thereasonable assurance level in making known to them material information relatedto us (including our consolidated subsidiaries) required to be included in thisreport.

 

Disclosure controls and procedures, no matter howwell designed and implemented, can provide only reasonable assurance ofachieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitationsinherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can befaulty and that breakdowns in internal control can occur because of humanfailures such as simple errors, mistakes or intentional circumvention of theestablished processes.

 

(b)         Changes in internal controls

 

There was no change in our internal controls duringthe fiscal first quarter 2006 that has materially affected, or are reasonablylikely to materially affect, our internal controls over financial reporting.

 

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**PART II.****                                    OTHERINFORMATION**

 

**ITEM 2.****                                         UnregisteredSales of Equity Securities and Use of Proceeds**

 

On November 1,2005, our Board of Directors authorized a stock repurchase program, under whichup to $100 million of our common shares may be repurchased without priornotice, through block trades or otherwise. We intend that any shares repurchased will be held as treasury sharesthat may be used for general corporate purposes.  The following lists the number of the sharespurchased under the repurchase program and, as of each month, the number ofshares that may yet be repurchased under announced plans (in thousands):

 
| **Period**                                                | ** ** | **(a) Total Number  of Shares (or  Units) Purchased** | ** ** | **(b) Average Price  Paid per Share (or  Unit)** | ** ** | **(c) Total Number  of Shares (or  Unites) Purchased  as part of Publicly  Announced Plans  or Programs** | ** ** | **(d) Maximum  Number (or  Approximate  Dollar Value) of  Shares (or Units)  that can be  Purchased Under  the Plans or  Programs** | ** **  |
|-----------------------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|-------------|
|                                                      |       |                                                       |       |                                                  |       |                                                                                                           |       |                                                                                                                                     |        |
| Month #1 (November 1 to November 11, 2005) |       | 0                                                          |       | 0                                                     |       | 0                                                                                                              |       | $                                                                                                                                        | 100 million |   |
|                                                           |            |                                                            |            |                                                       |            |                                                                                                                |            |                                                                                                                                          |             |  |

 

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**ITEM6.****                                     Exhibits**

 

Index:

 

3.1                                 Certificate ofIncorporation, as amended to date (incorporated by reference to Exhibit 3.1to the Company’s Registration Statement on Form S-8 filed with theCommission on July 19, 2005; Registration No. 333-117489)

 

3.2                                 Bylaws, as Amended

 

11.1                           StatementRegarding Computation of Per Share Earnings (incorporated by reference to Note2, “Net Income Per Common Share”, of the Notes to Unaudited ConsolidatedFinancial Statements contained herein)

 

31.1                           CertificationPursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934,Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2                           CertificationPursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934,Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1                           CertificationPursuant to 18 U.S.C. 1350, Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

32.2                           CertificationPursuant to 18 U.S.C. 1350, Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 

**INTERNATIONAL RECTIFIER CORPORATION**

**Registrant**

 

 
| November 11,  2005 | /s/ Michael P.  McGee                        |   |
|-------------------------|----------------------------------------------|--------|
|                    | Michael P. McGee                             |
|                    | Executive Vice  President,                   |
|                    | Chief Financial  Officer                     |
|                    | (Duly authorized  officer and                |
|                    | principal  financial and accounting officer) |

 

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